Cummins Inc. — Q1 2011 Form 10-Q
Reporting period: 12 weeks ended March 27, 2011; comparable period ended March 28, 2010. All financial amounts are in millions of dollars, except per-share amounts.
Business context
Cummins designs, manufactures, distributes and services engines, power-generation systems and related components worldwide. Its reportable segments are Engine, Power Generation, Components and Distribution. Management attributed the quarter’s strong performance to recovery in North American on-highway markets, continued emerging-market growth, improved pricing and higher sales in developed markets.
Financial performance
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net sales | $3,860 | $2,478 | +56% |
| Gross margin | $957; 24.8% of sales | $601; 24.3% of sales | +59%; +0.5 percentage points |
| Operating income | $529 | $246 | +115% |
| Income before income taxes | $522 | $257 | +103% |
| Net income attributable to Cummins | $343 | $149 | +130% |
| Diluted earnings per share | $1.75 | $0.75 | +$1.00 |
| Operating cash flow | $88 | $126 | -$38 |
Gross-margin improvement mainly reflected higher volume and favorable mix, better pricing and currency effects, partly offset by higher warranty and material costs. Warranty expense was 2.7% of sales versus 2.5%, with the increase attributed primarily to a higher mix of EPA 2010-compliant engines. SG&A rose to $389 from $335 and research, development and engineering expense to $129 from $92, reflecting increased staffing, compensation and spending. Equity, royalty and interest income from investees increased to $96 from $76.
By segment, sales increased in each business: Engine 68%, Power Generation 54%, Components 47% and Distribution 35% (segment sales include intersegment transactions). Segment EBIT was $290, $89, $105 and $89, respectively. Distribution EBIT margin declined to 13.9% from 15.1%, partly because Q1 2010 included a $12 million gain related to the Cummins Western Canada acquisition.
Balance sheet, cash flow and liquidity
- At March 27, 2011, cash and cash equivalents were $779 and marketable securities were $307, down from $1,023 and $339, respectively, at year-end 2010.
- Current assets were $6,494 and current liabilities $3,451; working capital was $3,043 and the current ratio 1.88, versus 1.93 at December 31, 2010.
- Total debt was $832, including $82 of loans payable and $685 of long-term debt. Debt to total capital was 13.8%, down from 14.4% at year-end. Debt carrying value was $832; its disclosed fair value was $875.
- Operating cash flow of $88 was lower year over year, chiefly because receivables increased with higher sales; higher payables and net income partly offset the cash use. Investing activities used $78, including $91 of capital expenditures. Financing activities used $262, including $190 of share repurchases and $51 of dividends. Cash declined $244 during the quarter.
- Management reported $1.21 billion available under the revolving credit facility, $273 million under other credit facilities and $151 million available under the receivables program. Cash plus marketable securities totaled $1.086 billion.
Outlook, risks and notable items
- Management expected demand to improve through the rest of 2011, with continued growth in China, India and Brazil (at a slower pace than in 2010), robust North American recovery and growth in most other markets. No specific consolidated revenue or earnings forecast was provided in the supplied filing text.
- Expected earnings pressures included higher warranty costs from EPA 2010-compliant engines, increased product-development investment, slower joint-venture growth while capacity is expanded, and rising commodity costs. Planned 2011 capital expenditures were approximately $600–$650 million.
- The March 2011 Japan earthquake, tsunami and nuclear disaster had no material Q2 impact anticipated at the time of filing, but management continued monitoring potential supply interruptions.
- Two planned Components divestitures were expected to generate combined pretax gains of $95–$105 million: the exhaust business for an expected $125–$135 million sale price and the light-duty filtration business for approximately $70–$75 million. Expected closings were Q2 and Q3 2011, respectively; the filtration sale was subject to a non-binding letter of intent.
- Product-liability, warranty, intellectual-property, tax, environmental and other ordinary-course claims were disclosed. Cummins said it did not consider the lawsuits material individually or in aggregate, while noting final outcomes could adversely affect results. A disputed insurance claim related to 2008 Indiana flood damage was $220 million; $92 million had been recovered by quarter-end.
- Other exposures included $65 million maximum potential loss under specified guarantees, approximately $55 million of potential supplier penalties if purchases stopped (not anticipated), and $84 million of additional commitments to existing joint ventures, of which $51 million was expected to be funded in 2011. The product warranty liability was $1.010 billion, versus $915 million a year earlier.
- Other notable comparisons: the effective tax rate was 30% versus 34% in Q1 2010, which included a $7 million discrete tax charge; Q1 2011 other operating expense included a $7 million legal judgment, while Q1 2010 other income included a $12 million acquisition gain. The 2007 $500 million repurchase authorization was completed, and a new $1 billion program had $921 million remaining at quarter-end.
Important facts for investors to verify
- Whether the strong market recovery and improving order trends persisted, particularly in North American on-highway markets and emerging economies.
- Subsequent warranty claims and costs for EPA 2010-compliant engines, and the adequacy of the $1.010 billion warranty liability.
- Cash conversion and working-capital requirements as receivables and inventories rose with sales; compare operating cash flow with earnings and capital spending.
- Completion, proceeds and realized gains from the two planned divestitures, and any ongoing supply or other agreements after sale.
- Resolution and potential financial effects of the flood-insurance dispute, litigation and other guarantees or commitments.
- Execution of the $600–$650 million capital-spending plan, pension funding requirements and pace of the new share-repurchase program.