Cummins Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended July 1, 2018; comparative periods ended July 2, 2017. Amounts are in millions except per-share data.
Business context
Cummins designs, manufactures, distributes and services engines, components, power-generation products and electrified power systems. Its reportable segments are Engine, Distribution, Components, Power Systems and Electrified Power. The company attributed broad-based sales growth to stronger truck, construction, mining, oil and gas, and power-generation demand, as well as the inclusion of its automated-transmission business acquired in 2017.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $6,132 | $5,078 | $11,702 | $9,667 |
| Gross margin | $1,440 | $1,251 | $2,640 | $2,383 |
| Gross margin as % of sales | 23.5% | 24.6% | 22.6% | 24.7% |
| Operating income | $722 | $586 | $1,252 | $1,126 |
| Net income attributable to Cummins | $545 | $424 | $870 | $820 |
| Diluted EPS | $3.32 | $2.53 | $5.27 | $4.88 |
| Operating cash flow | Not presented separately for the quarter | $473 | $826 |
Quarterly sales increased 21%, attributable net income increased 29%, and diluted EPS increased 31% year over year. First-half sales rose 21%, while attributable net income rose 6% and diluted EPS rose 8%. Higher volume, pricing and lower material costs supported gross profit, but emissions-campaign charges reduced gross margin as a percentage of sales. Segment EBITDA was $897 in Q2, up from $764, and $1,597 for the first half, up from $1,469.
Liquidity, debt and capital allocation
- At July 1, cash and cash equivalents were $1,318; marketable securities were $214, for combined liquidity of $1,532.
- Total debt was $2,462, versus $2,006 at year-end 2017; debt to total capital increased to 23.1% from 19.7%, primarily reflecting commercial paper issuance. Commercial paper outstanding was $802.
- Working capital was $3,731 and the current ratio was 1.61. Receivables were $4,095 and inventories were $3,559.
- First-half operating cash flow fell $353 to $473. Management cited higher working-capital needs, including a $536 working-capital cash outflow, partially offset by lower pension contributions and higher earnings. Capital expenditures and internal-use software investment totaled $221; the company planned 2018 capital expenditures of $730–$760.
- Cummins had $1.95 billion of available capacity under committed revolving facilities after commercial paper borrowings. One $1.0 billion facility was due to expire September 14, 2018; management intended to renew or replace facilities to maintain similar aggregate capacity.
- First-half dividends paid were $355 and share repurchases were $379. In July, the board raised the quarterly dividend 5.6%, from $1.08 to $1.14 per share.
Material changes and unusual items
- In Q2, Cummins recorded an additional $181 charge for an emissions-related Engine System Campaign; first-half 2018 campaign charges totaled $368. The total campaign accrual was $404, including prior-year amounts. The company reached an agreement with U.S. and California regulators on the affected engine population and repair plans; campaigns were expected to begin in Q3 2018 and be substantially completed by December 31, 2020.
- First-half results included $74 of unfavorable net discrete tax items, including items related to the 2017 Tax Cuts and Jobs Act. The first-half effective tax rate was 29.0%, versus 26.2% in the prior-year period; Q2’s rate was 22.5%, versus 26.4%.
- Revenue-standard adoption increased opening retained earnings by $28, net of tax; management said the impact on individual first-half financial-statement line items was not material.
- Foreign-currency translation reduced other comprehensive income by $299 in Q2 and $215 in the first half, versus gains in the comparable 2017 periods.
- Electrified Power, formed in 2018, reported a $21 Q2 EBITDA loss and a $31 first-half EBITDA loss. Cummins expected its battery system and hybrid plug-in systems for urban buses to launch in 2019 and 2020, respectively.
Outlook, commentary and risks
Management expected 2018 full-year effective tax to approximate 23%, excluding discrete items, and estimated full-year net periodic pension cost of approximately $86. It anticipated $20 of additional defined-benefit pension contributions in the remainder of 2018. No company-wide revenue or earnings guidance is stated in the supplied filing text.
Management expected North American medium- and heavy-duty truck, North American pickup, global mining, construction and power-generation demand to remain strong. It identified U.S. and trading-partner tariffs and the risk of prolonged trade disputes as potential sources of higher costs and weaker demand; it also expected Chinese truck demand to decline and marine markets to remain weak.
Other disclosed risks include product and emissions-system issues, recalls, market downturns, customer and supplier risks, foreign-exchange and commodity volatility, regulatory and trade changes, litigation, and political and economic conditions in international markets. Cummins stated that it did not believe pending lawsuits were material individually or in aggregate, while cautioning that outcomes could adversely affect results or cash flows. It also noted that Tax Legislation calculations remained provisional and could change during the measurement period.
Important facts for investors to verify
- Whether the $404 emissions-campaign accrual adequately covers the final affected population, repair approach and campaign execution costs.
- Whether working capital converts to cash as activity grows, given first-half operating cash flow of $473 versus $826 a year earlier.
- Whether tariff exposure, a possible decline in Chinese truck demand, and weak marine markets affect the demand and cost assumptions in management’s outlook.
- Final tax effects under the 2017 Tax Cuts and Jobs Act, including the measurement-period adjustments and their effect on the reported tax rate.
- Renewal or replacement of the $1.0 billion revolving facility due to expire in September 2018, and changes in commercial-paper usage and total debt.
- Progress and spending on the Electrified Power business, including planned product launches and the proposed Efficient Drivetrains acquisition, which was expected to close in Q3 2018.