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 October 1, 2006 |
Commission File Number 1-4949
CUMMINS INC.
(Exact name of registrant as specified in its charter)
Indiana |
35‑0257090 |
500 Jackson Street |
|
Telephone (812) 377-5000 (Registrant's telephone number, including area code) |
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 October 1, 2006, there were 52,460,308 shares of common stock outstanding with a par value of $2.50 per share.
1
CUMMINS INC. AND CONSOLIDATED SUBSIDIARIES
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
|
Page |
|
PART I. FINANCIAL INFORMATION |
||
|
||
ITEM 1. |
Condensed Financial Statements (Unaudited) |
3 |
Condensed Consolidated Statements of Earnings for the three and nine months ended October 1, 2006 and September 25, 2005 |
3 |
|
Condensed Consolidated Balance Sheets at October 1, 2006 and December 31, 2005 |
4 |
|
Condensed Consolidated Statements of Cash Flows for the nine months ended October 1, 2006 and September 25, 2005 |
5 |
|
Notes to Condensed Consolidated Financial Statements |
6 |
|
ITEM 2. |
Management's Discussion and Analysis of Financial Condition and Results of Operations |
17 |
|
||
ITEM 3. |
Quantitative and Qualitative Disclosures About Market Risk |
36 |
|
||
ITEM 4. |
Controls and Procedures |
36 |
|
||
PART II. OTHER INFORMATION |
||
ITEM 1. |
Legal Proceedings |
37 |
ITEM 1A. |
Risk Factors |
37 |
|
||
ITEM 2. |
Unregistered Sales of Equity Securities and Use of Proceeds |
37 |
ITEM 6. |
Exhibits |
38 |
|
||
Signatures |
39 |
|
2
PART I. FINANCIAL INFORMATION
ITEM 1. Condensed Financial Statements
CUMMINS INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
|
|
Three months ended |
|
Nine months ended |
|
||||||||
|
|
October 1, |
|
September 25, |
|
October 1, |
|
September 25, |
|
||||
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
|
Millions (except per share amounts) |
||||||||||||
Net sales (includes related party sales of $401, $320, $1,159 and $864, respectively) |
$ |
2,809 |
$ |
2,467 |
$ |
8,329 |
$ |
7,165 |
|||||
Cost of sales (includes related party purchases of $83, $53, $204 and $144, respectively) |
2,155 |
1,906 |
6,404 |
5,598 |
|||||||||
Gross margin |
654 |
561 |
1,925 |
1,567 |
|||||||||
Operating expenses and income |
|||||||||||||
Selling and administrative expenses |
328 |
286 |
949 |
832 |
|||||||||
Research and engineering expenses |
81 |
71 |
243 |
207 |
|||||||||
Investee equity, royalty and other income (Note 2) |
(37 |
) |
(31 |
) |
(105 |
) |
(103 |
) |
|||||
Other operating expense, net |
4 |
3 |
3 |
— |
|||||||||
|
|||||||||||||
Operating earnings |
278 |
232 |
835 |
631 |
|||||||||
Interest income |
(14 |
) |
(6 |
) |
(33 |
) |
(15 |
) |
|||||
Interest expense |
23 |
27 |
76 |
83 |
|||||||||
Other (income) expense, net |
(4 |
) |
(2 |
) |
(8 |
) |
8 |
||||||
Earnings before income taxes and minority interests |
273 |
213 |
800 |
555 |
|||||||||
Provision for income taxes |
92 |
61 |
244 |
153 |
|||||||||
Minority interests in earnings of consolidated subsidiaries |
10 |
7 |
30 |
19 |
|||||||||
Net earnings |
$ |
171 |
$ |
145 |
$ |
526 |
$ |
383 |
|||||
|
|||||||||||||
Earnings per share (Note 12) |
|||||||||||||
Basic |
$ |
3.40 |
$ |
3.27 |
$ |
11.24 |
$ |
8.68 |
|||||
Diluted |
$ |
3.37 |
$ |
2.90 |
$ |
10.46 |
$ |
7.70 |
|||||
Cash dividends declared per share |
$ |
0.36 |
$ |
0.30 |
$ |
0.96 |
$ |
0.90 |
The accompanying notes are an integral part of the condensed consolidated financial statements.
3
CUMMINS INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
|
|
October 1, |
|
December 31, |
|
|||
|
|
2006 |
|
2005 |
|
|||
|
|
Millions |
|
|||||
ASSETS |
||||||||
Current assets |
||||||||
Cash and cash equivalents |
$ |
1,027 |
$ |
779 |
||||
Marketable securities |
82 |
61 |
||||||
Receivables, net |
1,561 |
1,314 |
||||||
Receivables from related parties |
128 |
109 |
||||||
Inventories (Note 3) |
1,405 |
1,174 |
||||||
Deferred income taxes |
313 |
363 |
||||||
Prepaid expenses and other current assets |
146 |
116 |
||||||
Total current assets |
4,662 |
3,916 |
||||||
Long-term assets |
||||||||
Property, plant and equipment, net of accumulated depreciation of $2,515 and $2,384 |
1,545 |
1,557 |
||||||
Investments in and advances to equity investees |
331 |
278 |
||||||
Goodwill (Note 5) |
359 |
358 |
||||||
Other intangible assets, net (Note 5) |
113 |
100 |
||||||
Deferred income taxes |
400 |
500 |
||||||
Other assets |
169 |
176 |
||||||
Total assets |
$ |
7,579 |
$ |
6,885 |
||||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
Current liabilities |
||||||||
Short-term borrowings (Note 6) |
$ |
248 |
$ |
154 |
||||
Accounts payable |
1,061 |
904 |
||||||
Other accrued expenses |
1,300 |
1,160 |
||||||
Total current liabilities |
2,609 |
2,218 |
||||||
Long-term liabilities |
||||||||
Long-term debt |
813 |
1,213 |
||||||
Pensions |
263 |
396 |
||||||
Postretirement benefits other than pensions |
528 |
554 |
||||||
Other liabilities and deferred revenue |
455 |
415 |
||||||
Total liabilities |
4,668 |
4,796 |
||||||
Commitments and contingencies (Note 10) |
— |
— |
||||||
Minority interests |
240 |
225 |
||||||
Shareholders’ equity |
||||||||
Common stock, $2.50 par value, 150 shares authorized, 55.0 and 48.5 shares issued |
137 |
121 |
||||||
Additional contributed capital |
1,495 |
1,201 |
||||||
Retained earnings |
1,839 |
1,360 |
||||||
Accumulated other comprehensive loss (Note 11) |
||||||||
Minimum pension liability adjustment |
(525 |
) |
(523 |
) |
||||
Foreign currency translation adjustments |
(27 |
) |
(84 |
) |
||||
Unrealized gain on marketable securities |
2 |
3 |
||||||
Unrealized gain on derivatives |
24 |
1 |
||||||
Total accumulated other comprehensive loss |
(526 |
) |
(603 |
) |
||||
Common stock in treasury, at cost, 2.5 and 2.0 shares |
(167 |
) |
(101 |
) |
||||
Common stock held in trust for employee benefit plans, 1.9 and 2.0 shares |
(93 |
) |
(97 |
) |
||||
Unearned compensation |
(14 |
) |
(17 |
) |
||||
Total shareholders’equity |
2,671 |
1,864 |
||||||
Total liabilities and shareholders’equity |
$ |
7,579 |
$ |
6,885 |
||||
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)
|
Nine months ended |
|
|||||
|
October 1, |
|
September 25, |
||||
2006 |
|
2005 |
|||||
Cash flows from operating activities |
Millions |
||||||
Net earnings |
$ |
526 |
$ |
383 |
|||
Adjustments to reconcile net earnings to net cash provided by operating activities: |
|||||||
Depreciation and amortization |
222 |
216 |
|||||
Loss on disposals of property, plant and equipment, net |
3 |
3 |
|||||
Deferred income tax provision |
141 |
71 |
|||||
Equity in earnings of investees, net of dividends |
(37 |
) |
(12 |
) |
|||
Minority interests in earnings of consolidated subsidiaries |
30 |
19 |
|||||
Pension expense (Note 8) |
89 |
80 |
|||||
Pension contributions (Note 8) |
(154 |
) |
(121 |
) |
|||
Stock-based compensation expense (Note 13) |
13 |
11 |
|||||
Tax benefit on stock options exercised |
— |
7 |
|||||
Translation and hedging activities |
(19 |
) |
8 |
||||
Changes in current assets and liabilities: |
|||||||
Receivables |
(232 |
) |
(405 |
) |
|||
Inventories |
(200 |
) |
(196 |
) |
|||
Other current assets |
(19 |
) |
8 |
||||
Accounts payable |
132 |
175 |
|||||
Accrued expenses |
64 |
103 |
|||||
Changes in long-term liabilities |
11 |
49 |
|||||
Other, net |
43 |
(14 |
) |
||||
Net cash provided by operating activities |
613 |
385 |
|||||
Cash flows from investing activities |
|||||||
Capital expenditures |
(152 |
) |
(121 |
) |
|||
Investments in internal use software |
(33 |
) |
(25 |
) |
|||
Proceeds from disposals of property, plant and equipment |
32 |
13 |
|||||
Investments in and advances to equity investees |
(10 |
) |
(4 |
) |
|||
Acquisition of businesses, net of cash acquired |
— |
(2 |
) |
||||
Investments in marketable securities—acquisitions |
(180 |
) |
(89 |
) |
|||
Investments in marketable securities—liquidations |
159 |
98 |
|||||
Other, net |
(1 |
) |
5 |
||||
Net cash used in investing activities |
(185 |
) |
(125 |
) |
|||
Cash flows from financing activities |
|||||||
Proceeds from borrowings |
80 |
65 |
|||||
Payments on borrowings and capital lease obligations |
(132 |
) |
(344 |
) |
|||
Net borrowings under short-term credit agreements |
(1 |
) |
1 |
||||
Distributions to minority shareholders |
(16 |
) |
(16 |
) |
|||
Dividend payments on common stock |
(47 |
) |
(42 |
) |
|||
Tax benefit on share-based awards |
6 |
— |
|||||
Proceeds from issuing common stock |
8 |
27 |
|||||
Repurchases of common stock |
(76 |
) |
— |
||||
Other, net |
(5 |
) |
4 |
||||
Net cash used in financing activities |
(183 |
) |
(305 |
) |
|||
Effect of exchange rate changes on cash and cash equivalents |
3 |
(5 |
) |
||||
Net increase (decrease) in cash and cash equivalents |
248 |
(50 |
) |
||||
Cash and cash equivalents at beginning of year |
779 |
611 |
|||||
Cash and cash equivalents at end of period |
$ |
1,027 |
$ |
561 |
|||
Cash payments for: |
|||||||
Interest |
$ |
81 |
$ |
92 |
|||
Income taxes |
$ |
102 |
$ |
68 |
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 AND BASIS OF PRESENTATION
Nature of Operations
Cummins
Inc. (“Cummins,” “the Company,”
“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 products, including filtration and
emissions solutions, fuel systems, controls and air handling systems.
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 nine month interim periods ended October 1, 2006 and September 25, 2005. 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 2006 contain 13 and 39 weeks, respectively, while the interim periods for 2005 contain 13 and 38 weeks, respectively. Certain reclassifications have been made to prior period amounts to conform to the presentation of the current period condensed financial statements.
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 Consolidated Financial Statements in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2005. Our interim period financial results for the three and nine 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 consolidated balance sheet 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 are classified as "Selling and administrative expenses" in our Condensed Consolidated Statements of Earnings. For the three months ended October 1, 2006 and September 25, 2005, these costs were approximately $37 million and $29 million, respectively. For the nine months ended October 1, 2006 and September 25, 2005, these costs were approximately $96 million and $84 million, respectively.
Recently Adopted Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (Revised 2004), “Share-Based Payment.” This standard requires financial statement recognition of compensation cost related to share-based payment transactions. Share-based payment transactions within the scope of SFAS No. 123R include stock options, restricted stock plans, performance-based awards, stock appreciation rights, and employee share purchase plans. We implemented the revised standard in the first quarter of 2006. Prior to January 1, 2006, we accounted for stock-based employee awards issued after December 31, 2002, using the fair value method preferred by SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123R requires the Company to estimate forfeitures in calculating the expense relating to stock-based compensation as opposed to recognizing these forfeitures and the corresponding reduction in expense as they occur. SFAS No. 123R also requires prospective presentation of the “Tax benefit on share-based awards” as a financing activity rather than an operating activity in our Condensed Consolidated Statements of Cash Flows. See Note 13 for the impact that the adoption of this standard had on our Condensed Consolidated Financial Statements.
6
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections—a replacement of Accounting Principles Board (APB) Opinion No. 20 and FASB Statement No. 3.” This standard changes the requirements for the accounting for and reporting of a change in accounting principle and applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. APB No. 20 required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. This standard requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The provisions of SFAS No. 154 are effective for fiscal years beginning after December 15, 2005. The adoption of this standard did not have a material impact on our Condensed Consolidated Financial Statements.
Accounting Pronouncements Issued But Not Yet Effective
In February 2006, the 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. The Company will adopt SFAS No. 155 effective January 1, 2007. We do not expect the adoption of SFAS No. 155 to have a material impact on our Condensed 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 be initially 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. The Company will adopt SFAS No. 156 effective January 1, 2007. We do not expect the adoption of SFAS No. 156 to have a material effect on our Condensed 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,” 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. The Company will adopt FIN 48 effective January 1, 2007. We are currently evaluating the impact, if any, that FIN 48 will have on our Condensed Consolidated Financial Statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The Company will adopt SFAS No. 157 effective January 1, 2008. We are currently evaluating the impact, if any, that SFAS No. 157 will have on our Condensed Consolidated Financial Statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Plans and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R),” which requires employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other postretirement plans in their financial statements. In addition, SFAS No. 158 requires companies to measure plan assets and liabilities as of the end of a fiscal year rather than a date within 90 days of the end of the fiscal year. The Company will adopt SFAS No. 158 effective December 31, 2006, except for the change in measurement date provisions which are not effective until 2008. We are currently evaluating the impact that SFAS No. 158 will have on our Condensed Consolidated Financial Statements, however, based on our November 30, 2005, valuation we expect that total assets, total liabilities and total shareholders’ equity will be impacted in the following manner. Total assets are expected to decrease by approximately $37 million, total liabilities are expected to increase by approximately $76 million, and shareholders’ equity is expected to decrease by approximately $113 million. These estimates are subject to change based on our upcoming November 30, 2006, valuation when completed. We are still assessing the impact that the adoption of SFAS No. 158 will have on deferred taxes and as such, the deferred tax impact has been excluded. In addition, as a result of the adoption of SFAS No. 158, we expect a decrease in current portion of our pension liability and a corresponding increase in long-term portion of our pension liability of approximately $221 million. We do not expect the adoption of SFAS No. 158 to impact compliance with any of our financial covenants.
7
In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements: the “roll-over” method and the “iron curtain” method. The roll-over method focuses primarily on the impact of a misstatement on the income statement, including the reversing effect of prior year misstatements, but its use can lead to the accumulation of misstatements in the balance sheet. The iron curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior years on the income statement. We currently use the iron curtain method for quantifying identified financial statement misstatements. In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and roll-over methods. We will initially apply the provisions of SAB 108 in connection with the preparation of our Consolidated Financial Statements for the year ending December 31, 2006. We currently do not expect the application of SAB 108 to have a material effect on our Condensed Consolidated Financial Statements.
NOTE 2. INVESTMENTS IN EQUITY INVESTEES
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 |
|
Nine months ended |
|
||||||||
|
|
October 1, |
|
September 25, |
|
October 1, |
|
September 25, |
|
||||
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
|
|
Millions |
|
||||||||||
Dongfeng Cummins Engine Company, Ltd (DCEC) |
$ |
4 |
$ |
5 |
$ |
16 |
$ |
33 |
|||||
North American distributors |
13 |
8 |
34 |
20 |
|||||||||
Cummins Mercruiser |
— |
3 |
4 |
8 |
|||||||||
Chongqing Cummins |
6 |
4 |
13 |
10 |
|||||||||
Tata Cummins |
2 |
1 |
8 |
3 |
|||||||||
Fleetguard Shanghai |
2 |
1 |
4 |
3 |
|||||||||
All others |
2 |
3 |
10 |
8 |
|||||||||
Cummins share of net earnings |
29 |
25 |
89 |
85 |
|||||||||
Royalty and other income |
8 |
6 |
16 |
18 |
|||||||||
Investee equity, royalty and other income |
$ |
37 |
$ |
31 |
$ |
105 |
$ |
103 |
NOTE 3. INVENTORIES
Inventories included the following:
|
|
October 1, |
|
December 31, |
|
||
|
|
2006 |
|
2005 |
|
||
|
|
Millions |
|
||||
Finished products |
$ |
715 |
$ |
636 |
|||
Work-in-process and raw materials |
764 |
607 |
|||||
Inventories at FIFO cost |
1,479 |
1,243 |
|||||
Excess of FIFO over LIFO |
(74 |
) |
(69 |
) |
|||
Total inventories |
$ |
1,405 |
$ |
1,174 |
NOTE 4. PROVISION FOR INCOME TAXES
Our tax rates are generally less than the 35 percent U.S. income tax rate primarily because of lower taxes on foreign earnings, export tax benefits and (for 2005) research tax credits. The U.S. tax research credit expired on December 31, 2005 and has not yet been renewed.
Our effective tax rate for the three and nine months ended October 1, 2006, was 33.7 percent and 30.5 percent, respectively. Our provision for the nine months ended October 1, 2006, was impacted by a $12 million, or $0.23 per share, increase in the first quarter for the effect of new Indiana tax legislation, and a $28 million, or $0.55 per share, reduction in the second quarter due to the favorable resolution of tax uncertainties related to prior years. Our effective tax rate for the three and nine months ended September 25, 2005, was 28.6 percent and 27.6 percent, respectively. Our 2005 provision was reduced by $11 million ($6 million in the first quarter, $4 million in the second quarter and $1 million in the third quarter) for the tax benefits of foreign dividend distributions which qualified for a special 85-percent deduction under The American Jobs Creation Act of 2004.
8
NOTE 5. GOODWILL AND OTHER INTANGIBLE ASSETS
The changes in the carrying amounts of goodwill for the nine months ended October 1, 2006, were as follows:
|
|
Components |
|
Power |
|
Engine |
|
Distribution |
|
Total |
|
|||||||||||||
|
|
Millions |
|
|||||||||||||||||||||
Goodwill at December 31, 2005 |
$ |
332 |
$ |
13 |
$ |
7 |
$ |
6 |
$ |
358 |
||||||||||||||
Additions |
— |
— |
— |
— |
— |
|||||||||||||||||||
Disposition |
— |
— |
— |
(1 |
) |
(1 |
) |
|||||||||||||||||
Translation and other |
— |
2 |
— |
— |
2 |
|||||||||||||||||||
Goodwill at October 1, 2006 |
$ |
332 |
$ |
15 |
$ |
7 |
$ |
5 |
$ |
359 |
The
components of other intangible assets with finite lives subject to amortization
were as follows:
|
|
October 1, |
|
December 31, |
|
||
|
|
2006 |
|
2005 |
|
||
|
|
Millions |
|
||||
Software |
$ |
213 |
$ |
199 |
|||
Accumulated amortization |
(104 |
) |
(103 |
) |
|||
Net software |
109 |
96 |
|||||
Trademarks, patents and other |
7 |
6 |
|||||
Accumulated amortization |
(3 |
) |
(2 |
) |
|||
Net trademarks, patents and other |
4 |
4 |
|||||
Total |
$ |
113 |
$ |
100 |
NOTE 6. SHORT-TERM BORROWINGS
Short-term borrowings included the following:
|
|
October 1, |
|
December 31, |
|
||
|
|
2006 |
|
2005 |
|
||
|
|
Millions |
|
||||
Loans payable |
$ |
40 |
$ |
40 |
|||
Current maturities of long-term debt |
208 |
114 |
|||||
Total short-term borrowings |
$ |
248 |
$ |
154 |
NOTE 7. LONG-TERM DEBT
Junior Convertible Subordinated Debentures
On May 8, 2006, the Board of Directors approved the Company’s plan to redeem all of the 7% convertible quarterly income preferred securities that were issued in June 2001. On May 9, 2006, we gave the trustee our formal irrevocable notification of our intent to redeem the preferred securities. This notification provided the holders of the preferred securities 30 days in which to convert their securities into shares of common stock. Upon expiration of the notification period, all remaining securities not converted were redeemed for cash at a premium above liquidation value. Substantially all of the $300 million 7% convertible subordinated debentures outstanding were converted into shares of our common stock during the second quarter of 2006. As a result of the conversion, approximately 6.3 million shares of common stock were issued during the second quarter which resulted in an increase of approximately $16 million to common stock outstanding and an increase of approximately $276 million to additional contributed capital. Since substantially all holders converted their preferred securities to common stock, the loss on extinguishment of this debt was insignificant. See Note 11 to the Consolidated Financial Statements in our 2005 Annual Report to Shareholders on Form 10-K for more information regarding the preferred securities and debentures.
9
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 |
|
|||||||||||||
|
|
Three months ended |
|
||||||||||||||||
|
|
October 1, |
|
September 25, |
|
October 1, |
|
September 25, |
|
October 1, |
|
September 25, |
|
||||||
|
|
2006 |
|
2005 |
2006 |
|
2005 |
|
2006 |
|
2005 |
|
|||||||
Millions |
|||||||||||||||||||
Service cost |
|
$ |
12 |
$ |
12 |
$ |
8 |
$ |
5 |
$ |
1 |
$ |
— |
||||||
Interest cost |
26 |
26 |
14 |
13 |
8 |
10 |
|||||||||||||
Expected return on plan assets |
(31 |
) |
(31 |
) |
(14 |
) |
(13 |
) |
— |
— |
|||||||||
Amortization of prior service cost (credit) |
— |
1 |
1 |
1 |
(2 |
) |
— |
||||||||||||
Recognized net actuarial loss (gain) |
10 |
8 |
5 |
4 |
(1 |
) |
— |
||||||||||||
Other |
— |
— |
1 |
— |
— |
||||||||||||||
Net periodic benefit cost |
$ |
17 |
$ |
16 |
$ |
15 |
$ |
10 |
$ |
6 |
$ |
10 |
|
|
Pension |
|
|
|
|||||||||||||||
|
|
U.S. Plans |
Non-U.S. Plans |
|
Postretirement |
|
||||||||||||||
|
|
Nine months ended |
|
|||||||||||||||||
|
|
October 1, |
|
September 25, |
|
October 1, |
|
September 25, |
|
October 1, |
|
September 25, |
|
|||||||
|
|
2006 |
|
2005 |
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||||||
Millions |
||||||||||||||||||||
Service cost |
|
$ |
36 |
$ |
34 |
$ |
22 |
$ |
17 |
$ |
1 |
$ |
— |
|||||||
Interest cost |
80 |
80 |
38 |
39 |
24 |
29 |
||||||||||||||
Expected return on plan assets |
(95 |
) |
(93 |
) |
(39 |
) |
(41 |
) |
— |
— |
||||||||||
Amortization of prior service cost (credit) |
2 |
3 |
2 |
3 |
(8 |
) |
— |
|||||||||||||
Recognized net actuarial loss (gain) |
28 |
24 |
14 |
12 |
(1 |
) |
— |
|||||||||||||
Other |
— |
1 |
1 |
1 |
— |
— |
||||||||||||||
Net periodic benefit cost |
$ |
51 |
$ |
49 |
$ |
38 |
$ |
31 |
$ |
16 |
$ |
29 |
||||||||
For the three and nine months ended October 1, 2006, we contributed approximately $71 million and $154 million, respectively, to our pension plans and paid approximately $10 million and $41 million, respectively, of postretirement benefits. For the three and nine months ended September 25, 2005, we contributed approximately $66 million and $121 million, respectively, to our pension plans and paid approximately $15 million and $40 million, respectively, of postretirement benefits. We presently anticipate contributing approximately $101 million to $106 million to our pension plans and paying approximately $19 million in claims and premiums for postretirement benefits during the remainder of 2006. These contributions and payments include payments from Company funds to either increase pension plan assets or to make direct payments to plan participants. As a result, $227 million of pension liability was included in “other accrued expenses” on our Condensed Consolidated Balance Sheet at October 1, 2006.
The Company incurred expenses of $5 million and $4 million for the three months ended October 1, 2006 and September 25, 2005, respectively, relating to our defined contribution plans. The Company incurred expenses of $23 million and $21 million for the nine months ended October 1, 2006 and September 25, 2005, respectively, relating to our defined contribution plans.
10
NOTE 9. 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 nine month interim periods follows:
|
|
Nine months ended |
|
||||
|
|
October 1, |
|
September 25, |
|
||
|
|
2006 |
|
2005 |
|
||
|
|
Millions |
|||||
Balance, beginning of period |
$ |
581 |
$ |
495 |
|||
Provision for warranties issued during the period |
244 |
201 |
|||||
Deferred revenue on extended warranty contracts sold |
59 |
48 |
|||||
Payments |
(215 |
) |
(157 |
) |
|||
Amortization of deferred revenue on extended warranty contracts |
(26 |
) |
(17 |
) |
|||
Changes in estimates for pre-existing warranties |
3 |
(6 |
) |
||||
Foreign currency translation |
4 |
(2 |
) |
||||
Balance, end of period |
$ |
650 |
$ |
562 |
The amount of deferred revenue related to extended coverage programs at October 1, 2006 and December 31, 2005, was $160 million and $122 million, respectively.
At October 1, 2006, we had $25 million of receivables related to estimated supplier recoveries of which $17 million was included in “Receivables, net” and $8 million was included in “Other assets” on our Condensed Consolidated Balance Sheets. At December 31, 2005, we had $35 million of receivables related to estimated supplier recoveries of which $25 million was included in “Receivables, net” and $10 million was included in “Other assets” on our Condensed Consolidated Balance Sheets.
NOTE 10. 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 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 Financing
Since 1997 we have had an operating agreement with a financial institution that requires 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. The agreement has been amended, supplemented or otherwise modified several times since 1997 and 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 in effect until February 7, 2007 and may be renewed for additional one-year terms.
11
Residual Value Guarantees
We have various residual value guarantees on equipment leased under operating leases. The total amount of these residual value guarantees at October 1, 2006, was $10 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 was $13 million at October 1, 2006.
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 October 1, 2006, if we were to stop purchasing from each of these suppliers, the amount of the penalty would be approximately $19 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 and Other Commitments
As of October 1, 2006, we have committed to invest $11 million into three
joint ventures that were formed during 2005 and 2006.
NOTE
11. COMPREHENSIVE EARNINGS
A reconciliation of our net earnings to comprehensive earnings was as follows:
|
|
Three months ended |
|
Nine months ended |
|
||||||||
|
|
October 1, |
|
September 25, |
|
October 1, |
|
September 25, |
|
||||
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
|
Millions |
||||||||||||
Net earnings |
$ |
171 |
$ |
145 |
$ |
526 |
$ |
383 |
|||||
Other comprehensive earnings (loss), net of tax: |
|||||||||||||
Minimum pension liability adjustment |
(2 |
) |
— |
(2 |
) |
— |
|||||||
Change in cumulative translation adjustment |
26 |
(3 |
) |
57 |
(37 |
) |
|||||||
Unrealized gain (loss) on marketable securities |
1 |
(1 |
) |
— |
|||||||||
Unrealized (loss) gain on derivatives |
(6 |
) |
1 |
23 |
(5 |
) |
|||||||
Comprehensive earnings |
$ |
190 |
$ |
143 |
$ |
603 |
$ |
341 |
12
NOTE 12. 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 of 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. 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 |
|
Nine months ended |
|
||||||||||
|
|
October 1, |
|
September 25, |
|
October 1, |
|
September 25, |
|
||||||
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||||
|
|
Millions (except per share amounts) |
|
||||||||||||
Net earnings for basic EPS |
$ |
171.3 |
$ |
145.3 |
$ |
526.0 |
$ |
383.0 |
|||||||
Interest on junior convertible subordinated debentures, net of tax |
— |
3.2 |
5.9 |
|
|||||||||||
Net earnings for diluted EPS |
$ |
171.3 |
$ |
148.5 |
$ |
531.9 |
$ |
392.7 |
|||||||
Weighted-average common shares outstanding: |
|||||||||||||||
Basic |
50.3 |
44.4 |
46.8 |
44.1 |
|||||||||||
Dilutive effect of stock compensation awards |
0.4 |
0.5 |
0.4 |
0.6 |
|||||||||||
Dilutive effect of junior convertible subordinated debentures |
— |
6.3 |
3.7 |
6.3 |
|||||||||||
Diluted |
50.7 |
51.2 |
50.9 |
51.0 |
|||||||||||
Earnings per share: |
|||||||||||||||
Basic |
$ |
3.40 |
$ |
3.27 |
$ |
11.24 |
$ |
8.68 |
|||||||
Diluted |
$ |
3.37 |
$ |
2.90 |
$ |
10.46 |
$ |
7.70 |
|||||||
NOTE 13. STOCK INCENTIVE AND STOCK OPTION PLANS
In September 2003, our shareholders approved the 2003 Stock Incentive Plan (The Plan). The Plan allows for the granting of up to 2.5 million stock-based awards to executives and employees, of which one-half must be in the form of stock options. Awards available for grant under the plan include, but are not limited to, stock options, stock appreciation rights, performance shares, restricted stock and other stock awards. Stock options are generally granted with a strike price equal to the fair market value of the stock on the date of grant, a life of 10 years and a two-year vesting period.
The performance shares are granted as target awards and are earned based on the Company’s return on equity (ROE) performance. A payout factor has been established ranging from zero to 200 percent of the target award based on the actual ROE performance during the two-year period. Any shares earned are then restricted for one additional year. Employees leaving the Company prior to the end of the restriction period forfeit their shares. Compensation expense is recorded ratably over the period beginning on the grant date until the shares become unrestricted and is based on the amount of the award that is expected to be earned under the plan formula, adjusted each reporting period based on current information.
Under the stock incentive plan, restricted common stock is awarded from time to time at no cost to certain employees. Participants are entitled to cash dividends and voting rights. Restrictions limit the sale or transfer of the shares during a defined period. Generally, one-third of the shares are released after two years and one-third of the shares issued are released each year thereafter on the anniversary of the grant date, provided the participant remains an employee. Compensation expense is determined at the grant date and is recognized over the four-year restriction period on a straight-line basis.
Prior to January 1, 2006, we accounted for stock-based employee awards granted on or after January 1, 2003, utilizing the fair value method preferred by SFAS No. 123, “Accounting for Stock-Based Compensation.” For awards granted prior to January 1, 2003, we applied the disclosure-only provisions of SFAS No. 123. In accordance with SFAS No. 123, we applied APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations in accounting for our plans prior to January 1, 2003 and accordingly, did not recognize compensation expense for these plans because we granted options at exercise prices equal to the market value of our stock on the grant date.
13
Effective January 1, 2006, we adopted SFAS No. 123R, “Share-Based Payment,” which revised SFAS No. 123 and supercedes APB No. 25. We adopted this statement using the modified prospective transition method which does not require the restatement of prior periods. SFAS No. 123R requires the recognition of expense for share-based payments to be recorded in the consolidated financial statements based on the grant date fair value and to be recognized over their vesting periods. Under SFAS No. 123R, the Company is required to select a valuation technique or option-pricing model that meets the requirements of the standard. Allowable valuation models include a binomial model and the Black-Scholes model. At the present time, the Company is continuing to use the Black-Scholes model. Since we had previously accounted for our awards at fair value under SFAS No. 123, the impact of adopting SFAS No. 123R was not material to our Condensed Consolidated Financial Statements. The two most significant changes related to accounting for forfeitures and accounting for tax benefits of awards. SFAS No. 123R requires the Company to estimate forfeitures in calculating the expense relating to share-based compensation as opposed to recognizing these forfeitures and the corresponding reduction in expense as they occur. The cumulative adjustment recorded by the Company upon the adoption of SFAS No. 123R for the estimated forfeitures on grants outstanding on the date of adoption was not material. Excess tax benefits related to share-based compensation are now classified as a financing activity in the statement of cash flows rather than an operating activity. For the nine months ended October 1, 2006, we had $6 million of excess tax benefits related to share-based compensation presented in our Condensed Consolidated Statement of Cash Flows as a financing activity.
Compensation expense (net of estimated forfeitures) related to our share-based plans for the three and nine months ended October 1, 2006, was approximately $6 million and $13 million, respectively. Compensation expense (net of actual forfeitures) related to our share-based plans for the three and nine months ended September 25, 2005, was approximately $4 million and $11 million, respectively. The excess tax benefit associated with option exercises and share vesting during the three and nine months ended October 1, 2006, was zero and $6 million, respectively. The excess tax benefit associated with option exercises and share vesting during the three and nine months ended September 25, 2005, was approximately $5 million and $7 million, respectively. The total unrecognized compensation expense (net of estimated forfeitures) related to nonvested awards was approximately $37 million at October 1, 2006 and was expected to be recognized over a weighted-average period of 1.8 years.
The table below summarizes
the activity in our stock option plans:
|
|
Options |
|
Weighted-average |
|
|||
Balance, December 31, 2005 |
399,700 |
$ |
44.59 |
|||||
Granted |
450 |
105.24 |
||||||
Exercised |
(181,535 |
) |
45.97 |
|||||
Forfeited |
(1,650 |
) |
40.63 |
|||||
Expired |
— |
— |
||||||
Balance, October 1, 2006 |
216,965 |
$ |
43.59 |
|||||
|
|
|
|
|
|
|
||
Exercisable, October 1, 2006 |
|
216,965 |
|
|
$ |
43.59 |
|
The weighted-average grant date fair value of options granted by the Company during the nine months ended October 1, 2006 and September 25, 2005 was $105.24 and $69.89, respectively. The total intrinsic value of options exercised during the nine months ended October 1, 2006 and September 25, 2006, was approximately $13 million and $32 million, respectively.
14
The weighted-average
grant date fair value of performance and restricted shares at October 1, 2006
and during the first nine months of 2006 is as follows:
|
Performance Shares |
|
|
Weighted-average |
|
Nonvested at December 31, 2005 |
722,650 |
$ |
56.27 |
||
Granted |
175,148 |
98.86 |
|||
Vested |
(246,800 |
) |
48.05 |
||
Forfeited |
(12,870 |
) |
55.29 |
||
Nonvested at October 1, 2006 |
638,128 |
$ |
71.16 |
|
|
||||
|
Restricted Shares |
|
|
Weighted-average |
|
Nonvested at December 31, 2005 |
1,000 |
$ |
74.87 |
||
Granted |
50,000 |
107.85 |
|||
Vested |
— |
— |
|||
Forfeited |
— |
— |
|||
Nonvested at October 1, 2006 |
51,000 |
$ |
107.20 |
The fair value of each option grant was estimated on
the grant date using the Black-Scholes option pricing model with the following
assumptions:
Nine months ended |
|||||||
October 1, 2006 |
|
September 25, 2005 |
|||||
Expected life (years) |
7 |
7 |
|||||
Risk-free interest rate |
4.9 |
% |
4.1 |
% |
|||
Expected volatility |
26.4 |
% |
38.8 |
% |
|||
Dividend yield |
1.8 |
% |
2.5 |
% |
Expected life – The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding based upon our historical data.
Risk-free interest rate – The risk-free interest rate assumption is based upon the observed U.S. treasury security rate appropriate for the expected life of the Company’s employee stock options.
Expected volatility – The expected volatility assumption is based upon the weighted-average historical daily price changes of the Company’s common stock over the most recent period equal to the expected option life of the grant, adjusted for activity which is not expected to occur in the future.
Dividend yield – The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.
The table below
summarizes stock option information for options outstanding, all of which are
currently exercisable at October 1, 2006:
|
|
|
|
Options Outstanding and Exercisable |
||||||||||||
Exercise Price Range |
|
|
|
Number of |
|
Weighted-average |
|
Weighted-average |
|
Aggregate Intrinsic Value |
||||||
$23.95 – 35.92 |
650 |
1.9 |
$ |
32.01 |
$ |
56,692 |
||||||||||
$35.93 – 53.89 |
196,590 |
4.6 |
42.26 |
15,130,687 |
||||||||||||
$53.90 – 107.44 |
19,725 |
1.8 |
57.18 |
1,223,900 |
||||||||||||
216,965 |
4.4 |
$ |
43.59 |
$ |
16,411,279 |
15
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. See Note 19 to the Consolidated Financial Statements in our 2005 Annual Report on Form 10-K for additional detail and historical data.
A summary
of operating results by segment for the three and nine month periods is shown
below:
|
|
Engine |
|
Power |
|
Components |
|
|
|
Eliminations |
|
Total |
|
||||||||||||
|
|
Millions |
|
||||||||||||||||||||||
Three months ended
|
|||||||||||||||||||||||||
Net sales |
$ |
1,842 |
$ |
624 |
|
$ |
564 |
$ |
346 |
$ |
(567 |
) |
$ |
2,809 |
|||||||||||
Investee equity, royalty and other income |
16 |
4 |
2 |
15 |
— |
37 |
|||||||||||||||||||
Segment EBIT |
183 |
57 |
19 |
38 |
|
(1 |
) |
296 |
|||||||||||||||||
Three months ended
|
|||||||||||||||||||||||||
Net sales |
$ |
1,672 |
$ |
504 |
$ |
481 |
$ |
295 |
$ |
(485 |
) |
$ |
2,467 |
||||||||||||
Investee equity, royalty and other income |
17 |
2 |
3 |
9 |
— |
31 |
|||||||||||||||||||
Segment EBIT |
153 |
46 |
21 |
28 |
(8 |
) |
240 |
||||||||||||||||||
Nine months ended
|
|||||||||||||||||||||||||
Net sales |
$ |
5,559 |
$ |
1,758 |
|
$ |
1,682 |
$ |
999 |
|
$ |
(1,669 |
) |
$ |
8,329 |
||||||||||
Investee equity, royalty and other income |
51 |
10 |
6 |
38 |
— |
105 |
|||||||||||||||||||
Segment EBIT |
552 |
158 |
84 |
105 |
|
(23 |
) |
876 |
|||||||||||||||||
Nine months ended
|
|||||||||||||||||||||||||
Net sales |
$ |
4,819 |
$ |
1,424 |
$ |
1,465 |
$ |
845 |
$ |
(1,388 |
) |
$ |
7,165 |
||||||||||||
Investee equity, royalty and other income |
67 |
6 |
7 |
23 |
— |
103 |
|||||||||||||||||||
Segment EBIT |
426 |
96 |
65 |
74 |
(23 |
) |
638 |
||||||||||||||||||
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 |
|
Nine months ended |
|
||||||||
|
|
October 1, |
|
September 25, |
|
October 1, |
|
September 25, |
|
||||
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
Millions |
|||||||||||||
Segment EBIT |
$ |
296 |
$ |
240 |
$ |
876 |
$ |
638 |
|||||
Less: |
|||||||||||||
Interest expense |
23 |
27 |
76 |
83 |
|||||||||
Earnings before income taxes and minority interests |
$ |
273 |
$ |
213 |
$ |
800 |
$ |
555 |
16
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 2005 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 2005 Annual Report on Form 10-K and “Disclosure Regarding Forward-Looking Statements” presented at the end of this section. Certain prior year amounts included in this section have been reclassified to conform to the current year presentation. Our MD&A 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.
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.
17
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 maintain an internet website at www.cummins.com. Investors can obtain copies of our filings with the Securities Exchange Commission (SEC) from this website free of charge, as well as from the SEC website at www.sec.gov.
We experienced
another strong operating performance in the third quarter of 2006 with net
earnings of $171 million, or $3.37 per diluted share, on net sales of $2.8
billion, compared to third quarter 2005 net earnings of $145 million, or $2.90
per diluted share, on net sales of $2.5 billion. Year-to-date 2006 net
earnings were $526 million, or $10.46 per diluted share, on net sales of $8.3
billion, compared to year-to-date 2005 net earnings of $383 million, or $7.70
per diluted share, on net sales of $7.2 billion. Third quarter net
earnings and sales continued to be strong for Cummins as we continue to benefit
from improved economic conditions resulting in high levels of demand across our
businesses, as well as increased share in a number of markets and our focus on
cost reduction. All of our segments reported sales increases in the third
quarter and year to date compared to the same periods a year ago, with
particularly strong demand in the North American heavy-duty truck market and
the Power Generation commercial market, where year to date sales increased 21
percent and 30 percent, respectively. Overall, our Engine segment net
sales were up $740 million, or 15 percent, year to date. In addition, net
sales increased at our Power Generation segment (up $334 million, or 23
percent), Components segment (up $217 million, or 15 percent) and Distribution
segment (up $154 million, or 18 percent) on a year to date basis.
|
|
Three months ended |
|
Nine months ended |
|
||||||||
|
|
October 1, 2006 |
|
September 25, 2005 |
|
October 1, 2006 |
|
September 25, 2005 |
|
||||
Consolidated Results |
|
Millions (except earnings per share ) |
|
||||||||||
Net sales |
$ |
2,809 |
$ |
2,467 |
$ |
8,329 |
$ |
7,165 |
|||||
Gross margin |
654 |
561 |
1,925 |
1,567 |
|||||||||
Investee equity, royalty and other income |
(37 |
) |
(31 |
) |
(105 |
) |
(103 |
) |
|||||
Operating earnings |
278 |
232 |
835 |
631 |
|||||||||
Net earnings |
171 |
145 |
526 |
383 |
|||||||||
Diluted earnings per share |
$ |
3.37 |
$ |
2.90 |
$ |
10.46 |
$ |
7.70 |
During the first nine months of 2006, 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:
Business Expansion
In January 2006, we signed a joint venture agreement with KAMAZ Inc., the largest vehicle manufacturer in Russia, to produce B Series engines under the name ZAO Cummins Kama. The joint venture will build on the Cummins and KAMAZ relationship that dates back to the early 1980s. Among the customers of the new company are KAMAZ trucks and buses, as well as trucks, buses and agricultural equipment produced by other manufacturers in Russia, Belarus and the Ukraine.
18
In March 2006, we signed a feasibility study with Beiqi Foton Motor Company (Beiqi Foton) on the formation of a 50/50 joint venture company to produce two types of light-duty diesel engines for use primarily in the commercial market. In October 2006, we signed an agreement with Beiqi Foton to form a 50/50 joint venture, Beijing Foton Cummins Engine Company (BFCEC), to produce two types of Cummins light-duty, high performance diesel engines in Beijing. The engines will be used in light-duty commercial trucks, pickup trucks, multipurpose and sport utility vehicles. Certain types of marine, small construction equipment and industrial applications will also be served by this engine family. Cummins and Beiqi Foton will initially invest a combined $126 million into BFCEC, which is scheduled to begin production in 2008.
In July 2006, we announced that we had reached agreement with a major automotive manufacturer serving the North American market to produce and market a light-duty, diesel-powered engine. In October 2006, we announced that we would use an existing facility for production of this new engine platform and that DaimlerChrysler was our significant customer. As a part of the agreement, the Company will develop and manufacture a family of high-performance, light-duty diesel engines for a variety of on-highway applications in vehicles below 8,500 pounds gross vehicle weight, including standard pickup trucks and sport utility vehicles, as well as industrial applications. The first vehicles with this engine are expected to be ready for market by the end of the decade.
In August 2006, our first technical center in China was opened in Wuhan City. The East Asia Technical Center, a 55-45 joint venture between Cummins and Donfeng Cummins Engine Company Limited (DCEC), will provide engineering and technical development services for the full range of Cummins products built in China, including diesel and natural gas engines, power generators, turbochargers and filtration products. A series of projects has already been started in the technical center, including the development of a new 13-liter engine platform for the heavy-duty truck platform served by DCEC.
Business Divestiture
On September 22, 2006, the Company announced that it had reached an agreement to sell its SEG GmbH subsidiary based in Kempen, Germany to Woodward Governor Company, subject to customary approvals. The sale is expected to close in the fourth quarter. SEG, which is a part of the Company’s Power Generation segment, specializes in the design and manufacturing of measurement, control and protection products for power generation systems with an emphasis on the wind power generation segment. Total assets of SEG were approximately $41 million and $39 million at October 1, 2006 and December 31, 2005, respectively, which is less than 1 percent of our total assets at these dates. Total sales at SEG were approximately $44 million and $52 million, for the nine months ended October 1, 2006 and September 25, 2005, respectively, which is less than 1 percent of our total net sales for these periods.
Financing Matters
On May 8, 2006, the Board of Directors approved the Company’s plan to redeem all of the 7% convertible quarterly income preferred securities that were issued in June 2001. On May 9, 2006, we gave the trustee our formal irrevocable notification of our intent to redeem the preferred securities. As a result, substantially all of the related $300 million of 7% convertible subordinated debentures outstanding were converted into shares of our common stock.
During the second quarter of 2006, we completed our previously announced $100 million share repurchase program. In July 2006, the Board of Directors gave the Company authorization to acquire up to two million shares of Cummins common stock in addition to what has been acquired under previous authorizations. During the third quarter, the Company purchased over 120,000 shares for approximately $14 million. In addition, the Board also voted to increase the quarterly cash dividend per share by 20 percent to $0.36 per share.
Our level of debt at October 1, 2006, has decreased by $306 million since December 31, 2005 and our debt-to-capital ratio has improved to 28.4 percent at October 1, 2006, from 42.3 percent at December 31, 2005. As previously announced, we intend to repay our $250 million 9.5% notes in December 2006, the first call date for the debt. The notes were issued in 2002 and are expected to be repaid using cash generated from operations.
During the first nine months of 2006, we made contributions of approximately $154 million to our pension plans.
19
RESULTS OF OPERATIONS
Three Months Ended - 2006 versus 2005
|
|
Three Months Ended |
|
Change |
|
||||||||
|
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
||||
|
|
$ in millions |
|
|
|
||||||||
Net sales |
$ |
2,809 |
$ |
2,467 |
$ |
342 |
14 |
% |
|||||
Cost of sales |
2,155 |
1,906 |
249 |
13 |
% |
||||||||
Gross margin |
654 |
561 |
93 |
17 |
% |
||||||||
Operating expenses (income) |
|||||||||||||
Selling and administrative expenses |
328 |
286 |
42 |
15 |
% |
||||||||
Research and engineering expenses |
81 |
71 |
10 |
14 |
% |
||||||||
Investee equity, royalty and other income |
(37 |
) |
(31 |
) |
(6 |
) |
19 |
% |
|||||
Other operating expense, net |
4 |
3 |
1 |
33 |
% |
||||||||
Operating earnings |
278 |
232 |
46 |
20 |
% |
||||||||
Interest income |
(14 |
) |
(6 |
) |
(8 |
) |
NM |
||||||
Interest expense |
23 |
27 |
(4 |
) |
15 |
% |
|||||||
Other income, net |
(4 |
) |
(2 |
) |
(2 |
) |
NM |
||||||
Earnings before income taxes and minority interests |
273 |
213 |
60 |
28 |
% |
||||||||
Provision for income taxes |
92 |
61 |
31 |
51 |
% |
||||||||
Minority interests in earnings of consolidated subsidiaries |
10 |
7 |
3 |
43 |
% |
||||||||
Net earnings |
$ |
171 |
$ |
145 |
$ |
26 |
18 |
% |
|||||
Net Sales
Net sales increased in all segments. Engine sales were up $170 million, or 10 percent, due to strong demand from heavy- and medium-duty truck OEMs and higher engine volumes for industrial applications. These increases were partially offset by decreased shipments of light-duty automotive engines. Engine and part sales to on-highway markets were 7 percent higher compared to last year with increased volumes in all market segments, except light-duty automotive. Power Generation sales increased $120 million, or 24 percent, due to increased demand across all product lines. Components sales increased $83 million, or 17 percent, due to increased volume within all of our Components businesses. Distribution sales increased $51 million, or 17 percent, primarily due to increased demand for power generation products followed by increased parts and service volumes. See our “Operating Segment Results” section for further details on sales by segment.
Gross Margin
Gross margin improved primarily due to increased sales, the related absorption benefits on fixed manufacturing costs, and changes in sales mix, all of which increased gross margin by $93 million. In addition, $21 million of price realization, net of increased product costs, improved gross margin in the current period compared to the same period in the prior year. These increases in margin were partially offset by increased warranty expenses of $15 million, primarily as a result of the increased volumes. Other factors which impacted gross margin to a lesser extent were the impact of currency exchange rates and other miscellaneous fluctuations.
Warranty expense as a percent of sales increased slightly to 2.9 percent in the third quarter of 2006 compared to 2.7 percent in the third quarter of 2005.
Selling and Administrative Expenses
Selling and administrative expenses increased primarily due to higher compensation and related expenses of approximately $19 million, which included salaries, variable compensation and fringe benefits, as a result of improved financial performance of the company. Other factors affecting selling and administrative expenses to a lesser extent included increased consulting fees and other outside services of $10 million and increased marketing and administrative expenses of $6 million. The remaining change in selling and administrative expenses is due to a combination of increases in various other miscellaneous expenses, none of which were significant individually, including foreign currency impact. Overall selling and administrative expenses were 11.7 percent of sales in the third quarter of 2006 compared to 11.6 percent of sales in the third quarter of 2005.
20
Research and Engineering Expenses
Research and engineering expenses increased primarily due to increased compensation expense and consulting and outside services. 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 and Components segments each had increases in research and development of $3 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 increased slightly primarily due to an increase in earnings at several of our equity investees, led by a $5 million increase in earnings from our North American distributors and a $2 million increase in earnings from Chongqing Cummins Engine Company, Ltd (CCEC). In addition, royalty and other income from equity investees increased by $2 million. These increases were partially offset by a $3 million decrease in earnings at Cummins Mercruiser Diesel Marine, LLC (CMD) due to softness in North American recreational marine markets.
Other Operating Expense, Net
The major components of other operating expense are royalty income, amortization of intangible assets and gain or loss on sale of fixed assets. There were no individual fluctuations in the components of other operating expense that were significant.
Interest Income
Interest income increased primarily due to higher average cash balances in the third quarter of 2006 compared to the third quarter of 2005. The higher average cash balances are due to increased earnings and stronger cash flows from operations in 2006.
Interest Expense
Interest expense decreased primarily due to lower average debt balances in the third quarter of 2006 as compared to the same period in 2005. The conversion of our $300 million 7% convertible subordinated debentures during the second quarter resulted in a reduction in interest expense of over $5 million for the third quarter of 2006 as compared to 2005.
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 increase in other income is due to an approximately $5 million increase in foreign currency exchange gains. Partially offsetting this increase were fluctuations in the components of various miscellaneous other income and expenses, none of which were significant individually.
Provision for Income Taxes
Our tax rates are generally less than the 35 percent U.S. income tax rate primarily because of lower taxes on foreign earnings, export tax benefits and (for 2005) research tax credits. The U.S. tax research credit expired on December 31, 2005 and has not yet been renewed.
Our effective tax rate for the three months ended October 1, 2006, was 33.7 percent. Our effective tax rate for the three months ended September 25, 2005, was 28.6 percent. Our 2005 provision was reduced by $1 million in the third quarter for the tax benefits of foreign dividend distributions which qualified for a special 85-percent deduction under The American Jobs Creation Act of 2004.
The effective tax rate for the remainder of the year is expected to approximate 32.5 percent absent any additional discrete period activity.
Minority Interests in Earnings of Consolidated Subsidiaries
Minority interest is primarily attributable to Cummins India Ltd. (CIL), a 51 percent owned subsidiary, Wuxi Holset Engineering Co. Ltd. (Wuxi), a 55 percent owned subsidiary, and Cummins Eastern Canada LLP (CEC), a 51 percent owned subsidiary. These three subsidiaries account for over 80 percent of the total minority interest in the third quarter of 2006. Earnings at CIL and Wuxi increased this year resulting in a combined increase in minority interest of $1 million in the third quarter of 2006 compared to the third quarter of 2005. In addition, earnings at SEG GmbH & Co. KG, a 51 percent owned subsidiary, improved resulting in a $2 million quarter over quarter increase in minority interests. Earnings at CEC decreased slightly. The remainder of the consolidated partially-owned subsidiaries had a combination of immaterial increases and decreases in earnings.
21
Nine Months Ended - 2006 versus 2005
|
|
Nine Months Ended |
|
Change |
|
||||||||
|
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
||||
|
|
$ in millions |
|
|
|
||||||||
Net sales |
$ |
8,329 |
$ |
7,165 |
$ |
1,164 |
16 |
% |
|||||
Cost of sales |
6,404 |
5,598 |
806 |
14 |
% |
||||||||
Gross margin |
1,925 |
1,567 |
358 |
23 |
% |
||||||||
Operating expenses (income) |
|||||||||||||
Selling and administrative expenses |
949 |
832 |
117 |
14 |
% |
||||||||
Research and engineering expenses |
243 |
207 |
36 |
17 |
% |
||||||||
Investee equity, royalty and other income |
(105 |
) |
(103 |
) |
(2 |
) |
2 |
% |
|||||
Other operating expense, net |
3 |
— |
3 |
NM |
|||||||||
Operating earnings |
835 |
631 |
204 |
32 |
% |
||||||||
Interest income |
(33 |
) |
(15 |
) |
(18 |
) |
NM |
||||||
Interest expense |
76 |
83 |
(7 |
) |
8 |
% |
|||||||
Other (income) expense, net |
(8 |
) |
8 |
(16 |
) |
NM |
|||||||
Earnings before income taxes and minority interests |
800 |
555 |
245 |
44 |
% |
||||||||
Provision for income taxes |
244 |
153 |
91 |
59 |
% |
||||||||
Minority interests in earnings of consolidated subsidiaries |
30 |
19 |
11 |
58 |
% |
||||||||
Net earnings |
$ |
526 |
$ |
383 |
$ |
143 |
37 |
% |
|||||
Net Sales
Net sales increased in all segments. Engine sales were up $740 million, or 15 percent, due to strong demand from heavy- and medium-duty truck OEMs, higher engine volumes for industrial applications and increased shipments of light-duty engines. Engine and part sales to on-highway markets were 15 percent higher compared to last year with increased volumes in all market segments. Power Generation sales increased $334 million, or 23 percent, due to increased demand across all product lines. Components sales increased $217 million, or 15 percent, due to increased sales within all of our Components businesses. Distribution sales increased $154 million, or 18 percent, primarily due to increased demand for power generation products followed by increased parts, engine and service volumes. See our “Operating Segment Results” section for further details on sales by segment.
Gross Margin
Gross margin improved primarily due to increased sales, the related absorption benefits on fixed manufacturing costs, and changes in sales mix, all of which increased gross margin by $348 million. In addition, $62 million in price realization, net of increased product costs, improved gross margin in the current period compared to the same period in the prior year. These increases in margin were partially offset by increased warranty expenses of $52 million, primarily as a result of the increased volumes. Other factors which impacted gross margin to a lesser extent were the impact of currency exchange rates and other miscellaneous fluctuations.
Warranty expense as a percent of sales increased slightly to 3.0 percent in the first nine months of 2006 compared to 2.7 percent in the first nine months of 2005.
Selling and Administrative Expenses
Selling and administrative expenses increased primarily due to higher compensation and related expenses of approximately $45 million, which included salaries, variable compensation and fringe benefits, as a result of improved financial performance of the company. In addition, incremental staffing added to the increased compensation and related expenses. Other factors affecting selling and administrative expenses included increased consulting fees and other outside services of $26 million, increased marketing and administrative expenses of $12 million and increased travel expenses of $15 million. The remaining change in selling and administrative expenses is due to a combination of increases in various other miscellaneous expenses, none of which were significant individually, partially offset by a favorable foreign currency impact. Overall selling and administrative expenses were 11.4 percent of sales in the first nine months of 2006 compared to 11.6 percent of sales in the first nine months of 2005.
22
Research and Engineering Expenses
Research and engineering expenses increased primarily due to increased compensation expense and consulting and outside services, as well as higher spending on development programs for future products. 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 $17 million of the increase in research and engineering expenses along with an increase in the Components segment of $13 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 increased slightly primarily due to an increase in earnings at several of our equity investees, led by a $14 million increase in earnings from our North American distributors, a $5 million increase in earnings from Tata Cummins Ltd. and a $3 million increase in earnings from CCEC. These increases were partially offset, by a $17 million decrease in earnings from Dongfeng Cummins Engine Company, Ltd. (DCEC), due to a continued disruption in demand in the truck markets caused by changes in China’s regulatory environment regarding vehicle weight restrictions, and a $4 million decrease in earnings from CMD.
Other Operating Expense, Net
The major components of other operating expense are royalty income, amortization of intangible assets and gain or loss on sale of fixed assets. The fluctuation from the first nine months of 2005 to the first nine months of 2006 was primarily due to a decrease in royalty income of approximately $3 million. Other fluctuations in other operating income were not significant individually or in the aggregate.
Interest Income
Interest income increased primarily due to higher average cash balances in the first nine months of 2006 compared to the first nine months of 2005. The higher average cash balances are due to increased earnings and stronger cash flows from operations in 2006.
Interest Expense
Interest expense decreased primarily due to lower debt balances in the first nine months of 2006 as compared to the same period in 2005. The conversion of our $300 million 7% convertible subordinated debentures during the second quarter resulted in a reduction in interest expense of over $5 million for the first nine months of 2006.
Other (Income) Expense, Net
The major components of other (income) expense include foreign currency exchange gains and losses, bank charges and other miscellaneous income and expenses. The fluctuation in other income in the first nine months of 2006 compared to the first nine months of 2005 is due to an $11 million fluctuation in foreign currency exchange gains and losses from a loss of approximately $4 million in 2005 to a gain of approximately $7 million in 2006. In addition, there were several fluctuations in the components of miscellaneous other income and expenses, none of which were individually significant.
Provision for Income Taxes
Our tax rates are generally less than the 35 percent U.S. income tax rate primarily because of lower taxes on foreign earnings, export tax benefits and (for 2005) research tax credits. The U.S. tax research credit expired on December 31, 2005 and has not yet been renewed.
Our effective tax rate for the nine months ended October 1, 2006, was 30.5 percent. Our income tax provision for the nine months ended October 1, 2006, was impacted by a $12 million, or $0.23 per share, increase in the first quarter for the effect of new Indiana tax legislation, and a $28 million, or $0.55 per share, reduction in the second quarter due to the favorable resolution of tax uncertainties related to prior years. Our effective tax rate for the nine months ended September 25, 2005, was 27.6 percent. Our 2005 provision was reduced by $11 million ($6 million in the first quarter, $4 million in the second quarter and $1 million in the third quarter) for the tax benefits of foreign dividend distributions which qualified for a special 85-percent deduction under The American Jobs Creation Act of 2004.
The effective tax rate for the remainder of the year is expected to approximate 32.5 percent absent any additional discrete period activity.
23
Minority Interests in Earnings of Consolidated Subsidiaries
Minority interest is
primarily attributable to Cummins India Ltd. (CIL), a 51 percent owned
subsidiary, Cummins Eastern Canada LLP (CEC), a 51 percent owned subsidiary,
and Wuxi Holset Engineering Co. Ltd. (Wuxi), a 55 percent owned
subsidiary. These three subsidiaries account for over 75 percent of the
total minority interest in the first nine months of 2006. Earnings at these
three subsidiaries increased this year resulting in a combined increase in
minority interest of $3 million for the first nine months of 2006 compared to
the first nine months of 2005. In addition, earnings at SEG GmbH &
Co. KG, a 51 percent owned subsidiary, improved resulting in a $4 million year
over year increase in minority interests. The remainder of the
consolidated partially-owned subsidiaries had a combination of immaterial
increases and decreases in earnings.
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.
The following is a discussion of operating results for each of our business segments.
Engine Results
Three Months Ended - 2006 versus 2005
The net sales, investee
income and segment EBIT for Engine were as follows:
|
|
Three months ended |
|
Change |
|
|||||||
$ in millions |
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
|||
Net sales |
$ |
1,842 |
$ |
1,672 |
$ |
170 |
10 |
% |
||||
Investee equity, royalty and other income |
16 |
17 |
(1 |
) |
(6 |
)% |
||||||
Segment EBIT |
183 |
153 |
30 |
20 |
% |
|||||||
Segment EBIT as a percentage of net sales |
9.9% |
9.2% |
0.7 percentage point |
|||||||||
The increase in net sales for this segment was primarily due to strong demand across most markets, particularly the North American heavy-duty truck market along with strong industrial market volumes. Total on-highway-related sales were 63 percent of Engine segment net sales during the third quarter of 2006, compared with 64 percent during the third quarter of 2005.
The improvement in segment EBIT was primarily due to higher engine volumes across all major markets, except for light-duty automotive, the accompanying gross margin benefits of higher absorption of fixed manufacturing costs and improved pricing. Gross margin increased $44 million, or 14 percent, quarter over quarter. Selling and administrative expenses increased $19 million, or 14 percent, quarter over quarter, and selling and administrative expenses as a percentage of net sales increased by less than one half of a percentage point. Research and engineering expenses increased $3 million, or 6 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 decreased slightly compared with the third quarter of 2005.
A summary and discussion of
Engine net sales by market follows:
|
|
Three months ended |
|
Change |
|
|||||||
$ in millions |
|
October 1 , 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
|||
Heavy-duty truck |
$ |
632 |
$ |
524 |
$ |
108 |
21 |
% |
||||
Medium-duty truck and bus |
253 |
238 |
15 |
6 |
% |
|||||||
Light-duty automotive and RV |
267 |
314 |
(47 |
) |
(15 |
)% |
||||||
Total on-highway |
1,152 |
1,076 |
76 |
7 |
% |
|||||||
Industrial |
507 |
427 |
80 |
19 |
% |
|||||||
Stationary power |
183 |
169 |
14 |
8 |
% |
|||||||
Total net sales |
$ |
1,842 |
$ |
1,672 |
$ |
170 |
10 |
% |
A summary of unit shipments by engine classification (including unit shipments to Power Generation) follows:
|
|
Three months ended |
|
Change |
|
||||
|
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
Midrange |
104,800 |
106,100 |
(1,300 |
) |
(1 |
)% |
|||
Heavy-duty |
31,000 |
26,300 |
4,700 |
18 |
% |
||||
High-horsepower |
4,100 |
3,300 |
800 |
24 |
% |
||||
Total unit shipments |
139,900 |
135,700 |
4,200 |
3 |
% |
Heavy-Duty Truck
The increase in sales to the heavy-duty truck market was primarily driven by the North American truck market as OEMs work to meet growing demand from truck fleets replacing trucks ahead of the 2007 change in emissions standards. Global unit shipments of heavy-duty truck engines were up 23 percent in the third quarter of 2006, compared to the third quarter of 2005, with North American shipments up 23 percent and international shipments up 22 percent. In addition, our North American heavy-duty truck market share increased slightly compared to the same period in 2005.
Medium-Duty Truck and Bus
The increase in medium-duty truck and bus revenues is due to our growing market share position with North American OEMs in the medium duty truck market and increased shipments of bus engines in North America. Shipments of medium-duty truck engines were up 42 percent to North American OEMs and down 17 percent to international OEMs compared with the third quarter of 2005. The increase in medium-duty truck engine shipments in North America is due to an overall increase in demand and growing penetration at key OEMs. The decrease in shipments to international OEMs is primarily due to changes in emissions standards in Brazil to Euro III effective January 1, 2006. Sales of bus engines and parts remained relatively flat in the third quarter of 2006, compared to the third quarter of 2005 due to a combination of strong demand from North American OEMs with shipments up 70 percent while international shipments were down 42 percent. The improvement in the North American transit bus market is due to increased market share while the decrease in international shipments quarter over quarter is due to a large purchase made in 2005 by a transit customer in China.
Light-Duty Automotive and RV
Sales of light-duty automotive engines decreased as a result of lower volumes. Total light-duty automotive unit shipments were approximately 35,900 in the third quarter of 2006, a decrease of 23 percent compared to the same period in 2005. As a result of softness in the U.S. automotive industry, shipments to DaimlerChrysler decreased approximately 11,300 units, or 27 percent, compared to the third quarter of 2005. Our plant that produces the engine for the Dodge Ram experienced 13 incremental shutdown days compared to the same period in 2005 as DaimlerChrysler announced significant production cuts late in the quarter to reduce its dealer inventory. Global engine shipments to recreational vehicle OEMs increased by 46 percent in the third quarter of 2006 compared with the same period in 2005 due to new product introductions and growing penetration at key OEMs.
Industrial
Total sales were up in all industrial markets, except for agriculture, primarily due to strong demand in those markets. Unit shipments increased 19 percent in the third quarter of 2006 compared to the same period in 2005. Approximately 52 percent of the shipments were to North American markets and 48 percent to international markets in the third quarter compared to 54 percent and 46 percent, respectively, for the same period in 2005. 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 the Middle East and Asia. Shipments to the construction market increased 19 percent in total and increased 22 percent internationally. The other markets showing significant increases were the oil and gas market and the mining market with increased shipments of 53 percent and 23 percent, respectively. Continued strength in commodity prices are driving increased investment in oil and gas and mining equipment. Other industrial markets had modest increases compared to the same period in 2005.
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.
25
Nine Months Ended - 2006 versus 2005
The net sales, investee
income and segment EBIT for Engine were as follows:
|
|
Nine months ended |
|
Change |
|
|||||||
$ in millions |
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
|||
Net sales |
$ |
5,559 |
$ |
4,819 |
$ |
740 |
15 |
% |
||||
Investee equity, royalty and other income |
51 |
67 |
(16 |
) |
(24 |
)% |
||||||
Segment EBIT |
552 |
426 |
126 |
30 |
% |
|||||||
Segment EBIT as a percentage of net sales |
9.9% |
8.8% |
1.1 percentage points |
|||||||||
The increase in net sales for this segment was primarily due to strong demand across most markets, particularly the North American heavy-duty truck market and the light-duty automotive market with strong engine sales to DaimlerChrysler, along with strong industrial market sales. Total on-highway-related sales were 63 percent of Engine segment net sales during the first nine months of 2006 and were 64 percent of Engine segment net sales during the first nine months of 2005.
The improvement in segment EBIT was primarily due to the higher engine volumes across all major markets, the accompanying gross margin benefits of higher absorption of fixed manufacturing costs, improved pricing and manufacturing efficiencies, all of which resulted in a nearly one percentage point improvement in gross margin percentage in the first nine months of 2006 compared to the same period last year. Gross margin increased $188 million, or 21 percent, for the first nine months of 2006 compared to the same period last year. Selling and administrative expenses increased $53 million, or 14 percent, however selling and administrative expenses as a percentage of net sales decreased slightly. Research and engineering expenses increased $17 million, or 11 percent, compared to the first nine months of 2005 and decreased slightly as a percentage of net sales compared to the prior period.
In addition, earnings from joint ventures decreased $16 million compared with the first nine months of 2005, primarily due to a $17 million decrease in earnings at DCEC due to a continued disruption in demand in the truck markets caused by changes in China’s regulatory environment regarding vehicle weight restrictions.
A summary and discussion of
Engine net sales by market follows:
|
|
Nine months ended |
|
Change |
|
|||||||
$ in millions |
|
October 1 , 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
|||
Heavy-duty truck |
$ |
1,858 |
$ |
1,571 |
$ |
287 |
18 |
% |
||||
Medium-duty truck and bus |
715 |
657 |
58 |
9 |
% |
|||||||
Light-duty automotive and RV |
939 |
838 |
101 |
12 |
% |
|||||||
Total on-highway |
3,512 |
3,066 |
446 |
15 |
% |
|||||||
Industrial |
1,504 |
1,284 |
220 |
17 |
% |
|||||||
Stationary power |
543 |
469 |
74 |
16 |
% |
|||||||
Total net sales |
$ |
5,559 |
$ |
4,819 |
$ |
740 |
15 |
% |
26
A summary of unit
shipments by engine classification (including unit shipments to Power
Generation) follows:
|
|
Nine months ended |
|
Change |
|
||||
|
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
Midrange |
341,100 |
298,800 |
42,300 |
14 |
% |
||||
Heavy-duty |
92,500 |
78,700 |
13,800 |
18 |
% |
||||
High-horsepower |
11,800 |
10,200 |
1,600 |
16 |
% |
||||
Total unit shipments |
445,400 |
387,700 |
57,700 |
15 |
% |
Heavy-Duty Truck
The increase in sales to the heavy-duty truck market was primarily driven by the North American truck market as OEMs work to meet growing demand from truck fleets replacing trucks ahead of the 2007 change in emissions standards. Global unit shipments of heavy-duty truck engines were up 20 percent in the first nine months of 2006, compared to the first nine months of 2005, with North American shipments up 20 percent and international shipments up 15 percent.
Medium-Duty Truck and Bus
The increase in medium-duty truck and bus revenues is due to strong demand, our growing market share position with North American OEMs in the medium duty truck market and increased shipments of bus engines in North America. Shipments of medium-duty truck engines were up 29 percent to North American OEMs and down 16 percent to international OEMs compared with the first nine months of 2005. The increase in medium-duty truck engine shipments in North America is due to our increased penetration in this market and an overall increase in demand ahead of the emission standard changes. The decrease in shipments to international OEMs is primarily due to changes in emissions standards in Brazil to Euro III effective January 1, 2006. Sales of bus engines and parts increased in the first nine months of 2006 compared to the first nine months of 2005 due to strong demand from North American OEMs with shipments up 57 percent while international shipments were down 11 percent. The decrease in international shipments year over year is due to a large purchase made in 2005 by a customer in China.
Light-Duty Automotive and RV
Sales of light-duty automotive engines increased as a result of higher volumes. Total light-duty automotive unit shipments were approximately 135,000 in the first nine months of 2006, an increase of 10 percent compared to the same period in 2005. Most of the increase in light-duty automotive sales was driven by demand from DaimlerChrysler with increased shipments of approximately 9,200 units, or an 8 percent increase compared to the first nine months of 2005. Engine shipments to recreational vehicle OEMs increased by nearly 27 percent in the first nine months of 2006 compared with the same period in 2005 due to new product introductions and growing penetration at key OEMs.
Industrial
Total sales were up in most industrial markets, primarily due to strong demand in nearly all markets. Unit shipments increased 23 percent in the first nine months of 2006 compared to the same period in 2005. Approximately 53 percent of the shipments were to North American markets and 47 percent to international markets in the first nine months compared to 57 percent and 43 percent, respectively, for the same period in 2005. 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 the Middle East and Asia. Total shipments to the construction market increased 23 percent largely because international shipments increased 37 percent. Other markets showing significant increases in shipments were the mining market and the oil and gas market with increases of 13 percent and 59 percent, respectively. The mining market demand is up as the strength in commodity prices has been driving investment in mining capacity. The sales to the oil and gas market have increased as sustained oil and natural gas prices continue to drive activity and investments in new equipment. Other industrial markets had modest increases in shipments compared to the same period in 2005.
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.
27
Power Generation Results
Three Months Ended – 2006 versus 2005
The net sales, investee
income and segment EBIT for Power Generation were as follows:
|
|
Three months ended |
|
Change |
|
|||||||
$ in millions |
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
|||
Net sales |
$ |
624 |
504 |
120 |
24 |
% |
||||||
Investee equity, royalty and other income |
4 |
2 |
2 |
100 |
% |
|||||||
Segment EBIT |
57 |
46 |
11 |
24 |
% |
|||||||
Segment EBIT as a percentage of net sales |
9.1% |
9.1% |
0.0 percentage point |
|||||||||
The increase in net sales in this segment was primarily due to increased volumes as a result of strong demand in the commercial generator set and alternator lines of business. These lines improved due to increased pricing as well. Our commercial and alternator businesses are up in all markets, except China and Southeast Asia. Our power electronics and energy solutions businesses also saw significant increases, but from a lower base. We had a slight decrease in net sales in our consumer business due to fewer recreational vehicle units, offset somewhat by increased sales of portable units.
The improvement in segment EBIT was largely attributable to strong commercial generator set sales across geographic markets as well as improved mix and price realization. While material costs have risen period over period, we have been able to more than absorb these costs through improved pricing. Gross margin improved $22 million, or 23 percent, in the third quarter over the same period in 2005. Gross margin percentage decreased slightly compared to the same period in 2005. Selling and administrative expenses increased $11 million, or 22 percent, over the third quarter of 2005, however selling and administrative expenses as a percentage of net sales decreased slightly in the third quarter of 2006, compared to the same period in 2005. Research and engineering expenses increased $2 million, or 33 percent during the third quarter, compared to 2005 and research and engineering expenses as a percentage of net sales increased slightly compared to the same period in 2005.
A summary of engine
shipments used in power generation equipment by engine category follows:
|
|
Three months ended |
|
Change |
|
||||
|
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
Midrange |
7,100 |
4,800 |
2,300 |
48 |
% |
||||
Heavy-duty |
1,700 |
1,900 |
(200 |
) |
(11 |
)% |
|||
High-horsepower |
2,300 |
1,900 |
400 |
21 |
% |
||||
Total unit shipments |
11,100 |
8,600 |
2,500 |
29 |
% |
Nine Months Ended – 2006 versus 2005
The net sales, investee
income and segment EBIT for Power Generation were as follows:
|
|
Nine months ended |
|
Change |
|
|||||||
$ in millions |
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
|||
Net sales |
$ |
1,758 |
1,424 |
334 |
23 |
% |
||||||
Investee equity, royalty and other income |
10 |
6 |
4 |
67 |
% |
|||||||
Segment EBIT |
158 |
96 |
62 |
65 |
% |
|||||||
Segment EBIT as a percentage of net sales |
9.0% |
6.7% |
2.3 percentage points |
|||||||||
The increase in net sales in this segment was primarily due to increased volumes as a result of strong demand in the commercial generator set and alternator lines of business. Our commercial and alternator businesses are up in nearly all markets. We also saw increases in our consumer market due to strong demand in the towable recreational vehicle market. Our power electronics, energy solutions and rental markets also saw increases, but at a more modest pace. In addition, pricing actions contributed to the increase in net sales.
28
The improvement in segment EBIT was largely attributable to strong commercial generator set sales across geographic markets as well as improved mix and price realization. While material costs have increased period over period, we have been able to more than absorb these costs through improved pricing. Gross margin improved $88 million, or 37 percent, in the first nine months of 2006 over the same period in 2005. Gross margin percentage improved nearly two percentage points compared to the same period in 2005. Selling and administrative expenses increased $26 million, or 18 percent, over the first nine months of 2005, however selling and administrative expenses as a percentage of net sales improved by nearly one half of a percentage point in the first nine months of 2006, compared to the same period in 2005. Research and engineering expenses increased $5 million, or 31 percent during the first nine months, compared to 2005 and research and engineering expenses as a percentage of net sales increased slightly compared to the same period in 2005.
A summary of engine
shipments used in power generation equipment by engine category follows:
|
|
Nine months ended |
|
Change |
|
||||
|
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
Midrange |
21,100 |
14,500 |
6,600 |
46 |
% |
||||
Heavy-duty |
5,200 |
5,200 |
— |
— |
% |
||||
High-horsepower |
6,800 |
5,900 |
900 |
15 |
% |
||||
Total unit shipments |
33,100 |
25,600 |
7,500 |
29 |
% |
Components Results
Three Months Ended – 2006 versus 2005
The net sales, investee
income and segment EBIT for Components were as follows:
|
|
Three months ended |
|
Change |
|
|||||||
$ in millions |
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
|||
Net sales |
$ |
564 |
$ |
481 |
83 |
17% |
||||||
Investee equity, royalty and other income |
2 |
3 |
(1 |
) |
33% |
|||||||
Segment EBIT |
19 |
21 |
(2 |
) |
10% |
|||||||
Segment EBIT as a percentage of net sales |
3.4% |
4.4% |
(1.0) percentage points |
|||||||||
Our Components segment includes the following businesses: fuel systems, filtration, aftertreatment devices and turbochargers. Components net sales increased across all businesses and all geographic markets, but were primarily driven by strong demand for our filtration products in North America and Latin America with increases in both aftermarket volume and OEM volume. Sales of our turbochargers improved due to increased European OEM and China sales.
Segment EBIT decreased during the third quarter compared with the same period in 2005, primarily due to a reduction in gross margin percentage. Gross margin increased $9 million, or 11 percent, in the third quarter compared to the same period in 2005, however gross margin percentage decreased by nearly one percentage point compared to the same period in 2005. Gross margin percentage was negatively impacted by manufacturing inefficiencies as a result of closing two exhaust facilities and consolidating production into existing facilities. Pre-production activity for new products within each of the four businesses in this segment and some material cost pressure in the filtration business also impacted our gross margin percentage. Selling and administrative expenses increased $6 million, or 12 percent, compared to the third quarter of 2005, however selling and administrative expenses as a percentage of net sales decreased by one half of a percentage point. Research and engineering expenses increased due to additional investment in the development of a number of new products and critical technologies that will be launched in 2007 and beyond. Research and engineering expenses increased $3 million, or 21 percent, compared to the third quarter of 2005 and increased slightly as a percentage of net sales.
29
Nine Months Ended – 2006 versus 2005
The net sales, investee
income and segment EBIT for Components were as follows:
|
|
Nine months ended |
|
Change |
|
|||||||
$ in millions |
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
|||
Net sales |
$ |
1,682 |
$ |
1,465 |
$ |
217 |
15 |
% |
||||
Investee equity, royalty and other income |
6 |
7 |
(1 |
) |
(14) |
% |
||||||
Segment EBIT |
84 |
65 |
19 |
29 |
% |
|||||||
Segment EBIT as a percentage of net sales |
5.0% |
4.4% |
0.6 percentage points |
|||||||||
Components net sales increased across all businesses and all geographic markets, but were primarily driven by strong demand for our filtration products in North America and Latin America with increases in both aftermarket volume and OEM volume. Sales of our turbochargers increased primarily due to increased OEM sales.
Segment EBIT improved during the first nine months compared with same period in 2005, primarily due to improved volume. In addition, EBIT as a percentage of net sales increased by over one half of a percentage point. Gross margin increased $49 million, or 20 percent, in the first nine months compared to the same period in 2005, and gross margin percentage improved nearly one percentage point compared to the same period in 2005, primarily due to improved volume and improved pricing. Selling and administrative expenses increased $16 million, or 11 percent, compared to the first nine months of 2005, but decreased slightly as a percentage of net sales. Research and engineering expenses increased due to additional investment in the development of a number of new products and critical technologies that will be launched in 2007 and beyond. Research and engineering expenses increased $13 million, or 32 percent, compared to the first nine months of 2005 and increased by nearly one half of a percentage point as a percentage of net sales.
Distribution Results
Three Months Ended – 2006 versus 2005
The net sales, investee
income and segment EBIT for Distribution were as follows:
|
|
Three months ended |
|
Change |
|
|||||||
$ in millions |
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
|||
Net sales |
$ |
346 |
$ |
295 |
$ |
51 |
17% |
|||||
Investee equity, royalty and other income |
15 |
9 |
6 |
67% |
||||||||
Segment EBIT |
38 |
28 |
10 |
36% |
||||||||
Segment EBIT as a percentage of net sales |
11.0% |
9.5% |
1.5 percentage points |
|||||||||
Distribution net sales increased primarily due to strong overall demand in the Middle East, Europe and the South Pacific. The higher net sales were led by increases in power generation volumes followed by parts and service volumes. The reconstruction in the Middle East is the primary driver for the higher power generation volume accounting for over half of the increase. Parts and service volumes were up throughout several geographic markets, most notably Europe, the Middle East and the South Pacific.
Segment EBIT increased primarily due to higher gross margins resulting from greater sales of parts and service, power generation equipment and higher joint venture income. Gross margin in the third quarter of 2006 improved $9 million, or 13 percent, over the same period in 2005, however gross margin percentage decreased by nearly one percentage point due to a shift in mix from parts to engines and gensets. The increase in gross margin was partially offset by higher selling and administrative expenses which increased $6 million, or 11 percent, compared to the prior year period. Selling and administrative expenses as a percentage of net sales decreased by nearly one percentage point in the same period.
Also contributing to the improvement in segment EBIT quarter-over-quarter was a $6 million increase in investee equity earnings primarily attributable to a $5 million increase in earnings at our North American distributors.
30
Nine Months Ended – 2006 versus 2005
The net sales, investee
income and segment EBIT for Distribution were as follows:
|
|
Nine months ended |
|
Change |
|
|||||||
$ in millions |
|
October 1, 2006 |
|
September 25, 2005 |
|
Amount |
|
Percent |
|
|||
Net sales |
$ |
999 |
$ |
845 |
$ |
154 |
18% |
|||||
Investee equity, royalty and other income |
38 |
23 |
15 |
65% |
||||||||
Segment EBIT |
105 |
74 |
31 |
42% |
||||||||
Segment EBIT as a percentage of net sales |
10.5% |
8.8% |
1.7 percentage points |
|||||||||
Distribution net sales increased primarily due to strong overall demand in Europe, the Middle East and the South Pacific. The higher net sales were led by increases in power generation volume followed by parts and service and engine volume. The reconstruction in the Middle East is the primary driver for the higher power generation volume accounting for over half of the increase. Parts and service and engine volumes were up throughout several geographic markets, most notably Europe, East Asia, the South Pacific and the Middle East.
Segment EBIT increased primarily due to higher gross margins resulting from greater sales of engines, parts, and power generation equipment. Gross margin in the first nine months of 2006 improved $32 million, or 16 percent, over the same period in 2005, however gross margin percentage decreased slightly due to a shift in mix from parts to engines and gensets. The increase in gross margin was partially offset by higher selling and administrative expenses. Selling and administrative expenses increased $22 million, or 14 percent; however selling and administrative expenses decreased by over one half of a percentage point as a percentage of net sales in the same period.
Also contributing to the increase in segment EBIT year-over-year was a $15 million increase in investee equity earnings primarily attributable to a $14 million increase in earnings at our North American distributors.
Geographic Markets
Sales to international markets for the three and nine months ended October 1, 2006, were 51 percent and 49 percent, respectively, of total net sales, compared to 50 percent for the three and nine months ended September 25, 2005.
A summary of net sales
(dollar amount and percentage of total) by geographic territory follows:
|
|
Three months ended, |
|
Nine months ended, |
|
|||||||||||||||||
$ in millions |
|
October 1, 2006 |
|
September 25, 2005 |
|
October 1, 2006 |
|
September 25, 2005 |
|
|||||||||||||
United States |
$ |
1,384 |
49% |
$ |
1,223 |
50% |
$ |
4,212 |
51% |
$ |
3,585 |
50% |
||||||||||
Asia/Australia |
452 |
17% |
429 |
17% |
1,314 |
16% |
1,224 |
17% |
||||||||||||||
Europe/CIS |
399 |
14% |
326 |
13% |
1,169 |
14% |
1,008 |
14% |
||||||||||||||
Mexico/Latin America |
228 |
8% |
191 |
8% |
652 |
8% |
511 |
7% |
||||||||||||||
Canada |
199 |
7% |
186 |
7% |
574 |
6% |
529 |
8% |
||||||||||||||
Africa/Middle East |
147 |
5% |
112 |
5% |
408 |
5% |
308 |
4% |
||||||||||||||
Total international |
1,425 |
51% |
1,244 |
50% |
4,117 |
49% |
3,580 |
50% |
||||||||||||||
Total consolidated net sales |
$ |
2,809 |
100% |
$ |
2,467 |
100% |
$ |
8,329 |
100% |
$ |
7,165 |
100% |
||||||||||
31
LIQUIDITY AND CAPITAL RESOURCES
Available Liquidity
Cash provided by operations is the primary source of funding our working capital requirements. At certain times, cash provided by operations is subject to seasonal fluctuations, and as a result, we may use periodic borrowings, primarily our revolving credit facility and our accounts receivable sales program, to fund our working capital requirements. As of October 1, 2006, there were no amounts outstanding under our revolving credit facility or our accounts receivable sales program.
We have focused much of our efforts on improving our balance sheet through debt reduction and increasing our liquidity. We believe our net debt position is a strong indicator of how much progress we have made in these areas. This measure is not defined under U.S. GAAP and may not be computed the same as similarly titled measures used by other companies. The Company’s net debt position is as follows:
|
|
October 1, |
|
December 31, |
|
|||
|
|
2006 |
|
2005 |
|
|||
|
|
Millions |
|
|||||
Total debt |
$ |
1,061 |
$ |
1,367 |
||||
Less: cash, cash equivalents and marketable securities |
(1,109 |
) |
(840 |
) |
||||
Net debt |
$ |
(48 |
) |
$ |
527 |
|||
Total debt as a percent of our total capital, including total debt, was 28.4 percent at October 1, 2006 compared with 42.3 percent at December 31, 2005.
We believe our liquidity with cash and cash equivalents of $1 billion, marketable securities of $82 million, $540 million available under our revolving credit facility, $200 million available under our accounts receivable program and $135 million available under international credit facilities (see the table below under Available Credit Capacity) provides us with the financial flexibility needed to satisfy future short-term funding requirements for working capital, debt service obligations, capital expenditures, projected pension funding, dividend payments and expansion in emerging markets.
Available Credit Capacity
The table below provides
the components of available credit capacity:
|
|
October 1, 2006 |
|
|
Millions |
||||
Revolving credit facility |
$ |
540 |
||
International credit facilities accessible by local entities |
97 |
|||
International credit facilities accessible by corporate treasury |
38 |
|||
Accounts receivable sales program |
200 |
|||
Total available credit capacity |
$ |
875 |
Working
Capital Summary
|
|
October 1, |
|
December 31, |
|
||
|
2006 |
|
2005 |
|
|||
$ in millions |
|||||||
Current assets |
$ |
4,662 |
$ |
3,916 |
|||
Current liabilities |
2,609 |
2,218 |
|||||
Working capital |
$ |
2,053 |
$ |
1,698 |
|||
Current ratio |
1.79 |
1.77 |