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CMI > SEC Filings for CMI > Form 10-Q on 29-Jul-2014All Recent SEC Filings

Show all filings for CUMMINS INC

Form 10-Q for CUMMINS INC


29-Jul-2014

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Cummins Inc. and its consolidated subsidiaries are hereinafter sometimes referred to as "Cummins," "we," "our" or "us."

CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION

Certain parts of this quarterly report contain forward-looking statements intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements include those that are based on current expectations, estimates and projections about the industries in which we operate and management's beliefs and assumptions. Forward-looking statements are generally accompanied by words such as "anticipates," "expects," "forecasts," "intends," "plans," "believes," "seeks," "estimates," "could," "should" or words of similar meaning. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which we refer to as "future factors," which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Some future factors that could cause our results to differ materially from the results discussed in such forward-looking statements are discussed below and shareholders, potential investors and other readers are urged to consider these future factors carefully in evaluating forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. Future factors that could affect the outcome of forward-looking statements include the following:

• a sustained slowdown or significant downturn in our markets;

• a slowdown in infrastructure development;

• unpredictability in the adoption, implementation and enforcement of emission standards around the world;

• the actions of, and income from, joint ventures and other investees that we do not directly control;

• changes in the engine outsourcing practices of significant customers;

• a downturn in the North American truck industry or financial distress of a major truck customer;

• a major customer experiencing financial distress;

• any significant problems in our new engine platforms;

• supply shortages and supplier financial risk, particularly from any of our single-sourced suppliers;

•variability in material and commodity costs;

• product recalls;

• competitor pricing activity;

• increasing competition, including increased global competition among our customers in emerging markets;

• exposure to information technology security threats and sophisticated"cyber attacks;"

• political, economic and other risks from operations in numerous countries;

• changes in taxation;

• global legal and ethical compliance costs and risks;

• aligning our capacity and production with our demand;

• product liability claims;

• the development of new technologies;


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• obtaining additional customers for our new light-duty diesel engine platform and avoiding any related write-down in our investments in such platform;

• increasingly stringent environmental laws and regulations;

• foreign currency exchange rate changes;

• the price and availability of energy;

• the performance of our pension plan assets;

• labor relations;

• changes in accounting standards;

• our sales mix of products;

• protection and validity of our patent and other intellectual property rights;

• technological implementation and cost/financial risks in our increasing use of large, multi-year contracts;

• the cyclical nature of some of our markets;

• the outcome of pending and future litigation and governmental proceedings;

• continued availability of financing, financial instruments and financial resources in the amounts, at the times and on the terms required to support our future business;

• the consummation and integration of the planned acquisitions of our partially-owned United States and Canadian distributors; and

• other risk factors described in our Form 10-K, Part I, Item 1A under the caption "Risk Factors" and in this Form 10-Q, Part II, Item 1A under the caption "Risk Factors."

Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are made only as of the date of this quarterly report and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.


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ORGANIZATION OF INFORMATION

The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) was prepared to provide the reader with a view and perspective of our business through the eyes of management and should be read in conjunction with our Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements in the "Financial Statements" section of our 2013 Form 10-K. Our MD&A is presented in the following sections:

•Executive Summary and Financial Highlights

•Outlook

•Results of Operations

•Operating Segment Results

•Liquidity and Capital Resources

•Application of Critical Accounting Estimates

•Recently Issued Accounting Pronouncements


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EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS
We are a global power leader that designs, manufactures, distributes and services diesel and natural gas engines and engine-related component products, including filtration, aftertreatment, turbochargers, fuel systems, controls systems, air handling systems and electric power generation systems. We sell our products to original equipment manufacturers (OEMs), distributors and other customers worldwide. We have long-standing relationships with many of the leading manufacturers in the markets we serve, including PACCAR Inc, Daimler Trucks North America, Chrysler Group, LLC (Chrysler), Volvo AB, Komatsu, Navistar International Corporation, Aggreko plc, Ford Motor Company and MAN Nutzfahrzeuge AG. We serve our customers through a network of over 600 company-owned and independent distributor locations and over 6,800 dealer locations in more than 190 countries and territories.
Our reportable operating segments consist of the following: Engine, Components, Power Generation and Distribution. This reporting structure is organized according to the products and markets each segment serves and allows management to focus its efforts on providing enhanced service to a wide range of customers. The Engine segment produces engines and parts for sale to customers in on-highway and various industrial markets. Our engines are used in trucks of all sizes, buses and recreational vehicles, as well as in various industrial applications, including construction, mining, agriculture, marine, oil and gas, rail and military equipment. The Components segment sells filtration products, aftertreatment systems, turbochargers and fuel systems. The Power Generation segment is an integrated provider of power systems, which sells engines, generator sets and alternators. The Distribution segment includes wholly-owned and partially-owned distributorships engaged in wholesaling engines, generator sets and service parts, as well as performing service and repair activities on our products and maintaining relationships with various OEMs throughout the world.
Our financial performance depends, in large part, on varying conditions in the markets we serve, particularly the on-highway, construction and general industrial markets. Demand in these markets tends to fluctuate in response to overall economic conditions. Our sales may also be impacted by OEM inventory levels and production schedules and stoppages. Economic downturns in markets we serve generally result in reduced sales of our products and can result in price reductions in certain products and/or markets. As a worldwide business, our operations are also affected by currency, political, economic and regulatory matters, including adoption and enforcement of environmental and emission standards, in the countries we serve. As part of our growth strategy, we invest in businesses in certain countries that carry high levels of these risks such as China, Brazil, India, Mexico, Russia and countries in the Middle East and Africa. At the same time, our geographic diversity and broad product and service offerings have helped limit the impact from a drop in demand in any one industry or customer or the economy of any single country on our consolidated results.
Worldwide revenues increased 7 percent in the three months ended June 29, 2014, as compared to the same period in 2013, primarily due to improvements in North American on-highway demand. Revenue in the U.S. and Canada improved by 14 percent primarily due to higher demand in the North American on-highway markets driving sales in both the Engine and Components segments, as well as improved Distribution segment sales related to the consolidation of partially-owned North American distributors since March 30, 2013. These increases were partially offset by reduced demand in North American power generation. International economic uncertainty continued in the second quarter of 2014 and as a result, our international (excludes the U.S and Canada) revenues declined by 1 percent with sales down or relatively flat in most markets. Declines were led by the reduced international on-highway demand with decreased unit shipments of 30 percent and 19 percent in the heavy-duty and medium-duty truck markets, respectively, primarily in Brazil and India. These decreases were partially offset by improved demand in China.

Worldwide revenues increased 9 percent in the first six months of 2014 as compared to the same period in 2013, primarily due to improvements in North American on-highway demand. Revenue in the U.S. and Canada improved by 19 percent primarily due to increased demand in the North American on-highway markets driving sales in both the Engine and Components segments, as well as improved Distribution segment sales related to the consolidation of partially-owned North American distributors since December 31, 2012. These increases were partially offset by the reduced demand in the North American power generation markets as well as most industrial markets. International economic uncertainty continued in the first half of 2014 and our international revenues declined by 1 percent with sales down or relatively flat in most markets. Declines were led by reduced power generation equipment demand and reduced on-highway demand with decreased unit shipments of 15 percent and 10 percent in the heavy-duty and medium-duty truck markets, respectively. These decreases were partially offset by improved demand in China.

The following tables contain sales and earnings before interest expense, income taxes and noncontrolling interests (EBIT) results by operating segment for the three and six month periods ended June 29, 2014 and June 30, 2013. Refer to the section titled "Operating Segment Results" for a more detailed discussion of net sales and EBIT by operating segment, including the reconciliation of segment EBIT to income before taxes.


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                                                          Three months ended
Operating
Segments                     June 29, 2014                      June 30, 2013                  Percent change
                                 Percent                            Percent                     2014 vs. 2013
In millions           Sales     of Total      EBIT       Sales     of Total      EBIT        Sales          EBIT
Engine              $ 2,744         57  %   $  311     $ 2,656         59  %   $  339           3  %          (8 )%
Components            1,280         26  %      185       1,117         25  %      136          15  %          36  %
Power Generation        743         15  %       61         814         18  %       76          (9 )%         (20 )%
Distribution          1,238         26  %      126         954         21  %      100          30  %          26  %
Intersegment
eliminations         (1,170 )      (24 )%        -      (1,016 )      (23 )%        -          15  %           -
Non-segment               -          -         (26 )         -          -         (30 )         -            (13 )%
Total               $ 4,835        100  %   $  657     $ 4,525        100  %   $  621           7  %           6  %

Net income attributable to Cummins was $446 million, or $2.43 per diluted share, on sales of $4.8 billion for the three month interim reporting period ended June 29, 2014, versus the comparable prior year period with net income attributable to Cummins of $414 million, or $2.20 per diluted share, on sales of $4.5 billion. The increase in net income and earnings per share was driven by improved gross margin, partially offset by higher selling, general and administrative expenses. The improved gross margin was the result of higher volumes, lower material and commodity costs and improved Distribution segment sales related to the consolidation of partially-owned North American distributors since March 30, 2013, partially offset by unfavorable foreign currency fluctuations.

                                                             Six months ended
Operating Segments             June 29, 2014                        June 30, 2013                 Percent change
                                  Percent                              Percent                     2014 vs. 2013
In millions            Sales      of Total      EBIT        Sales     of Total      EBIT        Sales         EBIT
Engine               $ 5,307          57  %   $   580     $ 4,959         59  %   $   534          7  %          9  %
Components             2,510          27  %       352       2,135         25  %       255         18  %         38  %
Power Generation       1,382          15  %        86       1,560         18  %       127        (11 )%        (32 )%
Distribution           2,188          24  %       202       1,732         21  %       195         26  %          4  %
Intersegment
eliminations          (2,146 )       (23 )%         -      (1,939 )      (23 )%         -         11  %          -
Non-segment                -           -          (35 )         -          -          (53 )        -           (34 )%
Total                $ 9,241         100  %   $ 1,185     $ 8,447        100  %   $ 1,058          9  %         12  %

Net income attributable to Cummins was $784 million, or $4.26 per diluted share, on sales of $9.2 billion for the six months ended June 29, 2014, versus the comparable prior year period with net income attributable to Cummins of $696 million, or $3.69 per diluted share, on sales of $8.4 billion. The increase in net income and earnings per share was driven by improved gross margin, partially offset by higher selling, general and administrative expenses. The improved gross margin was the result of higher volumes, lower material and commodity costs and improved Distribution segment sales related to the consolidation of partially-owned North American distributors since December 31, 2012, partially offset by unfavorable foreign currency fluctuations. Diluted earnings per share for the six months ended June 29, 2014, benefited $0.05 from lower shares outstanding, primarily due to purchases under the stock repurchase program.

We generated $701 million of operating cash flows for the six months ended June 29, 2014, compared to $960 million for the same period in 2013. Refer to the section titled "Operating Activities" in the "Liquidity and Capital Resources" section for a discussion of items impacting cash flows.
In September 2013, we announced our intention to acquire the equity that we do not already own in most of our partially-owned United States and Canadian distributors over the next three to five years. We plan to spend approximately $450 million to $550 million on distributor acquisitions and debt retirements in 2014.
On May 5, 2014, we acquired the remaining 30 percent interest in Cummins Power Systems LLC (Power Systems) from the former distributor principal for consideration of approximately $14 million in cash. The entity was previously consolidated and, as a result, the acquisition was accounted for as an equity transaction instead of a business combination.
On March 31, 2014, we acquired the remaining 50 percent interest in Cummins Southern Plains LLC (Southern Plains) from the former distributor principal. The purchase consideration was $92 million, which included $41 million in cash and an additional $48 million paid to eliminate outstanding debt. As a result of this transaction, Distribution segment results included


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a $13 million gain, as we were required to re-measure our pre-existing 50 percent ownership interest in Southern Plains to fair value in accordance with GAAP for the three and six months ended June 29, 2014.
On February 14, 2014, we acquired the remaining 62.2 percent interest in Cummins Mid-South LLC (Mid-South) from the former distributor principal. The purchase consideration was $118 million, which included $32 million in cash, $61 million to eliminate outstanding debt, and $4 million payable in future periods. As a result of this transaction, Distribution segment results for the six months ended included a $7 million gain, as we were required to re-measure our pre-existing 37.8 percent ownership interest in Mid-South to fair value in accordance with GAAP.
We repurchased $430 million of stock under the 2012 Board of Directors authorized plan during the first half of 2014. In July 2014, our Board of Directors authorized the acquisition of up to $1 billion of additional common stock upon the completion of the 2012 repurchase plan.
Our debt to capital ratio (total capital defined as debt plus equity) at June 29, 2014, was 17.2 percent, compared to 18.1 percent at December 31, 2013. As of the date of filing this Quarterly Report on Form 10-Q, we had an 'A' credit rating with a 'Stable' outlook from Standard & Poor's Rating Services, an 'A' credit rating with a 'Stable' outlook from Fitch Ratings and an 'A3' credit rating with a 'Stable' outlook from Moody's Investors Service, Inc. In addition to the $2.4 billion in cash and marketable securities on hand, we also have access to our credit facilities, if necessary, to meet currently anticipated investment and funding needs.
In July 2014, the Board of Directors authorized a dividend increase of approximately 25 percent from $0.625 per share to $0.78 per share on a quarterly basis.
Our global pension plans, including our unfunded and non-qualified plans, were 107 percent funded at December 31, 2013. Our U.S. qualified plan, which represents approximately 55 percent of the worldwide pension obligation, was 121 percent funded and our United Kingdom (U.K.) plan was 106 percent funded. We expect to contribute $205 million to our global pension plans in 2014. We anticipate pension and other postretirement benefit cost in 2014 to decrease by approximately $36 million pre-tax, or approximately $0.12 per diluted share, when compared to 2013 due to reduced loss amortization resulting from improved U.S. asset performance and a higher discount rate, Refer to Note 4, "PENSION AND OTHER POSTRETIREMENT BENEFITS" for additional information regarding our pension plans.
We expect our effective tax rate for the full year of 2014 to approximate 28 percent, excluding any one-time tax items that may arise, compared to 25.1 percent for 2013.


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OUTLOOK

Near-Term
In the second quarter of 2014, demand remained strong in several end markets in North America compared to the same period in the prior year, led by strong North American on-highway demand. Demand remained weak in most international markets due to lower on-highway demand.
We currently expect the following positive trends for the remainder of 2014:
• Market share gains in the North American medium-duty truck and bus markets are expected to continue in 2014 and should positively impact sales in both the Engine and Components segments.

• Demand in the North American heavy-duty truck market is expected to continue to improve.

• We plan to continue acquiring our partially-owned North American distributors, which will increase our Distribution segment revenues and EBIT dollars , however, will be dilutive to Distribution EBIT as a percentage of sales.

• The new Euro VI regulations, effective January 1, 2014, are expected to continue to positively impact sales for aftertreatment products.

We currently expect the following challenges to our business that may reduce our earnings potential for the remainder of 2014:
• Power generation markets are expected to remain weak.

• Demand in most end markets in India is expected to remain weak.

• Weak economic growth in Brazil could continue to negatively impact our on-highway and power generation businesses.

• Demand in certain European markets could remain weak due to continued economic uncertainty.

• Growth in emerging markets could be negatively impacted if emission regulations are not strictly enforced.

• Foreign currency volatility could continue to put pressure on earnings.

Long-Term
We believe that, over the longer term, there will be economic improvements in most of our current markets and that our opportunities for long-term profitable growth will continue as the result of the following four macroeconomic trends that should benefit our businesses:
• tightening emissions controls across the world;

• infrastructure needs in emerging markets;

• energy availability and cost issues and

• globalization of industries like ours.


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RESULTS OF OPERATIONS
                                                  Three months ended                 Favorable/                 Six months ended                  Favorable/
                                                                                (Unfavorable)                                                    (Unfavorable)
In millions (except per share amounts)    June 29, 2014       June 30, 2013      Amount     Percent     June 29, 2014      June 30, 2013       Amount     Percent
NET SALES                                $       4,835      $         4,525     $   310         7  %   $       9,241     $         8,447     $    794         9  %
Cost of sales                                    3,608                3,372        (236 )      (7 )%           6,898               6,337         (561 )      (9 )%
GROSS MARGIN                                     1,227                1,153          74         6  %           2,343               2,110          233        11  %
OPERATING EXPENSES AND INCOME
Selling, general and administrative
expenses                                           535                  484         (51 )     (11 )%           1,037                 928         (109 )     (12 )%
Research, development and engineering
expenses                                           179                  177          (2 )      (1 )%             369                 359          (10 )      (3 )%
Equity, royalty and interest income
from investees                                     105                  108          (3 )      (3 )%             195                 190            5         3  %
Other operating income (expense), net               (6 )                 10         (16 )      NM                 (7 )                11          (18 )      NM
OPERATING INCOME                                   612                  610           2         -  %           1,125               1,024          101        10  %
Interest income                                      6                   10          (4 )     (40 )%              11                  15           (4 )     (27 )%
Interest expense                                    15                    8          (7 )     (88 )%              32                  14          (18 )      NM
Other income (expense), net                         39                    1          38        NM                 49                  19           30        NM
INCOME BEFORE INCOME TAXES                         642                  613          29         5  %           1,153               1,044          109        10  %
Income tax expense                                 170                  172           2         1  %             323                 291          (32 )     (11 )%
CONSOLIDATED NET INCOME                            472                  441          31         7  %             830                 753           77        10  %
Less: Net income attributable to
noncontrolling interests                            26                   27           1         4  %              46                  57           11        19  %
NET INCOME ATTRIBUTABLE TO CUMMINS
INC.                                     $         446      $           414     $    32         8  %   $         784     $           696     $     88        13  %
Diluted earnings per common share
attributable to Cummins Inc.             $        2.43      $          2.20     $  0.23        10  %   $        4.26     $          3.69     $   0.57        15  %

"NM" - not meaningful information


                                     Three months ended              Favorable/            Six months ended             Favorable/
                                                                   (Unfavorable)                         June 30,     (Unfavorable)
Percent of sales              June 29, 2014     June 30, 2013    Percentage Points     June 29, 2014       2013     Percentage Points
Gross margin                         25.4 %             25.5 %             (0.1 )           25.4 %         25.0 %              0.4
Selling, general and
administrative expenses              11.1 %             10.7 %             (0.4 )           11.2 %         11.0 %             (0.2 )
Research, development and
engineering expenses                  3.7 %              3.9 %              0.2              4.0 %          4.3 %              0.3

Net Sales
Net sales for the three months ended June 29, 2014, increased versus the comparable period in 2013, primarily due to higher demand and the impact from the acquisitions of the partially-owned North American distributors since March 31, 2013. The primary drivers by segment were as follows:
• Distribution segment sales increased by 30 percent primarily due to the acquisitions of North American distributors.

• Components segment sales increased by 15 percent and increased in all businesses and in most markets primarily due to higher demand in the North American on-highway markets and increased demand in Europe and China.

. . .

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