SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1995 CUMMINS ENGINE COMPANY, INC. Incorporated in the State of Indiana I.R.S. Employer Identification No. 35-0257090 500 Jackson Street, Box 3005, Columbus, Indiana 47202-3005 (Principal Executive Office) Telephone Number: (812) 377-5000 Securities registered pursuant to Section 12(b) of the Act: Common Stock, $2.50 par value, which is registered on the New York Stock Exchange and on the Pacific Stock Exchange. Securities registered pursuant to Section 12(g) of the Act: None. Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] Indicate by check mark if disclosures of delinquent filers pursuant to Item 405 of Regulation S-K are not contained herein and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [x] The aggregate market value of the voting stock held by non-affiliates was approximately $1.7 billion at January 28, 1996. As of January 28, 1996, there were outstanding 40.2 million shares of the only class of common stock. Documents Incorporated by Reference Portions of the registrant's definitive Proxy Statement filed with the Securities and Exchange Commission pursuant to Regulation 14A are incorporated by reference in Part III of this Form 10-K. TABLE OF CONTENTS _________________ Part Item Description Page ____ ____ _________________________________________________ ____ I 1 Business 3 2 Properties 14 3 Legal Proceedings 15 4 Submission of Matters to Vote of Security Holders 16 II 5 Market for the Registrant's Common Equity and Related Stockholder Matters 16 6 Selected Financial Data 18 7 Management's Discussion & Analysis of Results of Operations and Financial Condition 19 8 Financial Statements & Supplemental Data 24 9 Disagreements on Accounting & Financial Disclosure 24 III 10 Directors & Executive Officers of the Registrant 24 11 Executive Compensation 25 12 Security Ownership of Certain Beneficial Owners and Management 26 13 Certain Relationships & Related Transactions 26 IV 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 26 Index to Financial Statements 27 Signatures 46 Exhibit Index 49 PART I ______ ITEM 1. BUSINESS _______ ________ OVERVIEW ________ Cummins Engine Company, Inc. ("Cummins" or "the Company") is a leading worldwide designer and manufacturer of diesel engines, ranging from 76 to 6,000 horsepower. The Company also produces natural gas engines and engine components and subsystems. Cummins provides power for a wide variety of equipment in its key markets: heavy-duty truck, midrange truck, power generation, bus and light commercial vehicles, industrial products and marine. Cummins sells its products to original equipment manufacturers ("OEMs"), distributors and other customers worldwide and conducts manufacturing, sales, distribution and service activities in most areas of the world. Sales of products to major international firms outside North America are transacted by exports directly from the United States and shipments from foreign facilities (operated through subsidiaries, affiliates, joint ventures or licensees) which manufacture and/or assemble Cummins' products. In 1995, approximately 58 percent of net sales were made in the United States. Major international markets include Europe (15 percent of net sales); Asia, the Far East and Australia (14 percent of net sales); Canada (7 percent of net sales); and Mexico and South America (4 percent of net sales). BUSINESS MARKETS ________________ Heavy-duty Truck ________________ The Company has a complete line of 8-, 10-, 11- and 14-litre diesel engines that range from 260 to 525 horsepower serving the heavy-duty truck market. Cummins' heavy-duty diesel engines are offered as standard or optional power by most major heavy-duty truck manufacturers in North America. The seven largest US heavy-duty truck OEMs produced approximately 97 percent of the heavy-duty trucks sold in North America in 1995. The Company's largest customer for heavy- duty truck engines in 1995 was Navistar International Corporation, which represented approximately 7 percent of the Company's net sales. In 1995, the Company accounted for 58 percent of Navistar's heavy-duty engine purchases. In 1995, factory retail sales of North American heavy-duty trucks grew by 10 percent from the previous year's level. Factory retail sales were 227,000 units in 1995, compared to 207,000 in 1994 and 174,000 in 1993. The Company's share of the North American heavy-duty truck engine market exceeded 35 percent in 1995 based on data published by the American Automotive Manufacturers Association. The Company's share of the North American heavy-duty truck engine market was 34 percent in 1994 and 35 percent in 1993. Based on data published by the Society of Motor Manufacturers and Traders, the Company's share of engines for trucks sold in the United Kingdom was 15 percent in 1995. Based on data published by the National Association of Truck and Bus Manufacturers, Cummins remained the leader of the heavy-duty truck market in Mexico, despite the virtual halt in truck production in that country. In the fourth quarter of 1995, the Company introduced new versions of its M11 and N14 engines, both of which have advanced electronic controls and information technology. In 1995, the Company also began to ship alternate fueled engines (the L10 natural gas engine) for urban special-purpose truck markets and regional haul operations. In the heavy-duty truck market, the Company competes with independent engine manufacturers as well as truck producers who manufacture diesel engines for their own products. Certain of these integrated manufacturers also are customers of the Company. In North America, the Company's primary competitors in the heavy-duty truck engine market are Caterpillar, Inc., Detroit Diesel Corporation and Mack Trucks, Inc. The Company's principal competitors in international markets vary from country to country, with local manufacturers generally predominant in each geographic market. Other diesel engine manufacturers in international markets include Mercedes Benz, AB Volvo, Renault Vehicles Industriels, Iveco Diesel Engines, Hino Motors, Ltd., Mitsubishi Heavy Industries, Ltd., Isuzu Motors, Ltd., DAF Trucks N.V., Scania A.B., Nissan Diesel and Perkins Engines. Midrange Truck ______________ The Company has a line of diesel engines ranging from 160 to 300 horsepower serving midrange and intercity delivery truck customers worldwide. In 1996, the Company will begin introducing its next generation of midrange diesel engines, with higher horsepower and electronic controls. The Company entered the North American midrange diesel engine truck market in 1990. Based upon data published by R. L. Polk, the Company's share of the market for diesel-powered medium-duty trucks in 1995 was 35 percent, compared to 34 percent in 1994 and 31 percent in 1993. A major factor contributing to the Company's market share has been sales to Ford Motor Company. In 1993, Ford completed its introduction of Cummins' B and C Series engines as exclusive diesel power in its medium-duty truck line. Ford was the Company's largest customer for midrange engines for this market in 1995, representing approximately 4 percent of the Company's net sales. The Company sells its B and C Series engines and engine components outside North America to midrange truck markets in Asia, Europe and South America. Cummins and Tata Engineering and Locomotive Company ("TELCO"), India's largest truck manufacturer, formed a joint venture in 1993 to manufacture B Series engines in India for TELCO vehicles. In the midrange truck market, the Company competes with independent engine manufacturers as well as truck producers who manufacture diesel engines for their own products. Certain of these integrated manufacturers also are customers of the Company. Primary engine competitors in the midrange truck market in North America are Navistar International Corporation and Caterpillar, Inc. The Company's principal competitors in international markets vary from country to country, with local manufacturers generally predominant in each geographic market. Other diesel engine manufacturers in international markets include Mercedes Benz, AB Volvo, Renault Vehicles Industriels, Iveco Diesel Engines, Hino Motors Ltd., Mitsubishi Heavy Industries, Ltd., Isuzu Motors, Ltd., DAF Group N.V., Scania A.B., Perkins Engines Ltd., Nissan Diesel and MWM Brazil. Power Generation ________________ In 1995, power generation sales represented 21 percent of the Company's net sales. Products include the complete line of Cummins' engines, Onan's gasoline engines, generator sets and switches and Newage alternators. These products serve the stationary power and mobile markets. In 1994, the Company acquired Power Group International ("PGI"), a developer and manufacturer of a broad range of power generation equipment sold under the trade names of Petbow, Auto Diesel and Agreba. In stationary power, electrical power generation products and services are provided to major markets worldwide, with a product line ranging from 5 to 1,500 kilowatts. The Company's joint venture with Wartsila Diesel of Finland will extend Cummins' generator set range to 4,000 kilowatts. Providing power generation products for the utility industry has become an increasingly important market, with utilities turning to generator sets to manage peak and seasonal demands in lieu of making capital investments in additional capacity. Onan also provides load management systems for utility interruptible and peak- shaving applications. In the mobile business, Onan produces mobile generator sets, gasoline engines and power electronics for a wide variety of applications. Onan is a leading supplier of power generation sets for the recreational vehicle market in the United States. In Power Generation, Cummins competes on a global scale with a variety of engine manufacturers and generator set assemblers. Caterpillar, Inc., Detroit Diesel Corporation, Perkins Engines and AB Volvo are the major engine manufacturers with a presence in the high-speed segment of the market. Onan competes with Caterpillar, F G Wilson and Kohler, among others, in the generator set business. Newage competes globally with Leroy Somer, Marathon and Meccalte, among others. In recent years, Emerson Electric, which already owned Leroy Somer, has become a major player with its acquisition of F G Wilson and Caterpillar's subsequent investment in F G Wilson. Bus and Light Commercial Vehicles _________________________________ For this market, Cummins has both diesel and natural gas engines for pickup trucks, school buses, transit buses, delivery trucks and recreational vehicles. In North America, Chrysler, which offers the Cummins B Series engines in its Dodge Ram pickup truck, was the Company's largest customer for midrange engines in this market, representing approximately 7 percent of the Company's net sales in 1995. The Company's C Series and M11 diesel engines and L10 natural gas engine are available for the US transit bus market. The demand for alternate fueled products continues to grow. In 1994, Cummins introduced its B Series natural gas engine for school buses in the United States and, in 1995, introduced the C Series natural gas engine. In these markets, the Company competes with both independent manufacturers of diesel engines and with vehicle producers who manufacture diesel engines for their own products. Primary competitors who manufacture diesel engines for the bus and light commercial truck markets are Detroit Diesel Corporation, General Motors Corporation, Navistar International Corporation, Perkins Engines Ltd., MAN, AB Volvo, Mercedes Benz, Scania A.B. and MWM Brazil. Industrial Products ___________________ Cummins' engines power more than 3,000 models of equipment for the construction, logging, mining, agricultural, petroleum, rail and government markets throughout the world. Worldwide sales of Cummins products to this market in 1995 exceeded 67,000 engines, an increase of approximately 16 percent, compared to 1994. The Company introduced in 1993 its B Series engine rated at 200 horsepower that met the 1996 California off-highway emissions standards. The Company now has a complete line of diesel engines certified to meet these stringent standards. In construction markets, the Company's relationship with Komatsu continued to expand. Cummins and Komatsu formed joint ventures in 1993 to produce Cummins B Series engines in Japan and Komatsu's 30- litre engine in the United States. Production at both joint venture sites has begun on schedule. Coupled with Cummins' relationship with Komatsu Dresser in North America, this alliance provides a strong base in the Company's construction markets. The Company introduced in late 1995 its new high-horsepower products (the QSK19) using the CELECT high-pressure injection fuel system. Cummins' relationship with Wartsila has extended the Company's product line from 2,000 horsepower to 6,000 horsepower, which will provide new opportunities in mining and rail markets. Marine ______ Marine product applications span 76 to 6,000 horsepower for recreational, commercial and military markets. Cummins engines already comply with anticipated regulations through the year 2000. Fleetguard and Holset _____________________ Sales of filter and turbocharger products represented 11 percent of the Company's net sales in 1995. Fleetguard is a leading manufacturer of products for the North American heavy-duty filter industry. Its products also are produced and sold in international markets, including Europe, Mexico, India, Australia, China, South Africa and the Far East. Holset's products also are sold worldwide. In 1994, Holset introduced a variable geometry turbocharger design for truck powertrains. In 1994, Holset and TELCO entered into a joint venture to produce turbochargers in India. In 1995, Holset entered into a joint venture to produce and market turbochargers in China and an alliance with Mitsubishi Heavy Industries of Japan, covering cross-sourcing turbochargers, joint materials sourcing and collaborative international marketing. BUSINESS OPERATIONS ___________________ International _____________ The Company has manufacturing facilities worldwide, including major operations in Europe, India, Mexico and Brazil. Cummins has entered into license agreements that provide for the manufacture and sale of the Company's products in Turkey, China, Pakistan, South Korea and other countries. In addition, the Company has entered into alliances with business partners in various areas of the world. Cummins and Scania of Sweden have a joint venture to develop a fuel system for heavy-duty diesel engines. Cummins has a joint venture with TELCO of India to manufacture the Cummins B Series engines in India for TELCO trucks. Cummins and Komatsu Ltd. of Japan have formed joint ventures to manufacture the B Series engines in Japan and high-horsepower Komatsu- designed engines in the United States. In 1995, the Company formed a joint venture with China National Heavy Duty Truck Corporation, previously a Cummins' licensee, to manufacture a broad line of diesel engines in China. In 1995, the Company also entered into a joint venture with Wartsila Diesel International of Finland to manufacture both diesel and natural gas engines above 2,500 horsepower. Several of the Company's subsidiaries have similar ventures throughout the world. Because of the Company's increasingly global business, its operations are subject to risks, such as currency controls and fluctuations, import restrictions and changes in national governments and policies. Generally, Cummins expects to benefit from the North American Free Trade Agreement and the General Agreement on Tariffs and Trade. However, economic conditions in Mexico and the devaluation of the Mexican peso have adversely affected the Company's operations in Mexico and are expected to continue to do so in 1996. Research and Development ________________________ Cummins conducts an extensive research and engineering program to achieve product improvements, innovations and cost reductions for its customers, as well as to satisfy legislated emissions requirements. The Company is in the midst of a program to refurbish and extend its engine range. The Company also offers a natural gas-powered engine product line for certain of its markets. As disclosed in Note 1 to the Consolidated Financial Statements, research and development expenditures approximated $230 million in 1995, $200 million in 1994 and $160 million in 1993. Sales and Distribution ______________________ While the Company has supply agreements with some customers, including Ford, Chrysler and Komatsu Dresser, for Cummins engines in both on- and off-highway markets, most of the Company's business is done on open purchase orders. These purchase orders usually may be canceled on reasonable notice without cancellation charges. Therefore, while incoming orders generally are indicative of anticipated future demand, the actual demand for the Company's products may change at any time. While the Company typically does not measure backlog, customers provide information about future demand, which is used by the Company for production planning. Lead times for the Company's engines are dependent upon the customer, market and application. Historically, during the third quarter of the year, the Company has experienced modest seasonal declines in production, which have had an effect on the demand for Cummins' products during that quarter of each year. The Company's products compete on a number of factors, including performance, price, delivery, quality and customer support. Cummins believes that its continued focus on cost, quality and delivery, its extensive technical investment, its full product line and customer-led support programs are key elements of its competitive position. Cummins warrants its engines, subject to proper use and maintenance, against defects in factory workmanship or materials for either a specified time period or mileage or hours of use. Warranty periods vary by engine family and market segment. There are approximately 6,700 locations in North America, primarily owned and operated by OEMs or their dealers, at which Cummins-trained service personnel and parts are available to maintain and repair Cummins engines. The Company's parts distribution centers are located strategically throughout the world. Cummins also sells engines, parts and related products through distributorships worldwide. The Company believes its distribution system is an important part of its marketing strategy and competitive position. Most of its North American distributors are independently owned and operated. The Company has agreements with each of these distributors, which typically are for a term of three years, subject to certain termination provisions. Upon termination or expiration of the agreement, the Company is obligated to purchase various assets of the distributorship. The purchase obligation of the Company relates primarily to inventory of the Company's products, which can be resold by the Company over a reasonable period of time. In the event the Company had been required to fulfill its obligations to purchase assets from all distributors simultaneously at December 31, 1995, the aggregate cost would have been approximately $200 million. Management believes it is unlikely that a significant number of distributors would terminate their agreements at the same time, requiring the Company to fulfill its purchase obligation. Supply ______ The Company machines many of the components used in its engines, including blocks, heads, rods, turbochargers, crankshafts and fuel systems. Cummins has adequate sources of supply of raw materials and components required for its operations. The Company has arrangements with certain suppliers who are the sole sources for specific products. While the Company believes it has adequate assurances of continued supply, the inability of a supplier to deliver could have an adverse effect on production at certain of the Company's manufacturing locations. Employment __________ At December 31, 1995, Cummins employed 24,300 persons worldwide, approximately 10,100 of whom are represented by various unions. The Company has labor agreements covering employees in North America, South America and the United Kingdom. In 1995, members of the Diesel Workers Union and the Office Committee Union at the Company's midrange engine plant in Southern Indiana ratified 5-year agreements. In December 1995, members of the Office Committee Union ratified an early agreement which extends until 1999 for offices and plants in Southern Indiana and the Company's Technical Center. In 1993, members of the Diesel Workers Union reached an agreement that will extend until the year 2004. In 1995, members of the United Auto Workers at the Company's crankshaft plant in Fostoria, Ohio, reached an agreement which will extend for five years. The Company has no major contracts expiring during the next 18 months. ENVIRONMENTAL COMPLIANCE ________________________ Product Environmental Compliance ________________________________ Cummins engines are subject to extensive statutory and regulatory requirements that directly or indirectly impose standards with respect to emissions and noise. Cummins' products comply with emissions standards that the US Environmental Protection Agency ("EPA") and California Air Resources Board ("CARB") have established for heavy- duty on-highway diesel engines produced through 1996. Cummins' ability to comply with these and future emissions standards is an essential element in maintaining its leadership position in the North American heavy-duty truck and other automotive markets, as well as in supplying other markets. The Company will make significant capital and research expenditures to comply with these standards. Failure to comply could result in adverse effects on future financial results. Cummins has successfully completed the certification of its 1996 on- highway products, which include both midrange and heavy-duty engines. All of these products underwent extensive laboratory and field testing prior to their release. Emissions Averaging, Banking and Trading regulations were promulgated by the EPA in July 1990. By selling 1991, 1992 and 1993 model year engines with emissions levels below applicable standards and by introducing several of the Company's 1994 configurations early, Cummins generated substantial oxides of nitrogen and particulate matter credits. These credits expire on December 31, 1996 if not used before this date. While a portion of the Company's 1996 products will use some of these credits as part of an effort to achieve cost- effective compliance, the Company does not believe that the cost of compliance without relying on these credits would be material. The Company closely manages credit generation and use and believes that engines currently using credits will be brought into compliance during the course of normal engineering improvements or will be replaced by engines meeting future emissions standards without any material financial effect. The next major change in emissions requirements for heavy-duty on- highway diesel engines occurs in 1998, when the oxides of nitrogen standard is lowered from 5.0 to 4.0 g/bhp-hr. 1998 is also the effective date for the Clean Fuel Fleet Vehicle program. Beginning January 1, 1998, fifty percent of new vehicles purchased by certain centrally fueled fleets in 22 ozone non-attainment areas in the United States must be powered by engines which meet a combined oxides of nitrogen plus non-methane hydrocarbon standard of 3.8 g/bhp-hr. Design and development activity aimed at meeting these standards are well underway. Contained in the environmental regulations are several means for the EPA to ensure and verify compliance with emissions standards. Two of the principal means are tests of new engines as they come off the assembly line, referred to as selective enforcement audits ("SEA"), and tests of field engines, commonly called in-use compliance tests. The SEA provisions have been used by the EPA to verify the compliance of heavy-duty engines for several years. In 1995, two such audit tests were performed on Cummins engines, both of which were passed. The failure of an SEA could result in cessation of production of the noncompliant engines and the recall of engines produced prior to the audit. In the product development process, Cummins anticipates SEA requirements when it sets emissions design targets. No Cummins engines were chosen for in-use compliance testing in 1995. It is anticipated that the EPA will increase the in-use test rate in future years, raising the probability that one or more of the Company's engines will be selected. As with SEA testing, if an in-use test is failed, an engine recall may be necessary. In 1990, CARB redefined their medium-duty vehicle class in a way that affects the Company's products used in certain California vehicles from 8,500 to 14,000 pounds gross vehicle weight. CARB promulgated new standards for this category which began phasing-in during 1995. A new configuration of Cummins B Series engine has been developed and certified to meet the requirements for this regulatory category. In 1988, CARB promulgated a rule that necessitates the reporting of failures of emissions-related components when the failure rate reaches a specified level (25 component failures or one percent of build, whichever is greater). At somewhat higher failure rates (50 components or four percent of build), a recall may be required. The Company continues to monitor such failures. In 1995, there were no emissions-related failures which reached a level that required a report. In January 1992, CARB promulgated a regulation for engines rated at or above 175 horsepower used in mobile off-highway applications. In mid- 1994, the EPA also promulgated regulations for this category. The EPA regulation covers engines rated at or above 50 horsepower. In all other material respects these two regulations are the same. The effective dates are staged according to rated horsepower and began phasing in on January 1, 1996. Cummins has successfully completed certification of the majority of its mobile off-highway products which are included in the first phase (those with ratings between 175 to 750 horsepower). The remainder will be certified in the first half of 1996. All of these products have undergone, or will undergo, extensive laboratory and field tests prior to their release. Emissions standards in international markets, including Europe and Japan, are becoming more stringent. Given the Company's experience in meeting US emissions standards, it believes that it is well positioned to take advantage of opportunities in these markets as the need for emissions-control capability grows. There are several federal and state regulations which encourage and, in some cases, mandate the use of alternate fueled heavy-duty engines. The Company currently offers natural gas fueled versions of its L10 and B5.9 engines and has several development programs underway to expand its alternate fueled product offering. Vehicles and certain industrial equipment in which diesel engines are installed must meet federal noise standards. The Company believes that applications in which its engines are now installed meet those noise standards and that future installations also will be in compliance. Other Environmental Statutes and Regulations ____________________________________________ Cummins believes it is in compliance in all material respects with laws and regulations applicable to the plants and operations of the Company and its subsidiaries. During the past five years, expenditures for environmental control activities and environmental remediation projects at the Company's operating facilities in the United States have not been a major portion of annual capital outlays and are not expected to be material in 1996. Pursuant to notices received from federal and state agencies and/or defendant parties in site environmental contribution actions, the Company and its subsidiaries have been identified as potentially responsible parties ("PRPs") under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or similar state laws, at a number of waste disposal sites. Under such laws, PRPs typically are jointly and severally liable for any investigation and remediation costs incurred with respect to the sites. Therefore, the Company's ultimate responsibility for such costs could be a percentage greater than the percentage of waste actually contributed to the site by the Company. The sites at which the Company or its subsidiaries are currently named as a PRP are the following: Old City Landfill, Columbus, Indiana; Purity Oil Site, Fresno, California; Oak Grove Sanitary Landfill, Anoka County, Minnesota; Waste Disposal Engineering Landfill, Andover, Minnesota; White House Waste Oil Pits, Jacksonville, Florida; Seaboard Chemical, Jamestown, North Carolina; Double Eagle Refinery, Oklahoma City, Oklahoma; Wastex Research, East St. Louis, Illinois; North Hollywood Dump, Memphis, Tennessee; Commercial Oil, Oregon, Ohio; Berliner & Ferro, Swartz Creek, Michigan; Schnitzer Iron & Metal, St. Paul, Minnesota; Combustion Inc., Dedham Springs, Louisiana; Four County Landfill, Culver, Indiana; Schumann Site, South Bend, Indiana; Great Lakes Asphalt, Zionsville, Indiana; Third Site, Zionsville, Indiana; Auto-Ion, Kalamazoo, Michigan; PCB Treatment Inc., Kansas City, Kansas; ENRX, Buffalo, New York; Dubose, Contonement, Florida; Uniontown Landfill, Uniontown, Indiana; Sand Springs, Oklahoma; United Steel Drum, East St. Louis, Illinois; and Wayne Reclamation & Recycling, Ft. Wayne, Indiana. The Company presently is contesting its status as a PRP at several of these sites. At some of these sites, the Company will be released from liability at the site as a de minimis PRP for a nominal amount. While the Company is unable at this time to determine the aggregate cost of remediation at these sites, it has attempted to analyze its proportionate and actual liability by analyzing the amounts of waste contributed to the sites by the Company, the estimated costs for total remediation at the sites, the number of identities of other PRPs and the level of insurance coverage. The results of that analysis are described below. The Company and its subsidiaries have entered into administrative agreements at certain of these sites to perform remedial actions. At the Old City Landfill, the Company and two other PRPs have entered into a Consent Order with the Indiana Department of Environmental Management to implement the Record of Decision issued by EPA in 1992. The cost to implement the Consent Order is estimated to be approximately $300,000, of which the Company will pay 50 percent. At the Purity Oil Site, a subsidiary of the Company has been identified as a PRP and is one of several PRPs who have been issued an order by EPA to undertake remedial action at the site. The Company's subsidiary has contributed $282,000 toward the first phase of the remedial action at the site. While the subsidiary's liability for future expenditures has not been determined, the Company estimates that its percentage contribution of hazardous waste to the site was less than one percent. Because all records relating to the site are unavailable, the PRPs at this site have implemented an Alternative Dispute Resolution procedure involving a neutral third party who will recommend an allocation scheme for the PRPs. While waste-in quantities will be important to this determination, ultimate resolution of the allocation may vary from the waste-in amount. The Company believes it has adequate reserves to cover its share of future expenses at the site. Onan Corporation, a subsidiary of the Company, has entered into an administrative agreement to participate in remediation of the Waste Disposal Engineering Landfill. The cost of remediation at this site is estimated to range from $10 million to $15 million, of which Onan expects to contribute approximately $600,000, which has been reserved fully. Construction of the major remedies at the site have been completed, leaving only treatment and periodic sampling to be accomplished. Onan also has entered into an administrative agreement for the Oak Grove Landfill. The estimated cost to remediate this site is approximately $6 million. Onan has contributed $127,000 to cover its share of the costs of remediation. Construction is complete at this site, and only treatment and periodic sampling remain. Onan has filed litigation against its insurer at Oak Grove and Waste Disposal in order to enforce its contract of insurance for both the remedial costs and all related defense costs at those sites. This litigation is in its early stages. In addition, the Steering Committees for both sites have submitted each site for reimbursement under the Minnesota Landfill Cleanup Program, a legislative initiative that would reimburse parties for remediating hazardous waste landfills. Both sites have been qualified initially for the program by the Minnesota Pollution Control Agency. In the fourth quarter of 1995, Onan received reimbursement for approximately 15 percent of its contributions to the Waste Disposal site and expects to receive additional reimbursements for both sites in the first half of 1996. With respect to other sites at which the Company or its subsidiaries have been named as PRPs, the Company cannot accurately estimate the future remediation costs. At several sites, the remedial action to be implemented has not been determined for the site. In other cases, the Company or its subsidiary has only recently been named as a PRP and is collecting information on the site. Finally, in some cases, the Company believes it has no liability at the site and is actively contesting designation as a PRP. Based upon the Company's prior experiences at similar sites, however, the aggregate future cost to all PRPs to remediate these sites is not likely to be significant. In each of these cases, the Company believes that it has good defenses at several of the sites, that its percentage contribution at other sites is likely to be de minimis or that other PRPs will bear most of the future remediation costs. However, the environmental laws impose joint and several liability and, consequently, the Company's ultimate responsibility may be based on many factors outside the Company's control and could be material in the event that the Company becomes obligated to pay a significant portion of these expenses. Based upon information presently available, the Company believes that such an outcome is unlikely and that its actual and proportionate costs of participating in the remediation of these sites will not be material. ITEM 2. PROPERTIES _______ __________ Cummins' worldwide manufacturing facilities occupy approximately 15 million square feet, including approximately 5 million square feet outside the United States. Principal manufacturing facilities in the United States include the Company's plants in Southern Indiana; Jamestown, New York; Lake Mills, Iowa; Cookeville, Tennessee; and Fridley, Minnesota, as well as an engine plant in Rocky Mount, North Carolina, which is operated in partnership with Case Corporation. Countries of manufacture outside of the United States include England, Scotland, Brazil, Mexico, France, Spain, Australia and Germany. In addition, engines and engine components are manufactured by joint ventures or independent licensees at plants in France, China, India, Japan, Pakistan, South Korea and Turkey. Cummins believes that all of its plants have been maintained adequately, are in good operating condition and are suitable for its current needs through productive utilization of the facilities. ITEM 3. LEGAL PROCEEDINGS _______ _________________ The information appearing in Note 16 to the Consolidated Financial Statements is incorporated herein by reference. On April 5, 1990, Raphael Warkel and Alan J. Stransky filed a complaint in the US District Court for the Southern District of Indiana against the Company, all of its then current directors and one past director. The complaint purported to be brought as a class action on behalf of persons who purchased the Company's common stock between May 1, 1989 and September 21, 1989. The complaint alleged that the Company and the other defendants violated Section 10(b) and Section 20 of the Securities Exchange Act of 1934 by failing to disclose material financial information concerning the Company in an effort to "artificially inflate" the market price of the Company's common stock. The complaint sought compensatory damages of unspecified amount, costs and attorneys' fees. All defendants answered denying the substantive allegations of the complaint. The plaintiffs moved for class certification, which motion was opposed by the defendants. On November 30, 1992, the court granted defendants' motion for judgment on the pleadings and dismissed the complaint. The court held that the complaint failed to state a claim for relief under the federal securities laws. The court gave the plaintiffs 30 days to file an amended complaint. On December 29, 1992, plaintiffs filed an amended complaint against the same defendants. The amended complaint, which alleges the Company and other defendants violated Section 10(b) and Section 20 of the Securities Exchange Act by failing to disclose material financial information concerning the Company in an effort to "artificially inflate" the market price of the Company's common stock, is also brought as a class action and seeks compensatory damages of unspecified amount, costs and attorneys' fees. On March 3, 1993, defendants moved to dismiss the amended complaint. On September 13, 1993, the court dismissed the claims of plaintiff Stransky with prejudice. The court also dismissed the claims of plaintiff Warkel except for a claim based on an allegedly false and misleading press release issued by the Company in July 1989. Plaintiff Stransky appealed the dismissal of his claim to the US Court of Appeals for the Seventh Circuit. On April 7, 1995, the US Court of Appeals for the Seventh Circuit affirmed in part, reversed in part and remanded in part the decision of the US District Court for the Southern District of Indiana to dismiss all the claims of plaintiff Stransky with prejudice. On July 18, 1995, the US District Court for the Southern District of Indiana granted plaintiffs' motion to certify Warkel, et al., v. Cummins Engine Company, Inc., et al., as a class action on behalf of persons who purchased the Company's common stock between May 1, 1989 and October 11, 1989. On November 29, 1995, plaintiffs filed a motion for leave to amend their amended complaint to include a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 enacted thereunder that certain statements made in a press release issued by the Company in April 1989 were false and were known by Cummins to be false at the time they were made. The motion to amend has been fully briefed but not yet decided. On February 15, 1996, defendants (including the Company and the other past and current director defendants) and the plaintiffs reached an agreement in principle to settle the class action suit. The details of the settlement remain to be negotiated, and any final agreement must be approved by the District Court. Defendants continue to believe that plaintiffs' claims under Section 10(b) and Section 20 of the Securities Exchange Act of 1934 are entirely meritless. However, in the interests of avoiding the significant burdens and costs, both financial and non-financial, involved in defending the case through a trial (scheduled for September 1996), and any appeals, the defendants have agreed in principle to settle the case for $5.5 million. Defendants believe that the cost of defending this litigation through trial and appeals would approach or exceed $2.5 million. Defendants will pay the entirety of the settlement amount upon approval by the District Court of the settlement. Pursuant to the provisions of its by-laws and of Indiana law, the Company is obligated to indemnify the defendants for the cost of any settlement, and the Company will do so. The Company will seek reimbursement of approximately $3 million from the director defendants' indemnity insurer, an amount which represents the portion of the settlement amount that exceeds the deductible provided for in the policy, taking into account the amount that defendants will have expended in defense of the action. The insurer has indicated that it will deny a portion of this insurance claim when it is made. The Company believes the insurer's position is meritless. The Company continues to engage in discussions with the insurer with the intention of obtaining full reimbursement but ultimately may have to pursue litigation against the insurer to enforce the terms of the insurance policy in accordance with the Company's understanding of those terms. While the Company believes that its position is correct, there can be no assurance that the Company will achieve full reimbursement either through negotiations with the insurer or through litigation. The material in Item 1 "Other Environmental Statutes and Regulations" is incorporated herein by reference. ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS _______ _________________________________________________ None. PART II _______ ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS _______ _____________________________________________________ The Company's common stock is listed on the New York Stock Exchange and the Pacific Stock Exchange under the symbol "CUM". The following table sets forth, for the calendar quarters shown, the range of high and low composite prices of the common stock and the cash dividends declared on the common stock. High Low Dividends Declared ________ _______ __________________ 1995 ____ First quarter $46 7/8 $41 1/2 $.25 Second quarter 48 5/8 42 1/4 .25 Third quarter 47 1/4 36 5/8 .25 Fourth quarter 39 3/4 34 .25 1994 ____ First quarter $57 5/8 $44 1/2 $.125 Second quarter 53 1/8 40 1/8 .125 Third quarter 45 7/8 35 7/8 .125 Fourth quarter 46 1/4 38 5/8 .25 At December 31, 1995, the approximate number of holders of record of the Company's common stock was 5,000. The Board of Directors in the fourth quarter of 1994 authorized repurchase by the Company of up to 2.5 million shares of its common stock. During 1995, the Company repurchased on the open market 1.6 million shares at an aggregate price of $69 million, or average price of $43.57 per share. In 1994, the Company repurchased on the open market .1 million shares of common stock at an aggregate purchase price of $5 million, or average price of $42.47 per share. All of the acquired shares are held as common stock in treasury. In the fourth quarter of 1994, the Board of Directors increased the Company's quarterly common stock dividend from 12.5 cents per share to 25 cents per share. The declaration and payment of future dividends by the Board of Directors of the Company will be dependent upon the Company's earnings and financial condition, economic and market conditions and other factors deemed relevant by the Board of Directors. Certain of the Company's loan indentures and agreements contain provisions which permit the holders to require the Company to repurchase the obligations upon a change of control of the Company, as defined in the applicable debt instruments. As more fully described in Note 14 to the Consolidated Financial Statements, which information is incorporated herein by reference, the Company has a Shareholders' Rights Plan. The Company's bylaws provide that Cummins is not subject to the provisions of the Indiana Control Share Act. However, Cummins is governed by certain other laws of the State of Indiana applicable to transactions involving a potential change of control of the Company. ITEM 6. SELECTED FINANCIAL DATA (Dollars in Millions, Except Per Share Amounts) _______ _______________________________________________ 1995 1994 1993 1992 1991 ______ ______ ______ ______ ______ Net sales $5,245 $4,737 $4,248 $3,749 $3,406 Net earnings (loss) 224 253 177 (190) (14) Net earnings (loss) per share: Primary 5.52 6.11 4.79 (6.01) (.75) Fully diluted 5.52 6.11 4.63 (6.01) (.75) Cash dividends per share 1.00 .625 .20 .10 .35 Total assets 3,056 2,706 2,390 2,230 2,041 Long-term debt 117 155 190 412 443 In 1995, the Company's results included restructuring charges of $118 million ($77 million after taxes) to reduce the worldwide work force and to close or restructure selected operations in Europe, Brazil and North America. Net earnings in 1995 also included release of the tax valuation allowance of $68 million. In December 1993, the Company sold 2.6 million shares of its common stock in a public offering and used a portion of the proceeds to redeem $77 million in principal amount of the Company's outstanding 9- 3/4 percent sinking fund debentures. This early extinguishment of debt resulted in an extraordinary charge of $6 million. In 1992, the Company's results included a charge of $251 million for the cumulative effect of changes in accounting as prescribed by SFAS Nos. 106, 109 and 112 related to accounting for retirees' health care and life insurance benefits, income taxes and postemployment benefits. In 1992, the Company sold 4.6 million shares of its common stock in a public offering and used a portion of the proceeds to extinguish $71 million of debt of Consolidated Diesel Company, an unconsolidated, 50- percent owned partnership, $8 million of the Company's 8-7/8 percent sinking fund debentures and $11 million of a 15-percent note payable to an insurance company. These early extinguishments of debt resulted in an extraordinary charge of $6 million. The Company's results for 1991 included a credit of $52 million for the cumulative effect of changes in accounting to include in inventory certain production-related costs previously charged directly to expense and to adopt a modified units-of-production depreciation method for substantially all engine production equipment. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION _______ _____________________________________________________________ OVERVIEW ________ Cummins' record net sales of $5.2 billion in 1995 were 11 percent higher than 1994's record sales and 23 percent higher than 1993 sales. The Company shipped 338,900 engines in 1995, an 11-percent increase above 1994 and 29 percent higher than 1993. Shipments by engine family for the comparative periods were: Engine Shipments 1995 1994 1993 ________________ _______ _______ _______ Midrange engines 222,100 195,600 167,900 Heavy-duty engines 107,300 99,900 86,500 High-horsepower engines 9,500 8,800 8,600 _______ _______ _______ Total engine shipments 338,900 304,300 263,000 _______ _______ _______ Excluding the restructuring charges, earnings before taxes were a record $295 million in 1995, slightly higher than earnings before taxes of $294 million in 1994 and $90 million higher than in 1993. In the fourth quarter of 1995, the Company announced that it was evaluating the consolidation and disposal of certain assets and planned to reduce its worldwide work force by approximately 2,000. Restructuring charges related to these actions were $118 million, or $77 million after taxes, in 1995. In addition, the Company recorded a credit of $68 million in 1995 for the release of its tax valuation allowance. Net earnings in 1995 were $224 million, or $5.52 per share. Excluding the effects of the restructuring charges and tax credit, net earnings would have been $233 million, or $5.73 per share, compared to $253 million, or $6.11 per share, in 1994. Net earnings of $177 million, or $4.79 per share, in 1993 included a charge of $6 million for early extinguishment of debt. RESULTS OF OPERATIONS _____________________ The percentage relationship between net sales and other elements of the Company's Consolidated Statement of Earnings for each of the last three years was: Percent of Net Sales 1995 1994 1993 ____________________ _____ _____ _____ Net sales 100.0 100.0 100.0 Cost of goods sold 75.8 75.0 75.6 _____ _____ _____ Gross profit 24.2 25.0 24.4 Selling & administrative expenses 13.2 13.5 13.6 Research & engineering expenses 5.0 5.0 4.9 Interest expense .2 .4 .9 Other, net .2 (.1) .2 Restructuring charges 2.2 - - ____ ____ ____ Earnings before income taxes 3.4 6.2 4.8 Provision (credit) for income taxes (.9) .9 .5 ____ ____ ____ Earnings before extraordinary item 4.3 5.3 4.3 Early extinguishment of debt - - (.1) ____ ____ ____ Net earnings 4.3 5.3 4.2 ____ ____ ____ Sales by Market _______________ The Company's sales for each of its key markets during the last three years were: 1995 1994 1993 ________________ ________________ ________________ $ Millions Dollars Percent Dollars Percent Dollars Percent __________ _______ _______ _______ _______ _______ _______ Heavy-duty truck 1,506 29 1,410 30 1,230 29 Midrange truck 581 11 513 11 482 11 Power generation 1,130 21 1,039 22 963 23 Bus & light commercial vehicles 687 13 592 12 498 12 Industrial products 680 13 593 12 547 13 Marine 93 2 78 2 68 1 Fleetguard and Holset 568 11 512 11 460 11 _____ ___ _____ ___ _____ ___ Net sales 5,245 100 4,737 100 4,248 100 _____ ___ _____ ___ _____ ___ Sales to the heavy-duty truck market in 1995 were 7 percent higher than in 1994 and 22 percent higher than the 1993 level. The increase in sales during the last three years has been due to a high level of demand for engines for the North American heavy-duty truck market. In 1995, the Company's engine shipments for this market were 15 percent higher than in 1994 and 31 percent higher than in 1993. In 1995, factory retail sales of heavy-duty trucks in North America were 10 percent higher than the previous year's level. However, with the high level of cancellation rates in the second half of 1995 and lower truck production levels at OEMs, this market is expected to decline in 1996. Cummins continued to lead this market and its share exceeded 35 percent in 1995. The Company's market share was 34 percent in 1994 and 35 percent in 1993. International engine shipments for heavy-duty trucks were 41 percent lower than in 1994 and 25 percent below 1993. The decline in engine shipments in 1995 was primarily in Mexico where heavy-duty engine shipments have been at very low levels due to economic conditions in that country. The Company's operations in Mexico were near break-even in 1995, with the outlook uncertain for 1996. Engine shipments in Mexico are not expected to improve in 1996. Sales of engines for the midrange truck market in 1995 were 13 percent higher than in 1994 and 21 percent higher than in 1993. Engine shipments for the North American market were 16 percent higher than 1994 and 18 percent higher than 1993. Midrange truck engines for international markets were 8 percent higher than in 1994 and 33 percent higher than 1993, primarily in Europe and Brazil. In Mexico, engine sales for this market were at very low levels in 1995. Economic conditions in Brazil and Mexico are likely to result in a low level of demand in those countries in 1996. Sales of $1.1 billion to the power generation market in 1995 were 9 percent higher than in 1994 and 17 percent higher than 1993. The increase in 1995 was due to a 14-percent increase in shipments in the United States. International markets, which were affected in 1995 by economic conditions in Mexico and China, were 9 percent lower than 1994 and essentially level with 1993. In the bus and light commercial vehicles market, sales in 1995 were 16 percent higher than 1994 and 38 percent higher than 1993. The increase in 1995 was due primarily to record demand for the Company's midrange engines for the Chrysler Dodge Ram pickup truck. Engine shipments for bus markets were 23 percent higher than 1994, due primarily to engine demand for school buses in North America. International engine shipments were 12 percent higher than 1994. In 1995, sales to industrial markets were 15 percent higher than 1994 and 24 percent higher than 1993. The increase in sales in 1995 was for construction and agricultural markets in the United States and construction markets in North Asia and Europe. Sales of $93 million for marine applications in 1995 were 19 percent higher than 1994 and 37 percent higher than 1993. The increase in sales in 1995 was due to higher engine shipments in both North American and international markets. Sales of filters and turbochargers continued to represent approximately 11 percent of the Company's net sales in 1995. Sales of these products in 1995 were 11 percent higher, compared to 1994, and 23 percent higher than in 1993. The increase in sales in 1995 was due primarily to international markets. Gross Profit ____________ The Company's gross profit percentage was 24.2 percent of net sales in 1995, compared to 25.0 percent in 1994 and 24.4 percent in 1993. The Company's gross profit was affected by several factors in 1995, including increased product costs and a lower level of parts sales in North America. The most significant factor affecting product costs was the slowdown in the North American truck market late in the third quarter, which resulted in lower overhead absorption in the second half of 1995. Product costs also were affected by higher technical spending and material pricing pressures. As disclosed in Note 16 to the Consolidated Financial Statements, the Company has entered into commodity swap contracts that have the effect of fixing the cost of certain material purchases. The cost of product coverage programs was 2.4 percent of net sales in 1995, compared to 2.3 percent of net sales in 1994 and 2.1 percent in 1993. In 1993, and to a lesser extent in 1994, the cost of product coverage programs included adjustments to reduce the product coverage liability for engines previously placed in service. Operating Expenses __________________ Selling and administrative expenses were $692 million (13.2 percent of net sales) in 1995, compared to $641 million (13.5 percent of net sales) in 1994 and $579 million (13.6 percent of net sales) in 1993. Research and engineering expenses were $263 million in 1995, compared to $238 million in 1994 and $210 million in 1993. The 25-percent increase in research and engineering expenses since 1993 has been related to expenditures for the development of fuel systems and future products. Other Income and Expense ________________________ Interest expense of $13 million was $4 million lower than in 1994 and $23 million lower than 1993 as a result of the Company's early retirement of debt obligations during 1993. Other income and expense includes a variety of items such as foreign exchange gains and losses, interest income, earnings and losses of unconsolidated companies and royalty income. The increase in other expense of $12 million in 1995, compared to 1994, was due to start-up expenses of the Company's joint ventures. As disclosed in Note 16 to the Consolidated Financial Statements, the Company enters into forward exchange contracts that serve to hedge the effects of fluctuating currency rates on certain assets and liabilities that are denominated in other than the functional currencies of international entities. Restructuring Charges _____________________ As disclosed more fully in Note 2 to the Consolidated Financial Statements, results of operations in 1995 included restructuring charges of $118 million ($77 million after taxes) for costs to consolidate operations and reduce the worldwide work force. In addition to the restructuring charges, the Company expects to incur approximately $25 million in 1996, primarily for continuity payments and employee and equipment relocations associated with the facility consolidations and closings. Provision for Income Taxes __________________________ As described in Note 9 to the Consolidated Financial Statements, the Company reduced its valuation allowance for tax benefit carryforwards $68 million in 1995, $32 million in 1994 and $34 million in 1993. The tax provision for 1995 also included a credit of $35 million for additional tax benefits related to the amendment of prior years' returns. Early Extinguishment of Debt ____________________________ As disclosed in Note 6 to the Consolidated Financial Statements, the Company extinguished certain indebtedness in 1993 that resulted in an extraordinary charge of $6 million. CASH FLOW AND FINANCIAL CONDITION _________________________________ Key elements of the Consolidated Statement of Cash Flows were: $ Millions 1995 1994 1993 __________ ____ ____ ____ Net cash provided by operating activities $406 $376 $286 Net cash used for investing activities (373) (261) (149) Net cash flows from operating and ____ ____ ____ investing activities 33 115 137 Net cash used for financing activities (121) ( 50) (114) Effect of exchange rate changes on cash 1 5 - ____ ____ ____ Net change in cash & cash equivalents $(87) $ 70 $ 23 _____ ____ ____ Net cash flows from operating and investing activities totaled $33 million in 1995. Capital expenditures during 1995 were $223 million, compared to $238 million in 1994 and $174 million in 1993. The expenditures in 1995 were related to continued investments for new products and fuel systems. The Company expects a significant increase in these expenditures in 1996, some of which may be funded externally. Investments in and advances to unconsolidated companies of $155 million in 1995 included temporary advances to Consolidated Diesel Company. The outstanding balance of $50 million at December 31, 1995 will be repaid in 1996. Investments also included capital contributions of $67 million for previously announced joint ventures, including the joint ventures with Wartsila to manufacture diesel and natural gas engines above 2,500 horsepower; in China to manufacture a broad line of diesel engines and related products; with TELCO to produce midrange engines in India for TELCO vehicles; and with Komatsu to produce midrange engines in Japan and high-horsepower engines in the United States. The Company expects to continue to make investments in certain of these joint ventures during 1996. At December 31, 1995, the Company had no borrowings outstanding on its $300 million revolving credit agreement. The Company's debt-to- capital ratio was 16 percent at December 31, 1995 and 18 percent at December 31, 1994. The ratio is expected to be higher in 1996 due to funding capital expenditures. As disclosed in Note 11 to the Consolidated Financial Statements, the Company called for redemption of its preference stock in 1994. In lieu of accepting the cash redemption price, most holders elected to convert their shares of preference stock into common stock of the Company. As disclosed in Note 12 to the Consolidated Financial Statements, the Board of Directors in the fourth quarter of 1994 authorized repurchase by the Company of up to 2.5 million shares of common stock. Concurrently, the Board of Directors increased the Company's quarterly common stock dividend from 12.5 cents per share to 25 cents per share. In 1993, the Board of Directors of the Company increased the quarterly common stock dividend from 2.5 cents per share to 12.5 cents per share. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA _______ __________________________________________ See Index to Financial Statements on page 27. ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE _______ ____________________________________________________ None. PART III ________ ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ________ __________________________________________________ The information appearing under the caption "Election of Directors" of the Company's definitive Proxy Statement for the Annual Meeting of the Shareholders to be held on April 9, 1996 ("the Proxy Statement") is incorporated by reference in partial answer to this item. Except as otherwise specifically incorporated by reference, the Proxy Statement is not to be deemed filed as part of this report. The executive officers of the Company at December 31, 1995 are set forth below. The Chairman of the Board and President are elected annually by the Board of Directors at the Board's first meeting following the Annual Meeting of the Shareholders. Other officers are appointed by the Chairman and ratified by the Board of Directors and hold office for such period as the Board of Directors or Chairman of the Board may prescribe. Present Position & Business Experience During Name Age Last 5 Years _______________ ___ __________________________________________________ Mark E. Chesnut 48 Vice President - Corporate Responsibility & Public Affairs (1995 to present), Vice President - Quality & Organizational Effectiveness (1992 to 1995), Vice President - Human Resources & Organizational Effectiveness (1989-1992) C. Roberto Cordaro 45 Group Vice President - Marketing (1990 to present) John K. Edwards 51 Vice President - International (1989 to present) Robert L. Fealy 44 Vice President - Business Strategy and Treasurer (1996 to present), Vice President - Treasurer (1988 to 1996) Mark R. Gerstle 40 Vice President - General Counsel and Secretary (1995 to present), Assistant General Counsel (1991 to 1995) James A. Henderson 61 Chairman and Chief Executive Officer (1995 to present), President & Chief Executive Officer (1994 to 1995), President and Chief Operating Officer (1977-1994) M. David Jones 48 Vice President - Aftermarket Group (1989 to present) F. Joseph Loughrey 46 Group Vice President - Worldwide Operations & Technology (1995 to present), Group Vice President - Worldwide Operations (1990 to 1995) John McLachlan 63 Vice President - Corporate Controller (1991 to present Theodore M. Solso 48 President and Chief Operating Officer (1995 to present), Executive Vice President and Chief Operating Officer (1994 to 1995), Executive Vice President - Operations (1992 to 1994), Vice President & General Manager Engine Business (1988 to 1992) Richard B. Stoner-Jr. 49 Vice President - Cummins Power Generation Group and President - Onan Corporation (1993 to present), Managing Director - Holset (1986-1993) ITEM 11. EXECUTIVE COMPENSATION ________ ______________________ The information appearing under the following captions in the Company's Proxy Statement is hereby incorporated by reference: "The Board of Directors and Its Committees", "Executive Compensation -- Compensation Tables and Other Information", "Executive Compensation -- Change of Control Arrangements" and "Executive Compensation -- Compensation Committee Interlocks and Insider Participation". The Company has adopted various benefit and compensation plans covering officers and other key employees under which certain benefits become payable upon a change of control of the Company. Cummins also has adopted an employee retention program covering approximately 500 employees of the Company and its subsidiaries, which provides for the payment of severance benefits in the event of termination of employment following a change of control of Cummins. The Company and its subsidiaries also have severance programs for other exempt employees of the Company whose employment is terminated following a change of control of the Company. Certain of the pension plans covering employees of the Company provide, upon a change of control of Cummins, that excess plan assets become dedicated solely to fund benefits for plan participants. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ________ ______________________________________________________________ A discussion of the security ownership of certain beneficial owners and management appearing under the captions "Principal Security Ownership", "Election of Directors" and "Executive Compensation -- Security Ownership of Management" in the Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ________ ______________________________________________ The information appearing under the captions "The Board of Directors and Its Committees", "Executive Compensation - Compensation Committee Interlocks and Insider Participation" and "Other Transactions and Agreements with Directors, Officers and Certain Shareholders" in the Proxy Statement is incorporated herein by reference. PART IV _______ ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ________ _______________________________________________________________ Documents filed as a part of this report: 1. See Index to Financial Statements on page 27 for a list of the financial statements filed as a part of this report. 2. See Exhibit Index on page 49 for a list of the exhibits filed or incorporated herein as a part of this report. No reports on Form 8-K were filed during the fourth quarter of 1995. INDEX TO FINANCIAL STATEMENTS _____________________________ Page ____ Management's Responsibility for Financial Statements 28 Report of the Independent Public Accountants 29 Consolidated Statement of Earnings 30 Consolidated Statement of Financial Position 31 Consolidated Statement of Cash Flows 32 Consolidated Statement of Shareholders' Investment 33 Notes to Consolidated Financial Statements 34 Quarterly Financial Data 46 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS ____________________________________________________ Management is responsible for the preparation of the Company's consolidated financial statements and all related information appearing in this Form 10-K. The statements and notes have been prepared in conformity with generally accepted accounting principles and include some amounts which are estimates based upon currently available information and management's judgment of current conditions and circumstances. The Company engaged Arthur Andersen LLP, independent public accountants, to examine the consolidated financial statements. Their report appears on page 29. To provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition and that accounting records are reliable for preparing financial statements, management maintains a system of accounting and controls, including an internal audit program. The system of accounting and controls is improved and modified in response to changes in business conditions and operations and recommendations made by the independent public accountants and the internal auditors. The Board of Directors has an Audit Committee whose members are not employees of the Company. The committee met four times in 1995 with management, internal auditors and representatives of the Company's independent public accountants to review the Company's program of internal controls, audit plans and results, and the recommendations of the internal and external auditors and management's responses to those recommendations. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ________________________________________ To the Shareholders and Board of Directors of Cummins Engine Company, Inc.: We have audited the accompanying consolidated statement of financial position of Cummins Engine Company, Inc., (an Indiana corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of earnings, cash flows and shareholders' investment for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Cummins Engine Company, Inc., and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. Arthur Andersen LLP Chicago, Illinois, January 22, 1996. CUMMINS ENGINE COMPANY, INC. CONSOLIDATED STATEMENT OF EARNINGS (Millions, Except Per Share Amounts) ____________________________________ 1995 1994 1993 ______ ______ ______ Net sales $5,245 $4,737 $4,248 Cost of goods sold 3,974 3,551 3,211 ______ ______ ______ Gross profit 1,271 1,186 1,037 Selling & administrative expenses 692 641 579 Research & engineering expenses 263 238 210 Interest expense 13 17 36 Other, net 8 (4) 7 Restructuring charges 118 - - _____ _____ _____ Earnings before income taxes 177 294 205 Provision (credit) for income taxes (47) 41 22 _____ _____ _____ Earnings before extraordinary item 224 253 183 Early extinguishment of debt - - (6) _____ _____ _____ Net earnings 224 253 177 Preference stock dividends - - 8 ______ ______ ______ Earnings available for common shares $ 224 $ 253 $ 169 ______ ______ ______ Primary earnings per share: Before extraordinary item $ 5.52 $ 6.11 $ 4.95 Net 5.52 6.11 4.79 Fully diluted earnings per share: Before extraordinary item $ 5.52 $ 6.11 $ 4.77 Net 5.52 6.11 4.63 The accompanying notes are an integral part of this statement. CUMMINS ENGINE COMPANY, INC. CONSOLIDATED STATEMENT OF FINANCIAL POSITION (Millions, Except Per Share Amounts) ____________________________________________ December 31, 1995 1994 ______ ______ Assets Current assets: Cash and cash equivalents $ 60 $ 147 Receivables 597 504 Inventories 513 514 Other current assets 218 133 _____ ______ 1,388 1,298 _____ ______ Investments and other assets: Investments in and advances to unconsolidated companies 234 100 Other assets 92 90 _____ _____ 326 190 _____ _____ Property, plant and equipment: Land and buildings 436 386 Machinery, equipment and fixtures 1,875 1,779 Construction in progress 164 204 _____ _____ 2,475 2,369 Less accumulated depreciation 1,327 1,279 _____ _____ 1,148 1,090 _____ _____ Intangibles, deferred taxes & deferred charges 194 128 ______ ______ Total assets $3,056 $2,706 ______ ______ Liabilities and shareholders' investment Current liabilities: Loans payable $ 60 $ 41 Current maturities of long-term debt 42 37 Accounts payable 376 322 Accrued salaries and wages 85 87 Accrued product coverage & marketing expenses 152 131 Income taxes payable 30 27 Other accrued expenses 308 195 _____ _____ 1,053 840 _____ _____ Long-term debt 117 155 _____ ______ Other liabilities 703 639 _____ _____ Shareholders' investment: Common stock, $2.50 par value, 43.9 and 43.8 shares issued 110 109 Additional contributed capital 926 927 Retained earnings 406 232 Common stock in treasury,at cost,3.7 & 2.2 shares (135) (72) Unearned compensation ( 51) (55) Cumulative translation adjustments ( 73) (69) _____ _____ 1,183 1,072 _____ _____ Total liabilities & shareholders' investment $3,056 $2,706 ______ ______ The accompanying notes are an integral part of this statement. CUMMINS ENGINE COMPANY, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (Millions) ____________________________________ 1995 1994 1993 ______ ______ ______ Cash flows from operating activities: Net earnings $ 224 $ 253 $ 177 _____ _____ _____ Adjustments to reconcile net earnings to net cash from operating activities: Restructuring charges 114 - - Depreciation and amortization 143 128 125 Early extinguishment of debt - - 6 Accounts receivable ( 91) ( 37) ( 59) Inventories 3 ( 46) 1 Accounts payable and accrued expenses 99 69 8 Deferred income taxes (100) ( 7) ( 2) Other 14 16 30 ____ ____ ____ Total adjustments 182 123 109 ____ ____ ____ Net cash provided by operating activities 406 376 286 ____ ____ ____ Cash flows from investing activities: Property, plant and equipment: Additions (223) (238) (174) Disposals 6 5 12 Investments in and advances to unconsolidated companies (155) ( 8) 10 Acquisition of new businesses, net of cash acquired ( 1) ( 20) 3 _____ _____ _____ Net cash used for investing activities (373) (261) (149) _____ _____ _____ Net cash flows from operating and investing activities 33 115 137 ____ ____ ____ Cash flows from financing activities: Proceeds from borrowings 2 - 57 Payments on borrowings ( 37) ( 34) (248) Net borrowings under credit agreements 19 17 ( 26) Net proceeds from common stock issuances - - 125 Repurchase of common stock ( 69) ( 5) - Dividend payments ( 40) ( 26) ( 15) Other 4 ( 2) ( 7) _____ _____ _____ Net cash used for financing activities (121) ( 50) (114) _____ _____ _____ Effect of exchange rate changes on cash 1 5 - _____ _____ ____ Net change in cash and cash equivalents ( 87) 70 23 Cash & cash equivalents at beginning of year 147 77 54 ____ ____ ____ Cash & cash equivalents at end of year $ 60 $147 $ 77 ____ ____ ____ Cash payments during the year for: Interest $ 13 $ 19 $ 40 Income taxes 59 43 18 The accompanying notes are an integral part of this statement. CUMMINS ENGINE COMPANY, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' INVESTMENT (Millions, Except Per Share Amounts) __________________________________________________ 1995 1994 1993 ______ ______ ______ Convertible preference stock, no par value, 1.0 shares authorized: Beginning balance (.2 shares) $ - $ 112 $ 115 Converted to common stock or redeemed (.2 shares) - (112) ( 3) ______ _______ _______ Ending balance - - 112 ______ ______ ______ Common stock, $2.50 par value, 150.0 shares authorized: Beginning balance (43.8, 40.6 & 36.5 shares) 109 101 92 Issued in public offerings (2.6 shares) - - 7 Conversion of preference stock & LYONs (2.9 & 1.1 shares) - 7 1 Other (.1, .3 and .4 shares) 1 1 1 ______ ______ ______ Ending balance (43.9, 43.8 & 40.6 shares) 110 109 101 ______ ______ ______ Additional contributed capital: Beginning balance 927 823 654 Issued in public offerings - - 118 Conversion of preference stock and LYONs - 104 48 Other ( 1) - 3 _______ ______ ______ Ending balance 926 927 823 ______ ______ ______ Retained earnings (deficit): Beginning balance 232 4 (146) Net earnings for the year 224 253 177 Cash dividends declared: Convertible preference stock - - ( 8) Common stock ( 40) (26) ( 7) Additional minimum liability for pensions ( 10) 1 ( 12) _______ ______ _______ Ending balance 406 232 4 ______ ______ ______ Common stock in treasury: Beginning balance (2.2, 2.1 & 2.1 shares) ( 72) (67) ( 67) Stock repurchased (1.6 and .1 shares) ( 69) ( 5) - Stock issued (.1 shares) 6 - - _______ _______ _______ Ending balance (3.7, 2.2 & 2.1 shares) (135) (72) ( 67) _______ _______ _______ Unearned compensation: Beginning balance ( 55) (59) ( 64) Shares allocated to participants 4 4 5 _______ _______ _______ Ending balance ( 51) (55) ( 59) ______ _______ _______ Cumulative translation adjustments: Beginning balance ( 69) (93) (83) Adjustments ( 4) 24 (10) _______ _______ _______ Ending balance ( 73) (69) (93) ______ ______ ______ Shareholders' investment $1,183 $1,072 $ 821 ______ ______ ______ The accompanying notes are an integral part of this statement. CUMMINS ENGINE COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions, Unless Otherwise Stated) ______________________________________________ NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Principles of Consolidation: The consolidated financial statements include the accounts of Cummins Engine Company, Inc., and its majority- owned subsidiaries. Affiliated companies in which Cummins does not have a controlling interest or in which control is expected to be temporary are accounted for using the equity method. The statements and notes have been prepared in conformity with generally accepted accounting principles and include some amounts which are estimates based upon currently available information and management's judgment of current conditions and circumstances. Revenue Recognition: The Company recognizes revenues on the sale of its products, net of estimated costs of returns, allowances and sales incentives, when the products are shipped to customers. Product Coverage Programs: Estimated costs of product coverage programs are charged to earnings at the time the Company sells its products. Foreign Currency: The Company uses the local currency as the functional currency for its manufacturing operations outside the United States, except those in Brazil and Mexico for which it uses the US dollar. At operations which use the local currency as the functional currency, results are translated into US dollars using average exchange rates for the year, while assets and liabilities are translated into US dollars using year-end exchange rates. The resulting translation adjustments are recorded as a separate component of shareholders' investment. Gains and losses from foreign currency transactions are included in net earnings. At the Company's operations in Brazil and Mexico, cash and certain other monetary assets and liabilities, such as receivables and payables, and revenues and expenses are translated into US dollars using current exchange rates. Inventories and nonmonetary assets, such as fixed assets, are translated into US dollars using historical exchange rates. The resulting translation adjustments and gains and losses from foreign currency transactions are reflected in net earnings. Technical Investment: Expenditures for research and development of new products, as well as engineering expenditures during early production and ongoing efforts to improve existing products, are charged to earnings as incurred, net of contract reimbursements: Technical Investment 1995 1994 1993 ____________________ ____ ____ ____ Research & engineering $263 $238 $210 Reimbursements 46 31 29 Other 52 43 38 ____ ____ ____ Total $361 $312 $277 ____ ____ ____ Included above in research and engineering were research and development costs approximating $230 in 1995, $200 in 1994 and $160 in 1993. Cash Equivalents: Cash equivalents are investments that are readily convertible to known amounts of cash and have original maturities of three months or less. Inventories: The Company accounts for approximately 30 percent of its inventories using the last-in, first-out (LIFO) cost method. These LIFO inventories include substantially all of the Company's US heavy- duty and high-horsepower engine and engine parts inventories. All other inventories are valued at the lower of first-in, first-out (FIFO) cost or net realizable value. December 31, Inventories 1995 1994 ___________ ____ ____ Finished products $283 $291 Work-in-process & raw materials 292 277 ____ ____ Inventories at FIFO cost 575 568 Excess of FIFO over LIFO (62) (54) ____ ____ Inventories $513 $514 ____ ____ Property, Plant and Equipment: Property, plant and equipment are recorded at cost. The Company depreciates substantially all engine production equipment using a modified units-of-production method, which is based upon units produced subject to a minimum level. Depreciation of all other equipment is computed using the straight- line method for financial reporting purposes. The estimated service lives to compute depreciation range from 20 to 40 years for buildings and 3 to 20 years for machinery, equipment and fixtures. Where appropriate, the Company uses accelerated depreciation methods for tax purposes. Maintenance and repair costs are charged to earnings as incurred. Earnings Per Common Share: Primary earnings per share of common stock are computed by subtracting preference stock dividend requirements from net earnings and dividing that amount by the weighted-average number of common shares outstanding during each year. Fully diluted earnings per share are computed by dividing net earnings by the weighted-average number of shares outstanding, assuming the exercise of stock options and the conversion of debt and preference stock to common stock. NOTE 2. RESTRUCTURING CHARGES: Results of operations in 1995 included restructuring charges of $118 ($77 after taxes) for costs to reduce the worldwide work force by approximately 2,000 people through a series of actions, including voluntary and involuntary separations, retirements and plant consolidations. Facility consolidations include closing or restructuring selected operations in Europe, Brazil and North America. The components of the restructuring charges are as follows: Work force reductions ............$ 82 Asset write downs................. 32 Other 4 ___ Total $118 ____ Estimated costs for work force reductions were based on amounts pursuant to benefit programs and contractual provisions or statutory requirements at the affected operations. At December 31, 1995, approximately 1,300 employees had separated from the Company as a result of the restructuring actions. In addition to the restructuring charges, the Company expects to incur approximately $25 in 1996, primarily for continuity payments and equipment and employee relocations associated with the facility consolidations and closings. NOTE 3. OPERATING LEASES: Certain of the Company's manufacturing plants, warehouses and offices are leased facilities. The Company also leases manufacturing and office equipment. Most of these leases require fixed rental payments, expire over the next ten years and can be renewed or replaced with similar leases. Rental expense under these leases in 1995, 1994 and 1993 was $54, $52 and $51, respectively. Future minimum payments for operating leases with original terms of more than one year are $31 in 1996, $26 in 1997, $20 in 1998, $20 in 1999, $22 in 2000 and $84 thereafter. NOTE 4. SALE OF RECEIVABLES: The Company has an agreement to sell, without recourse, up to $110 of eligible trade receivables. The amount of receivables outstanding was $110 under this agreement at both December 31, 1995 and 1994. As collections reduce previously sold receivables, new receivables customarily are sold up to the $110 level. NOTE 5. INVESTMENTS IN UNCONSOLIDATED COMPANIES: December 31, 1995 1994 ____ ____ Consolidated Diesel Company $ 96 $ 33 Kirloskar Cummins Limited 27 22 Cummins Wartsila 31 - Chongqing Cummins 15 - Tata Cummins Ltd. 13 8 Other 52 37 ____ ____ Carrying value $234 $100 ____ ____ Included above in the Company's carrying value of Consolidated Diesel Company is temporary financing of $50 that will be repaid to Cummins in 1996. Other investments at December 31, 1995 and 1994 included $23 and $19, respectively, for temporarily owned distributorships. Cummins' sales to these distributorships approximated $20 in 1995, $40 in 1994 and $50 in 1993. Summary financial information for 50-percent or less owned companies: Earnings Data 1995 1994 1993 _____________ ______ ______ ______ Net sales $1,091 $ 914 $ 746 Earnings 6 15 3 Cummins' share 1 6 1 December 31, Balance Sheet Data 1995 1994 __________________ ____ ____ Current assets $330 $199 Noncurrent assets 340 186 Current liabilities (231) (146) Noncurrent liabilities ( 63) ( 42) ____ ____ Net assets $376 $197 ____ ____ Cummins' share $211 $ 81 ____ ____ NOTE 6. EARLY EXTINGUISHMENT OF DEBT: In December 1993, the Company sold 2.6 million shares of its common stock in a public offering and used a portion of the proceeds to redeem $77 in principal amount of outstanding 9-3/4 percent sinking fund debentures. This early extinguishment of debt resulted in an extraordinary charge of $6. NOTE 7. LONG-TERM DEBT: December 31, Long-term Debt 1995 1994 ______________ ____ ____ 9.74%-10.65% medium-term notes, through 1998 $ 73 $102 8.76% guaranteed notes of ESOP Trust, due 1998 68 70 Other 18 20 ____ ____ Total indebtedness 159 192 Less current maturities 42 37 ____ ____ Long-term debt $117 $155 ____ ____ Aggregate maturities of long-term debt for the five years subsequent to December 31, 1995 are $42, $25, $81, $3 and $1. At December 31, 1995 and 1994, the weighted-average interest rate on loans payable and current maturities of long-term debt was 8 percent and 7 percent, respectively. The Company maintains a $300 revolving credit agreement, under which there were no outstanding borrowings at December 31, 1995 or 1994. The Company also maintains other domestic and international credit lines with approximately $110 available at December 31, 1995. The Company has guaranteed the outstanding borrowings of its ESOP Trust. The ESOP was established for certain of the Company's salaried employees who participate in the qualified benefit savings plans. Cash contributions to the ESOP Trust, together with the dividends accumulated on the common stock held by the Trust, are used to pay interest and principal due on the notes. Cash contributions and dividends to the ESOP Trust to fund principal and interest payments approximated $10 in both 1995 and 1994. The Company's compensation expense was $8 in 1995, $9 in 1994 and $10 in 1993. The unearned compensation, which is reflected as a reduction to shareholders' investment, represents the historical cost of the ESOP Trust's shares of common stock that have not yet been allocated to participants. NOTE 8. OTHER LIABILITIES: December 31, Other Liabilities 1995 1994 _________________ ____ ____ Accrued retirement & post-employment benefits $533 $475 Accrued product coverage & marketing expenses 86 91 Deferred taxes 21 21 Accrued compensation 21 12 Other 42 40 ____ ____ Other liabilities $703 $639 ____ ____ NOTE 9. INCOME TAXES: Tax Provision 1995 1994 1993 _____________ ____ ____ ____ Current: US federal and state $ 30 $ 29 $ 5 Foreign 23 19 19 ___ ___ ___ 53 48 24 ___ ___ ___ Deferred: US federal and state (93) (9) (12) Foreign ( 7) 2 10 ____ ____ ____ (100) (7) ( 2) ____ ____ ____ Tax provision (credit) $(47) $ 41 $ 22 _____ ____ ____ Significant components of the Company's net deferred tax assets relate to the following tax effects of differences between financial and tax reporting: December 31, Net Deferred Tax Assets 1995 1994 _______________________ ____ ____ US accrued employee benefits $236 $219 US accrued product coverage & marketing expenses 73 66 Restructuring charges 25 - US plant & equipment (124) (111) Other net US differences 7 10 UK taxable differences, primarily plant & equipment ( 5) ( 13) Other net foreign taxable differences ( 2) ( 1) US federal carryforward benefits: General business tax credits, expiring 2000 to 2010 58 62 Minimum tax credits, no expiration 11 6 Less valuation allowance - ( 68) ____ ____ Net deferred tax assets $279 $170 ____ ____ Balance Sheet Classification ____________________________ Current assets $164 $ 90 Noncurrent assets 136 101 Noncurrent liabilities (21) (21) ___ ____ Net deferred tax assets $279 $170 ____ ____ During 1995, the valuation allowance maintained against the tax carryforward benefits was released to earnings as a reduction of income tax expense. Assessments of the likelihood of realizing net deferred tax assets take into consideration historical information, expected future income and tax planning strategies. Based upon the most recent assessment, the Company now expects to realize all of its tax assets, including the use of all carryforwards before any expiration. The Company previously had released the valuation allowance to earnings as carryforwards were actually used, leaving unused carryforward benefits offset by the allowance. The reduction in income tax expense resulting from reducing the beginning-of-the- year valuation allowance amounted to $68 in 1995, $32 in 1994 and $34 in 1993. The Company determined during 1995 that its levels and character of taxable income were sufficient to allow changes to its tax treatment of foreign tax credits and foreign sales corporation benefits for prior years. As a consequence, $35 of foreign taxes paid and previously used as deductions were used as full credits against US federal taxes, increasing their value $23. In addition, foreign sales corporation benefits for prior years were maximized, producing a net tax benefit of $12. These additional tax benefits of $35 related to prior years have been recorded as a reduction to 1995 income tax expense. Earnings before income taxes and differences between the effective tax rate and US federal income tax rates were: 1995 1994 1993 ____ ____ ____ Earnings before income taxes: US $135 $181 $111 International 42 113 94 ____ ____ ____ $177 $294 $205 ____ ____ ____ Tax at 35 percent US statutory rate $ 62 $103 $ 72 Change in US tax rate - - (4) Adjustment to beginning-of-year valuation allowance (68) (32) (34) Modification of foreign tax credit and foreign sales corporation benefits of prior years (35) - - Research tax credits ( 6) ( 9) ( 8) Current-year foreign sales corporation benefits ( 5) - - Differences in rates and taxability of foreign subsidiaries - (18) 1 All other, net 5 ( 3) ( 5) ____ ____ ____ Tax provision (credit) $(47) $ 41 $ 22 ____ ____ ____ NOTE 10. RETIREMENT PLANS: The Company has several contributory and noncontributory pension plans covering substantially all employees. Benefits for salaried plans generally are based upon compensation during the three to five years preceding retirement. Under the hourly plans, benefits generally are based upon various monthly amounts for each year of service. The Company has a non-qualified excess benefit plan that provides certain employees with defined retirement benefits in excess of qualified plan limits imposed by US tax law. In addition, the Company has a supplementary life insurance plan that provides officers and other key employees with term life protection during their active employment and supplemental benefits upon retirement. December 31, 1995 December 31, 1994 __________________________ __________________________ Over- Under- Over- Under- Funded Status funded funded Combined funded funded Combined _____________ ______ ______ ________ ______ ______ ________ Benefit obligation: Vested $(600) $(539) $(1,139) $(397) $(544) $( 941) Accumulated $(674) $(658) $(1,332) $(459) $(642) $(1,101) Projected $(779) $(688) $(1,467) $(533) $(693) $(1,226) Plan assets 863 504 1,367 623 562 1,185 _____ ______ ________ _____ ______ ________ Funded status 84 (184) ( 100) 90 (131) ( 41) Unrecognized: Experience (gain) loss ( 30) 4 ( 26) ( 33) ( 35) ( 68) Prior service cost 21 85 106 12 105 117 Transition asset ( 19) ( 10) ( 29) ( 21) ( 18) ( 39) Additional liability - ( 63) ( 63) - ( 32) ( 32) _____ ______ ________ _____ ______ ________ Accrued asset (liability) $ 56 $(168) $ ( 112) $ 48 $(111) $( 63) _____ ______ ________ ______ ______ ________ In 1995, the projected benefit obligation was determined using weighted-average discount rates of 7 percent for the US plans and 8.5 percent for the international plans and, in 1994, rates of 8.25 percent and 8.5 percent, respectively. The assumed long-term rates of compensation increase for salaried plans approximated expected inflation. The long-term rates of return on assets were assumed to be 10 percent in 1995 and 8.5 percent in 1994 for US plans and 9.25 percent in 1995 and 8.75 percent in 1994 for the international plans. It is the Company's policy to make contributions to these plans sufficient to meet the funding requirements of applicable laws and regulations, plus such additional amounts as deemed to be appropriate. Plan assets consist principally of equity securities and corporate and fixed-income Government obligations. Pension Cost 1995 1994 1993 ____________ ____ ____ ____ Service cost $ 40 $ 42 $ 32 Interest cost 99 89 83 Asset return: Actual (214) (26) (203) Deferred 110 (79) 100 Transition asset amortization ( 9) ( 9) ( 9) Other 14 12 3 ____ ____ ____ Pension cost $ 40 $ 29 $ 6 ____ _____ ____ While the Company provides certain health care and life insurance benefits to eligible retirees and their dependents, it reserves the right to change benefits covered under these plans. The plans are contributory, with retirees' contributions adjusted annually, and contain other cost-sharing features, such as deductibles, coinsurance and spousal contributions. The general policy is to fund these benefits as claims and premiums are incurred. Health Care Cost 1995 1994 1993 ________________ ____ ____ ____ Service cost $ 8 $ 10 $ 6 Interest cost 38 33 30 Other 7 10 (1) ____ ____ ____ Total $ 53 $ 53 $ 35 ____ ____ ____ December 31, Accrued Liability 1995 1994 _________________ ____ ____ Accumulated benefit obligation for: Retirees $238 $226 Employees eligible to retire 125 92 Others 163 148 Unrecognized: Prior service cost (10) (17) Net experience loss (40) ( 6) ____ ____ Accrued liability $476 $443 ____ ____ The weighted-average discount rate used to determine the accumulated benefit obligation was 7 percent in 1995 and 8.25 percent in 1994. The trend rate for medical benefits provided prior to Medicare eligibility is 11 percent, grading down to an ultimate rate of 4.75 percent by 2008. For benefits provided after Medicare eligibility, the trend rate is 6.25 percent, grading down to an ultimate rate of 4.75 percent by 1999. The health care cost trend rate assumption could have a significant effect on the determination of the obligation. For example, increasing the rate by one percent would increase the accumulated benefit obligation by $31 and net cost by $3. NOTE 11. PREFERENCE STOCK REDEMPTION: In 1994, the Company called for redemption, at a price of $51.05 per depositary share, plus accrued dividends, of all its outstanding Convertible Exchangeable Preference Stock, which had a face value of $112. Holders of the stock elected to convert their shares into 2.9 million shares of common stock. NOTE 12. COMMON STOCK REPURCHASE PROGRAM: In 1994, the Board of Directors authorized repurchase by the Company of up to 2.5 million shares of its common stock. During 1995, the Company repurchased on the open market 1.6 million shares at an aggregate purchase price of $69, or average price of $43.57 per share. In 1994, the Company repurchased on the open market .1 million shares at an aggregate purchase price of $5, or average price of $42.47 per share. All of the acquired shares are held as common stock in treasury. NOTE 13. EMPLOYEE STOCK PLANS: Under the Company's stock incentive and option plans, officers and other eligible employees may be awarded stock options, stock appreciation rights and restricted stock. Under the provisions of the stock incentive plan, up to one percent of the Company's outstanding shares of common stock at the end of the preceding year is available for issuance under the plan each year. At December 31, 1995, there were 408,109 shares of common stock available for grant and 451,500 options exercisable under the plans. Number of Options Shares Option Price per Share ________ _________ ______________________ December 31, 1993 525,070 $15.94 to $52.56 Granted 349,927 $36.81 to $53.25 Exercised ( 10,200) $20.72 to $37.41 _________ December 31, 1994 864,797 $15.94 to $53.25 Granted 360,625 $34.94 to $46.13 Exercised (22,520) $15.94 to $42.06 Cancelled (19,627) $21.94 to $52.56 _________ December 31, 1995 1,183,275 $15.94 to $53.25 _________ In 1995, the Financial Accounting Standards Board issued Statement No. 123, "Accounting for Stock-based Compensation", which is effective in 1996. This statement encourages, but does not require, a fair-value based method of accounting for stock options. The Company does not expect to change its method of accounting for stock options. NOTE 14. SHAREHOLDERS' RIGHTS PLAN: The Company has a Shareholders' Rights Plan which it first adopted in 1986. The Rights Plan provides that each share of the Company's common stock has associated with it a stock purchase right. The Rights Plan becomes operative when a person or entity acquires 15 percent of the Company's common stock or commences a tender offer to purchase 20 percent or more of the Company's common stock without the approval of the Board of Directors. In the event a person or entity acquires 15 percent of the Company's common stock, each right, except for the acquiring person's rights, can be exercised to purchase $400 worth of common stock for $200. In addition, for a period of 10 days after such acquisition, the Board of Directors can exchange such right for a new right which permits the holders to purchase one share of the Company's common stock for $1 per share. If a person or entity commences a tender offer to purchase 20 percent or more of the Company's common stock, unless the Board of Directors redeems the rights within 10 days of the event, each right can be exercised to purchase one share for $200. The plan also allows holders of the rights to purchase shares of the acquiring person's stock at a discount if the Company is acquired or 50 percent of the assets or earnings power of the Company is transferred to an acquiring person. NOTE 15. SEGMENTS OF THE BUSINESS: The Company operates in a single industry segment -- designing, manufacturing and marketing diesel engines and related products. The Company's key markets for diesel engines are heavy-duty and midrange trucks, power generation, bus and light commercial vehicles, industrial products and marine. Manufacturing, marketing and technical operations are maintained in major areas of the world. Summary financial information is listed below for each geographic area. Earnings (loss) for each area may not be a meaningful representation of each area's contribution to consolidated operating results because of significant sales of products between and among the Company's various domestic and international operations. All Corporate US Europe Other Items Combined _____ ______ _____ _________ ________ 1995 ____ Net sales: To customers in the area $3010 $ 772 $524 $ - $4306 To customers outside the area 587 342 10 - 939 Intergeographic transfers 367 186 126 (679) - _____ _____ ____ ______ _____ Total $3964 $1300 $660 $(679) $5245 Earnings (loss) before income taxes $ 178 $ 113 $ 24 $(138) $ 177 Identifiable assets $1853 $ 598 $483 $ 122 $3056 1994 ____ Net sales: To customers in the area $2708 $ 657 $538 $ - $3903 To customers outside the area 594 234 6 - 834 Intergeographic transfers 410 159 114 (683) - _____ _____ _____ _____ _____ Total $3712 $1050 $658 $(683) $4737 Earnings (loss) before income taxes $ 177 $ 87 $ 44 $( 14) $ 294 Identifiable assets $1618 $ 499 $412 $ 177 $2706 1993 ____ Net sales: To customers in the area $2374 $ 590 $439 $ - $3403 To customers outside the area 589 251 5 - 845 Intergeographic transfers 317 149 84 (550) - _____ _____ ____ ______ _____ Total $3280 $ 990 $528 $(550) $4248 Earnings (loss) before income taxes $ 140 $ 89 $ 19 $( 43) $ 205 Identifiable assets $1487 $ 407 $340 $ 157 $2391 Total sales for each geographic area are classified by manufacturing source and include sales to customers within and outside the area and intergeographic transfers. Transfer prices for sales between the Company's various operating units generally are at arm's length, based upon business conditions, distribution costs and other costs which are expected to be incurred in producing and marketing products. Corporate items include interest and other income and expense. Identifiable assets are those resources associated with the operations in each area. Corporate assets are principally cash and investments. The Company generally sells its products on open account under credit terms customary to the region of distribution. The Company performs ongoing credit evaluations of its customers and generally does not require collateral to secure its customers' receivables. Net sales by marketing territory: Net Sales 1995 1994 1993 _________ ______ ______ ______ United States $3,018 $2,712 $2,389 Europe 783 671 600 Asia, Far East & Australia 723 626 559 Canada 384 330 257 Mexico & South America 233 318 330 Africa & Middle East 104 80 113 ______ ______ ______ Net sales $5,245 $4,737 $4,248 ______ ______ ______ NOTE 16. GUARANTEES, COMMITMENTS AND OTHER CONTINGENCIES: At December 31, 1995, loans, leases and accounts receivable that have been sold with recourse amounted to $25. Commitments under outstanding letters of credit, guarantees and contingencies approximated $170. Based on borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the fair value of total indebtedness of $219 at December 31, 1995 approximated $240. The carrying values of all other receivables and liabilities approximated fair values at December 31, 1995. The Company enters into forward exchange contracts to hedge the effects of fluctuating currency rates on certain assets and liabilities, such as accounts receivable and payable, that are denominated in other than the functional currencies of entities. The contracts typically provide for the exchange of different currencies at specified future dates and rates. The gain or loss due to the difference between the forward exchange rates of the contracts and current rates offsets in whole or in part the loss or gain on the assets or liabilities being hedged. The Company had $84 of contracts outstanding at December 31, 1995, which mature in 1996 and are denominated in a variety of foreign currencies where the Company does business. Commodity swap contracts at December 31, 1995 amounted to $39 and have the effect of fixing the Company's cost of certain future material purchases. These contracts mature through 1998. Gains or losses on the contracts are reflected in earnings concurrently with the hedged items. No significant concentration of credit or market risk exists for the Company. Cummins and its subsidiaries are defendants in a number of pending legal actions, including actions relating to use and performance of the Company's products. The Company carries product liability insurance covering significant claims for damages involving personal injury and property damage. In the event the Company is determined to be liable for damages in connection with such actions and proceedings, the unreserved and uninsured portion of such liability is not expected to be material. The Company also has been identified as a potentially responsible party at several waste disposal sites under US and related state environmental statutes and regulations. The Company denies liability with respect to many of these legal actions and environmental proceedings and vigorously is defending such actions or proceedings. The Company has established reserves which it believes are adequate for its expected future liability in such actions and proceedings where the nature and extent of such liability can be estimated reasonably based upon presently available information. NOTE 17. QUARTERLY FINANCIAL DATA (unaudited): First Second Third Fourth Full 1995 Quarter Quarter Quarter Quarter Year ____ _______ _______ _______ _______ ______ Net sales $1,334 $1,361 $1,219 $1,331 $5,245 Gross profit 343 340 277 311 1,271 Net earnings 67 69 46 42 224 Primary and fully diluted earnings per share $ 1.63 $ 1.69 $ 1.14 $ 1.05 $ 5.52 1994 ____ Net sales $1,099 $1,205 $1,156 $1,277 $4,737 Gross profit 271 297 295 323 1,186 Net earnings 55 66 62 70 253 Primary and fully diluted earnings per share $ 1.35 $ 1.58 $ 1.48 $ 1.68 $ 6.11 Included in net earnings in the fourth quarter of 1995 was a restructuring charge of $116 ($76 after taxes). There also was a tax credit of $68. Net earnings for 1995 included restructuring charges of $118 ($77 after taxes.) SIGNATURES __________ Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CUMMINS ENGINE COMPANY, INC. By /s/Kiran M. Patel By /s/John McLachlan __________________ _________________ Kiran M. Patel John McLachlan Vice President and Chief Vice President - Financial Officer Corporate Controller (Principal Financial (Principal Accounting Officer) Officer) Date: March 4, 1996 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signatures Title Date __________ _____ ____ Director & Chairman of the Board 3/2/96 * of Directors & Chief Executive _____________________ Officer (Principal Executive Officer) (James A. Henderson) * Director and President & Chief 3/2/96 _____________________ Operating Officer (Theodore M. Solso) * 3/2/96 _____________________ Director (Harold Brown) * _____________________ Director 3/2/96 (K. R. Dabrowski) * _____________________ Director 3/2/96 (Robert J. Darnall) * _____________________ Director 3/2/96 (W. Y. Elisha) * _____________________ Director 3/2/96 (Hanna H. Gray) * _____________________ Director 3/2/96 (D. G. Mead) * _____________________ Director 3/2/96 (J. Irwin Miller) * _____________________ Director 3/2/96 (William I. Miller) * _____________________ Director 3/2/96 (Donald S. Perkins) * ________________________ Director 3/2/96 (William D. Ruckelshaus) * _____________________ Director 3/2/96 (H. B. Schacht) * _____________________ Director 3/2/96 (F. A. Thomas) * _____________________ Director 3/2/96 (J. Lawrence Wilson) By /s/Mark R. Gerstle __________________ Mark R. Gerstle Attorney-in-fact CUMMINS ENGINE COMPANY, INC. EXHIBIT INDEX ____________________________ 3(a) Restated Articles of Incorporation of Cummins Engine Company, Inc., as amended (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended April 3, 1994, by reference to Quarterly Report on Form 10-Q for the quarter ended October 1, 1989 and by reference to Form 8-K, dated July 26, 1990). 3(b) By-laws of Cummins Engine Company, Inc., as amended and restated effective as of August 12, 1994 (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended October 2, 1994). 4(a) Amended and Restated Credit Agreement (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended October 2, 1994). 4(b) Rights Agreement, as amended (incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1989, by reference to Form 8-K, dated July 26, 1990, by reference to Form 8, dated November 6, 1990, by reference to Form 8-A12B/A, dated November 1, 1993, and by reference to Form 8-A12B/A, dated January 12, 1994). 10(a) Target Bonus Plan (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended July 3, 1994). 10(b) Deferred Compensation Plan (incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1994). 10(c) Key Employee Stock Investment Plan, as amended (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended July 3, 1994). 10(d) Supplemental Life Insurance and Deferred Income Plan (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended October 2, 1994). 10(e) Financial Counseling Program, (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended July 3, 1994). 10(f) 1986 Stock Option Plan (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended March 30, 1986). 10(g) Deferred Compensation Plan for Non-Employee Directors, as amended, effective as of April 15, 1994 (incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1994). 10(h) Key Executive Compensation Protection Plan (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended October 2, 1994). 10(i) Excess Benefit Retirement Plan, (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended October 2, 1994). 10(j) Restated Sponsors Agreement between Case Corporation and Cummins Engine Company, Inc., dated December 7, 1990, together with the Restated Partnership Agreement between Case Engine Holding Company, Inc., and Cummins Engine Holding Company, Inc., dated December 7, 1990 (incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1990). 10(k) Retirement Plan for Non-Employee Directors of Cummins Engine Company, Inc., effective September 1989 (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended April 2, 1995). 10(l) Stock Unit Appreciation Plan effective October 1990 (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended April 2, 1995). 10(m) Investment Agreement between Ford Motor Company and Cummins Engine Company, Inc., dated July 16, 1990 (incorporated by reference to Form 8-K, dated July 26, 1990). 10(n) Investment Agreement between Tenneco Inc., and Cummins Engine Company, Inc., dated July 16, 1990 (incorporated by reference to Form 8-K, dated July 26, 1990). 10(o) Investment Agreement between Kubota Corporation and Cummins Engine Company, Inc., dated July 16, 1990 (incorporated by reference to Form 8-K, dated July 26, 1990). 10(p) Three Year Performance Plan effective December 1992 (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended April 2, 1995). 10(q) Consulting arrangement with Harold Brown (incorporated by reference to the description thereof provided in the Company's definitive Proxy Statement). 10(r) Consulting arrangement with Henry B. Schacht (incorporated by reference to the description thereof provided in the Company's definitive Proxy Statement). 10(s) 1992 Stock Incentive Plan (filed herewith). 10(t) Restricted Stock Plan for Non-Employee Directors (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended April 3, 1994). 10(u) Executive Retention Plan (filed herewith). 10(v) Performance Share Plan, as amended January 1989 (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended April 2, 1995). 10(w) Senior Executive Bonus Plan (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended April 2, 1995). 10(x) Senior Executive Three Year Performance Plan (incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended April 2, 1995). 11 Schedule of Computation of Per Share Earnings for each of the Three Years Ended December 31, 1995 (filed herewith). 21 Subsidiaries of the Registrant (filed herewith). 23 Consent of Arthur Andersen LLP (filed herewith). 24 Powers of Attorney (filed herewith). 27 Financial Data Schedule (filed herewith).