Cummins Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended April 2, 2017; comparative period ended April 3, 2016. Cummins designs, manufactures, distributes and services engines, components and power systems worldwide.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $4.589 billion | $4.291 billion | Up 7% |
| Gross margin | $1.128 billion; 24.6% of sales | $1.056 billion; 24.6% | Up $72 million; margin flat |
| Operating income | $546 million | $470 million | Up 16% |
| Net income attributable to Cummins | $396 million | $321 million | Up 23% |
| Diluted EPS | $2.36 | $1.87 | Up 26% |
| Operating cash flow | $379 million | $267 million | Up $112 million |
Higher volumes, favorable pricing, increased investee income and a lower effective tax rate supported earnings growth. Higher SG&A partly offset these gains. Gross margin dollars rose, but the margin percentage was unchanged; higher warranty costs partly offset volume and pricing benefits.
- Segments: Distribution sales increased 12% and EBIT 15%; Components sales increased 9% and EBIT 10%; Power Systems sales increased 9% and EBIT 24%; Engine sales increased 2% and EBIT 16%. Segment results benefited from varied market demand and, in some cases, acquisitions or higher earnings from investees.
- Cash and liquidity: Cash and cash equivalents were $1.322 billion, with $145 million in marketable securities. Working capital was $3.497 billion and the current ratio was 1.75. Cash and securities totaled $1.467 billion; available revolving-credit capacity was approximately $1.476 billion.
- Debt: Total debt was $1.945 billion, versus $1.856 billion at year-end 2016. Debt was 20.6% of total capital, unchanged. Commercial paper outstanding was $274 million.
- Investment and shareholder returns: Capital expenditures and internal-use software spending totaled $108 million. The company paid $171 million in dividends and repurchased $51 million of shares. The declared quarterly dividend was $1.025 per share.
Changes and outlook
International demand improved, particularly in China, India, Russia and the U.K.; international sales represented 43% of total sales, versus 39% a year earlier. Growth reflected stronger industrial and Components demand, while North American on-highway demand was weaker. Foreign currency reduced sales growth by about 1 percentage point.
Management described potential improvement in off-highway markets in China and India, North American construction and heavy-duty trucks, and global mining and North American oil and gas. Challenges included soft power-generation markets, weak Brazilian conditions and continued currency pressure. The filing gives no specific full-year revenue or earnings guidance. Management expected a 2017 effective tax rate of approximately 26%, excluding one-time items; capital expenditures of $500–$530 million; and pension contributions of approximately $134 million.
Risks, contingencies and notable items
- Warranty costs increased by $34 million due to revised estimates following higher claims on certain 2013 and 2014 engines. Total product-warranty liability was $1.437 billion.
- A field campaign addressing emissions-test failures involving third-party aftertreatment systems was underway. The remaining accrual was $181 million; final costs may differ, and related cost allocation litigation with an OEM was pending. Cummins said it did not currently expect EPA or CARB fines or penalties.
- On April 10, 2017, after quarter-end, Cummins agreed to invest approximately $600 million for a 50% interest in an automated-transmission joint venture with Eaton, subject to regulatory approval. Closing was expected in Q3 2017; Cummins planned to consolidate the venture in Components.
- Other risks include market downturns, customer and supplier concentration or financial risk, product recalls and liability, emissions regulation, foreign exchange, litigation, pension assumptions and operations in higher-risk countries. The company said it did not believe pending lawsuits were material individually or collectively, while noting outcomes could still adversely affect results.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether the $34 million warranty-estimate increase and related engine claims result in further charges or cash payments.
- The ultimate cost, timing and litigation outcome of the emissions campaign, including the adequacy of the $181 million remaining accrual.
- Regulatory approval, closing, funding and financial-statement impact of the Eaton joint venture.
- Whether improving industrial demand offsets weakness in on-highway, power-generation and Brazilian markets, and the effect of currency movements.
- Execution of the stated capital-spending and pension-contribution plans, and continued access to liquidity as commercial paper and other funding needs change.