QuickLinks-- Click here to rapidly navigate through this documentUNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549FORM 10-K/
A2AAmendment No. 1
ANNUAL REPORT PURSUANT TO SECTION 13
orOR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934For the Fiscal Year Ended December 31,
1998 CUMMINS ENGINE COMPANY, INC.2003Commission File Number 1-4949
Incorporated in the State of Indiana I.R.S. Employer Identification No. 35-0257090CUMMINS INC.
| Indiana (State of Incorporation) | 35-0257090 (IRS Employer Identification No.) |
500 Jackson Street
Box 3005
Columbus, Indiana 47202-3005
(Principal Executive Office)
(Address of principal executive offices)
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.
| Title of each class | Name of each exchange on which registered | |
| Common Stock, $2.50 par value | New York Stock Exchange 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]o No [ ]ý
Indicate by check mark if disclosuresdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K areis 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]o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý No o
The aggregate market value of the voting stock held by non-affiliates was approximately $1.6$1.4 billion at JanuaryJune 29, 1999.2003.
As of January 29, 1999,March 1, 2004, there were outstanding 42.042.9 million shares of the only class of$2.50 par value per share common stock.
stock outstanding.
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. 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
We are filing this amendment 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
______ ______ ______
______ ______ ______
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.
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.
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.
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.
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.
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.
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 of Dongfeng Cummins Engine Company Limited, a 50% owned unconsolidated subsidiary, which are required to be filed under Regulation S-X by March 30, 2004. The financial statements were excluded from the annual report to shareholders by Rule 14a-3(b).
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
Financial Data 28
11
RESPONSIBILITY FOR FINANCIAL STATEMENTS
_______________________________________
Management is responsibleStatement Schedules
* Previously filed
On October 30, 2003, we filed a Current Report on Form 8-K under Item 7 and Item 12 containing our press release announcing financial results for the preparationthird quarter ended September 28, 2003.
On December 5, 2003, we filed a Current Report on Form 8-K/A under Item 7 amending the Form 8-K filed on October 30, 2003.
Exhibit 31(a). Certification Pursuant to Rule 13a-15(e) and 15d-15(e), As Adopted Pursuant to Section 302 of the Company's
consolidatedSarbanes-Oxley Act of 2002.
Exhibit 31(b). Certification Pursuant to Rule 13a-15(e) and 15d-15(e), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32. Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
2
Financial Statements of Dongfeng Cummins Engine Company Limited
(Financial statements required by Regulation S-X which are excluded from the annual report to changes in business conditions and operations
and recommendations madeshareholders by Rule 14a-3(b))
3
DONGFENG CUMMINS ENGINE COMPANY LIMITED
FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 2003
4
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Report of Independent Auditors
To the independent public accountants and the
internal auditors.
The Board of Directors has an Audit Committee whose members are not
employeesand Shareholders 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 ofDongfeng Cummins Engine Company Inc.:Limited
We have audited the accompanying consolidated statement of financial position of Dongfeng Cummins Engine Company Inc., (an Indiana corporation) and
subsidiariesLimited (the "Company") as of December 31, 1998 and 1997,2003 and the related consolidated statements of earnings,operations, of cash flows and of shareholders' investmentequity for each of the three years in the period ended December
31, 1998.year then ended. 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.audit.
We conducted our auditsaudit in accordance with auditing standards generally accepted auditing
standards. Those standardsin the United States of America which 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 provideaudit provides 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 Dongfeng Cummins Engine Company Inc.,Limited at December 31, 2003, and subsidiariesits results of operations and cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
The accompanying statement of financial position of Dongfeng Cummins Engine Company Limited as of December 31, 1998 and
1997,2002 and the resultsrelated statements of their operations, and theirof cash flows and of shareholders' equity for each of the three years in the period ended December 31, 1998,2002 and 2001 were not audited by us in conformityaccordance with auditing standards generally accepted accounting principles.
Arthur Andersen LLP
Chicago, Illinois,
January 26, 1999.
12in the United States of America and, accordingly, we do not express an opinion on them.
/s/ PricewaterhouseCoopers Zhong Tian CPAs Limited Company
Chongqing, People's Republic of China
February 23, 2004
5
DONGFENG CUMMINS ENGINE COMPANY INC.
CONSOLIDATED STATEMENTLIMITED
STATEMENTS 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
OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
IN RENMINBI
| | 2003 | Unaudited 2002 | Unaudited 2001 | ||||
|---|---|---|---|---|---|---|---|
| Net sales(includes sales to related parties of RMB2,439,944,635, RMB470,250,900 and RMB257,090,203, respectively) | 2,616,270,513 | 841,939,907 | 527,832,589 | ||||
| Cost of sales | (2,010,633,066 | ) | (690,803,356 | ) | (465,341,776 | ) | |
| Gross profit | 605,637,447 | 151,136,551 | 62,490,813 | ||||
| Selling expenses | (87,305,453 | ) | (28,680,389 | ) | (41,833,783 | ) | |
| General and administrative expenses | (78,520,000 | ) | (36,460,068 | ) | (31,855,516 | ) | |
| Operating income | 439,811,994 | 85,996,094 | (11,198,486 | ) | |||
| Interest income | 1,109,217 | 899,826 | 1,687,461 | ||||
| Interest expense | (868,475 | ) | (908,462 | ) | (2,714,100 | ) | |
| Other income (expenses), net | 732,464 | (1,244,482 | ) | (236,342 | ) | ||
| Income (loss) before income tax | 440,785,200 | 84,742,976 | (12,461,467 | ) | |||
| Income tax benefit | 6,138,983 | — | — | ||||
| Net income (loss) | 446,924,183 | 84,742,976 | (12,461,467 | ) | |||
The accompanying notes are an integral part of this statement.
13these financial statements.
6
DONGFENG CUMMINS ENGINE COMPANY INC.
CONSOLIDATED STATEMENTLIMITED
STATEMENTS OF FINANCIAL POSITION
____________________________________________
Millions, except per share amounts December
AS OF 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
______ ______
______ ______
2003 AND 2002
IN RENMINBI
| | December 31, 2003 | Unaudited December 31, 2002 | |||
|---|---|---|---|---|---|
| ASSETS | |||||
| Current assets: | |||||
| Cash and cash equivalents | 96,820,069 | 84,126,095 | |||
| Trade receivable, net | 45,346,917 | 18,797,605 | |||
| Amounts due from related parties (note 3) | 420,473,063 | 44,981,837 | |||
| Notes receivable (note 4) | 204,523,049 | 14,311,550 | |||
| Inventories (note 5) | 354,735,252 | 126,630,143 | |||
| Prepayment | 163,249 | 9,010,084 | |||
| Other current assets | 10,205,243 | 7,564,401 | |||
| Total current assets | 1,132,266,842 | 305,421,715 | |||
| Property, plant and equipment, net (note 6) | 605,459,692 | 292,654,477 | |||
| Intangible assets, net (note 7) | 24,401,277 | 31,190,880 | |||
| Deferred income tax (note 11) | 28,751,437 | — | |||
| Total assets | 1,790,879,248 | 629,267,072 | |||
| LIABILITIES AND EQUITY | |||||
| Current liabilities: | |||||
| Short-term bank loans (note 8) | — | 10,000,000 | |||
| Accounts payable | 353,311,716 | 46,318,837 | |||
| Amounts due to related parties (note 3) | 149,009,724 | 72,490,453 | |||
| Accrued product coverage | 20,812,031 | 1,332,790 | |||
| Other accrued expenses | 12,582,523 | 5,278,299 | |||
| Other current liabilities (note 9) | 36,083,447 | 15,330,464 | |||
| Total current liabilities | 571,799,441 | 150,750,843 | |||
| Long-term liabilities: | |||||
| Reserve for staff retrenchment (note 12) | 4,714,325 | — | |||
| Other long-term liabilities (note 10) | 2,901,616 | 2,901,616 | |||
| Total long-term liabilities | 7,615,941 | 2,901,616 | |||
| Total liabilities | 579,415,382 | 153,652,459 | |||
| Equity: | |||||
| Paid in capital (note 14) | 751,483,660 | 414,198,250 | |||
| Capital surplus | 3,132,199 | 3,040,934 | |||
| Surplus reserves (note 15) | 8,756,315 | — | |||
| Retained earnings | 448,091,692 | 58,375,429 | |||
| Total equity | 1,211,463,866 | 475,614,613 | |||
| Total liabilities and equity | 1,790,879,248 | 629,267,072 | |||
The accompanying notes are an integral part of this statement.
14these financial statements.
7
DONGFENG CUMMINS ENGINE COMPANY INC.
CONSOLIDATED STATEMENTLIMITED
STATEMENTS 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
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
IN RENMINBI
| | 2003 | Unaudited 2002 | Unaudited 2001 | |||||
|---|---|---|---|---|---|---|---|---|
| Cash flows from operating activities: | ||||||||
| Net income (loss) | 446,924,183 | 84,742,976 | (12,461,467 | ) | ||||
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||
| Depreciation and amortization | 68,901,168 | 20,719,920 | 11,623,973 | |||||
| Provision for (reversal of) obsolete inventories and doubtful debts | 4,372,829 | (123,437 | ) | 78,425 | ||||
| Loss on disposal of property, plant and equipment | 2,338,388 | 255,977 | — | |||||
| Changes in assets and liabilities: | ||||||||
| Receivables | (593,459,496 | ) | 5,066,304 | (45,288,620 | ) | |||
| Inventories | (231,985,821 | ) | (1,509,657 | ) | (88,892,415 | ) | ||
| Accounts payable | 404,868,479 | 21,820,872 | 12,614,183 | |||||
| Others | 27,543,149 | (2,382,185 | ) | 4,709,654 | ||||
| Net cash provided by (used in) operating activities | 129,502,879 | 128,590,770 | (117,616,267 | ) | ||||
| Cash flows from investing activities: | ||||||||
| Proceeds from sale of property, plant and equipment | 1,060,805 | — | — | |||||
| Purchases of property, plant and equipment | (59,418,105 | ) | (75,893,746 | ) | (94,237,925 | ) | ||
| Net cash used in investing activities | (58,357,300 | ) | (75,893,746 | ) | (94,237,925 | ) | ||
| Cash flows from financing activities: | ||||||||
| Cash received from capital injection | — | — | 139,251,614 | |||||
| Proceeds from borrowings | — | 10,000,000 | 150,146,860 | |||||
| Repayment of bank loans | (10,000,000 | ) | (28,968,100 | ) | (121,178,760 | ) | ||
| Distribution of profits | (48,451,605 | ) | — | — | ||||
| Net cash used in financing activities | (58,451,605 | ) | (18,968,100 | ) | 168,219,714 | |||
| Net change in cash and cash equivalents | 12,693,974 | 33,728,924 | (43,634,478 | ) | ||||
| Cash and cash equivalents at beginning of year | 84,126,095 | 50,397,171 | 94,031,649 | |||||
| Cash and cash equivalents at end of year | 96,820,069 | 84,126,095 | 50,397,171 | |||||
| Cash payment for interest during the year | 868,475 | 908,462 | 1,454,875 | |||||
The accompanying notes are an integral part of this statement.
15these financial statements.
8
DONGFENG CUMMINS ENGINE COMPANY INC.
CONSOLIDATED STATEMENTLIMITED
STATEMENTS 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 -
___ ___ ____
___ ___ ____
EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
IN RENMINBI
| | 2003 | Unaudited 2002 | Unaudited 2001 | ||||
|---|---|---|---|---|---|---|---|
| Paid in capital | |||||||
| Balance at beginning of year | 414,198,250 | 414,198,250 | 277,631,200 | ||||
| Capital injection during the year (note 14) | 337,285,410 | — | 136,567,050 | ||||
| Balance at end of year | 751,483,660 | 414,198,250 | 414,198,250 | ||||
| Capital surplus | |||||||
| Balance at beginning of year | 3,040,934 | 3,040,934 | 356,370 | ||||
| Capital contribution in excess of registered amount | — | — | 2,685,328 | ||||
| Exchange difference relating to foreign currency capital contribution | — | — | (764 | ) | |||
| Non-cash assets donation received | 91,265 | — | — | ||||
| Balance at end of year | 3,132,199 | 3,040,934 | 3,040,934 | ||||
| Surplus reserves | |||||||
| Balance at beginning of year | — | — | — | ||||
| Appropriation from net income (note 15) | 8,756,315 | — | — | ||||
| Balance at end of year | 8,756,315 | — | — | ||||
| Retained Earnings | |||||||
| Balance at beginning of year | 58,375,429 | (26,367,547 | ) | (13,906,080 | ) | ||
| Net income (loss) | 446,924,183 | 84,742,976 | (12,461,467 | ) | |||
| Appropriation to surplus reserves (note 15) | (8,756,315 | ) | — | — | |||
| Profit distribution to owners (note 15) | (48,451,605 | ) | — | — | |||
| Balance at end of year | 448,091,692 | 58,375,429 | (26,367,547 | ) | |||
| Total | 1,211,463,866 | 475,614,613 | 390,871,637 | ||||
The accompanying notes are an integral part of this statement.
16these financial statements.
9
DONGFENG CUMMINS ENGINE COMPANY INC.
LIMITED
NOTES TO CONSOLIDATEDTHE FINANCIAL STATEMENTS
__________________________________________
NOTE
1. ACCOUNTING POLICIES:
PrinciplesOrganization and principal activities
Dongfeng Cummins Engine Company Limited (the "Company") is a sino-foreign equity joint venture amongst Cummins Engine Company, Inc. ("Cummins USA"), Cummins (China) Investment Co., Ltd. ("CCI") and Dongfeng Automobile Co., Ltd. ("Dongfeng Auto") established under the relevant laws and regulations of Consolidation:the People's Republic of China ("PRC").
The consolidatedCompany, which was established on May 14, 1996, is engaged in the manufacture and sale of diesel engines, related parts and the provision of after-sale services.
The joint venture has a term of 35 years from the date of establishment and may be extended subject to the unanimous approval of the Board of Directors and the approval of the relevant authorities.
2. Summary of significant accounting policies
Basis of presentation
The financial statements include all significant majority-owned subsidiaries. Affiliated
companieshave been prepared in which Cummins does not have a controlling interest, or
for which control is expected to be temporary, are accounted for usingaccordance with accounting principles generally accepted in the equity method. United States of America.
Use of estimates and assumptions as determined by
management is required in the
The preparation of consolidated financial statements in conformity with generally accepted accounting principles.principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimatesthose estimates.
Comparative figures
The financial statements as of December 31, 2002 and assumptions.
for the years ended December 31, 2002 and 2001 are unaudited. Those unaudited Financial Statements include all adjustments of a normal recurring nature necessary to present fairly our financial position, results of operations and cash flows for the years presented.
Revenue Recognition:recognition
The Company recognizes revenues on the sale of
its products, net of estimated costs of returns, allowances and sales incentives, when products are shipped to customers and title and risk of ownership transfers.
Foreign currency translation
The Company's financial records are maintained in Renminbi ("RMB"), the functional currency. Transactions in foreign currencies are translated into Renminbi at the exchange rates prevailing at the transaction dates. Monetary assets and liabilities expressed in foreign currencies at the balance sheet date are translated into Renminbi at the exchange rates at the balance sheet date. Exchange differences arising in these cases are recorded in the Statement of Operations.
10
Income tax accounting
The Company determines the income tax provision using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax effects of temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The Company also recognizes future tax benefits associated with tax loss and credit carry forwards as deferred tax assets. Deferred tax assets are reduced by a valuation allowance to the extent there is uncertainty as to their ultimate realization. The Company measures deferred tax assets and liabilities using enacted tax rates in effect for the year in which the temporary differences are expected to be settled or recovered.
Cash equivalents
All financial instruments purchased with original maturities of three months or less are considered to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market. Inventory cost calculated on the weighted average basis comprises materials, direct labor and the manufacturing overhead expenditures.
Property, plant and equipment
Property, plant and equipment are recorded at cost. Property, plant and equipment are depreciated at rates sufficient to write off their cost over their estimated useful lives on a straight-line basis, taking into account their residual value which is estimated at 10% of cost. The applicable useful lives of fixed assets are as follows:
| Years | ||
|---|---|---|
| Buildings | 20 | |
| Production machinery | 10 | |
| Vehicles | 5 | |
| Office equipment | 5 |
Major additions and betterments are capitalized and depreciated over their estimated useful lives and repairs and maintenance expenses are charged to the Statement of Operations in the period incurred.
Upon retirement or other disposal of fixed assets, the cost and related amount of accumulated depreciation or amortization are eliminated from the asset and accumulated depreciation accounts, respectively. The difference, if any, between the net asset value and the proceeds is adjusted to earnings.
Construction in progress represents capital assets under construction or being installed and is stated at cost. Cost comprises original cost of plant and equipment, installation, construction and other direct costs which include interest costs on specific borrowings used to finance the capital assets, prior to the date of reaching the expected usable condition. Construction in progress is transferred to the property, plant and equipment account and depreciation commences when the asset has been substantially completed and reaches the expected usable condition.
No interest cost was capitalized in 2003 (2002 and 2001: nil).
11
Impairment of long-lived assets
The Company evaluates the long-lived assets for impairment when events or changes in circumstances indicate, in management's judgment, that the carrying value of such assets may not be recoverable. The determination of whether an impairment has occurred is based on management's estimate of undiscounted future cash flows attributable to the assets as compared to the carrying value of the assets. If an impairment has occurred, the amount of the impairment recognized is determined by estimating the fair value for the assets and recording a provision for loss if the carrying value is greater than fair value.
Intangible assets
Intangible assets with finite useful lives are subject to amortization. Intangible assets are presented at cost net of accumulated amortization.
Software
The Company capitalizes external software costs and amortizes them generally over 5 years.
Product coverage
The Company charges the estimated costs of product coverage programs, other than product recalls, to earnings at the time products are shipped to customers. The Company generallyuses historical experience of product coverage programs to estimate the remaining liability for various product coverage programs. As a result of the uncertainty surrounding the nature of product recall programs, the liability for such programs is recorded when the recall action is announced.
Below is the summary of the activity in the product coverage liability account for the years ended December 31, 2003, 2002 and 2001:
| | 2003 RMB | Unaudited 2002 RMB | Unaudited 2001 RMB | ||||
|---|---|---|---|---|---|---|---|
| Beginning balance | 1,332,790 | 3,836,916 | 1,122,389 | ||||
| Provision for warranties issued | 38,443,586 | 4,965,717 | 3,567,106 | ||||
| Payments | (18,964,345 | ) | (7,469,843 | ) | (852,579 | ) | |
| Ending balance | 20,812,031 | 1,332,790 | 3,836,916 | ||||
Allowance for doubtful accounts
The Company provides an allowance for doubtful accounts based on collection experience and an analysis of accounts receivable in light of the current economic environment. In addition, when necessary, the Company provides for the full amount of specific accounts deemed to be uncollectable. The activity in the allowance for doubtful accounts for the years ended December 31, 2003, 2002 and 2001 was as follows:
| | 2003 RMB | Unaudited 2002 RMB | Unaudited 2001 RMB | |||
|---|---|---|---|---|---|---|
| Beginning balance | 77,166 | 200,603 | 122,178 | |||
| Provision | 943,302 | — | 78,425 | |||
| Write-offs | (451,185 | ) | (123,437 | ) | — | |
| Ending balance | 569,283 | 77,166 | 200,603 | |||
12
Research and development expenses
Research and development expenses are charged to operations as incurred. For the year ended December 31, 2003, the Company incurred research and development costs amounting to RMB4,274,654 (2002: RMB1,424,403; 2001: RMB1,020,447).
Shipping and handling
Shipping and handling costs are included in selling expenses. For the year ended December 31, 2003, the Company incurred shipping and handling costs amounting to RMB7,537,492 (2002: RMB1,713,214; 2001: RMB1,285,026).
3. Related party transactions
The Company purchases products and components from related parties, and sells products and components to related parties. Related party transfer prices may differ from normal selling prices. In accordance with the provision of various agreements, certain products transferred are priced at cost, some are priced on a cost-plus basis, and others are priced at market value.
The following table lists the major related parties and their relationship with the Company:
| Name of related parties | Relationship with the Company | |
|---|---|---|
| Cummins USA | Owner | |
| CCI | Owner | |
| Dongfeng Auto | Owner | |
| Dongfeng Motor Co., Ltd. ("Dongfeng Motor") | Parent company of Dongfeng Auto | |
| Darlington Engine Co., Ltd. ("Darlington UK") | Subsidiary of Cummins USA | |
| Cummins Engine (Shanghai) Trade & Service Co., Ltd. ("Cummins Shanghai") | Subsidiary of CCI |
The following table summarizes related party sales for the years ended December 31, 2003, 2002 and 2001:
| | 2003 RMB | Unaudited 2002 RMB | Unaudited 2001 RMB | |||
|---|---|---|---|---|---|---|
| Dongfeng Motor and its subsidiaries | 2,326,766,421 | 452,509,000 | 249,703,955 | |||
| CCI | 98,482,778 | 8,739,200 | 4,717,231 | |||
| Cummins Shanghai | 11,278,938 | 699,800 | — | |||
| Others | 3,416,498 | 8,302,900 | 2,669,017 | |||
| 2,439,944,635 | 470,250,900 | 257,090,203 | ||||
13
The following table summarizes related party purchases for the years ended December 31, 2003, 2002 and 2001:
| | 2003 RMB | Unaudited 2002 RMB | Unaudited 2001 RMB | |||
|---|---|---|---|---|---|---|
| Darlington UK | 494,166,790 | 399,173,900 | 450,516,967 | |||
| Dongfeng Motor and its subsidiaries | 399,358,149 | 60,471,557 | 3,674,068 | |||
| Others | 5,525,818 | 1,023,300 | — | |||
| 899,050,757 | 460,668,757 | 454,191,035 | ||||
In accordance with the provision of the joint venture agreement, the Company is required to pay an annual royalty fee of US$750,000 to Cummins USA for the production of its products on open account underB series engines. In addition, the Company is required to pay a royalty fee to Cummins USA at the rate of US$90 per unit for each of its C series engine produced. For the year ended December 31, 2003, the total royalty fee paid to Cummins USA amounted to RMB 18,429,866 (2002: RMB3,405,992; 2001: RMB5,518,920).
For the year ended December 31, 2003, the Company paid an after-sale service network fee of RMB10,000,000 each to both CCI and Dongfeng Auto (2002: RMB10,000,000 to each party; 2001: RMB13,209,908 to each party).
The following tables summarizes significant related party balances:
| | December 31, 2003 RMB | Unaudited December 31, 2002 RMB | ||
|---|---|---|---|---|
| Amounts due from related parties | ||||
| —Dongfeng Motor and its subsidiaries | 414,423,150 | 44,796,854 | ||
| —CCI | 3,698,528 | 3,324 | ||
| —Cummins Shanghai | 2,351,385 | 8,606 | ||
| —Others | — | 173,053 | ||
| 420,473,063 | 44,981,837 | |||
| | December 31, 2003 RMB | Unaudited December 31, 2002 RMB | ||
|---|---|---|---|---|
| Amounts due to related parties | ||||
| —Dongfeng Motor and its subsidiaries | 67,618,734 | 11,689,680 | ||
| —Darlington UK | 63,439,737 | 48,253,743 | ||
| —Cummins USA | 17,257,182 | 5,629,818 | ||
| —CCI | — | 5,205,846 | ||
| —Others | 694,071 | 1,711,366 | ||
| 149,009,724 | 72,490,453 | |||
4. Notes receivable
Notes receivable consists of bank acceptances due within 1-6 months.
14
5. Inventories
Inventories are comprised of the following:
| | December 31, 2003 RMB | Unaudited December 31, 2002 RMB | |||
|---|---|---|---|---|---|
| Raw materials | 278,214,786 | 103,040,844 | |||
| Work in process | 8,367,417 | 396,656 | |||
| Self-produced semi-finished products | 13,170,031 | 6,143,012 | |||
| Finished goods | 58,893,730 | 17,079,631 | |||
| 358,645,964 | 126,660,143 | ||||
| Less: provision for loss on realization of inventories | (3,910,712 | ) | (30,000 | ) | |
| 354,735,252 | 126,630,143 | ||||
6. Property, plant and equipment
Property, plant and equipment is comprised of the following:
| | December 31, 2003 RMB | Unaudited December 31, 2002 RMB | |||
|---|---|---|---|---|---|
| Buildings | 164,653,661 | 81,396,515 | |||
| Production machinery | 761,977,037 | 210,391,126 | |||
| Vehicles | 4,687,596 | 2,657,666 | |||
| Office equipment | 17,517,734 | 9,572,954 | |||
| Construction in progress | 43,253,330 | 11,077,019 | |||
| 992,089,358 | 315,095,280 | ||||
| Less: accumulated depreciation | (386,629,666 | ) | (22,440,803 | ) | |
| 605,459,692 | 292,654,477 | ||||
Depreciation expense for the year ended December 31, 2003 was RMB61,927,941 (2002: RMB13,812,382; 2001: RMB5,324,744).
15
7. Intangible assets
The gross and net amount of intangible assets were:
| | December 31, 2003 RMB | Unaudited December 31, 2002 RMB | |||
|---|---|---|---|---|---|
| Land occupancy rights—gross | 8,504,040 | 8,504,040 | |||
| Less: accumulated amortization | (1,093,391 | ) | (850,416 | ) | |
| Net | 7,410,649 | 7,653,624 | |||
| Proprietary technology—gross | 41,488,327 | 41,488,327 | |||
| Less: accumulated amortization | (26,992,428 | ) | (20,994,108 | ) | |
| Net | 14,495,899 | 20,494,219 | |||
| Software—gross | 3,950,838 | 3,767,214 | |||
| Less: accumulated amortization | (1,456,109 | ) | (724,177 | ) | |
| Net | 2,494,729 | 3,043,037 | |||
| Total | 24,401,277 | 31,190,880 | |||
For the year ended December 31, 2003, amortization expense for software and other intangibles amounted to RMB6,973,227 (2002: RMB6,907,538; 2001: RMB6,299,229). The estimated amortization expense for the five succeeding years, assuming no further acquisitions or disposals, is approximately RMB6,960,044 in 2004, RMB6,717,071 in 2005, RMB3,996,592 in 2006, RMB279,698 in 2007, and RMB255,214 in 2008.
8. Borrowing arrangements
| December 31, 2003 RMB | Unaudited December 31, 2002 RMB | |||
|---|---|---|---|---|
| Bank loans—unsecured | — | 10,000,000 | ||
Short-term loans are denominated in Renminbi and bear annual interest at the rate of 4.8%.
The company repaid all bank loans during the year.
As of December 31, 2003, the Company had RMB1,600,000,000 of unused domestic credit terms
customaryfacilities.
9. Other current liabilities
Other current liabilities are comprised of the following:
| | December 31, 2003 RMB | Unaudited December 31, 2002 RMB | ||
|---|---|---|---|---|
| Current portion of reserve for staff retrenchment | 1,064,119 | — | ||
| Welfare payable | 1,167,509 | — | ||
| Value added tax & other taxes payable | 7,087,900 | 484,213 | ||
| Advance from customers | 12,094,959 | 11,249,729 | ||
| Other payable | 14,668,960 | 3,596,522 | ||
| 36,083,447 | 15,330,464 |
16
10. Other long-term liabilities
Pursuant to the regionland use right transfer agreement dated 24 December 1996 (the "Contract Date") reached by the Company and the Land Bureau of distribution.Xiangfan, Hubei Province, the Company is entitled to the use of a parcel of land of 65,800 square meters in Xiangfan Automobile Industry Development Zone for a period of thirty-five years starting from the Contract Date. As consideration, a land use fee amounting to RMB8,504,040 is to be paid in three installments of which the first 30% installment is to be paid within ten days after the Contract Date. The second 30% installment and the third 40% installment are to be paid before 30 December 2001 and 2011, respectively. In 2002, the Company has paid RMB500,000 of the third installment. The unpaid third installment is recorded as other long-term liabilities.
11. Income taxes
Sino-foreign joint ventures are subject to the income tax laws of the PRC applicable to Foreign Investment Enterprises. Such joint ventures are generally subject to income taxes at an effective rate of 33% on taxable income.
In accordance with the PRC income tax laws, the Company is exempted from state and local income taxes for two years starting from the first year of profitable operations, followed by a 50% exemption from such taxes for the next three years, after recouping all tax losses brought forward from the previous five years.
The Company's first profit-making year was 2002. The Company is not subject to income tax in 2003.
Tax effect of temporary differences between the tax bases of assets or liabilities and their reported amounts in financial statements that give rise to net deferred assets at December 31 were:
| December 31, 2003 RMB | Unaudited December 31, 2002 RMB | |||
|---|---|---|---|---|
| Provision on receivable and inventories | 285,096 | — | ||
| Receivables written off subject to tax authority approval | 74,446 | — | ||
| Assets received through donation | 30,117 | — | ||
| Reserve on staff retrenchment | 1,134,336 | — | ||
| Asset appreciation on contributed assets | 27,586,984 | |||
| Product coverage | 4,614,988 | — | ||
| Deferred tax assets | 33,725,967 | — | ||
The deferred income tax balances are classified in the Statement of Financial Position as follows:
| December 31, 2003 RMB | Unaudited December 31, 2002 RMB | |||
|---|---|---|---|---|
| Current assets | 4,974,530 | — | ||
| Non current assets | 28,751,437 | — | ||
| 33,725,967 | — | |||
12. Reserve for staff retrenchment
During 2003, the Company initiated and completed a plan to reduce the Company's work force. As a result, 49 employees were retired prior to their statutory retirement age. The Company recorded a
17
reserve of RMB5,778,444 (2002 and 2001: nil) of estimated employee related expenses associated with the termination of those employees, which will be paid over the next 14 years. For the year ended December 31, 2003, the Company paid RMB704,697 to the early retired employees as retirement compensation.
13. Fair value of financial instruments
The Company's financial instruments are comprised of cash, trade receivables and payables, notes receivables and short-term borrowings. Due to the short-term nature of these instruments and the related interest rates, the carrying amounts approximate fair values.
14. Paid in capital
| | December 31, 2003 RMB | Unaudited December 31, 2002 RMB | ||
|---|---|---|---|---|
| Cummins USA | 252,063,985 | 124,279,575 | ||
| CCI | 82,819,550 | 82,819,550 | ||
| Dongfeng Auto | 416,600,125 | 207,099,125 | ||
| 751,483,660 | 414,198,250 | |||
In 2003, in accordance with the revised joint venture contract dated February 22, 2003, investors of the Company contributed additional capital in the form of cash, fixed assets and intangible assets. As of December 31, 2003, the Company has fully paid in its registered capital in conformity with PRC law and regulations.
15. Surplus reserves and profit appropriations
In accordance with the "Law of the PRC on Joint Ventures Using Chinese and Foreign Investment" and the Company's Articles of Association, appropriations from net profit should be made to the Reserve Fund, the Staff and Workers' Bonus and Welfare Fund and the Enterprise Expansion Fund, after offsetting accumulated losses from prior years, and before profit distributions to the investors. The percentages to be appropriated to the Reserve Fund, the Staff and Workers' Bonus and Welfare Fund and the Enterprise Expansion Fund are determined by the Board of Directors of the Company.
The Staff and Workers' Bonus and Welfare Fund is available to fund payments of special bonuses to staff and for collective welfare benefits. Upon approval from the Board of Directors, the Reserve Fund can be used to offset accumulated losses or to increase capital; the Enterprise Expansion Fund can be used to expand production or to increase capital.
According to a resolution at the Board of Director's meeting dated November 17, 2002, the Company appropriated 12% of net income (after offsetting accumulated losses of previous years) of RMB58,375,429 for the year ended December 31, 2002 to the Reserve Fund; 2% to the Staff and Workers' Bonus and Welfare Fund, and 3% to the Enterprise Expansion Fund. In addition, dividends of RMB48,451,605 were declared to the investors.
18
Reserve fund and enterprise expansion fund is recorded in the surplus reserves account. The activity in the surplus reserves account for the year ended December 31, 2003 was as follows:
| | Surplus reserves | |||||
|---|---|---|---|---|---|---|
| | Reserve Fund | Enterprise Expansion Fund | Total | |||
| Balance as at December 31, 2002 | — | — | — | |||
| Current year additions | 7,005,051 | 1,751,264 | 8,756,315 | |||
| Balance as at December 31, 2003 | 7,005,051 | 1,751,264 | 8,756,315 | |||
According to generally accepted accounting principles in the United States of America, appropriation of staff and workers' bonus and welfare fund of RMB1,167,509 were accounted for as expenses and the balance of the fund as a liability of the Company.
16. Segment information
The Company engages in the sales of engine product and only has one reportable segment. All products are sold within the PRC with no particular geographic focus.
The Company's largest customer is Dongfeng Motor and its subsidiaries. For the year ended December 31, 2003, sales to Dongfeng Motor and its subsidiaries amounted to RMB2,326,766,421 (2002: RMB452,509,000; 2001: RMB249,703,955), representing 89% (2002: 54%; 2001: 47%) of net sales. No other customer accounted for more than 10% of net sales.
17. Retirement benefit arrangements
In accordance with statutory regulations in the PRC, the Company participates in a government sponsored multi-employer pension plan which provides retirement benefits to the Company's employees through a defined contribution plan. Regulations issued by the local labor bureau require the Company to pay a monthly premium to the local labor bureau based on 69% (2002: 64%; 2001: 63%) of its current employees' total salaries, of which 52% (2002: 47%; 2001: 46%) are borne by the Company and the remaining 17% (2002 and 2001: 17%) are borne by the individual. The local labor bureau is responsible for meeting all retirement benefit obligations and the Company has no further commitments beyond the monthly premium.
For the year ended December 31, 2003, the Company incurred retirement expenses amounting to RMB32,007,936 (2002: RMB2,890,506; 2001: RMB 2,705,512).
18. Leases
The Company leases land, office equipment and automobile for varying periods under lease agreements. Most of the leases are non-cancelable and all leases are operating leases with fixed rental payments, and expire over the next 3 to 35 years. For the year ended December 31, 2003, rental expenses under these leases amounted to RMB3,711,937 (2002: RMB987,000; 2001: RMB987,000).
19
Following is a summary of the future minimum payments under operating leases with terms of more than one year at December 31, 2003.
| Operating leases RMB | ||
|---|---|---|
| Year 2004 | 5,415,916 | |
| Year 2005 | 5,415,916 | |
| Year 2006 | 5,330,666 | |
| Year 2007 | 4,392,916 | |
| Year 2008 | 4,392,916 | |
| Years after 2008 | 102,867,450 | |
| Total future minimum leasepayments | 127,815,780 | |
19. Capital Commitment
As of December 31, 2003, the Company has various equipment renovation projects in progress. Committed capital expenditure in connection with these projects approximates RMB26,550,000.
20. Concentration of credit risk
Sales to the Company's largest customer, Dongfeng Motor and its subsidiaries, represented 89%, 54% and 47% of total revenue for the years ended December 31, 2003, 2002 and 2001, respectively. Amounts due from Dongfeng Motor and its subsidiaries represented 87% and 68% of the total trade receivable balance (including third party receivable and amounts due from related parties) as of December 31, 2003 and 2002, respectively.
21. Risk and uncertainties
The Chinese market in which the Company operates poses certain macro-economic and regulatory risks and uncertainties. Though the PRC has implemented a wide range of market-oriented economic reforms since 1978, continued reforms and progress towards a full market-oriented economy are uncertain and are likely to be readjusted and refined on an ongoing basis. This refinement and readjustment process, along with changes in government policies and regulations, may not always have a positive effect on the operations of the Company. In addition, the automotive industry has been designated as a pillar industry by the PRC government and as a result remains highly regulated. With China's accession to the World Trade Organization, the industry will eventually be more accessible to foreign invested enterprises. The PRC legal system has also seen marked changes since 1978; however, current enforcement of existing laws may be uncertain and sporadic, and implementation and interpretation there of may be inconsistent, resulting in a higher than usual degree of uncertainty as to the outcome of any litigation or legal process.
Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash, cash equivalents, and accounts receivable. As of December 31, 2003, substantially all of the Company's cash and cash equivalents were held in financial institutions located in the PRC. Accounts receivable are typically unsecured, denominated in Renminbi, and are derived from revenues earned from customers primarily located in the PRC. 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 andif necessary, maintains reserves for potential credit losses. Historically, such 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
____ ____
____ ____
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 within management's expectations.
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
____ ____ _____
____ ____ _____
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
Pursuant to the recent experiencerequirements of higher-
than-anticipated base warranty costs to repair certain automotive
engines manufactured in previous years, and $35 million related to a
revised estimateSection 13 or 15(d) 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.
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.
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 usedAct of 1934, the Registrant has duly caused this report 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 ofbe signed on its ESOP
Trust. The notes were refinanced in July 1998. Cash contributions to
the Trust, together with the dividends accumulated on the common stock
heldbehalf 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 costundersigned, thereunto duly authorized.
By: | /s/ SUSAN K. CARTER Susan K. Carter Vice President of Finance and Chief Accounting Officer (Principal Accounting Officer) |
Date: March 25, 2004