Cummins Inc. — 2018 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018. The filing also reports fourth-quarter results; it is an annual report, not a standalone quarterly filing. Amounts are in U.S. dollars unless stated otherwise.
Business context and reporting period
Cummins designs, manufactures, distributes and services diesel and natural-gas engines, components, power generation equipment and electrified power systems. Its five reportable segments are Engine, Distribution, Components, Power Systems and Electrified Power. The company serves customers in more than 190 countries through approximately 600 distributor locations and over 7,600 dealer locations. Electrified Power became a reportable segment in 2018.
Key financial metrics
| Metric | 2018 | 2017 | Change or context |
|---|---|---|---|
| Net sales | $23.771 billion | $20.428 billion | Up 16%; all operating segments reported higher sales |
| Gross margin | $5.737 billion; 24.1% of sales | $5.100 billion; 25.0% of sales | Amount up 12%; margin down 0.9 percentage points |
| Operating income | $2.786 billion | $2.334 billion | Up 19% |
| Net income attributable to Cummins | $2.141 billion | $999 million | 2018 diluted EPS $13.15 versus $5.97 |
| Effective tax rate | 20.6% | 58.0% | 2017 included substantial Tax Cuts and Jobs Act charges |
| Operating cash flow | $2.378 billion | $2.277 billion | Up $101 million |
| Capital expenditures | $709 million | $506 million | Excludes internal-use software investment |
| Cash and marketable securities | $1.525 billion | $1.567 billion | At year-end |
| Total debt | $2.476 billion | $2.006 billion | Debt-to-capital ratio increased to 23.1% from 19.7% |
| Working capital / current ratio | $3.434 billion / 1.54 | $3.251 billion / 1.57 | Inventory increased to $3.759 billion from $3.166 billion |
Year-end liquidity also included $2.72 billion of available revolving credit capacity after commercial paper borrowings. The company had $780 million of commercial paper outstanding and reported compliance with its debt covenants. Long-term debt was $1.597 billion.
Fourth-quarter 2018 net sales were $6.126 billion, gross margin $1.546 billion, net income attributable to Cummins $579 million and diluted EPS $3.63. In fourth-quarter 2017, sales were $5.476 billion, gross margin $1.376 billion, net loss attributable to Cummins $274 million and diluted loss per share $1.65; the 2017 quarter was heavily affected by tax-reform charges.
Material changes versus prior periods
- Revenue rose 16%, reflecting strong North American on-highway demand and growth across most international markets, including higher construction and mining demand.
- Gross margin dollars increased, but the gross margin rate fell to 24.1%. A $368 million Engine System Campaign, higher compensation costs and Chinese tariffs partly offset volume, mix and pricing benefits.
- Net income increased sharply from 2017, but the comparison is distorted by the $777 million net adverse 2017 impact of U.S. tax legislation. Excluding Tax Legislation, management reported 2018 net income of $2.180 billion and diluted EPS of $13.39, versus $1.776 billion and $10.62 in 2017; these are non-GAAP supplemental measures.
- Operating cash flow increased modestly despite a $485 million cash outflow from working capital in 2018, versus a $90 million inflow in 2017. Higher inventory and receivables were notable working-capital uses.
- Share repurchases totaled $1.140 billion in 2018, versus $451 million in 2017; dividends paid were $718 million. The quarterly dividend was raised to $1.14 per share beginning in the third quarter.
- Research and development expense, net of reimbursements, rose to $894 million from $734 million, including investment in electrification and acquired transmission operations.
Outlook, management commentary and risks
- For 2019, management expected strong North American medium- and heavy-duty truck and pickup demand, strong power generation markets, and strength in North American and European construction; mining demand was expected to stabilize.
- Expected headwinds included declining truck and construction demand in China, lower North American oil and gas demand, weak marine markets, tariffs and uncertainty around Brexit. The filing does not provide a specific 2019 revenue or EPS forecast.
- Management expected a 2019 effective tax rate of approximately 21.5%, excluding discrete items; capital expenditures of $650–$700 million plus $65–$75 million for internal-use software; and approximately $123 million of defined-benefit pension contributions.
- The EPA and California Air Resources Board-related Engine System Campaign covered certain 2010–2015 engine systems. Cummins recorded $368 million of additional 2018 charges; $372 million remained accrued at year-end. Campaign work was expected to be substantially complete by December 31, 2020.
- Key risks include cyclical markets, customer decisions to manufacture engines internally, dependence on major OEMs, regulatory and emissions compliance costs, product recalls and warranty claims, trade restrictions, foreign exchange and commodity volatility, supply-chain concentration, cybersecurity, and competition from electrification and alternative technologies.
- PACCAR accounted for 15% of 2018 sales; sales to PACCAR, Navistar, Daimler and Fiat Chrysler together represented 35%. Cummins also derives significant income from unconsolidated investees, with more than half of that income associated with China-based investees.
- Management stated that ordinary-course lawsuits and environmental matters were not believed to be material individually or in aggregate, while noting that outcomes could adversely affect results. Maximum potential losses under guarantees were $52 million; supplier minimum-purchase arrangements carried approximately $65 million of potential penalties if purchases ceased.
- The automated-transmission reporting unit had $544 million of goodwill and estimated fair value 21% above carrying value. Management identified this as its only reporting unit with material goodwill whose fair value did not substantially exceed carrying amount, making successful launches and market penetration important.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded controls were effective at December 31, 2018.
Most important facts for investors to verify
- Whether campaign costs, claims experience and the remaining $372 million warranty accrual develop as expected.
- Whether 2019 demand assumptions hold, particularly for China, North American trucks and oil and gas, and how tariffs affect costs and orders.
- How much reported earnings growth reflects operating improvement versus the unusually high 2017 tax expense; review the company’s non-GAAP tax-adjusted comparisons alongside GAAP results.
- Whether working capital, especially inventory, converts into cash and whether debt and share repurchases remain consistent with liquidity priorities.
- Whether the Eaton Cummins automated-transmission business achieves projected adoption and avoids impairment of its goodwill and intangible assets.
- Whether customer concentration, China-based investee earnings, regulatory compliance and single-source supplier exposures change materially.