Cummins Inc. — Q2 2011 Form 10-Q
Business context and period. Cummins designs, manufactures, distributes and services engines, power-generation systems and related components. This unaudited filing covers the 13 weeks ended June 26, 2011, and the six months ended that date; comparisons are with the corresponding 2010 periods.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $4.641 billion | $3.208 billion | $8.501 billion | $5.686 billion |
| Gross margin | $1.203 billion; 25.9% | $753 million; 23.5% | $2.160 billion; 25.4% | $1.354 billion; 23.8% |
| Operating income | $768 million | $396 million | $1.297 billion | $642 million |
| Net income attributable to Cummins | $505 million | $246 million | $848 million | $395 million |
| Diluted EPS | $2.60 | $1.25 | $4.34 | $2.00 |
| Operating cash flow | Not separately reported for the quarter | $744 million | $427 million |
Sales increased 45% in Q2 and 50% for the first half; diluted EPS more than doubled in both comparisons. Gross-margin expansion reflected higher volume and pricing, partly offset by increased warranty and commodity costs. Q2 operating margin was approximately 16.5%, versus 12.3% a year earlier; first-half operating margin was approximately 15.3%, versus 11.3%.
Segments: All four segments reported higher sales and EBIT. Q2 segment sales growth was 53% in Engine, 28% in Power Generation, 42% in Components and 36% in Distribution. Engine benefited particularly from North American truck-market recovery; Components from emissions systems and turbo technologies; and Distribution from broad-based regional and product demand.
Balance sheet, cash flow and capital allocation
- At June 26, cash and cash equivalents were $1.111 billion and marketable securities were $363 million, totaling $1.474 billion. Current assets were $7.137 billion and current liabilities $3.713 billion; working capital was $3.424 billion and the current ratio was 1.92.
- Total debt was $847 million ($59 million current loans and $788 million long-term debt); the debt-to-capital ratio was 13.3%, down from 14.4% at year-end 2010. Cash and marketable securities exceeded reported debt by approximately $627 million.
- First-half operating cash flow rose to $744 million from $427 million. Increased earnings and payables helped, while higher receivables (a $513 million cash use) and inventories (a $290 million cash use) absorbed cash. Capital expenditures were $215 million, versus $91 million.
- Investing activities used $151 million; financing activities used $513 million, including $373 million of share repurchases and $102 million of dividends. Cash increased $88 million over the half-year.
- Management reported $1.21 billion available under its revolving facility, $274 million under other credit facilities and $126 million under its receivables program. Approximately $1.1 billion of cash and securities was held outside the United States; the company said it did not anticipate needing to repatriate earnings soon.
Outlook, developments and risks
- Management expected demand to improve through the remainder of 2011 and order trends to support organic revenue growth. North American markets, especially on-highway trucks, were expected to continue recovering; emerging markets were expected to grow, but China could slow.
- Expected 2011 challenges included higher new-product-development investment, slower joint-venture growth while capacity is expanded, and rising commodity costs. Management expected an effective tax rate of approximately 29.5%, absent discrete items.
- Management planned approximately $600–$650 million of 2011 capital expenditures, about two-thirds outside the United States, and anticipated approximately $130 million of defined-benefit pension contributions and $51 million of other postretirement claims and premiums.
- The exhaust-business divestiture closed in Q2 for $123 million and generated a $68 million pretax gain ($37 million after tax, or $0.19 per diluted share). A working-capital adjustment remained pending; management did not expect a significant change to the gain. A proposed light-duty filtration sale was expected to close in the second half of 2011 for approximately $90–$95 million, with an anticipated $45–$50 million pretax gain.
- In July 2011, the board raised the quarterly dividend from $0.2625 to $0.40 per share. This was a post-quarter action; the increased dividend was payable September 1, 2011.
- Risks include cyclical and economically sensitive markets, customer financing and OEM production levels, competition, emissions regulation and product-development execution, commodity and currency fluctuations, and litigation. The company cited ordinary-course claims and environmental matters, and an ongoing dispute with insurers over a $220 million claim for 2008 Indiana flood losses; $92 million had been recovered by June 26, 2011, with no assurance of further recovery.
Most important facts for investors to verify
- How much of the earnings improvement reflects underlying volume, price and margin performance versus the $68 million divestiture gain and other nonrecurring items.
- Whether receivables and inventory growth converts to cash as demand and production expand, and whether planned capital spending remains within the stated range.
- Whether higher warranty accruals, EPA 2010 product costs and commodity inflation affect future margins; the filing notes lower-than-expected EPA 2010 warranty costs to date.
- Progress and final economics of the proposed filtration divestiture, including the expected gain and closing timing.
- Outcome of the disputed flood-insurance claim and material developments in litigation, guarantees and other contingencies.