UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 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 March 29, 1998 Commission File Number 1-4949 ______________ ______ Indiana 35-0257090 _______ __________ (State or Other Jurisdiction of (I.R.S. 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 March 29, 1998, the number of shares outstanding of the registrant's only class of common stock was 42.1 million. TABLE OF CONTENTS _________________ Page No. ________ PART I. FINANCIAL INFORMATION ______________________________ Item 1. Financial Statements Consolidated Statement of Earnings for the First 3 Quarter Ended March 29, 1998 and March 30, 1997 Consolidated Statement of Financial Position at 4 March 29, 1998 and December 31, 1997 Consolidated Statement of Cash Flows for the First 5 Quarter Ended March 29, 1998 and March 30, 1997 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Results of 8 Operations, Cash Flow and Financial Condition PART II. OTHER INFORMATION ___________________________ Item 4. Submission of Matters to a Vote of Security Holders 11 Item 6. Exhibits and Reports on Form 8-K 12 Index to Exhibits 13 CUMMINS ENGINE COMPANY, INC. CONSOLIDATED STATEMENT OF EARNINGS Unaudited __________________________________ First Quarter Ended Millions, except per share amounts 3/29/98 3/30/97 __________________________________ _______ _______ Net sales $1,500 $1,304 Cost of goods sold 1,160 1,018 Special charge 43 - ______ ______ Gross profit 297 286 Selling & administrative expenses 202 178 Research & engineering expenses 67 61 Net expense (income) from joint ventures and alliances 4 (7) Interest expense 17 5 Other income, net (7) (7) ______ ______ Earnings before income taxes 14 56 Provision for income taxes 4 15 Minority interest 3 - ______ ______ Net earnings $ 7 $ 41 ______ ______ Basic earnings per share $ .18 $ 1.07 Diluted earnings per share .18 1.06 Cash dividends declared per share .275 .25 CUMMINS ENGINE COMPANY, INC. CONSOLIDATED STATEMENT OF FINANCIAL POSITION Unaudited ____________________________________________ Millions, except per share amounts 3/29/98 12/31/97 __________________________________ _______ ________ Assets Current assets: Cash and cash equivalents $ 48 $ 49 Receivables 926 771 Inventories 781 677 Other current assets 197 213 ______ ______ 1,952 1,710 Investments and other assets 351 346 Property, plant & equipment less accumulated depreciation of $1,515 and $1,434 1,635 1,532 Intangibles, deferred taxes & deferred charges 558 177 ______ ______ Total assets $4,496 $3,765 ______ ______ Liabilities and shareholders' investment Current liabilities: Loans payable $ 32 $ 90 Current maturities of long-term debt 37 42 Accounts payable 458 386 Other current liabilities 582 537 ______ ______ 1,109 1,055 ______ ______ Long-term debt 1,181 522 ______ ______ Other liabilities 742 713 ______ ______ Minority interest 55 53 ______ ______ Shareholders' investment: Common stock, $2.50 par value, 47.9 and 48.1 shares issued 120 120 Additional contributed capital 1,106 1,119 Retained earnings 708 713 Common stock in treasury, at cost, 5.8 & 6.0 shares (226) (245) Common stock held in trust for employee benefit plans, 3.6 and 3.7 shares (174) (175) Unearned compensation (ESOP) ( 38) ( 42) Cumulative translation adjustments ( 87) ( 68) ______ _______ 1,409 1,422 ______ ______ Total liabilities & shareholders' investment $4,496 $3,765 ______ ______ CUMMINS ENGINE COMPANY, INC. CONSOLIDATED STATEMENT OF CASH FLOWS Unaudited ____________________________________ First Quarter Ended Millions 3/29/98 3/30/97 ________ _______ _______ Cash flows from operating activities: Net earnings $ 7 $ 41 _____ _____ Adjustments to reconcile net earnings to net cash from operating activities: Depreciation and amortization 47 39 Restructuring actions ( 6) ( 4) Accounts receivable (113) ( 71) Inventories ( 54) ( 31) Accounts payable and accrued expenses 120 44 Income taxes payable ( 7) 4 Other 27 8 _____ ______ Total adjustments 14 ( 11) _____ _____ Net cash provided by operating activities 21 30 _____ _____ Cash flows from investing activities: Property, plant and equipment: Additions ( 83) (104) Disposals 2 7 Investments in joint ventures and alliances ( 20) 3 Acquisition of businesses (453) ( 3) Other - 1 ______ ____ Net cash used in investing activities (554) ( 96) ______ _____ Net cash flows used for operating and investing activities (533) ( 66) ______ _____ Cash flows from financing activities: Proceeds from borrowings 710 189 Payments on borrowings (103) ( 9) Net payments under credit agreements ( 62) ( 70) Repurchase of common stock - ( 58) Dividend payments ( 12) ( 10) Other ( 1) ( 2) ______ ______ Net cash provided from financing activities 532 40 _____ ______ Effect of exchange rate changes on cash - ( 1) _____ ______ Net change in cash and cash equivalents ( 1) ( 27) Cash & cash equivalents at beginning of the year 49 108 _____ _____ Cash & cash equivalents at the end of the quarter $ 48 $ 81 _____ _____ CUMMINS ENGINE COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Unaudited ______________________________________________ Note 1. Accounting Policies: The Consolidated Financial Statements for the interim periods ended March 29, 1998 and March 30, 1997 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. Acquisition: In January 1998, Cummins completed the acquisition of the stock of Nelson Industries, Inc., for $453 million. Nelson, a filtration and exhaust systems manufacturer, was consolidated from the date of its acquisition. The purchase price in excess of net assets will be amortized over 40 years. In the first quarter of 1998, no valuation adjustments were made to Nelson's assets and liabilities. Note 3. Special Charge: In the first quarter of 1998, the Company recorded a one-time charge for product coverage expense primarily attributable to the recent experience of higher-than-anticipated costs to repair certain automotive engines manufactured in previous years. The Company believes it is necessary to make a one-time charge of $43 million pre-tax to accrue for such product coverage costs expected to be incurred in the future on these engines currently in the field. Note 4. 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. Note 5. Long-term Debt: In January 1998, the Company's revolving credit agreement was amended, forming two $500 million agreements maturing in 1999 and 2003. In February 1998, the Company issued $765 million face amount of notes and debentures. Net proceeds were used to finance the acquisition of Nelson and pay down other indebtedness outstanding at December 31, 1997. The $500 million revolving credit agreement maturing in 1999 was terminated in March 1998, with the financing need being replaced by the debt issue. Note 6. Earnings per Share: Basic earnings per share of common stock are computed by dividing net earnings by the weighted-average number of common shares outstanding during the period. Diluted earnings per share are computed by dividing net earnings by the weighted-average number of shares, assuming the exercise of stock options. Shares of stock held by the employee benefits trust are not included in outstanding shares for EPS until distributed from the trust. Weighted Per- Net Average Share Millions, except per share amounts Earnings Shares Amount __________________________________ ________ ________ ______ 1998 ____ Basic $ 7 38.5 $ .18 Options - .4 ___ ____ Diluted $ 7 38.9 $ .18 1997 ____ Basic $41 38.2 $1.07 Options - .3 ___ ____ Diluted $41 38.5 $1.06 Note 7. Comprehensive Income: Effective January 1, 1998, Cummins adopted SFAS No. 130, a new accounting rule on reporting comprehensive income. The new rule requires reporting of comprehensive income, which includes net income and all other nonowner changes in equity during a period. First Quarter Ended Millions March 29, 1998 March 30, 1997 ________ ______________ ______________ Net income $ 7 $ 41 Minimum liability for pensions - - Translation loss (19) (20) _____ _____ Comprehensive income $(12) $ 21 _____ ____ Note 8. Contingency: The Environmental Protection Agency, the U. S. Department of Justice and the California Air Resources Board (collectively the government agencies) have raised concerns with diesel engine manufacturers, including Cummins, about the level of Nitrogen Oxide (NOx) emissions from diesel engines under certain driving conditions. The government agencies also have raised concerns about the strategies that diesel manufacturers have employed to maximize fuel economy and lessen other pollutants, while also meeting Clean Air Act standards for NOx emissions. The government agencies have indicated that they may conclude that diesel manufacturers have been in violation of the Clean Air Act and have, therefore, issued conditional certificates of conformity on the 1998 heavy-duty, on highway diesel engine models. Cummins believes that it is in full compliance with all laws and regulations regarding emissions. The government agencies have not made any final determinations or allegations. The industry and Cummins are engaged in confidential discussions regarding these emissions, the technical challenges confronted if new emissions standards are imposed, the commercial impact of the government's policy and legal positions and related issues. Both the industry and the government agencies are taking these concerns and discussions very seriously and are working diligently toward an amicable resolution. It is premature to predict the outcome of the discussions or whether the outcome will have a material effect on Cummins. CUMMINS ENGINE COMPANY, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS, CASH FLOW AND FINANCIAL CONDITION _____________________________________________________________ Overview ________ Earnings before interest and taxes in the first quarter of 1998 were $74 million, excluding the effect of a one-time pre-tax charge of $43 million for product coverage costs related to previously produced engines. This was 21 percent higher than the first quarter of 1997 on a 15-percent increase in sales. However, after the higher interest expense for the acquisition of Nelson, income taxes and minority interest, the Company's net earnings before the one-time charge were $37 million or 96 cents per share. Including the charge, net earnings were $7 million or 18 cents per share. Net earnings in the first quarter of 1997 were $41 million or $1.06 per share. Results of Operations _____________________ Net Sales _________ Revenues from sales of engines were 55 percent of the Company's net sales in the first quarter of 1998, with engine revenues 12 percent higher than first-quarter 1997 and unit shipments 9 percent higher. This positive variance reflected a mix shift from midrange to heavy-duty engines in the first quarter of 1998: First Quarter Unit Shipments 1998 1997 ________________ ______ ______ Midrange Engines 65,000 63,100 Heavy-duty Engines 26,900 20,800 High-horsepower Engines 2,200 2,300 ______ ______ 94,100 86,200 ______ ______ Revenues from non-engine products, which were 45 percent of net sales in the first quarter of 1998, were 18 percent higher than the first quarter of 1997. The major changes within non-engine revenues were in filtration, with the sales of Nelson included from the date of acquisition by Cummins, and PowerCare (which includes sales of new parts and remanufactured parts and engines). The Company's sales for each of its key markets during the comparative first quarters were: First Quarter $ Millions 1998 1997 __________ ______ ______ Automotive $ 684 $ 598 Power Generation 291 275 Industrial 269 257 Filtration and Other 256 174 ______ ______ $1,500 $1,304 ______ ______ Sales of $684 million in the first quarter of 1998 for automotive markets were 14 percent higher than the first quarter of 1997. Heavy- duty truck engine revenues were 39 percent higher than the first quarter of 1997 on a 40-percent increase in units. The higher level of sales was due to both the strong market and the Company's higher market share in North America, as well as continued strong demand in Mexico and the recovery in European automotive markets. Revenues from the sales of engines for medium-duty trucks in the first quarter of 1998 were 18 percent lower than the prior year's quarter on an 18-percent decrease in units. In North America, the Company was affected by a shutdown at Ford to relocate production. The effect of this shutdown was partially offset by higher demand in international markets, for which unit shipments were 28 percent higher than the year ago level. Engine revenues of the bus and light commercial vehicle market were 10 percent higher than the first quarter of 1997 on a 6-percent increase in unit shipments, with the difference due primarily to pricing on new engine models. In January, Cummins jointly announced with Chrysler a new, fully electronic engine -- the ISB -- for the Dodge Ram pickup. In the first quarter, Cummins shipped 22,200 engines to Chrysler, 8 percent higher than the first-quarter 1997 level, all while ramping up production for the new engine. In the first quarter of 1998, the Company's power generation markets benefited from the consolidation of Cummins India Limited. Without this, power generation revenues would have been down 3 percent compared to first quarter 1997. Sales of the Company's generator sets continued to reflect growth in North America, Latin America and Europe, which offset declines in demand for generator sets in Southeast Asia, China and Korea. However, engine sales to generator set assemblers were down 39 percent due to lower demand in Southeast Asia, China, Korea and markets served from the Company's operations in the United Kingdom. Sales of all other power generation products were at higher levels than in the first quarter of 1997. Sales to industrial markets were 5 percent higher than the first quarter of 1997, primarily due to strong demand in North American and European construction markets. Agricultural markets in North America and Latin America also remained strong. Filtration and other sales were $82 million higher than the first quarter of 1997. In January, the Company completed the acquisition of Nelson whose sales were $76 million in the first quarter. In total, international markets represented 47 percent of the Company's revenues in the first quarter of 1998. The Company continued to benefit from recovery in European automotive markets and increased industrial business in the first quarter, with Europe and the CIS representing 13 percent of sales. Business in Mexico, Brazil and Latin America also continued to be strong. Asian and Australian markets, in total, represented 13 percent of the Company's sales in the first quarter. In Australia, sales are primarily for automotive, power generation and mining markets. In Indonesia, Malaysia, Thailand and Korea, the Company's business is primarily power generation, industrial and parts. Business fell in this area in the first quarter, with revenues almost 60 percent lower than the first quarter of 1997. The economy in India and portions of China also has slowed. Gross Margin: _____________ The Company's gross margin percentage before the special charge for product coverage costs was 22.7 percent in the first quarter of 1998, compared to 21.9 percent in the prior year's quarter. The Company's gross margin percentage benefited from volume in the first quarter of 1998 ($25 million dollars, or 30-percent leverage). In addition, the acquisition of Nelson and consolidation of Cummins India Limited added $35 million. Gross margin percentage after the special charge was 19.8 percent in the first quarter of 1998. Operating Expenses: ___________________ Selling and administrative expenses were 13.4 percent of sales in the first quarter of 1998, compared to 13.7 percent in the first quarter of 1997. Excluding Nelson and Cummins India Limited, selling and administrative expenses were $11 million higher than the first quarter of 1997, due equally to costs of new products, information systems and Year 2000 projects. Research and engineering expenses were 4.5 percent of sales in the first quarter of 1998, compared to 4.7 percent in the prior year's quarter. The Company's losses from joint ventures and alliances were $4 million in the first quarter of 1998, compared to income of $7 million in the first quarter of 1997. The $11 million difference was primarily caused by the consolidation of Cummins India Limited and higher start-up costs at the Company's joint venture with Wartsila. Other: ______ Interest expense was $17 million in the first quarter of 1998. The increase over the prior year's quarter was due to the increased level of borrowings to support working capital on the higher sales level and to complete the acquisition of Nelson. Other income of $7 million was equal to the first quarter of 1997. Provision for Income Taxes: ___________________________ The Company's income tax provision in the first quarter of 1998 was $4 million, reflecting an effective tax rate of 29 percent for the year. Cash Flow and Financial Condition _________________________________ Key elements of cash flows were: First Quarter $ Millions 1998 1997 __________ ______ ______ Net cash used for operating and investing activities $(533) $ (66) Net cash from financing activities 532 40 Effect of exchange rate changes on cash - ( 1) ______ ______ Net change in cash and cash equivalents $ ( 1) $ (27) ______ ______ In the first quarter of 1998, net cash used for operating and investing activities was $533 million. This high level of net cash requirements was due primarily to the acquisition of Nelson and planned capital expenditures of $83 million. In the first quarter of 1998, the Company issued $765 million face amount of notes and debentures to support working capital and to complete the acquisition of Nelson. As disclosed in Note 8, diesel engine manufacturers, including Cummins, are involved in discussions with the Environmental Protection Agency, the US Department of Justice and the California Air Resources Board regarding diesel engine emissions. FORWARD-LOOKING STATEMENTS __________________________ The Company has included certain forward-looking statements in this Management's Discussion and Analysis of Results of Operations, Cash Flow and Financial Condition. These statements are based on current expectations, estimates and projections about the industries in which the Company operates, management's beliefs and various assumptions made by management which are difficult to predict. Among the factors that could affect the outcome of the statements are general industry and market conditions and growth rates. Therefore, actual outcomes and their impact on the Company may differ materially from what is expressed or forecasted. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. PART II. OTHER INFORMATION ___________________________ Item 4. Submission of Matters to a Vote of Security Holders ____________________________________________________________ The Company held its annual meeting of security holders on April 7, 1998 at which security holders elected 13 directors of the Company for the ensuing year and ratified the appointment of Arthur Andersen LLP as auditors for the year 1998. Results of the voting in connection with each of the items were as follows: Voting on Directors: ____________________ For Withheld __________ ________ H. Brown 32,040,765 826,548 R. Darnall 32,410,308 457,005 J. M. Deutch 32,403,211 464,102 W. Y. Elisha 32,406,962 460,351 H. H. Gray 32,396,085 471,228 J. A. Henderson 32,389,013 478,300 W. I. Miller 32,407,082 460,231 D. S. Perkins 32,394,111 473,202 W. D. Ruckelshaus 32,409,063 458,250 H. B. Schacht 32,401,593 465,720 T. M. Solso 32,356,038 511,275 F. A. Thomas 32,409,662 457,651 J. L. Wilson 32,411,817 455,496 Ratify Appointment of Auditors: _______________________________ For Against Abstain __________ _______ _______ 35,794,688 302,328 59,879 With regard to the election of directors, votes were cast in favor of or withheld from each nominee; votes that were withheld were excluded entirely from the vote and had no effect. Abstentions on the ratification of the appointment of Arthur Andersen LLP were counted as present for purposes of determining the existence of a quorum. Under the rules of the New York Stock Exchange, brokers who held shares in street names had the authority to vote on certain items when they did not receive instructions from beneficial owners. Brokers who did not receive instructions were entitled to vote on the election of directors. Under applicable Indiana law, a broker non-vote had no effect on the outcome of the election of directors. 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) On February 19, 1998, the Company filed a Form 8-K Other Event to report the merger of Safari Inc., a wholly owned subsidiary of the Company, with and into Nelson Industries, Inc. pursuant to an Agreement and Plan of Merger dated as of December 3, 1997 among the Company, Safari Inc. and Nelson Industries, Inc. 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/Rick J. Mills May 1, 1998 ________________ Rick J. Mills Vice President - Corporate Controller (Chief Accounting Officer) CUMMINS ENGINE COMPANY, INC. ____________________________ INDEX TO EXHIBITS _________________ 4(a) Amended and Restated Credit Agreement (filed herewith) 4(b) Credit Agreement (filed herewith) 27 Financial Data Schedule (filed herewith)