UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE |
For the Quarterly Period Ended July 1, 2007 |
Commission File Number 1-4949
CUMMINS INC.
(Exact name of registrant as specified in its charter)
Indiana |
35‑0257090 |
|
|
|
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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of July 1, 2007, there were 104,047,408 shares of common stock outstanding with a par value of $2.50 per share.
Website Access to Company's Reports
Cummins maintains an
internet website at www.cummins.com. Investors can obtain copies
of our filings from this website
free of charge as soon as reasonably practicable after they are electronically
filed with, or furnished to the Securities and Exchange Commission.
CUMMINS INC. AND CONSOLIDATED SUBSIDIARIES
TABLE OF CONTENTS
QUARTERLY REPORT ON
FORM 10-Q
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Page |
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PART I. FINANCIAL INFORMATION |
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ITEM 1. |
Condensed Financial Statements (Unaudited) |
3 |
Condensed Consolidated Statements of
Earnings for the three and six months ended July 1, 2007 and July 2, 2006 |
3 |
|
Condensed Consolidated Balance Sheets at
July 1, 2007 and December 31, 2006 |
4 |
|
Condensed Consolidated Statements of Cash Flows
for the six months ended July 1, 2007 and July 2, 2006 |
5 |
|
Notes to Condensed Consolidated Financial
Statements |
6 |
|
ITEM 2. |
Management's Discussion and Analysis of
Financial Condition and Results of Operations |
16 |
|
||
ITEM
3. |
Quantitative and Qualitative Disclosures
About Market Risk |
35 |
|
||
ITEM 4. |
Controls and Procedures |
35 |
|
||
PART
II. OTHER INFORMATION |
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ITEM
1. |
Legal Proceedings |
36 |
ITEM 1A. |
Risk Factors |
36 |
|
||
ITEM
2. |
Unregistered Sales of Equity Securities and
Use of Proceeds |
36 |
ITEM
4. |
Submission of Matters to a Vote of Security
Holders |
37 |
ITEM 6. |
Exhibits |
38 |
|
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Signatures |
39 |
|
2
ITEM 1. Condensed Financial Statements
CUMMINS INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
|
|
Three months ended |
|
Six months ended |
|
||||||||
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
Millions (except per share amounts) |
||||||||||||
Net sales (includes related party sales of $368, $397, $822 and $758, respectively) |
$ |
3,343 |
$ |
2,842 |
$ |
6,160 |
$ |
5,520 |
|||||
Cost of sales |
2,673 |
2,196 |
4,938 |
4,308 |
|||||||||
Gross margin |
670 |
646 |
1,222 |
1,212 |
|||||||||
Operating expenses and income |
|||||||||||||
Selling and administrative expenses |
314 |
294 |
597 |
562 |
|||||||||
Research and engineering expenses |
74 |
80 |
154 |
162 |
|||||||||
Investee equity, royalty and other income (Note 5) |
52 |
37 |
88 |
68 |
|||||||||
Other operating income, net |
7 |
— |
5 |
1 |
|||||||||
|
|||||||||||||
Operating earnings |
341 |
309 |
564 |
557 |
|||||||||
Interest income |
7 |
10 |
18 |
19 |
|||||||||
Interest expense |
14 |
26 |
30 |
53 |
|||||||||
Other income, net |
6 |
6 |
15 |
4 |
|||||||||
Earnings before income taxes and minority interests |
340 |
299 |
567 |
527 |
|||||||||
Provision for income taxes (Note 6) |
112 |
67 |
187 |
152 |
|||||||||
Minority interests in earnings of consolidated subsidiaries |
14 |
12 |
23 |
20 |
|||||||||
Net earnings |
$ |
214 |
$ |
220 |
$ |
357 |
$ |
355 |
|||||
|
|||||||||||||
Earnings per common share (Note 7) |
|||||||||||||
Basic |
$ |
2.14 |
$ |
2.40 |
$ |
3.57 |
$ |
3.94 |
|||||
Diluted |
$ |
2.13 |
$ |
2.19 |
$ |
3.55 |
$ |
3.54 |
|||||
Cash dividends declared per share |
$ |
0.18 |
$ |
0.15 |
$ |
0.36 |
$ |
0.30 |
The accompanying notes are an integral part of the
condensed consolidated financial statements.
3
CUMMINS INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
|
|
July 1, |
|
December 31, |
|
||||||
|
|
2007 |
|
2006 |
|
||||||
|
|
Millions, |
|
||||||||
ASSETS |
|||||||||||
Current assets |
|||||||||||
Cash and cash equivalents |
$ |
626 |
$ |
840 |
|||||||
Marketable securities |
105 |
95 |
|||||||||
Receivables, net (includes related party receivables of $235 and $180, respectively) |
2,071 |
1,767 |
|||||||||
Inventories (Note 8) |
1,652 |
1,393 |
|||||||||
Deferred income taxes |
270 |
277 |
|||||||||
Prepaid expenses and other current assets |
128 |
116 |
|||||||||
Total current assets |
4,852 |
4,488 |
|||||||||
Long-term assets |
|||||||||||
Property, plant and equipment, net of accumulated depreciation of $2,608 and $2,521 |
1,536 |
1,574 |
|||||||||
Investments in and advances to equity investees |
406 |
345 |
|||||||||
Goodwill (Note 9) |
369 |
356 |
|||||||||
Other intangible assets, net (Note 9) |
148 |
128 |
|||||||||
Deferred income taxes |
391 |
433 |
|||||||||
Other assets |
142 |
141 |
|||||||||
Total assets |
$ |
7,844 |
$ |
7,465 |
|||||||
LIABILITIES |
|||||||||||
Current liabilities |
|||||||||||
Short-term borrowings (Note 10) |
$ |
122 |
$ |
164 |
|||||||
Accounts payable |
1,329 |
1,104 |
|||||||||
Other accrued expenses |
1,092 |
1,131 |
|||||||||
Total current liabilities |
2,543 |
2,399 |
|||||||||
Long-term liabilities |
|||||||||||
Long-term debt |
544 |
647 |
|||||||||
Pensions |
291 |
367 |
|||||||||
Postretirement benefits other than pensions |
511 |
523 |
|||||||||
Other liabilities and deferred revenue |
526 |
473 |
|||||||||
Total liabilities |
4,415 |
4,409 |
|||||||||
Commitments and contingencies (Note 12) |
— |
— |
|||||||||
MINORITY INTERESTS |
270 |
254 |
|||||||||
SHAREHOLDERS' EQUITY |
|||||||||||
Common stock, $2.50 par value, 300 shares authorized, 110.2 and 110.0 shares issued |
276 |
137 |
|||||||||
Additional paid-in capital |
1,377 |
1,500 |
|||||||||
Retained earnings |
2,329 |
2,009 |
|||||||||
Accumulated other comprehensive loss (Note 13) |
|||||||||||
Defined benefit postretirement plans |
(536 |
) |
(511 |
) |
|||||||
Other |
63 |
(15 |
) |
||||||||
Total accumulated other comprehensive loss |
(473 |
) |
(526 |
) |
|||||||
Treasury stock, at cost, 6.2 and 5.8 shares |
(245 |
) |
(212 |
) |
|||||||
Common stock held in trust for employee benefit plans, 3.8 and 3.8 shares |
(92 |
) |
(92 |
) |
|||||||
Unearned compensation |
(13 |
) |
(14 |
) |
|||||||
Total shareholders’ equity |
3,159 |
2,802 |
|||||||||
Total liabilities, minority interests and shareholders' equity |
$ |
7,844 |
$ |
7,465 |
The accompanying notes are an integral part of the
condensed consolidated financial statements.
4
CUMMINS INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
|
Six months ended |
|
|||||
|
July 1, |
|
July 2, |
||||
2007 |
|
2006 |
|||||
Cash flows from operating activities |
Millions |
||||||
Net earnings |
$ |
357 |
$ |
355 |
|||
Adjustments to reconcile net earnings to net cash provided by operating activities: |
|||||||
Depreciation and amortization |
142 |
148 |
|||||
Net gain on disposal of property, plant and equipment |
(4 |
) |
— |
||||
Deferred income tax provision |
47 |
74 |
|||||
Equity in earnings of investees, net of dividends |
(22 |
) |
(20 |
) |
|||
Minority interests in earnings of consolidated subsidiaries |
23 |
20 |
|||||
Pension expense (Note 4) |
49 |
57 |
|||||
Pension contributions |
(102 |
) |
(83 |
) |
|||
Stock-based compensation expense |
12 |
7 |
|||||
Translation and hedging activities |
(8 |
) |
(13 |
) |
|||
Changes in current assets and liabilities, net of acquisitions: |
|||||||
Receivables |
(287 |
) |
(249 |
) |
|||
Inventories |
(236 |
) |
(125 |
) |
|||
Other current assets |
(10 |
) |
(12 |
) |
|||
Accounts payable |
215 |
147 |
|||||
Accrued expenses |
(65 |
) |
5 |
||||
Changes in long-term liabilities |
37 |
8 |
|||||
Other, net |
8 |
36 |
|||||
Net cash provided by operating activities |
156 |
355 |
|||||
Cash flows from investing activities |
|||||||
Capital expenditures |
(108 |
) |
(102 |
) |
|||
Investments in internal use software |
(28 |
) |
(22 |
) |
|||
Proceeds from disposals of property, plant and equipment |
19 |
24 |
|||||
Investments in and advances to equity investees |
(28 |
) |
(3 |
) |
|||
Acquisition of businesses, net of cash acquired |
(20 |
) |
— |
||||
Investments in marketable securities—acquisitions |
(194 |
) |
(99 |
) |
|||
Investments in marketable securities—liquidations |
191 |
92 |
|||||
Other, net |
(8 |
) |
— |
||||
Net cash used in investing activities |
(176 |
) |
(110 |
) |
|||
Cash flows from financing activities |
|||||||
Proceeds from borrowings |
4 |
54 |
|||||
Payments on borrowings and capital lease obligations |
(115 |
) |
(111 |
) |
|||
Net borrowings under short-term credit agreements |
(8 |
) |
6 |
||||
Distributions to minority shareholders |
(10 |
) |
(11 |
) |
|||
Dividend payments on common stock |
(38 |
) |
(28 |
) |
|||
Tax benefit on share-based awards |
10 |
6 |
|||||
Proceeds from issuing common stock |
3 |
6 |
|||||
Repurchases of common stock |
(36 |
) |
(62 |
) |
|||
Other, net |
(9 |
) |
(6 |
) |
|||
Net cash used in financing activities |
(199 |
) |
(146 |
) |
|||
Effect of exchange rate changes on cash and cash equivalents |
5 |
— |
|||||
Net (decrease) increase in cash and cash equivalents |
(214 |
) |
99 |
||||
Cash and cash equivalents at beginning of year |
840 |
779 |
|||||
Cash and cash equivalents at end of period |
$ |
626 |
$ |
878 |
|||
|
|||||||
Cash payments for: |
|||||||
Interest |
$ |
30 |
$ |
55 |
|||
Income taxes |
$ |
132 |
$ |
66 |
The accompanying notes are an integral part of the condensed consolidated financial statements.
5
CUMMINS INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE
1. NATURE OF OPERATIONS
Cummins Inc.
("Cummins," "the Company," "the
registrant," "we," "our," or "us") is
a global power leader that designs, manufactures, distributes and services
diesel and natural gas engines, electric power generation systems and
engine-related component products, including filtration and emissions
solutions, fuel systems, controls and air handling systems. We were founded in
1919 as one of the first manufacturers of diesel engines and are headquartered
in Columbus, Indiana. We sell our products to Original Equipment Manufacturers
(OEMs), distributors and other customers worldwide. We serve our customers
through a network of more than 550 company-owned and independent distributor
locations and approximately 5,000 dealer locations in more than 160 countries and
territories.
NOTE
2. BASIS OF PRESENTATION
The unaudited Condensed Consolidated Financial Statements reflect all
adjustments which, in the opinion of management, are necessary for a fair
statement of the results for the three and six month interim periods
ended July 1, 2007 and July 2, 2006. All such adjustments are of a normal
recurring nature. The Condensed Consolidated Financial Statements have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission (SEC) and in accordance
with accounting principles generally accepted in the United States of America
(GAAP) for interim financial information. Certain information and
footnote disclosures normally included in annual financial statements prepared
in accordance with GAAP have been condensed or omitted as permitted by such
rules and regulations. The interim periods for both 2007 and 2006 contain 13
and 26 weeks, respectively. Certain reclassifications have been made to prior
period amounts to conform to the presentation of the current period condensed
financial statements. This includes all share and per share amounts which
have been retroactively adjusted to reflect the two-for-one stock split that
was distributed April 9, 2007. See Note 7.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts in the Condensed Consolidated Financial Statements. Significant estimates and assumptions in these Condensed Consolidated Financial Statements require the exercise of judgment and are used for, but not limited to, allowance for doubtful accounts, estimates of future cash flows and other assumptions associated with goodwill and long-lived asset impairment tests, useful lives for depreciation and amortization, warranty programs, determination of discount and other rate assumptions for pension and other postretirement benefit expenses, income taxes and deferred tax valuation allowances and contingencies. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be different from these estimates.
You should read these interim condensed financial statements in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2006. Our interim period financial results for the three and six month interim periods presented are not necessarily indicative of results to be expected for any other interim period or for the entire year. The year end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.
Shipping and Handling Costs
Our shipping and handling costs are expensed as
incurred. Those shipping and handling costs associated with operations of our
inventory distribution centers and warehouse facilities were previously
classified as "Selling and administrative expenses" in our Condensed
Consolidated Statements of Earnings. In accordance with Emerging
Issues Task Force (EITF) Issue No. 00-10 "Accounting for Shipping and
Handling Fees and Costs," we previously disclosed the amount of these
shipping and handling costs that were included as "Selling and
administrative expenses" in the notes to our Consolidated Financial
Statements. Beginning January 1, 2007, we revised our accounting
policy and all shipping and handling costs are now classified as "Cost of
sales." This presentation is more consistent with current industry
practice. For purposes of comparability, the $26 million and $59 million
previously classified as "Selling and administrative expenses" for
the three and six months ended July 2, 2006, has been adjusted retrospectively
to apply the new method. This change had no impact on operating earnings,
net earnings, or earnings per share.
6
NOTE 3. RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Recently Adopted Accounting Pronouncements
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140." SFAS No. 155 changes certain accounting requirements for certain hybrid financial instruments by permitting fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. The new standard also changed certain accounting requirements for interest-only and principal-only strips and other aspects of accounting for securitized financial assets. We adopted SFAS No. 155 on January 1, 2007. We have no instruments covered by this standard, thus the adoption of SFAS No. 155 had no impact on our Consolidated Financial Statements.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140," that provides guidance on accounting for separately recognized servicing assets and servicing liabilities. In accordance with the provisions of SFAS No. 156, separately recognized servicing assets and servicing liabilities must initially be measured at fair value, if practicable. Subsequent to initial recognition, the company may use either the amortization method or the fair value measurement method to account for servicing assets and servicing liabilities within the scope of this Statement. We adopted SFAS No. 156 on January 1, 2007. We have no instruments covered by this standard, thus the adoption of SFAS No. 156 had no impact on our Consolidated Financial Statements.
In July 2006, the FASB issued FASB Interpretation (FIN) No. 48, "Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (SFAS 109)," which prescribes a recognition threshold and measurement process for recording in the financial statements, uncertain tax positions taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on the derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. We adopted FIN 48 effective January 1, 2007. The adoption of FIN 48 resulted in an adjustment of less than $1 million to beginning retained earnings and had no impact to our results of operations. See Note 6 for further information regarding the adoption of FIN 48.
Accounting Pronouncements Issued But Not Yet Effective
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS 157), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. We will adopt SFAS 157 effective January 1, 2008. We are currently evaluating the impact, if any, that SFAS 157 will have on our Consolidated Financial Statements.
In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities – Including an Amendment
of FASB Statement No. 115" (SFAS 159), which is effective for fiscal
years beginning after November 15, 2007. SFAS 159 permits an entity to
choose to measure many financial instruments and certain other items at fair
value at specified election dates. Subsequent unrealized gains and losses on
items for which the fair value option has been elected will be reported in
earnings. We are currently evaluating the potential impact, if any, that SFAS
159 will have on our Consolidated Financial Statements.
7
NOTE 4. PENSION AND OTHER POSTRETIREMENT BENEFITS
The components of net periodic pension and other postretirement benefit expense under our plans consisted of the following:
|
|
Pension |
|
|
|
||||||||||||||||||||
|
|
U.S. Plans |
|
Non-U.S. Plans |
|
Postretirement Benefits |
|
||||||||||||||||||
|
|
Three months ended |
|
||||||||||||||||||||||
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
||||||||||||
|
|
2007 |
|
2006 |
2007 |
|
2006 |
|
2007 |
|
2006 |
|
|||||||||||||
Millions |
|||||||||||||||||||||||||
Service cost |
|
$ |
12 |
$ |
12 |
$ |
8 |
$ |
8 |
$ |
— |
$ |
— |
||||||||||||
Interest cost |
27 |
27 |
16 |
13 |
7 |
8 |
|||||||||||||||||||
Expected return on plan assets |
(35 |
) |
(32 |
) |
(18 |
) |
(14 |
) |
— |
— |
|||||||||||||||
Amortization of prior service cost (credit) |
(1 |
) |
1 |
1 |
— |
(2 |
) |
(3 |
) |
||||||||||||||||
Recognized net actuarial loss |
8 |
9 |
7 |
5 |
— |
— |
|||||||||||||||||||
Net periodic benefit cost |
$ |
11 |
$ |
17 |
$ |
14 |
$ |
12 |
$ |
5 |
$ |
5 |
|
|
Pension |
|
|
|
|||||||||||||||||||
|
|
U.S. Plans |
|
Non-U.S. Plans |
|
Postretirement Benefits |
|
|||||||||||||||||
|
|
Six months ended |
|
|||||||||||||||||||||
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
|||||||||||
|
|
2007 |
|
2006 |
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||||||||||
Millions |
||||||||||||||||||||||||
Service cost |
|
$ |
23 |
$ |
24 |
$ |
16 |
$ |
14 |
$ |
— |
$ |
— |
|||||||||||
Interest cost |
54 |
54 |
31 |
24 |
15 |
16 |
||||||||||||||||||
Expected return on plan assets |
(70 |
) |
(64 |
) |
(35 |
) |
(25 |
) |
— |
— |
||||||||||||||
Amortization of prior service cost (credit) |
(1 |
) |
2 |
2 |
1 |
(5 |
) |
(6 |
) |
|||||||||||||||
Recognized net actuarial loss |
16 |
18 |
13 |
9 |
— |
— |
||||||||||||||||||
Net periodic benefit cost |
$ |
22 |
$ |
34 |
$ |
27 |
$ |
23 |
$ |
10 |
$ |
10 |
For
the three and six months ended July 1, 2007, we contributed approximately $41
million and $102 million, respectively, to our pension plans and paid
approximately $20 million and $26 million, respectively, of postretirement
benefits. For the three and six months ended July 2, 2006, we contributed
approximately $42 million and $83 million, respectively, to our pension plans
and paid approximately $23 million and $31 million, respectively, of postretirement
benefits We presently anticipate contributing $230 to $240 million
to our pension plans in 2007 and paying approximately $55 million in claims and
premiums. The $230 to $240 million of contributions for the full year
includes voluntary contributions of $160 to $170 million. These
contributions and payments include payments from our funds to either increase
pension plan assets or to make direct payments to plan participants.
We incurred expenses of $4
million for the three months ended July 1, 2007 and $5 million for the three
months ended July 2, 2006, relating to our defined contribution plans. We
incurred expenses of $15 million for the six months ended July 1, 2007 and $18
million for the six months ended July 2, 2006, for defined contribution
plans.
8
Investee equity, royalty and other income included in our Condensed
Consolidated Statements of Earnings for the interim reporting periods was as follows:
|
|
Three months ended |
|
Six months ended |
|
||||||||
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
Millions |
|
||||||||||
North American distributors |
$ |
22 |
$ |
12 |
$ |
37 |
$ |
21 |
|||||
Dongfeng Cummins Engine Company, Ltd |
11 |
7 |
17 |
12 |
|||||||||
Chongqing Cummins Engine Company, Ltd |
5 |
4 |
10 |
7 |
|||||||||
Cummins MerCruiser Diesel Marine LLC. |
4 |
3 |
7 |
4 |
|||||||||
Tata Cummins Limited |
4 |
3 |
6 |
6 |
|||||||||
Fleetguard Shanghai Filter Co. Ltd. |
2 |
1 |
3 |
2 |
|||||||||
All others |
2 |
4 |
3 |
8 |
|||||||||
Cummins share of net earnings |
50 |
34 |
83 |
60 |
|||||||||
Royalty and other income |
2 |
3 |
5 |
8 |
|||||||||
Investee equity, royalty and other income |
$ |
52 |
$ |
37 |
$ |
88 |
$ |
68 |
NOTE 6. INCOME TAXES
Our effective tax rate for the three and six months ended July 1, 2007, was 33 percent. This rate was less than the 35 percent U.S. income tax rate primarily due to research tax credits and lower taxes on foreign earnings. Our income tax provision for the three months ended July 2, 2006, was reduced by $28 million due to the favorable resolution of tax uncertainties related to prior years. In addition, our provision for the six months ended July 2, 2006, was also impacted by a $12 million increase in the first quarter for the effect of new Indiana tax legislation. As a result, our effective tax rate for the three and six months ended July 2, 2006, was 22 percent and 29 percent, respectively.
On January 1, 2007, we adopted FASB Interpretation (FIN) No. 48, "Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109." FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition rules. The adoption of FIN 48 resulted in an adjustment to beginning retained earnings of less than $1 million and did not have any impact on our results of operations. As of the adoption date, we had gross unrecognized tax benefits of $49 million. Of this total, $37 million, if recognized, would favorably affect the effective tax rate in future periods. Also, as of the adoption date, we had accrued interest expense related to the unrecognized tax benefits of $9 million. We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense.
As a result of our global operations, Cummins or its subsidiaries file income tax returns in various jurisdictions including U.S. federal, U.S. state, and foreign jurisdictions. We are routinely subject to examination by taxing authorities throughout the world, including such jurisdictions as Australia, Belgium, Brazil, Canada, China, France, India, Mexico, the United Kingdom and the U.S. Our U.S. federal income tax returns have been examined through 2004. With few exceptions, major U.S. state and foreign jurisdictions are no longer subject to income tax examinations for years before 2001. Various U.S. state and foreign tax audits are currently underway; however, we do not expect any significant change to our unrecognized tax benefits within the next year.
NOTE 7. EARNINGS PER SHARE
We calculate basic earnings per share (EPS) of common stock by dividing net earnings by the weighted-average daily number of common shares outstanding for the period. The calculation of diluted EPS reflects the potential dilution that occurs if share based awards or debt securities are exercised or converted into common stock and the effect the exercise or conversion reduces EPS. We exclude shares of common stock held by our Retirement Savings Plan in the Employee Benefits Trust from the calculation of the weighted-average common shares outstanding until those shares are distributed from the trust.
9
The following is a reconciliation of net earnings and weighted-average common shares outstanding for purposes of calculating basic and diluted net earnings per share:
|
|
Three months ended |
|
Six months ended |
|
||||||||
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
Millions (except per share amounts) |
|
||||||||||
Net earnings for basic EPS |
$ |
214 |
$ |
220 |
$ |
357 |
$ |
355 |
|||||
Interest on junior convertible subordinated debentures, net of tax |
— |
3 |
— |
6 |
|||||||||
Net earnings for diluted EPS |
$ |
214 |
$ |
223 |
$ |
357 |
$ |
361 |
|||||
Weighted-average common shares outstanding: |
|||||||||||||
Basic |
100.0 |
91.5 |
100.0 |
90.1 |
|||||||||
Dilutive effect of stock compensation awards |
0.6 |
0.8 |
0.6 |
0.7 |
|||||||||
Dilutive effect of junior convertible subordinated debentures |
— |
9.4 |
— |
11.0 |
|||||||||
Diluted |
100.6 |
101.7 |
100.6 |
101.8 |
|||||||||
Earnings per common share: |
|||||||||||||
Basic |
$ |
2.14 |
$ |
2.40 |
$ |
3.57 |
$ |
3.94 |
|||||
Diluted |
$ |
2.13 |
$ |
2.19 |
$ |
3.55 |
$ |
3.54 |
The
Board of Directors authorized a two-for-one split of Cummins stock on March 8,
2007, which was distributed on April 9, 2007, to shareholders of record as of
March 26, 2007. All share and per share amounts in this Form 10-Q have
been adjusted to reflect the two-for-one stock split. During the second
quarter our shareholders ratified a proposal to increase our common stock
authorization to 300 million shares. See "Item 4. Submission of
matters to a Vote of Security Holders" in "Part II. Other
Information" for additional information.
NOTE 8. INVENTORIES
Inventories included the following:
|
|
July 1, |
|
December 31, |
|
|||
|
|
2007 |
|
2006 |
|
|||
|
|
Millions |
|
|||||
Finished products |
$ |
757 |
$ |
705 |
||||
Work-in-process and raw materials |
970 |
761 |
||||||
Inventories at FIFO cost |
1,727 |
1,466 |
||||||
Excess of FIFO over LIFO |
(75 |
) |
(73 |
) |
||||
Total inventories |
$ |
1,652 |
$ |
1,393 |
NOTE 9. GOODWILL AND OTHER INTANGIBLE ASSETS
The changes in the carrying amounts of goodwill for the six months ended July 1, 2007, were as follows:
|
|
Components |
|
Power |
|
Engine |
|
Distribution |
|
Total |
|
|||||||||||||
|
|
Millions |
|
|||||||||||||||||||||
Goodwill at December 31, 2006 |
$ |
332 |
$ |
12 |
$ |
7 |
$ |
5 |
$ |
356 |
||||||||||||||
Additions |
11 |
— |
— |
2 |
13 |
|||||||||||||||||||
Disposition |
— |
— |
— |
— |
— |
|||||||||||||||||||
Translation and other |
1 |
— |
— |
(1 |
) |
— |
||||||||||||||||||
Goodwill at July 1, 2007 |
$ |
344 |
$ |
12 |
$ |
7 |
$ |
6 |
$ |
369 |
10
The components of other intangible assets with finite lives subject to amortization were as follows:
|
|
July 1, |
|
December 31, |
|
|||
|
|
2007 |
|
2006 |
|
|||
|
|
Millions |
|
|||||
Software |
$ |
256 |
$ |
222 |
||||
Accumulated amortization |
(116 |
) |
(101 |
) |
||||
Net software |
140 |
121 |
||||||
Trademarks, patents and other |
12 |
10 |
||||||
Accumulated amortization |
(4 |
) |
(3 |
) |
||||
Net trademarks, patents and other |
8 |
7 |
||||||
Total |
$ |
148 |
$ |
128 |
NOTE 10. SHORT-TERM BORROWINGS AND
FINANCING ARRANGEMENTS
Short-term Borrowings
Short-term borrowings included the following:
|
|
July 1, |
|
December 31, |
|
||
|
|
2007 |
|
2006 |
|
||
|
|
Millions |
|
||||
Loans payable |
$ |
18 |
$ |
37 |
|||
Current maturities of long-term debt |
104 |
127 |
|||||
Total short-term borrowings |
$ |
122 |
$ |
164 |
Approximately $62 million of our $120 million 6.75% debentures were repaid on February 15, 2007, at the election of the holders. Such election and notification was required to be made between December 15, 2006 and January 15, 2007. At December 31, 2006, we included the $62 million repaid on February 15, 2007, in short-term borrowings in our Condensed Consolidated Balance Sheet.
Sale of Accounts Receivable
In January 2004, we
entered into a three-year facility agreement with a financial institution to
sell a designated pool of trade receivables to Cummins Trade Receivables, LLC
(CTR), a wholly-owned special purpose subsidiary. In January 2007, this
facility was extended for one year. As necessary, CTR may transfer a
direct interest in its receivables, without recourse, to the financial
institution. To maintain a balance in the designated pools of receivables sold,
we sell new receivables to CTR as existing receivables are collected.
Receivables sold to CTR in which an interest is not transferred to the financial
institution are included in "Receivables, net" on our Consolidated
Balance Sheets. The maximum interest in sold receivables that can be
outstanding at any point in time is limited to the lesser of $200 million
or the amount of eligible receivables held by CTR. There are no provisions in
this agreement that require us to maintain a minimum investment credit rating;
however, the terms of the agreement contain the same financial covenants as our
revolving credit facility. In July 2007, we amended the agreement to
extend the facility until July 2010 and raised the purchase limitation from
$200 million to $400 million. The agreement also provides us with an
option to increase the purchase limitation up to $500 million upon
approval. There was no activity under this program in the first six
months of 2007. At this time, we do not intend to borrow any funds from this
facility in the foreseeable future.
11
NOTE 11. PRODUCT WARRANTY LIABILITY
A summary of the activity in our current and long-term warranty liability accounts, as well as our deferred revenue accounts, for the six month interim periods follows:
|
|
Six months ended |
|
|||||
|
|
July 1, |
|
July 2, |
|
|||
|
|
2007 |
|
2006 |
|
|||
|
|
Millions |
||||||
Balance, beginning of period |
$ |
652 |
$ |
581 |
||||
Provision for warranties issued |
182 |
167 |
||||||
Deferred revenue on extended warranty contracts sold |
32 |
39 |
||||||
Payments |
(150 |
) |
(144 |
) |
||||
Amortization of deferred revenue on extended warranty contracts |
(24 |
) |
(17 |
) |
||||
Changes in estimates for pre-existing warranties |
(13 |
) |
(1 |
) |
||||
Foreign currency translation |
3 |
3 |
||||||
Balance, end of period |
$ |
682 |
$ |
628 |
The amount of deferred revenue related to extended coverage programs at July 1, 2007, was $173 million.
At July 1, 2007, we had $21 million of receivables related to estimated supplier recoveries of which $9 million was included in "Receivables, net" and $12 million was included in "Other assets" on our Condensed Consolidated Balance Sheets.
NOTE 12. COMMITMENTS AND CONTINGENCIES
We are defendants in a number of pending legal actions, including actions related to the use and performance of our products. We carry product liability insurance covering significant claims for damages involving personal injury and property damage. We also establish reserves for these and other matters in which losses are probable and can be reasonably estimated. In the event we are determined to be liable for damages in connection with actions and proceedings, the unaccrued portion of such liability is not expected to be material. We also have been identified as a potentially responsible party at several waste disposal sites under U.S. and related state environmental statutes and regulations and may have joint and several liability for any investigation and remediation costs incurred with respect to such sites. We deny liability with respect to many of these legal actions and environmental proceedings and are vigorously defending such actions or proceedings. We have established reserves that we believe are adequate for our expected future liability in such actions and proceedings where the nature and extent of such liability can be reasonably estimated based upon presently available information.
U.S. Distributor Guarantees
Since 1997 we have had an operating agreement with a financial institution that required us to guarantee revolving loans, equipment term loans and leases, real property loans and letters of credit made by the financial institution to certain independent Cummins and Onan distributors in the United States, and to certain distributors in which we own an equity interest. In the first quarter of 2006, we amended, restated and simplified the terms of the operating agreement and removed the Cummins guarantee of distributor borrowings.
If any distributor defaults under its financing arrangement with the financial institution, and the maturity of amounts owed under the agreement is accelerated, then we are required to purchase from the financial institution at amounts approximating fair market value certain property, inventory and rental generator sets manufactured by Cummins that are secured by the distributor's financing agreement.
The operating agreement will continue to be in effect until February 7, 2008 and is subject to an automatic one year renewal without requiring the action of either party.
Residual Value Guarantees
We have various residual value guarantees on equipment leased under operating leases. The total amount of these residual value guarantees at July 1, 2007, was $9 million.
Other Guarantees
In addition to the guarantees discussed above, from time to time we enter into other guarantee arrangements, including guarantees of non-U.S. distributor financing and other miscellaneous guarantees of third-party obligations. The maximum potential loss related to these other guarantees is $5 million at July 1, 2007.
12
We have arrangements with
certain suppliers that require us to purchase minimum volumes or be subject to
monetary penalties. The penalty amounts are less than our purchase commitments
and essentially allow the supplier to recover their tooling costs. At
July 1, 2007, if we were to stop purchasing from each of these suppliers,
the amount of the penalty would be approximately $18 million. However, based on
current forecasts, we do not anticipate paying any penalties under these
contracts.
Indemnifications
Periodically, we enter into various contractual arrangements where we agree to indemnify a third-party against certain types of losses. Common types of indemnifications include:
product liability and license, patent or trademark indemnifications,
asset sale agreements where we agree to indemnify the purchaser against future environmental exposures related to the asset sold, and
any contractual agreement where we agree to indemnify the counter-party for losses suffered as a result of a misrepresentation in the contract.
We regularly evaluate the probability of having to incur costs associated with these indemnifications and accrue for expected losses that are probable. Because the indemnifications are not related to specified known liabilities and due to their uncertain nature, we are unable to estimate the maximum amount of the potential loss associated with these indemnifications.
Joint Venture Commitments
As of July 1, 2007, we have committed (subject to future regulatory approvals) to invest $63 million into existing joint ventures. It is expected that $38 million will be funded in 2007 with the remaining amounts expected to be funded in 2008 and 2009.
NOTE 13. COMPREHENSIVE EARNINGS
A reconciliation of our net earnings to comprehensive earnings was as follows:
|
|
Three months ended |
|
Six months ended |
|
||||||||
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
Millions |
||||||||||||
Net earnings |
$ |
214 |
$ |
220 |
$ |
357 |
$ |
355 |
|||||
Other comprehensive earnings (loss), net of tax: |
|||||||||||||
Change in defined postretirement benefits |
7 |
— |
(25 |
) |
— |
||||||||
Change in cumulative translation adjustment |
28 |
22 |
74 |
31 |
|||||||||
Unrealized loss on marketable securities |
— |
(1 |
) |
— |
(2 |
) |
|||||||
Unrealized gain on derivatives |
5 |
22 |
4 |
29 |
|||||||||
Comprehensive earnings |
$ |
254 |
$ |
263 |
$ |
410 |
$ |
413 |
NOTE 14. OPERATING SEGMENTS
Our reportable operating segments consist of the following: Engine, Power Generation, Components and Distribution. This reporting structure is organized according to the products and markets each segment serves. We use segment EBIT (defined as earnings before interest expense, income taxes and minority interests) as the primary basis for the chief operating decision-maker to evaluate the performance of each operating segment.
13
A summary of operating results by segment for the three and six month periods is shown below:
|
|
Engine |
|
Power |
|
Components |
|
|
|
Non-segment items(1) |
|
Total |
|
||||||||||||||||
|
|
Millions |
|
||||||||||||||||||||||||||
Three months ended July 1, 2007 |
|||||||||||||||||||||||||||||
External sales |
$ |
1,855 |
$ |
605 |
$ |
516 |
$ |
367 |
$ |
— |
$ |
3,343 |
|||||||||||||||||
Intersegment sales |
254 |
164 |
241 |
1 |
(660 |
) |
— |
||||||||||||||||||||||
Net sales |
2,109 |
769 |
757 |
368 |
(660 |
) |
3,343 |
||||||||||||||||||||||
Investee equity, royalty and other income |
25 |
4 |
(1 |
) |
24 |
— |
52 |
||||||||||||||||||||||
Interest income |
6 |
1 |
— |
— |
— |
7 |
|||||||||||||||||||||||
Segment EBIT |
186 |
88 |
48 |
46 |
(14 |
) |
354 |
||||||||||||||||||||||
Three months ended July 2, 2006 |
|||||||||||||||||||||||||||||
External sales |
$ |
1,680 |
$ |
467 |
$ |
363 |
$ |
332 |
$ |
— |
$ |
2,842 |
|||||||||||||||||
Intersegment sales |
216 |
131 |
200 |
4 |
(551 |
) |
— |
||||||||||||||||||||||
Net sales |
1,896 |
598 |
563 |
336 |
(551 |
) |
2,842 |
||||||||||||||||||||||
Investee equity, royalty and other income |
18 |
3 |
2 |
14 |
— |
37 |
|||||||||||||||||||||||
Interest income |
7 |
2 |
— |
1 |
— |
10 |
|||||||||||||||||||||||
Segment EBIT |
190 |
56 |
34 |
36 |
9 |
325 |
|||||||||||||||||||||||
|
|||||||||||||||||||||||||||||
Six months ended July 1, 2007 |
|||||||||||||||||||||||||||||
External sales |
$ |
3,377 |
$ |
1,136 |
$ |
971 |
$ |
676 |
$ |
— |
$ |
6,160 |
|||||||||||||||||
Intersegment sales |
497 |
308 |
443 |
1 |
(1,249 |
) |
— |
||||||||||||||||||||||
Net sales |
3,874 |
1,444 |
1,414 |
677 |
(1,249 |
) |
6,160 |
||||||||||||||||||||||
Investee equity, royalty and other income |
42 |
7 |
(2 |
) |
41 |
— |
88 |
||||||||||||||||||||||
Interest income |
14 |
3 |
1 |
— |
— |
18 |
|||||||||||||||||||||||
Segment EBIT |
314 |
165 |
72 |
85 |
(39 |
) |
597 |
||||||||||||||||||||||
|
|||||||||||||||||||||||||||||
Six months ended July 2, 2006 |
|||||||||||||||||||||||||||||
External sales |
$ |
3,279 |
$ |
878 |
$ |
718 |
$ |
645 |
$ |
— |
$ |
5,520 |
|||||||||||||||||
Intersegment sales |
438 |
256 |
400 |
8 |
(1,102 |
) |
— |
||||||||||||||||||||||
Net sales |
3,717 |
1,134 |
1,118 |
653 |
(1,102 |
) |
5,520 |
||||||||||||||||||||||
Investee equity, royalty and other income |
35 |
6 |
4 |
23 |
— |
68 |
|||||||||||||||||||||||
Interest income |
14 |
3 |
— |
2 |
— |
19 |
|||||||||||||||||||||||
Segment EBIT |
369 |
101 |
65 |
67 |
(22 |
) |
580 |
||||||||||||||||||||||
(1) Includes intercompany eliminations and unallocated corporate expenses.
14
A reconciliation of our segment information to the corresponding amounts in the Condensed Consolidated Financial Statements is shown in the table below:
|
|
Three months ended |
|
Six months ended |
|
||||||||
|
|
July 1, |
|
July 2, |
|
July 1, |
|
July 2, |
|
||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
Millions |
|||||||||||||
Segment EBIT |
$ |
354 |
$ |
325 |
$ |
597 |
$ |
580 |
|||||
Less: |
|||||||||||||
Interest expense |
14 |
26 |
30 |
53 |
|||||||||
Earnings before income taxes and minority interests |
$ |
340 |
$ |
299 |
$ |
567 |
$ |
527 |
15
ITEM
2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Certain prior year amounts included in this section have been reclassified to conform to the current year presentation.
When used in this report the terms "Cummins," "the Company," "the registrant," "we," "our," or "us" mean Cummins Inc. and all entities included in our consolidated financial statements.
ORGANIZATION OF INFORMATION
The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with our Consolidated Financial Statements and related Notes to Consolidated Financial Statements in the "Financial Statements" section of our 2006 Annual Report on Form 10-K. All references to earnings per share amounts are diluted per share amounts. Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under "RISK FACTORS RELATING TO OUR BUSINESS" included in Part I of our 2006 Annual Report on Form 10-K and "Disclosure Regarding Forward-Looking Statements" presented at the end of this section. This overview summarizes the MD&A which includes the following sections:
Executive Summary and Financial Highlights – a brief discussion providing an overview of our Company, highlighting the significant events affecting our Company and a summary of our Company's financial performance.
Results of Operations – an analysis of our consolidated results of operations for the periods presented in our Condensed Consolidated Financial Statements.
Operating Segment Results – an analysis of the performance of each of our reportable operating segments for the periods presented in our Condensed Consolidated Financial Statements.
Liquidity and Capital Resources – an analysis of cash flows, sources and uses of cash, off balance sheet arrangements and contractual obligations.
Application of Critical Accounting Estimates – a summary of our critical accounting estimates and our policies relating to the application of those estimates.
Disclosure Regarding Forward-Looking Statements – cautionary information about forward-looking statements and a description of certain risks and uncertainties that could cause our actual results to differ materially from our historical results or our current expectations or projections.
16
EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS
We are a global power leader that designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related products, including filtration and aftertreatment devices, fuel systems, controls and air handling systems. We sell our products to Original Equipment Manufacturers (OEMs), distributors and other customers worldwide. We have long-standing relationships with many of the leading manufacturers in the markets we serve, including DaimlerChrysler AG (DaimlerChrysler), Volvo AB, PACCAR Inc., International Truck and Engine Corporation (Navistar International Corporation), CNH Global N.V., Komatsu and Scania AB. We serve our customers through a network of more than 550 company-owned and independent distributor locations and approximately 5,000 dealer locations in more than 160 countries and territories.
Our financial performance depends, in large part, on varying conditions in the markets we serve, particularly the on-highway, construction and general industrial markets. Demand in these markets tends to fluctuate in response to overall economic conditions and is particularly sensitive to changes in interest rate levels and the price of crude oil (fuel costs). OEM inventory levels, production schedules and work stoppages also impact our sales. Economic downturns in the markets we serve generally result in reduced sales, which affect our profits and cash flow.
We experienced strong operating performance in the second quarter of 2007 with net earnings of $214 million, or $2.13 per diluted share, on net sales of $3.3 billion, compared to second quarter 2006 net earnings of $220 million, or $2.19 per diluted share, on net sales of $2.8 billion. Year-to-date 2007 net earnings were $357 million, or $3.55 per diluted share, on net sales of $6.2 billion, compared to year-to-date 2006 net earnings of $355 million, or $3.54 per diluted share, on net sales of $5.5 billion. Our second quarter net sales increased $501 million led by record sales levels in the Engine, Power Generation, and Components segments. In addition, we continued to see strong demand in our Distribution segment. Sales in our Engine segment were up $213 million, or 11 percent over the second quarter of last year due to strong sales in almost all on- and off-highway markets, except the North American heavy-duty truck market. These increased sales were offset by the expected decline in the North American heavy-duty truck market as a result of the 2007 change in emissions standards. Our Power Generation segment net sales were up $171 million, or 29 percent, and our Components segment net sales were up $194 million, or 34 percent, compared to the second quarter of 2006. Distribution segment net sales were up $32 million, or 10 percent, despite the deconsolidation of one of our North American joint ventures beginning in 2007. Net sales for this joint venture were approximately $39 million during the second quarter of 2006 and approximately $80 million for the first six months of 2006.
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
||||
|
|
Three months ended |
|
Six months ended |
|
||||||||
|
|
July 1, 2007 |
|
July 2, 2006 |
|
July 1, 2007 |
|
July 2, 2006 |
|
||||
Consolidated Results |
|
Millions (except earnings per share ) |
|
||||||||||
Net sales |
$ |
3,343 |
$ |
2,842 |
$ |
6,160, |
$ |
5,520 |
|||||
Gross margin |
670 |
646 |
1,222 |
1,212 |
|||||||||
Investee equity, royalty and other income |
52 |
37 |
88 |
68 |
|||||||||
Operating earnings |
341 |
309 |
564 |
557 |
|||||||||
Net earnings |
214 |
220 |
357 |
355 |
|||||||||
Diluted earnings per share |
$ |
2.13 |
$ |
2.19 |
$ |
3.55 |
$ |
3.54 |
17
During the first six months of 2007, we continued our commitment to building a strong balance sheet, investing in profitable growth around the globe and returning value to our shareholders. Some of the transactions and events that highlight this are as follows:
RESULTS OF OPERATIONS
Three Months Ended - 2007 versus 2006
|
|
Three Months Ended |
|
Favorable/(Unfavorable) |
|
||||||||
|
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
||||
|
|
$ in millions |
|
|
|
||||||||
Net sales |
$ |
3,343 |
$ |
2,842 |
$ |
501 |
18 |
% |
|||||
Cost of sales |
2,673 |
2,196 |
(477 |
) |
(22 |
)% |
|||||||
Gross margin |
670 |
646 |
24 |
4 |
% |
||||||||
Operating expenses and income |
|||||||||||||
Selling and administrative expenses |
314 |
294 |
(20 |
) |
(7 |
)% |
|||||||
Research and engineering expenses |
74 |
80 |
6 |
8 |
% |
||||||||
Investee equity, royalty and other income |
52 |
37 |
15 |
41 |
% |
||||||||
Other operating income, net |
7 |
— |
7 |
NM |
|||||||||
Operating earnings |
341 |
309 |
32 |
10 |
% |
||||||||
Interest income |
7 |
10 |
(3 |
) |
(30 |
)% |
|||||||
Interest expense |
14 |
26 |
12 |
46 |
% |
||||||||
Other income, net |
6 |
6 |
— |
— |
% |
||||||||
Earnings before income taxes and minority interests |
340 |
299 |
41 |
14 |
% |
||||||||
Provision for income taxes |
112 |
67 |
(45 |
) |
(67 |
)% |
|||||||
Minority interests in earnings of consolidated subsidiaries |
14 |
12 |
(2 |
) |
(17 |
)% |
|||||||
Net earnings |
$ |
214 |
$ |
220 |
$ |
(6 |
) |
(3 |
)% |
Net Sales
The increase in net sales was led by record sales in our Engine, Power Generation, and Component segments. Net sales in the Power Generation segment increased $171 million, or 29 percent, led primarily by increases in commercial generator sales and alternator sales. Net sales in our Components segment increased $194 million, or 34 percent, led by increased sales in our emissions solutions and turbocharger businesses. Engine sales were up $213 million, or 11 percent, due to record sales in almost all on-highway and off-highway markets. The increased engine sales were partially offset by decreased demand in our heavy-duty on-highway market as a result of the 2007 change in emissions standards, however, sales were stronger than previously anticipated. Engine and part sales to industrial markets were 29 percent higher compared to last year with increased volumes in most market segments. Distribution segment net sales were up $32 million, or 10 percent, primarily due to increased demand for power generation products followed by increased parts, and engine sales which were partially offset by the deconsolidation of one of our North American joint ventures beginning in 2007. Net sales for this joint venture were approximately $39 million during the second quarter of 2006. See our "Operating Segment Results" section for further details on sales by segment.
18
Gross Margin
Gross margin increased primarily due to $135 million for new pricing and $33 million for increased volume which was partially offset by increased costs for new products of $118 million. The deconsolidation of one of our North American joint ventures, beginning in 2007 and the sale of one of our subsidiaries in the fourth quarter of 2006 also decreased margins by approximately $17 million. In addition, an increase in warranty expenses of $22 million had an unfavorable impact on gross margin. Warranty expense as a percent of sales increased to 3.1 percent in the second quarter of 2007 compared to 2.9 percent in the second quarter of 2006. The increase in warranty expense was expected as the mix of new 2007 engines increases. These emissions compliant engines initially carry a higher accrual rate until we gain claims experience in the marketplace. Gross margin as a percentage of sales declined by 2.7 percentage points as margins declined in three of our segments, primarily due to new product introduction.
Selling and Administrative Expenses
Selling and administrative expenses increased in the second quarter over the same period last year primarily as a result of annual merit increases, higher volume across most businesses and due to the adverse impact of foreign currency translation. Overall, selling and administrative expenses as a percent of sales declined slightly from 10.3 percent to 9.4 percent in the second quarter of 2007 compared to the second quarter of 2006, due to our lower cost structure. An increase in selling and administrative expenses as a percent of sales in the Distribution segment was more than offset by a decrease in the Power Generation and Components segments, while the Engine segment remained flat.
Research and Engineering Expenses
Research and engineering expenses decreased in 2007 compared to 2006 due to heavy investments in 2006 in the development of a number of new products and critical technologies in addition to higher levels of customer funding for new product development in 2007. Last year we had significant research and engineering expenses across the Engine and Components segments related to new product development for 2007 and beyond as well as research and engineering expenses for growth platforms across geographies. The Engine segment accounted for $7 million of the decrease in research and engineering expenses along with a decrease in the Components segment of $4 million. Fluctuations in other miscellaneous research and development expenses were not significant individually or in the aggregate.
Investee Equity, Royalty and Other Income
Investee equity, royalty and other income improved primarily due to an increase in earnings from our North American distributors of $10 million. More than half of that increase was due to organic growth, with the remainder due to acquisitions and the deconsolidation of a North American joint venture in 2007. In addition, Dongfeng Cummins Engine Company, Ltd. (DCEC) increased $4 million compared to the same period in the prior year.
Other Operating Income, Net
The major components of other operating income are royalty income and gain on sale of fixed assets. The fluctuation from the second quarter of 2007 to the second quarter of 2006 was primarily due to a gain of approximately $8 million on the sale of fixed assets in 2007. Other fluctuations in other operating income were not significant individually or in the aggregate.
Interest Expense
Interest expense decreased due to significantly lower debt balances in the second quarter of 2007 as compared to the same period in 2006.
Provision for Income Taxes
Our effective tax rate for the three months ended July 1, 2007, was 33 percent. This rate was less than the 35 percent U.S. income tax rate primarily due to research tax credits and lower taxes on foreign earnings. Our effective tax rate for the three months ended July 2, 2006, was 22 percent. This rate was lower due to the resolution of tax uncertainties related to prior years in the amount of $28 million, or $0.28 per share. The effective tax rate for the remainder of the year is expected to approximate 33 percent absent any discrete period activity.
On January 1, 2007, we adopted FASB Interpretation (FIN) No. 48, "Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109." The adoption of FIN 48 did not have a material impact on our consolidated financial position or results of operations. See Note 6 to the Condensed Consolidated Financial Statements for further details.
19
Six Months Ended - 2007 versus 2006
|
|
Six Months Ended |
|
Favorable/(Unfavorable) |
|
||||||||
|
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
||||
|
|
$ in millions |
|
|
|
||||||||
Net sales |
$ |
6,160 |
$ |
5,520 |
$ |
640 |
12 |
% |
|||||
Cost of sales |
4,938 |
4,308 |
(630 |
) |
(15 |
)% |
|||||||
Gross margin |
1,222 |
1,212 |
10 |
1 |
% |
||||||||
Operating expenses and income |
|||||||||||||
Selling and administrative expenses |
597 |
562 |
(35 |
) |
(6 |
)% |
|||||||
Research and engineering expenses |
154 |
162 |
8 |
5 |
% |
||||||||
Investee equity, royalty and other income |
88 |
68 |
20 |
29 |
% |
||||||||
Other operating income, net |
5 |
1 |
4 |
NM |
% |
||||||||
Operating earnings |
564 |
557 |
7 |
1 |
% |
||||||||
Interest income |
18 |
19 |
(1 |
) |
(5 |
)% |
|||||||
Interest expense |
30 |
53 |
23 |
43 |
% |
||||||||
Other income, net |
15 |
4 |
11 |
NM |
% |
||||||||
Earnings before income taxes and minority interests |
567 |
527 |
40 |
8 |
% |
||||||||
Provision for income taxes |
187 |
152 |
(35 |
) |
(23 |
)% |
|||||||
Minority interests in earnings of consolidated subsidiaries |
23 |
20 |
(3 |
) |
(15 |
)% |
|||||||
Net earnings |
$ |
357 |
$ |
355 |
$ |
2 |
1 |
% |
Net Sales
Net sales increased in all segments led by record sales in the Power Generation and the Components segments. The Power Generation segment was up $310 million, or 27 percent, led by commercial generator sales and alternator sales. Components segment sales were up $296 million, or 26 percent, led by increased sales in our emissions solutions and turbocharger businesses. Engine sales were up $157 million, or 4 percent, due to higher engine volumes for industrial applications. Engine and parts sales to industrial and stationary markets were both 29 percent higher compared to last year with increased volumes in nearly all market segments. Distribution segment sales increased $24 million, or 4 percent, primarily due to increased demand for power generation products followed by increased parts and engine sales which were partially offset by the deconsolidation of one of our North American joint ventures beginning in 2007. Net sales for this joint venture were approximately $80 million for the first six months of 2006. See our "Operating Segment Results" section for further details on sales by segment.
Gross Margin
Gross margin increased primarily due to $220 million for increased pricing which was partially offset by increased costs for new products of $192 million. The deconsolidation of one of our North American joint ventures, beginning in 2007 and the sale of one of our subsidiaries in the fourth quarter of 2006 also decreased margins. Gross margin as a percentage of sales declined by 2.2 percentage points as margins declined in three of our segments, primarily due to new product introduction. Warranty expense as a percent of sales decreased slightly to 2.7 percent in the first six months of 2007 compared to 3.0 percent for the prior year period.
Selling and Administrative Expenses
Selling and administrative expenses increased over the same period last year primarily as a result of annual merit increases, higher volume across most businesses and due to the adverse impact of foreign currency translation. Overall, selling and administrative expenses as a percent of sales declined slightly from 10.2 percent to 9.7 percent compared to 2006, due to our lower cost structure. An increase in selling and administrative expenses as a percent of sales in the Engine segment was more than offset by a decrease in the other three segments.
Research and Engineering Expenses
Research and engineering expenses decreased in 2007 compared to 2006 due to heavy investments in 2006 in the development of a number of new products and critical technologies in addition to higher levels of customer funding for new product development in 2007. We had significant research and engineering expenses across the Engine and Components segments related to new product development for 2007 and beyond as well as research and engineering expenses for growth platforms across geographies. The Engine segment accounted for $10 million of the decrease in research and engineering expenses along with a decrease in the Components segment of $3 million. Fluctuations in other miscellaneous research and development expenses were not significant individually or in the aggregate.
20
Investee Equity, Royalty and Other Income
Investee equity, royalty and other income increased primarily due to improved earnings from our North American distributors of $16 million. Approximately half of that increase was due to organic growth, with the remainder due to acquisitions and the deconsolidation of a North American joint venture in 2007. Other joint ventures showing increases compared to the same period in the prior year include DCEC, Cummins Mercruiser, and Chongqing Cummins Engine Company. These were offset by slight decreases at other joint ventures.
Other Operating Income, Net
The major components of other operating income are royalty income and gain on sale of fixed assets. The fluctuation from the first six months of 2006 to the first six months of 2007 was primarily due to a gain of approximately $8 million on the sale of fixed assets in 2007 compared to a gain of $4 million on the sale of assets in 2006. Other fluctuations in other operating income were not significant individually or in the aggregate.
Interest Expense
Interest expense decreased due to significantly lower debt balances in the first six months of 2007 as compared to the same period in 2006.
Other Income, Net
The major components of other income include foreign currency exchange gains and losses, bank charges and other miscellaneous income and expenses. The fluctuation in other income in the first six months of 2007 compared to the first six months of 2006 is due to an increase in foreign currency exchange gains of approximately $6 million.
Provision for Income Taxes
Our effective tax rate for the six months ended July 1, 2007, was 33 percent. This rate was less than the 35 percent U.S. income tax rate primarily due to research tax credits and lower taxes on foreign earnings. Our income tax provision for the six months ended July 2, 2006, was reduced by $28 million, or $0.28 per share, due to favorable resolution of tax uncertainties related to prior years. In addition, our provision for the six months ended July 2, 2006, was also impacted by a $12 million, or $0.12 per share, increase in the first quarter for the effect of new Indiana tax legislation. As a result, our effective tax rate for the six months ended July 2, 2006, was 29 percent. The effective tax rate for the remainder of the year is expected to approximate 33 percent absent any discrete period activity. In July 2007, the United Kingdom passed tax legislation which reduces our U.K. tax rate from 30 percent to 28 percent. While the reduced tax rate will benefit future operations, we expect to have an additional charge to our third quarter tax provision of approximately $5 million to $7 million to reduce the value of our U.K. deferred tax assets.
On January 1, 2007, we adopted FASB Interpretation (FIN) No. 48, "Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109." The adoption of FIN 48 did not have a material impact on our consolidated financial position or results of operations. See Note 6 to the Condensed Consolidated Financial Statements for further details.
OPERATING SEGMENT RESULTS
Our reportable operating segments consist of the following: Engine, Power Generation, Components and Distribution. This reporting structure is organized according to the products and markets each segment serves. We use segment EBIT (defined as earnings before interest expense, income taxes and minority interests) as the primary basis for the chief operating decision-maker to evaluate the performance of each operating segment. Following is a discussion of operating results for each of our business segments.
21
Engine Results and Updated Outlook
Three Months Ended - 2007 versus 2006
Financial data for the Engine segment was as follows:
|
|
Three months ended |
|
Favorable/(Unfavorable) |
|
|||||||
$ in millions |
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
|||
External sales |
$ |
1,855 |
$ |
1,680 |
$ |
175 |
10 |
% |
||||
Intersegment sales |
254 |
216 |
38 |
18 |
% |
|||||||
Net sales |
2,109 |
1,896 |
213 |
11 |
% |
|||||||
Investee equity, royalty and other income |
25 |
18 |
7 |
39 |
% |
|||||||
Interest income |
6 |
7 |
(1 |
) |
(14 |
)% |
||||||
Segment EBIT |
186 |
190 |
(4 |
) |
(2 |
)% |
||||||
Segment EBIT as a percentage of net sales |
8.8% |
10.0% |
(1.2) percentage points |
|||||||||
The increase in net
sales for this segment was due to improved demand across all markets, excluding
the on-highway heavy-duty truck market. The North American
on-highway heavy-duty truck market was down as a result of the 2007 emissions
standards change. Total on-highway-related sales were 57 percent of
Engine segment net sales during the second quarter of 2007, compared with 64 percent
during the second quarter of 2006. Industrial markets were strong
compared to the same period in 2006, with increased volumes in all markets, led
by construction, mining and marine markets.
Segment EBIT was relatively flat with new product pricing offsetting incremental product costs, the deterioration in engine mix being offset by both increased engine sales in other markets and increased parts sales. Gross margin decreased $5 million, or 1 percent, quarter over quarter. Selling and administrative expenses increased $11 million, or 8 percent, quarter over quarter, and selling and administrative expenses as a percentage of net sales was flat. Research and engineering expenses decreased $7 million, or 12 percent, compared to the same quarter last year and decreased slightly as a percentage of net sales compared to the prior period.
In addition, earnings from
joint ventures increased compared with the prior period of 2006, primarily
due to a $4 million improvement in earnings at DCEC due to strong demand in the
Chinese truck market.
A summary and discussion of Engine net sales by market follows:
|
|
Three months ended |
|
Favorable/(Unfavorable) |
|
|||||||
$ in millions |
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
|||
Heavy-duty truck |
$ |
473 |
$ |
618 |
$ |
(145 |
) |
(23 |
)% |
|||
Medium-duty truck and bus |
320 |
247 |
73 |
30 |
% |
|||||||
Light-duty automotive and RV |
418 |
341 |
77 |
23 |
% |
|||||||
Total on-highway |
1,211 |
1,206 |
5 |
— |
% |
|||||||
Industrial |
665 |
516 |
149 |
29 |
% |
|||||||
Stationary power |
233 |
174 |
59 |
34 |
% |
|||||||
Total net sales |
$ |
2,109 |
$ |
1,896 |
$ |
213 |
11 |
% |
22
A summary of unit shipments by engine classification (including unit shipments to Power Generation) follows:
|
|
Three months ended |
|
Favorable/(Unfavorable) |
|
||||
|
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
Midrange |
133,500 |
121,800 |
11,700 |
10 |
% |
||||
Heavy-duty |
23,800 |
31,400 |
(7,600 |
) |
(24 |
)% |
|||
High-horsepower |
4,700 |
4,000 |
700 |
18 |
% |
||||
Total unit shipments |
162,000 |
157,200 |
4,800 |
3 |
% |
Heavy-Duty Truck
The decrease in sales to the heavy-duty truck market was primarily driven by the North American truck market as OEMs experienced reduced demand from truck fleets, following increased purchases in 2006 to replace trucks ahead of the 2007 change in emissions standards. Global unit shipments of heavy-duty truck engines were down 32 percent in the second quarter of 2007, compared to the second quarter of 2006, with North American shipments down 42 percent and international shipments up 32 percent.
Medium-Duty Truck and Bus
The increase in medium-duty truck and bus revenues is due to improved demand due to our growing position with North American OEMs in the medium-duty truck market and increased shipments of bus engines in North America and internationally compared to last year. Shipments of medium-duty truck engines were up 29 percent to North American OEMs and up 17 percent to international OEMs compared with the second quarter of 2006. Sales of bus engines and parts increased in the second quarter of 2007 compared to the second quarter of 2006 due to strong demand from North American OEMs with shipments up 39 percent while international shipments were up 92 percent. The increase in overall North American bus sales is being driven by market share gains within the school bus market.
Light-Duty Automotive and RV
Sales of light-duty automotive engines increased primarily due to higher pricing for the 2007 emission compliant product. Total light-duty automotive unit shipments were approximately 50,400 in the second quarter of 2007, an increase of 1 percent compared to the same period in 2006 driven by higher shipments to DaimlerChrysler of approximately 1,000 units, or a 2 percent increase compared to the second quarter of 2006. Global engine shipments to recreational vehicle OEMs increased by 14 percent in the second quarter of 2007 compared with the same period in 2006. The increase is being driven by market share gains with the chassis manufacturers supplying the North American recreational vehicle market.
Industrial
Total industrial sales were up in all markets, primarily due to stronger demand in those markets. Unit shipments increased 9 percent in the second quarter of 2007 compared to the same period in 2006. Approximately 48 percent of the shipments were to North American markets and 52 percent to international markets in the second quarter compared to 53 percent and 47 percent, respectively, for the same period in 2006. The overall change in the geographic sales mix is due to the continued strength of the international construction market. Shipments to the construction market increased 9 percent in total and increased 20 percent internationally. The other markets showing significant increases were the government, commercial marine, mining, oil and gas and rail with increased shipments of 78 percent, 19 percent, 26 percent, 9 percent, and 149 percent, respectively. The mining market demand is up as the strength in commodity prices is driving investment in mining capacity. Sales to the oil and gas market and the commercial marine market have increased as sustained oil and natural gas prices continue to drive activity and investments in new equipment and offshore supply vessels. The rail market is up due to increased demand in both North America and China. The government market is up due to increased North American demand in the second quarter of 2007.
Stationary Power
The increase in sales to stationary power markets is due to the increased net sales to our Power Generation segment. These net sales are eliminated in our Condensed Consolidated Statements of Earnings. See the Power Generation Results for a discussion of the increase in net sales.
23
Financial data for the Engine segment was as follows:
|
|
Six months ended |
|
Favorable/(Unfavorable) |
|
|||||||
$ in millions |
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
|||
External sales |
$ |
3,377 |
$ |
3,279 |
$ |
98 |
3 |
% |
||||
Intersegment sales |
497 |
438 |
59 |
13 |
% |
|||||||
Net sales |
3,874 |
3,717 |
157 |
4 |
% |
|||||||
Investee equity, royalty and other income |
42 |
35 |
7 |
20 |
% |
|||||||
Interest income |
14 |
14 |
— |
— |
% |
|||||||
Segment EBIT |
314 |
369 |
(55 |
) |
(15 |
)% |
||||||
Segment EBIT as a percentage of net sales |
8.1% |
9.9% |
(1.8) percentage points |
|||||||||
The increase in net sales for this segment was primarily due to strong demand across most markets, particularly strong industrial market sales. Total on-highway-related sales were 55 percent of Engine segment net sales during the first six months of 2007 as compared to 63 percent in the first six months of 2006.
The decrease in segment EBIT was primarily due to the lower engine volumes in the on-highway markets, the accompanying gross margin impact of lower absorption of fixed manufacturing costs and higher costs for new emissions compliant products. These costs were partially offset by favorable pricing for our new emissions compliant products. Gross margin decreased $55 million, or 8 percent, for the first six months of 2007 compared to the same period last year. Selling and administrative expenses increased $22 million, or 9 percent, however selling and administrative expenses as a percentage of net sales remained flat. Research and engineering expenses decreased $10 million, or 9 percent, compared to the first six months of 2006 and decreased slightly as a percentage of net sales compared to the prior period.
In addition, earnings from joint ventures increased compared with the first six months of 2006, primarily due to a $5 million increase in earnings at DCEC due to strong demand in the Chinese truck market.
A summary and discussion of Engine net sales by market follows:
|
|
Six months ended |
|
Favorable/(Unfavorable) |
|
|||||||
$ in millions |
|
July 1 , 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
|||
Heavy-duty truck |
$ |
897 |
$ |
1,226 |
$ |
(329 |
) |
(27 |
)% |
|||
Medium-duty truck and bus |
526 |
462 |
64 |
14 |
% |
|||||||
Light-duty automotive and RV |
706 |
672 |
34 |
5 |
% |
|||||||
Total on-highway |
2,129 |
2,360 |
(231 |
) |
(10 |
)% |
||||||
Industrial |
1,282 |
997 |
285 |
29 |
% |
|||||||
Stationary power |
463 |
360 |
103 |
29 |
% |
|||||||
Total net sales |
$ |
3,874 |
$ |
3,717 |
$ |
157 |
4 |
% |
A summary of unit shipments by engine classification (including unit shipments to Power Generation) follows:
|
|
Six months ended |
|
Favorable/(Unfavorable) |
|
||||
|
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
Midrange |
240,700 |
236,300 |
4,400 |
2 |
% |
||||
Heavy-duty |
42,800 |
61,500 |
(18,700 |
) |
(30 |
)% |
|||
High-horsepower |
9,000 |
7,700 |
1,300 |
17 |
% |
||||
Total unit shipments |
292,500 |
305,500 |
(13,000 |
) |
(4 |
)% |
24
Heavy-Duty Truck
The decrease in sales to the heavy-duty truck market was primarily driven by the North American truck market as OEMs experienced reduced demand from truck fleets, following increased purchases in 2006 to replace trucks ahead of the 2007 change in emissions standards. Global unit shipments of heavy-duty truck engines were down 38 percent in the first six months of 2007, compared to the first six months of 2006, with North American shipments down 50 percent and international shipments up 44 percent.
Medium-Duty Truck and Bus
The increase in medium-duty truck and bus revenues is due to increased demand due to our growing position with North American OEMs in the medium-duty truck market and increased shipments of bus engines in North America and internationally. This was partially offset by reduced shipments at the beginning of the year as a result of the effect of the change in emissions regulations in North America. Shipments of medium-duty truck engines were up 2 percent to North American OEMs and up 12 percent to international OEMs compared with the first six months of 2006. The increase in medium-duty truck engine shipments in North America is due to our increased penetration in this market. Sales of bus engines and parts increased in the first six months of 2007 compared to the first six months of 2006 due to strong demand from North American OEMs with shipments up 33 percent while international shipments were up 51 percent.
Light-Duty Automotive and RV
Total sales of light-duty automotive engines increased primarily due to higher pricing for the 2007 emission compliant product. Volume was 13 percent lower due to decreased demand from DaimlerChrysler of approximately 13,600 units, or 15 percent compared to the first six months of 2006. Global sales to recreational vehicle OEMs were down 12 percent while shipments decreased by 22 percent in the first six months of 2007 compared with the same period in 2006.
Industrial
Total sales were up in all industrial markets primarily due to strong demand in those markets. Unit shipments increased 14 percent in the first six months of 2007 compared to the same period in 2006. Approximately 47 percent of the shipments were to North American markets and 53 percent to international markets in the first six months compared to 53 percent and 47 percent, respectively, for the same period in 2006. The overall change in the geographic sales mix is due to the continued strength of the international construction market which is being driven by strong demand in Europe and China. Total shipments to the construction market increased 17 percent largely because international shipments increased 28 percent. Other markets showing significant increases in shipments were government, marine, mining, the oil and gas and rail with increases of 87 percent, 17 percent, 20 percent, 10 percent, and 88 percent, respectively. The government market is up due to new government contracts in 2007. The mining market demand is up as the strength in commodity prices is driving investment in mining capacity. Sales to the oil and gas and commercial marine markets have increased as sustained oil and natural gas prices continue to drive activity and investments in new equipment and offshore supply vessels. The rail market is up due to increased demand in both North America and China.
Stationary Power
The increase in sales to stationary power markets is due to the increased net sales to our Power Generation segment. These net sales are eliminated in our Condensed Consolidated Statements of Earnings. See the Power Generation Results for a discussion of the increase in net sales.
Updated Outlook for 2007
Based on the strong performance in the first six months of 2007, we now expect engine segment net sales to increase 5 to 7 percent for the year. In addition to the sustainable demand in all of our industrial markets, our forecasted revenue from on-highway markets has improved based on market share gains. Segment earnings for the full year are now expected to be solidly within the targeted range of 7 to 10 percent of sales.
25
Power Generation Results and Updated Outlook
Three Months Ended – 2007 versus 2006
Financial data for the Power Generation segment was as follows:
|
|
Three months ended |
|
Favorable/(Unfavorable) |
|
|||||||
$ in millions |
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
|||
External sales |
$ |
605 |
$ |
467 |
$ |
138 |
30 |
% |
||||
Intersegment sales |
164 |
131 |
33 |
25 |
% |
|||||||
Net sales |
769 |
598 |
171 |
29 |
% |
|||||||
Investee equity, royalty and other income |
4 |
3 |
1 |
33 |
% |
|||||||
Interest income |
1 |
2 |
(1 |
) |
(50 |
)% |
||||||
Segment EBIT |
88 |
56 |
32 |
57 |
% |
|||||||
Segment EBIT as a percentage of net sales |
11.4% |
9.4% |
2 percentage points |
|||||||||
The increase in net sales in this segment was primarily due to increased volumes as a result of strong demand across most regions, especially North America, the Middle East, Europe and India and improved pricing in the commercial and alternator lines of business. Commercial generator sales, the largest line of business in the segment, rose 33 percent compared to the same period in 2006, while alternator sales increased 41 percent. Every line of business in the segment reported double-digit percentage sales growth during the quarter.
The improvement in segment EBIT was largely driven by the gross margin line as significant price realization, net of increased material costs improved segment earnings. Gross margin improved $32 million, or 28 percent, in the second quarter of 2007 over the same period in 2006. Gross margin percentage remained flat compared to the same period in 2006. Selling and administrative expenses increased $8 million, or 15 percent, over the second quarter of 2006, however selling and administrative expenses as a percentage of net sales improved by over one percentage point in the second quarter of 2007, compared to the same period in 2006. Research and engineering expenses increased $3 million, or 50 percent during the second quarter, compared to 2006 and increased slightly as a percentage of net sales compared to the same period in 2006.
A summary of engine shipments used in power generation equipment by engine category follows:
|
|
Three months ended |
|
Favorable/(Unfavorable) |
|
||||
|
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
Midrange |
7,400 |
7,300 |
100 |
1 |
% |
||||
Heavy-duty |
2,000 |
1,800 |
200 |
11 |
% |
||||
High-horsepower |
2,600 |
2,400 |
200 |
8 |
% |
||||
Total unit shipments |
12,000 |
11,500 |
500 |
4 |
% |
Six Months Ended – 2007 versus 2006
Financial data for the Power Generation segment was as follows:
|
|
Six months ended |
|
Favorable/(Unfavorable) |
|
|||||||
$ in millions |
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
|||
External sales |
$ |
1,136 |
$ |
878 |
$ |
258 |
29 |
% |
||||
Intersegment sales |
308 |
256 |
52 |
20 |
% |
|||||||
Net sales |
1,444 |
1,134 |
310 |
27 |
% |
|||||||
Investee equity, royalty and other income |
7 |
6 |
1 |
17 |
% |
|||||||
Interest income |
3 |
3 |
— |
— |
% |
|||||||
Segment EBIT |
165 |
101 |
64 |
63 |
% |
|||||||
Segment EBIT as a percentage of net sales |
11.4% |
8.9% |
2.5 percentage points |
|||||||||
26
The increase in net sales in this segment was primarily due to increased volumes as a result of strong demand and improved pricing in the commercial and alternator lines of business, as well as increased volumes in our energy solutions business. In addition, net sales increased in all major geographic regions year over year. Sales of commercial generator equipment, the largest line of business in the segment, rose 30 percent compared to the same period in 2006, while alternator sales increased 42 percent. Every line of business in the segment reported double-digit percentage sales growth during the quarter.
The improvement in segment EBIT was largely driven by the gross margin line as significant price realization, net of increased material costs, and the absorption benefit from higher volumes improved segment earnings. Gross margin improved $66 million, or 32 percent, in the first six months of 2007 over the same period in 2006. Gross margin percentage improved nearly one percentage point compared to the same period in 2006. Selling and administrative expenses increased $11 million, or 10 percent, over the first six months of 2006, however selling and administrative expenses as a percentage of net sales improved by over one percentage point in the first six months of 2007, compared to the same period in 2006. Research and engineering expenses increased $4 million, or 31 percent, compared to 2006 and increased slightly as a percentage of net sales compared to the same period in 2006.
A summary of engine shipments used in power generation equipment by engine category follows:
|
|
Six months ended |
|
Favorable/(Unfavorable) |
|
||||
|
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
Midrange |
15,400 |
14,000 |
1,400 |
10 |
% |
||||
Heavy-duty |
3,600 |
3,500 |
100 |
3 |
% |
||||
High-horsepower |
5,100 |
4,500 |
600 |
13 |
% |
||||
Total unit shipments |
24,100 |
22,000 |
2,100 |
10 |
% |
Updated Outlook for 2007
Based on
the strong performance in the first six months of 2007 and an improved outlook, we
now expect full year segment
net sales to grow 21 to 26 percent. Demand for commercial generator
equipment, including alternators, remains strong due to construction spending on
data centers in North America and India and on general infrastructure development in the Middle East. Consumer sales are projected to increase
primarily on the strength of portable gensets. Continued significant price
realization and clear visibility to strong second half orders are forecasted to
sustain earnings for the segment above the top end of its targeted
range of 7 to 9 percent of sales for the year.
Components Results and
Updated Outlook
Three Months Ended – 2007 versus 2006
Financial data for the Components segment was as follows:
|
|
Three months ended |
|
Favorable/(Unfavorable) |
|
|||||||
$ in millions |
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
|||
External sales |
$ |
516 |
$ |
363 |
$ |
153 |
42 |
% |
||||
Intersegement sales |
241 |
200 |
41 |
21 |
% |
|||||||
Net sales |
757 |
563 |
194 |
34 |
% |
|||||||
Investee equity, royalty and other income |
(1) |
2 |
(3 |
) |
NM |
|||||||
Interest income |
— |
— |
— |
NM |
||||||||
Segment EBIT |
48 |
34 |
14 |
41 |
% |
|||||||
Segment EBIT as a percentage of net sales |
6.3 |
6.0 |
0.3 percentage points |
|||||||||
Our Components segment includes the following businesses: filtration, turbochargers, fuel systems and emissions solutions. The increase in Components net sales was driven by increased sales in our emissions solutions business where sales more than doubled compared to the same period in 2006, a 46 percent increase in sales of our turbochargers and an 11 percent increase in sales in our filtration business. All of our businesses benefited from sales of new products to allow their customers to meet new on-highway emissions standards in the U.S. and Europe.
27
Segment EBIT increased during the second quarter compared with the same period in 2006, primarily due to overall improved margins in our filtration business, particularly Europe and Asia Pacific, and increased sales in our emissions solution business. The increased margins were the result of increased sales volumes partially offset by a decrease in gross margin as a percent of sales. Gross margin increased $14 million, or 15 percent, in the second quarter compared to the same period in 2006, however, gross margin percentage decreased three percentage points compared to the same period in 2006. Gross margin in this segment is depressed primarily due to overall product mix and the turbocharger business, which was negatively impacted by high material costs and increased production spending as we ramp up new products and new capacity. Selling and administrative expenses increased $4 million, or 9 percent, compared to the second quarter of 2006, and decreased by nearly two percentage points as a percentage of net sales. As a result of higher levels of customer funding for new product development, research and engineering expenses decreased $4 million, or 22 percent, compared to the second quarter of 2006 and decreased one percentage point of net sales.
Six Months Ended – 2007 versus 2006
Financial data for the Components segment was as follows:
|
|
Six months ended |
|
Favorable/(Unfavorable) |
|
|||||||
$ in millions |
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
|||
External sales |
$ |
971 |
$ |
718 |
$ |
253 |
35 |
% |
||||
Intersegement sales |
443 |
400 |
43 |
11 |
% |
|||||||
Net sales |
1,414 |
1,118 |
296 |
26 |
% |
|||||||
Investee equity, royalty and other income |
(2 |
) |
4 |
(6 |
) |
NM |
||||||
Interest income |
1 |
— |
1 |
NM |
||||||||
Segment EBIT |
72 |
65 |
7 |
11 |
% |
|||||||
Segment EBIT as a percentage of net sales |
5.1% |
5.8% |
(0.7) percentage points |
|||||||||
The increase in Components net sales was driven by increased sales in our emissions solutions business where sales more than doubled compared to the same period in 2006, a 37 percent increase in sales of our turbochargers and a 7 percent increase in sales in our filtration business. All of our businesses benefited from sales of new products to allow their customers to meet new on-highway emissions standards in the U.S. and Europe.
Segment EBIT improved during the first six months compared with the same period in 2006, primarily due to higher volume. Gross margin increased $16 million, or 9 percent, in the first six months compared to the same period in 2006, and gross margin percentage declined over two percentage points compared to the same period in 2006. Selling and administrative expenses increased $7 million, or 8 percent, compared to the first six months of 2006, but decreased slightly as a percentage of net sales. Research and engineering expenses decreased in 2007 as a result of higher levels of customer funding for new product development. Research and engineering expenses decreased $3 million, or 8 percent, compared to the first six months of 2006 and decreased by over one percentage point as a percentage of net sales.
Updated Outlook for 2007
Based on improvements in performance in the first six months of 2007
and an improved outlook, particularly from our emissions solutions and turbocharger businesses, we now expect full year segment
net sales to grow 22 to 27 percent and earnings to reach the targeted range of 7 to 9
percent of sales for the year.
Distribution Results and Updated Outlook
Three Months Ended – 2007 versus 2006
Financial data for the Distribution segment was as follows:
|
|
Three months ended |
|
Favorable/(Unfavorable) |
|
|||||||
$ in millions |
|
July 1, 2007 |
|
July 2, 2006 |
|
Amount |
|
Percent |
|
|||
External sales |
$ |
367 |
$ |
332 |
$ |
35 |
11 |
% |
||||
Intersegment sales |
1 |
4 |
(3 |
) |
(75 |
)% |
||||||
Net sales |
368 |
336 |
32 |
10 |
% |
|||||||
Investee equity, royalty and other income |
24 |