Cummins Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter ended July 1, 2012; the quarter contained 13 weeks. The six-month period contained 26 weeks, compared with 25 weeks in the prior-year period. Financial amounts are in millions of dollars except per-share data.
Business context and results
Cummins designs, manufactures, distributes and services engines, engine-related components and power-generation products worldwide. Its reportable segments are Engine, Components, Power Generation and Distribution. North American on-highway demand was strong in the first half, while demand weakened in some emerging-market and industrial markets, notably construction in China and medium-duty trucks in Brazil.
| Metric | Three months ended July 1, 2012 | Year-over-year change | Six months ended July 1, 2012 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $4,452 | Down 4% | $8,924 | Up 5% |
| Gross margin | $1,210; 27.2% of sales | Margin up 1.3 percentage points | $2,408; 27.0% of sales | Margin up 1.6 percentage points |
| Operating income | $648 | Down 16% | $1,296 | Essentially flat |
| Net income attributable to Cummins | $469 | Down 7% | $924 | Up 9% |
| Diluted EPS | $2.47 | Down from $2.60 | $4.85 | Up from $4.34 |
| Operating cash flow | Not separately presented | $397 | Down from $744 |
Financial position, cash flow and capital allocation
- At July 1, cash and cash equivalents were $1,145 and marketable securities were $261, for combined balances of $1,406, down from $1,761 at year-end 2011. Working capital was $3,676; the current ratio was 2.03.
- Total debt on the balance sheet was $794, compared with $783 at December 31, 2011. Debt was 11.0% of total capital, versus 11.8% at year-end. The filing reports debt fair value of $951.
- Six-month operating cash flow of $397 was pressured by a $714 net working-capital cash outflow, including a $439 inventory increase. Cash used in investing was $350, including $266 of capital expenditures; cash used in financing was $386.
- Cummins repurchased $196 of shares and paid $152 in dividends during the first half. In July, the board raised the quarterly dividend 25%, from $0.40 to $0.50 per share, effective in Q3. The $1 billion repurchase authorization had $286 remaining at July 1.
- Liquidity sources included $1.2 billion available under the revolving credit facility, $282 of international and other domestic credit facilities, and $228 available under the receivables program. Management described liquidity and financial condition as strong.
Changes versus the prior comparable period
- Q2 sales and net income declined, reflecting lower volumes in international construction and medium-duty truck markets, higher SG&A and research and development costs, and lower investee income. The comparison was also affected by the $68 pretax gain on the 2011 exhaust-business sale; Q2 2012 included only a $6 gain from final sale adjustments.
- Despite lower Q2 sales, gross margin percentage improved, supported by product mix, pricing, lower material and warranty costs, and productivity actions.
- First-half sales, net income and diluted EPS rose. Higher North American on-highway volumes and improved gross margins, together with a lower effective tax rate, offset higher operating expenses and the prior-year divestiture gain.
- First-half operating cash flow fell by $347 year over year, mainly due to working-capital movements and lower deferred tax benefits. The periods differed in length by one week.
- Segment trends were mixed: first-half Engine and Components EBIT rose 13% and 15%, respectively; Power Generation EBIT fell 12% and Distribution EBIT fell 5%. In Q2, EBIT declined in Components, Power Generation and Distribution, while Engine EBIT was approximately flat.
Outlook, management commentary and risks
- Management gave no specific full-year sales or earnings forecast in the provided filing text. It expected the year’s effective tax rate to be approximately 26%, absent discrete items, and planned 2012 capital expenditures of $750–$800. Pension contributions were expected to total approximately $130 for 2012.
- Near-term challenges identified included Brazilian economic weakness and post-emissions-regulation pre-buy effects, lower industrial demand in China, currency and inflation pressures in India, continued uncertainty in Europe, and potential further declines in North American oil and gas markets. Management also cited continued investment in product development.
- Management’s longer-term opportunities included tighter global emissions standards, emerging-market infrastructure needs, energy availability and cost issues, and industry globalization.
- After quarter-end, Cummins completed the Hilite doser-technology acquisition on July 18 for approximately $176, funded primarily with cash; the filing expected it to be included in Components results in Q3. It also acquired an additional 45% interest in Cummins Central Power for approximately $17, expected to be included in Distribution results in Q3. Management estimated combined cash investment for acquisitions through Q3 at approximately $205.
- Warranty liability was $1,062 at period-end. The company disclosed ordinary-course litigation and environmental claims, including potential responsibility at waste sites, while stating it did not believe lawsuits were material individually or in aggregate. Other exposures included $31 maximum potential loss under specified guarantees, $33 of potential supplier penalties if purchases stopped, a $73 annual take-or-pay supply commitment through 2018, and $73 of performance-related guarantees. Cummins stated it did not anticipate supplier penalties.
- Key risks include cyclical market demand, emissions regulation changes, new-product execution, currency and commodity volatility, supplier risks, litigation, and pension-asset performance. Management cautioned that actual results may differ from forward-looking statements.
Most important facts for investors to verify
- Whether working capital—particularly inventory, which rose to $2,581—and operating cash conversion improved after the first-half cash-flow decline.
- Whether North American on-highway strength can offset weakness in China, Brazil, Europe and oil and gas markets, and whether the outlook’s market assumptions hold.
- Whether margin gains persist as volumes, product mix, foreign exchange, material costs and warranty costs change.
- Whether higher SG&A and R&D spending translates into product launches and growth, and whether the Hilite and Cummins Central Power acquisitions deliver expected benefits.
- How pension funding, warranty estimates, legal and environmental contingencies, and the disclosed supplier commitments affect future cash needs.