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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2009

Commission File Number 1-4949



LOGO

CUMMINS INC.

Indiana
(State of Incorporation)
  35-0257090
(IRS Employer Identification No.)

500 Jackson Street
Box 3005
Columbus, Indiana 47202-3005

(Address of principal executive offices)

Telephone (812) 377-5000

Securities registered pursuant to Section 12(b) of the Act:

Title of each class   Name of each exchange on which registered
Common Stock, $2.50 par value   New York Stock Exchange

         Securities registered pursuant to Section 12(g) of the Act: None.



         Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý    No o

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

         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 ý    No o

         Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceeding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý    No o

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

         Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ý   Accelerated filer o   Non-accelerated filer o
(Do not check if a
smaller reporting company)
  Smaller reporting company o

         Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý

         The aggregate market value of the voting stock held by non-affiliates was approximately $7 billion at June 28, 2009. This value includes all shares of the registrant's common stock, except for treasury shares.

         As of January 29, 2010, there were 201,359,036 shares outstanding of $2.50 par value common stock.

Documents Incorporated by Reference

         Portions of the registrant's definitive Proxy Statement for its 2010 annual meeting of shareholders, which will be filed with the Securities and Exchange Commission on Schedule 14A within 120 days after the end of 2009, will be incorporated by reference in Part III of this Form 10-K to the extent indicated therein upon such filing.


Table of Contents


TABLE OF CONTENTS

Part
  Item    
   
   
  Page

       

Cautionary Statements Regarding Forward-Looking Information

  3

I

    1  

Business

  4

           

Overview

  4

           

Operating Segments

  4

               

Engine Segment

  4

               

Power Generation Segment

  5

               

Components Segment

  6

               

Distribution Segment

  8

           

Joint Ventures, Alliances and Non-Wholly-Owned Subsidiaries

  9

           

Supply

  11

           

Patents and Trademarks

  11

           

Seasonality

  12

           

Largest Customers

  12

           

Backlog

  12

           

Research and Development Expense

  12

           

Environmental Compliance

  13

           

Employees

  14

           

Available Information

  14

           

Executive Officers of the Registrant

  15

    1A  

Risk Factors

  16

    1B  

Unresolved Staff Comments

  22

    2  

Properties

  23

    3  

Legal Proceedings

  24

    4  

Submission of Matters to a Vote of Security Holders

  25

II

    5  

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

  26

    6  

Selected Financial Data

  28

    7  

Management's Discussion and Analysis of Financial Condition and Results of Operations

  29

    7A  

Quantitative and Qualitative Disclosures About Market Risk

  67

    8  

Financial Statements and Supplementary Data

  70

    9  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  142

    9A  

Controls and Procedures

  142

    9B  

Other Information

  142

III

    10  

Directors, Executive Officers and Corporate Governance

  142

    11  

Executive Compensation

  142

    12  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  143

    13  

Certain Relationships, Related Transactions and Director Independence

  143

    14  

Principal Accountant Fees and Services

  143

IV

    15  

Exhibits and Financial Statement Schedules

  143

       

Index to Financial Statements

  70

       

Exhibit Index

  144

       

Signatures

 
146

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        Cummins Inc. and its consolidated subsidiaries are sometimes referred to in this annual report as "Cummins," the "Company," "we," "our," or "us."


CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION

        Certain parts of this annual report, particularly "Management's Discussion and Analysis of Financial Condition and Results of Operations", contain forward-looking statements intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements include those that are based on current expectations, estimates and projections about the industries in which we operate and management's beliefs and assumptions. Forward-looking statements are generally accompanied by words such as "anticipates," "expects," "forecasts," "intends," "plans," "believes," "seeks," "estimates," "could," "should," or words of similar meaning. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which we refer to as "future factors," which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Some future factors that could cause our results to differ materially from the results discussed in such forward-looking statements are discussed below and shareholders, potential investors and other readers are urged to consider these future factors carefully in evaluating forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Future factors that could affect the outcome of forward-looking statements include the following:

        In addition, such statements could be affected by general industry and market conditions and growth rates, general domestic and international economic conditions, including the price of crude oil (diesel fuel), interest rate and currency exchange rate fluctuations, commodity prices and other future factors.

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PART I

Item 1.    Business

OVERVIEW

        Cummins Inc. was founded in 1919 as a corporation in Columbus, Indiana, as one of the first diesel engine manufacturers. We are a global power leader that designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration, exhaust aftertreatment, fuel systems, controls and air handling systems. We sell our products to original equipment manufacturers (OEMs), distributors and other customers worldwide. We serve our customers through a network of more than 500 company-owned and independent distributor locations and approximately 5,200 dealer locations in more than 190 countries and territories.


OPERATING SEGMENTS

        We have four complementary operating segments: Engine, Power Generation, Components and Distribution. These segments share technology, customers, strategic partners, brand recognition and our distribution network to gain a competitive advantage in their respective markets. In each of our operating segments, we compete worldwide with a number of other manufacturers and distributors that produce and sell similar products. Our products primarily compete on the basis of performance, fuel economy, speed of delivery, quality, customer support and price. Financial information about our operating segments, including geographic information, is incorporated by reference from Note 25, "OPERATING SEGMENTS," to our Consolidated Financial Statements.


Engine Segment

        Engine segment sales and EBIT as a percentage of consolidated results were:

 
  Years ended December 31,  
 
  2009   2008   2007  

Percent of consolidated net sales(1)

    49 %   50 %   52 %

Percent of consolidated EBIT(1)(2)

    34 %   41 %   47 %

(1)
Measured before intersegment eliminations

(2)
Defined as earnings before interest and taxes

        Our Engine segment manufactures and markets a broad range of diesel and natural gas powered engines under the Cummins brand name, as well as certain customer brand names, for the heavy- and medium-duty truck, bus, recreational vehicle (RV), light-duty automotive, agricultural, construction, mining, marine, oil and gas, rail and governmental equipment markets. We offer a wide variety of engine products including:

        Our Engine segment is organized by engine displacement size and serves these end-user markets:

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        The principal customers of our heavy- and medium-duty truck engines include truck manufacturers, such as PACCAR, Volvo Trucks North America, Daimler Trucks North America, Ford and Volkswagen AG. We sell our industrial engines to manufacturers of construction, agricultural and marine equipment, including Case New Holland, Komatsu, Hyundai, Hitachi, Ingersoll Rand, Brunswick and Terex. The principal customers of our light-duty on-highway engines are Chrysler and manufacturers of RVs.

        In the markets served by our Engine segment, we compete with independent engine manufacturers as well as OEMs who manufacture engines for their own products. Our primary competitors in North America are Detroit Diesel Corporation, Volvo Powertrain, International Truck and Engine Corporation (Engine Division) and Caterpillar Inc. (CAT). Our primary competitors in international markets vary from country to country, with local manufacturers generally predominant in each geographic market. Other engine manufacturers in international markets include Volvo, Weichai Power Co. Ltd., GE Jenbacher, MAN Nutzfahrzeuge AG (MAN), Tognum AG, GuangxiYuchai Group, Yanmar Co., Ltd., Deutz AG and CAT.


Power Generation Segment

        Power Generation segment sales and EBIT as a percentage of consolidated results were:

 
  Years ended December 31,  
 
  2009   2008   2007  

Percent of consolidated net sales(1)

    19 %   20 %   19 %

Percent of consolidated EBIT(1)(2)

    22 %   28 %   26 %

(1)
Measured before intersegment eliminations

(2)
Defined as earnings before interest and taxes

        Our Power Generation segment designs and manufactures most of the components that make up power generation systems, including engines, controls, alternators, transfer switches and switchgear. This segment is a global provider of power generation systems, components and services for a diversified customer base and includes the following:

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        In 2009, our Power Generation segment reorganized its reporting structure and now reports the following businesses:

        For revised sales data by product category for 2008 and 2007 see "Management's Discussion and Analysis of Financial Condition and Results of Operations."

        This segment continuously explores emerging technologies, such as fuel cells, wind and hybrid solutions and provides integrated power generation products utilizing technologies other than reciprocating engines. We use our own research and development capabilities as well as leverage business partnerships to develop cost-effective and environmentally sound power solutions.

        Our customer base for power generation products is highly diversified, with customer groups varying based on their power needs. India, the Middle East, Western Europe and East Asia, are our largest geographic markets outside of North America.

        This operating segment competes with a variety of engine manufacturers and generator set assemblers across the world. CAT, Tognum (MTU) and Mitsubishi (MHI) remain our primary competitors, but we also compete with FG Wilson (Caterpillar group), Kohler, SDMO (Kohler group), Generac and numerous regional generator set assemblers. Our Alternator business competes globally with Emerson Electric Co., Marathon Electric and Meccalte, among others.


Components Segment

        Components segment sales and EBIT as a percentage of consolidated results were:

 
  Years ended December 31,  
 
  2009   2008   2007  

Percent of consolidated net sales(1)

    18 %   18 %   19 %

Percent of consolidated EBIT(1)(2)

    13 %   13 %   12 %

(1)
Measured before intersegment eliminations

(2)
Defined as earnings before interest and taxes

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        Our Components segment supplies products which complement our Engine segment, including filtration products, turbochargers, aftertreatment systems, intake and exhaust systems and fuel systems for commercial diesel applications. We manufacture filtration and exhaust systems for on- and off-highway heavy-duty and mid-range equipment, and we are a supplier of filtration products for industrial and passenger car applications. In addition, we develop aftertreatment and exhaust systems to help our customers meet increasingly stringent emissions standards and fuel systems which to date have primarily supplied our Engine segment and our partner Scania.

        Our Components segment is organized around the following businesses:

        Customers of our Components segment generally include our Engine and Distribution segments, truck manufacturers and other OEMs, many of which are also customers of our Engine segment, such as PACCAR, CNH Global N.V., International Truck and Engine, Volvo, Iveco and other manufacturers that use our filtration products in their product platforms. Our customer base for replacement filtration parts is highly fragmented and primarily consists of various end-users of on- and off-highway vehicles and equipment.

        Our Components segment competes with other manufacturers of filtration, exhaust and fuel systems and turbochargers. Our primary competitors in these markets include Donaldson Company, Inc., Clarcor Inc., Mann+Hummel Group, Tokyo Roki Co., Ltd., Borg-Warner, Bosch, Tenneco and Honeywell International.

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Distribution Segment

        Distribution segment sales and EBIT as a percentage of consolidated results were:

 
  Years ended December 31,  
 
  2009   2008   2007  

Percent of consolidated net sales(1)

    14 %   12 %   10 %

Percent of consolidated EBIT(1)(2)

    31 %   18 %   15 %

(1)
Measured before intersegment eliminations

(2)
Defined as earnings before interest and taxes

        Our Distribution segment consists of 19 company-owned and 18 joint venture distributors that service and distribute the full range of our products and services to end-users at approximately 300 locations in approximately 70 distribution territories. Our company-owned distributors are located in key markets, including India, China, Japan, Australia, Europe, the Middle East, South Africa, Brazil, North America and Russia.

        The Distribution segment is organized into four primary geographic regions:

        EMEA and Asia Pacific are composed of seven smaller regional distributor organizations (Greater Europe, Africa, the Middle East, India, China, Northeast/Southeast Asia and the South Pacific) which allow us to better manage these vast geographic territories.

        Our largest market, North and Central America, is mostly comprised of a network of partially-owned distributors. Internationally, our network consists of independent, partially-owned and wholly-owned distributors. Through this network, we provide parts and service to our customers. These full-service solutions include maintenance contracts, engineering services and integrated products, where we customize our products to cater to specific needs of end-users. Our distributors also serve and develop dealers, predominantly OEM dealers, in their territories by providing technical support, tools, training, parts and product information.

        In addition to managing our investments in wholly-owned and partially-owned distributors, our Distribution segment is responsible for managing the performance and capabilities of our independent distributors. Our distributors collectively serve a highly diverse customer base with approximately 44 percent of their 2009 revenues being generated from the sale of new engines and power generation equipment, compared to 50 percent in 2008, and the remaining revenue generated by parts and service revenue.

        Financial information about our distributors accounted for under the equity method are incorporated by reference from Note 1, "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES," and Note 2, "INVESTMENTS IN EQUITY INVESTEES," to our Consolidated Financial Statements.

        During 2008, we purchased a majority interest in three previously independent North American distributors in order to increase our ownership interests in key portions of the distribution channel. The acquisitions were accounted for under the purchase method of accounting and resulted in an aggregate purchase price of $81 million which we funded with $54 million of borrowings and $27 million of cash.

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The assets of the acquired businesses were primarily accounts receivable, inventory and fixed assets. There was less than $1 million of goodwill generated from these transactions.

        Our distributors compete with distributors or dealers that offer similar products. In many cases, these competing distributors or dealers are owned by, or affiliated with, the companies that are listed above as competitors of our Engine, Power Generation or Components segments. These competitors vary by geographical location.


JOINT VENTURES, ALLIANCES AND NON-WHOLLY-OWNED SUBSIDIARIES

        We have entered into a number of joint venture agreements and alliances with business partners around the world. Our joint ventures are either distribution or manufacturing entities. We also own a controlling interest in a non-wholly-owned manufacturing subsidiary.

        In the event of a change of control of either party to these joint ventures and other strategic alliances, certain consequences may result including automatic termination and liquidation of the venture, exercise of "put" or "call" rights of ownership by the non-acquired partner, termination or transfer of technology license rights to the non-acquired partner and increases in component transfer prices to the acquired partner. We will continue to evaluate joint venture and partnership opportunities in order to penetrate new markets, develop new products and generate manufacturing and operational efficiencies.

        Financial information about our investments in joint ventures and alliances is incorporated by reference from Note 1, "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES," Note 2, "INVESTMENTS IN EQUITY INVESTEES," and Note 23, "VARIABLE INTEREST ENTITIES," to the Consolidated Financial Statements.

        Our equity income from these investees was as follows:

 
  Years ended December 31,  
In millions
  2009   2008   2007  

Distribution Entities

                                     

North American distributors

  $ 100     51 % $ 100     43 % $ 83     43 %

Komatsu Cummins Chile, Ltda. 

    12     6 %   7     3 %   4     2 %

All other distributors

    3     1 %   5     2 %   2     1 %

Manufacturing Entities

                                     

Chongqing Cummins Engine Company, Ltd. 

    36     18 %   30     13 %   22     11 %

Dongfeng Cummins Engine Company, Ltd. 

    33     17 %   55     24 %   41     21 %

Valvoline Cummins, Ltd. 

    7     4 %   2     1 %   1     1 %

Shanghai Fleetguard Filter Co., Ltd. 

    7     4 %   8     4 %   6     3 %

Tata Cummins Ltd. 

    5     3 %   7     3 %   13     7 %

Cummins MerCruiser Diesel Marine, LLC

    (10 )   (5 )%   3     1 %   11     6 %

All other manufacturers

    3     1 %   14     6 %   9     5 %
                           
 

Cummins share of net income(1)

  $ 196     100 % $ 231     100 % $ 192     100 %
                           

(1)
This total represents Cummins share of net income of our equity investees and is exclusive of royalties and interest income from our equity investees. To see how this amount reconciles to the "equity, royalty and interest income from investees" in the Consolidated Statements of Income, see Note 2, "INVESTMENTS IN EQUITY INVESTEES."

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Distribution Entities

        Our licensing agreements with independent and partially-owned distributors generally have a three-year term and are restricted to specified territories. Our distributors develop and maintain a network of dealers with which we have no direct relationship. The distributors are permitted to sell other, noncompetitive products only with our consent. We license all of our distributors to use our name and logo in connection with the sale and service of our products, with no right to assign or sublicense the marks, except to authorized dealers, without our consent. Products are sold to the distributors at standard domestic or international distributor net prices, as applicable. Net prices are wholesale prices we establish to permit our distributors an adequate margin on their sales. Subject to local laws, we can refuse to renew these agreements at will and we may terminate them upon 90-day notice for inadequate sales, change in principal ownership and certain other reasons. Distributors also have the right to terminate the agreements upon 60-day notice without cause, or 30-day notice for cause. Upon termination or failure to renew, we are required to purchase the distributor's current inventory, signage and special tools, and may, at our option purchase other assets of the distributor, but are under no obligation to do so. See further discussion of our distribution network under the Distribution segment section above.

Manufacturing Entities

        Manufacturing joint ventures are generally formed with customers and allow us to increase our market penetration in geographic regions, reduce capital spending, streamline our supply chain management and develop technologies. Our largest manufacturing joint ventures are based in China and are included in the list below. Our engine manufacturing joint ventures are supplied by our Components segment in the same manner as they supply our wholly-owned Engine segment and Power Generation segment manufacturing facilities. Components segment joint ventures and wholly owned entities provide fuel system, filtration and turbocharger products that are used in our engines as well as some competitors' products. These joint ventures are not included in our Consolidated Financial Statements.

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Non-Wholly-Owned Manufacturing Subsidiary

        We have a controlling interest in Cummins India Ltd. (CIL), which is a publicly listed company on various stock exchanges in India. CIL produces mid-range, heavy-duty and high-horsepower engines, as well as generators for the Indian and export markets. CIL also produces compressed natural gas spark-ignited engines licensed from another of our joint ventures. CIL's net income attributable to Cummins was $28 million, $36 million and $26 million for 2009, 2008 and 2007, respectively.


SUPPLY

        We source our materials and manufactured components from leading suppliers both domestically and internationally. We machine and assemble some of the components used in our engines and power generation units, including blocks, heads, turbochargers, connecting rods, camshafts, crankshafts, filters, exhaust systems, alternators and fuel systems. We single source approximately 70 to 80 percent of the total types of parts in our product designs. We have long-term agreements with critical suppliers who are the sole source for specific products or supply items. Although we elect to source a relatively high proportion of our total raw materials and component requirements from sole suppliers, we have established a process to annually review our sourcing strategies with a focus on the reduction of risk, which has led us to dual source critical components, where possible. We are also developing suppliers in many global or emerging markets to serve our businesses across the globe and provide alternative sources in the event of disruption from existing suppliers.


PATENTS AND TRADEMARKS

        We own or control a significant number of patents and trademarks relating to the products we manufacture. These patents and trademarks have been granted and registered over a period of years. Although these patents and trademarks are generally considered beneficial to our operations, we do not believe any patent, group of patents, or trademark (other than our leading brand house trademarks) is considered significant to our business.

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SEASONALITY

        While individual product lines may experience modest seasonal declines in production, there is no material effect on the demand for the majority of our products on a quarterly basis with the exception that our Power Generation segment normally experiences seasonal declines in the first quarter due to general declines in construction spending during this period and our Distribution segment normally experiences seasonal declines in first quarter business activity due to holiday periods in Asia and Australia.


LARGEST CUSTOMERS

        We have thousands of customers around the world and have developed long-standing business relationships with many of them. We have long-term heavy-duty engine supply agreements with PACCAR and Volvo Trucks North America. We have mid-range supply agreements with PACCAR, as its exclusive engine supplier, as well as with Daimler Trucks North America (formerly Freightliner LLC), Ford and MAN (formerly Volkswagen). We also have an agreement with Chrysler, for supplying the engine for use in Dodge Ram trucks. Collectively, our net sales to these six customers was approximately 22 percent of consolidated net sales in 2009, compared to approximately 21 percent in 2008 and 27 percent in 2007 and individually was less than nine percent of consolidated net sales to any single customer in 2009, compared to less than eight percent in both 2008 and 2007. These agreements contain standard purchase and sale agreement terms covering engine and engine parts pricing, quality and delivery commitments, as well as engineering product support obligations. The basic nature of our agreements with OEM customers is that they are long-term price and operations agreements that assure the availability of our products to each customer through the duration of the respective agreements. Agreements with most OEMs contain bilateral termination provisions giving either party the right to terminate in the event of a material breach, change of control or insolvency or bankruptcy of the other party.


BACKLOG

        As a result of the current recessed economic conditions many of our order lead times have decreased significantly from lead times in prior years. While we have supply agreements with some truck and off-highway equipment OEMs, most of our business is transacted through open purchase orders. These open orders are historically subject to month-to-month releases and are subject to cancellation on reasonable notice without cancellation charges and therefore are not considered firm.


RESEARCH AND DEVELOPMENT EXPENSE

        Our research and development program is focused on product improvements, innovations and cost reductions for our customers. We expense research and development expenditures, net of contract reimbursements, when incurred. Research and development expenses, net of contract reimbursements, were $362 million in 2009, $422 million in 2008 and $318 million in 2007. Contract reimbursements were $92 million in 2009, $61 million in 2008 and $52 million in 2007. For 2009 and 2008, approximately 42 percent, or $151 million, and approximately 27 percent, or $116 million, respectively, were directly related to compliance with 2010 EPA emissions standards. For 2007, 17 percent, or $55 million, was related to compliance with 2010 EPA emissions standards. In 2009, we reduced research, development and engineering expenses but continued to invest in critical technologies and products for 2010 and beyond. We will continue to make investments to improve our current technologies, to continue to meet the future emissions requirements around the world and improve fuel economy.

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ENVIRONMENTAL COMPLIANCE

Sustainability

        In 2009, we continued to be a leader in sustainable business development. We have invested significantly in new products and technologies designed to further lower exhaust emissions from our products. We have increased our commitment to addressing the global impact of climate change and have introduced our first set of 10 climate change principles that address ways that we plan to become a greater part of the solution and also articulated our positions on key public policy issues surrounding climate change. For the fourth consecutive year, we were named to the Dow Jones World Sustainability index, which recognizes the top 10 percent of the world's largest 2,500 companies in economic, environmental and social leadership. Our sustainability report for 2009 is available on our website at www.cummins.com.

Product Environmental Compliance

        Our engines are subject to extensive statutory and regulatory requirements that directly or indirectly impose standards governing emissions and noise. Our products comply with all current emissions standards that the Environmental Protection Agency (EPA), the California Air Resources Board (CARB) and other state and international regulatory agencies have established for heavy-duty on-highway diesel and gas engines and off-highway engines. Our ability to comply with these and future emissions standards is an essential element in maintaining our leadership position in regulated markets. We have made, and will continue to make significant capital and research expenditures to comply with these standards. Failure to comply with these standards could result in adverse effects on our future financial results.

EPA Engine Certifications

        The current on-highway emissions standards came into effect in the U.S. on January 1, 2010. To meet the 2010 U.S. EPA heavy-duty on-highway emissions standards, we are using an evolution of our proven 2007 technology solution to maintain power and torque with substantial fuel economy improvement and maintenance intervals comparable with our 2007 compliant engines. We will offer a complete lineup of on-highway engines to meet the near-zero emissions standards. Mid-range and heavy-duty engines for EPA 2010 require nitrogen oxide (NOx) aftertreatment. NOx reduction is achieved by an integrated technology solution comprised of the XPI High Pressure Common Rail fuel system, selective catalytic reduction (SCR) technology, next-generation cooled exhaust gas recirculation (EGR), advanced electronic controls, proven air handling and the Cummins Particulate Filter. The EPA and CARB have certified that our engines meet the 2010 emission requirements. Emissions standards in international markets, including Europe, Japan, Mexico, Australia, Brazil, India and China are becoming more stringent. We believe that our experience in meeting U.S. emissions standards leaves us well positioned to take advantage of opportunities in these markets as the need for emissions control capability grows.

        Federal and California regulations require manufacturers to report failures of emissions-related components to the EPA and CARB when the failure rate reaches a specified level. At higher failure rates, a product recall may be required. In 2009, we submitted three reports to the EPA relating to two different defects affecting oxidation catalysts and vehicle labels. The oxidation catalyst defect necessitated the campaign of approximately 360 engines.

Other Environmental Statutes and Regulations

        Expenditures for environmental control activities and environmental remediation projects at our facilities in the U.S. have not been a substantial portion of our annual capital outlays and are not

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expected to be material in 2010. Except as follows, we believe we are in compliance in all material respects with laws and regulations applicable to our plants and operations.

        In the U.S., pursuant to notices received from federal and state agencies and/or defendant parties in site environmental contribution actions, we have been identified as a Potentially Responsible Party (PRP) under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended or similar state laws, at approximately 19 waste disposal sites. Based upon our experiences at similar sites we believe that our aggregate future remediation costs will not be significant. We have established accruals that we believe are adequate for our expected future liability with respect to these sites.

        In addition, we have four other sites where we are working with governmental authorities on remediation projects. The costs for these remediation projects are not expected to be material.


EMPLOYEES

        As of December 31, 2009, we employed approximately 34,900 persons worldwide. Approximately 13,200 of our employees worldwide are represented by various unions under collective bargaining agreements that expire between 2010 and 2014. For a discussion of the effects of our 2008 and 2009 restructuring actions on employment, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 3, "RESTRUCTURING AND OTHER CHARGES," to our Consolidated Financial Statements in this Form 10-K.


AVAILABLE INFORMATION

        We file annual, quarterly and current reports, proxy statements and other information electronically with the Securities and Exchange Commission (the "SEC"). You may read and copy any document we file with the SEC at the SEC's public reference room at 100 F Street, N.E., Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an internet site that contains annual, quarterly and current reports, proxy and information statements and other information that issuers (including Cummins) file electronically with the SEC. The SEC's internet site is www.sec.gov.

        Our internet site is www.cummins.com. You can access our Investors and Media webpage through our internet site, by clicking on the heading "Investors and Media." We make available, free of charge, on or through our Investors and Media webpage, our proxy statements, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934 or the Securities Act of 1933, as amended, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.

        We also have a Corporate Governance webpage. You can access our Governance Documents webpage through our internet site, www.cummins.com, by clicking on the heading "Investors and Media," followed by the "Investor Relations" link and then the topic heading of "Governance Documents" within the "Corporate Governance" heading. Code of Conduct, Committee Charters and other governance documents are included at this site. Cummins Code of Conduct applies to all employees, regardless of their position or the country in which they work. It also applies to the employees of any entity owned or controlled by us. We will post any amendments to the Code of Conduct and any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange LLC (NYSE), on our internet site. The information on Cummins internet site is not incorporated by reference into this report.

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        In accordance with NYSE Rules, on May 21, 2009, we filed the annual certification by our CEO that, as of the date of the certification, he was unaware of any violation by the company of the NYSE's corporate governance listing standards.


EXECUTIVE OFFICERS OF THE REGISTRANT

        Following are the names and ages of the executive officers of Cummins Inc., their positions with us as of January 31, 2010, and summaries of their backgrounds and business experience:

Name and Age
  Present Cummins Inc. position and
year appointed to position
  Principal position during the past
five years other than Cummins Inc.
position currently held
Theodore M. Solso (62)   Chairman of the Board of Directors and Chief Executive Officer (2000)    

N. Thomas Linebarger (47)

 

President and Chief Operating Officer (2008)

 

Executive Vice President and President—Power Generation (2005-2008), Vice President and President Cummins Power Generation (2003-2005)

Pamela L. Carter (60)

 

Vice President and President—Distribution Business (2008)

 

President—Cummins Filtration (2006-2008), President—Fleetguard (2005-2006), Vice President—WW Sales, Marketing and Logistics—Fleetguard (2001-2005)

Steven M. Chapman (55)

 

Group Vice President—China and Russia (2009)

 

Vice President—Emerging Markets and Businesses (2005-2009), Vice President—International and President International Distributor Business (2002-2005)

Richard J. Freeland (52)

 

Vice President and President—Components Group (2008)

 

Vice President and President—Worldwide Distribution Business (2005-2008), Vice President and General Manager—PowerCare and Distribution (2004-2005)

Mark R. Gerstle (54)

 

Vice President—Corporate Quality and Chief Risk Officer (2005)

 

Vice President—Corporate/Cummins Business Services and Corporate Quality (2004-2005)

Richard E. Harris (57)

 

Vice President—Chief Investment Officer (2008)

 

Vice President—Treasurer (2003-2008)

Marsha L. Hunt (46)

 

Vice President—Corporate Controller (2003)

 

 

James D. Kelly (57)

 

Vice President and President—Engine Business (2005)

 

Vice President and General Manager—Mid-range and Heavy-Duty Engine Business (2004-2005)

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Name and Age
  Present Cummins Inc. position and
year appointed to position
  Principal position during the past
five years other than Cummins Inc.
position currently held
Marya M. Rose (47)   Vice President—General Counsel and Corporate Secretary (2001)    

Livingston L. Satterthwaite (49)

 

Vice President and President—Power Generation (2008)

 

Vice President—Generator Set Business (2003-2008)

John C. Wall (58)

 

Vice President—Chief Technical Officer (2000)

 

 

Patrick J. Ward (46)

 

Vice President—Chief Financial Officer (2008)

 

Vice President—Engine Business Controller (2005-2008), Executive Director—Power Generation Business Controller (2003-2005)

        Our Chairman and Chief Executive Officer is elected annually by our Board of Directors and holds office until the first meeting of the Board of Directors following the annual meeting of the shareholders. Other officers are appointed by the Chairman and Chief Executive Officer, are ratified by our Board of Directors and hold office for such period as the Chairman and Chief Executive Officer or the Board of Directors may prescribe.

Item 1A.    Risk Factors

        Set forth below and elsewhere in this Annual Report on Form 10-K are some of the principal risks and uncertainties that could cause our actual business results to differ materially from any forward-looking statements contained in this Report and could individually or combined have a material adverse effect on our results of operations, financial position and cash flows. In addition, future results could be materially affected by general industry and market conditions, changes in laws or accounting rules, general U.S. and non-U.S. economic and political conditions, including a global economic slow-down, fluctuation of interest rates or currency exchange rates, terrorism, political unrest or international conflicts, political instability, major health concerns, natural disasters, commodity prices or other disruptions of expected economic and business conditions. These risk factors should be considered in addition to our cautionary comments concerning forward-looking statements in this Report, including statements related to markets for our products and trends in our business that involve a number of risks and uncertainties. Our separate section above, "CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION," should be considered in addition to the following statements.

Although the global economy showed mild signs of recovery in late 2009, a further downturn could materially adversely affect our results of operations, financial condition and cash flows again.

        Although we began to see some signs of improvement in late 2009, the global economy remains fragile. The global economic recession that began in late 2008 and continued through 2009 had a significant adverse impact on our business, customers and suppliers. If the global economy were to take another significant downturn, depending upon the length, duration and severity of such a so-called "double-dip" recession, our results of operations, financial condition and cash flow would almost certainly be materially adversely affected again. Specifically, our revenues would likely decrease, we may be forced to consider further restructuring actions, we may need to increase our allowance for doubtful accounts, our days sales outstanding may increase and we could experience impairments to assets of certain of our businesses.

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The discovery of any significant problems with our new EPA compliant engine platforms in North America could materially adversely impact our results of operations, financial condition and cash flows.

        We have received EPA and CARB certification for our heavy-duty ISX15 and mid-range ISB6.7, ISC8.3 and ISL9 engines which went into commercial production in early 2010. Certification of these engines confirms that our 2010 engine line-up for on-highway applications meets the near zero emissions levels required for all engines manufactured in 2010. The launch of these new platforms, which includes the introduction of SCR technology, will impact a number of our operating segments and is crucial to our success in North America. Although these engine platforms have undergone extensive testing and we believe that they are ready for production, the discovery of any significant problems in these platforms could result in delays in our product launches, recall campaigns, increased warranty costs, reputational risk and brand risk.

We may need to write off significant investments in our new light-duty diesel engine platforms if customer commitments further deteriorate.

        We began development of a new light-duty diesel engine platform in July 2006 to be used in a variety of on- and off-highway applications. Since that time, and as of December 31, 2009, we have capitalized investments of approximately $216 million. Market uncertainty due to the global recession has resulted in some customers delaying or cancelling their vehicle programs, while others remain on schedule. If customer expectations or volume projections further deteriorate from our current levels and we do not identify new customers, we may need to recognize an impairment charge and write the asset down to net realizable value.

We are vulnerable to supply shortages from single-sourced suppliers.

        For 2009, we single sourced approximately 70 to 80 percent of the total types of parts in our product designs. Any delay in our suppliers' deliveries may adversely affect our operations at multiple manufacturing locations, forcing us to seek alternative supply sources to avoid serious disruptions. Delays may be caused by factors affecting our suppliers, including capacity constraints, labor disputes, economic downturns, availability of credit, the impaired financial condition of a particular supplier, suppliers' allocations to other purchasers, weather emergencies or acts of war or terrorism. Any extended delay in receiving critical supplies could impair our ability to deliver products to our customers.

Government regulation could adversely affect our business.

        Our engines are subject to extensive statutory and regulatory requirements governing emissions and noise, including standards imposed by the EPA, the European Union, state regulatory agencies, such as the California Air Resources Board ("CARB") and other regulatory agencies around the world. We have made, and will be required to continue to make, significant capital and research expenditures to comply with these regulatory standards. Developing engines to meet changing government regulatory requirements, with different implementation timelines and emissions requirements, makes developing engines efficiently for multiple markets complicated and could result in substantial additional costs that may be difficult to recover in certain markets. In some cases, we may be required to develop new products to comply with new regulations, particularly those relating to air emissions. For example, we were required to develop new engines to comply with stringent emissions standards in the U.S. by January 1, 2010. While we were able to meet this and previous deadlines, our ability to comply with other existing and future regulatory standards will be essential for us to maintain our position in the engine markets we serve. Further, the successful development and introduction of new and enhanced products in order to comply with new regulatory requirements are subject to other risks, such as delays in product development, cost over-runs and unanticipated technical and manufacturing difficulties.

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Greenhouse gas legislation or regulation could adversely affect our business.

        There is growing consensus that some form of U.S. federal legislation and/or regulation may be forthcoming with respect to regulating manufacturers' greenhouse gas emissions. Any such regulation could result in the imposition on us of significant additional costs in the form of taxes, manufacturing restrictions and/or emission allowances. The impact of any future mandatory greenhouse gas legislative, regulatory and/or product standard requirements on our global businesses is dependent on the design, terms and applicability of the mandate or standard. We are unable to predict whether and/or the extent to which any of these potential requirements will be enacted or imposed upon us.

Our products are exposed to variability in material and commodity costs.

        Our businesses establish prices with our customers in accordance with contractual time frames; however, the timing of market price increases may prevent us from passing these additional costs on to our customers through timely pricing actions. Additionally, higher material and commodity costs around the world may offset our efforts to reduce our cost structure. While we customarily enter into financial transactions to address some of these risks, there can be no assurance that commodity price fluctuations will not adversely affect our results of operations, financial condition and cash flows. In addition, while the use of commodity price hedging instruments may provide us with protection from adverse fluctuations in commodity prices, by utilizing these instruments we potentially forego the benefits that might result from favorable fluctuations in price. As a result, higher material and commodity costs, as well as hedging these commodity costs during periods of decreasing prices, both could result in declining margins.

We are subject to currency exchange rate and other related risks.

        We conduct operations in many areas of the world involving transactions denominated in a variety of currencies. We are subject to currency exchange rate risk to the extent that our costs are denominated in currencies other than those in which we earn revenues. In addition, since our financial statements are denominated in U.S. dollars, changes in currency exchange rates between the U.S. dollar and other currencies have had, and will continue to have, an impact on our results of operations. While we customarily enter into financial transactions to address these risks, there can be no assurance that currency exchange rate fluctuations will not adversely affect our results of operations, financial condition and cash flows. In addition, while the use of currency hedging instruments may provide us with protection from adverse fluctuations in currency exchange rates, by utilizing these instruments we potentially forego the benefits that might result from favorable fluctuations in currency exchange rates.

        We also face risks arising from the imposition of exchange controls and currency devaluations. Exchange controls may limit our ability to convert foreign currencies into U.S. dollars or to remit dividends and other payments by our foreign subsidiaries or businesses located in or conducted within a country imposing controls. Currency devaluations result in a diminished value of funds denominated in the currency of the country instituting the devaluation.

Further deterioration in the North American and European automotive industries could adversely impact our business.

        A number of companies in the global automotive industry continue to experience financial difficulties. In North America, General Motors Corporation ("GM"), Ford Motor Company and Chrysler Group, LLC ("Chrysler") have experienced declining markets; furthermore, GM and Chrysler have filed for, and then exited, bankruptcy under Chapter 11 of the U.S. bankruptcy code and have accepted substantial monetary infusions from the United States government. Automakers across Europe and Japan are also experiencing difficulties from a weakened economy and tightening credit markets. Because many of our suppliers also supply automotive industry participants, the difficult automotive

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industry conditions have also adversely affected our supply base. Lower production levels for some of our key suppliers, increases in certain raw material, commodity and energy costs and the global credit market crisis have resulted in severe financial distress among many companies within the automotive supply base. The continuation of financial distress within the automotive industry and our shared supply base and/or the subsequent bankruptcy of one or more additional automakers may lead to further supplier bankruptcies, commercial disputes, supply chain interruptions, supplier requests for company sponsored capital support or a collapse of the supply chain.

Significant declines in future financial and stock market conditions could diminish our pension plan asset performance and adversely impact our results of operations, financial condition and cash flows.

        We sponsor both funded and unfunded domestic and foreign defined benefit pension and other retirement plans. Our pension expense and the required contributions to our pension plans are directly affected by the value of plan assets, the projected and actual rates of return on plan assets and the actuarial assumptions we use to measure our defined benefit pension plan obligations, including the discount rate at which future projected and accumulated pension obligations are discounted to a present value. We could experience increased pension expense due to a combination of factors, including the decreased investment performance of pension plan assets, decreases in the discount rate and changes in our assumptions relating to the expected return on plan assets.

        Significant declines in future financial and stock market conditions could cause material losses in our pension plan assets, which could result in increased pension expense in future years and adverse changes to our financial condition. We may be legally required to make contributions to our U.S. pension plans in the future, and these contributions could be material. In addition, if local legal authorities increase the minimum funding requirements for our pension plans outside the U.S., we could be required to contribute more funds.

We are exposed to political, economic and other risks that arise from operating a multinational business.

        Approximately 52 percent of our net sales for 2009 were attributable to customers outside the U.S., compared to 59 percent in 2008. Accordingly, our business is subject to the political, economic and other risks that are inherent in operating in numerous countries. These risks include:

        As we continue to operate our business globally, our success will depend, in part, on our ability to anticipate and effectively manage these and other related risks. There can be no assurance that the consequences of these and other factors relating to our multinational operations will not have a material adverse effect upon us.

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Our business is exposed to risks of product liability claims.

        We face an inherent business risk of exposure to product liability claims in the event that our products' failure to perform to specification results, or is alleged to result, in property damage, bodily injury and/or death. We may experience material product liability losses in the future. While we maintain insurance coverage with respect to certain product liability claims, we may not be able to obtain such insurance on acceptable terms in the future, if at all, and any such insurance may not provide adequate coverage against product liability claims. In addition, product liability claims can be expensive to defend and can divert the attention of management and other personnel for significant periods of time, regardless of the ultimate outcome. An unsuccessful defense of a significant product liability claim could have a material adverse effect upon us. In addition, even if we are successful in defending against a claim relating to our products, claims of this nature could cause our customers to lose confidence in our products and us.

Our products are subject to recall for performance-related issues.

        Our products may be subject to recall for performance-related or safety-related issues. Product recalls subject us to harm to our reputation, loss of current and future customers, reduced revenue and product recall costs. Product recall costs are incurred when we decide, either voluntarily or involuntarily, to recall a product through a formal campaign to solicit the return of specific products due to a known or suspected performance issue.

Our truck manufacturers and OEM customers may not continue to outsource their engine supply needs.

        Several of our engine customers, including PACCAR Inc., Volvo AB and Chrysler, are truck manufacturers or OEMs that manufacture engines for some of their own products. Despite their engine manufacturing abilities, these customers have historically chosen to outsource certain types of engine production to us due to the quality of our engine products, our emissions capability, our systems integration, their customers' preferences, their desire for cost reductions, their desire for eliminating production risks and their desire to maintain company focus. However, there can be no assurance that these customers will continue to outsource, or outsource as much of, their engine production in the future. Increased levels of OEM vertical integration could result from a number of factors, such as shifts in our customers' business strategies, acquisition by a customer of another engine manufacturer, the inability of third-party suppliers to meet product specifications and the emergence of low-cost production opportunities in foreign countries. Any significant reduction in the level of engine production outsourcing from our truck manufacturer or OEM customers could have a material adverse effect upon us.

Our operations are subject to extensive environmental laws and regulations.

        Our plants and operations are subject to increasingly stringent environmental laws and regulations in all of the countries in which we operate, including laws and regulations governing air emissions, discharges to water and the generation, handling, storage, transportation, treatment and disposal of waste materials. While we believe that we are in compliance in all material respects with these environmental laws and regulations, there can be no assurance that we will not be adversely impacted by costs, liabilities or claims with respect to existing or subsequently acquired operations, under either present laws and regulations or those that may be adopted or imposed in the future. We are also subject to laws requiring the cleanup of contaminated property. If a release of hazardous substances occurs at or from any of our current or former properties or at a landfill or another location where we have disposed of hazardous materials, we may be held liable for the contamination and the amount of such liability could be material.

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We rely on income from investees that we do not directly control.

        Our net income includes significant equity, royalty and interest income from investees that we do not directly control. For 2009, we recognized $214 million of equity, royalty and interest income from investees. The majority of our equity, royalty and interest income from investees comes from our 13 unconsolidated North American distributors, and from two of our joint ventures in China, Dongfeng Cummins Engine Company, Ltd. ("DCEC") and Chongqing Cummins Engine Company, Ltd. ("CCEC"). Our equity ownership interests in our unconsolidated North American distributors generally range from 30 percent to 50 percent. We have 50 percent equity ownership interests in DCEC and CCEC. As a result, although a significant percentage of our net income is derived from these unconsolidated entities, we do not unilaterally control their management or operations, which put a substantial portion of our net income at risk from the actions or inactions of these other entities. A significant reduction in the level of contribution by these entities to our net income would likely have a material adverse effect upon us.

We face reputational and legal risk from affiliations with foreign joint venture partners.

        Several of our joint venture partners are domiciled in areas of the world with laws, rules and business practices that differ from those in the U.S. Although we strive to select joint venture partners who share our values and understand our reporting requirements as a U.S. domiciled company and to ensure that an appropriate business culture exists within these ventures to minimize and mitigate our risk, we nonetheless face the reputational and legal risk that our joint venture partners will violate applicable laws, rules and business practices.

Unanticipated changes in our tax provisions, the adoption of new U.S. tax legislation or exposure to additional income tax liabilities could adversely affect our profitability.

        We are subject to ongoing tax audits in various U.S. and foreign jurisdictions. Tax authorities may disagree with certain tax reporting positions taken by us and, as a result, assess additional taxes against us. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision. However, there can be no assurance that we will accurately predict the outcomes of these audits, and the amounts ultimately paid upon resolution of these or subsequent tax audits could be materially different from the amounts previously included in our income tax expense and, therefore, could have a material impact on our tax provision.

        Our effective tax rate in the future could be adversely affected by changes to our operating structure, changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws and the discovery of new information in the course of our tax return preparation process. In particular, the carrying value of deferred tax assets, which are predominantly in the U.S., is dependent on our ability to generate future taxable income in the U.S.

        President Obama's administration has recently announced proposals for new U.S. tax legislation that, if adopted, could adversely affect our tax rate. The proposed changes that could have an impact include the deferral of certain U.S. income tax deductions and foreign tax credit reform. Although the scope of the proposed changes is unclear, it is possible that these or other changes in the U.S. tax laws could increase our effective tax rate and adversely affect our profitability. In addition, as a result of the economic recession, many states are considering new tax legislation to raise revenues and reduce their spending deficits. Implementation of any of these new tax laws could adversely affect us.

We may be adversely impacted by work stoppages and other labor matters.

        As of December 31, 2009, we employed approximately 34,900 persons worldwide. Approximately 13,200 of our employees worldwide are represented by various unions under collective bargaining

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agreements that expire between 2010 and 2014. While we have no reason to believe that we will be impacted by work stoppages and other labor matters, there can be no assurance that future issues with our labor unions will be resolved favorably or that we will not encounter future strikes, work stoppages, or other types of conflicts with labor unions or our employees. Any of these consequences may have an adverse effect on us or may limit our flexibility in dealing with our workforce. In addition, many of our customers have unionized work forces. Work stoppages or slow-downs experienced by our customers could result in slow-downs or closures at vehicle assembly plants where our engines are installed. If one or more of our customers experience a material work stoppage, it could have a material adverse effect on our operations.

We face significant competition in the markets we serve.

        The markets in which we operate are highly competitive. We compete worldwide with a number of other manufacturers and distributors that produce and sell similar products. Our products primarily compete on the basis of price, performance, fuel economy, speed of delivery, quality and customer support. There can be no assurance that our products will be able to compete successfully with the products of these other companies. For a more complete discussion of the competitive environment in which each of our segments operates, see "Operating Segments" in "Item 1 Business."

Item 1B.    Unresolved Staff Comments

        None.

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Item 2.    Properties

Manufacturing Facilities

        Our principal manufacturing facilities include our plants used by the following segments in the following locations:

Segment
  U.S. Facilities   Facilities Outside the U.S.
Engine   Indiana: Columbus, Seymour   Belgium: Mechelen
    Tennessee: Memphis   Brazil: Sao Paulo
    New York: Lakewood   India: Pune
    North Carolina: Whitakers   Mexico: San Luis Potosi
        United Kingdom (U.K.): Darlington, Daventry
        Singapore: Singapore SG

Power Generation

 

Indiana: Elkhart

 

Brazil: Sao Paulo
    Minnesota: Fridley   China: Wuxi, Wuhan
        Germany: Karlshuld, Ingolstadt
        India: Pune, Daman, Ahmendnagar, Ranjangaon
        Mexico: San Luis Potosi
        Romania: Craiova
        Singapore: Singapore SG
        U.K.: Margate, Manston, Stamford

Components

 

Indiana: Columbus
Iowa: Lake Mills
Ohio: Findlay
South Carolina: Ladson, Charleston
Tennessee: Cookeville
Texas: El Paso
Wisconsin: Janesville, Mineral Point, Arcadia, Black River Falls, Viroqua

 

Australia: Scoresby, Kilsyth
Brazil: Sao Paulo
China: Beijing, Hubei Sheng, Shangai, Wuxi
France: Quimper
India: Pune, Daman, Dewas, Pithampur
Japan: Tokyo
Mexico: Ciudad Juarez, San Luis Potosi
Singapore: Singapore SG
South Africa: Pretoria, Johannesburg
U.K.: Darlington, Huddersfield

        In addition, engines and engine components are manufactured by joint ventures or independent licensees at manufacturing plants in the U.K., China, India, Japan, Pakistan, South Korea, Turkey and Indonesia.

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Distribution Facilities

        The principal distribution facilities used by our Distribution segment are located in the following locations:

U.S. Facilities   Facilities Outside the U.S.
Connecticut: Rocky Hill   Australia: Scoresby
Maryland: Baltimore   Belgium: Mechelen
New Jersey: Newark   China: Beijing, Shanghai
New York: Bronx   Germany: Gross Gerau
Pennsylvania: Bristol, Harrisburg   India: Pune
    Japan: Tokyo
    Russia: Moscow
    Singapore: Singapore SG
    South Africa: Johannesburg
    U.K.: Wellingborough
    United Arab Emirates: Dubai


Headquarters and Other Offices

        Our Corporate Headquarters are located in Columbus, Indiana. Additional marketing and operational headquarters are in the following locations:

U.S. Facilities   Facilities Outside the U.S.
Indiana: Columbus, Indianapolis   China: Beijing, Shanghai
Tennessee: Franklin, Nashville   India: Pune
Washington DC   U.K.: Staines, Stockton

Item 3.    Legal Proceedings

        We are subject to numerous lawsuits and claims arising out of the ordinary course of our business, including actions related to product liability; personal injury; the use and performance of our products; warranty matters; patent, trademark or other intellectual property infringement; contractual liability; the conduct of our business; tax reporting in foreign jurisdictions; distributor termination; workplace safety; and environmental matters. We also have been identified as a potentially responsible party at multiple waste disposal sites under U.S. federal 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, as more fully described in Item 1 of this Form 10-K under "Environmental Compliance-Other Environmental Statutes and Regulations." We have denied liability with respect to many of these lawsuits, claims and proceedings and are vigorously defending such lawsuits, claims and proceedings. We carry various forms of commercial, property and casualty, product liability and other forms of insurance; however, such insurance may not be applicable or adequate to cover the costs associated with a judgment against us with respect to these lawsuits, claims and proceedings. We do not believe that these lawsuits are material individually or in the aggregate. While we believe we have also established adequate accruals for our expected future liability with respect to pending lawsuits, claims and proceedings, where the nature and extent of any such liability can be reasonably estimated based upon then presently available information, there can be no assurance that the final resolution of any existing or future lawsuits, claims or proceedings will not have a material adverse effect on our business, results of operations, financial condition or cash flows.

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        In June 2008, four of our sites in Southern Indiana, including our Technical Center, experienced extensive flood damage. We have submitted a claim for $237 million to our insurance carriers, which includes a claim for business interruption. Our insurance carriers have disputed certain aspects of our claim and each party has filed suit against the other. Although we believe that we should be insured against the full amount of such claim, there can be no assurance that we will be successful in pursuing these claims.

Item 4.    Submission of Matters to a Vote of Security Holders

        There were no matters submitted to a vote of our shareholders during the last quarter of 2009.

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PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

        (a)   Our common stock, par value $2.50 per share, is listed on the NYSE under the symbol "CMI." For information about the quoted market prices of our common stock, information regarding dividend payments and the number of common stock shareholders, see "Selected Quarterly Financial Data" in this report. For other matters related to our common stock and shareholders' equity, see Note 15, "CUMMINS INC. SHAREHOLDERS' EQUITY," to the Consolidated Financial Statements.

        (b)   Use of proceeds—not applicable.

        (c)   The following information is provided pursuant to Item 703 of Regulation S-K:

 
  ISSUER PURCHASES OF EQUITY SECURITIES  
Period
  (a) Total
Number of
Shares
Purchased(1)
  (b) Average
Price Paid
per Share
  (c) Total Number of
Shares Purchased
as Part of Publicly
Announced
Plans or Programs
  (d) Maximum
Number of Shares
that May Yet Be
Purchased Under the
Plans or Programs(2)
 

September 28 - November 1, 2009

      $         320,635  

November 2 - November 29, 2009

    475,995     46.63     435,000     281,197  

November 30 - December 31, 2009

    21,942     46.46         256,791  
                     

Total

    497,937   $ 46.62     435,000        
                     

(1)
Shares purchased represent shares under the 2007 Board authorized repurchase program (for up to $500 million of our common shares) and our Key Employee Stock Investment Plan established in 1969 (there is no maximum repurchase limitation in this plan).

(2)
These values reflect shares held in loan status for our Key Employee Stock Investment Plan. The $500 million repurchase program authorized by our Board of Directors in 2007 does not limit the number of shares that may be purchased and was excluded from this column.

        In December 2007, our Board of Directors authorized us to acquire an additional $500 million of our common stock. This authorization does not have an expiration date. In 2008, we acquired $128 million followed by a further $20 million in 2009, leaving $352 million available for purchase under this authorization at December 31, 2009. We announced in February 2009 that we temporarily suspended our stock repurchase program to conserve cash. We lifted the suspension in October 2009 and will from time to time repurchase stock.

        During the fourth quarter of 2009, we repurchased 62,937 shares of common stock from employees in connection with the Key Employee Stock Investment Plan which allows certain employees, other than officers, to purchase shares of common stock on an installment basis up to an established credit limit. Loans are issued for five-year terms at a fixed interest rate established at the date of purchase and may be refinanced after its initial five-year period for an additional five-year period. Participants must hold shares for a minimum of six months from date of purchase and after shares are sold must wait six months before another share purchase may be made. We hold participants' shares as security for the loans and would, in effect, repurchase shares if the participant defaulted in repayment of the loan. There is no maximum amount of shares that we may purchase under this plan.

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Performance Graph (Unaudited)

        The following Performance Graph and related information shall not be deemed "soliciting material" or to be "filed" with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.

        The following graph compares the cumulative total shareholder return on our common stock for the last five years with the cumulative total return on the S&P 500 Index and an index of peer companies selected by us. Our peer group included ArvinMeritor Inc., Caterpillar, Inc., Deere & Company, Eaton Corporation, Ingersoll-Rand Company Ltd., Navistar International Corporation and PACCAR Inc. We have a unique business and selected peers that we believe are the most closely aligned with our business. Each of the three measures of cumulative total return assumes reinvestment of dividends. The comparisons in this table are required by the SEC and are not intended to forecast or be indicative of possible future performance of our stock.


COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN AMONG CUMMINS, INC.,
S&P 500 INDEX AND CUSTOM PEER GROUP

GRAPHIC

ASSUMES $100 INVESTED ON JAN. 01, 2005
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING DEC. 31, 2009

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Item 6.    Selected Financial Data

        The selected financial information presented below for each of the five years ended December 31, 2009, was derived from our Consolidated Financial Statements. This information should be read in conjunction with our Consolidated Financial Statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations."

In millions, except per share amounts
  2009   2008   2007   2006   2005  

For the years ended December 31,

                               

Net sales

  $ 10,800   $ 14,342   $ 13,048   $ 11,362   $ 9,918  

U.S. percentage of sales

   
48

%
 
41

%
 
46

%
 
50

%
 
49

%

Non-U.S. percentage of sales

    52 %   59 %   54 %   50 %   51 %

Gross margin

   
2,169
   
2,940
   
2,556
   
2,465
   
2,044
 

Research, development and engineering expenses

    362     422     329     321     278  

Equity, royalty and interest income from investees

    214     253     205     140     131  

Interest expense

    35     42     58     96     109  

Net income(1)

    484     818     788     759     582  

Net income attributable to Cummins Inc.(1)(2)

    428     755     739     715     550  

Net earnings per share attributable to Cummins Inc.(3)

                               
 

Basic

  $ 2.17   $ 3.87   $ 3.72   $ 3.76   $ 3.11  
 

Diluted

    2.16     3.84     3.70     3.55     2.75  

Cash dividends declared per share

    0.70     0.60     0.43     0.33     0.30  

Cash flows from operations

  $ 1,137   $ 987   $ 810   $ 840   $ 760  

Capital expenditures

    310     543     353     249     186  

At December 31,

                               

Cash and cash equivalents

  $ 930   $ 426   $ 577   $ 840   $ 779  

Total assets

    8,816     8,519     8,195     7,465     6,885  

Long-term debt

    637     629     555     647     1,213  

Total equity(4)

    4,020     3,480     3,702     3,056     2,089  

(1)
For the year ended December 31, 2009, net income includes $99 million in restructuring and other charges and a gain of $12 million related to flood damage recoveries. For the year ended December 31, 2008, net income includes a $37 million restructuring charge, a $36 million decrease in cash surrender value in corporate owned life insurance and $5 million of losses related to flood damage recoveries.

(2)
On January 1, 2009, we adopted changes issued by the Financial Accounting Standards Board to consolidation accounting and reporting. These changes, among others, require that minority interests be renamed noncontrolling interests and a company present a consolidated net income measure that includes the amount attributable to such noncontrolling interests for all periods presented.

(3)
All per share amounts have been adjusted for the impact of a two-for-one stock split on April 9, 2007 and an additional two-for-one stock split on January 2, 2008.

(4)
During 2006, we adopted the provisions of employers' accounting for defined benefit pension and other postretirement plans under accounting principles generally accepted in the United States of America (GAAP), which resulted in a $94 million non-cash charge to equity. In 2008, we recorded a $433 million non-cash charge to equity to reflect losses associated with the effect of market conditions on our pension plans.

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Item 7.    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") was prepared to provide the reader with a view and perspective of our businesses through the eyes of management and should be read in conjunction with our Consolidated Financial Statements and the accompanying notes to those financial statements. Our MD&A is presented in the following sections:


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 component products, including filtration, exhaust aftertreatment, 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 PACCAR Inc., Daimler Trucks North America, Chrysler Group, LLC, Volvo AB, Ford Motor Company, Komatsu, MAN Nutzfahrzeuge AG (formerly Volkswagen) and Case New Holland. We serve our customers through a network of more than 500 company-owned and independent distributor locations and approximately 5,200 dealer locations in more than 190 countries and territories.

        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 and allows management to focus its efforts on providing enhanced service to a wide range of customers. The Engine segment produces engines and parts for sale to customers in on-highway and various industrial markets. The engines are used in trucks of all sizes, buses and recreational vehicles, as well as various industrial applications including construction, mining, agriculture, marine, oil and gas, rail and military. The Power Generation segment is an integrated provider of power systems which sells engines, generator sets and alternators. The Components segment sells filtration products, exhaust aftertreatment systems, turbochargers and fuel systems. The Distribution segment includes wholly-owned and partially-owned distributorships engaged in wholesaling engines, generator sets and service parts, as well as performing service and repair activities on our products and maintaining relationships with various OEMs throughout the world.

        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 our customers' access to credit. Our sales may also be impacted by OEM inventory levels and production schedules and stoppages. Economic downturns in markets we serve

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generally result in reductions in sales and pricing of our products. As a worldwide business, our operations are also affected by political, economic and regulatory matters, including environmental and emissions standards, in the countries we serve. At the same time, our geographic diversity and broad product and service offerings have helped limit the impact from a drop in demand in any one industry or customer and the economy of any single country on our consolidated results.

        The global economic downturn in 2009 extensively challenged most of our businesses and the markets in which they operate. All of our operating segments incurred double digit declines in net sales and three business units incurred a decrease in EBIT ranging from 44 percent to 56 percent. Our joint ventures throughout the world also experienced severe downturns in operating results causing income from equity investees to decline 15 percent. We experienced significant decreases in market demand for many of our products. The challenging worldwide economy impacted all of our business units in different ways. Our Power Generation and Distribution businesses, which have longer lead times, began to see declines in 2009 while our other businesses started to experience declines in the second half of 2008, especially in the fourth quarter. Demand in most of our markets around the world appears to have reached bottom and we believe those markets have stabilized at these lower levels. We are also seeing improvements in emerging markets including China, India and Brazil. The economy in the United States (U.S.), while showing some signs of recovery, still remains fragile and unemployment continues to remain high. In the second half of 2009, we experienced increased sales in our global engine markets and in North America, we experienced a temporary increase in engine (and related component) demand prior to the 2010 emissions standard change. The increased demand was consistent with sales trends we observed in prior emissions implementations and was the primary reason for sales to U.S. markets increasing to 48 percent of total net sales in 2009, compared with 41 percent of total net sales in 2008. Throughout the year, we took actions to align our businesses with reduced customer demand, particularly in the first nine months of 2009. These actions included global workforce reductions and closing certain manufacturing operations. Costs associated with these restructuring actions, in conjunction with significantly reduced demand and volumes, negatively impacted our operating results in 2009 compared to 2008 and 2007 results. At the same time, we took actions which enabled us to end the year with a stronger balance sheet. We closely monitored our receivables and customer relationships, reduced inventories 25 percent, reduced capital expenditures 43 percent and increased our cash and marketable securities by over $0.6 billion, generating over $1.1 billion in cash from operations. At the same time, we lowered our debt to capital ratio, maintained our credit ratings, improved our pension funding through increased contributions and strong returns and our $1.1 billion line of credit remains unused.

        As a result of the temporary increase in sales in the second half of 2009, and the challenging economy, we expect new Environmental Protection Agency (EPA) emission compliant engine and component demand will be weak in the first half of 2010. Excluding the emerging markets, we expect overall demand in most of our businesses to remain at relatively low levels for the first half of 2010.

        While we expect overall demand for most of our products to be weak in the first half of 2010, with some improvements in demand in emerging markets, the actions that we initiated in late 2008 and throughout 2009 will continue to enable us to navigate through the challenging economic environment and will position us to respond to market conditions when and where they improve. Our short term priorities remain:

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        Net income attributable to Cummins Inc. was $428 million, or $2.16 per diluted share, on sales of $10.8 billion, compared to 2008 net income attributable to Cummins Inc. of $755 million, or $3.84 per diluted share, on sales of $14.3 billion. The decrease in income was driven by a 25 percent decrease in net sales and a 26 percent decrease in gross margin, as we were impacted by lower demand across most of our businesses. Focused cost reduction efforts helped mitigate the impact of lower volumes. Restructuring and other charges in 2009 were $99 million ($65 million after-tax, or $0.33 per diluted share). For a detailed discussion of restructuring see Note 3, "RESTRUCTURING AND OTHER CHARGES," to our Consolidated Financial Statements.


RESULTS OF OPERATIONS

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2009 vs. 2008   2008 vs. 2007  
In millions, except per share amounts
  2009   2008   2007   Amount   Percent   Amount   Percent  

Net sales

  $ 10,800   $ 14,342   $ 13,048   $ (3,542 )   (25 )% $ 1,294     10 %

Cost of sales

    8,631     11,402     10,492     2,771     24 %   (910 )   (9 )%
                                   

Gross margin

    2,169     2,940     2,556     (771 )   (26 )%   384     15 %

Operating expenses and income

                                           
 

Selling, general and administrative expenses

    1,239     1,450     1,296     211     15 %   (154 )   (12 )%
 

Research, development and engineering expenses

    362     422     329     60     14 %   (93 )   (28 )%
 

Equity, royalty and interest income from investees

    214     253     205     (39 )   (15 )%   48     23 %
 

Restructuring and other charges

    99     37         (62 )   NM     (37 )   NM  
 

Other operating (expense) income, net

    (1 )   (12 )   22     11     92 %   (34 )   NM  
                                   

Operating income

    682     1,272     1,158     (590 )   (46 )%   114     10 %
 

Interest income

    8     18     36     (10 )   (56 )%   (18 )   (50 )%
 

Interest expense

    35     42     58     7     17 %   16     28 %
 

Other (expense) income, net

    (15 )   (70 )   33     55     79 %   (103 )   NM  
                                   

Income before income taxes

    640     1,178     1,169     (538 )   (46 )%   9     1 %

Income tax expense

    156     360     381     204     57 %   21     6 %
                                   

Net income

    484     818     788     (334 )   (41 )%   30     4 %

Less: Net income attributable to noncontrolling interests

    56     63     49     7     11 %   (14 )   (29 )%
                                   

Net income attributable to Cummins Inc

  $ 428   $ 755   $ 739   $ (327 )   (43 )% $ 16     2 %
                                   

Diluted earnings per share attributable to Cummins Inc

  $ 2.16   $ 3.84   $ 3.70   $ (1.68 )   (44 )% $ 0.14     4 %
                                   

Percent of sales

                                           
 

Gross margin

    20.1 %   20.5 %   19.6 %   (0.4 )%         0.9 %      
 

Selling, general and administrative expenses

    11.5 %   10.1 %   9.9 %   (1.4 )%         (0.2 )%      
 

Research, development and engineering expenses

    3.4 %   2.9 %   2.5 %   (0.5 )%         (0.4 )%      

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2009 vs. 2008

Net Sales

        Net sales decreased in all segments primarily due to lower demand as a result of the global economic downturn. The primary drivers were:

        A more detailed discussion of sales by segment is presented in the "OPERATING SEGMENT RESULTS" section.

Gross Margin

        Significant drivers of the change in gross margins were as follows:

In millions
  2009 vs. 2008
Increase (Decrease)
 

Volume/Mix

  $ (1,228 )

Price

    252  

Production costs

    132  

Warranty expense

    46  

Material Costs

    13  

Currency

    8  

Other

    6  
       

Total

  $ (771 )
       

        Gross margin decreased by $771 million, and as a percentage of sales decreased by 0.4 percentage points. The decrease was led by lower volumes which were partially offset by increased engine purchases ahead of the January 1, 2010, emissions standards change, improved pricing and decreased production costs. The overall decrease in volumes was due to lower sales resulting from the global economic downturn. Our warranty provision on sales in 2009 was 3.3 percent compared to 2.9 percent in 2008. Our 2008 warranty expense included $117 million recorded in the fourth quarter associated with increases in the estimated warranty liability primarily for certain mid-range engine products launched in 2007. The accrual rates in 2009 for these related engine products were higher than those recorded in 2008 before this change in estimate. As such, our warranty as a percent of sales for these engine families is higher on products sold in 2009 than it was in 2008. Overall, our relative product mix also impacted the rate as a percent of sales when comparing these two periods.

        A more detailed discussion of margin by segment is presented in the "OPERATING SEGMENT RESULTS" section.

Selling, General and Administrative Expenses

        Selling, general and administrative expenses decreased primarily due to a decrease of $74 million in discretionary spending, in order to conserve cash, and a decrease of $71 million in compensation and related expenses. Compensation and related expenses include salaries, fringe benefits and variable

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compensation. Salaries and fringe benefits decreased due to severance actions taken throughout 2009. Overall selling, general and administrative expenses as a percentage of sales increased to 11.5 percent in 2009 from 10.1 percent in 2008, primarily due to the 25 percent decrease in net sales.

Research, Development and Engineering Expenses

        Research, development and engineering expenses decreased primarily due to a decrease in the number of engineering projects to conserve cash while focusing on the development of critical technologies and new products and increased reimbursements from third parties for engineering projects. Overall, research, development and engineering expenses as a percentage of sales increased to 3.4 percent in 2009 from 2.9 percent in 2008, primarily due to the 25 percent decrease in net sales.

Equity, Royalty and Interest Income from Investees

        Equity, royalty and interest income from investees decreased primarily due to the following changes in equity income:

 
  Increase/(Decrease)  
In millions
  2009 vs. 2008  

Dongfeng Cummins Engine Company, Ltd. (DCEC)

  $ (22 )

Cummins MerCruiser Diesel, LLC (MerCruiser)

    (13 )

        These decreases were primarily due to lower demand as a result of the global economic conditions. The effects of the global economic downturn were partially offset by modest increases in some markets.

Other Operating (Expense) Income, Net

        Other operating (expense) income was as follows:

 
  Years ended
December 31,
 
In millions
  2009   2008  

Flood damage gain (loss)(1)

  $ 12   $ (5 )

Royalty income

    8     12  

Royalty expense

    (7 )   (10 )

Amortization of other intangibles

    (7 )   (13 )

(Loss) gain on sale of fixed assets

    (8 )   5  

Other, net

    1     (1 )
           

Total other operating (expense) income, net

  $ (1 ) $ (12 )
           

(1)
The flood gain represents flood insurance proceeds received during the third and fourth quarters of 2009 which more than offset flood related expenses recognized in 2008 and 2009.

Interest Income

        Interest income decreased primarily due to lower interest rates in 2009 compared to 2008.

Interest Expense

        Interest expense decreased primarily due to declining short-term interest rates.

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Other (Expense) Income, Net

        Other (expense) income was as follows:

 
  Years ended December 31,  
In millions
  2009   2008  

Foreign currency loss(1)

  $ (20 ) $ (46 )

Bank charges

    (14 )   (12 )

Change in cash surrender value of corporate owned life insurance(2)

    (4 )   (36 )

Dividend income

    5     6  

Other, net

    18     18  
           

Total other (expense) income, net

  $ (15 ) $ (70 )
           

(1)
The foreign currency exchange losses in 2009 and 2008 were due to unfavorable currency fluctuations, especially with the British Pound and the Brazilian Real in 2009 and the British Pound, the Euro, the Australian Dollar and the Indian Rupee in 2008.

(2)
The change in the cash surrender value of corporate owned life insurance was due to market deterioration, especially in the fourth quarter of 2008, which included the write down of certain investments to zero.

Income Tax Expense

        Our income tax rates are generally less than the 35 percent U.S. income tax rate primarily because of lower taxes on foreign earnings and research tax credits. Our effective tax rate for 2009 was 24.4 percent compared to 30.6 percent for 2008. The decrease is due to tax on foreign earnings, which are subject to lower tax rates, and an increase in research tax credits. Our 2009 income tax provision also includes a $29 million (4.5 percent) reduction in the fourth quarter related to adjustments to deferred tax accounts. We released $19 million (3.0 percent) of deferred tax liabilities on foreign earnings, now considered to be permanently reinvested outside the U.S. and recorded a deferred tax asset of $10 million (1.5 percent) related to prior period matters.

        We expect our 2010 effective tax rate to be 32 percent excluding any discrete items that may arise. The research tax credit expired December 31, 2009 and has not yet been renewed by Congress. If the research credit is extended, we would anticipate the 2010 effective tax rate to drop to 30 percent.

Noncontrolling Interests

        Noncontrolling interests eliminate the income or loss attributable to non-Cummins ownership interests in our consolidated entities. Noncontrolling interests decreased primarily due to lower income of $8 million at Cummins India Limited, a publicly traded company at various exchanges in India, as a result of the decline in demand due to the global economic downturn. There were no other individual fluctuations in the subsidiaries that were significant.

Net Income Attributable to Cummins Inc. and Diluted Earnings Per Share Attributable to Cummins Inc.

        Net income attributable to Cummins Inc. and diluted earnings per share attributable to Cummins Inc. decreased primarily due to significantly lower volumes, restructuring and other charges and decreased equity income partially offset by a lower effective tax rate.

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Outlook

Near-Term:

        Many of the markets we serve have slowed significantly as a result of the credit crisis and the challenging global economic environment; however, demand in most of our markets appears to have reached bottom and we are seeing signs that markets have stabilized at these levels. We are also seeing improvement in emerging markets including China, India and Brazil. Consistent with prior emissions standards implementation, the North American on-highway markets experienced increased demand prior to the implementation of the EPA's 2010 emissions standards. Based on our prior experience we expect EPA 2010 engine and component sales to on-highway OEM customers to be very weak in the first half of 2010. In most of our other markets we expect demand to remain stable with current levels for the first half of 2010, while we expect emerging markets to have sales comparable to 2008 levels.

Long-Term:

        While there is uncertainty in the near-term market as a result of the current economic conditions and market dynamics surrounding the EPA 2010 emissions standards change, we are confident that opportunities for long-term growth and profitability will continue in the future.

2008 vs. 2007

Net Sales

        Net sales increased in all segments due to the following drivers.

        A detailed discussion of sales by segment is presented in the "OPERATING SEGMENT RESULTS" section.

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Gross Margin

        Significant drivers of the change in gross margin were as follows:

In millions
  2008 vs. 2007
Increase (Decrease)
 

Price

  $ 402  

Volume/Mix

    227  

Production costs

    47  

Currency

    47  

Warranty expense

    (179 )

Material costs

    (173 )

Other

    13  
       

Total

  $ 384  
       

        Gross margin increased by $384 million, and as a percentage of sales increased by 0.9 percentage points. Benefits from increased pricing and a more favorable volume/mix of products sold were partially offset by higher material costs reflecting the increase in commodity prices during the year and higher warranty expense. Our warranty expense reflected favorable warranty experience for some engine products and our provision related to sales in 2008 was 2.9 percent of sales, down from 3.1 percent in 2007. This result was more than offset by negative trends primarily in certain mid-range engine products launched in 2007 for which we recorded additional warranty liability of approximately $117 million in the fourth quarter of 2008.

        A more detailed discussion of margin by segment is presented in the "OPERATING SEGMENT RESULTS" section.

Selling, General and Administrative Expenses

        Selling, general and administrative expenses increased primarily due to increased consulting expenses of $36 million, increased compensation and related expenses of approximately $34 million and the acquisition of a majority ownership interest in three previously independent North American distributors. Increased headcount and compensation and related expenses included salaries, variable compensation and fringe benefits across the business in support of higher volumes and business growth. Overall, selling, general and administrative expenses as a percentage of sales increased to 10.1 percent in 2008 from 9.9 percent in 2007.

Research, Development and Engineering Expenses

        Research, development and engineering expenses increased significantly, primarily due to higher spending on development programs for future products including increased headcount, compensation and related expenses. Compensation and related expenses include salaries, variable compensation and fringe benefits. Fluctuations in other miscellaneous research and development expenses were not significant individually or in the aggregate. Overall, research, development and engineering expenses as a percentage of sales increased to 2.9 percent in 2008 from 2.5 percent in 2007.

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Equity, Royalty and Interest Income from Investees

        Equity, royalty and interest income from investees decreased primarily due to the following:

 
  Increase/(Decrease)  
In millions
  2008 vs. 2007
 

North American Distributors

  $ 17  

Dongfeng Cummins Engine Company, Ltd. (DCEC)

    14  

Royalty and interest income

    9  

Chongqing Cummins Engine Company, Ltd. (CCEC)

    8  

Shanghai Fleetguard Filter Co., Ltd. 

    2  

Tata Cummins Ltd. (TCL)

    (6 )

MerCruiser

    (8 )

        Results from our North American distributors increased primarily due to income from a joint venture which we formed in the fourth quarter of 2007. DCEC sales increased largely due to prebuy activity in the first half of 2008 prior to a mid-year emissions change. CCEC increased primarily due to increased sales volumes. TCL experienced decreased sales volumes for the year while MerCruiser profits declined due to significant deterioration in the recreational marine market and increased research, development and engineering expenses.

Other Operating (Expense) Income, Net

        Other operating (expense) income was as follows:

 
  Years ended
December 31,
 
In millions
  2008   2007  

Royalty income

  $ 12   $ 7  

Gain on sale of fixed assets(1)

    5     22  

Flood damage loss

    (5 )    

Royalty expense

    (10 )   (4 )

Amortization of other intangibles(2)

    (13 )   (1 )

Other, net

    (1 )   (2 )
           

Total other operating (expense) income, net

  $ (12 ) $ 22  
           

(1)
The decrease in the gain on sale of fixed assets was primarily due to the $10 million gain on the sale of Universal Silencer in 2007.

(2)
The increase in amortization of other intangibles was primarily due to amortization of purchased premiums related to the acquisition of a North American distributor in 2008.

Interest Income

        Interest income decreased primarily due to lower average cash balances in 2008 compared to 2007.

Interest Expense

        Interest expense decreased primarily due to declining short-term interest rates and a benefit from our interest rate swap.

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Other (Expense) Income, Net

        Other (expense) income was as follows:

 
  Years ended
December 31,
 
In millions
  2008   2007  

Change in cash surrender value of corporate owned life insurance(1)

  $ (36 ) $  

Bank charges

    (12 )   (12 )

Foreign currency (losses) gains(2)

    (46 )   28  

Dividend income

    6     5  

Other, net

    18     12  
           

Total other (expense) income, net

  $ (70 ) $ 33  
           

(1)
The change in the cash surrender value of corporate owned life insurance was due to market deterioration, especially in the fourth quarter of 2008, which included the write down of certain investments to zero.

(2)
The foreign currency exchange losses in 2008 were due to unfavorable currency fluctuations in 2008, especially with the British Pound, the Euro, the Australian Dollar and the Indian Rupee.

Income Tax Expense

        Our income tax rates are generally less than the 35 percent U.S. income tax rate primarily because of lower taxes on foreign earnings and research tax credits. Our effective tax rate for 2008 was 30.6 percent compared to 32.6 percent for 2007. The decrease is primarily due to greater foreign earnings in 2008, which are subject to lower tax rates. Our 2008 income tax provision also included a $10 million (0.8 percent) reduction in the fourth quarter due to the legislative reinstatement of the U.S. research tax credit.

Noncontrolling Interests

        Noncontrolling interests eliminate the income or loss attributable to non-Cummins ownership interests in our consolidated entities. Noncontrolling interests increased primarily due to higher income of $10 million at Cummins India Limited, a publicly traded company at various exchanges in India, due to the creation of a new export business in 2008 and favorable price adjustments for high horsepower products. There were no other individual fluctuations in the subsidiaries that were significant.

Net Income Attributable to Cummins Inc. and Diluted Earnings Per Share Attributable to Cummins Inc.

        Net income attributable to Cummins Inc. and diluted earnings per share attributable to Cummins Inc. increased primarily due to higher volumes, improved margins, higher equity income and a lower effective tax rate. These increases were partially offset by warranty expense, restructuring charges and investment losses primarily occurring during the fourth quarter of 2008, in addition to unfavorable foreign currency effects.


RESTRUCTURING AND OTHER CHARGES

2009 Restructuring Actions

        In 2009, we executed restructuring actions in response to a reduction in orders in most of our U.S. and foreign markets due to the continuing deterioration in the global economy. We reduced our global workforce by approximately 1,000 professional employees. In addition, we took numerous employee

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actions at many of our manufacturing locations, including approximately 3,200 hourly employees, significant downsizing at numerous facilities and complete closure of several facilities and branch distributor locations. Employee termination and severance costs were recorded based on approved plans developed by the businesses and corporate management which specified positions to be eliminated, benefits to be paid under existing severance plans, union contracts or statutory requirements and the expected timetable for completion of the plan. Estimates of restructuring were made based on information available at the time charges were recorded. Due to the inherent uncertainty involved, actual amounts paid for such activities may differ from amounts initially recorded and we may need to revise previous estimates.

        We incurred $2 million of restructuring expenses for lease terminations and $5 million of restructuring expenses for asset impairments in response to closures and downsizing noted above. During 2009, we recorded a total pre-tax restructuring charge of $85 million, comprising $90 million of charges related to 2009 actions net of the $3 million favorable change in estimate related to 2008 actions and the $2 million favorable change in estimate related to earlier 2009 actions, in "Restructuring and other charges" in our Consolidated Statements of Income. These restructuring actions included:

In millions
  Year ended
December 31, 2009
 

Workforce reductions

  $ 81  

Exit activities

    7  

Other

    2  

Changes in estimate

    (5 )
       

Total restructuring charges

    85  

Curtailment loss

    14  
       

Total restructuring and other charges

  $ 99  
       

        In addition, as a result of the restructuring actions described above, we also recorded a $14 million curtailment loss in our pension and other postretirement plans. See Note 12, "PENSION AND OTHER POSTRETIREMENT BENEFITS," to our Consolidated Financial Statements for additional detail.

        At December 31, 2009, of the approximately 4,200 employees affected by this plan, all terminations were substantially complete. If the 2009 restructuring actions are successfully implemented, we expect the annualized savings from the professional actions to be approximately $50 million. Our charge related to the professional actions was approximately $30 million. Approximately 40 percent of the savings from the restructuring actions will be realized in cost of sales, 45 percent in selling, general and administrative expenses and 15 percent in research, development and engineering expenses. We expect the accrual to be paid in cash which will be funded with cash generated from operations.

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        The following table summarizes the balance of accrued restructuring charges by expense type and the changes in the accrued amounts for the applicable periods. The restructuring related accruals were recorded in "Other accrued expenses" in our Consolidated Balance Sheets.

In millions
  Severance
Costs
  Exit
Activities
  Other   Total  

2009 Restructuring charges

  $ 81   $ 7   $ 2   $ 90  

Cash payments for 2009 actions

    (70 )   (1 )       (71 )

Noncash items

        (5 )   (2 )   (7 )

Changes in estimates

    (2 )           (2 )

Translation

    1             1  
                   

Balance at December 31, 2009

  $ 10   $ 1   $   $ 11  
                   

        We do not include restructuring and other charges in our operating segment results. The pre-tax impact of allocating restructuring and other charges to the segment results would have been as follows:

In millions
  Year ended
December 31, 2009
 

Engine

  $ 47  

Power Generation

    12  

Components

    35  

Distribution

    5  
       

Total restructuring charges

  $ 99  
       

2008 Restructuring Actions

        We executed restructuring actions primarily in the form of voluntary and involuntary separation programs in the fourth quarter of 2008. These actions were in response to the continued deterioration in our U.S. businesses and most key markets around the world in the second half of 2008, as well as a reduction in orders in most U.S. and global markets for 2009. We reduced our worldwide professional workforce by approximately 650 employees, or 4.5 percent. We offered a voluntary retirement package to certain active professional employees in the U.S. based on a clearly defined set of criteria. We also took voluntary and involuntary actions which included approximately 800 hourly employees, the majority of which received severance benefits. The compensation packages contained salary and continuation of benefits, including health care, life insurance and outplacement services. The voluntary retirement package was accepted by approximately 150 employees. The remaining professional reductions of 500 employees were involuntary. The expenses recorded during the year ended December 31, 2008, included severance costs related to both voluntary and involuntary terminations. During 2008, we incurred a pre-tax charge related to the professional and hourly restructuring initiatives of approximately $37 million.

        Employee termination and severance costs were recorded based on approved plans developed by the businesses and corporate management which specified positions to be eliminated, benefits to be paid under existing severance plans or statutory requirements and the expected timetable for completion of the plan. Estimates of restructuring were made based on information available at the time charges were recorded. Due to the inherent uncertainty involved, actual amounts paid for such activities may differ from amounts initially recorded and we may need to revise previous estimates.

        At December 31, 2008, of the approximately 1,450 employees affected by this plan, 1,250 had been terminated. All terminations were substantially complete as of December 31, 2009. We expect the 2008 restructuring actions to yield approximately $45 million to $50 million in annual savings from professional actions. Approximately 41 percent of the savings from the restructuring actions will be

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realized in cost of sales, 44 percent in selling, general and administrative expenses, and 15 percent in research, development and engineering expenses.

        The table below summarizes the balance of accrued restructuring expenses for 2008 actions, which were included in the balance of "Other accrued expenses" in our Consolidated Balance Sheets as of December 31, 2009 and 2008:

In millions
  Severance Costs  

2008

       

Restructuring charges

  $ 37  

Cash payments for 2008 actions

    (3 )
       

Balance at December 31, 2008

    34  

2009

       

Cash payments for 2008 actions

    (31 )

Change in estimate

    (3 )
       

Balance at December 31, 2009

  $  
       

        We do not include restructuring charges in the segment results. The pre-tax impact of allocating restructuring charges for the year ended December 31, 2008, would have been as follows:

In millions
   
 

Engine

  $ 17  

Power Generation

    3  

Components

    15  

Distribution

    2  
       

Total restructuring charges

  $ 37  
       

        There were no material changes to the estimated savings, or periods under which we expect to recognize the savings, for the 2008 actions.


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 and allows management to focus its efforts on providing enhanced service to a wide range of customers. The Engine segment produces engines and parts for sale to customers in on-highway and various industrial markets. The engines are used in trucks of all sizes, buses and RVs, as well as various industrial applications including construction, mining, agriculture, marine, oil and gas, rail and military. The Power Generation segment is an integrated provider of power systems which sells engines, generator sets and alternators. The Components segment includes sales of filtration products, exhaust and aftertreatment systems, turbochargers and fuel systems. The Distribution segment includes wholly-owned and partially-owned distributorships engaged in wholesaling engines, generator sets, and service parts, as well as performing service and repair activities on our products and maintaining relationships with various OEMs.

        We use segment EBIT (defined as earnings before interest expense, taxes and noncontrolling interests) as a primary basis for the chief operating decision-maker to evaluate the performance of each of our operating segments. Segment amounts exclude certain expenses not specifically identifiable to segments.

        The accounting policies of our operating segments are the same as those applied in our Consolidated Financial Statements. We prepared the financial results of our operating segments on a

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basis that is consistent with the manner in which we internally disaggregate financial information to assist in making internal operating decisions. We have allocated certain common costs and expenses, primarily corporate functions, among segments differently than we would for stand-alone financial information prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). These include certain costs and expenses of shared services, such as information technology, human resources, legal and finance. We also do not allocate debt-related items, actuarial gains or losses, prior service costs or credits, restructuring and other charges, investment gains or losses, flood damage gains or losses, or income taxes to individual segments. Segment EBIT may not be consistent with measures used by other companies.


Engine Segment Results

        Financial data for the Engine segment was as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended
December 31,
 
 
  2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007   Amount   Percent   Amount   Percent  

External sales

  $ 5,582   $ 7,432   $ 7,129   $ (1,850 )   (25 )% $ 303     4 %

Intersegment sales

    823     1,378     1,053     (555 )   (40 )%   325     31 %
                                   
 

Total sales

    6,405     8,810     8,182     (2,405 )   (27 )%   628     8 %

Depreciation and amortization

    185     180     176     (5 )   (3 )%   (4 )   (2 )%

Research, development and engineering expenses

    241     286     222     45     16 %   (64 )   (29 )%

Equity, royalty and interest income from investees

    54     99     92     (45 )   (45 )%   7     8 %

Interest income

    3     10     26     (7 )   (70 )%   (16 )   (62 )%

Segment EBIT

    252     535     589     (283 )   (53 )%   (54 )   (9 )%

Segment EBIT as a percentage of net sales

   
3.9

%
 
6.1

%
 
7.2

%
 

(2.2) percentage points

   

(1.1) percentage points

 

        A summary and discussion of Engine segment net sales by market follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007   Amount   Percent   Amount   Percent  

Heavy-duty truck

  $ 1,996   $ 2,308   $ 1,948   $ (312 )   (14 )% $ 360     18 %

Medium-duty truck and bus

    1,232     1,550     1,284     (318 )   (21 )%   266     21 %

Light-duty automotive and RV

    688     804     1,340     (116 )   (14 )%   (536 )   (40 )%
                                   

Total on-highway

    3,916     4,662     4,572     (746 )   (16 )%   90     2 %

Industrial

    1,821     3,029     2,676     (1,208 )   (40 )%   353     13 %

Stationary power

    668     1,119     934     (451 )   (40 )%   185     20 %
                                   
 

Total sales

  $ 6,405   $ 8,810   $ 8,182   $ (2,405 )   (27 )% $ 628     8 %
                                   

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        A summary of unit shipments by engine classification (including unit shipments to Power Generation) follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2009 vs. 2008   2008 vs. 2007  
 
  2009   2008   2007   Amount   Percent   Amount   Percent  

Mid-range

    269,200     418,300     486,800     (149,100 )   (36 )%   (68,500 )   (14 )%

Heavy-duty

    85,900     108,300     91,400     (22,400 )   (21 )%   16,900     18 %

High-horsepower

    13,400     20,600     18,500     (7,200 )   (35 )%   2,100     11 %
                                   
 

Total unit shipments

    368,500     547,200     596,700     (178,700 )   (33 )%   (49,500 )   (8 )%
                                   

2009 vs. 2008

Net Sales

        Engine segment sales experienced deterioration across all major markets, versus 2008, as a result of the global economic downturn. The following are the primary drivers by market.

        Total on-highway-related sales were 61 percent of total Engine segment sales, compared to 53 percent in 2008.

Segment EBIT

        Engine segment EBIT decreased primarily due to lower gross margin and equity, royalty and interest income from investees which were partially offset by decreased selling, general and

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administrative expenses and decreased research, development and engineering expenses. Changes in Engine segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31,
2009 vs. 2008
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ (330 )   (24 )%   0.6 %

Selling, general and administrative expenses

    57     9 %   (1.7 )%

Research, development and engineering expenses

    45     16 %   (0.6 )%

Equity, royalty and interest income from investees

    (45 )   (45 )%   NM  

        The decrease in gross margin was primarily due to lower engine volumes in most markets as a result of the global economic downturn, which was partially offset by increased sales in the U.S. in the fourth quarter of 2009 ahead of the January 1, 2010, emissions standards change, price improvements and by cost reduction activities at our manufacturing plants. Equity, royalty and interest income from investees decreased due to significantly lower demand at DCEC, Komatsu-Cummins Engine Company (KCEC) and Cummins MerCruiser Diesel Marine LLC. The decrease in selling, general and administrative expenses and research, development and engineering expenses was primarily due to lower discretionary spending, higher recovery of engineering expenses from third parties and decreased payroll costs as the result of restructuring actions.

2008 vs. 2007

Net Sales

        Engine segment sales increased compared to 2007. The following are the primary drivers by market.

        These increases were partially offset by a 50 percent decline in units sold to Chrysler. This decline was due to the deteriorating demand for light duty trucks in North America as the result of the softening U.S. economy and concerns over fuel prices earlier in the year.

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        Total on-highway-related sales were 53 percent of total Engine segment sales in 2008, compared to 56 percent in 2007.

Segment EBIT

        Engine segment EBIT decreased primarily due to increased research, development and engineering and increased selling, general and administrative expenses which were partially offset by increased gross margin. Changes in Engine segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31,
2008 vs. 2007
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ 73     6 %   (0.3 )%

Selling, general and administrative expenses

    (30 )   (5 )%   (0.1 )%

Research, development and engineering expenses

    (64 )   (29 )%   (0.5 )%

        The increase in research, development and engineering expenses was the result of increased spending on emissions related programs. The increased selling, general and administrative expenses was primarily due to higher payroll costs as the result of salary increases and an increase in the number of segment employees during the year. The increase in gross margin was primarily due to price improvements, especially in industrial engines and parts, and favorable product mix in the on-highway market. The increase in gross margin was partially offset by increased warranty expense from the increased mix of newer emissions-driven products and higher repair costs on certain engines and increased material prices due to higher commodity prices during the year.


Power Generation Segment Results

        Financial data for the Power Generation segment was as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007   Amount   Percent   Amount   Percent  

External sales

  $ 1,879   $ 2,601   $ 2,375   $ (722 )   (28 )% $ 226     10 %

Intersegment sales

    538     899     685     (361 )   (40 )%   214     31 %
                                   
 

Total sales

    2,417     3,500     3,060     (1,083 )   (31 )%   440     14 %

Depreciation and amortization

    49     41     42     (8 )   (20 )%   1     2 %

Research, development and engineering expenses

    33     41     34     8     20 %   (7 )   (21 )%

Equity, royalty and interest income from investees

    22     23     17     (1 )   (4 )%   6     35 %

Interest income

    3     3     6         %   (3 )   (50 )%

Segment EBIT

    167     376     334     (209 )   (56 )%   42     13 %

Segment EBIT as a percentage of net sales

   
6.9

%
 
10.7

%
 
10.9

%
 

(3.8) percentage points

   

(0.2) percentage points

 

        In 2009, the Power Generation segment reorganized its reporting structure to include the following businesses: commercial products, alternators, commercial projects, power electronics and consumer.

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Sales for our Power Generation segment by business (including 2008 and 2007 revised balances) were as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007   Amount   Percent   Amount   Percent  

Commercial products

  $ 1,456   $ 2,116   $ 1,761   $ (660 )   (31 )% $ 355     20 %

Alternator

    512     686     623     (174 )   (25 )%   63     10 %

Commercial projects

    177     328     219     (151 )   (46 )%   109     50 %

Consumer

    140     238     349     (98 )   (41 )%   (111 )   (32 )%

Power electronics

    132     132     108         %   24     22 %
                                   
 

Total sales

  $ 2,417   $ 3,500   $ 3,060   $ (1,083 )   (31 )% $ 440     14 %
                                   

        A summary of unit shipments used in power generation equipment by engine classification follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2009 vs. 2008   2008 vs. 2007  
 
  2009   2008   2007   Amount   Percent   Amount   Percent  

Mid-range

    23,700     33,400     31,700     (9,700 )   (29 )%   1,700     5 %

Heavy-duty

    4,800     8,400     8,000     (3,600 )   (43 )%   400     5 %

High-horsepower

    8,000     11,500     10,500     (3,500 )   (30 )%   1,000     10 %
                                   
 

Total unit shipments

    36,500     53,300     50,200     (16,800 )   (32 )%   3,100     6 %
                                   

2009 vs. 2008

Net Sales

        Power Generation segment sales decreased in most businesses, versus 2008, as the result of the global economic downturn. The following are the primary drivers by business.

Segment EBIT

        Power Generation segment EBIT decreased primarily due to a lower gross margin, which was partially offset by decreases in selling, general and administrative and research, development and

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engineering expenses. Changes in Power Generation segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31,
2009 vs. 2008
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ (258 )   (39 )%   (2.3 )%

Selling, general and administrative expenses

    57     21 %   (1.2 )%

Research, development and engineering expenses

    8     20 %   (0.2 )%

Equity, royalty and interest income from investees

    (1 )   (4 )%   NM  

        The decrease in gross margin was primarily due to lower volumes, unfavorable sales mix and increased material and commodity costs which were partially offset by improved pricing and favorable foreign currency translation. The decrease in selling, general and administrative and research, development and engineering expenses was primarily due to favorable foreign currency translation, lower variable compensation costs, implementation of severance programs and decreased discretionary spending.

2008 vs. 2007

Net Sales

        Power Generation segment sales increased compared to 2007 primarily due to the following drivers.

        These increases were partially offset by a significant sales decrease in our consumer business, primarily due to the softening U.S. economy.

Segment EBIT

        Power Generation segment EBIT increased primarily due to higher gross margin partially offset by increases in selling, general and administrative and research, development and engineering expenses. Changes in Power Generation segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31,
2008 vs. 2007
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ 83     15 %   %

Selling, general and administrative expenses

    (20 )   (8 )%   0.5 %

Research, development and engineering expenses

    (7 )   (21 )%   (0.1 )%

        The increase in gross margin was primarily due to significant price realization, increased volume and favorable product mix which were partially offset by increased material costs, including increased engine and commodity prices. The increase in selling, general and administrative expenses was primarily due to higher payroll costs and increases in the number of segment employees.

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Components Segment Results

        Financial data for the Components segment was as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007   Amount   Percent   Amount   Percent  

External sales

  $ 1,562   $ 2,154   $ 2,007   $ (592 )   (27 )% $ 147     7 %

Intersegment sales

    793     998     925     (205 )   (21 )%   73     8 %
                                   
 

Total sales

    2,355     3,152     2,932     (797 )   (25 )%   220     8 %

Depreciation and amortization

    73     65     59     (8 )   (12 )%   (6 )   (10 )%

Research, development and engineering expenses

    88     95     73     7     7 %   (22 )   (30 )%

Equity, royalty and interest income from investees

    13     14     4     (1 )   (7 )%   10     NM  

Interest income

    1     3     3     (2 )   (67 )%       %

Segment EBIT

    95     169     153     (74 )   (44 )%   16     10 %

Segment EBIT as a percentage of net sales

   
4.0

%
 
5.4

%
 
5.2

%
 

(1.4) percentage points

   

0.2 percentage points

 

        Our Components segment includes the following businesses: filtration, turbochargers, emissions solutions and fuel systems. Sales for our Components segment by business were as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007   Amount   Percent   Amount   Percent  

Filtration

  $ 851   $ 1,194   $ 1,215   $ (343 )   (29 )% $ (21 )   (2 )%

Turbochargers

    704     979     860     (275 )   (28 )%   119     14 %

Emissions solutions

    495     553     448     (58 )   (10 )%   105     23 %

Fuel systems

    305     426     409     (121 )   (28 )%   17     4 %
                                   
 

Total sales

  $ 2,355   $ 3,152   $ 2,932   $ (797 )   (25 )% $ 220     8 %
                                   

(1)
Beginning January 1, 2009, we reorganized the reporting structure of two businesses and moved a portion of our filtration business into the emission solutions business. For the year ended 2009, the sales for the portion of the business included in emissions solutions were $86 million. Sales for the portion of the business included in filtration for the years ended 2008 and 2007 were $136 million and $222 million, respectively. The 2008 and 2007 balances were not reclassified.

2009 vs. 2008

Net Sales

        Components segment sales for the year ended 2009 decreased in all businesses versus 2008 as the result of the global economic downturn. The following are the primary drivers by business.

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Segment EBIT

        Components segment EBIT decreased versus 2008, primarily due to a lower gross margin which was partially offset by decreased selling, general and administrative and research, development and engineering expenses. Changes in Components segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31,
2009 vs. 2008
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ (138 )   (28 )%   (0.6 )%

Selling, general and administrative expenses

    43     19 %   (0.6 )%

Research, development and engineering expenses

    7     7 %   (0.7 )%

        The decrease in gross margin was due to lower volumes for most markets, partially offset by implementation of severance programs. The decrease in selling, general and administrative and research, development and engineering expenses was primarily due to implementation of severance programs, closing certain facilities, decreased discretionary spending and decreased research and development spending.

2008 vs. 2007

Net Sales

        Components segment sales increased compared to 2007 primarily due to the following drivers.

        These increases were partially offset by the sale of Universal Silencer and the discontinuance of a product line in 2007, which contributed a combined $75 million in sales in the year ended December 31, 2007.

Segment EBIT

        Components segment EBIT increased primarily due to higher gross margins which were partially offset by increased research, development and engineering expenses, as well as increased selling,

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general and administration expenses. Changes in Components segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31,
2008 vs. 2007
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ 69     17 %   1.2 %

Selling, general and administrative expenses

    (21 )   (10 )%   (0.2 )%

Research, development and engineering expenses

    (22 )   (30 )%   (0.5 )%

        The increase in gross margin was primarily due to higher volumes in most of our businesses, manufacturing efficiencies achieved in all of our businesses in 2008 and price realization exceeding increased commodity costs, which was partially offset by increased warranty expense. The increase in selling, general and administrative expenses was primarily due to higher payroll costs and increases in the number of segment employees. The increased research, development and engineering spending was focused on developing new products to meet future emissions standards for both developed and emerging markets.


Distribution Segment Results

        Financial data for the Distribution segment was as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007   Amount   Percent   Amount   Percent  

External sales

  $ 1,777   $ 2,155   $ 1,537   $ (378 )   (18 )% $ 618     40 %

Intersegment sales

    7     9     3     (2 )   (22 )%   6     NM  
                                   
 

Total sales

    1,784     2,164     1,540     (380 )   (18 )%   624     41 %

Depreciation and amortization

    17     25     11     8     32 %   (14 )   NM  

Equity, royalty and interest income from investees

    125     117     92     8     7 %   25     27 %

Interest income

    1     2     1     (1 )   (50 )%   1     100 %

Segment EBIT

    235     242     187     (7 )   (3 )%   55     29 %

Segment EBIT as a percentage of net sales

   
13.2

%
 
11.2

%
 
12.1

%
 
2.0 percentage points
   
(0.9) percentage points
 

        Sales for our Distribution segment by region were as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007   Amount   Percent   Amount   Percent  

Asia Pacific

  $ 755   $ 812   $ 673   $ (57 )   (7 )% $ 139     21 %

Europe, Middle East and Africa

    692     1,022     816     (330 )   (32 )%   206     25 %

North & Central America

    278     260         18     7 %   260     NM  

South America

    59     70     51     (11 )   (16 )%   19     37 %
                                   
 

Total sales

  $ 1,784   $ 2,164   $ 1,540   $ (380 )   (18 )% $ 624     41 %
                                   

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2009 vs. 2008

Net Sales

        Distribution segment sales for 2009 decreased versus 2008, primarily due to the decline in power generation equipment and engine sales as a result of the global economic downturn and unfavorable foreign currency translation. Excluding the unfavorable currency impact and the net benefit resulting from full-year 2009 consolidated income from distributor acquisitions with only partial-year 2008 income, sales were down $309 million, or 14 percent. Decreased sales were led by decreased sales volumes primarily in Power Generation and Engines.

Segment EBIT

        Distribution segment EBIT decreased primarily due to lower gross margin, partially offset by decreased selling, general and administrative expenses and higher equity, royalty and interest income from investees. Changes in Distribution segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31,
2009 vs. 2008
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ (86 )   (18 )%   (0.2 )%

Gross margin, excluding acquisition(1)

    (94 )   (20 )%   (0.7 )%

Selling, general and administrative expenses

    54     16 %   (0.3 )%

Equity, royalty and interest income from investees

    8     7 %   NM  

(1)
Represents the acquisition of one distributor in 2009 partially offset by three distributor acquisitions in 2008.

        The decrease in gross margin was primarily due to lower sales volumes as a result of the global economic downturn and unfavorable foreign currency translation. Selling, general and administrative expenses decreased primarily due to favorable foreign currency translation, lower sales volumes and decreased discretionary spending.

Acquisition of a business

        In January 2010, we purchased an additional 50 percent ownership interest in Cummins Western Canada, bringing our total ownership interest to 80 percent. A new owner purchased the other 20 percent interest from the previous owner. The total accounting purchase price of the business is expected to be approximately $105 million to $110 million. Western Canada recorded revenues of $226 million and we recorded equity earnings of $11 million for the year ended December 31, 2009.

2008 vs. 2007

Net Sales

        Distribution segment sales increased compared to 2007 as a result of strong organic growth in all regions, mainly in Europe, the South Pacific and the Middle East. We had higher sales of $260 million from the acquisition of a majority ownership interest in three previously independent distributors. We had a favorable impact from foreign currency translation. The higher sales were led by increased sales volumes in power generation, parts and engine volumes, followed by service.

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Segment EBIT

        Distribution segment EBIT increased primarily due to higher margins which were partially offset by increased selling, general and administrative expenses. Changes in Distribution segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31,
2008 vs. 2007
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ 145     45 %   0.7 %

Gross margin, excluding acquisitions(1)

    88     27 %   (1.9 )%

Selling, general and administrative expenses

    (78 )   (31 )%   1.2 %

Equity, royalty and interest income from investees

    25     27 %   NM  

(1)
The acquisitions represent the consolidation of three new distributors during the year and one new North American joint venture.

        The increase in gross margin was primarily due to the increase in sales volumes for power generation, parts and engines followed by service. These increases in gross margin were partially offset by unfavorable currency translation. The increase in selling, general and administrative expenses was primarily due to higher payroll costs as the result of 2008 salary increases and an increase in the number of segment employees including increased costs related to the acquisition of three new distributors and the North American joint venture.


Reconciliation of Segment EBIT to Income Before Income Taxes

        The table below reconciles the segment information to the corresponding amounts in the Consolidated Statements of Income:

 
  Years ended December 31,  
In millions
  2009   2008   2007  

Total segment EBIT

  $ 749   $ 1,322   $ 1,263  

Non-segment EBIT(1)

    (74 )   (102 )   (36 )
               

Total EBIT

  $ 675   $ 1,220   $ 1,227  

Less:

                   
 

Interest expense

    35     42     58  
               

Income before income taxes

  $ 640   $ 1,178   $ 1,169  
               

(1)
Includes intercompany eliminations and unallocated corporate expenses. For the year ended December 31, 2009, unallocated corporate expenses include $99 million in restructuring and other charges and a gain of $12 million related to flood damage recoveries. For the year ended December 31, 2008, unallocated corporate expenses include $37 million of restructuring charges, a $36 million decrease in cash surrender value in corporate owned life insurance and $5 million of losses related to flood damage recoveries. There were no significant unallocated corporate expenses in 2007.

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LIQUIDITY AND CAPITAL RESOURCES

Management's Assessment of Liquidity

        We believe our financial condition and liquidity remain strong despite the difficult environment in the U.S. and global economies. Our strong financial performance, particularly in the fourth quarter of 2009, enabled us to finish the year with minimal debt and sizable cash and marketable securities balances. This cash performance was driven primarily by improved inventory management, controls on capital and discretionary spending and lower repurchases of common stock.

        We assess our liquidity in terms of our ability to generate adequate cash to fund our operating, investing and financing activities. Cash provided by operations is our principal source of liquidity. As of December 31, 2009, other sources of liquidity include:

        The maturity schedule of our existing long-term debt does not require significant cash outflows in the intermediate term. Required annual principal payments range from $17 million to $67 million over each of the next five years.

        While the impact of the continued market volatility cannot be predicted, we believe our liquidity will provide us with the financial flexibility needed to fund working capital, capital expenditures, projected pension obligations, dividend payments, common stock repurchases and debt service obligations.

        We have considered the impact of ongoing market instability and credit availability in assessing the adequacy of our liquidity and capital resources and are monitoring the impact on our customers and suppliers. We have noticed an impact as reflected in our days sales in receivables, but have not seen a significant impact on our results of operations, financial position or cash flows in 2009. We expect that general market conditions could impact the rate at which we realize our receivables in the future and could impact eligible receivables under our accounts receivable program, however, we expect to generate positive cash flow from operations in 2010. We will continue to diligently monitor our receivables for potential slowing in collections that could occur as a result of continued difficult economic conditions and our customer's access to credit. The overall decline in market valuations negatively impacted the current value of our pension trusts in 2008; however, pension assets produced strong positive returns in 2009.

        At this time, we are comfortable that the currently unused $1.07 billion credit capacity under our revolving credit facility is available to us. This assertion is based upon the fact that we drew upon our revolving credit facility, throughout the year, with a prompt repayment, to confirm participation by the banks included in the facility. We successfully tested the facility again in February 2010. As a result, we believe our access to liquidity sources has not been materially impacted by the current credit environment and we do not expect that it will be materially impacted in the near future. There can be no assurance, however, that the cost or availability of future borrowings, if any, in the debt markets or our credit facilities will not be materially impacted by the ongoing capital market disruptions.

        A significant portion of our cash flows is generated outside the U.S. More than half of our cash and cash equivalents and most of our marketable securities at December 31, 2009, are denominated in

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foreign currencies. We manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct our business and the cost effectiveness with which those funds can be accessed. The repatriation of cash balances from certain subsidiaries could have adverse tax consequences; however, those balances are generally available without legal restrictions to fund ordinary business operations at the local level. We have and will continue to transfer cash from these subsidiaries to us and to other international subsidiaries when it is cost effective to do so.


Working Capital Summary

        We fund our working capital with cash from operations and short-term borrowings when necessary. Various assets and liabilities, including short-term debt, can fluctuate significantly from month to month depending on short-term liquidity needs. As a result, working capital is a prime focus of management attention.

In millions
  2009   2008   Change
2009 vs. 2008
 

Cash and cash equivalents

  $ 930   $ 426   $ 504  

Accounts and notes receivable

    2,004     1,782     222  

Inventories

    1,341     1,783     (442 )

Other current assets

    728     722     6  
               
 

Current assets

    5,003     4,713     290  
               

Accounts and loans payable

   
994
   
1,048
   
(54

)

Current portion of accrued warranty

    428     434     (6 )

Other accrued expenses

    1,010     1,157     (147 )
               
 

Current liabilities

    2,432     2,639     (207 )
               

Working capital

 
$

2,571
 
$

2,074
 
$

497
 

Current ratio

    2.06     1.79     0.27  

Days' sales in receivables

    64     48     16  

Inventory turnover

    5.2     6.2     (1.0 )

        Current assets increased primarily due to an increase in cash and cash equivalents, caused by management's efforts to conserve cash, reduce inventories and limit discretionary spending during the global recession (see Cash Flows below) and an increase in receivables. The increase in receivables was due to higher sales in global engine markets, higher sales in the fourth quarter of 2009 than in the fourth quarter of 2008 as a result of a temporary increase in engine (and related component) demand prior to the 2010 emissions standards change and the significant decrease in sales in the fourth quarter of 2008 as a result of the onset of the economic recession. These increases were partially offset by a decrease in inventories as a result of our efforts to reduce our working capital.

        Current liabilities decreased primarily due to a decline in other accrued expenses and accounts payable as a result of reduced purchasing volume and controls around discretionary spending.

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Cash Flows

        Cash and cash equivalents increased $504 million during the year ended December 31, 2009, compared to a $151 million decrease in cash and cash equivalents during the year ended December 31, 2008. The change in cash and cash equivalents is as follows:


Operating Activities

 
   
   
   
  Change  
 
  Years ended December 31,  
 
  2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007  

Net income

  $ 484   $ 818   $ 788   $ (334 ) $ 30  

Depreciation

    326     314     290     12     24  

Equity in income of investees, net of dividends

    23     (45 )   (75 )   68     30  

Pension expense, net of contributions

    (36 )   (31 )   (152 )   (5 )   121  

Changes in:

                               
 

Receivables

    (181 )   88     (203 )   (269 )   291  
 

Inventory

    482     (251 )   (255 )   733     4  
 

Accounts payable

    (75 )   (174 )   136     99     (310 )
 

Accrued expenses

    (132 )   124     217     (256 )   (93 )

Other, net

    246     144     64     102     80  
                       
 

Net cash provided by operating activities

  $ 1,137   $ 987   $ 810   $ 150   $ 177  
                       

2009 vs. 2008

        Net cash provided by operating activities increased for the year ended December 31, 2009, compared to 2008, primarily due to favorable working capital fluctuations, primarily inventories, as a result of management's response to the challenging global economy and increased dividends from our equity investees which were partially offset by decreased income as the result of declining sales. Management's priorities included reducing inventory, aligning our cost and capacity with the real demand for our products and managing the business to generate positive cash flows by improving our working capital.

Pensions

        The funded status of our pension plans is dependent upon a variety of variables and assumptions including return on invested assets, market interest rates and levels of voluntary contributions to the plans. As a result of the credit crisis and the related market recession, our pension assets experienced significant deterioration in 2008. The financial market distress of 2008 continued into early 2009 with the debt and equity markets bottoming out in the first quarter. In the second half of 2009, the financial markets began to rebound. The recovery helped to improve our plan performance. Thus, for the year ended December 31, 2009, the return for our U.S. plan was above 18 percent while our U.K. plan return was above 16 percent. The most recent three-year average return for all of our pension invested assets was slightly above one percent. Approximately 94 percent of our pension plan assets are invested in highly liquid investments such as equity and fixed income securities. The remaining six percent of our plan assets are invested in less liquid but market valued investments, including real estate and private equity. We made $129 million of pension contributions in 2009 and we anticipate making contributions of $175 million to $185 million to our pension plans in 2010. Expected contributions to our defined benefit pension plans in 2010 will meet or exceed the current funding requirements. Claims and premiums for other postretirement benefits are expected to approximate $53 million in 2010. The $129 million of pension contributions in 2009 included voluntary contributions of $108 million. These contributions and payments include payments from our funds either to increase pension plan assets or to make direct payments to participants.

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2008 vs. 2007

        Net cash provided by operating activities increased for the year ended December 31, 2008, compared to 2007, primarily due to decreased pension funding, increased net income as the result of increased sales and increased equity in earnings net of dividends, which was partially offset by unfavorable working capital fluctuations. The unfavorable working capital fluctuation was primarily due to an increase in inventory, which was primarily to support strong business growth while the decreases in accounts payable and accounts receivable were more reflective of early shutdowns in many of our manufacturing facilities at the close of 2008, as demand softened throughout the fourth quarter. The increase in accrued expenses was primarily due to an increase in warranty expense.


Investing Activities

 
   
   
   
  Change  
 
  Years ended December 31,  
 
  2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007  

Capital expenditures

  $ (310 ) $ (543 ) $ (353 ) $ 233   $ (190 )

Investments in and advances to equity investees

    (3 )   (89 )   (66 )   86     (23 )

Acquisitions of businesses, net of cash acquired

    (2 )   (142 )   (20 )   140     (122 )

Proceeds from the sale of businesses

        64     35     (64 )   29  

Investments in marketable securities, net

    (96 )   19     (10 )   (115 )   29  

Other, net

    (98 )   (157 )   (101 )   59     (56 )
                       
 

Net cash used in investing activities

  $ (509 ) $ (848 ) $ (515 ) $ 339   $ (333 )
                       

2009 vs. 2008

        Net cash used in investing activities decreased for the year ended December 31, 2009, compared to 2008, primarily due to decreased capital expenditures and lower investments in the acquisition of businesses which were partially offset by increased cash paid for investments in marketable securities and lower cash proceeds from the sale of a business. These decreases primarily occurred as a result of management's decision to conserve cash and maintain liquidity during the recession.

        Capital expenditures decreased as management tightened capital spending substantially across all business by limiting expenditures to critical projects and investments in development of new products. Despite the expected challenges in some of our markets in 2010, our financial position allows us the flexibility to increase capital expenditures for 2010 to approximately $400 million.

2008 vs. 2007

        Net cash used in investing activities increased for the year ended December 31, 2008, compared to 2007, primarily due to an increase in capital expenditures and higher investments in businesses related to the purchase of three previously independent distributors and the acquisition of Consolidated Diesel Corporation, a manufacturing facility (see Note 22, "ACQUISITIONS AND DIVESTITURES," to the Consolidated Financial Statements for additional information). These increases were partially offset by an increase in cash generated from net investments in marketable securities and the proceeds from the sale of a business.

        Capital expenditures for the year ended December 31, 2008 increased 54 percent over 2007 to support our growth, and included investments to increase capacity and to fund development of our new products. Our investments in capacity improvements and development of new products accelerated across all of our businesses.

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Financing Activities

 
   
   
   
  Change  
 
  Years ended December 31,  
 
  2009 vs. 2008   2008 vs. 2007  
In millions
  2009   2008   2007  

Proceeds from borrowings

  $ 76   $ 76   $ 15   $   $ 61  

Payments on borrowings and capital lease obligations

    (97 )   (152 )   (144 )   55     (8 )

Net (payments) borrowings under short-term credit agreements

    (2 )   33     (12 )   (35 )   45  

Dividend payments on common stock

    (141 )   (122 )   (89 )   (19 )   (33 )

Proceeds from sale of common stock held by employee benefits trust

    72     63     13     9     50  

Repurchases of common stock

    (20 )   (128 )   (335 )   108     207  

Other, net

    (29 )   (7 )   (24 )   (22 )   17  
                       
 

Net cash used in financing activities

  $ (141 ) $ (237 ) $ (576 ) $ 96   $ 339  
                       

2009 vs. 2008

        Net cash used in financing activities decreased for the year ended December 31, 2009, compared to 2008, primarily due to the decrease in repurchases of common stock and lower payments on borrowings, which was partially offset by a decrease in proceeds from borrowings and higher dividend payments.

        Our total debt was $704 million as of December 31, 2009, compared with $698 million at December 31, 2008. Total debt as a percent of our total capital, including total long-term debt, was 14.9 percent at December 31, 2009, compared to 16.7 percent at December 31, 2008.

2008 vs. 2007

        Net cash used in financing activities decreased for the year ended December 31, 2008, compared to 2007, primarily due to the decrease in repurchases of common stock, the increase in proceeds from borrowings, the increase in proceeds from sale of stock held by employee benefit trust and an increase in net borrowings under short-term credit arrangements. These fluctuations were partially offset by the increase in dividend payments. Our total debt as of December 31, 2008, was $698 million compared to $674 million as of December 31, 2007.

        Total debt as a percent of our total capital, including long-term debt, was 16.7 percent at December 31, 2008, compared to 15.4 percent at December 31, 2007. The 2008 debt to capital ratio was negatively impacted by a $675 million ($433 after-tax) charge to Cummins Inc. shareholders' equity to recognize the funded status of our defined benefit pension and other postretirement plans.

Revolving Credit Agreement

        On June 30, 2008, we entered into a three-year revolving credit agreement with a syndicate of lenders. The credit agreement provides us with a $1.1 billion senior unsecured revolving credit facility, the proceeds of which are to be used by us for working capital or other general corporate purposes.

        The credit facility matures on June 30, 2011. Amounts payable under our revolving credit facility will rank pro rata with all of our other unsecured, unsubordinated indebtedness. Up to $100 million under our credit facility is available for swingline loans denominated in U.S. dollars. Advances under the facility bear interest at (i) a base rate or (ii) a rate equal to LIBOR plus an applicable margin based on the credit ratings of our outstanding senior unsecured long-term debt. Based on our current long-term debt ratings, the applicable margin on LIBOR loans was 0.75 percent per annum as of

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December 31, 2009. Advances under the facility may be prepaid without premium or penalty, subject to customary breakage costs.

        The credit agreement includes various covenants, including, among others, maintaining a leverage ratio of no more than 3.0 to 1.0 and maintaining fixed charge coverage ratio of at least 1.5 to 1.0. As of December 31, 2009, we were in compliance with all such covenants, including our leverage ratio of 0.6 to 1.0 and our fixed charge coverage ratio of 22.5 to 1.0.

Repurchase of Common Stock

        In July 2006, the Board of Directors authorized us to acquire up to eight million shares of Cummins common stock. In 2007, we repurchased approximately $335 million of common stock, at an average cost of $55.76 per share, representing approximately six million shares. This concluded the share repurchase program authorized by the Board of Directors in July 2006.

        In December 2007, the Board of Directors authorized the acquisition of up to $500 million of Cummins common stock. We began making purchases under the plan in March 2008 and purchased $128 million of stock during 2008 at an average cost of $55.49 per share.

        We announced in February 2009 that we had temporarily suspended our stock repurchase program to conserve cash. In the fourth quarter of 2009, we lifted the suspension and will from time to time repurchase stock. We purchased $20 million of common stock during the fourth quarter at an average cost of $46.52 per common share.

Quarterly Dividends

        In July 2008, our Board of Directors voted to increase our quarterly cash dividend per share by 40 percent resulting in increasing our cash dividends from $0.125 per common share to $0.175 per common share. Cash dividends per share paid to common shareholders for the last three years were as follows:

 
  Quarterly Dividends  
 
  2009   2008   2007  

First quarter

  $ 0.175   $ 0.125   $ 0.09  

Second quarter

    0.175     0.125     0.09  

Third quarter

    0.175     0.175     0.125  

Fourth quarter

    0.175     0.175     0.125  

        Total dividends paid to common shareholders in 2009, 2008 and 2007 were $141 million, $122 million, and $89 million, respectively. Declaration and payment of dividends in the future depends upon income and liquidity position, among other factors, and is subject to declaration by our Board of Directors, who meet quarterly to consider the dividend payment. We expect to fund dividend payments from cash from operations.


Credit Rating Impact on our Credit Facilities

        A number of our contractual obligations and financing agreements, such as our revolving credit facility and our equipment sale-leaseback agreements have restrictive covenants and/or pricing modifications that may be triggered in the event of downward revisions to our corporate credit rating. There were no downgrades of our credit ratings in 2009 that have impacted these covenants or pricing modifications.

        On March 10, 2008, Standard & Poor's (S&P) upgraded our senior unsecured debt ratings from "BBB-" to "BBB" and revised our outlook to stable citing our improved operating performance over the past several years, including during the expected emissions-related downturn in heavy-duty truck

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demand in 2007, combined with significant on- and off-balance sheet debt reduction, and increased business diversification.

        On June 17, 2008, Fitch upgraded our senior unsecured debt ratings from "BBB" to "BBB+" citing our recent market share gains and improving credit profile, including improvement in our geographic and business diversification. In the second quarter of 2009, Moody's Investor Service, Inc. and Fitch reaffirmed our credit ratings.

        Credit ratings are not recommendations to buy and are subject to change, and each rating should be evaluated independently of any other rating. In addition, we undertake no obligation to update disclosures concerning our credit ratings, whether as a result of new information, future events or otherwise. Our ratings and outlook as of December 31, 2009, from each of the credit rating agencies are shown in the table below.

Credit Rating Agency
  Senior Long-
Term
Debt Rating
  Short-
Term Debt
Rating
  Outlook

Moody's Investors Service, Inc. 

  Baa3   Non-Prime   Stable

Standard & Poor's

  BBB   NR   Stable

Fitch

  BBB+   BBB+   Stable


CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS

        A summary of payments due for our contractual obligations and commercial commitments, as of December 31, 2009, is shown in the tables below:

Contractual Cash Obligations
  2010   2011-2012   2013-2014   After 2014   Total  
In millions
   
   
   
   
   
 

Loans payable

  $ 37   $   $   $   $ 37  

Long-term debt and capital lease obligations(1)

    97     235     140     1,462     1,934  

Operating leases

    96     119     73     85     373  

Capital expenditures

    124     37     11         172  

Purchase commitments for inventory

    391                 391  

Other purchase commitments

    118     47     5         170  

Pension funding(2)

    70     130     130     65     395  

Other postretirement benefits

    53     104     98     249     504  
                       

Total

  $ 986   $ 672   $ 457   $ 1,861   $ 3,976  
                       

(1)
Includes principal payments and expected interest payments based on the terms of the obligations. In February of 2009, we renegotiated our sale and leaseback transaction to extend the term for an additional two years and removed the requirement to provide residual insurance. The lease obligations are included in this line item. See Note 14, "COMMITMENTS AND CONTINGENCIES," to our Consolidated Financial Statements for additional information on our sale and leaseback transaction.

(2)
We are contractually obligated to fund $70 million in 2010; however, our expected range of total pension contributions for 2010 is approximately $175 million to $185 million. After 2010 our contractual agreement is $65 million per year through 2015.

        The contractual obligations reported above exclude our unrecognized tax benefits of $56 million, all of which is non-current, as of December 31, 2009. We are not able to reasonably estimate the

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period in which cash outflows relating to uncertain tax contingencies could occur. See Note 4, "INCOME TAXES," to the Consolidated Financial Statements for further details.

Other Commercial Commitments
  2010   2011-2012   2013-2014   After 2014   Total  
In millions
   
   
   
   
   
 

Standby letters of credit under revolving credit agreement

  $ 35   $   $   $   $ 35  

International and other domestic letters of credit

    20     8     1     1     30  

Performance and excise bonds

    6     17     52         75  

Guarantees and other commitments

    1             74     75  
                       

Total

  $ 62   $ 25   $ 53   $ 75   $ 215  
                       


OFF BALANCE SHEET FINANCING

Sale of Accounts Receivable

        In July 2007, we amended our agreement with a financial institution to sell a designated pool of trade receivables to Cummins Trade Receivables, LLC (CTR), a wholly-owned special purpose subsidiary, to extend the facility until July 2010, and raised the purchase limitation from $200 million to $400 million. The agreement also provides us with an option to increase the purchase limitation up to $500 million upon approval. As necessary, CTR may transfer a direct interest in its receivables, without recourse, to the financial institution. To maintain a balance in the designated pools of receivables sold, we sell new receivables to CTR as existing receivables are collected. Receivables sold to CTR in which an interest is not transferred to the financial institution are included in "Receivables, net" on our Consolidated Balance Sheets. The maximum interest in sold receivables that can be outstanding at any point in time is limited to the lesser of $400 million or the amount of eligible receivables held by CTR. There are no provisions in this agreement that require us to maintain a minimum investment credit rating; however, the terms of the agreement contain the same financial covenants as our revolving credit facility. As of December 31, 2009, the amount available under this program was $154 million. As of December 31, 2009 and 2008, there were no amounts outstanding under this program.


Financing Arrangements for Affiliated Parties

        In accordance with the provisions of various joint venture agreements, we may purchase and/or sell products and components from/to the joint ventures and the joint ventures may sell products and components to unrelated parties. The transfer price of products purchased from the joint ventures may differ from normal selling prices. Certain joint venture agreements transfer product to us at cost, some transfer product to us on a cost-plus basis and other agreements provide for the transfer of products at market value.


APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

        A summary of our significant accounting policies is included in Note 1, "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES," to our Consolidated Financial Statements which discusses accounting policies that we have selected from acceptable alternatives.

        Our Consolidated Financial Statements are prepared in accordance with GAAP which often requires management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts presented and disclosed in the financial statements. Our management reviews these estimates and assumptions based on historical experience, changes in business conditions and other relevant factors they believe to be reasonable under the circumstances. In any given reporting period, our actual results may differ from the estimates and assumptions used in preparing our Consolidated Financial Statements.

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        Critical accounting estimates are defined as follows: the estimate requires management to make assumptions about matters that were highly uncertain at the time the estimate was made; different estimates reasonably could have been used; or if changes in the estimate are reasonably likely to occur from period to period and the change would have a material impact on our financial condition or results of operations. Our senior management has discussed the development and selection of our accounting policies, related accounting estimates and the disclosures set forth below with the Audit Committee of our Board of Directors. We believe our critical accounting estimates include those addressing the recoverability of an investment related to new products, the estimation of liabilities for warranty programs, accounting for income taxes, pension benefits and annual assessment of recoverability of goodwill.


Recoverability of Investment Related to New Products

        We have capitalized $216 million associated with the future launch of our light-duty diesel engine product. Market uncertainty due to the global recession has resulted in some customers delaying or cancelling their vehicle programs. We concluded that events and circumstances indicated that these assets should be reviewed for possible impairment at December 31, 2009. We used projections to assess whether future cash flows on an undiscounted basis related to the assets are likely to exceed the related carrying amount to determine if a write-down is appropriate. These projections require estimates about product volume and the size of the market for vehicles that are not yet developed. We used input from our customers in developing alternative cash flow scenarios. Our analysis indicated that the assets are recoverable at December 31, 2009. If customer expectations or projected volumes deteriorate and we do not identify alternative customers and/or product applications, we could be required to write-down these assets to net realizable value.


Warranty Programs

        We estimate and record a liability for warranty programs, primarily base warranty and other than product recalls, at the time our products are sold. Our estimates are based on historical experience and reflect management's best estimates of expected costs at the time products are sold and subsequent adjustment to those expected costs when actual costs differ. As a result of the uncertainty surrounding the nature and frequency of product recall programs, the liability for such programs is recorded when we commit to a recall action, which generally occurs when it is announced. Our warranty liability is generally affected by component failure rates, repair costs and the time of failure. Future events and circumstances related to these factors could materially change our estimates and require adjustments to our liability. New product launches require a greater use of judgment in developing estimates until historical experience becomes available. Product specific experience is typically available four or five quarters after product launch, with a clear experience trend evident eight quarters after launch. We generally record warranty expense for new products upon shipment using a factor based upon historical experience only in the first year, a blend of actual product and historical experience in the second year and product specific experience thereafter. Note 11, "PRODUCT WARRANTY LIABILITY," to our Consolidated Financial Statements contains a summary of the activity in our warranty liability account for 2009 and 2008 including adjustments to pre-existing warranties.


Accounting for Income Taxes

        We determine our provision for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax effects of temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Future tax benefits of tax loss and credit carryforwards are also recognized as deferred tax assets. We evaluate the recoverability of our deferred tax assets each quarter by assessing the likelihood of future profitability and available tax planning strategies that could be implemented to

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realize our net deferred tax assets. At December 31, 2009, we recorded net deferred tax assets of $729 million. These assets included $151 million for the value of tax loss and credit carryforwards. A valuation allowance of $44 million was recorded to reduce the tax assets to the net value management believed was more likely than not to be realized. In the event our operating performance deteriorates, future assessments could conclude that a larger valuation allowance will be needed to further reduce the deferred tax assets. In addition, we operate within multiple taxing jurisdictions and are subject to tax audits in these jurisdictions. These audits can involve complex issues, which may require an extended period of time to resolve. We reduce our net tax assets for the estimated additional tax and interest that may result from tax authorities disputing uncertain tax positions we have taken and we believe we have made adequate provision for income taxes for all years that are subject to audit based upon the latest information available. A more complete description of our income taxes and the future benefits of our tax loss and credit carryforwards is disclosed in Note 4, "INCOME TAXES," to our Consolidated Financial Statements.


Pension Benefits

        We sponsor a number of pension plans primarily in the U.S. and the U.K. and to a lesser degree in various other countries. In the U.S. and the U.K. we have several major defined benefit plans that are separately funded. We account for our pension programs in accordance with employers' accounting for defined benefit pension and other postretirement plans under GAAP. GAAP requires that amounts recognized in financial statements be determined using an actuarial basis. As a result, our pension benefit programs are based on a number of statistical and judgmental assumptions that attempt to anticipate future events and are used in calculating the expense and liability related to our plans each year at December 31. These assumptions include discount rates used to value liabilities, assumed rates of return on plan assets, future compensation increases, employee turnover rates, actuarial assumptions relating to retirement age, mortality rates and participant withdrawals. The actuarial assumptions we use may differ significantly from actual results due to changing economic conditions, participant life span and withdrawal rates. These differences may result in a material impact to the amount of net periodic pension expense to be recorded in our Consolidated Financial Statements in the future.

        The expected long-term return on plan assets is used in calculating the net periodic pension expense. We considered several factors in developing our expected rate of return on plan assets. The long-term rate of return considers historical returns and expected returns on current and projected asset allocations and is generally applied to a 5-year average market value of return. The long-term rate of return on plan assets represents an estimate of long-term returns on an investment portfolio consisting of a mixture of equities, fixed income, real estate and other miscellaneous investments. The differences between the actual return on plan assets and expected long-term return on plan assets are recognized in the asset value used to calculate net periodic expense over five years. The table below sets forth the expected return assumptions used to develop our pension expense for the period 2007-2009 and our expected rate for 2010.

 
  Long-Term Expected
Return Assumptions
 
 
  2010   2009   2008   2007  

U.S. Plans

    8.00 %   8.25 %   8.25 %   8.50 %

Non-U.S. Plans

    7.25 %   7.25 %   7.25 %   7.24 %

        A lower expected rate of return will increase our net periodic pension expense and reduce profitability.

        The difference between the expected return and the actual return on plan assets is deferred from recognition in our results of operations and, under certain circumstances such as when the difference exceeds 10 percent of the market value of plan assets or the projected benefit obligation (PBO),

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amortized over future years of service. This is also true of changes to actuarial assumptions. As of December 31, 2009, we had net pension actuarial losses of $801 million and $364 million for the U.S. and non-U.S. pension plans, respectively. Under GAAP, the actuarial gains and losses are recognized and recorded in accumulated other comprehensive loss. As these amounts exceed 10 percent of our PBO, the excess is amortized over the average remaining service lives of participating employees.

        The table below sets forth the net periodic pension expense for the period 2007 through 2009 and our expected expense for 2010.

 
  Net Periodic Pension
Expense
 
In millions
  2010   2009   2008   2007  

Pension expense

  $ 71   $ 93   $ 71   $ 98  

        The increase in periodic pension expense in 2009 was due to lower than historical returns on assets driven by the global economic recession. Another key assumption used in the development of the net periodic pension expense is the discount rate. The discount rates used to develop our net periodic pension expense are set forth in the table below.

 
  Discount Rates  
 
  2010   2009   2008   2007  

U.S. Plans

    5.60 %   6.20 %   6.10 %   5.60 %

Non-U.S. Plans

    5.80 %   6.20 %   5.80 %   4.96 %

        Changes in the discount rate assumptions will impact the interest cost component of the net periodic pension expense calculation.

        The discount rate enables us to state expected future cash payments for benefits as a present value on the measurement date. The guidelines for setting this rate are discussed in GAAP which suggests the use of a high-quality corporate bond rate. We used bond information provided by Standard & Poors for the U.S. and iBoxx for the U.K. All bonds used to develop our hypothetical portfolio in the U.S. and U.K. were high-quality, non-callable bonds (AA- or better) as of December 31, 2009. The average yield of this hypothetical bond portfolio was used as the benchmark for determining the discount rate to be used to value the obligations of the plans subject to GAAP accounting for postretirement benefits other than pensions.

        Our model called for 60 years of benefit payments. For the U.S. plans, the sum of the cash flows from the 60 bonds matched the cash flow from the benefit payment stream upon completion of the process. The number of bonds purchased for each issue was used to determine the price of the entire portfolio. The discount rate benchmark was set to the internal rate of return needed to discount the cash flows to arrive at the portfolio price.

        In developing the U.K. discount rate, excess cash flows resulted in the early years of the 60-year period when the sum of the cash flow from the bonds maturing in later years exceeded the benefit payments in early years, thus no bonds maturing in early years are needed. As a result, the price of the entire portfolio of bonds was too high because all benefit payments were covered with excess cash flow remaining. We made no adjustment to the cash flow and the discount rate was determined as the internal rate of return needed to discount the cash flows to arrive at the portfolio price.

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        The table below sets forth the estimated impact on our 2010 net periodic pension expense relative to a change in the discount rate and a change in the expected rate of return on plan assets.

In millions
  Impact on Pension
Expense Increase (Decrease)
 

Discount rate used to value liabilities:

       
 

0.25 percent increase

  $ (5 )
 

0.25 percent decrease

    5  

Expected rate of return on assets:

       
 

1 percent increase

    (28 )
 

1 percent decrease

    28  

        The above sensitivities reflect the impact of changing one assumption at a time. A higher discount rate decreases the plan obligations and decreases our net periodic pension expense. A lower discount rate increases the plan obligations and increases our net periodic pension expense. It should be noted that economic factors and conditions often affect multiple assumptions simultaneously and the effects of changes in key assumptions are not necessarily linear.

        Our investment policies in the U.S. and U.K. provide for the rebalancing of assets to maintain our long-term strategic asset allocation. We are committed to its long-term strategy and do not attempt to time the market given empirical evidence that asset allocation is more critical than individual asset or investment manager selection. Rebalancing of the assets has and continues to occur. The rebalancing is critical to having the proper weighting of assets to achieve the expected total portfolio returns.

        For the U.S. qualified pension plans, our assumptions for the expected return on assets was 8.25 percent in 2009. Projected returns are based primarily on broad, publicly traded equity and fixed income indices and forward-looking estimates of active portfolio and investment management. As of December 31, 2009, based upon our target asset allocations it is anticipated that our U.S. investment policy will generate an average annual return over the 20-year projection period equal to or in excess of 7.50 percent approximately 40 percent of the time while returns of 8.70 percent or greater are anticipated 25 percent of the time. We expect additional positive returns from active investment management. Except for the short-term adverse conditions in the equity markets in 2008, our recent three-year annual rates of return have all exceeded 8.50 percent. As a result, based on the historical returns and forward-looking return expectations, we believe an investment return assumption of 8.00 percent per year in 2010 for U.S. pension assets is reasonable. The methodology used to determine the rate of return on pension plan assets in the U.K. was based on establishing an equity-risk premium over current long-term bond yields adjusted based on target asset allocations. Our strategy with respect to our investments in pension plan assets is to be invested with a long-term outlook. Therefore, the risk and return balance of our asset portfolio should reflect a long-term horizon. Our pension plan asset allocation at December 31, 2009 and 2008 and target allocation for 2010 are as follows:

 
   
  Percentage
of Plan
Assets at
December 31,
 
 
  Target Allocation
2010
 
Investment description
  2009   2008  

Equity securities

    55.0 %   59.1 %   56.0 %

Fixed income

    33.6 %   34.6 %   39.6 %

Real estate/Other

    11.4 %   6.3 %   4.4 %
               
 

Total

    100.0 %   100.0 %   100.0 %
               

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        Actual cash funding for our U.S. pension plans is governed by employee benefit and tax laws and the Pension Protection Act of 2006 ("the Act"). The Act extends the use of an average corporate bond rate for determining current liabilities for funding purposes. Among its many provisions, the Act establishes a 100 percent funding target for plan years beginning after December 31, 2007, which has now been extended to 2011 by the U.S. Congress due to the recession. Our funding strategy is to make contributions to our various qualified plans in accordance with statutory funding requirements and any additional contributions we determine are appropriate. The table below sets forth our pension contributions for the period 2008-2009 and our expected range of contributions for 2010.

 
  Pension Contributions  
In millions
  2010   2009   2008  

Contributions

  $ 175 - 185   $ 129   $ 102  

        Contributions beyond 2010 will depend on the funded status of our U.S. plans at that time in relation to the targeted funding established under the Act and contractual obligations negotiated in the U.K.

        Our pension plans in the U.S. and outside the U.S. were under-funded at December 31, 2009, by a total of $522 million due to pension trust asset performance.

        Under GAAP, the actuarial gains and losses and prior service costs (credits) are recognized and recorded in accumulated other comprehensive loss. Increases in actuarial losses reduced our shareholders' equity by $11 million (after-tax) in 2009. The increases resulted from lower discount rates and higher mortality assumptions partially offset by improved plan asset performance in 2009.

        Note 12, "PENSION AND OTHER POSTRETIREMENT BENEFITS," to our Consolidated Financial Statements provides a summary of our pension benefit plan activity, the funded status of our plans and the amounts recognized in our Consolidated Financial Statements.


Annual Assessment for Recoverability of Goodwill

        Under GAAP accounting for goodwill and other intangible assets, the carrying value of goodwill is reviewed annually. The fair value of each reporting unit was estimated by discounting the future cash flows less requirements for working capital and fixed asset additions. In accordance with GAAP, our reporting units are generally defined as one level below an operating segment. However, there were two situations where we have aggregated two or more components which share similar economic characteristics and thus are aggregated into a single reporting unit for testing purposes. These two situations are described further below. This analysis has resulted in the following reporting units for our goodwill testing:

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        No other reporting units have goodwill. Our valuation method requires us to make projections of revenue, operating expenses, working capital investment and fixed asset additions for the reporting units over a multi-year period. Additionally, management must estimate a weighted-average cost of capital, which reflects a market rate, for each reporting unit for use as a discount rate. The discounted cash flows are compared to the carrying value of the reporting unit and, if less than the carrying value, a separate valuation of the goodwill is required to determine if an impairment loss has occurred. In addition, we also perform a sensitivity analysis to determine how much our forecasts can fluctuate before the fair value of a reporting unit would be lower than its carrying amount. As of the end of the third quarter in 2009, we performed the annual impairment assessment required by GAAP and determined that our goodwill was not impaired. At December 31, 2009, our recorded goodwill was $364 million, approximately 90 percent of which resided in the emissions solutions plus filtration reporting unit. For this reporting unit, a 10 percent reduction in our estimated future cash flows would not have impacted our assessment. Changes in our projections or estimates, a deterioration of our operating results and the related cash flow effect or a significant increase in the discount rate could decrease the estimated fair value of our reporting units and result in a future impairment of goodwill.


RECENTLY ADOPTED AND RECENTY ISSUED ACCOUNTING PRONOUNCEMENTS

Accounting Pronouncements Recently Adopted

        In December 2007, the Financial Accounting Standards Board (FASB) amended its existing standards for business combinations, which is effective for fiscal years beginning after December 15, 2008. The amended standards make significant changes to both the accounting and disclosures related to the acquisition of a business and could materially impact how we account for future business combination transactions. Because the standard will only impact transactions entered into after January 1, 2009, the amended standards did not impact our Consolidated Financial Statements upon adoption.

        In December 2007, the FASB amended its existing standards for noncontrolling interests in consolidated financial statements, which was effective for interim and annual fiscal periods beginning after December 15, 2008. The new standard established accounting and reporting standards for the noncontrolling interest in a subsidiary and for the accounting for future ownership changes with respect to those subsidiaries. The new standard defined a noncontrolling interest, previously called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. The new standard required, among other items, that a noncontrolling interest be included in the consolidated balance sheet within equity, separate from the parent's equity; consolidated net income to be reported at amounts inclusive of both the parent's and noncontrolling interest's shares and, separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statements of income; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. We adopted the new standard effective January 1, 2009 and applied it retrospectively. As a result, we reclassified noncontrolling interests of $246 million, $292 million and $253 million, respectively, from the mezzanine section to equity in the December 31, 2008, 2007 and 2006 balance sheets. Certain reclassifications have been made to prior period amounts to conform to the presentation of the current period under the new standard.

        In March 2008, the FASB amended its existing standards for disclosures about derivative instruments and hedging activities, which was effective for interim and annual fiscal periods beginning after November 15, 2008. The new standards require enhanced disclosures about a company's derivative and hedging activities. We adopted the new standard effective January 1, 2009 and applied it prospectively. The new disclosures required are included in Note 20, "DERIVATIVES," to our Consolidated Financial Statements.

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        In June 2009, the FASB amended its existing standards for subsequent events, which was effective for interim and annual fiscal periods ending after June 15, 2009 and established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The new standard established the period after the balance sheet date during which we should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which we should recognize events or transactions occurring after the balance sheet date and the disclosures that should be made about events or transactions that occurred after the balance sheet date. In preparing our Consolidated Financial Statements, we evaluated subsequent events through February 25, 2010, which is the date our annual report was filed with the Securities and Exchange Commission.


Accounting Pronouncements Issued But Not Yet Effective

        In June 2009, the FASB amended its standards for accounting for transfers of financial assets, which is effective for interim and annual fiscal periods beginning after November 15, 2009. The new standard removes the concept of a qualifying special-purpose entity from GAAP. The new standard modifies the financial-components approach used in previous standards and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized. The new standard also requires enhanced disclosure regarding transfers of financial interests and a transferor's continuing involvement with transferred assets. The new standard will require us to report any future activity under our sale of receivables program as secured borrowings as of January 1, 2010. As of December 31, 2009, we had no amounts outstanding under this program.

        In June 2009, the FASB amended its existing standards related to the consolidation of variable interest entities, which is effective for interim and annual fiscal periods beginning after November 15, 2009. The new standard requires entities to analyze whether their variable interests give it a controlling financial interest of a variable interest entity (VIE) and outlines what defines a primary beneficiary. The new standard amends GAAP by: (a) changing certain rules for determining whether an entity is a VIE; (b) replacing the quantitative approach previously required for determining the primary beneficiary with a more qualitative approach; and (c) requiring entities to continuously analyze whether they are the primary beneficiary of a VIE among other amendments. The new standard also requires enhanced disclosures regarding an entity's involvement in a VIE. While we are still finalizing our evaluation of the impact of this amendment on our Consolidated Financial Statements, we believe the only impact will be the deconsolidation of Cummins Komatsu Engine Company (CKEC). This deconsolidation will not have a material impact on our Consolidated Financial Statements. Financial information about CKEC is included in Note 23, "VARIABLE INTEREST ENTITIES," to our Consolidated Financial Statements.

        In October 2009, the FASB amended its rules regarding the accounting for multiple element revenue arrangements. The objective of the amendment is to allow vendors to account for revenue for different deliverables separately as opposed to part of a combined unit when those deliverables are provided at different times. Specifically, this amendment addresses how to separate deliverables and simplifies the process of allocating revenue to the different deliverables when more than one deliverable exists. The new rules are effective for us beginning January 1, 2011. We are in the process of evaluating the impact that this amendment will have on our Consolidated Financial Statements.

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

        We are exposed to financial risk resulting from volatility in foreign exchange rates, interest rates and commodity prices. This risk is closely monitored and managed through the use of financial derivative instruments including commodity swap contracts, foreign currency forward contracts and interest rate swaps. As stated in our policies and procedures, financial derivatives are used expressly for hedging purposes, and under no circumstances are they used for speculative purposes. When material,

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we adjust the value of our derivative contracts for counter-party or our credit risk. The results and status of our hedging transactions are reported to senior management on a monthly and quarterly basis. Further information regarding financial instruments and risk management is contained in Note 20, "DERIVATIVES," to our Consolidated Financial Statements.

        The following describes our risk exposures and provides results of sensitivity analysis performed as of December 31, 2009. The sensitivity analysis assumes instantaneous, parallel shifts in foreign currency exchange rates and commodity prices.


FOREIGN EXCHANGE RATES

        As a result of our international business presence, we are exposed to foreign currency exchange risks. We transact business in foreign currencies and, as a result our income experiences some volatility related to movements in foreign currency exchange rates. To help manage our exposure to exchange rate volatility, we use foreign exchange forward contracts on a regular basis to hedge forecasted intercompany and third-party sales and purchases denominated in non-functional currencies. Our internal policy allows for managing anticipated foreign currency cash flow for up to one year. These foreign currency forward contracts are designated and qualify as foreign currency cash flow hedges under GAAP. The effective portion of the unrealized gain or loss on the forward contract is deferred and reported as a component of "Accumulated other comprehensive loss" (AOCL). When the hedged forecasted transaction (sale or purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income. The ineffective portion of the hedge, unrealized gain or loss, if any, is recognized in current income during the period of change. As of December 31, 2009, the amount expected to be reclassified to income over the next year is not material. For the years ended December 31, 2009, and 2008, there were no circumstances that would have resulted in the discontinuance of a cash flow hedge.

        To minimize the income volatility resulting from the remeasurement of net monetary assets and payables denominated in a currency other than the functional currency, we enter into foreign currency forward contracts, which are considered economic hedges. The objective is to offset the gain or loss from remeasurement with the gain or loss from the fair market valuation of the forward contract. These derivative instruments are not designated as hedges under GAAP.

        As of December 31, 2009, the potential gain or loss in the fair value of our outstanding foreign currency contracts, assuming a hypothetical 10 percent fluctuation in the currencies of such contracts, would be approximately $31 million. The sensitivity analysis of the effects of changes in foreign currency exchange rates assumes the notional value to remain constant for the next 12 months. The analysis ignores the impact of foreign exchange movements on our competitive position and potential changes in sales levels. It should be noted that any change in the value of the contracts, real or hypothetical, would be significantly offset by an inverse change in the value of the underlying hedged items (see Note 20, "DERIVATIVES," to our Consolidated Financial Statements).


INTEREST RATES

        We are exposed to market risk from fluctuations in interest rates. We manage our exposure to interest rate fluctuations through the use of interest rate swaps. The objective of the swaps is to more effectively balance our borrowing costs and interest rate risk.

        In November 2005, we entered into an interest rate swap to effectively convert our $250 million debt, due in 2028, from a fixed rate of 7.125% to a floating rate based on a LIBOR spread. The terms of the swap mirror those of the debt, with interest paid semi-annually. This swap qualifies as a fair value hedge under GAAP. The gain or loss on this derivative instrument as well as the offsetting gain

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or loss on the hedged item attributable to the hedged risk are recognized in current income as "Interest expense." These gains and losses for the year December 31, 2009, were as follows:

 
  December 31, 2009  
In millions
Income Statement Classification
  Gain/(Loss)
on Swaps
  Gain/(Loss) on
Borrowings
 

Interest expense

  $ (54 ) $ 54  


COMMODITY PRICES

        We are exposed to fluctuations in commodity prices due to contractual agreements with component suppliers. In order to protect ourselves against future price volatility and, consequently, fluctuations in gross margins, we periodically enter into commodity swap contracts with designated banks to fix the cost of certain raw material purchases with the objective of minimizing changes in inventory cost due to market price fluctuations. The commodity swap contracts are derivative contracts that are designated as cash flow hedges under GAAP. The effective portion of the unrealized gain or loss is deferred and reported as a component of AOCL. When the hedged forecasted transaction (purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income. The ineffective portion of the hedge, if any, is recognized in current income in the period in which the ineffectiveness occurs. As of December 31, 2009, we expect to reclassify an unrealized net gain of $5 million from AOCL to income over the next year. For the year ended December 31, 2009, we discontinued hedge accounting on certain contracts where the forecasted transactions were no longer probable. The amount reclassified to income as a result of this action was a loss of $4 million. Our internal policy allows for managing these cash flow hedges for up to three years.

        As of December 31, 2009, the potential gain or loss related to the outstanding commodity swap contracts, assuming a hypothetical 10 percent fluctuation in the price of such commodities, was $10 million. The sensitivity analysis of the effects of changes in commodity prices assumes the notional value to remain constant for the next 12 months. The analysis ignores the impact of commodity price movements on our competitive position and potential changes in sales levels. It should be noted that any change in the value of the swap contracts, real or hypothetical, would be significantly offset by an inverse change in the value of the underlying hedged items (see Note 20, "DERIVATIVES," to the Consolidated Financial Statements).

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Item 8.    Financial Statements and Supplementary Data

        

Index to Financial Statements

NOTE 1   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NOTE 2   INVESTMENTS IN EQUITY INVESTEES
NOTE 3   RESTRUCTURING AND OTHER CHARGES
NOTE 4   INCOME TAXES
NOTE 5   MARKETABLE SECURITIES
NOTE 6   FAIR VALUE OF FINANCIAL INSTRUMENTS
NOTE 7   INVENTORIES
NOTE 8   PROPERTY, PLANT AND EQUIPMENT
NOTE 9   GOODWILL AND OTHER INTANGIBLE ASSETS
NOTE 10   DEBT
NOTE 11   PRODUCT WARRANTY LIABILITY
NOTE 12   PENSION AND OTHER POSTRETIREMENT BENEFITS
NOTE 13   OTHER LIABILITIES AND DEFERRED REVENUE
NOTE 14   COMMITMENTS AND CONTINGENCIES
NOTE 15   CUMMINS INC. SHAREHOLDERS' EQUITY
NOTE 16   OTHER COMPREHENSIVE INCOME (LOSS)
NOTE 17   STOCK INCENTIVE AND STOCK OPTION PLANS
NOTE 18   NONCONTROLLING INTERESTS
NOTE 19   EARNINGS PER SHARE
NOTE 20   DERIVATIVES
NOTE 21   SALES OF ACCOUNTS RECEIVABLE
NOTE 22   ACQUISITIONS AND DIVESTITURES
NOTE 23   VARIABLE INTEREST ENTITIES
NOTE 24   OTHER (EXPENSE) INCOME
NOTE 25   OPERATING SEGMENTS

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MANAGEMENT'S REPORT TO SHAREHOLDERS

Management's Report on Financial Statements and Practices

        The accompanying Consolidated Financial Statements of our Company were prepared by management, which is responsible for their integrity and objectivity. The statements were prepared in accordance with generally accepted accounting principles and include amounts that are based on management's best judgments and estimates. The other financial information included in the annual report is consistent with that in the financial statements.

        Management also recognizes its responsibility for conducting our affairs according to the highest standards of personal and corporate conduct. This responsibility is characterized and reflected in key policy statements issued from time to time regarding, among other things, conduct of its business activities within the laws of the host countries in which we operate, within The Foreign Corrupt Practices Act and potentially conflicting interests of its employees. We maintain a systematic program to assess compliance with these policies.

        To comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, we designed and implemented a structured and comprehensive compliance process to evaluate our internal control over financial reporting across the enterprise.


Management's Report on Internal Control Over Financial Reporting

        Management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and preparation of the Company's Consolidated Financial Statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

        Management assessed the effectiveness of our internal control over financial reporting and concluded it was effective as of December 31, 2009. In making its assessment, management utilized the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework.

        The effectiveness of the Company's internal control over financial reporting as of December 31, 2009, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.


Officer Certifications

        Please refer to Exhibits 31(a) and 31(b) attached to this report for certifications required under Section 302 of the Sarbanes-Oxley Act of 2002.

/s/ THEODORE M. SOLSO

Chairman and Chief Executive Officer
  /s/ PATRICK J. WARD

Vice President and Chief Financial Officer

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Cummins Inc.:

        In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of Cummins Inc. and its subsidiaries at December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying "Management's Report on Internal Control over Financial Reporting". Our responsibility is to express opinions on these financial statements, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

        A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

Indianapolis, Indiana
February 25, 2010

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Table of Contents


CUMMINS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

 
  Years ended December 31,  
In millions, except per share amounts
  2009   2008   2007  

NET SALES(a)

  $ 10,800   $ 14,342   $ 13,048  

Cost of sales

    8,631     11,402     10,492  
               

GROSS MARGIN

    2,169     2,940     2,556  

OPERATING EXPENSES AND INCOME

                   
 

Selling, general and administrative expenses

    1,239     1,450     1,296  
 

Research, development and engineering expenses

    362     422     329  
 

Equity, royalty and interest income from investees (Note 2)

    214     253     205  
 

Restructuring and other charges (Note 3)

    99     37      
 

Other operating (expense) income, net

    (1 )   (12 )   22  
               

OPERATING INCOME

    682     1,272     1,158  

Interest income

   
8
   
18
   
36
 

Interest expense (Note 10)

    35     42     58  

Other (expense) income, net (Note 24)

    (15 )   (70 )   33  
               

INCOME BEFORE INCOME TAXES

    640     1,178     1,169  

Income tax expense (Note 4)

   
156
   
360
   
381
 
               

NET INCOME

    484     818     788  

Less: Net income attributable to noncontrolling interests

   
56
   
63
   
49
 
               

NET INCOME ATTRIBUTABLE TO CUMMINS INC

  $ 428   $ 755   $ 739  
               

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CUMMINS INC. (Note 19)

                   
 

Basic

  $ 2.17   $ 3.87   $ 3.72  
 

Diluted

  $ 2.16   $ 3.84   $ 3.70  

(a)
Includes sales to nonconsolidated equity investees of $1,830, $2,217 and $1,816 for the years ended December 31, 2009, 2008 and 2007, respectively.

The accompanying notes are an integral part of our Consolidated Financial Statements.

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CUMMINS INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 
  December 31,  
In millions
  2009   2008