Cummins Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended April 1, 2018, compared with the three months ended April 2, 2017. Unaudited consolidated results; balance-sheet comparisons are with December 31, 2017. Cummins designs, manufactures, distributes and services engines, components, power systems and electrified power products worldwide.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $5.570 billion | $4.589 billion |
| Gross margin | $1.200 billion; 21.5% of sales | $1.132 billion; 24.7% |
| Operating income | $530 million | $540 million |
| Net income attributable to Cummins | $325 million | $396 million |
| Diluted EPS | $1.96 | $2.36 |
| Cash from operations | $(117) million | $379 million |
- Sales increased 21%; reported net income fell 18% and diluted EPS fell 17%. Operating margin was approximately 9.5%, versus 11.8% in the prior-year quarter.
- Growth was broad-based: segment sales rose 21% at Engine, 13% at Distribution, 30% at Components and 22% at Power Systems. Power Systems EBITDA rose 67%; Distribution EBITDA declined 5%. Electrified Power, newly reported in 2018, had $2 million of sales and a $10 million EBITDA loss.
- Cash and marketable securities totaled $1.387 billion at quarter-end, down from $1.567 billion at year-end. Total debt was $2.277 billion, versus $2.006 billion; debt to total capital was 21.5%, versus 19.7%.
- Current assets were $9.201 billion and current liabilities $5.832 billion; working capital was $3.369 billion and the current ratio 1.58. Inventory increased to $3.411 billion from $3.166 billion.
- Capital expenditures were $87 million, including internal-use software, versus $108 million. The company paid $178 million in dividends and repurchased $163 million of shares; declared dividends were $1.08 per share.
Material changes and drivers
- Higher volumes, improved pricing and lower material costs increased gross-margin dollars, but the gross-margin rate declined 3.2 percentage points, principally because of emissions-campaign costs and higher compensation expense.
- A $187 million first-quarter charge was recorded for expanded field campaigns involving certain 2010–2015 engine systems with aftertreatment-component degradation. The filing says further costs could range from zero to approximately $400 million above the quarter-end accrual, depending on repair needs and regulatory acceptance of proposed solutions. Cummins did not then expect EPA or CARB fines or penalties.
- Q1 cash from operations was $496 million lower year over year. Management attributed the change primarily to higher working-capital needs and lower earnings; working capital used $446 million of cash, including payment of higher accrued variable compensation.
- Income tax expense included $78 million of unfavorable discrete items, or $0.47 per share, primarily related to Tax Cuts and Jobs Act adjustments. The quarterly effective tax rate was 37.9%, versus 26.1%.
- The 2017 acquisition of the automated-transmission business contributed to Components sales growth. Foreign exchange also supported sales; management cited a 2% favorable impact on total sales.
Outlook, liquidity and risks
- Management expected 2018 effective tax rate to be approximately 23%, excluding discrete items, and planned $730–$760 million of 2018 capital expenditures.
- Management expected North American medium- and heavy-duty truck and pickup demand to remain strong, with possible improvement in mining, construction and power generation. China truck demand was expected to decline and marine markets to remain weak.
- Management described liquidity and financial condition as strong. Cummins had $1.387 billion in cash and marketable securities and $2.157 billion of available revolving-credit capacity after commercial paper borrowings. Its committed facilities totaled $2.75 billion; the $1.0 billion 364-day facility was due to expire in September 2018.
- Commercial paper outstanding was $593 million. Long-term debt was $1.571 billion; required principal payments were $8–$51 million annually over the next five years.
- Other disclosed exposures include ordinary-course litigation and environmental claims, Brazilian tax and labor disputes, supplier minimum-purchase commitments and guarantees. Management said pending litigation was not believed material individually or in aggregate, but noted outcomes could adversely affect results or cash flows.
- Forward-looking risks include market downturns, emissions regulation and product issues, customer and supplier risks, commodity and currency volatility, trade policy, competition, technology shifts, litigation and pension assumptions.
Most important facts for investors to verify
- Progress, regulatory acceptance and actual cost of the emissions-related field campaigns, including whether exposure approaches the stated additional $400 million.
- Whether sales growth converts into stronger margins and earnings after campaign costs, elevated R&D and SG&A, and tax adjustments.
- Working-capital trends and operating cash generation, particularly receivables, inventory and accrued compensation movements.
- Demand developments in North American trucks, China trucks, mining, construction, power generation and marine markets.
- Renewal or replacement of the $1.0 billion revolving facility expiring in September 2018, and changes in short-term borrowing and leverage.
- Finalization of provisional Tax Act accounting during the measurement period ending December 22, 2018; the filing cautions that adjustments could differ, possibly materially, from estimates.