UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 CUMMINS ENGINE COMPANY, INC. ____________________________ For the Quarter Ended June 30, 1996 Commission File Number 1-4949 _____________ ______ Indiana 35-0257090 _______ __________ (State or Other Jurisdiction of (IRS Employer Identification No.) Incorporation or Organization) 500 Jackson Street, Box 3005, _____________________________ Columbus, Indiana 47202-3005 _________________ __________ (Address of Principal Executive Offices) (Zip Code) 812-377-5000 ____________ (Registrant's Telephone Number) 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 proceeding 12 months and (2) has been subject to such filing requirements for the past 90 days: Yes [x] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: As of June 30, 1996, the number of shares outstanding of the registrant's only class of common stock was 39.7 million. TABLE OF CONTENTS _________________ Page No. ________ PART I. FINANCIAL INFORMATION ______________________________ Item 1. Financial Statements Consolidated Statement of Earnings for the Second 3 Quarter and First Half Ended June 30, 1996 and July 2, 1995 Consolidated Statement of Financial Position at 4 June 30, 1996 and December 31, 1995 Consolidated Statement of Cash Flows for the First 5 Half Ended June 30, 1996 and July 2, 1995 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Results of 7 Operations and Financial Condition PART II. OTHER INFORMATION ___________________________ Item 1. Legal Proceedings 12 Item 5. Other Information 12 Item 6. Exhibits and Reports on Form 8-K 12 Index to Exhibits 13 CUMMINS ENGINE COMPANY, INC. CONSOLIDATED STATEMENT OF EARNINGS FOR THE SECOND QUARTER AND FIRST HALF ENDED JUNE 30, 1996 AND JULY 2, 1995 Unaudited _____________________________________ Second Quarter First Half ________________ ________________ Millions, Except per Share Amounts 1996 1995 1996 1995 __________________________________ ______ ______ ______ ______ Net sales $1,316 $1,361 $2,632 $2,695 Cost of goods sold 1,016 1,021 2,016 2,012 ______ ______ ______ ______ Gross profit 300 340 616 683 Selling & administrative expenses 180 181 360 364 Research & engineering expenses 66 67 128 133 Expense (income) from joint ventures and alliances 3 (1) 5 (2) Interest expense 4 3 8 7 Other (income) expense, net (15) - (18) 4 _______ ______ ______ ______ Earnings before income taxes 62 90 133 177 Provision for income taxes 18 21 40 41 ______ ______ ______ ______ Net earnings $ 44 $ 69 $ 93 $ 136 ______ ______ ______ ______ ______ ______ ______ ______ Earnings per share $ 1.10 $ 1.69 $ 2.31 $ 3.32 Cash dividends declared per share .25 .25 .50 .50 CUMMINS ENGINE COMPANY, INC. CONSOLIDATED STATEMENT OF FINANCIAL POSITION Unaudited ____________________________________________ Millions, Except per Share Amounts 6/30/96 12/31/95 __________________________________ _______ ________ Assets Current assets: Cash and cash equivalents $ 169 $ 60 Receivables 699 597 Inventories 575 513 Other current assets 214 218 ______ ______ 1,657 1,388 Investments and other assets 272 326 Property, plant & equipment less accumulated depreciation of $1,347 and $1,327 1,138 1,148 Intangibles, deferred taxes and deferred charges 203 194 ______ _____ Total assets $3,270 $3,056 ______ ______ ______ ______ Liabilities and shareholders' investment Current liabilities: Loans payable $ 16 $ 60 Current maturities of long-term debt 49 42 Accounts payable 414 376 Other current liabilities 566 575 ______ ______ 1,045 1,053 ______ ______ Long-term debt 262 117 ______ ______ Other liabilities 736 703 ______ ______ Shareholders' investment: Common stock, $2.50 par value, 43.9 shares issued 110 110 Additional contributed capital 925 926 Retained earnings 478 406 Common stock in treasury, at cost, 4.2 and 3.7 shares (157) (135) Unearned compensation ( 46) (51) Cumulative translation adjustments ( 83) (73) ______ ______ 1,227 1,183 ______ ______ Total liabilities and shareholders' investment $3,270 $3,056 ______ ______ ______ ______ CUMMINS ENGINE COMPANY, INC. CONSOLIDATED STATEMENT OF CASH FLOWS Unaudited ____________________________________ First Half Ended _____________________ Millions 6/30/96 7/2/95 ________ _______ ______ Cash flows from operating activities: Net earnings $ 93 $136 ____ ____ Adjustments to reconcile net earnings to net cash from operating activities: Depreciation and amortization 76 70 Restructuring actions ( 23) - Accounts receivable (111) (110) Inventories ( 64) ( 60) Accounts payable and accrued expenses 62 101 Income taxes payable 21 8 Other ( 2) 19 ____ ____ Total adjustments (41) 28 ____ ____ Net cash provided by operating activities 52 164 ____ ____ Cash flows from investing activities: Property, plant and equipment: Additions (84) (84) Disposals 18 2 Investments in and advances from (to) joint ventures and alliances 40 (45) Disposition of business activities 11 - Other 7 ( 1) _____ _____ Net cash used in investing activities ( 8) (128) _____ _____ Net cash flows from operating & investing activities 44 36 ____ ____ Cash flows from financing activities: Proceeds from borrowings 160 - Payments on borrowings ( 8) ( 3) Net payments under credit agreements ( 44) (16) Payments of dividends ( 20) (20) Repurchases of common stock ( 21) (53) Other ( 2) 1 _____ ____ Net cash provided from (used for) financing activities 65 (91) _____ ____ Effect of exchange rate changes on cash - 1 ____ ___ Net change in cash and cash equivalents 109 (54) Cash & cash equivalents at beginning of year 60 147 ____ ____ Cash & cash equivalents at end of first half $169 $ 93 ____ ____ ____ ____ CUMMINS ENGINE COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Unaudited __________________________________________ Note 1. Accounting Policies: The Consolidated Financial Statements for the interim periods ended June 30, 1996 and July 2, 1995 have been prepared in accordance with the accounting policies described in the Company's Annual Report to Shareholders and Form 10-K. Management believes the statements include all adjustments of a normal recurring nature necessary to present fairly the results of operations for the interim periods. Inventory values at interim reporting dates are based upon estimates of the annual adjustments for taking physical inventory and for the change in cost of LIFO inventories. Note 2. Income Taxes: Income tax expense is reported during the interim reporting periods on the basis of the estimated annual effective tax rate for the taxable jurisdictions in which the Company operates. In the first half of 1995, the Company recognized approximately $21 million related to a reduction in its valuation allowance for tax benefit carryforwards. Note 3. Long-term Debt: The Company maintains a revolving credit agreement, under which there were no outstanding borrowings at June 30, 1996. In the second quarter of 1996, the agreement was amended, increasing the available amount to $400 million and extending the term to 2001. The revolving credit agreement supported commercial paper borrowings of $50 million at June 30, 1996. The commercial paper borrowings were issued as replacement financing for an arrangement whereby the Company sold up to $110 million receivables without recourse. The agreement for the sale of receivables expired in the second quarter of 1996 and was not renewed by the Company. In the first quarter of 1996, a subsidiary of the Company issued 8.2 percent notes, which resulted in net proceeds of $100 million. Note 4. Common Stock Repurchase Program: In October 1994, the Board of Directors authorized repurchase by the Company of up to 2,500,000 shares of its common stock. During the first half of 1996, the Company repurchased on the open market 492,100 shares at an aggregate purchase price of $21 million, or average price of $43.49 per share. The Company repurchased 1,575,400 shares at an aggregate purchase price of $69 million, or average price of $43.57 per share in 1995 and 103,100 shares at an aggregate purchase price of $4 million, or average price of $42.47 per share, in 1994. NOTE 5. Earnings per Share: Earnings per share of common stock are computed by dividing net earnings by the weighted-average number of common shares outstanding during the period. The weighted-average number of shares, which includes the exercise of certain stock options granted to employees, was 40.1 million in the second quarter of 1996 and 40.2 million shares in the first half of 1996. The weighted- average number of shares was 40.8 million shares in the second quarter of 1995 and 41.0 million shares in the first half of 1995. CUMMINS ENGINE COMPANY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION _____________________________________________ OVERVIEW ________ Sales of $1.3 billion in the second quarter of 1996 were 3 percent below the Company's record second-quarter 1995 sales of $1.4 billion, reflecting the decrease in market size for heavy-duty truck engines in both North America and Europe. The decline in heavy-duty truck markets was partially offset by strong demand in international markets for power generation, whose sales of $310 million were a quarterly record. In the first half of 1996, the Company's net sales were $2.6 billion, 2 percent below the first half of 1995. The Company shipped 174,500 engines in the first half of 1996, which was 3 percent lower than first-half 1995. Second Quarter First Half _______________ ________________ Engine Shipments 1996 1995 1996 1995 ________________ ______ ______ _______ _______ Midrange engines 61,100 60,400 123,600 118,500 Heavy-duty engines 21,900 28,900 46,400 57,300 High-horsepower engines 2,400 2,400 4,500 4,800 ______ ______ _______ _______ Total 85,400 91,700 174,500 180,600 ______ ______ _______ _______ ______ ______ _______ _______ Net earnings were $44 million, or $1.10 per share, in the second quarter of 1996, compared to $69 million, or $1.69 per share, in the second quarter of 1995. For the first half of 1996, net earnings were $93 million, or $2.31 per share, compared to $136 million, or $3.32 per share, in the first half of 1995. RESULTS OF OPERATIONS _____________________ The percentage relationships between net sales and other elements of the Company's Consolidated Statement of Earnings for the comparative reporting periods were: Second Quarter First Half ______________ _____________ Percent of Net Sales 1996 1995 1996 1995 ____________________ ______ _____ _____ _____ Net sales 100.0 100.0 100.0 100.0 Cost of goods sold 77.2 75.0 76.6 74.7 _____ _____ _____ _____ Gross profit 22.8 25.0 23.4 25.3 Selling and administrative expenses 13.7 13.3 13.7 13.5 Research and engineering expenses 5.0 4.9 4.9 4.9 Expense (income) from joint ventures and alliances .2 - .2 - Interest expense .3 .2 .3 .3 Other (income) expense, net (1.1) - (.8) .1 ______ ______ _____ _____ Earnings before income taxes 4.7 6.6 5.1 6.5 Provision for income taxes 1.4 1.5 1.6 1.5 _____ _____ _____ _____ Net earnings 3.3 5.1 3.5 5.0 _____ _____ _____ _____ _____ _____ _____ _____ Net Sales _________ Sales for each of the Company's markets for the comparative reporting periods were: Second Quarter First Half ______________ ______________ Dollars in Millions 1996 1995 1996 1995 ___________________ ______ ______ ______ ______ Heavy-duty truck $ 309 $ 398 $ 655 $ 794 Midrange truck 151 159 314 303 Bus and light commercial vehicles 194 180 396 363 Power generation 310 278 570 555 Industrial products 183 181 357 350 Marine 30 25 62 46 Fleetguard and Holset 139 140 278 284 ______ ______ ______ ______ Net sales $1,316 $1,361 $2,632 $2,695 ______ ______ ______ ______ ______ ______ ______ ______ Heavy-duty truck engine sales of $309 million in the second quarter and $655 million in the first half of 1996 were 22 percent and 18 percent lower than the respective periods of 1995. The decline in sales in 1996 was due primarily to a declining market size in North America. International engine shipments for heavy-duty trucks were also lower in 1996, due primarily to softer demand in Europe. Sales of $151 million in the second quarter of 1996 for the midrange truck market were 5 percent lower than the second quarter of 1995, due to a decrease in demand for medium-duty trucks. In the first half of 1996, sales of $314 million for this market were 4 percent higher than the first half of 1995. Midrange truck engines for international markets in the second quarter and first half of 1996 were slightly higher than the comparative periods of 1995. In the bus and light commercial vehicles market, the Company's sales of $194 million in the second quarter and $396 million in the first half of 1996 were almost 10 percent higher than the respective periods of 1995. The increase in sales was due to engines for Chrysler. Engine shipments for bus markets in 1996 have been approximately 5 percent lower than the prior year's levels. The Company expects sales of heavy-duty and midrange truck engines to decline further in the second half of 1996. It also expects some instability in the third quarter as truck manufacturers adjust build rates due to the decline in the heavy-duty truck order backlog. In addition, sales of light-duty truck engines in the third quarter of 1996 are expected to be lower than the second quarter of 1996, due to seasonal plant shutdowns. Sales to the power generation market represented 24 percent of the Company's net sales in the second quarter of 1996. Sales of $310 million were $32 million higher, a 12-percent increase compared to the second quarter of 1995. In the first half of 1996, power generation sales were $570 million, 3 percent higher than the first half of 1995. The increase in 1996 was all in international markets. Power generation, however, has been affected by increasing price competition in its international markets and a shift in sales to lower margin products. Sales of $183 million to industrial markets in the second quarter and $357 million in the first half of 1996 were slightly higher than second- quarter and first-half 1995 levels due to strong sales for construction equipment in international markets, which offset lower demand in agricultural markets in North America. Sales of filtration products and turbochargers in the second quarter and first half of 1996 were slightly lower than the prior year's levels, due primarily to the softer demand in North American and European heavy-duty markets. Gross Profit ____________ In the second quarter of 1996, the Company's gross profit percentage was 22.8 percent of net sales, compared to 25.0 percent in the second quarter of 1995. In the first half of 1996, the gross profit percentage was 23.4 percent of net sales, compared to 25.3 percent in the first half of 1995. The reduction in gross profit was due to several factors, the most significant of which was the decline in heavy- duty production that resulted in lower fixed cost absorption. Gross profit in 1996 also was affected by higher sales of lower margin power generation products, costs of new product introductions and expenses associated with restructuring actions. While the restructuring and reduction of non-core businesses are proceeding, as reflected by capital gains in "other income", expenses associated with implementation of certain of these actions adversely affected 1996 gross profit. Depreciation expense has been higher in 1996, reflecting capital spending levels over the last two years to fund new products and fuel systems. In the second quarter and first half of 1996, product coverage expense was 2.9 percent and 2.7 percent of net sales, respectively, compared to 2.5 percent in both periods of 1995. Operating Expenses __________________ Selling and administrative expenses of $180 million in the second quarter and $360 million in the first half of 1996 were essentially level with the respective periods of 1995. In 1996, expenditures associated with the restructuring actions to relocate and consolidate operations and advertising programs offset a decrease in administrative expenses. In the second quarter and first half of 1996, research and engineering expenses of $66 million and $128 million, respectively, were slightly lower than the prior year's levels, reflecting a reduction in the number of employees and lower costs in 1996. Expense of $3 million in the second quarter and $5 million in the first half of 1996 from joint ventures and alliances was associated with product development and start-up costs of the joint venture with Wartsila. The Company formed this joint venture in the second quarter of 1995. Interest and Other Income and Expense _____________________________________ Interest expense in the second quarter and first half of 1996 was slightly higher than the comparable periods of 1995 due to the increase in long-term debt. Other income and expense includes a variety of items, such as foreign currency gains and losses, royalties, interest income, and gains and losses associated with fixed asset dispositions. In the first half of 1996, other income of $18 million was generated primarily from capital gains associated with various asset disposals. Provision for Income Taxes __________________________ The estimated effective tax rate for 1996 is 30 percent. This is lower than the US federal statutory rate of 35 percent, primarily because of export sales and lower taxes on foreign subsidiaries. In the first half of 1995, the Company recognized approximately $21 million related to a reduction in its valuation allowance for tax benefit carryforwards. CASH FLOW AND FINANCIAL CONDITION _________________________________ Key elements of the Consolidated Statement of Cash Flows were: First Half ________________ Dollars in Millions 1996 1995 ___________________ ____ ____ Net cash provided by operating activities $ 52 $164 Net cash used for investing activities (8) (128) _____ _____ Net cash flows from operating and investing activities 44 36 Net cash provided from (used for) financing activities 65 (91) Effect of exchange rate changes on cash - 1 _____ _____ Net change in cash and cash equivalents $109 $(54) _____ _____ _____ _____ During the first half of 1996, the Company generated cash flows from operating activities of $52 million. In the second quarter of 1996, an agreement for the sale of up to $110 million of accounts receivable was not renewed by the Company, which resulted in an increase in receivables and the lower level of net cash flows provided by operating activities. Investing activities required net cash resources of $8 million in the first half of 1996. Net cash provided from financing activities was $65 million in the first half of 1996. Total indebtedness was $327 million at June 30, 1996, compared to $219 million at December 31, 1995. As disclosed more fully in Note 3 to the Consolidated Financial Statements, the Company amended its revolving credit agreement in the second quarter of 1996 to increase the available amount to $400 million and extend the term to 2001. There were no outstanding borrowings under the agreement at June 30, 1996. Commercial paper borrowings of $50 million were outstanding at June 30, 1996. In the first quarter of 1996, a subsidiary of the Company issued 8.2 percent notes, which resulted in net proceeds of $100 million. As disclosed more fully in Note 4 to the Consolidated Financial Statements, the Company repurchased on the open market 492,100 shares of its common stock at an average price of $43.49 per share in the first half of 1996. PART II. OTHER INFORMATION ___________________________ Item 1. Legal Proceedings: ___________________________ On July 8, 1996, the United States District Court for the Southern District of Indiana entered an order approving the settlement of Warkel v. Cummins Engine Company, et. al. Item 5. Other Information: ___________________________ Certain information contained in this Form 10-Q is forward-looking and involves risks and uncertainties, including general economic and competitive conditions that could significantly affect expected results. Item 6. Exhibits and Reports on Form 8-K: __________________________________________ (a) See the Index to Exhibits on Page 13 for a list of exhibits filed herewith. (b) The Company was not required to file a Form 8-K during the second quarter of 1996. Signatures __________ Pursuant to the requirements 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/John McLachlan _________________ John McLachlan Vice President - Corporate Controller (Chief Accounting Officer) July 19, 1996 CUMMINS ENGINE COMPANY, INC. ____________________________ INDEX TO EXHIBITS _________________ 4(a) Amended and Restated Credit Agreement (filed herewith) 10(y) Guarantees of Perpetual Loan Facility of Cummins Finance Limited dated January 31, 1996 with the Toronto Dominion Bank, The Bank of New York and Societe Generale (filed herewith) 11 Schedule of Computation of Per Share Earnings for the Second Quarter and First Half Ended June 30, 1996 and July 2, 1995 (filed herewith) 27 Financial Data Schedule (filed herewith)