Cummins Inc. — Q3 2013 Form 10-Q
Business context and period. Cummins designs, manufactures, distributes and services engines, engine-related components and power-generation systems worldwide. This unaudited report covers the 13 weeks ended September 29, 2013, and the nine months ended that date; comparable 2012 periods ended September 30, 2012. Amounts are in millions of dollars except per-share data.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $4,266 | $4,118 | $12,713 | $13,042 |
| Gross margin | $1,109 | $1,042 | $3,219 | $3,450 |
| Gross margin % | 26.0% | 25.3% | 25.3% | 26.5% |
| Operating income | $524 | $493 | $1,548 | $1,789 |
| Net income attributable to Cummins | $355 | $352 | $1,051 | $1,276 |
| Diluted EPS | $1.90 | $1.86 | $5.60 | $6.72 |
Q3 sales rose 4% year over year, while nine-month sales fell 3%. Q3 diluted EPS rose 2%; nine-month diluted EPS declined 17%. Nine-month operating cash flow was $1,333, versus $787 in 2012. Investing cash use was $545, including $417 of capital expenditures; financing provided $344. Cash and cash equivalents increased by $1,130 during the nine months.
At September 29, cash and marketable securities totaled $2,661; total debt was $1,793, up from $775 at December 31, 2012. Debt-to-capital increased to 19.4% from 10.0%. Working capital was $5,136 and the current ratio was 2.52, versus $4,031 and 2.29 at year-end. The company reported $1.7 billion available under its revolving credit facility and $279 million under other credit facilities.
Cash dividends declared were $0.625 per share in Q3, up from $0.50 a year earlier. The board raised the quarterly dividend 25% in July. Nine-month common-stock repurchases were $289.
Material changes versus prior comparable periods
- Q3 gross margin improved 0.7 percentage points, supported by favorable pricing, lower material and commodity costs, and higher volumes; unfavorable product mix partly offset the gains.
- Nine-month gross margin declined 1.2 percentage points as lower volumes and unfavorable product mix outweighed pricing and input-cost benefits.
- Q3 segment EBIT increased in Engine and Components, but declined in Power Generation and Distribution. Nine-month EBIT fell in Engine and Power Generation; Components improved and Distribution was nearly flat.
- North American distributor consolidations and the prior-year Hilite acquisition supported sales. International weakness, particularly in mining and power generation, weighed on results.
- Nine-month earnings were also affected by a higher effective tax rate (28.3% versus 25.5%) and lower equity, royalty and interest income from investees.
Outlook, management commentary and risks
Management expected steady North American on-highway demand and continued medium-duty truck market-share gains for the remainder of 2013. It identified weak mining-engine demand, weak demand in India and international power generation, sluggish conditions in some European markets and currency volatility as potential pressures. No specific full-year revenue or earnings guidance was provided.
Management expected a 2013 effective tax rate of approximately 28.5%, excluding possible one-time items; planned 2013 capital spending of approximately $700; pension contributions of approximately $170; and other postretirement benefit claims and premiums of approximately $47. Management described liquidity and financial condition as strong. Longer-term opportunities cited include tighter emissions standards, emerging-market infrastructure needs, energy issues and globalization.
In September, Cummins issued $1 billion of senior unsecured notes: $500 million at 3.65% due 2023 and $500 million at 4.875% due 2043, receiving net proceeds of $979 million. Proceeds were intended partly for planned acquisitions of remaining interests in U.S. and Canadian distributors and partly for general corporate purposes. Credit ratings were affirmed at A/A/A3 with stable outlooks. Interest expense is expected to increase following the issuance.
Unusual and other items include an $8 million legal settlement recorded in Q3 and a $12 million gain from remeasurement of pre-existing interests in acquired distributors during the nine months. The 2013 nine-month tax rate included discrete tax items: a $28 million research-credit benefit and a $17 million tax expense in Q1, plus a $7 million net tax expense in Q3. Cummins reported ongoing ordinary-course lawsuits and environmental matters, which it did not consider material individually or in aggregate, but noted that final outcomes could adversely affect results. Potential maximum losses on other guarantees were $8 million; supplier-contract termination penalties were approximately $109 million, though the company did not anticipate paying them. It also cited risks tied to integrating planned distributor acquisitions and realizing expected benefits.
Most important facts for investors to verify
- Whether North American demand and market-share gains can offset continued weakness in mining, power generation and international markets.
- Whether gross-margin pressure, product mix and lower volumes persist, particularly in Engine and Power Generation.
- How the $1 billion debt issuance affects interest expense, leverage and funding of planned distributor acquisitions.
- Whether operating cash flow remains strong after the favorable working-capital movements that supported the nine-month comparison.
- Whether distributor acquisitions close on expected terms and deliver benefits without material integration costs or disruption.
- Developments in warranty obligations, litigation and environmental matters, and any changes to the estimated 2013 tax rate, capital spending or pension contributions.