Cummins Inc. — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015; filed February 12, 2016. Cummins designs, manufactures, distributes and services engines, components and power-generation systems. Its four segments are Engine, Distribution, Components and Power Generation.
Financial performance
| Metric | 2015 | 2014 |
|---|---|---|
| Net sales | $19.110 billion | $19.221 billion |
| Gross margin | $4.947 billion; 25.9% of sales | $4.861 billion; 25.3% of sales |
| Operating income | $2.057 billion | $2.365 billion |
| Net income attributable to Cummins | $1.399 billion | $1.651 billion |
| Diluted EPS | $7.84 | $9.02 |
| Operating cash flow | $2.059 billion | $2.266 billion |
| Capital expenditures | $744 million | $743 million |
| Cash and marketable securities at year-end | $1.811 billion | $2.394 billion |
| Total debt at year-end | $1.639 billion | $1.686 billion |
Sales declined 1%; operating income fell 13%, net income attributable to Cummins fell 15%, and diluted EPS fell 13%. Gross margin improved 0.6 percentage points, but operating margin declined to approximately 10.8% from 12.3%. The effective tax rate was 27.4%, versus 28.7%.
Working capital was $4.144 billion (2014: $5.034 billion); the current ratio was 2.09 (2.25). The debt-to-capital ratio was 17.5% (17.2%). The company reported $1.742 billion available on its revolving facility, plus $184 million under other credit facilities, and was in compliance with its leverage covenant.
Material changes and segment trends
- International sales weakened amid currency effects and lower demand, particularly in Brazil, Europe and China. North American on-highway demand improved; U.S. and Canada revenue rose 7%.
- Engine segment sales fell 5% and EBIT fell 34%, to $807 million, including the light-duty diesel impairment, restructuring costs and a contingency charge.
- Distribution sales rose 20% to $6.229 billion, largely because North American distributors were consolidated; EBIT declined 16% to $412 million.
- Components sales increased 1% and EBIT increased 6% to $727 million. Power Generation sales fell 5% and EBIT fell 7% to $156 million.
- Operating cash flow decreased $207 million. Working capital use was $260 million, compared with a $68 million source in 2014. Cash declined $590 million during the year.
- Shareholders received $622 million in dividends; Cummins repurchased $900 million of stock. The quarterly dividend was increased 25% in July to $0.975 per share.
Outlook, commentary, risks and unusual items
- For 2016, management expected strong North American medium-duty truck and pickup demand and some improvement in Indian end markets. It expected annualized restructuring savings of approximately $160 million.
- Challenges identified for 2016 included declining North American heavy-duty truck production, weak power-generation markets, continued weakness in Brazil, China, oil and gas, and mining, and foreign-currency volatility. Further facility closures or restructuring could bring additional charges. The filing does not provide a consolidated 2016 revenue or EPS forecast.
- Fourth-quarter 2015 charges included a $211 million light-duty diesel asset impairment ($133 million after tax), $90 million of restructuring charges ($61 million after tax), and a $60 million loss-contingency accrual ($38 million after tax). The impairment followed loss of a prospective customer program and reduced utilization expectations; Cummins said it would continue servicing existing contracts and was not exiting the product line.
- The $60 million contingency related to a proposed field campaign after certain engines failed in-use emissions testing because of a wash-coat quality issue in third-party aftertreatment systems. Cummins expected to share campaign costs, was seeking cost sharing from the vehicle manufacturer, and did not expect EPA or CARB fines or penalties.
- Restructuring reduced the worldwide workforce by about 1,900 employees; most of the program was expected to be completed by April 2016. Management also said it would continue reviewing manufacturing capacity.
- Key risks include cyclical market downturns, customer concentration and potential OEM insourcing, foreign exchange, supplier dependence (56% of direct material in product designs was single-sourced), emissions compliance, product recalls/liability, and reliance on unconsolidated joint ventures. PACCAR represented about 15% of 2015 sales; the seven largest customers collectively represented about 40%.
- Litigation and environmental matters arise in the ordinary course. Management said it did not believe pending lawsuits were material individually or in aggregate, but acknowledged outcomes could adversely affect results. Environmental remediation costs were not expected to be significant based on current estimates.
- A $500 million accelerated share repurchase agreement was signed February 9, 2016, after year-end; completion was expected by the end of the second quarter of 2016.
Important facts for investors to verify
- Whether North American truck demand, international markets and currency movements develop as management anticipated, and how these affect segment margins.
- Whether the $160 million annualized restructuring savings are achieved, and whether additional plant actions or charges occur.
- The ultimate cost and any recovery for the emissions-related field campaign, including any binding cost-sharing agreement.
- Light-duty diesel asset utilization and recoverability after the impairment, while existing customer commitments continue.
- Cash conversion and working-capital trends, capital allocation, and the effect of the $500 million share repurchase and elevated dividends on liquidity.
- Performance of key joint ventures and major customers, and exposure to single-source suppliers and emissions-regulation changes.