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| CMI > SEC Filings for CMI > Form 10-K on 27-Feb-2009 | All Recent SEC Filings |
27-Feb-2009
Annual Report
Cummins Inc. and its consolidated subsidiaries are hereinafter sometimes referred to as "Cummins," "the Company," "the registrant," "we," "our," or "us."
ORGANIZATION OF INFORMATION
The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") was prepared to provide the reader with a view and perspective of our businesses through the eyes of management and should be read in conjunction with our Consolidated Financial Statements and the accompanying notes to those financial statements. Our MD&A is presented in the following sections:
º •
º Executive Summary and Financial Highlights
º •
º Results of Operations
º •
º Restructuring Charges
º •
º Operating Segment Results
º •
º Liquidity and Capital Resources
º •
º Contractual Obligations and Other Commercial Commitments
º •
º Off Balance Sheet Financing
º •
º Application of Critical Accounting Estimates
º •
º Recently Adopted and Recently Issued Accounting Pronouncements
EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS
We are a leading global power provider that designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration and exhaust aftertreatment, fuel systems, controls and air handling systems. We sell our products to Original Equipment Manufacturers (OEMs), distributors and other customers worldwide. We have long-standing relationships with many of the leading manufacturers in the markets we serve, including PACCAR Inc., International Truck and Engine Corporation (Navistar International Corporation), Chrysler LLC, Volvo AB, Daimler Trucks North America (formerly Freightliner), Ford Motor Company, Case New Holland, Komatsu, and Volkswagen. We serve our customers through a network of more than 500 company-owned and independent distributor locations and approximately 5,200 dealer locations in more than 190 countries and territories.
Our reportable operating segments consist of the following: Engine, Power Generation, Components and Distribution. This reporting structure is organized according to the products and markets each segment serves. This type of reporting structure allows management to focus its efforts on providing enhanced service to a wide range of customers. The Engine segment produces engines and parts for sale to customers in on-highway and various industrial markets. The engines are used in trucks of all sizes, buses and recreational vehicles, as well as various industrial applications including construction, mining, agriculture, marine, oil and gas, rail and military. The Power Generation segment is an integrated provider of power systems which sells engines, generator sets and alternators. The Components segment includes sales of filtration products, exhaust aftertreatment systems, turbochargers and fuel systems. The Distribution segment includes wholly-owned and partially-owned distributorships engaged in wholesaling engines, generator sets, and service parts, as well as performing service and repair activities on our products and maintaining relationships with various OEMs throughout the world.
Our financial performance depends, in large part, on varying conditions in the markets we serve, particularly the on-highway, construction and general industrial markets. Demand in these markets tends to fluctuate in response to overall economic conditions and is particularly sensitive to changes in interest rate levels and our customers' access to credit. Our sales may also be impacted by OEM inventory levels and production schedules and stoppages. Economic downturns in markets we serve generally result in reductions in sales and pricing of our products. As a worldwide business, our operations are also affected by political, economic and regulatory matters, including environmental and emissions standards, in the countries we serve. However, our geographic diversity and broad product and service offerings have helped limit the impact of any one industry or customer and the economy of any single country on our consolidated results. In 2008, softness in the pick-up truck, recreational vehicle, and recreational marine markets worsened and evidence of a downturn in the United States (U.S.) and European economies and softening in global markets became more evident, particularly in the fourth quarter when we saw severe declines in the truck and construction businesses. Despite these unfavorable conditions, we reported increased net sales and net income during 2008 compared to 2007. Approximately 54 percent of our annual 2007 sales came from countries other than the U.S. and that trend grew to 59 percent for the year ended December 31, 2008, which helped to mitigate some of our exposure in the U.S. economy. The diversity of our business portfolio has contributed to the significant organic growth we have experienced over the past several years and continued into 2008 despite more difficult economic conditions.
We continued our strong performance of the past four years into 2008 with a fifth straight year of record net sales and net income. Net income was $755 million, or $3.84 per diluted share, on sales of $14.3 billion, compared to 2007 net income of $739 million, or $3.70 per diluted share, on sales of $13.0 billion. The income improvement was driven by a 10 percent increase in net sales and a 15 percent increase in gross margin, as we benefited from improved pricing and higher demand across most of our businesses, increased market share in a number of markets and focused cost reduction
efforts. However, as the result of the deepening global credit crisis that began impacting many of our markets in the fourth quarter of 2008 and the bleak global economic outlook for 2009, we implemented targeted restructuring actions in the fourth quarter of 2008 at a pretax cost of $37 million ($26 million after-tax), or $0.13 per share. We are also taking additional restructuring actions in early 2009 to adjust for continued weakening markets and decaying economic conditions affecting most of our markets. For a detailed discussion of restructuring see "Restructuring Charges" and Note 3 to the Consolidated Financial Statements.
RESULTS OF OPERATIONS
Favorable/ (Unfavorable)
Years ended December 31, 2008 vs. 2007 2007 vs. 2006
Dollars in millions 2008 2007 2006 Amount Percent Amount Percent
Net sales $ 14,342 $ 13,048 $ 11,362 $ 1,294 10 % $ 1,686 15 %
Cost of sales 11,402 10,492 8,897 (910 ) (9 )% (1,595 ) (18 )%
Gross margin 2,940 2,556 2,465 384 15 % 91 4 %
Operating expenses and income
Selling, general and
administrative expenses 1,450 1,296 1,153 (154 ) (12 )% (143 ) (12 )%
Research, development and
engineering expenses 422 329 321 (93 ) (28 )% (8 ) (2 )%
Equity, royalty and
interest income from
investees 253 205 140 48 23 % 65 46 %
Restructuring charges 37 - - (37 ) NM - - %
Other operating (expense)
income, net (12 ) 22 - (34 ) NM 22 NM
Operating income 1,272 1,158 1,131 114 10 % 27 2 %
Interest income 18 36 47 (18 ) (50 )% (11 ) (23 )%
Interest expense 42 58 96 16 28 % 38 40 %
Other (expense) income,
net (70 ) 33 1 (103 ) NM 32 NM
Income before income taxes
and minority interests 1,178 1,169 1,083 9 1 % 86 8 %
Income tax expense 360 381 324 21 6 % (57 ) (18 )%
Minority interests in income
of consolidated subsidiaries 63 49 44 (14 ) (29 )% (5 ) (11 )%
Net income $ 755 $ 739 $ 715 $ 16 2 % $ 24 3 %
Diluted earnings per share $ 3.84 $ 3.70 $ 3.55 $ 0.14 4 % $ 0.15 4 %
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2008 vs. 2007
Net Sales
Net sales increased in all segments due to the following drivers.
º •
º Our commercial power generation business experienced increased demand,
especially internationally.
º •
º We increased our market share in North American (includes the United
States (U.S.) and Canada and excludes Mexico) heavy-duty truck and
medium-duty truck and bus markets.
º •
º Industrial engine markets demand increased, particularly the
international construction and commercial marine markets.
º •
º Our Distribution segment benefited from increased demand as well as
the acquisition of a majority interest in three previously independent
distributors.
º •
º Our turbocharger and emissions solutions businesses experienced
increased demand.
º •
º We had a favorable impact from foreign currency translation.
These increases in net sales were partially offset by softening in the U.S. economy which has resulted in a significant reduction in demand in light-duty automotive and recreational markets for engines as well as decreased demand for consumer power generation products and a significant reduction in most other markets in the fourth quarter of 2008 as the result of the economic recession.
A more detailed discussion of sales by segment is presented in the Operating Segments Results section.
Gross Margin
Significant drivers of the change in gross margins were as follows:
2008 vs. 2007
Increase (Decrease)
in millions
Price $ 402
Volume/Mix 233
Production costs 47
Currency 47
Warranty expense (185 )
Material Costs (173 )
Other 13
Total $ 384
|
Gross margin increased by $384 million, and as a percentage of sales increased by 0.9 percentage points. Benefits from increased pricing and a more favorable volume/mix of products sold were partially offset by higher material costs reflecting the increase in commodity prices during the year and higher warranty expense. Our warranty expense reflects favorable warranty experience for some engine products and our provision related to sales in 2008 was 2.9 percent of sales, down from 3.1 percent in 2007. This result was more than offset by negative trends primarily in certain mid-range engine products launched in 2007 for which we recorded additional warranty liability of approximately $117 million in the fourth quarter of 2008.
A more detailed discussion of margin by segment is presented in the "Operating Segments Results" section.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased primarily due to increased consulting expenses of $36 million, increased compensation and related expenses of approximately $34 million, and the acquisition of a majority ownership interest in three previously independent North American distributors. Increased headcount and compensation and related expenses included salaries, variable compensation and fringe benefits across the business in support of higher volumes and business growth. Overall selling, general and administrative expenses as a percentage of sales increased to 10.1 percent in 2008 from 9.9 percent in 2007.
Research, Development and Engineering Expenses
Research, development and engineering expenses increased significantly, primarily due to higher spending on development programs for future products including increased headcount, compensation and related expenses. Compensation and related expenses include salaries, variable compensation and fringe benefits. Fluctuations in other miscellaneous research and development expenses were not significant individually or in the aggregate. Overall, research, development and engineering expenses as a percentage of sales increased to 2.9 percent in 2008 from 2.5 percent in 2007.
Equity, Royalty and Interest Income from Investees
Equity, royalty and interest income from investees increased significantly, primarily due to increases in income from North American distributors of $17 million, Dongfeng Cummins Engine Company, Ltd. (DCEC) of $14 million, increased royalty and interest income of $9 million and increased income from Chongqing Cummins Engine Company Limited (CCEC) of $8 million. Shanghai Fleetguard Filter Co., Ltd also experienced an increase of $2 million. These increases were slightly offset by decreases from Tata Cummins Ltd. (TCL) of $6 million and Cummins MerCruiser Diesel Marine LLC (MerCruiser) of $8 million. North American distributors increased primarily due to income from a joint venture which we formed in the fourth quarter of 2007. DCEC sales increased largely due to prebuy activity in the first half of 2008 prior to a mid-year emissions change. CCEC increased primarily due to increased sales volumes. TCL experienced decreased sales volumes for the year while MerCruiser profits declined due to a significant decline in the recreational marine market and increased research, development and engineering expenses.
Other Operating (Expense) Income, Net
Years ended
December 31,
2008 2007
in millions
Other operating (expense) income:
Royalty income $ 12 $ 7
Gain on sale of fixed assets(1) 5 22
Flood damage expenses (5 ) -
Royalty expense (10 ) (4 )
Amortization of other intangibles(2) (13 ) (1 )
Other, net (1 ) (2 )
Total other operating (expense) income, net $ (12 ) $ 22
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º (2)
º The increase in amortization of other intangibles was primarily due to
amortization of purchased premiums related to the acquisition of a North
American distributor in 2008.
Interest Income
Interest income decreased primarily due to lower average cash balances in 2008 compared to 2007.
Interest Expense
Interest expense decreased primarily due to declining short-term interest
rates and a benefit from our interest rate swap.
Other (Expense) Income, Net
Years ended
December 31,
2008 2007
in millions
Other (expense) income:
Change in cash surrender value of
corporate owned life insurance(1) $ (36 ) $ -
Bank charges (12 ) (12 )
Foreign currency (losses) gains(2) (46 ) 28
Other, net 24 17
Total other (expense) income, net $ (70 ) $ 33
|
º (2)
º The foreign currency exchange losses in 2008 were due to unfavorable
currency fluctuations in 2008, especially with the British Pound, the Euro,
the Australian Dollar and the Indian Rupee.
Income Tax Expense
Our income tax rates are generally less than the 35 percent U.S. income tax rate primarily because of lower taxes on foreign earnings and research tax credits. Our effective tax rate for 2008 was 30.6 percent compared to 32.6 percent for 2007. The decrease is primarily due to greater foreign earnings in 2008, which are subject to lower tax rates. Our 2008 income tax provision also includes a $10 million (0.8 percent) reduction in the fourth quarter due to the legislative reinstatement of the U.S. research tax credit.
We expect our 2009 effective tax rate to be 31 percent excluding any discrete items that may arise.
Minority Interests in Income of Consolidated Subsidiaries
Minority interests in income of consolidated subsidiaries eliminates the income or loss attributable to non-Cummins ownership interests in our consolidated entities. Minority interests in income of consolidated subsidiaries increased primarily due to higher income at our consolidated subsidiary in India. Cummins India Limited's (CIL's), a 51 percent owned subsidiary, minority interest increased $10 million due to the creation of a new export business in 2008 and favorable price adjustments for high horsepower products. There were no other individual fluctuations in the subsidiaries that were significant.
Net Income and Diluted Earnings Per Share
Net income and diluted earnings per share increased primarily due to higher volumes, improved margins, higher equity income and a lower effective tax rate. These increases were partially offset by warranty expense, restructuring charges and investment losses primarily occurring during the fourth quarter of 2008, in addition to unfavorable foreign currency effects.
Outlook
Near-Term:
We expect sales and profits to be lower in 2009 given the economic outlook. Our operating results in 2009 will depend on how the current global economic conditions impact the markets we serve. Forecasting for 2009 is a significant challenge with these uncertain market conditions. Many of the markets we serve are slowing significantly as a result of the credit crisis and softening global economic environment and we expect 2009 sales will be down significantly from 2008 levels. In response to anticipated market conditions we executed voluntary and involuntary separation actions in December of 2008 and January of 2009. We expect to continue to focus on cost reductions and scaling production to meet current demand. If uncertainties in the credit and capital markets continue, the overall impact on our customers as well as end user demand for our products could have a significant adverse impact on our near-term results. In light of current economic conditions, if conditions continue to worsen in 2009, it is reasonably possible that we may be required to incur impairment charges on certain assets as we decrease production or close certain manufacturing facilities in response to decreasing demand. Impairments could have a material impact on our results of operations and financial position. At this time we cannot estimate these potential impairment charges.
Long-Term:
While there is uncertainty in the near-term market as a result of the current economic conditions, we continue to be optimistic that opportunities for long-term growth and profitability will continue in the future.
2007 vs. 2006
Net Sales
Net sales increased in all segments due to the following drivers.
º •
º Our commercial generator and alternator businesses benefited from
improved pricing and strong organic growth.
º •
º Our emission solutions and turbocharger businesses experienced strong
organic growth.
º •
º We benefited from improved pricing for emission compliant engines.
º •
º Most on-highway and off-highway markets experienced strong demand.
º •
º We had a favorable impact from foreign currency translation.
These increases were partially offset by:
º •
º Demand in our North American heavy-duty on-highway market decreased as
a result of the 2007 change in emissions standards.
º •
º We deconsolidated one of our North American joint ventures beginning
in 2007 whose 2006 sales totaled $163 million.
A more detailed discussion of sales by segment is presented in the Operating Segment Results section.
Gross Margin
Significant drivers of the change in gross margin were as follows:
2007 vs. 2006
Increase (Decrease)
in millions
Price $ 516
Volume/Mix 158
Production costs (419 )
Warranty expense (87 )
Deconsolidation of a joint venture (65 )
Other (12 )
Total $ 91
|
Gross margin as a percentage of sales declined by 2.1 percentage points as margin percentages declined in three of our segments. The provision for warranties issued for the year was 3.1 percent of consolidated sales, compared to 2.8 percent for 2006.
A more detailed discussion of margin by segment is presented in our Operating Segment Results section.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased primarily due to increased compensation and related expenses of approximately $116 million in support of higher volumes and business growth, and increased consulting fees and other outside services of $32 million. Increased headcount, compensation and related expenses included salaries, variable compensation and fringe benefits across the business in support of higher volumes and business growth. Overall selling, general and administrative expenses as a percentage of sales declined to 9.9 percent in 2007 from 10.1 percent in 2006.
Research, Development and Engineering Expenses
Research, development and engineering expenses increased primarily due to higher spending on new product development and critical technologies for 2010 and beyond including increased headcount, compensation and related expenses to support business growth. Compensation and related expenses include salaries, variable compensation, and fringe benefits. Fluctuations in other miscellaneous research, development and engineering expenses were not significant individually or in the aggregate. Overall, research, development and engineering expenses declined to 2.5 percent in 2007 from 2.8 percent in 2006.
Equity, Royalty and Interest Income from Investees
Equity, royalty and interest income from investees increased significantly, primarily due to improved income from North American distributors of $35 million, DCEC of $22 million, CCEC of $7 million and MerCruiser of $5 million, while the other joint ventures had slight increases. North American distributors increased primarily as the result of organic growth, acquisitions and the deconsolidation of a North American joint venture in 2007.
Other Operating (Expense) Income, Net
Years ended
December 31,
2007 2006
in millions
Other operating (expense) income:
Gain on sale of fixed assets(1) $ 22 $ 4
Royalty income 7 3
Amortization of other intangibles (1 ) 1
Royalty expense (4 ) (3 )
Other, net (2 ) (5 )
Total other operating (expense) income, net $ 22 $ -
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Interest Income
Interest income decreased primarily due to lower average cash balances in 2007 compared to 2006.
Interest Expense
Interest expense decreased primarily due to a decline of $137 million in
debt balances, partially offset by higher interest rates.
Other (Expense) Income, Net
Years ended
December 31,
2007 2006
in millions
Other (expense) income:
Loss on early extinguishment of debt(1) $ - $ (12 )
. . .
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