(EDGAR Online via COMTEX) -- ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 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 the accompanying notes to those financial statements. Our MD&A is presented in the following sections: EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS RESULTS OF OPERATIONS OPERATING SEGMENT RESULTS 2021 OUTLOOK LIQUIDITY AND CAPITAL RESOURCES CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS APPLICATION OF CRITICAL ACCOUNTING ESTIMATES RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS The following is the discussion and analysis of changes in the financial condition and results of operations for fiscal year 2020 compared to fiscal year 2019. The discussion and analysis of fiscal year 2018 and changes in the financial condition and results of operations for fiscal year 2019 compared to fiscal year 2018 that are not included in this Form 10-K may be found in Part II, ITEM 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the Securities and Exchange Commission (SEC) on February 11, 2020. EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS Overview We are a global power leader that designs, manufactures, distributes and services diesel, natural gas, electric and hybrid powertrains and powertrain-related components including filtration, aftertreatment, turbochargers, fuel systems, controls systems, air handling systems, automated transmissions, electric power generation systems, batteries, electrified power systems, hydrogen production and fuel cell products. We sell our products to original equipment manufacturers (OEMs), distributors, dealers and other customers worldwide. We have long-standing relationships with many of the leading manufacturers in the markets we serve, including PACCAR Inc, Navistar International Corporation, Daimler Trucks North America and Stellantis N.V. (Chrysler). We serve our customers through a network of over 500 wholly-owned, joint venture and independent distributor locations and over 9,000 Cummins certified dealer locations with service to approximately 190 countries and territories. Our reportable operating segments consist of Engine, Distribution, Components, Power Systems and New Power. This reporting structure is organized according to the products and markets each segment serves. The Engine segment produces engines (15 liters and smaller) and associated parts for sale to customers in on-highway and various off-highway markets. Our engines are used in trucks of all sizes, buses and recreational vehicles, as well as in various industrial applications, including construction, agriculture, power generation systems and other off-highway applications. 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. The Components segment sells filtration products, aftertreatment systems, turbochargers, electronics, fuel systems and automated transmissions. The Power Systems segment is an integrated power provider, which designs, manufactures and sells engines (16 liters and larger) for industrial applications (including mining, oil and gas, marine and rail), standby and prime power generator sets, alternators and other power components. The New Power segment designs, manufactures, sells and supports hydrogen production solutions as well as electrified power systems ranging from fully electric to hybrid along with innovative components and subsystems, including battery and fuel cell technologies. We continue to serve all our markets as they adopt electrification and alternative power technologies, meeting the needs of our OEM partners and end customers. Table of Contents 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, 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, public health crises, epidemics or pandemics 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. COVID-19 Update The outbreak of COVID-19 spread throughout the world and became a global pandemic with the resultant economic impacts evolving into a worldwide recession. The pandemic triggered a significant downturn in our markets globally, which continued to unfavorably impact market conditions throughout 2020 and these challenging market conditions could continue for an extended period of time. In an effort to contain the spread of COVID-19, maintain the well-being of our employees and stakeholders, match the reduced demand from our customers and in accordance with governmental requirements, we closed or partially shut down certain office, manufacturing, distribution and technical center facilities around the world in March 2020. Although most of our manufacturing, distribution and technical center facilities re-opened early in the second quarter of 2020, some operated at reduced capacities, most of our global office buildings remained closed through the remainder of 2020. Despite many of our markets recovering in the second half of 2020, the ongoing spread of the virus prior to widespread vaccination presents several risks to our business, especially in the first half of 2021. COVID-19 vaccines are currently being administered around the world with the hope that the majority of the population will have access to the vaccine by the middle of 2021. If the distribution and the effectiveness of the vaccine are consistent with current government and health organization estimates, we anticipate the vaccine will mitigate the spread of the virus by the end of 2021 and allow a return to more normal operations in the second half of the year. While the impacts of the pandemic and the resulting global recession are expected to be temporary, the duration of the production and supply chain disruptions, and related financial impacts, cannot be estimated at this time. Should the reduced manufacturing and distribution capacities continue for an extended period of time or worsen, the impact on our production and supply chain could have a material adverse effect on our results of operations, financial condition and cash flows. Our Board of Directors (the Board) continues to monitor and evaluate all of these factors along with the continuing impacts of the COVID-19 pandemic on our business and operations. 2020 Results A summary of our results is as follows: Years ended December 31, In millions, except per share amounts 2020 2019 2018 Net sales $ 19,811 $ 23,571 $ 23,771 Net income attributable to Cummins Inc. 1,789 2,260 2,141 Earnings per common share attributable to Cummins Inc. Basic $ 12.07 $ 14.54 $ 13.20 Diluted 12.01 14.48 13.15
Worldwide revenues decreased 16 percent in 2020 compared to 2019, as we experienced lower demand in all major operating segments and most geographic regions due to the economic impacts of COVID-19 and the anticipated 2020 down cycle in most of our markets. Net sales in the U.S. and Canada declined by 21 percent primarily due to COVID-19 impacts resulting in decreased demand in the North American on-highway markets, which also negatively impacted our emission solutions, automated transmissions and turbo technologies businesses, reduced sales in all distribution product lines, decreased demand for power generation equipment and lower demand in off-highway markets (especially construction). International demand (excludes the U.S. and Canada) declined by 7 percent compared to 2019, with lower sales in all geographic regions except China. The decrease in international sales was principally due to COVID-19 impacts resulting in lower demand for industrial products (primarily international mining markets), decreased demand for power generation equipment, lower volumes in on-highway markets (mainly medium-duty truck markets), reduced demand in all distribution product lines and unfavorable foreign currency impacts of 2 percent of international sales (primarily the
Operating Segments 2020 2019 Percent change Percent Percent 2020 vs. 2019 In millions Sales of Total EBITDA Sales of Total EBITDA Sales EBITDA Engine $ 8,022 41 % $ 1,235 $ 10,056 43 % $ 1,454 (20) % (15) % Distribution 7,136 36 % 665 8,071 34 % 656 (12) % 1 % Components 6,024 31 % 961 6,914 29 % 1,097 (13) % (12) % Power Systems 3,631 18 % 343 4,460 19 % 512 (19) % (33) % New Power 72 - % (172) 38 - % (149) 89 % (15) %
Net income attributable to Cummins Inc. for 2020 was $1.8 billion, or $12.01 per diluted share, on sales of $19.8 billion, compared to 2019 net income attributable to Cummins Inc. of $2.3 billion, or $14.48 per diluted share, on sales of $23.6 billion. The decrease in net income attributable to Cummins Inc. and earnings per diluted share was driven by lower net sales, decreased gross margin, a higher effective tax rate and unfavorable foreign currency fluctuations (primarily the Brazilian real), partially offset by prior restructuring actions, temporary salary reductions and reduced variable compensation resulting in lower overall compensation expenses, increased equity, royalty and interest income from investees primarily in China (due to stronger demand for construction equipment and trucks) and favorable adjustments related to India Tax Law Changes in March 2020. The decrease in gross margin and gross margin percentage was mainly due to lower volumes, partially offset by prior restructuring actions, temporary salary reductions and lower variable compensation resulting in decreased compensation expenses and lower material costs. Diluted earnings per common share for 2020 benefited $0.24 per share from fewer weighted-average shares outstanding, primarily due to the stock repurchase program.
Table of Contents RESULTS OF OPERATIONS
Favorable/(Unfavorable) Years ended December 31, 2020 vs. 2019 2019 vs. 2018 In millions (except per share amounts) 2020 2019 2018 Amount Percent Amount Percent NET SALES $ 19,811 $ 23,571 $ 23,771 $ (3,760) (16) % $ (200) (1) % Cost of sales 14,917 17,591 18,034 2,674 15 % 443 2 % GROSS MARGIN 4,894 5,980 5,737 (1,086) (18) % 243 4 % OPERATING EXPENSES AND INCOME Selling, general and administrative expenses 2,125 2,454 2,437 329 13 % (17) (1) % Research, development and engineering expenses 906 1,001 902 95 9 % (99) (11) % Equity, royalty and interest income from investees 452 330 394 122 37 % (64) (16) % Restructuring actions - 119 - 119 100 % (119) NM Other operating expense, net (46) (36) (6) (10) (28) % (30) NM OPERATING INCOME 2,269 2,700 2,786 (431) (16) % (86) (3) % Interest expense 100 109 114 9 8 % 5 4 % Other income, net 169 243 81 (74) (30) % 162 NM INCOME BEFORE INCOME TAXES 2,338 2,834 2,753 (496) (18) % 81 3 % Income tax expense 527 566 566 39 7 % - - % CONSOLIDATED NET INCOME 1,811 2,268 2,187 (457) (20) % 81 4 % Less: Net income attributable to noncontrolling interests 22 8 46 (14) NM 38 83 % NET INCOME ATTRIBUTABLE TO CUMMINS INC. $ 1,789 $ 2,260 $ 2,141 $ (471) (21) % $ 119 6 % Diluted earnings per common share attributable to Cummins Inc. $ 12.01 $ 14.48 $ 13.15 $ (2.47) (17) % $ 1.33 10 % "NM" - not meaningful information Favorable/(Unfavorable) Percentage Points Percent of sales 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Gross margin 24.7 % 25.4 % 24.1 % (0.7) 1.3 Selling, general and administrative expenses 10.7 % 10.4 % 10.3 % (0.3) (0.1) Research, development and engineering expenses 4.6 % 4.2 % 3.8 % (0.4) (0.4) 2020 vs. 2019 Net Sales
Feb 10, 2021
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