Cummins Inc. — Form 10-Q Summary
Reporting period: Third quarter ended September 30, 2012; comparisons are with the quarter ended September 25, 2011. Each quarter had 13 weeks. Nine-month periods were 39 weeks in 2012 and 38 weeks in 2011. Dollar amounts are in millions unless stated otherwise.
Business context and results
Cummins designs, manufactures, distributes and services engines, engine components, emission solutions and power-generation products. It reports four segments: Engine, Components, Power Generation and Distribution. The company described slowing global demand, especially in China, Brazil and several industrial markets, while North American on-highway markets provided support earlier in the year.
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $4,118 | $4,626 | $13,042 | $13,127 |
| Gross margin | $1,042 | $1,188 | $3,450 | $3,348 |
| Gross margin % | 25.3% | 25.7% | 26.5% | 25.5% |
| Operating income | $493 | $639 | $1,789 | $1,936 |
| Net income attributable to Cummins | $352 | $452 | $1,276 | $1,300 |
| Diluted EPS | $1.86 | $2.35 | $6.72 | $6.69 |
| Operating cash flow | Not separately stated | Not separately stated | $787 | $1,368 |
Financial position, cash flow and capital
- Cash and cash equivalents were $1,033 at September 30, 2012, down $451 from year-end 2011. Marketable securities were $239, for combined cash and securities of $1,272.
- Total debt was $801, versus $783 at December 31, 2011; debt to total capital was 10.5%, down from 11.8%. Cash and marketable securities exceeded reported total debt by approximately $471.
- Current assets were $7,115 and current liabilities $3,309; working capital was $3,806 and the current ratio 2.15. Inventories rose $429 to $2,570. Inventory turnover declined to 5.3 from 6.3, and days’ sales in receivables increased to 53 from 48.
- Nine-month operating cash flow fell $581 year over year, chiefly because of working-capital movements. Working-capital assets consumed $898 of cash, versus $351 in the comparable period; cash outflows included higher accrued expenses and lower accounts payable.
- Investing activities used $719, including $424 of capital expenditures and $215 for acquisitions. Financing activities used $550, including $246 of dividends and $231 of share repurchases. The company repurchased 2.3 million shares in the first nine months.
- The company reported $1.2 billion available under its revolving credit facility, $292 of availability under other credit facilities and $183 available under its receivables sales program. Approximately 87% of cash and cash equivalents was held outside the U.S.; repatriation of some foreign earnings could trigger U.S. tax.
Material changes and segment performance
- Q3 sales declined 11% and operating income 23%; attributable net income fell 22%. Management attributed the earnings decline primarily to lower volumes, weaker gross margin, higher research and development spending, and lower investee income. SG&A savings and a lower effective tax rate partially offset the declines.
- For nine months, sales declined 1% and attributable net income declined 2%, while diluted EPS increased from $6.69 to $6.72, including a $0.04 per-share benefit from lower shares outstanding due to repurchases. Nine-month gross margin improved by 1.0 percentage point; the prior-year period included a $68 gain on the exhaust-business divestiture, compared with a $6 adjustment gain in 2012.
- Q3 segment sales and EBIT: Engine $2,527 / $239; Components $938 / $89; Power Generation $814 / $73; Distribution $801 / $99. Engine, Components and Power Generation EBIT declined year over year; Distribution EBIT also declined modestly despite sales growth.
- For the nine months, segment EBIT was Engine $996, Components $348, Power Generation $243 and Distribution $285. Components sales benefited from emission-solutions demand and the Hilite acquisition; Distribution sales benefited from acquisitions and parts and filtration demand. Engine and Power Generation results were pressured by weaker markets.
Outlook, management commentary and risks
- Management expected challenges for the remainder of 2012, including further softening in North American heavy-duty trucks, weak industrial demand in China, Brazilian market and channel-inventory pressure, currency volatility, declining oil-and-gas and mining markets, and European economic uncertainty. No specific revenue or earnings guidance was provided in the supplied filing text.
- In October 2012, Cummins announced cost actions, including reduced work weeks, some facility shutdowns and targeted workforce reductions; it expected to reduce headcount by 1,000 to 1,500 by year-end. Management cautioned these actions could have a net negative effect on fourth-quarter results.
- Expected 2012 capital expenditures were revised to approximately $650–$700. The company expected full-year pension contributions of approximately $130, including $8 million more during the remainder of 2012; it also expected approximately $20 million of remaining-year other postretirement benefit payments.
- The board increased the quarterly dividend 25%, from $0.40 to $0.50 per share. In October, Fitch upgraded Cummins to A with a stable outlook; S&P was A/stable and Moody’s Baa1/positive as of filing.
- In July, Cummins completed the $176 Hilite doser-technology acquisition and acquired an additional 45% of Cummins Central Power for approximately $20. The latter generated a $7 fair-value remeasurement gain on the previously held interest.
- Warranty liability was $1,083, up from $1,014 at the start of the year. The nine-month roll-forward included $320 of warranty provisions, $294 of payments and a $36 reduction in estimates for pre-existing warranties.
- Ordinary-course litigation and environmental matters were described as not material individually or in aggregate, but the company noted outcomes could still materially affect results or cash flows. Other disclosed exposures included $29 maximum potential loss under specified guarantees ($8 liability recorded), supplier termination penalties of approximately $102, and a take-or-pay commitment of about $73 annually through 2018. Cummins said it did not anticipate paying the supplier penalties.
- Key forward-looking risks include economic and market cyclicality, emissions regulation, customer demand and production, competition, supply and commodity costs, foreign exchange, product recalls and liability, pension-asset performance, and litigation. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the Q3 demand slowdown and announced cost actions affect fourth-quarter sales, margins and restructuring costs as expected.
- Whether elevated inventories and weaker cash conversion normalize, and whether receivables and payable trends change.
- How much of the nine-month earnings and margin comparison reflects operating performance versus tax benefits, share repurchases and prior-period divestiture gains.
- Integration and returns from the Hilite and Cummins Central Power acquisitions, including the impact of acquisition-related goodwill and intangibles.
- Developments in warranty estimates, Brazil-related legal and tax matters, supplier commitments, guarantees and other contingencies.