SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A2
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1998
CUMMINS ENGINE COMPANY, INC.
Commission File Number 1-4949
Incorporated in the State of Indiana I.R.S. Employer Identification
No. 35-0257090
500 Jackson Street, Box 3005, Columbus, Indiana 47202-3005
(Principal Executive Office)
Telephone Number: (812) 377-5000
Securities registered pursuant to Section 12(b) of the Act: Common
Stock, $2.50 par value, which is registered on the New York Stock
Exchange and on the Pacific Stock Exchange.
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports)
and (2) has been subject to such filing requirements for the past 90
days. Yes [x] No [ ]
Indicate by check mark if disclosures of delinquent filers pursuant to
Item 405 of Regulation S-K are not contained herein and will not be
contained, to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. [x]
The aggregate market value of the voting stock held by non-affiliates
was approximately $1.6 billion at January 29, 1999.
As of January 29, 1999, there were outstanding 42.0 million shares of
the only class of common stock.
Documents Incorporated by Reference
Portions of the registrant's definitive Proxy Statement filed with the
Securities and Exchange Commission pursuant to Regulation 14A are
incorporated by reference in Part III of this Form 10-K.
<PAGE> 2
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
_______ _____________________________________________________________
OVERVIEW
________
Net sales were a record $6.3 billion in 1998, 11 percent higher than
in 1997, and 19 percent higher than in 1996. Nelson Industries, Inc.,
acquired in January 1998, and Cummins India Limited, which was first
consolidated in the fourth quarter of 1997, added sales of $428
million. Without these additional sales, net sales for 1998 would
have been $5.8 billion, an increase of 4 percent over 1997.
As disclosed in Notes 3 and 4 to the Consolidated Financial
Statements, the Company recorded charges in 1998 totaling $217
million, comprised of $78 million for revised estimates of additional
product coverage liability for both base and extended warranty
programs, $114 million of costs associated with the Company's plan to
restructure, consolidate and exit certain business activities and $25
million for a civil penalty resulting from an agreement reached with
the U.S. Environmental Protection Agency and the Department of Justice
regarding diesel engine emissions. Excluding these charges, earnings
before interest and taxes were $282 million in 1998, compared to $312
million in 1997 and $232 million in 1996. Including the charges, the
Company's net loss was $21 million or $(.55) per share in 1998. Net
earnings in 1997 were $212 million or $5.48 per share and $160 million
or $4.01 per share in 1996.
To maintain Cummins' technological leadership, the Company has been in
the process of upgrading or replacing engines across all product
lines. This new product development program peaked in 1998 with a
record six new engine introductions. While this investment in product
development offers competitive advantages, it resulted in a temporary
increase in product costs and a decrease in profitability in 1998.
RESULTS OF OPERATIONS
_____________________
Net Sales:
__________
In 1998, the Company achieved its seventh consecutive year of record
sales, totaling $6.3 billion. Revenues from sales of engines were 55
percent of the Company's net sales in 1998, with engine revenues and
unit shipments 8 percent and 9 percent higher, respectively, than in
1997. The Company shipped a record 403,300 engines in 1998, compared
to 369,800 in 1997 and 332,300 in 1996 as follows:
Unit shipments 1998 1997 1996
________________ _______ _______ _______
Midrange engines 287,400 264,300 237,400
Heavy-duty engines 106,100 94,900 85,000
High-horsepower engines 9,800 10,600 9,900
_______ _______ _______
403,300 369,800 332,300
_______ _______ _______
_______ _______ _______
Revenues from non-engine products, which were 45 percent of net sales
in 1998, were 16 percent higher than in 1997. The major changes
within non-engine revenues were in filtration, with the sales of
Nelson included from the date of acquisition by Cummins, and PowerCare
(which includes new parts and remanufactured engines and parts).
Sales of the remaining non-engine products, in the aggregate, were
essentially level with 1997.
The Company's sales for each of its key segments during the last three
years were:
$ Millions 1998 1997 1996
__________ ______ ______ ______
Automotive markets $2,928 $2,622 $2,447
Industrial markets 1,054 1,044 863
_____ _____ _____
Engine Business 3,982 3,666 3,310
Power Generation Business 1,230 1,205 1,213
Filtration Business & Other 1,054 754 734
______ ______ ______
$6,266 $5,625 $5,257
______ ______ ______
______ ______ ______
<PAGE> 3
Cummins' engine business is the Company's largest business segment,
producing engines and parts for sale to customers in both automotive
and industrial markets. Engine business customers are each serviced
through the Company's worldwide distributor network. The engines are
used in trucks of all sizes, buses and recreational vehicles, as well
as a variety of industrial applications including construction,
mining, agriculture, marine, rail and military. Engine business
revenues were $4.0 billion in 1998, a 9 percent increase over 1997 and
20 percent over 1996.
Sales of $2.9 billion in 1998 for automotive markets were 12 percent
higher than in 1997 and 20 percent higher than in 1996. In 1998,
heavy-duty truck engine revenues were 19 percent higher than in 1997
on a 20-percent increase in units. Within the North American heavy-
duty truck market, unit shipments were up 20 percent over 1997, and
Cummins continued to be the market leader with a 32-percent market
share. In 1998, the Company began limited production of the Signature
600, a new electronic engine designed to capture a larger share of
this market. International unit shipments for the heavy-duty market
in 1998 were 20 percent higher than in 1997 due to continued strong
demand in European and Mexican automotive markets.
Revenues from the sales of engines for medium-duty trucks in 1998 were
13 percent lower than in 1997 on a 12-percent decrease in units. In
North America, the Company was affected by Ford's relocation of its
production facilities, partially offset by increased sales in
international markets, primarily Brazil.
For the bus and light commercial vehicle market, engine revenues in
1998 were 26 percent higher than in 1997, on a 22-percent increase in
unit shipments. In January, Cummins jointly announced with
DaimlerChrysler a new, fully electronic engine -- the ISB -- for the
Dodge Ram pickup. The increase in 1998 was due primarily to record
unit shipments to DaimlerChrysler for the Dodge Ram pickup, which were
26 percent higher than in 1997 and 37 percent higher than in 1996, and
continued strong demand in bus markets.
In 1998, revenues from industrial markets were 1 percent higher than
in 1997. Revenues from sales of engines decreased, while parts sales
increased. Engine revenues in 1998 were 1 percent lower than in 1997
on an 8-percent increase in unit shipments. The variance between
revenues and units resulted from lower heavy-duty and high-horsepower
engine sales and a shift in product mix of midrange engine sales. The
increased level of shipments was due to continued strong construction
volumes in North America and Europe, partially offset by declines in
worldwide agricultural markets. Sales of engines and parts into the
marine market in 1998 were 6 percent lower than in 1997, due primarily
to the economic turmoil in Asia. Sales into the mining market were 21
percent lower than the prior year. In 1998, Cummins announced an
agreement with Komatsu, a joint venture partner, to develop a 3.3
liter engine targeted for the construction market, scheduled for
release in the second half of 1999.
Revenues of $1.2 billion in 1998 for power generation were 2 percent
higher than in 1997 and 1 percent higher than in 1996, with sales
continuing to be impacted by the economic conditions in Asia and lower
sales in Europe. Without the consolidation of Cummins India Limited,
power generation sales would have decreased 4 percent from 1997.
Sales of the Company's generator sets continued to reflect growth in
North America, which offset declines in demand for generator sets in
Asia. Engine sales to generator set assemblers were down 12 percent
from the prior year and sales of alternators were down 11 percent, due
primarily to lower demand in Asia and the Company's change in
strategy, emphasizing sales of generator sets. Sales of small
generator sets for recreational vehicles and other consumer markets
remained strong in North America, increasing 12 percent from 1997.
Sales of $1.1 billion in 1998 for filtration and other were 40 percent
higher than in 1997 and 44 percent higher than in 1996, with Nelson,
acquired in January 1998, contributing sales of $311 million.
International distributor sales increased 12 percent from 1997 due to
the consolidation of Cummins India Limited in the fourth quarter of
1997.
<PAGE> 4
Net sales by marketing territory for each of the last three years
were:
$ Millions 1998 1997 1996
__________ ______ ______ ______
United States $3,595 $3,123 $2,925
Asia/Australia 806 898 868
Europe/CIS 791 796 759
Mexico/Latin America 468 364 260
Canada 459 318 313
Africa/Middle East 147 126 132
______ ______ ______
$6,266 $5,625 $5,257
______ ______ ______
______ ______ ______
In total, international markets accounted for 43 percent of the
Company's revenues in 1998. Europe and the CIS, representing 13
percent of the Company's sales in 1998, were 1 percent lower than in
1997 and 4 percent higher than in 1996. Sales to Canada, representing
7 percent of sales in 1998, were 44 percent higher than in 1997 due to
the acquisition of Nelson and the relocation of certain customer
production facilities. Asian and Australian markets, in total,
represented 13 percent of the Company's sales in 1998, as compared to
16 percent in 1997 and 17 percent in 1996. In Asia, sales to China
were essentially flat compared to 1997, while revenues in Korea
decreased 64 percent, Southeast Asia declined 47 percent and sales to
Japan and India were 19 percent below 1997 levels, excluding the
effect of Cummins India Limited consolidation.
Business in Mexico and Latin America, representing 8 percent of sales,
was 29 percent higher than in 1997, but began to decline in the latter
part of 1998. Sales to Latin America, including Brazil, represented 4
percent of the Company's sales in 1998 and were 28 percent higher than
in 1997. Brazil individually accounted for 2 percent of sales in 1998.
The recent economic events in Brazil have resulted in increased interest
rates and devalued currencies in the region. Many of the Company's
customers are sensitive to interest rates, which will affect sales
demand. The devaluation of local currencies also could have an impact
on operations, as certain of the Company's transactions are based in
Brazilian currency, and could result in currency gains or losses. Sales
to Mexico, representing approximately 4 percent of the Company's sales
in 1998, could also potentially be affected by the economic uncertainty
in Brazil. These events could reasonably be expected to have an adverse
effect on the Company's business, however, the extent cannot be
estimated reasonably based upon presently available information.
Gross Margin:
_____________
As disclosed in Note 3 to the Consolidated Financial Statements, the
Company recorded special charges of $92 million for product coverage
costs and inventory write-downs. The product coverage special charges
of $78 million include $43 million primarily attributable to base
warranty costs and $35 million for extended warranty programs. The
$43 million charge attributable to base warranty costs resulted from
recent claim payment information which indicated engines in the field
were experiencing higher warranty costs than expected due to some
specific high-cost failures on certain engines. The estimate of base
warranty liability was adjusted to reflect the impact of all this new
information regarding the products' performance. The $35 million
charge attributable to extended warranty costs was the result of the
use of improved estimating techniques to determine the liability for
these costs. The special charges recorded in 1998 also include $14
million for inventory write-downs associated with the Company's
restructuring and exit activities. These write-downs reflect amounts
of inventory rendered excess or unusable due to the closing or
consolidation of facilities.
The Company's gross margin percentage before the product coverage and
inventory special charges was 21.4 percent in 1998, compared to 22.8
percent in 1997 and 22.5 percent in 1996. The Company's gross margin
percentage declined due to a temporary increase in product coverage
costs from ISB and ISC engines and higher new product costs
attributable to the production ramp-up of the ISB, ISC and Signature
600 engines. This decrease was partially offset by the benefit from
higher volume and pricing. The acquisition of Nelson and
consolidation of Cummins India Limited added $124 million. Gross
margin percentage after the special charges was 19.9 percent. Product
coverage costs, excluding the special charges, were 3.3 percent of net
sales in 1998, compared to 2.6 percent in 1997 and 2.7 percent in
1996.
<PAGE> 5
Operating Expenses:
___________________
Selling and administrative expenses were 12.5 percent of net sales in
1998, compared to 13.2 percent in 1997 and 13.8 percent in 1996. On
the 11-percent sales increase in 1998, these expenses, which include
volume-variable components, were up less than 6 percent in absolute
dollars. Net benefits of the Company's cost reduction and
restructuring actions were partially offset by increases in expenses
associated with new product launches and information systems during
1998.
Research and engineering expenses were 4.1 percent of net sales in
1998, compared to 4.6 percent in 1997 and 4.8 percent in 1996. This
is a result of a reduction in technical spending and certain product
developments moving to the production stage.
The Company's losses from joint ventures and alliances were $30
million in 1998, compared to income of $10 million in 1997. The
difference was due primarily to the consolidation of Cummins India
Limited and losses at the Company's joint venture with Wartsila.
Cummins Wartsila is being affected by lower sales, primarily due to
decreased demand in Asia, and higher product coverage expenses.
In an effort to address the decline in the Company's business in Asia,
to leverage overhead costs for all operations and to improve joint
venture operating performance, the Company established a restructuring
program in 1998. As a result of this program, the Company recorded a
charge of $100 million for costs to reduce the worldwide workforce by
approximately 1,100 people, as well as costs associated with
streamlining certain majority-owned and international joint venture
operations.
The charges for majority-owned operations included $38 million for
severance and related costs associated with workforce reductions in the
engine and power generation businesses, primarily for administrative
positions. The costs of these reductions were based on amounts pursuant
to benefit programs and contractual provisions or statutory requirements
at the affected operations. Approximately one-half of these 1,100
employees left the Company prior to December 31, 1998. An asset
impairment loss of $22 million, calculated according to the provisions of
SFAS No. 121, was recorded primarily for engine manufacturing equipment
to be disposed of upon the closure or consolidation of facilities or the
outsource of production. The recovery value for the equipment to be
disposed of was based on estimated liquidation value. The carrying value
of assets held for disposal and the effect on earnings from suspending
depreciation on such assets is immaterial. The equipment write-off of $22
million was for the following:
$ Millions
__________
N-14 engine component assets for which production
is scheduled to be outsourced in the first half of
1999 $12
Brazilian engine operation assets for which production
is planned to be discontinued by the end of 1999 4
Holset Germany operations assets to be disposed of
by the end of 1998 3
Other facility closures and consolidations to be
completed by the end of 1998 3
Facility consolidation and other costs of $17 million included lease
termination and facility exit costs of $10 million, product support
costs of $3 million, and litigation and other costs of $4 million. As
the restructuring consists primarily of the closing or consolidation
of smaller operations, the Company does not expect these actions to
have a material effect on future revenues.
The charges for restructuring joint venture operations totaled $23
million, the majority of which relates to actions being taken at the
Company's joint venture with Wartsila, which is part of the Company's
power generation business. The charges included $11 million for
employee severance and related benefits for approximately 1,200
people, $7 million for a tax asset impairment loss and $5 million for
other facility and equipment-related charges.
<PAGE> 6
Approximately $25 million, including $12 million of payments related
to employee severance, has been charged to the restructuring
liabilities as of December 31, 1998. Of the total charges associated
with restructuring activities, cash outlays will approximate $60
million. The program is expected to be essentially complete by the
end of 1999 and yield approximately $50 million in annual savings at
completion. The annual savings of $50 million are expected to come
from lower depreciation of approximately $2 million and reduced
employee costs of approximately $48 million and relate to actions
within the engine business totaling $33 million and actions within the
power generation business of $17 million.
In 1998, the Company recorded a charge of $25 million for a civil
penalty to be paid by the Company as a result of an agreement reached
with the U.S. Environmental Protection Agency, the Department of
Justice and the California Air Resources Board regarding diesel engine
emissions. In addition to the civil penalty, the agreement provides a
schedule for diesel engines to meet certain emission standards and
requires manufacturers to continue to invest in environmental projects
to further reduce oxides of nitrogen (NOx) emissions. The Company has
developed extensive corporate action plans to comply with all aspects
of the agreement. Additionally, three separate court actions have
been filed as a result of allegations of the diesel emissions matter.
The New York Supreme Court ruled in favor of the Company. This matter
is now on appeal. A California State Court recently ruled in favor of
the Company. A recent action was just filed in the U.S. District
Court, the District of Columbia.
Year 2000:
__________
The Company continues to address the impact of the Year 2000 issue on
its businesses worldwide. This issue affects computer systems that
have date-sensitive programs that may not properly recognize the year
2000. With respect to the Company, this issue affects not only
computer systems but also machinery and equipment used in production
that may contain embedded computer technology.
Following a review and assessment of information systems and
technology used in its internal business operations and production,
the Company inventoried and identified those systems and products that
the Company believes may be vulnerable to Year 2000 failures and
established a program to address Year 2000 issues. The Company's Year
2000 efforts are being carried out by the Company's Year 2000 Team
under the leadership of the Director of Year 2000 Compliance. A Year
2000 program office has been established at each of the Company's
facilities and is overseen by a Year 2000 coordinator. The Year 2000
Team maintains a reporting structure to ensure that progress is made
and tracked on Year 2000 issues. In addition to internal resources,
the Company has retained external resources to assist with the
implementation of its Year 2000 program.
The Company's program consists of the remediation, replacement or
retirement of affected systems. Remediation is the alteration of a non-
compliant application to make it compliant, replacement is the
substitution of a non-compliant application with a compliant upgrade
or product and retirement is the discarding of non-compliant
applications that have been determined to be dispensable.
The Company completed a substantial portion of its remediation efforts
and testing in 1998, and expects to complete that process by the end
of the second quarter of 1999.
The Year 2000 Team will remain in place through January 1, 2000, and
beyond as needed. Their role is to ensure that compliance is
maintained once it is attained. The Company maintains contact with
its key suppliers to obtain information relating to the status of such
suppliers with respect to Year 2000 issues, placing particular
emphasis on determining the Year 2000 readiness of its critical
suppliers.
The Company expects to incur total expenditures of approximately $45
million in connection with its Year 2000 program and remediation
efforts. To date, the Company has incurred approximately $30 million
in costs relating to its Year 2000 efforts.
<PAGE> 7
There can be no assurances that the systems or products of third
parties, which the Company relies upon, will be timely converted or
that a failure by a third party, or a conversion that is incompatible
with the Company's systems, would not have a material adverse effect
on the Company. This is particularly true because the Company
utilizes sole suppliers for certain products. The high level of skill
and expertise required to develop certain components makes it
impossible to change suppliers quickly. The failure of a sole
supplier may lead to a delay in production.
The Company continues to develop contingency plans in the event that
its operations are disrupted on January 1, 2000. Such contingency
plans include the stockpiling of certain business critical inventory,
and identifying alternative suppliers where possible.
The estimated time of completion of the Company's Year 2000 program
and compliance efforts, and the expenses related to the Company's Year
2000 compliance efforts are based upon management's best estimates,
which were based on assumptions of future events, including the
availability of certain resources, third party modification plans and
other factors. There can be no assurances that these results and
estimates will be achieved, and the actual results could materially
differ from those anticipated. Specific factors that might cause such
material differences include, but are not limited to, the availability
of personnel trained in this area and the ability to locate and
correct all relevant computer codes.
Other:
______
Interest expense of $71 million was $45 million higher than in 1997
and $53 million higher than in 1996 due to the increased level of
borrowings to support working capital on the higher sales level and to
complete the acquisition of Nelson. Other income decreased $13
million in 1998 as compared to the year-ago period, primarily due to
the Nelson goodwill amortization and lower royalty income.
Provision for Income Taxes:
___________________________
The Company's effective income tax rate normally is below the 35% U.S.
federal corporate tax rate. The lower tax rate is a result of tax
benefits on export sales and tax credits on research expenses. These
benefits in 1998 were more than offset by the unfavorable tax effects
of nondeductible losses in foreign joint ventures and nondeductible
EPA penalty and goodwill amortization. The combined effect was a 1998
income tax provision of $4 million.
CASH FLOW AND FINANCIAL CONDITION
_________________________________
Key elements of cash flows were:
$ Millions 1998 1997 1996
__________ ______ ______ ______
Net cash used in operating and
investing activities $(481) $(154) $ (66)
Net cash from financing activities 471 96 110
Effect of exchange rate changes on cash (1) (1) 4
_____ _____ _____
Net change in cash $ (11) $ (59) $ 48
_____ _____ _____
_____ _____ _____
During 1998, net cash used for operating and investing activities was
$481 million. The higher level of net cash requirements in 1998 was
due primarily to the acquisition of Nelson, planned capital
expenditures ($271 million in 1998, compared to $405 million in 1997
and $304 million in 1996) for investments in new products and for
working capital. Net working capital as a percent of sales was 12.8
percent in 1998, compared to 11.6 percent in 1997. Investments in
joint ventures and alliances of $22 million reflected the net effect
of capital contributions and cash generated by certain joint ventures.
<PAGE> 8
Net cash provided from financing activities was $471 million in 1998.
As disclosed in Note 6, the Company issued $765 million face amount of
notes and debentures under a $1 billion registration statement filed
with the Securities and Exchange Commission in December 1997. Net
proceeds were used to finance the acquisition of Nelson and pay down
other indebtedness outstanding at December 31, 1997. Based on the
Company's projected cash flow from operations and existing credit
facilities, management believes that sufficient liquidity is available
to meet anticipated capital and dividend requirements in the
foreseeable future.
Market Risk:
____________
The Company is exposed to financial risk resulting from volatility in
foreign exchange rates, interest rates and commodity prices. This risk
is closely monitored and managed through the use of financial derivative
contracts. As clearly stated in the Company's policies and procedures,
financial derivatives are used expressly for hedging purposes, and under
no circumstances are they used for speculating or for trading.
Transactions are entered into only with banking institutions with strong
credit ratings, and thus the credit risk associated with these contracts
is considered immaterial. Hedging program results and status are
reported to senior management on a monthly and quarterly basis.
The following section describes the Company's risk exposures and
provides results of sensitivity analyses performed on December 31,
1998. The sensitivity tests assumed instantaneous, parallel shifts in
foreign currency exchange rates, commodity prices and interest rate
yield curves.
A. Foreign Exchange Rates
Due to its international business presence, the Company transacts
extensively in foreign currencies. As a result, corporate earnings
experience some volatility related to movements in exchange rates. In
order to exploit the benefits of global diversification and naturally
offsetting currency positions, foreign exchange balance sheet
exposures are aggregated and hedged at the corporate level through the
use of foreign exchange forward contracts. The objective of the
foreign exchange hedging program is to reduce earnings volatility
resulting from the translation of net foreign exchange balance sheet
positions. A hypothetical, instantaneous 10% adverse movement in
foreign exchange rates would decrease earnings by approximately $4
million in the current reporting period. The sensitivity analysis
ignores the impact of foreign exchange movements on Cummins'
competitive position as well as the remoteness of the likelihood that
all foreign currencies will move in tandem against the U.S. dollar.
The analysis also ignores the offsetting impact on income of the
revaluation of the underlying balance sheet exposures.
B. Interest Rates
The Company currently has in place an interest rate swap that
effectively converts fixed-rate debt into floating-rate debt. The
objective of the swap is to lower the cost of borrowed funds. A
sensitivity analysis assumed a hypothetical, instantaneous, 100 basis-
point parallel shift in the floating interest rate yield curve, after
which rates remained fixed at the new, higher level for a one-year
period. This change in the yield curve would correspond to a $2
million increase in interest expense for the one-year period. This
sensitivity analysis does not account for the change in the Company's
competitive environment indirectly related to changes in interest
rates and the potential managerial response taken in response to these
changes.
C. Commodity Prices
The Company is exposed to fluctuations in commodity prices through the
purchase of raw materials as well as contractual agreements with
component suppliers. Given the historically volatile nature of
commodity prices, this exposure can significantly impact product
costs. The Company uses commodity swap agreements to partially hedge
exposures to changes in copper and aluminum prices. Given a
hypothetical, instantaneous 10% depreciation of the underlying
commodity price, with prices then remaining fixed for a 12-month
period, the Company would experience a loss of approximately $3
million for the annual reporting period. This amount excludes the
offsetting impact of decreases in commodity costs.
<PAGE> 9
Forward-looking Statements
__________________________
This Management's Discussion and Analysis of Results of Operations and
Financial Condition and other sections of this Form 10-K contain
forward-looking statements that are based on current expectations,
estimates and projections about the industries in which Cummins
operates, management's beliefs and assumptions made by management.
Words, such as "expects," "anticipates," "intends," "plans,"
"believes," "seeks," "estimates," variations of such words and similar
expressions are intended to identify such forward-looking statements.
These statements are not guarantees of future performance and involve
certain risks, uncertainties and assumptions ("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. Cummins undertakes no obligation to update
publicly any forward-looking statements, whether as a result of new
information, future events or otherwise.
Future Factors include increasing price and product competition by
foreign and domestic competitors, including new entrants; rapid
technological developments and changes; the ability to continue to
introduce competitive new products on a timely, cost-effective basis;
the mix of products; the achievement of lower costs and expenses;
domestic and foreign governmental and public policy changes, including
environmental regulations; protection and validity of patent and other
intellectual property rights; reliance on large customers;
technological, implementation and cost/financial risks in increasing
use of large, multi-year contracts; the cyclical nature of Cummins'
business; the outcome of pending and future litigation and
governmental proceedings; and continued availability of financing,
financial instruments and financial resources in the amounts, at the
times and on the terms required to support Cummins' future business.
These are representative of the Future Factors that could affect the
outcome of the forward-looking statements. In addition, such
statements could be affected by general industry and market conditions
and growth rates, general domestic and international economic
conditions, including interest rate and currency exchange rate
fluctuations, and other Future Factors.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
___________________________________________________
See Index to Financial Statements on page 10 for a list of the
financial statements filed as a part of this report.
<PAGE> 10
INDEX TO FINANCIAL STATEMENTS
_____________________________
Page
____
Responsibility for Financial Statements 11
Report of the Independent Public Accountants 11
Consolidated Statement of Earnings 12
Consolidated Statement of Financial Position 13
Consolidated Statement of Cash Flows 14
Consolidated Statement of Shareholders' Investment 15
Notes to Consolidated Financial Statements 16
Quarterly Financial Data 28
<PAGE> 11
RESPONSIBILITY FOR FINANCIAL STATEMENTS
_______________________________________
Management is responsible for the preparation of the Company's
consolidated financial statements and all related information
appearing in this Form 10-K. The statements and notes have been
prepared in conformity with generally accepted accounting principles
and include some amounts which are estimates based upon currently
available information and management's judgment of current conditions
and circumstances. The Company engaged Arthur Andersen LLP,
independent public accountants, to examine the consolidated financial
statements. Their report appears on this page.
To provide reasonable assurance that assets are safeguarded against
loss from unauthorized use or disposition and that accounting records
are reliable for preparing financial statements, management maintains
a system of accounting and controls, including an internal audit
program. The system of accounting and controls is improved and
modified in response to changes in business conditions and operations
and recommendations made by the independent public accountants and the
internal auditors.
The Board of Directors has an Audit Committee whose members are not
employees of the Company. The committee meets periodically with
management, internal auditors and representatives of the Company's
independent public accountants to review the Company's program of
internal controls, audit plans and results, and the recommendations of
the internal and external auditors and management's responses to those
recommendations.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
________________________________________
To the Shareholders and Board of Directors of Cummins Engine Company,
Inc.:
We have audited the accompanying consolidated statement of financial
position of Cummins Engine Company, Inc., (an Indiana corporation) and
subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of earnings, cash flows and shareholders'
investment for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Cummins
Engine Company, Inc., and subsidiaries as of December 31, 1998 and
1997, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
Arthur Andersen LLP
Chicago, Illinois,
January 26, 1999.
<PAGE> 12
CUMMINS ENGINE COMPANY, INC.
CONSOLIDATED STATEMENT OF EARNINGS
__________________________________
Millions, except per share amounts 1998 1997 1996
__________________________________ ______ ______ ______
Net sales $6,266 $5,625 $5,257
Cost of goods sold 4,925 4,345 4,072
Special charges 92 - -
______ ______ ______
Gross profit 1,249 1,280 1,185
Selling & administrative expenses 787 744 725
Research & engineering expenses 255 260 252
Net expense (income) from joint
ventures and alliances 30 (10) -
Interest expense 71 26 18
Other income, net (13) (26) (24)
Restructuring and other
non-recurring charges 125 - -
_____ _____ _____
Earnings (loss) before income taxes (6) 286 214
Provision for income taxes 4 74 54
Minority interest 11 - -
_____ _____ _____
Net earnings (loss) $ (21) $ 212 $ 160
_____ _____ _____
_____ _____ _____
Basic earnings (loss) per share $(.55) $5.55 $4.02
Diluted earnings (loss) per share (.55) 5.48 4.01
The accompanying notes are an integral part of this statement.
<PAGE> 13
CUMMINS ENGINE COMPANY, INC.
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
____________________________________________
Millions, except per share amounts December 31,
__________________________________ 1998 1997
______ ______
Assets
Current assets:
Cash and cash equivalents $ 38 $ 49
Receivables 833 771
Inventories 731 677
Other current assets 274 213
_____ _____
1,876 1,710
_____ _____
Investments and other assets:
Investments in joint ventures and alliances 136 204
Other assets 144 142
_____ _____
280 346
_____ _____
Property, plant and equipment:
Land and buildings 590 495
Machinery, equipment and fixtures 2,320 2,079
Construction in process 185 392
_____ _____
3,095 2,966
Less accumulated depreciation 1,424 1,434
_____ _____
1,671 1,532
_____ _____
Goodwill, net of amortization of $17 and $5 384 12
_____ _____
Other intangibles, deferred taxes and
deferred charges 331 165
______ ______
Total assets $4,542 $3,765
______ ______
______ ______
Liabilities and shareholders' investment
Current liabilities:
Loans payable $ 64 $ 90
Current maturities of long-term debt 26 42
Accounts payable 340 386
Accrued salaries and wages 99 87
Accrued product coverage & marketing expenses 209 120
Income taxes payable 13 18
Other accrued expenses 320 312
_____ _____
1,071 1,055
_____ _____
Long-term debt 1,137 522
_____ _____
Other liabilities 1,000 713
_____ _____
Minority interest 62 53
_____ _____
Shareholders' investment:
Common stock, $2.50 par value, 48.1
shares issued 120 120
Additional contributed capital 1,121 1,119
Retained earnings 648 715
Accumulated other comprehensive income (167) (70)
Common stock in treasury,at cost,6.1 & 6.0 shares (240) (245)
Common stock held in trust for employee benefit
plans, 3.6 and 3.7 shares (172) (175)
Unearned compensation (38) (42)
_____ _____
1,272 1,422
_____ _____
Total liabilities & shareholders' investment $4,542 $3,765
______ ______
______ ______
The accompanying notes are an integral part of this statement.
<PAGE> 14
CUMMINS ENGINE COMPANY, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
____________________________________
Millions 1998 1997 1996
________ ______ ______ ______
Cash flows from operating activities:
Net earnings (loss) $ (21) $ 212 $ 160
_____ _____ _____
Adjustments to reconcile net earnings (loss)
to net cash from operating activities:
Depreciation and amortization 199 158 149
Restructuring actions 110 (24) (42)
Equity in (earnings) losses of joint
ventures and alliances 38 (1) 11
Receivables (10) (80) (56)
Inventories (26) (65) (62)
Accounts payable and accrued expenses 56 (18) 28
Deferred income taxes (65) 22 17
Other (10) (4) (12)
____ ____ ____
Total adjustments 292 (12) 33
____ ____ ____
271 200 193
____ ____ ____
Cash flows from investing activities:
Property, plant and equipment:
Additions (271) (405) (304)
Disposals 7 21 26
Investments in joint ventures and alliances (22) (47) (5)
Acquisitions and dispositions of business
activities (468) 76 10
Other 2 1 14
____ ____ ____
(752) (354) (259)
____ ____ ____
Net cash used in operating and
investing activities (481) (154) (66)
____ ____ ____
Cash flows from financing activities:
Proceeds from borrowings 711 281 200
Payments on borrowings (161) (50) (47)
Net (payments) borrowings under credit
agreements (30) (12) 32
Repurchases of common stock (14) (75) (34)
Dividend payments (46) (45) (40)
Other 11 (3) (1)
____ ____ ____
471 96 110
____ ____ ____
Effect of exchange rate changes on cash (1) (1) 4
____ ____ ____
Net change in cash and cash equivalents (11) (59) 48
Cash & cash equivalents at beginning of year 49 108 60
____ ____ ____
Cash & cash equivalents at end of year $ 38 $ 49 $108
____ ____ ____
____ ____ ____
Cash payments during the year for:
Interest $ 56 $ 21 $ 16
Income taxes 73 42 40
The accompanying notes are an integral part of this statement.
<PAGE> 15
CUMMINS ENGINE COMPANY, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' INVESTMENT
__________________________________________________
Millions, except per share amounts 1998 1997 1996
__________________________________ ___________ __________ __________
Common stock:
Balance at beginning of year $ 120 $ 110 $ 110
Issued to trust for employee
benefit plans - 9 -
Other - 1 -
_____ _____ ____
Balance at end of year 120 120 110
_____ _____ ____
Additional contributed capital:
Balance at beginning of year 1,119 929 926
Issued to trust for employee
benefit plans - 171 -
Other 2 19 3
_____ _____ _____
Balance at end of year 1,121 1,119 929
_____ _____ _____
Retained earnings:
Balance at beginning of year 715 548 428
Net earnings (loss) (21) $(21) 212 $212 160 $160
___ ____ ___
Cash dividends (46) (45) (40)
____ ____ ____
Balance at end of year 648 715 548
____ ____ ____
Accumulated other comprehensive income:
Balance at beginning of year (70) (60) (95)
Foreign currency translation
adjustments (43) (21) 26
Minimum pension liability
adjustments (54) 12 9
Unrealized losses on securities - (1) -
___ ___ ___
Other comprehensive income (97) (97) (10) (10) 35 35
___ ___ ___ ___ __ ___
Comprehensive income $(118) $202 $195
____ ___ ___
____ ___ ___
Balance at end of year (167) (70) (60)
____ ___ ___
Common stock in treasury:
Balance at beginning of year (245) (169) (135)
Repurchased (14) (76) (34)
Issued 19 - -
_____ _____ _____
Balance at end of year (240) (245) (169)
_____ _____ _____
Common stock held in trust for
employee benefit plans:
Balance at beginning of year (175) - -
Issued - (180) -
Shares allocated to benefit plans 3 5 -
_____ _____ ______
Balance at end of year (172) (175) -
_____ _____ ______
Unearned compensation:
Balance at beginning of year (42) (46) (51)
Shares allocated to participants 4 4 5
______ ______ ______
Balance at end of year (38) (42) (46)
______ ______ ______
Shareholders' investment $1,272 $1,422 $1,312
______ ______ ______
______ ______ ______
Shares of stock
Common stock, $2.50 par value,
150.0 shares authorized
Balance at beginning of year 48.1 43.9 43.9
Shares issued - 4.2 -
____ ____ ____
Balance at end of year 48.1 48.1 43.9
____ ____ ____
____ ____ ____
Common stock in treasury
Balance at beginning of year 6.0 4.5 3.7
Shares repurchased .4 1.5 .8
Shares issued (.3) - -
___ ___ ___
Balance at end of year 6.1 6.0 4.5
___ ___ ___
___ ___ ___
Common stock held in trust for
employee benefit plans
Balance at beginning of year 3.7 - -
Shares issued - 3.8 -
Shares allocated to benefit plans (.1) (.1) -
___ ___ ___
Balance at end of year 3.6 3.7 -
___ ___ ____
___ ___ ____
The accompanying notes are an integral part of this statement.
<PAGE> 16
CUMMINS ENGINE COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
__________________________________________
NOTE 1. ACCOUNTING POLICIES:
Principles of Consolidation: The consolidated financial statements
include all significant majority-owned subsidiaries. Affiliated
companies in which Cummins does not have a controlling interest, or
for which control is expected to be temporary, are accounted for using
the equity method. Use of estimates and assumptions as determined by
management is required in the preparation of consolidated financial
statements in conformity with generally accepted accounting
principles. Actual results could differ from these estimates and
assumptions.
Revenue Recognition: The Company recognizes revenues on the sale of
its products, net of estimated costs of returns, allowances and sales
incentives, when the products are shipped to customers. The Company
generally sells its products on open account under credit terms
customary to the region of distribution. The Company performs ongoing
credit evaluations of its customers and generally does not require
collateral to secure its customers' receivables.
Foreign Currency: Assets and liabilities of foreign entities, where
the local currency is the functional currency, have been translated at
year-end exchange rates, and income and expenses have been translated
to US dollars at average-period rates. Adjustments resulting from
translation have been recorded in shareholders' investment and are
included in net earnings only upon sale or liquidation of the
underlying foreign investment.
For foreign entities where the US dollar is the functional currency,
including those operating in highly inflationary economies, inventory,
property, plant and equipment balances and related income statement
accounts have been translated using historical exchange rates. The
resulting gains and losses have been credited or charged to net
earnings.
Derivative Instruments: The Company makes use of derivative
instruments in its foreign exchange, commodity price and interest rate
hedging programs. Derivatives currently in use are commodity and
interest rate swaps, as well as foreign currency forward contracts.
These contracts are used strictly for hedging, and not for speculative
purposes. Refer to Note 8 for more information on derivative
financial instruments.
The Company enters into commodity swaps to offset the Company's
exposure to price volatility for certain raw materials used in the
manufacturing process. As the Company has the discretion to settle these
transactions either in cash or by taking physical delivery, these
contracts are not considered financial instruments for accounting
purposes. These commodity swaps are accounted for as hedges.
Other Costs: Estimated costs of commitments for product coverage
programs are charged to earnings at the time the Company sells its
products.
Research & development expenditures, net of contract reimbursements,
are expensed when incurred and were $228 million in 1998, $250 million
in 1997 and $235 million in 1996.
Maintenance and repair costs are charged to earnings as incurred.
Cash Equivalents: Cash equivalents include all highly liquid
investments with an original maturity of three months or less at time
of purchase.
Inventories: Inventories are generally stated at cost or net
realizable value. Approximately 25 percent of domestic inventories
(primarily heavy-duty and high-horsepower engines and engine parts)
are valued using the last-in, first-out (LIFO) cost method.
Inventories at December 31 were as follows:
$ Millions 1998 1997
__________ ____ ____
Finished products $400 $351
Work-in-process and raw materials 387 388
____ ____
Inventories at FIFO cost 787 739
Excess of FIFO over LIFO (56) (62)
____ ____
$731 $677
____ ____
____ ____
<PAGE> 17
Property, Plant and Equipment: Property, plant and equipment are
stated at cost. A modified units-of-production method, which is based
upon units produced subject to a minimum level, is used to depreciate
substantially all engine production equipment. The straight-line
depreciation method is used for all other equipment. The estimated
depreciable lives range from 20 to 40 years for buildings and 3 to 20
years for machinery, equipment and fixtures.
Software: Internal and external software costs (excluding research,
reengineering and training) are capitalized and amortized generally
over 5 years. Effective January 1, 1998, the Company adopted SOP 98-1
on accounting for internal use software costs. Internal software
costs capitalized in 1998 in accordance with this new rule were $9
million. Capitalized software, net of amortization, was $75 million
at December 31, 1998 and $32 million at December 31, 1997.
Earnings Per Share: Effective January 1, 1997, the Company adopted
SFAS No. 128, a new accounting rule on calculating earnings per share.
Under the new rule, basic earnings per share of common stock are
computed by dividing net earnings by the weighted-average number of
shares outstanding for the period. Diluted earnings per share are
computed by dividing net earnings by the weighted-average number of
shares, assuming the exercise of stock options when the effect of
their exercise is dilutive. Shares of stock held by the employee
benefits trust are not included in outstanding shares for EPS until
distributed from the trust. Years prior to 1997 have been restated to
reflect this new rule.
Net Weighted
Millions, except Earnings Average
per share amounts (Loss) Shares Per share
_________________ ________ ________ _________
1998
____
Basic $(21) 38.5 $(.55)
Options - - _____
____ ____ _____
Diluted $(21) 38.5 $(.55)
____ ____ _____
____ ____ _____
1997
____
Basic $212 38.2 $5.55
Options - .5 _____
____ ____ _____
Diluted $212 38.7 $5.48
____ ____ _____
____ ____ _____
1996
____
Basic $160 39.8 $4.02
Options - .1 _____
____ ____ _____
Diluted $160 39.9 $4.01
____ ____ _____
____ ____ _____
<PAGE> 18
NOTE 2. ACQUISITION: In January 1998, the Company completed the
acquisition of the stock of Nelson Industries, Inc., for $453 million.
Nelson, a filtration and exhaust systems manufacturer, was
consolidated from the date of its acquisition. On a pro forma basis,
if the Company had acquired Nelson on January 1, 1997, consolidated
net sales for 1997 would have been $5.9 billion and consolidated
earnings would not have been materially different. In accordance with
APB Opinion No. 16, Nelson's net assets were recorded at fair value at
the date of acquisition. The purchase price in excess of net assets
will be amortized over 40 years.
NOTE 3. SPECIAL CHARGES: In 1998, the Company recorded special
charges of $92 million for product coverage costs and inventory write-
downs. The product coverage special charges of $78 million included
$43 million primarily attributable to the recent experience of higher-
than-anticipated base warranty costs to repair certain automotive
engines manufactured in previous years, and $35 million related to a
revised estimate of product coverage cost liability primarily for
extended warranty programs. The Company believed it was necessary to
make these special charges to accrue for such product coverage costs
expected to be incurred in the future on these engines currently in
the field. The special charges also included $14 million for
inventory write-downs associated with the Company's restructuring and
exit activities. These write-downs relate to amounts of inventory
rendered excess or unusable due to the closing or consolidation of
facilities. The Company has committed to these facility closures and
consolidations as part of a plan to reduce costs and improve operating
performance.
NOTE 4. RESTRUCTURING AND OTHER NON-RECURRING CHARGES: In 1998, the
Company recorded charges of $125 million, comprised of $100 million
for costs to reduce the worldwide workforce, as well as costs
associated with streamlining certain majority-owned and international
joint venture operations and $25 million for a civil penalty to be
paid by the Company as a result of an agreement reached with the U.S.
Environmental Protection Agency (EPA), the Department of Justice (DOJ)
and the California Air Resources Board (CARB) regarding diesel engine
emissions.
The major components of these charges are as follows:
$ Millions
__________
Restructuring of majority-owned operations:
Workforce reductions $ 38
Asset impairment loss 22
Facility consolidations and other 17
___
77
___
Restructuring of joint venture operations:
Workforce reductions 11
Tax asset impairment loss 7
Facility and equipment-related costs 5
___
23
___
EPA penalty 25
___
Total $125
____
____
The restructuring program was undertaken to address the decline in the
Company's business in Asia, to leverage overhead costs for all
operations and to improve joint venture operating performance.
The charges for majority-owned operations include $38 million for
severance and related costs associated with workforce reductions of
approximately 1,100 people. These reductions are in the engine and
power generation businesses and are primarily for administrative
positions. Costs for workforce reductions were based on amounts
pursuant to benefit programs and contractual provisions or statutory
requirements at the affected operations. Approximately one-half of
these employees left the Company prior to December 31, 1998.
The asset impairment loss, calculated according to the provisions of
SFAS 121, was recorded primarily for engine manufacturing equipment to
be disposed of upon the closure or consolidation of facilities or the
outsource of production. The recovery value for the equipment to be
disposed of was based on estimated liquidation value. The carrying
value of assets held for disposal and the effect on earnings from
suspending depreciation on such assets is immaterial.
Facility consolidation and other costs of $17 million include lease
termination and facility exit costs of $10 million, product support
costs of $3 million and litigation and other costs of $4 million. As
the restructuring consists primarily of the closing or consolidation
of smaller operations, the Company does not expect these actions to
have a material effect on future revenues.
<PAGE> 19
The charges for restructuring joint venture operations totaled $23
million, the majority of which relates to actions being taken at the
Company's joint venture with Wartsila, which is part of the Company's
power generation business. The charges include $11 million for
employee severance and related benefits for approximately 1,200
people, $7 million for a tax asset impairment loss and $5 million for
other facility and equipment-related charges.
Approximately $25 million, primarily related to employee severance,
has been charged to the restructuring liabilities as of December 31,
1998. Of the total charges associated with restructuring activities,
cash outlays will approximate $60 million. The program is expected to
be essentially complete by the end of 1999 and yield approximately $50
million in annual savings at completion.
In addition to the civil penalty, the agreement with the EPA/DOJ/CARB
provides a schedule for diesel engines to meet certain emission
standards and requires manufacturers to continue to invest in
environmental projects to further reduce oxides of nitrogen (NOx)
emissions. The Company has developed extensive corporate action plans
to comply with all aspects of the agreement. Additionally, three
separate court actions have been filed as a result of allegations of
the diesel emissions matter. The New York Supreme Court ruled in
favor of the Company. This matter is now on appeal. A California
State Court recently ruled in favor of the Company. A recent action
was just filed in the U.S. District Court, the District of Columbia.
NOTE 5. INVESTMENTS IN JOINT VENTURES AND ALLIANCES: Investments in
joint ventures and alliances at December 31 were as follows:
$ Millions 1998 1997
__________ ____ ____
Consolidated Diesel $ 39 $ 32
Tata Cummins 22 16
Komatsu alliances 17 10
Chongqing Cummins 15 16
Behr America, Inc. 14 14
Dong Feng 8 7
Cummins Wartsila (6) 88
Other 27 21
____ ____
$136 $204
____ ____
____ ____
Summary balance sheet information for the joint ventures and alliances
was as follows:
December 31,
$ Millions 1998 1997
__________ ____ ____
Current assets $527 $447
Noncurrent assets 613 533
Current liabilities (406) (258)
Noncurrent liabilities (455) (305)
____ ____
Net assets $279 $417
____ ____
____ ____
Cummins' share $136 $204
____ ____
____ ____
The Company has guaranteed $79 million in outstanding debt of the
Cummins Wartsila joint venture as of December 31, 1998.
In connection with various joint venture agreements, Cummins is
required to purchase products from the joint ventures in amounts to
provide for the recovery of specified costs of the ventures. Under
the agreement with Consolidated Diesel, Cummins' purchases were $535
million in 1998 and $538 million in 1997.
NOTE 6. LONG-TERM DEBT: Long-term debt at December 31 was:
$ Millions 1998 1997
__________ ____ ____
7.125% debentures due 2028 $249 $ -
6.45% notes due 2005 224 -
Commercial paper 142 242
5.65% debentures due 2098, net
of unamortized discount of $40
(effective interest rate 7.48%) 125 -
6.25% notes due 2003 125 -
6.75% debentures due 2027 120 120
8.2% notes through 2003 79 96
Guaranteed notes of ESOP Trust due 2010 63 65
10.35%-10.65% medium-term notes through 1998 - 14
Other 36 27
_____ ____
Total 1,163 564
Current maturities (26) (42)
______ ____
Long-term debt $1,137 $522
______ ____
______ ____
Maturities of long-term debt for the five years subsequent to December
31, 1998 are $26 million, $26 million, $25 million, $27 million and
$141 million. At both December 31, 1998 and 1997, the weighted-
average interest rate on loans payable and current maturities of long-
term debt approximated 7 percent.
<PAGE> 20
The Company maintains a $500 million revolving credit agreement,
maturing in 2003, under which there were no outstanding borrowings at
December 31, 1998 or 1997. The revolving credit agreement supports
the Company's commercial paper borrowings. In February 1998, the
Company issued $765 million face amount of notes and debentures under
a $1 billion Registration Statement filed with the Securities and
Exchange Commission in 1997. Net proceeds were used to finance the
acquisition of Nelson and pay down other indebtedness outstanding at
December 31, 1997. The Company also has other domestic and
international credit lines with approximately $193 million available
at December 31, 1998.
In 1997, the Company issued $120 million of 6.75 percent debentures
that mature in 2027. Holders have a one-time option in 2007 to redeem
the debentures and Cummins has a recall right after ten years.
The Company has guaranteed the outstanding borrowings of its ESOP
Trust. The notes were refinanced in July 1998. Cash contributions to
the Trust, together with the dividends accumulated on the common stock
held by the Trust, are used to pay interest and principal. Cash
contributions and dividends to the Trust approximated $10 million in
each year. The unearned compensation, which is reflected as a
reduction to shareholders' investment, represents the historical cost
of the shares of common stock that have not yet been allocated by the
Trust to participants.
NOTE 7. OTHER LIABILITIES: Other liabilities at December 31 included
the following:
$ Millions 1998 1997
__________ ____ ____
Accrued retirement & post-employment benefits $720 $487
Accrued product coverage & marketing expenses 156 111
Accrued compensation 38 34
Deferred income taxes 17 25
Other 69 56
______ ____
$1,000 $713
______ ____
______ ____
<PAGE> 21
NOTE 8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT: The Company is
exposed to financial risk resulting from volatility in foreign
exchange rates and interest rates. This risk is closely monitored and
managed through the use of financial derivative contracts. As clearly
stated in the Company's policies and procedures, financial derivatives
are used expressly for hedging purposes, and under no circumstances
are they used for speculating or trading. Transactions are entered
into only with banking institutions with strong credit ratings, and
thus the credit risk associated with these contracts is considered
immaterial. Hedging program results and status are reported to senior
management on a periodic basis.
Foreign Exchange Rates
Due to its international business presence, the Company uses foreign
exchange forward contracts to manage its exposure to exchange rate
volatility. Foreign exchange balance sheet exposures are aggregated
and hedged at the corporate level. Maturities on these instruments
generally fall within the one-month and six-month range. The
objective of the hedging program is to reduce earnings volatility
resulting from the translation of net foreign exchange balance sheet
positions. The total notional amount of these forward contracts
outstanding at December 31, 1998, and December 31, 1997, were $174
million and $257 million, respectively.
Interest Rates
The Company manages its exposure to interest rate fluctuations through
the use of interest rate swaps. Currently the Company has in place
one interest rate swap that effectively converts fixed-rate debt into
floating-rate debt. The objective of this swap is to lower the cost
of borrowed funds. The contract was established during October 1998
with a notional value of $225 million. There were no interest rate
swap contracts outstanding at December 31, 1997.
Fair Value of Financial Instruments
Based on borrowing rates currently available to the Company for bank
loans with similar terms and average maturities, the fair value of
total debt, including current maturities, at December 31, 1998,
approximated $1,214 million. The carrying value at that date was
$1,227 million. At December 31, 1997, the fair and carrying values of
total debt, including current maturities, were $664 and $654 million,
respectively. The carrying values of all other receivables and
liabilities approximated fair values.
NOTE 9. INCOME TAXES: The provision for income taxes was as follows:
$ Millions 1998 1997 1996
_____________ ____ ____ ____
Current:
U.S. Federal and state $16 $16 $22
Foreign 41 32 15
__ __ __
57 48 37
__ __ __
Deferred:
U.S. Federal and state (34) 26 -
Foreign (19) - 17
__ __ __
(53) 26 17
___ ___ __
$ 4 $74 $54
___ ___ ___
___ ___ ___
The Company expects to realize all of its tax assets, including the
use of all carryforwards, before any expiration.
Significant components of net deferred tax assets related to the
following tax effects of differences between financial and tax
reporting at December 31:
$ Millions 1998 1997
__________ ____ ____
Employee benefit plans $300 $266
Product coverage & marketing expenses 106 64
Restructuring charges 14 9
US plant & equipment (176) (139)
Net foreign taxable differences, primarily plant
and equipment 6 (23)
US Federal carryforward benefits:
General business tax credits, expiring 2009 to 2013 43 31
Minimum tax credits, no expiration 12 10
Other net differences 12 13
____ ____
$317 $231
____ ____
____ ____
Balance Sheet Classification
____________________________
Current assets $203 $129
Noncurrent assets 131 127
Noncurrent liabilities (17) (25)
____ ____
$317 $231
____ ____
____ ____
<PAGE> 22
Earnings before income taxes and differences between the effective tax
rate and US Federal income tax rates were:
$ Millions 1998 1997 1996
__________ ____ ____ ____
Earnings (loss) before income taxes:
US $(21) $205 $134
Foreign 15 81 80
____ ____ ____
$ (6) $286 $214
____ ____ ____
____ ____ ____
Tax at 35 percent US statutory rate $ (2) $100 $ 75
Nondeductible EPA penalty 9 - -
Nondeductible goodwill amortization 3 - -
Research tax credits (10) (11) (6)
Foreign sales corporation benefits (9) (11) (11)
Differences in rates and taxability of
foreign subsidiaries 15 (3) -
All other, net (2) (1) (4)
____ ____ ____
$ 4 $ 74 $(54)
____ ____ ____
____ ____ ____
NOTE 10. RETIREMENT PLANS: The Company has various contributory and
noncontributory pension plans covering substantially all employees.
Cummins common stock represented 9 percent of pension plan assets at
December 31, 1998.
Cummins also provides various health care and life insurance benefits
to eligible retirees and their dependents but reserves the right to
change benefits covered under these plans. The plans are contributory
with retirees' contributions adjusted annually, and they contain other
cost-sharing features, such as deductibles, coinsurance and spousal
contributions. The general policy is to fund benefits as claims and
premiums are incurred.
The projected benefit obligation, accumulated benefit obligation and
fair value of plan assets for plans with accumulated benefit
obligations in excess of plan assets were $1,296 million, $1,251
million, and $999 million, respectively as of December 31, 1998, and
$418 million, $381 million, and $339 million, respectively, as of
December 31, 1997. The assumed long-term rate of compensation
increase for salaried plans was 4.25% in 1998 and 5.00% in 1997.
Other significant assumptions for the Company's principal plans were:
Pension Other
Benefits Benefits
1998 1997 1998 1997
____ ____ ____ ____
Weighted-average discount rate 6.5% 7.5% 6.5% 7.5%
Long-term rate of return on plan assets 10.0% 10.0%
For measurement purposes a 7% annual increase in health care costs was
assumed for 1999, decreasing gradually to 4.25% in ten years and
remaining constant thereafter.
Increasing the health care cost trend rate by one percent would
increase the obligation by $42 million and annual expense by $3
million. Decreasing the health care cost trend rate by one percent
would decrease the obligation by $38 million and annual expense by $3
million.
<PAGE> 23
The Company's net periodic benefit cost under these plans was as follows:
Pension Benefits Other Benefits
$ Millions 1998 1997 1996 1998 1997 1996
____________ ____ ____ ____ ____ ____ ____
Service cost $ 47 $ 41 $ 45 $ 8 $ 8 $ 9
Interest cost 123 115 104 40 41 36
Expected return on plan
assets (153) (134) (116) - - -
Amortization of transition
asset (4) (9) (9) - - -
Other 12 13 16 4 9 10
____ ____ ____ ____ ____ ____
$ 25 $ 26 $ 40 $ 52 $ 58 $ 55
____ ____ ____ ____ ____ ____
____ ____ ____ ____ ____ ____
Pension Benefits Other Benefits
$ Millions 1998 1997 1998 1997
__________ ______ ______ ______ ______
Change in benefit obligation:
Benefit obligation at beginning of year $1,693 $1,491 $ 596 $ 545
Service cost 47 41 8 8
Interest cost 123 115 44 41
Plan participants' contributions 7 6 1 1
Amendments 2 4 - -
Experience (gain) loss 161 128 20 26
Benefits paid (123) (96) (29) (25)
Other (3) 4 - -
_____ _____ _____ _____
Benefit obligation at end of year $1,907 $1,693 $ 640 $ 596
_____ _____ _____ _____
_____ _____ _____ _____
Change in plan assets:
Fair value of plan assets at
beginning of year $1,905 $1,555 $ - $ -
Actual return on plan assets (129) 414 - -
Employer contribution 34 23 28 24
Plan participants' contributions 7 6 1 1
Benefits paid (123) (96) (29) (25)
Other (2) 3 - -
_____ _____ _____ _____
Fair value of plan assets at end of
year $1,692 $1,905 $ - $ -
_____ _____ _____ _____
_____ _____ _____ _____
Funded status $ (215) $ 212 $ (640) $ (596)
Unrecognized:
Experience (gain) loss (a) 172 (269) 80 62
Prior service cost (b) 55 63 (11) (12)
Transition asset (c) (7) (11) - -
_____ _____ _____ _____
Net amount recognized $ 5 $ (5) $ (571) $ (546)
_____ _____ _____ _____
_____ _____ _____ _____
Amounts recognized in the statement
of financial position:
Prepaid benefit cost $ 50 $ 9 $ - $ -
Accrued benefit liability (232) ( 14) (571) (546)
Intangible asset 104 - - -
Accumulated other comprehensive income 83 - - -
_____ _____ _____ _____
Net amount recognized $ 5 $ (5) $ (571) $ (546)
_____ _____ _____ _____
_____ _____ _____ _____
(a) The net deferred gain (loss) resulting from investments, other
experience and changes in assumptions.
(b) The prior service effect of plan amendments deferred for
recognition over remaining service.
(c) The balance of the initial difference between assets and
obligations deferred for recognition over a 15-year period.
<PAGE> 24
NOTE 11. COMMON STOCK: The Company increased its quarterly common
stock dividend from 25 cents per share to 27.5 cents, effective with
the dividend payment in June 1997.
In 1998, the Company repurchased 0.4 million shares on the open market
at an aggregate purchase price of $14 million. In 1997, the Company
repurchased 1.3 million shares from Ford Motor Company and another 0.2
million shares on the open market at an aggregate purchase price of
$75 million. The Company repurchased 0.8 million shares on the open
market at an aggregate purchase price of $34 million in 1996. All of
the acquired shares are held as common stock in treasury.
In 1997, the Company issued 3.75 million shares of its common stock to
an employee benefits trust to fund obligations of employee benefit and
compensation plans, principally retirement savings plans. Shares of
the stock held by this trust are not used in the calculation of
earnings per share until allocated to a benefit plan.
NOTE 12. SHAREHOLDERS' RIGHTS PLAN: The Company has a Shareholders'
Rights Plan which it first adopted in 1986. The Rights Plan provides
that each share of the Company's common stock has associated with it a
stock purchase right. The Rights Plan becomes operative when a person
or entity acquires 15 percent of the Company's common stock or
commences a tender offer to purchase 20 percent or more of the
Company's common stock without the approval of the Board of Directors.
NOTE 13. EMPLOYEE STOCK PLANS: Under the Company's stock incentive
and option plans, officers and other eligible employees may be awarded
stock options, stock appreciation rights and restricted stock. Under
the provisions of the stock incentive plan, up to one percent of the
Company's outstanding shares of common stock at the end of the
preceding year is available for issuance under the plan each year. At
December 31, 1998, there were no shares of common stock available for
grant and 1,234,875 options exercisable under the plans.
The Company accounts for stock options in accordance with APB Opinion
No. 25 and related interpretations. No compensation expense has been
recognized for stock options since the options have exercise prices
equal to the market price of the Company's common stock at the date of
grant.
Number of Weighted-average
Shares Options exercise price
_________ _____________ ________________
1,183,275 Dec. 31, 1995 38.45
394,150 Granted 40.13
(47,475) Exercised 32.43
(19,800 Cancelled 41.00
_________
1,510,150 Dec. 31, 1996 38.88
766,500 Granted 60.61
(294,025) Exercised 35.85
(61,775) Cancelled 42.66
_________
1,920,850 Dec. 31, 1997 46.08
703,660 Granted 45.34
(54,075) Exercised 36.36
(27,425) Cancelled 53.80
_________
2,543,010 Dec. 31, 1998 48.08
_________
_________
Options outstanding at December 31, 1998, have exercise prices between
$15.94 and $79.81 and a weighted-average remaining life of 8 years.
The weighted-average fair value of options granted was $18.61 per
share in 1998 and $14.94 per share in 1997. The fair value of each
option was estimated on the date of grant using a risk-free interest
rate of 5.6 percent in 1998 and 6.4 percent in 1997, current annual
dividends, expected lives of 10 years and expected volatility of 34
percent. A fair-value method of accounting for awards subsequent to
January 1, 1996, would have had no material effect on results of
operations.
NOTE 14. COMPREHENSIVE INCOME: Effective January 1, 1998, the
Company adopted SFAS No. 130, a new accounting rule which requires
companies to report comprehensive income. Comprehensive income
includes net income and all other nonowner changes in equity during a
period.
<PAGE> 25
The tax effect on other comprehensive income is as follows:
Total
Foreign Minimum Other
Currency Unrealized Pension Compre-
Translation Losses on Liability hensive
Adjustments Securities Adjustments Income
___________ __________ ___________ ______
1998
____
Pre-tax amount $(44) $(1) $(83) $(128)
Tax (expense) benefit 1 1 29 31
____ ___ ____ _____
Net amount $(43) $ - $(54) $ (97)
____ ___ ____ _____
____ ___ ____ _____
1997
____
Pre-tax amount $(21) $(1) $ 12 $ (10)
Tax (expense) benefit - - - -
____ ___ ____ _____
Net amount $(21) $(1) $ 12 $ (10)
____ ___ ____ _____
____ ___ ____ _____
1996
____
Pre-tax amount $ 26 $ - $ 9 $ 35
Tax (expense) benefit - - - -
____ ___ ____ _____
Net amount $ 26 $ - $ 9 $ 35
____ ___ ____ _____
____ ___ ____ _____
The components of accumulated other comprehensive income are as follows:
Accum-
ulated
Foreign Minimum Other
Currency Unrealized Pension Compre-
Translation Losses on Liability hensive
Adjustments Securities Adjustments Income
___________ __________ ___________ ______
Balance at 12/31/95 $ (73) $ - $(22) $ (95)
Change in 1996 26 - 9 35
_____ ___ ____ _____
Balance at 12/31/96 (47) - (13) (60)
Change in 1997 (21) (1) 12 (10)
_____ ___ ____ _____
Balance at 12/31/97 (68) (1) (1) (70)
Change in 1998 (43) - (54) (97)
_____ ___ ____ _____
Balance at 12/31/98 $(111) $(1) $(55) $(167)
_____ ___ ____ _____
_____ ___ ____ _____
NOTE 15. SEGMENTS OF THE BUSINESS: Effective for 1998 annual
reporting, the Company adopted SFAS No. 131 on segment reporting.
Under the provisions of the new standard, Cummins has three reportable
segments: Engine, Power Generation, and Filtration and Other. The
engine segment produces engines and parts for sale to customers in
automotive and industrial markets. The engines are used in trucks of
all sizes, buses and recreational vehicles, as well as various
industrial applications including construction, mining, agriculture,
marine, rail and military. The power generation segment is the
Company's power systems supplier, selling engines, generator sets and
alternators. The filtration and other segment includes sales of
filtration products and exhaust systems, turbochargers and company-
owned distributors.
The Company's reportable segments are organized according to products
and the markets they each serve. This business structure was designed
to focus efforts on providing enhanced service to a wide range of
customers.
<PAGE> 26
The accounting policies of the segments are the same as those
described in the summary of significant accounting policies except
that the Company evaluates performance based on earnings before
interest and income taxes and on net assets, and, therefore, no
allocation of debt-related items and income taxes is made to the
individual segments.
Operating segment information is as follows:
Power Filtration
1998 Engine Generation and Other Total
____ ______ __________ ___________ ______
Net sales $3,982 $1,230 $1,054 $6,266
Depreciation & amortization 120 40 39 199
Income (expense) from joint
ventures and alliances (4) (25) (1) (30)
Earnings before interest,
income taxes and special
charges 136 25 121 282
Special charges 165 50 2 217
Earnings (loss) before
interest & income taxes (29) (25) 119 65
Net assets 946 511 803 2,260
Investment in joint
ventures and alliances 132 3 1 136
Capital expenditures 172 67 32 271
Additions to goodwill 12 2 370 384
1997
____
Net sales $3,666 $1,205 $ 754 $5,625
Depreciation & amortization 102 34 22 158
Income (expense) from joint
ventures and alliances 12 (2) - 10
Earnings (loss) before
interest and income taxes 207 (2) 107 312
Net assets 1,074 531 312 1,917
Investment in joint
ventures and alliances 133 65 6 204
Capital expenditures 304 79 22 405
1996
____
Net sales $3,310 $1,213 $ 734 $5,257
Depreciation & amortization 97 31 21 149
Income (expense) from joint
ventures and alliances (2) 2 - -
Earnings before interest and
income taxes 160 14 58 232
Net assets 784 459 249 1,492
Investment in joint
ventures and alliances 114 89 4 207
Capital expenditures 242 44 18 304
<PAGE> 27
Reconciliation to Consolidated Financial Statements:
1998 1997 1996
______ ______ ______
Earnings before interest & income
taxes for reportable segments $ 65 $ 312 $ 232
Interest expense 71 26 18
Income tax expense 4 74 54
Minority interest 11 - -
______ ______ ______
Net earnings (loss) $ (21) $ 212 $ 160
______ ______ ______
______ ______ ______
Net assets for reportable segments $2,260 $1,917 $1,492
Liabilities deducted in arriving
at net assets 1,926 1,583 1,586
Deferred tax assets not allocated
to segments 334 256 284
Debt-related costs not allocated
to segments 22 9 7
______ ______ ______
Total assets $4,542 $3,765 $3,369
______ ______ ______
______ ______ ______
Summary geographic information is listed below:
$ Millions US UK Canada Other Total
__________ ______ ______ ______ ______ ______
1998
____
Net sales (a) $3,595 $ 389 $ 459 $1,823 $6,266
Long-lived assets $1,470 $ 209 $ - $ 272 $1,951
1997
____
Net sales (a) $3,123 $ 384 $ 318 $1,800 $5,625
Long-lived assets $1,360 $ 251 $ - $ 267 $1,878
1996
____
Net sales (a) $2,925 $ 348 $ 313 $1,671 $5,257
Long-lived assets $1,201 $ 200 $ - $ 211 $1,612
(a) Net sales are attributed to countries based on location of customer.
Revenues from the Company's largest customer represent approximately
$1.1 billion of the Company's net sales in 1998. These sales are
included in the engine and filtration and other segments.
NOTE 16. GUARANTEES, COMMITMENTS AND OTHER CONTINGENCIES: At
December 31, 1998, the Company had the following minimum rental
commitments for noncancelable operating leases: $41 million in 1999,
$38 million in 2000, $30 million in 2001, $25 million in 2002, $21
million in 2003 and $46 million thereafter. Rental expense under
these leases approximated $70 million in 1998, $60 million in 1997 and
$55 million in 1996.
Commitments under outstanding letters of credit, guarantees and
contingencies at December 31, 1998, approximated $195 million.
Cummins and its subsidiaries are defendants in a number of pending
legal actions, including actions related to use and performance of the
Company's products. The Company carries product liability insurance
covering significant claims for damages involving personal injury and
property damage. In the event the Company is determined to be liable
for damages in connection with actions and proceedings, the unreserved
and uninsured portion of such liability is not expected to be
material. The Company also has been identified as a potentially
responsible party at several waste disposal sites under US and related
state environmental statutes and regulations. The Company denies
liability with respect to many of these legal actions and
environmental proceedings and vigorously is defending such actions or
proceedings. The Company has established reserves that it believes
are adequate for its expected future liability in such actions and
proceedings where the nature and extent of such liability can be
estimated reasonably based upon presently available information.
<PAGE> 28
NOTE 17. QUARTERLY FINANCIAL DATA (unaudited):
$ Millions, except First Second Third Fourth Full
per share amounts Quarter Quarter Quarter Quarter Year
__________________ _______ _______ _______ _______ ______
1998
____
Net sales $1,500 $1,635 $1,525 $1,606 $6,266
Gross profit 297 369 258 325 1,249
Net earnings (loss) 7 53 (110) 29 (21)
Basic earnings (loss) per share $ .18 $ 1.39 $(2.86) $ .75 $ (.55)
Diluted earnings (loss) per share .18 1.38 (2.86) .75 (.55)
1997
____
Net sales $1,304 $1,396 $1,366 $1,559 $5,625
Gross profit 286 324 309 361 1,280
Net earnings 41 53 54 64 212
Basic earnings per share $ 1.07 $ 1.40 $ 1.41 $ 1.69 $ 5.55
Diluted earnings per share 1.06 1.38 1.38 1.66 5.48
Earnings per share for the first three quarters of 1997 have been restated to
reflect the adoption of SFAS No. 128 as disclosed in Note 1.
NOTE 18. ADDITIONAL INFORMATION:
Long-Lived Assets: The Company evaluates the carrying value of its
long-lived assets for impairment whenever adverse events or changes in
circumstances indicate that the carrying value of an asset may be
impaired. In accordance with SFAS 121, if the quoted market price or
if not available, the undiscounted cash flows are not sufficient to
support the recorded asset value, an impairment loss is recorded to
reduce the carrying value of the asset to the amount of expected
discounted cash flows. This same policy is followed for goodwill.
Foreign Currency Gains and Losses: Total foreign currency
remeasurement and transaction losses included in earnings were $5
million in 1998, $1 million in 1997 and $2 million in 1996.
Foreign Exchange Forward Contracts: The notional amounts of foreign
exchange forward contracts outstanding at December 31 were as follows:
Millions
________
Currency 1998 1997
________ ____ ____
British Pound $ 86 $ 90
French Franc 23 -
German Mark 19 27
Australian Dollar 13 103
Canadian Dollar 11 12
Hong Kong Dollar 8 -
Other 14 9
___ ___
$174 $241
____ ____
____ ____
Employee Stock Plans: A fair-value method of accounting for awards
subsequent to January 1, 1996, would have resulted in an increase in
compensation expense of $8 million, net of tax ($.20 per share) in
1998, $6 million, net of tax ($.14 per share) in 1997 and $2 million,
net of tax ($.05 per share) in 1996.
Investment in Joint Ventures and Alliances: Additional summary financial
information for joint ventures and alliances was as follows:
Year Ended December 31
$Millions 1998 1997 1996
_________ ______ ______ ______
Net sales $1,245 $1,307 $1,328
Gross profit 25 111 84
Net earnings (loss) (105) 5 3
Cummins' share (52) 2 2
<PAGE> 29
Other Income: The major components of Other Income, Net include the
following:
$ Millions 1998 1997 1996
__________ ____ ____ ____
Goodwill amortization $ 12 $ 2 $ 2
Interest income (9) (5) (11)
Gain on sale of businesses (7) (13) (8)
Rental income (6) (3) -
Royalty income (5) (12) (6)
Foreign currency losses 5 1 2
Gain on sale of building - - (8)
Distribution system support - - 7
Other (3) 4 (2)
____ ____ ____
Total $(13) $(26) $(24)
____ ____ ____
____ ____ ____
Restructuring and Other Non-Recurring Charges: Activity in the major
components of these charges was as follows:
Original Charges Balance
$ Millions Provision 1998 Dec. 31, 1998
__________ _________ _______ _____________
Restructuring of majority-
owned operations:
Workforce reductions $ 38 $(12) $ 26
Asset impairment loss 22 - 22
Facility consolidations
and other 17 (8) 9
____ ____ ____
77 (20) 57
____ ____ ____
Restructuring of joint
venture operations:
Workforce reductions 11 - 11
Tax asset impairment loss 7 - 7
Facility and equipment-
related costs 5 - 5
____ ____ ____
23 - 23
____ ____ ____
Inventory write-downs
associated with exit
activities 14 (5) 9
____ ____ ____
Total $114 $(25) $ 89
____ ____ ____
____ ____ ____
The remaining one-half of the employees to be severed related to these
actions are expected to be terminated at various dates during 1999.
The tax asset impairment loss relates to a write-down of the
investment in the Cummins Wartsila joint venture in an amount equal to
certain deferred taxes previously recorded for losses of the joint
venture. The Company had been adjusting the investment in the joint
venture to reflect deferred taxes associated with net operating losses
for the venture. Upon review of the restructuring plan and future
operating results, it was determined that certain of the associated
deferred tax assets for this joint venture are less likely to be
recoverable.
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
_________________________________________
As independent public accountants, we hereby consent to the
incorporation of our report, included in this Form 10-K, into the
Company's previously filed Registration Statement File Nos. 2-32091,
2-53247, 2-58696, 33-2161, 33-8842, 33-31095, 33-37690, 33-46096,
33-46097, 33-46098, 33-50665, 33-56115, 333-2165, 333-31573,
333-42687 and 333-67391.
ARTHUR ANDERSEN LLP
Chicago, Illinois
November 3, 1999.
