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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, 2011

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 preceding 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 $18.8 billion at June 26, 2011. This value includes all shares of the registrant's common stock, except for treasury shares.

          As of February 3, 2012, there were 191,927,547 shares outstanding of $2.50 par value common stock.

Documents Incorporated by Reference

          Portions of the registrant's definitive Proxy Statement for its 2012 annual meeting of shareholders, which will be filed with the Securities and Exchange Commission on Schedule 14A within 120 days after the end of 2011, will be incorporated by reference in Part III of this Form 10-K to the extent indicated therein upon such filing.

Website Access to Company's Reports

          We maintain an internet website at www.cummins.com. Investors may obtain copies of our filings from this website free of charge as soon as reasonable practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission.

   


Table of Contents


CUMMINS INC. AND SUBSIDIARIES
TABLE OF CONTENTS

PART
  ITEM    
  PAGE  

     

Cautionary Statements Regarding Forward-Looking Information

  3  

I

  1  

Business

  5  

     

Overview

  5  

     

Operating Segments

  5  

     

Engine Segment

  5  

     

Components Segment

  6  

     

Power Generation Segment

  8  

     

Distribution Segment

  9  

     

Joint Ventures, Alliances and Non-Wholly-Owned Subsidiaries

  10  

     

Supply

  13  

     

Patents and Trademarks

  14  

     

Seasonality

  14  

     

Largest Customers

  14  

     

Backlog

  15  

     

Research and Development Expense

  15  

     

Environmental Compliance

  15  

     

Employees

  17  

     

Available Information

  17  

     

Executive Officers of the Registrant

  18  

  1A  

Risk Factors

  19  

  1B  

Unresolved Staff Comments

  26  

  2  

Properties

  26  

  3  

Legal Proceedings

  27  

  4  

Mine Safety Disclosures

  28  

II

  5  

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

  28  

  6  

Selected Financial Data

  30  

  7  

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

  32  

  7A  

Quantitative and Qualitative Disclosures About Market Risk

  71  

  8  

Financial Statements and Supplementary Data

  74  

     

Index to Financial Statements

  74  

  9  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  149  

  9A  

Controls and Procedures

  149  

  9B  

Other Information

  149  

III

  10  

Directors, Executive Officers and Corporate Governance

  149  

  11  

Executive Compensation

  149  

  12  

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

  150  

  13  

Certain Relationships, Related Transactions and Director Independence

  150  

  14  

Principal Accountant Fees and Services

  150  

IV

  15  

Exhibits and Financial Statement Schedules

  151  

     

Signatures

  152  

     

Cummins Inc. Exhibit Index

  154  

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        Cummins Inc. and its consolidated subsidiaries are hereinafter sometimes referred to as "Cummins," "we," "our," or "us."

CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION

        Certain parts of this annual report 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. Some of the future factors that could affect the outcome of forward-looking statements include the following:

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        Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are made only as of the date of this annual report and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

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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 and engine-related component products, including filtration, exhaust aftertreatment, fuel systems, controls systems, air handling systems and electric power generation 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 600 company-owned and independent distributor locations and more than 6,500 dealer locations in more than 190 countries and territories.

OPERATING SEGMENTS

        We have four complementary operating segments: Engine, Components, Power Generation and Distribution. These segments share technology, customers, strategic partners, brand recognition and our distribution network in order to compete more efficiently and effectively 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 compete primarily 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 23, "OPERATING SEGMENTS," to our Consolidated Financial Statements.

Engine Segment

        Engine segment sales and earnings before interest and taxes (EBIT) as a percentage of consolidated results were:

 
  Years ended
December 31,
 
 
  2011   2010   2009  

Percent of consolidated net sales(1)

    52 %   49 %   49 %

Percent of consolidated EBIT(1)

    53 %   48 %   34 %

(1)
Measured before intersegment eliminations

        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 Inc (PACCAR), Daimler Trucks North America, MAN Latin America and Ford. We sell our industrial engines to manufacturers of construction, agricultural and marine equipment, including Komatsu, Hyundai, Belaz, Liugong and Hitachi. 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 International Truck and Engine Corporation (Engine Division), Detroit Diesel Corporation, Caterpillar Inc. (CAT) and Volvo Powertrain. 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 Weichai Power Co. Ltd., MAN Nutzfahrzeuge AG (MAN), Fiat Power Systems, GE Jenbacher, Tognum AG, CAT, Volvo, Yanmar Co., Ltd., GuangxiYuchai Group and Deutz AG.

Components Segment

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

 
  Years ended
December 31,
 
 
  2011   2010   2009  

Percent of consolidated net sales(1)

    18 %   19 %   18 %

Percent of consolidated EBIT(1)

    18 %   16 %   13 %

(1)
Measured before intersegment eliminations

        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 emission standards and fuel systems which to date have primarily supplied our Engine segment and our joint venture partner Scania.

        Our Components segment is organized around the following businesses:

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        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, Daimler, Volvo, Iveco, Scania and other manufacturers that use our components in their product platforms.

        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, Honeywell International, Borg-Warner, Robert Bosch GmbH, Tenneco Inc., Eberspacher Holding GmbH & Co. KG and Denso Corporation.

        In the second quarter of 2011, we sold certain assets and liabilities of our exhaust business which manufactures exhaust products and select components for emission systems for a variety of applications not core to our other product offerings. This business was historically included in our Components segment. The sales price was $123 million. We recognized a gain on the sale of $68 million ($37 million after-tax), which included a goodwill allocation of $19 million. The gain was excluded from segment results as it was not considered in our evaluation of operating results for the year ended December 31, 2011.

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        Sales for this business were $62 million, $171 million and $126 million in 2011 (through closing), 2010 and 2009, respectively. Operating results for this business were approximately $9 million, $22 million and $11 million in 2011 (through closing), 2010 and 2009, respectively.

        During the fourth quarter of 2011, we sold certain assets and liabilities of our light-duty filtration business which manufactures light-duty automotive and industrial filtration solutions. The sales price was $90 million and included a note receivable from the buyer of approximately $1 million. There are no earnouts or other contingencies associated with the sales price. We recognized a gain on the sale of $53 million ($33 million after-tax), which included a goodwill allocation of $6 million. The gain was excluded from segment results as it was not considered in our evaluation of operating results for the year ended December 31, 2011.

        Sales for this business were $64 million, $74 million and $54 million in 2011 (through closing), 2010 and 2009, respectively. Operating results for this business were approximately $13 million, $9 million and $2 million in 2011 (through closing), 2010 and 2009, respectively.

Power Generation Segment

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

 
  Years ended
December 31,
 
 
  2011   2010   2009  

Percent of consolidated net sales(1)

    16 %   18 %   19 %

Percent of consolidated EBIT(1)

    14 %   18 %   22 %

(1)
Measured before intersegment eliminations

        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, including the following:

        Our Power Generation segment is organized around the following businesses:

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

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

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

Distribution Segment

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

 
  Years ended
December 31,
 
 
  2011   2010   2009  

Percent of consolidated net sales(1)

    14 %   14 %   14 %

Percent of consolidated EBIT(1)

    15 %   18 %   31 %

(1)
Measured before intersegment eliminations

        Our Distribution segment consists of 22 company-owned and 18 joint venture distributors that service and distribute the full range of our products and services to end-users at approximately 400 locations in approximately 70 distribution territories. Our company-owned distributors are located in key markets, including North America, Australia, Europe, the Middle East, India, China, Africa, Russia, Japan, Brazil and Singapore, while our joint venture distributors are located in North America, South America, Africa, China, Thailand, Singapore and Vietnam.

        The Distribution segment consists of the following businesses which service and/or distribute the full range of our products and services:

        The Distribution segment is organized into five primary geographic regions:

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

        North and Central America are mostly comprised of a network of partially-owned distributors. Internationally, our network consists of independent, partially-owned and wholly-owned distributors. Through these networks, 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 new products, technical support, tools, training, parts and product information.

        In addition to managing our involvement with our wholly-owned and partially-owned distributors, our Distribution segment is responsible for managing the performance and capabilities of our independent distributors. Our Distribution segment serves a highly diverse customer base with approximately 47 percent of its 2011 sales being generated from new engines and power generation equipment, compared to 42 percent in 2010, with its remaining sales generated by parts and service revenue.

        Financial information about our distributors accounted for under the equity method are incorporated by reference from Note 3, "INVESTMENTS IN EQUITY INVESTEES," to our Consolidated Financial Statements.

        In November 2010, we purchased a majority interest in a previously independent North American distributorship. The acquisition was accounted for under the purchase method of accounting and resulted in an aggregate purchase price of $27 million. The assets of the acquired business were primarily accounts receivable, inventory, and fixed assets. The transaction generated $1 million of goodwill.

        On January 4, 2010, we acquired the remaining 70 percent interest in Cummins Western Canada (CWC) from our former principal for consideration of approximately $71 million in order to increase our ownership interests in key portions of the distribution channel. We formed a new partnership with a new distributor principal in which we own 80 percent of CWC and the new distributor principal owns 20 percent. The acquisition, which was effective on January 1, 2010, was accounted for as a business combination and resulted in $2 million of goodwill. The results of the acquired entity for 2011 and 2010 were included in the Distribution operating segment. The assets of the acquired business were primarily inventory, fixed assets and accounts receivable. See Note 2, "DIVESTITURES AND ACQUISITIONS," to our Consolidated Financial Statements for additional detail.

        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, Components or Power Generation 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

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controlling interests in non-wholly-owned manufacturing and distribution subsidiaries. Three entities, in which we own more than a 50 percent equity interest, are consolidated in our Distribution segment results as well as several manufacturing joint ventures in the other operating segments.

        In the event of a change of control of either party to certain of 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 3, "INVESTMENTS IN EQUITY INVESTEES," to the Consolidated Financial Statements.

        Our equity income from these investees was as follows:

 
  Years ended December 31,  
In millions
  2011   2010   2009  

Distribution Entities

                                     

North American distributors

  $ 134     36 % $ 101     32 % $ 100     51 %

Komatsu Cummins Chile, Ltda. 

    22     6 %   16     5 %   12     6 %

All other distributors

    4     1 %   3     1 %   3     1 %

Manufacturing Entities

                                     

Dongfeng Cummins Engine Company, Ltd. 

    80     21 %   99     31 %   33     17 %

Chongqing Cummins Engine Company, Ltd. 

    68     18 %   46     14 %   36     18 %

Shanghai Fleetguard Filter Co., Ltd. 

    15     4 %   12     4 %   7     4 %

Tata Cummins, Ltd. 

    14     4 %   14     4 %   5     3 %

Cummins Westport, Inc. 

    14     4 %   10     3 %   3     1 %

Valvoline Cummins, Ltd. 

    7     2 %   8     3 %   7     4 %

Komatsu manufacturing alliances

    3     1 %   11     3 %   (2 )   (1 )%

Cummins MerCruiser Diesel Marine, LLC

    (3 )   (1 )%   (3 )   (1 )%   (10 )   (5 )%

Beijing Foton Cummins Engine Co., Ltd. 

    (7 )   (2 )%   (16 )   (5 )%   (5 )   (3 )%

All other manufacturers

    24     6 %   20     6 %   7     4 %
                           

Cummins share of net income(1)

  $ 375     100 % $ 321     100 % $ 196     100 %
                           

(1)
This total represents our 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 3, "INVESTMENTS IN EQUITY INVESTEES," to our Consolidated Financial Statements.

Distribution Entities

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        Our distribution agreements with independent and partially-owned distributors generally have a renewable 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. Our 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 trademarks, 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 generally refuse to renew these agreements upon expiration or terminate them upon written 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

        Our manufacturing joint ventures have generally been formed with customers and generally are intended to 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 it supplies our wholly-owned Engine segment and Power Generation segment manufacturing facilities. Our 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. The results and investments in our joint ventures in which we have 50 percent or less ownership interest are included in "Equity, royalty and interest income from investees" and "Investments and advances related to equity method investees" in our Consolidated Statements of Income and Consolidated Balance Sheets, respectively.

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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 $44 million, $46 million and $28 million for 2011, 2010 and 2009, 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 60 to 70 percent of the

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total types of parts in our product designs. We have long-term agreements with critical suppliers to help assure our capacity, delivery and quality requirements including one "take or pay" contract with an emission solutions business supplier requiring us to purchase approximately $73 million annually from 2012 through 2018. 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, and establish programs to proactively detect suppliers with potential risks. 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 were 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 significant to our business.

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 its 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. PACCAR is our largest customer, accounting for approximately 12 percent of our consolidated net sales in 2011, compared to approximately seven percent in 2010 and nine percent in 2009. We have long-term supply agreements with PACCAR for our heavy-duty ISX 15 liter and ISX 11.9 liter engines and our ISL 9 liter mid-range engine. While a significant number of our sales to PACCAR are under long-term supply agreements, these agreements provide for particular engine requirements for specific vehicle models and not a specific volume of engines. PACCAR is our only customer accounting for more than ten percent of our net sales in 2011. The loss of this customer or a significant decline in the production level of PACCAR vehicles that use our engines would have an adverse effect on our results of operations and financial condition. We have been an engine supplier to PACCAR for over 67 years. A summary of principal customers for each operating segment is included in our segment discussion.

        In addition to our agreement with PACCAR, we have long-term heavy-duty engine supply agreements with Volvo Trucks North America and long-term mid-range supply agreements with Daimler Trucks North America, Ford and MAN. We also have an agreement with Chrysler for supplying the engine for its Ram trucks. In our off-highway markets, we have various engine and component supply agreements ranging across our midrange and high-horsepower businesses with Komatsu Ltd., as well as various joint ventures and other license agreements in our Engine, Component and Distribution segments. Collectively, our net sales to these seven customers, including PACCAR, was approximately 31 percent of our consolidated net sales in 2011, compared to approximately 25 percent in 2010 and 23 percent in 2009. Excluding PACCAR, net sales to individual customers were less than six percent of our consolidated net sales to any single customer in 2011, compared to less than four percent in 2010 and 2009. These agreements contain standard purchase and

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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 help 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

        Our 2011 lead times for the majority of our businesses remained consistent or improved from their 2010 levels. 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. Research and development expenditures include salaries, contractor fees, building costs, utilities, administrative expenses and allocation of corporate costs and are expensed, net of contract reimbursements, when incurred. Research and development expenses, net of contract reimbursements, were $621 million in 2011, $402 million in 2010 and $362 million in 2009. Contract reimbursements were $75 million in 2011, $68 million in 2010 and $92 million in 2009.

        For 2011, 2010 and 2009, approximately $1 million, $38 million and $151 million or less than one percent, nine percent and 42 percent respectively, of our research and development expenditures were directly related to compliance with 2010 Environmental Protection Agency (EPA) emission standards. For 2011 and 2010, approximately $104 million and $36 million or 17 percent and nine percent, of our research and development expenditures were directly related to compliance with 2013 EPA emission standards. In 2011, we increased our research, development and engineering expenses as we continued to invest in future critical technologies and products. We will continue to make investments to improve our current technologies, continue to meet the future emission requirements around the world and improve fuel economy.

ENVIRONMENTAL COMPLIANCE

Sustainability

        We continue to be a leader in sustainable business development and practices. We have invested significantly to further lower emissions from and increase the efficiency of our products. Our ten climate change principles direct our actions to address this environmental challenge across our products, businesses, employees and communities. We have worked collaboratively with customers to improve their fuel economy and reduce their carbon footprint. We have significantly reduced greenhouse gas (GHG) emissions from our facilities and exceeded our 2010 goal of 25 percent intensity reduction by achieving a 28 percent reduction, resulting in a savings of approximately $20 million annually. We will continue these efforts through our new facility goal to expand this reduction to 40 percent GHG intensity reduction by 2015. Over the past three years, we have reduced water usage by 22 percent, reduced hazardous waste produced during manufacturing by 26 percent and landfill waste by 11 percent, normalized to employee hours. We have articulated our positions on key public policy issues surrounding a wide range of environmental issues and were actively engaged in developing the first-ever GHG and fuel efficiency standards for commercial vehicles that were finalized in the U.S. in 2010. For the seventh 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,

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environmental and social leadership. Our sustainability report for 2010/2011 as well as a supplement of more detailed environmental data 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 emission and noise. Our products comply with all current emission standards that the 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 emission 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. Our failure to comply with these standards could result in adverse effects on our future financial results.

EPA Engine Certifications

        The current on-highway emission standards came into effect in the U.S. on January 1, 2010. To meet the 2010 U.S. EPA heavy-duty on-highway emission standards, we used 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 offer a complete lineup of on-highway engines to meet the near-zero emission standards. Mid-range and heavy-duty engines for EPA 2010 require 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. For model year 2011 we made changes to the engine control module in response to EPA's and CARB's evolving SCR guidance. The EPA and CARB have certified that our engines meet the 2011 emission requirements. Emission 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. emission standards leaves us well positioned to take advantage of opportunities in these markets as the need for emission control capability grows.

        Federal and California regulations require manufacturers to report failures of emission-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 2011, we submitted five reports to the EPA relating to software corrections in our engine control module. These software corrections related to the engine control module necessitated the campaigns of approximately 1,250 engines at a cost of less than $1 million.

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 expected to be material in 2012. 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 20 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.

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        In addition, we have two 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, 2011, we employed approximately 43,900 persons worldwide. Approximately 15,700 of our employees worldwide are represented by various unions under collective bargaining agreements that expire between 2012 and 2015.

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" followed by the "Investor Relations" link. 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. Our 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 our internet site is not incorporated by reference into this report.

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EXECUTIVE OFFICERS OF THE REGISTRANT

        Following are the names and ages of our executive officers, their positions with us as of January 31, 2012, 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
N. Thomas Linebarger (49)   Chairman of the Board of Directors and Chief Executive Officer (2012)   President and Chief Operating Officer (2008-2011),
Executive Vice President and President—Power Generation (2005-2008)

Sharon R. Barner (54)

 

Vice President—General Counsel (2012)

 

Partner—Law firm of Foley & Lardner (2011-2012)
Deputy Under Secretary of Commerce—Intellectual Property and Deputy Director of the United States Patent and Trademark Office (2009-2011)
Partner—Law firm of Foley & Lardner (1996-2009)

Jean S. Blackwell (57)

 

Executive Vice President, Corporate Responsibility (2008)

 

Executive Vice President—Chief Financial Officer (2005-2008)

Pamela L. Carter (62)

 

Vice President and President—Distribution Business (2007)

 

Vice President and President—Cummins Filtration (2005-2007)

Steven M. Chapman (57)

 

Group Vice President—China and Russia (2009)

 

Vice President—Emerging Markets and Businesses (2005-2009)

Jill E. Cook (48)

 

Vice President—Human Resources (2003)

 

 

Richard J. Freeland (54)

 

Vice President and President—Engine Business (2010)

 

Vice President and President—Components Group (2008-2010), Vice President and President—Worldwide Distribution Business (2005-2008)

Mark R. Gerstle (56)

 

Vice President—Community Relations (2011)

 

Vice President—Chief Administrative Officer (2008-2011), Vice President—Corporate Quality and Chief Risk Officer (2005-2008)

Richard E. Harris (59)

 

Vice President—Chief Investment Officer (2008)

 

Vice President—Treasurer (2003-2008)

Marsha L. Hunt (48)

 

Vice President—Corporate Controller (2003)

 

 

Marya M. Rose (49)

 

Vice President—Chief Administrative Officer (2011)

 

Vice President—General Counsel and Corporate Secretary (2001-2011)

Livingston L. Satterthwaite (51)

 

Vice President and President—Power Generation (2008)

 

Vice President—Generator Set Business (2003-2008)

Anant Talaulicar (50)

 

Vice President and President—Components Group (2010)

 

Vice President and Managing Director—India ABO (2004-present), Chairman and Managing Director—Cummins India Ltd. (2003-present)

John C. Wall (60)

 

Vice President—Chief Technical Officer (2000)

 

 

Patrick J. Ward (48)

 

Vice President—Chief Financial Officer (2008)

 

Vice President—Engine Business Controller (2006-2008)

Lisa M. Yoder (48)

 

Vice President—Global Supply Chain & Manufacturing (2011)

 

Vice President—Corporate Supply Chain (2010-2011), Executive Director—Supply Chain & Operations-Power Generation (2007-2010)

        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.

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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 in combination, have a material adverse effect on our results of operations, financial position or cash flows. 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.

Another sustained slowdown or significant downturn in our markets could materially and adversely affect our results of operations, financial condition or cash flows again.

        Although emerging markets, notably China, India and Brazil, experienced strong growth and certain domestic markets showed more robust recoveries in 2011, the global economy remains fragile. Growth rates in certain emerging markets, including China and India, began to slow in the second half of 2011 as governments looked to control inflation through tight monetary policies, while in the developed economies, particularly in Europe, the recovery remains sluggish due to the unwinding of fiscal stimuli, lingering high unemployment, concerns over European sovereign debt issues and the tightening of government budgets. As a result, further disruptions in Europe or in other economies could affect our revenues or liquidity. Continued inflationary pressures in emerging market countries could cause their governments to further tighten credit and raise interest rates, resulting in slowing economic growth. If the global economy, or some of our significant markets, were to undergo a sustained slowdown or another significant downturn, depending upon the length, duration and severity of such a slowdown or downturn, 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.

A slowdown in infrastructure development could adversely affect our business.

        Infrastructure development has been a significant driver of our business in recent years. Some governments and financial institutions have tightened credit availability and made the terms of available credit more onerous, which may lead to a slowdown in economic growth and infrastructure spending. Concern over inflationary or other economic pressures may cause governments or financial institutions to take similar measures in the future. General weakness in economic growth or the perception that infrastructure has been overbuilt also may lead to a decrease in infrastructure spending. Any significant declines in infrastructure development that result from these circumstances could adversely affect our business.

Unpredictability in the adoption, implementation and enforcement of increasingly stringent emission standards could adversely affect our business.

        Our engines are subject to extensive statutory and regulatory requirements governing emission and noise, including standards imposed by the EPA, the European Union, state regulatory agencies (such as the 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 emission standards. Developing engines to meet changing government regulatory requirements, with different implementation timelines and emission requirements, makes developing engines efficiently for multiple markets complicated and could result in substantial additional costs that may be difficult to recover in

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certain markets. In some cases, we may be required to develop new products to comply with new regulations, particularly those relating to air emission. For example, we were required to develop new engines to comply with stringent emission standards in the U.S. by January 1, 2010, including the reduction of NOx emission to near zero levels, among other requirements. 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. 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. In addition to these risks, the nature and timing of government implementation and enforcement of increasingly stringent emission standards around the world is unpredictable and subject to change, delays and reversals that can result in new or modified products that we have developed to comply with the standards becoming unnecessary, or becoming necessary later than expected, and in some cases negating our competitive advantage. This in turn can delay, diminish or eliminate the expected return on capital and research expenditures that we have invested in such products and may adversely affect our perceived competitive advantage in being an early, advanced developer of compliant engines.

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 2011, we recognized $ 416 million of equity, royalty and interest income from investees, compared to $ 351 million in 2010. The majority of our equity, royalty and interest income from investees comes from our 12 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 puts 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 on our results of operations.

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

        Several of our engine customers, including PACCAR, Volvo AB and Chrysler, are truck manufacturers or OEMs that manufacture engines for some of their own products. Despite their own 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 emission capabilities, 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 on our results of operations.

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

        The Environmental Protection Agency (EPA) and California Air Resources Board (CARB) have certified all of our 2011 on-highway and off-highway engines, which utilize selective catalytic reduction (SCR) technology to meet requisite emission levels. We introduced SCR technology into our engine platforms in 2010. The effective performance of SCR technology and the overall performance of these engine platforms impact a number of our operating segments and remain crucial to our success in North America. While these 2010 engine platforms have performed well in the field, the discovery of any significant problems in these platforms could result in recall campaigns, increased warranty costs, reputational risk and brand risk.

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 that attempt 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 some 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.

Another downturn in the North American and European automotive industries could adversely impact our business.

        During the recession, lower production levels for some of our key suppliers, increases in certain raw material, commodity and energy costs and the global credit market crisis resulted in severe financial distress among many companies within the automotive supply base. A return to financial distress within the automotive industry and our shared supply base and/or the subsequent bankruptcy of one or more 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.

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

        During 2011, we single sourced approximately 60 to 70 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, natural disasters or acts of war or terrorism. Any extended delay in receiving critical supplies could impair our ability to deliver products to our customers.

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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 material and commodity 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 that attempt to address some of these risks (notably with respect to copper, platinum and palladium), there can be no assurance that commodity price fluctuations will not adversely affect our results of operations, financial condition or cash flows. In addition, while the use of commodity price hedging instruments may provide us with some 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, could result in declining margins.

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

        Our products may be subject to recall for performance 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. Any significant product recalls could have a material adverse effect on our results of operations, financial condition and cash flows.

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. We primarily compete in the market with diesel engines and related diesel products; however, new technologies continue to be developed for gasoline and other technologies and we will continue to face new competition from these expanding technologies. Our products primarily compete on the basis of price, performance, fuel economy, speed of delivery, quality and customer support. We also face competitors in some emerging markets who have established local practices and long standing relationships with participants in these markets. There can be no assurance that our products will be able to compete successfully with the products of other companies and in other markets. For a more complete discussion of the competitive environment in which each of our segments operates, see "Operating Segments" in "Item 1 Business."

Increasing global competition among our customers may affect our existing customer relationships and restrict our ability to benefit from some of our customers' growth.

        As our customers in emerging markets continue to grow in size and scope, they are increasingly seeking to export their products to other countries. This has meant greater demand for our advanced engine technologies to help these customers meet the more stringent emissions requirements of developed markets, as well as greater demand for access to our distribution systems for purposes of equipment servicing. As these emerging market customers enter into and begin to compete in more developed markets, they may increasingly begin to compete with our existing customers in these markets. Our further aid to emerging market customers could affect our relationships with developed market customers and, as a result, we may feel pressure to restrict some of our activities in areas of competition. In addition, to the extent the competition does not correspond to overall growth in demand, we may see little or no benefit from this type of expansion by our emerging market customers.

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

        Approximately 59 percent of our net sales for 2011 were attributable to customers outside the U.S., compared to 64 percent in 2010. 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.

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

        We are subject to income taxes in the U.S. and numerous international jurisdictions. Our income tax provision and cash tax liability in the future could be adversely affected by changes in the distribution 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. 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. We are also subject to ongoing tax audits. These audits can involve complex issues, which may require an extended period of time to resolve and can be highly judgmental. 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. 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 provision and, therefore, could have a material impact on our tax provision.

We are exposed to risks arising from the price and availability of energy.

        The level of demand for our products and services is influenced in multiple ways by the price and availability of energy. High energy costs generally drive greater demand for better fuel economy in almost all countries in which we operate. Some of our engine products have been developed with a primary purpose of offering fuel economy improvements, and if energy costs decrease or increase less than expected, demand for these products may likewise decrease. The relative unavailability of electricity in some emerging market countries also influences demand for our electricity generating products, such as our diesel generators. If these countries add energy capacity by expanding their power grids at a rate equal to or faster than the growth in demand for energy, the demand for our generating products could also decrease or increase less than would otherwise be the case.

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We face reputational and legal risk from operations outside the U.S. and affiliations with joint venture partners.

        Several of our foreign subsidiaries, affiliates and joint venture partners are located outside the U.S. with laws, rules and business practices that differ from those of the U.S. The activities of these entities may not comply with U.S. laws or customs or our Code of Business Conduct and actions by these entities may cause us legal or reputational risk if they violate applicable laws, rules or business practices.

We face the challenge of increasing our capacity and ramping up our production at the appropriate pace.

        We experience capacity constraints and longer lead times for certain products. Accurately forecasting our expected volumes and appropriately adjusting our capacity have been, and will continue to be, important factors in determining our results of operations. We cannot guarantee that we will be able to increase manufacturing capacity to a level that meets demand for our products, which could prevent us from meeting increased customer demand and could harm our business. However, if we overestimate our demand and overbuild our capacity, we may have significantly underutilized assets and we may experience reduced margins. If we do not accurately align our manufacturing capabilities with demand it could have a material adverse effect on our results of operations.

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.

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

        We began development of a North American 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, 2011, we have capitalized investments of approximately $221 million. Market uncertainty due to the global recession resulted in some customers delaying or cancelling their vehicle programs, while others remain active. If customer expectations or volume projections further deteriorate from our current expected levels and we do not identify new customers, we may need to recognize an impairment charge and write the assets down to net realizable value.

Our operations are subject to increasingly stringent 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 emission, 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

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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.

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. Depending upon the severity of market declines and government regulatory changes, we may be legally obligated to make pension payments in the U.S. and perhaps other countries, and these contributions could be material.

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

        As of December 31, 2011, we employed approximately 43,900 persons worldwide. Approximately 15,700 of our employees worldwide are represented by various unions under collective bargaining agreements that expire between 2012 and 2015. While we have no reason to believe that we will be materially impacted by work stoppages or 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 and suppliers have unionized work forces. Work stoppages or slow-downs experienced by our customers or suppliers could result in slow-downs or closures that would have a material adverse effect on our operations.

Our financial statements are subject to changes in accounting standards that could adversely impact our profitability or financial position.

        Our financial statements are subject to the application of accounting principles generally accepted in the United States of America (GAAP), which are periodically revised and/or expanded. Accordingly, from time to time we are required to adopt new or revised accounting standards issued by recognized authoritative bodies, including the Financial Accounting Standards Board. Recently, accounting standard setters issued new guidance which further interprets or seeks to revise accounting pronouncements related to revenue recognition and lease accounting as well as to issue new standards expanding disclosures. The impact of accounting pronouncements that have been issued but not yet implemented is disclosed in our annual and quarterly reports on Form 10-K and Form 10-Q. An assessment of proposed standards is not provided, as such proposals are subject to change through the exposure process and, therefore, their effects on our financial statements cannot be meaningfully assessed. It is possible that future accounting standards we are required to adopt could change the current accounting treatment that we apply to our consolidated financial statements and that such changes could have a material adverse effect on the reported results of operations and financial position.

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ITEM 1B.    Unresolved Staff Comments

        None.

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: Rumst

  Tennessee: Memphis   Brazil: Sao Paulo

  New Mexico: Clovis   China: Wuhan

  New York: Lakewood   India: Pune

  North Carolina: Whitakers   Mexico: San Luis Potosi

      U.K.: Darlington, Daventry, Cumbernauld

      Singapore: Singapore SG

Components

 

Indiana: Columbus

 

Australia: Kilsyth

  Iowa: Lake Mills   Brazil: Sao Paulo

  South Carolina: Ladson, Charleston   China: Beijing, Hubei Sheng, Shanghai, Wuxi

  Tennessee: Cookeville   France: Quimper

  Texas: El Paso   India: Pune, Daman, Dewas, Pithampur,

  Wisconsin: Janesville, Mineral Point,   Radurapur

  Neillsville   Japan: Tokyo

      Mexico: Ciudad Juarez, San Luis Potosi

      Singapore: Singapore SG

      South Africa: Pretoria, Johannesburg

      South Korea: Hwasung City

      Turkey: Ismir

      U.K.: Darlington, Huddersfield

Power Generation

 

Indiana: Elkhart

 

Brazil: Sao Paulo

  Minnesota: Fridley   China: Wuxi, Wuhan

      Germany: Ingolstadt

      India: Pirangut, Daman, Ahmendnagar, Ranjangaon

      Mexico: San Luis Potosi

      Romania: Craiova

      U.K.: Margate, Manston, Stamford

        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.
Massachusetts: Dedham   Australia: Scoresby
New York: Bronx   Belgium: Mechelen
Pennsylvania: Bristol, Harrisburg   Canada: Surrey, Edmonton
    China: Beijing, Shanghai
    Germany: Gross Gerau
    India: Pune
    Japan: Tokyo
    Korea: Chonan
    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. 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.

        We conduct significant business operations in Brazil that are subject to the Brazilian federal, state and local labor, social security, tax and customs laws. While we believe we comply with such laws, they

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are complex, subject to varying interpretations and we are often engaged in litigation regarding the application of these laws to particular circumstances.

        In June 2008, four of our sites in Southern Indiana, including our Technical Center, experienced extensive flood damage. In October 2011, we received $40 million from our insurance carriers to settle all outstanding 2008 flood claims. As a result, we recognized a gain of approximately $38 million ($24 million after-tax), net of any remaining flood related expenses, in "Other operating (expense) income, net" in our Consolidated Statements of Income.

ITEM 4.    Mine Safety Disclosures

        Not Applicable.


PART II

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

        (a)   Our common stock 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, "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 26, - October 30, 2011

    44,748   $ 81.20     41,363     190,655  

October 31 - November 27, 2011

    3,964     102.77         188,493  

November 28 - December 31, 2011

    900,185     88.56     898,888     185,094  
                     

Total

    948,897   $ 88.27     940,251        
                     

(1)
Shares purchased represent shares under the 2011 Board of Directors authorized $1 billion repurchase program and our Key Employee Stock Investment Plan established in 1969 (there is no maximum repurchase limitation in this plan).

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

        In December 2007, the Board of Directors authorized us to acquire up to $500 million of our common stock beginning in 2008. We acquired $128 million in 2008, $20 million in 2009, $241 million in 2010 and $111 million in 2011, completing the repurchase program. In February 2011, the Board of Directors approved a new share repurchase program and authorized the acquisition of up to $1 billion of our common stock upon the completion of the $500 million program. We acquired $ 518 million of our common stock in 2011, or 5.3 million shares, leaving $ 482 million available for purchase under this authorization at December 31, 2011. We repurchased a total of 6.4 million shares of common stock in 2011 at a cost of $629 million.

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        During the fourth quarter of 2011, we repurchased 8,646 shares 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 initial 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.


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 of our future filings 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 includes BorgWarner Inc, Caterpillar, Inc., Daimler AG, Danaher Corporation, Deere & Company, Donaldson Company Inc., Eaton Corporation, Emerson Electric Co., W.W. Grainger Inc. , Honeywell International, Illinois Tool Works Inc., Ingersoll-Rand Company Ltd., Navistar International Corporation, PACCAR Inc, Parker-Hannifin Corporation, Textron Inc. and Volvo AB. Each of the 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 DEC. 31, 2006
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING DEC. 31, 2011

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ITEM 6.    Selected Financial Data

        The selected financial information presented below for each of the last five years ended December 31, beginning with 2011, 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
  2011   2010   2009   2008   2007  

For the years ended December 31,

                               

Net sales

  $ 18,048   $ 13,226   $ 10,800   $ 14,342   $ 13,048  

U.S. percentage of sales

   
41

%
 
36

%
 
48

%
 
41

%
 
46

%

Non-U.S. percentage of sales

    59 %   64 %   52 %   59 %   54 %

Gross margin

   
4,589
   
3,168
   
2,169
   
2,940
   
2,556
 

Research, development and engineering expenses

    629     414     362     422     329  

Equity, royalty and interest income from investees

    416     351     214     253     205  

Interest expense

    44     40     35     42     58  

Consolidated net income(1)

    1,946     1,140     484     818     788  

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

    1,848     1,040     428     755     739  

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

                               

Basic

  $ 9.58   $ 5.29   $ 2.17   $ 3.87   $ 3.72  

Diluted

    9.55     5.28     2.16     3.84     3.70  

Cash dividends declared per share

    1.325     0.875     0.70     0.60     0.43  

Cash flows from operations

  $ 2,073   $ 1,006   $ 1,137   $ 987   $ 810  

Capital expenditures

    622     364     310     543     353  

At December 31,

                               

Cash and cash equivalents

  $ 1,484   $ 1,023   $ 930   $ 426   $ 577  

Total assets

    11,668     10,402     8,816     8,519     8,195  

Long-term debt

    658     709     637     629     555  

Total equity(4)

    5,831     4,996     4,020     3,480     3,702  

(1)
For the year ended December 31, 2011, consolidated net income included a $68 million gain ($37 million after-tax) related to the disposition of certain assets and liabilities of our exhaust business and a $53 million gain ($33 million after-tax) recorded for the disposition of certain assets and liabilities of our light-duty filtration business, both from the Components segment, and a $38 million gain ($24 million after-tax) related to flood damage recoveries from the insurance settlement related to a June 2008 flood in Southern Indiana. For the year ended December 31, 2010, consolidated net income included $32 million in Brazil tax recoveries ($21 million after-tax) and $2 million in flood damage expenses. In 2010 it was determined that we overpaid a Brazilian revenue based tax during the period of 2004-2008. Consolidated net income includes a pre-tax recovery related to tax credits on imported products arising from this overpayment. For the year ended December 31, 2009, consolidated net income included $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, consolidated net income included 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 damages.

(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

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(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)
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. In 2010, we recorded a $125 million non-cash credit to equity to reflect gains 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 business 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:

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EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS

        We are a global power leader that designs, manufactures, distributes and services diesel and natural gas engines and engine-related component products, including filtration, exhaust aftertreatment, fuel systems, controls systems, air handling systems and electric power generation 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, Chrysler Group, LLC, Daimler Trucks North America, MAN Nutzfahrzeuge AG, Ford Motor Company, Komatsu, Volvo AB and Case New Holland. We serve our customers through a network of more than 600 company-owned and independent distributor locations and approximately 6,500 dealer locations in more than 190 countries and territories.

        Our reportable operating segments consist of the following: Engine, Components, Power Generation 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. Our engines are used in trucks of all sizes, buses and recreational vehicles, as well as in various industrial applications, including construction, mining, agriculture, marine, oil and gas, rail and military equipment. The Components segment sells filtration products, exhaust aftertreatment systems, turbochargers and fuel systems. The Power Generation segment is an integrated provider of power systems which sells engines, generator sets and alternators. 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 generally result in reductions in sales and pricing of our products. As a worldwide business, our operations are also affected by currency, political, economic and regulatory matters, including adoption and enforcement of environmental and emission standards, in the countries we serve. As part of our growth strategy, we invest in businesses in certain countries that carry high levels of these risks such as China, Brazil, India, Mexico, South Africa, Russia and countries in the Middle East. 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 or the economy of any single country on our consolidated results.

        In 2011, certain North American markets experienced robust recoveries, especially the North American on-highway markets which was enhanced by the depletion of transition engine inventory purchased in 2009 in advance of the EPA's 2010 emission change. Demand for heavy-duty on-highway products in North America was three times higher in 2011 compared to 2010 and medium-duty truck and bus shipments in North America were two times higher. North American oil and gas markets and global mining markets also continued to experience strong growth in 2011. Emerging markets continued to experience strong growth in 2011, especially in the international construction markets. Emerging market growth was particularly strong in China, India and Brazil, although the growth rates began to soften in the second half of the year, especially in the on-highway truck and off-highway construction markets in China and power generation markets in India. Growth rates are slowing in certain emerging markets like China and India as governments look to control inflation through tight monetary policies in the form of rising interest rates and tightening access to credit. Currently, inflation concerns appear to be declining in China and there is a growing expectation that the government will start to ease monetary policy, which would enhance our end markets. Inflation concerns in India also appear to be

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declining. The European economy remains an uncertainty as we enter 2012, with continued volatility in the Euro countries. Although we do not have any significant direct exposure to European sovereign debt, we do generate approximately nine percent of our net sales from Euro zone countries. Therefore, continued economic decline in Europe could have an adverse impact on our financial results.

        The following table contains sales and EBIT results by operating segment for the years ended 2011 and 2010. Refer to the section titled "Operating Segment Results" for a more detailed discussion of net sales and EBIT by operating segment including the reconciliation of segment EBIT to income before taxes.

Operating Segments

 
  2011   2010   Percent change
2011 vs. 2010
 
 
   
  Percent
of Total
   
   
  Percent
of Total
   
 
In millions
  Sales   EBIT   Sales   EBIT   Sales   EBIT  

Engine

  $ 11,307     63 % $ 1,384   $ 7,888     60 % $ 809     43 %   71 %

Components

    4,063     23 %   470     3,046     23 %   278     33 %   69 %

Power Generation

    3,498     19 %   373     2,919     22 %   299     20 %   25 %

Distribution

    3,044     17 %   386     2,324     18 %   297     31 %   30 %

Intersegment eliminations

    (3,864 )   (22 )%       (2,951 )   (23 )%       31 %    

Non segment

            102             (26 )       NM  
                                       

Total

  $ 18,048     100 % $ 2,715   $ 13,226     100 % $ 1,657     36 %   64 %
                                       

        Net income attributable to Cummins Inc. for 2011 was $1,848 million, or $9.55 per diluted share, on sales of $18.0 billion, compared to 2010 net income attributable to Cummins Inc. of $1,040 million, or $5.28 per diluted share, on sales of $13.2 billion. The increase in income was driven by higher volumes in most markets and geographic regions, including the recovery of the North American on-highway truck markets, stronger demand in certain emerging markets, significantly improved gross margins, the gain on disposition of certain assets and liabilities of our exhaust business and light-duty filtration business, a lower effective tax rate, increased equity income and the gain related to flood damage recoveries from the insurance settlement regarding a June 2008 flood in Southern Indiana. These were partially offset by higher selling, general and administrative expenses and research, development and engineering expenses in 2011 as compared to 2010. Diluted earnings per share for 2011 also benefited $0.17 from lower shares primarily due to the stock repurchase program.

        In 2011, we recorded a gain on the disposition of certain assets and liabilities of our exhaust business of $68 million ($37 million after-tax or $0.19 per diluted share) and a gain on the disposition of certain assets and liabilities of our light-duty filtration business of $53 million ($33 million after-tax or $0.17 per diluted share). For a detailed discussion of the divestitures, see Note 2, "DIVESTITURES AND ACQUISITIONS," to the Consolidated Financial Statements. Also in 2011, we recorded a gain related to flood damage recoveries from the insurance settlement for a June 2008 flood in Southern Indiana of $38 million ($24 million after-tax or $0.13 per diluted share). For a detailed discussion of the gain, see Note 14, "COMMITMENTS AND CONTINGENCIES," to the Consolidated Financial Statements. The gains have been excluded from segment results as they were not considered in our evaluation of operating results for the year. In 2010, we recorded a recovery of $32 million ($21 million after-tax, or $0.11 per diluted share) related to the overpayment of revenue based taxes on imported products in Brazil from 2004-2008. The tax recovery was recorded in cost of sales in our non segment business results as it was not considered in our evaluation of operating results for the year.

        We generated $2.1 billion of operating cash flows in 2011, compared to $1.0 billion in 2010. Refer to the section titled "Operating Activities" in the "Liquidity and Capital Resources" section for a discussion of items impacting cash flows.

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        In December 2007, our Board of Directors authorized the acquisition of up to $500 million of our common stock which was completed in the first quarter of 2011. In February 2011, the Board of Directors approved a new share repurchase program and authorized the acquisition of up to $1 billion of Cummins common stock upon the completion of the $500 million program. We repurchased $629 million in 2011, $ 111 million of which was under the repurchase program that was originally authorized in 2007 and $ 518 million of which was under the repurchase program that was authorized in 2011.

        In July 2011, our Board of Directors authorized a dividend increase of 52 percent to $0.40 per share on a quarterly basis effective in the third quarter. Our debt to capital ratio (capital is defined as debt plus equity) at December 31, 2011, was 11.8 percent, compared to 14.4 percent at December 31, 2010. As of the date of filing of this Annual Report on Form 10-K, we had a Baa1 credit rating with a positive outlook from Moody's Investors Service, Inc., an A credit rating with a stable outlook from Standard & Poor's Rating Services and an A- credit rating and a positive outlook from Fitch Ratings. In addition to our $1.8 billion in cash and marketable securities on hand, we have sufficient access to our revolving credit facility with $1.2 billion available, net of outstanding letters of credit and our accounts receivable program with $209 million available, based on eligible reserves, to meet currently anticipated growth and funding needs.

        Our global pension plans, including our unfunded non-qualified plans, were 98 percent funded at year-end 2011. Our U.S. qualified plan, which represents approximately 60 percent of our worldwide pension obligation, was 103 percent funded and the international plans were 106 percent funded. Asset returns in 2011 for the U.S. qualified plan were 13 percent while the year-end 2011 discount rate was 4.8 percent, down 0.6 percentage points from the 2010 discount rate of 5.4 percent. We expect to contribute $130 million of cash to our global pension plans in 2012. We do not have a required minimum pension contribution obligation for our U.S. plans in 2012. We expect pension and other postretirement benefit expense in 2012 to increase by approximately $4 million pre-tax, or $0.01 per diluted share, when compared to 2011. Refer to application of critical accounting estimates within MD&A and Note 12, "PENSION AND OTHER POST RETIREMENT BENEFITS," to the Consolidated Financial Statements, for additional information concerning our pension and other post-retirement benefit plans.

2012 OUTLOOK

Near-Term:

        In 2011, North America experienced a robust recovery in demand in heavy-, medium- and light-duty on-highway truck markets. Economies in emerging markets, including China, India and Brazil, experienced strong growth although demand began to soften in the second half of the year, especially in on-highway truck and off-highway construction markets in China and power generation markets in India.

        We currently expect the following positive trends in 2012:

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        We currently expect the following challenges to our business that may reduce our earnings potential in 2012:

Long-Term:

        We believe that, over the longer term, there will be economic improvements in most of our current markets and that our opportunities for long-term profitable growth will continue in the future.

RESULTS OF OPERATIONS

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
In millions (except per share amounts)
  2011   2010   2009   Amount   Percent   Amount   Percent  

Net sales

  $ 18,048   $ 13,226   $ 10,800   $ 4,822     36 % $ 2,426     22 %

Cost of sales

    13,459     10,058     8,631     (3,401 )   (34 )%   (1,427 )   (17 )%
                                   

Gross margin

    4,589     3,168     2,169     1,421     45 %   999     46 %

Operating expenses and income

                                           

Selling, general and administrative expenses

    1,837     1,487     1,239     (350 )   (24 )%   (248 )   (20 )%

Research, development and engineering expenses

    629     414     362     (215 )   (52 )%   (52 )   (14 )%

Equity, royalty and interest income from investees

    416     351     214     65     19 %   137     64 %

Gain on sale of businesses

    121             121     100 %        

Restructuring and other charges

            99             99     100 %

Other operating (expense) income, net

    21     (16 )   (1 )   37     NM     (15 )   NM  
                                   

Operating income

    2,681     1,602     682     1,079     67 %   920     NM  

Interest income

    34     21     8     13     62 %   13     NM  

Interest expense

    44     40     35     (4 )   (10 )%   (5 )   (14 )%

Other income (expense), net

        34     (15 )   (34 )   (100 )%   49     NM  
                                   

Income before income taxes

    2,671     1,617     640     1,054     65 %   977     NM  

Income tax expense

    725     477     156     (248 )   (52 )%   (321 )   NM  
                                   

Consolidated net income

    1,946     1,140     484     806     71 %   656     NM  

Less: Net income attributable to noncontrolling interests

    98     100     56     2     2 %   (44 )   (79 )%
                                   

Net income attributable to Cummins Inc

  $ 1,848   $ 1,040   $ 428   $ 808     78 % $ 612     NM  
                                   

Diluted earnings per common share attributable to Cummins Inc

  $ 9.55   $ 5.28   $ 2.16   $ 4.27     81 % $ 3.12     NM  
                                   

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  Favorable/(Unfavorable)
Percentage Points
 
Percent of sales
  2011   2010   2009   2011 vs. 2010   2010 vs. 2009  

Gross margin

    25.4 %   24.0 %   20.1 %   1.4     3.9  

Selling, general and administrative expenses

    10.2 %   11.2 %   11.5 %   1.0     0.3  

Research, development and engineering expenses

    3.5 %   3.1 %   3.4 %   (0.4 )   0.3  

2011 vs. 2010

Net Sales

        Sales increased in all segments primarily due to increased demand from most markets including recovery of the North American on-highway markets. The primary drivers for the increase in sales were:

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

        Sales to international markets were 59 percent of total net sales in 2011, compared with 64 percent of total net sales in 2010.

Gross Margin

        Gross margin increased by $ 1,421 million and as a percentage of sales increased by 1.4 percentage points. The significant improvement was led by increases in volume, improved price realization, higher product content on certain products and favorable currency impacts, partially offset by higher material costs, higher commodity costs and higher base warranty costs due to increased volumes and increasing mix of EPA 2010 products. Gross margin in 2010 also benefited from a one-time $32 million tax recovery in Brazil. See Note 14, "COMMITMENTS AND CONTINGENCIES," in our Consolidated Financial Statements for more information.

        The provision for warranties issued as a percentage of sales in 2011 was 2.1 percent compared to 3.0 percent in 2010. Accrual rates for engines sold this year were generally lower than the rates charged in prior years as our warranty costs for EPA 2010 products have been lower than expected. 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 an increase of $174 million in compensation and related expenses including increased headcount to support our strategic growth initiatives, merit increases and increased discretionary spending. Compensation and related expenses include salaries, fringe benefits and variable compensation. Variable compensation related to 2011 performance increased $42 million over variable compensation related to 2010 performance. Overall, selling, general and administrative expenses, as a percentage of sales, decreased from 11.2 percent in 2010 to 10.2 percent in 2011.

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Research, Development and Engineering Expenses

        Research, development and engineering expenses increased primarily due to an increase of $79 million in compensation and related expenses, an increase in the number of engineering programs with increased costs of $79 million and increased discretionary spending. Compensation and related expenses include salaries, fringe benefits and variable compensation. Variable compensation related to 2011 performance increased $8 million over variable compensation related to 2010 performance. Overall, research, development and engineering expenses, as a percentage of sales, increased to 3.5 percent in 2011 from 3.1 percent in 2010. Research activities continue to focus on development of new products to meet future emission standards around the world and improvements in fuel economy performance.

Equity, Royalty and Interest Income From Investees

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

In millions
  2011 vs. 2010
Increase/(Decrease)
 

North American distributors

  $ 33  

Chongqing Cummins Engine Company, Ltd. 

    22  

Beijing Foton Cummins Engine Co., Ltd. 

    9  

Dongfeng Cummins Engine Company, Ltd. 

    (19 )

Other

    9  

Royalty and interest income

    11  

        These overall increases were primarily due to the economic recovery in North America, particularly in the oil and gas markets, and strong demand for power generation and mining products in China with CCEC, which was partially offset by lower sales at DCEC due to weaker demand in the on-highway truck market.

Gain on Sale of Businesses

        In the second quarter of 2011, we sold certain assets and liabilities of our exhaust business which manufactures exhaust products and select components for emission systems for a variety of applications not core to our other product offerings. This business was historically included in our Components segment. The sales price was $123 million. We recognized a gain on the sale of $68 million ($37 million after-tax), which included a goodwill allocation of $19 million. The gain was excluded from segment results as it was not considered in our evaluation of operating results for the year ended December 31, 2011.

        Sales for this business were $62 million, $171 million and $126 million in 2011 (through closing), 2010 and 2009, respectively. Operating results for this business were approximately $9 million, $22 million and $11 million in 2011 (through closing), 2010 and 2009, respectively.

        During the fourth quarter of 2011, we sold certain assets and liabilities of our light-duty filtration business which manufactures light-duty automotive and industrial filtration solutions. The sales price was $90 million and included a note receivable from the buyer of approximately $1 million. There are no earnouts or other contingencies associated with the sales price. We recognized a gain on the sale of $53 million ($33 million after-tax), which included a goodwill allocation of $6 million. The gain was excluded from segment results as it was not considered in our evaluation of operating results for the year ended December 31, 2011.

        Sales for this business were $64 million, $74 million and $54 million in 2011 (through closing), 2010 and 2009, respectively. Operating results for this business were approximately $13 million, $9 million and $2 million in 2011 (through closing), 2010 and 2009, respectively.

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        We have entered into supply and other agreements with the operations that represent ongoing involvement and as such, the results of these operations have not been presented as discontinued operations.

Other Operating (Expense) Income, Net

        Other operating (expense) income was as follows:

 
  Years ended
December 31,
 
In millions
  2011   2010  

Flood damage gain (loss)

  $ 38   $ (2 )

Royalty income

    12     10  

Royalty expense

    (3 )   (3 )

Amortization of intangible assets

    (5 )   (15 )

Legal settlement

    (5 )    

Gain (loss) on sale of fixed assets

    (10 )   (4 )

Other, net

    (6 )   (2 )
           

Total other operating (expense) income, net

  $ 21   $ (16 )
           

        In June 2008, four of our sites in Southern Indiana, including our Technical Center, experienced extensive flood damage. In October 2011, we received $40 million from our insurance carriers to settle all outstanding 2008 flood claims. As a result, we recognized a gain of approximately $38 million ($24 million after-tax), net of any remaining flood related expenses, in "Other operating (expense) income, net" in our Consolidated Statements of Income.

Interest Income

        Interest income increased primarily due to higher average cash balances in addition to higher average interest rates.

Interest Expense

        Interest expense increased primarily due to lower capitalized interest in 2011 and higher average debt, partially offset by lower interest rates.

Other Income (Expense), Net

        Other income (expense) was as follows:

 
  Years ended December 31,  
In millions
  2011   2010  

Change in cash surrender value of corporate owned life insurance

  $ 12   $ 12  

Dividend income

    7     7  

Gain on fair value adjustment for Cummins Western Canada

        12  

Life insurance proceeds

        7  

Foreign currency gains (losses), net

    (14 )   (1 )

Bank charges

    (16 )   (15 )

Other, net

    11     12  
           

Total other income (expense), net

  $   $ 34  
           

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Income Tax Expense

        Our income tax rates are generally less than the 35 percent U.S. statutory income tax rate primarily because of lower taxes on foreign earnings and research tax credits. Our effective tax rate for 2011 was 27.1 percent compared to 29.5 percent for 2010. Our 2011 income tax provision includes a discrete tax benefit of $48 million related to prior year refund claims filed for additional research tax credits, as well as additional foreign income and related foreign tax credits, net of related tax reserves. Our effective tax rate for 2011 also includes a tax benefit of $19 million related to the release of deferred U.S. tax liabilities on certain foreign earnings, as a result of restructuring our foreign operations. Also included in 2011 is a discrete tax benefit of $16 million resulting from the reduction of our unrecognized tax benefits primarily due to settlements with taxing authorities. The 2011 income tax provision also includes other discrete tax items totaling to a $2 million net tax charge, primarily relating to the enactment of state law changes in Indiana and the U.K. as well as adjustments to our income tax accounts based on our 2010 tax return filings. Our 2010 income tax provision includes a $17 million reduction in the fourth quarter related to the legislative reinstatement of the U.S. research tax credit as well as a $3 million discrete tax benefit related to the release of deferred U.S. tax liabilities on foreign earnings now considered to be permanently reinvested outside of the U.S.

        We expect our 2012 effective tax rate to be 29 percent excluding any discrete items that may arise. The research tax credit expired December 31, 2011, and has not yet been renewed by Congress. If the research credit is reinstated, we would anticipate the 2012 effective tax rate to be 28 percent. Earnings of our China operations will be considered to be permanently reinvested beginning in 2012 and additional U.S. deferred tax will no longer be provided on future earnings. We have $693 million of retained earnings and related cumulative translation adjustments in our China operations as of December 31, 2011 and have provided a U.S. deferred tax liability of $172 million related to these earnings that will be distributed to the U.S. in the future as well as the related translation impacts as of December 31, 2011.

Noncontrolling Interests

        Noncontrolling interests eliminate the income or loss attributable to non-Cummins ownership interests in our consolidated entities. Noncontrolling interests in income of consolidated subsidiaries decreased primarily due to a decline of $9 million at Wuxi Cummins Turbo Technologies Co. Ltd. and $4 million at Cummins India Ltd., a publicly traded company on various exchanges in India. These decreases were partially offset by an increase of $6 million at Cummins Western Canada LP, $4 million at Cummins Power Systems LLC and $1 million at Cummins Northeast LLC.

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

        Net income and diluted earnings per share attributable to Cummins Inc. increased primarily due to higher volumes in most markets and geographic regions, including the recovery of the North American on-highway truck markets, significantly improved gross margins, the gain on disposition of certain assets and liabilities of our exhaust business and our light-duty filtration business, a lower effective tax rate, increased equity income and the gain related to flood damage recoveries from the insurance settlement regarding a June 2008 flood in Southern Indiana. These favorable drivers were partially offset by higher selling, general and administrative expenses and research, development and engineering expenses in 2011 as compared to 2010. Diluted earnings per share for 2011 also benefited $0.17 from lower shares primarily due to the stock repurchase program.

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2010 vs. 2009

Net Sales

        Sales increased in all segments primarily due to increased demand from the recovery of emerging markets and improvement in developed markets. The primary drivers for the increase in sales were:

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

        Sales to international markets were 64 percent of total net sales in 2010, compared with 52 percent of total net sales in 2009.

Gross Margin

        Gross margin increased by $999 million and as a percentage of sales increased by 3.9 percentage points. The significant improvement was led by higher volumes, decreases in warranty expense, increased pricing and favorable material costs.

        The warranty provision on sales issued in 2010 as a percentage of sales was 3.0 percent compared to 3.3 percent in 2009. The decrease as a percentage of sales was primarily due to engine mix. A more detailed discussion of margin by segment is presented in the "OPERATING SEGMENT RESULTS" section.

        In the third quarter of 2010, it was determined that we overpaid a Brazilian revenue based tax on imported products during the period 2004-2008. Our results include a pre-tax recovery of $32 million in cost of sales ($21 million after-tax) related to tax credits arising from an overpayment. This recovery has been excluded from segment results as it was not considered in our evaluation of operating results for the year.

Selling, General and Administrative Expenses

        Selling, general and administrative expenses increased primarily due to higher volumes in support of the business and an increase of $151 million in compensation and related expenses. Compensation and related expenses include salaries, fringe benefits and variable compensation. Variable compensation related to 2010 performance increased $93 million over variable compensation related to 2009 performance. Salaries and fringe benefits increased due to severance actions taken throughout 2009 that were partially offset by increased employment in 2010. Overall, selling, general and administrative expenses as a percentage of sales decreased slightly to 11.2 percent in 2010 from 11.5 percent in 2009.

Research, Development and Engineering Expenses

        Research, development and engineering expenses increased primarily due to an increase of $35 million in compensation and related expenses and a decrease of $24 million in reimbursements.

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Compensation and related expenses include salaries, fringe benefits and variable compensation. Variable compensation related to 2010 performance increased $20 million over variable compensation related to 2009 performance. Overall, research, development and engineering expenses, as a percentage of sales, decreased slightly to 3.1 percent in 2010 from 3.4 percent in 2009. Research activities continue to focus on development of new products to meet future emission standards around the world and improvements in fuel economy performance.

Equity, Royalty and Interest Income From Investees

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

In millions
  2010 vs. 2009
Increase/(Decrease)
 

Dongfeng Cummins Engine Company, Ltd. 

  $ 66  

Komatsu manufacturing alliances

    13  

Royalty and interest income

    12  

        These overall increases were primarily due to higher demand as a result of economic recovery in emerging markets.

Other Operating (Expense) Income, Net

        Other operating (expense) income was as follows:

 
  Years ended
December 31,
 
In millions
  2010   2009  

Amortization of intangible assets

  $ (15 ) $ (7 )

Loss on sale of fixed assets

    (4 )   (8 )

Royalty expense

    (3 )   (7 )

Flood damage (loss) gain(1)

    (2 )   12  

Royalty income

    10     8  

Other, net

    (2 )   1  
           

Total other operating (expense) income, net

  $ (16 ) $ (1 )
           

(1)
In 2009, the flood gain represents flood insurance proceeds received which more than offset flood related expenses recognized in 2009 and 2008.

Interest Income

        Interest income increased primarily due to higher investment balances in 2010 compared to 2009.

Interest Expense

        Interest expense increased primarily due to higher borrowings in 2010 compared to 2009.

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Other Income (Expense), Net

        Other income (expense) was as follows:

 
  Years ended
December 31,
 
In millions
  2010   2009  

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

  $ 12   $ (4 )

Gain on fair value adjustment for Cummins Western Canada

    12      

Dividend income

    7     5  

Life insurance proceeds

    7      

Foreign currency losses, net(2)

    (1 )   (20 )

Bank charges

    (15 )   (14 )

Other, net

    12     18  
           

Total other income (expense), net

  $ 34   $ (15 )
           

(1)
The change in cash surrender value of corporate owned life insurance for the year ended December 31, 2010, was due to improved market performance. The change in the cash surrender value of corporate owned life insurance for the year ended December 31, 2009, was due to market deterioration.

(2)
The foreign currency exchange losses in 2009 were due to unfavorable currency fluctuations; primarily in the British Pound and Brazilian Real.

Income Tax Expense

        Our income tax rates are generally less than the 35 percent U.S. statutory income tax rate primarily because of lower taxes on foreign earnings and research tax credits. Our effective tax rate for 2010 was 29.5 percent compared to 24.4 percent for 2009. Our 2010 income tax provision also includes a $17 million (1.1 percent) reduction in the fourth quarter related to the legislative reinstatement of the U.S. research tax credit. During 2010, we also released $3 million (0.2 percent) of deferred U.S. tax liabilities on foreign earnings now considered to be permanently reinvested outside of the U.S. 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. In 2009, we released $19 million of deferred tax liabilities on foreign earnings now considered to be permanently reinvested outside of the U.S. and recorded a deferred tax asset of $10 million related to prior period matters.

Noncontrolling Interests

        Noncontrolling interests eliminate the income or loss attributable to non-Cummins ownership interests in our consolidated entities. Noncontrolling interests in income of consolidated subsidiaries increased primarily due to an increase of $18 million at Cummins India Ltd., a publicly traded company on various exchanges in India and a $15 million increase from Wuxi Cummins Turbo Technologies Co. Ltd., reflecting the economic recovery in emerging markets.

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

        Net income and diluted earnings per share attributable to Cummins Inc. increased primarily due to higher volumes in emerging markets and certain developed countries, significantly improved gross margins, increased equity income and restructuring charges incurred in 2009 that were not repeated in 2010. These were partially offset by higher income tax expense, selling, general and administrative expenses and research, development and engineering expenses. Diluted earnings per share also benefited $0.06 from lower shares primarily due to the stock repurchase program.

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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 deterioration in the global economy. We reduced our global workforce by approximately 1,000 professional employees. In addition, we took numerous employee 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 costs were made based on information available at the time charges were recorded.

        In response to closures and downsizing noted above, we incurred $2 million of restructuring expenses for lease terminations and $5 million of restructuring expenses for asset impairments. 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 the 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 the Consolidated Financial Statements for additional detail.

        At December 31, 2010, of the approximately 4,200 employees affected by this plan, substantially all terminations were complete.

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

In millions
  Year ended
December 31, 2009
 

Engine

  $ 47  

Components

    35  

Power Generation

    12  

Distribution

    5  
       

Total restructuring and other charges

  $ 99  
       

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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 )

Non cash items

        (5 )   (2 )   (7 )

Changes in estimates

    (2 )           (2 )

Translation

    1             1  
                   

Balance at December 31, 2009

  $ 10   $ 1   $   $ 11  

Cash payments for 2009 actions

    (7 )           (7 )

Changes in estimates

    (3 )   (1 )       (4 )
                   

Balance at December 31, 2010

  $   $   $   $  
                   

OPERATING SEGMENT RESULTS

        Our reportable operating segments consist of the following: Engine, Components, Power Generation 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. Our engines are used in trucks of all sizes, buses and recreational vehicles, as well as in various industrial applications, including construction, mining, agriculture, marine, oil and gas, rail and military equipment. The Components segment sells filtration products, exhaust aftertreatment systems, turbochargers and fuel systems. The Power Generation segment is an integrated provider of power systems which sells engines, generator sets and alternators. 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.

        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 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, changes in cash surrender value of corporate owned life insurance, restructuring and other charges, flood damage gains or losses, or income taxes to individual segments. In 2011 non-segment items included the gain on disposition of certain assets and liabilities of our exhaust business and our light-duty filtration business while 2010 included a Brazil revenue tax recovery. These gains were not allocated to the businesses as they were not considered in our evaluation of operating results for the year. Segment EBIT may not be consistent with measures used by other companies.

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        Following is a discussion of operating results for each of our business segments.

Engine Segment Results

        Financial data for the Engine segment was as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009   Amount   Percent   Amount   Percent  

External sales

  $ 9,649   $ 6,594   $ 5,582   $ 3,055     46 % $ 1,012     18 %

Intersegment sales

    1,658     1,294     823     364     28 %   471     57 %
                                   

Total sales

    11,307     7,888     6,405     3,419     43 %   1,483     23 %

Depreciation and amortization

    181     171     185     (10 )   (6 )%   14     8 %

Research, development and engineering expenses

    397     263     241     (134 )   (51 )%   (22 )   (9 )%

Equity, royalty and interest income from investees

    166     161     54     5     3 %   107     NM  

Interest income

    18     12     3     6     50 %   9     NM  

Segment EBIT

    1,384     809     252     575     71 %   557     NM  

                     

Percentage Points

   

Percentage Points

 

Segment EBIT as a percentage of total sales

    12.2 %   10.3 %   3.9 %         1.9           6.4  

        Engine segment sales by market were as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009   Amount   Percent   Amount   Percent  

Heavy-duty truck

  $ 2,791   $ 1,503   $ 1,996   $ 1,288     86 % $ (493 )   (25 )%

Medium-duty truck and bus

    2,320     1,435     1,232     885     62 %   203     16 %

Light-duty automotive and RV

    1,176     1,022     688     154     15 %   334     49 %
                                   

Total on-highway

    6,287     3,960     3,916     2,327     59 %   44     1 %

Industrial

    3,850     2,889     1,821     961     33 %   1,068     59 %

Stationary power

    1,170     1,039     668     131     13 %   371     56 %
                                   

Total sales

  $ 11,307   $ 7,888   $ 6,405   $ 3,419     43 % $ 1,483     23 %
                                   

        Unit shipments by engine classification (including unit shipments to Power Generation) were as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
 
  2011   2010   2009   Amount   Percent   Amount   Percent  

Mid-range

    509,400     368,900     269,200     140,500     38 %   99,700     37 %

Heavy-duty

    116,300     61,200     85,900     55,100     90 %   (24,700 )   (29 )%

High-horsepower

    21,600     18,500     13,400     3,100     17 %   5,100     38 %
                                   

Total unit shipments

    647,300     448,600     368,500     198,700     44 %   80,100     22 %
                                   

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2011 vs. 2010

Sales

        Engine segment sales increased in all businesses versus 2010, as demand improved in most markets including a significant rebound in North American on-highway markets, improvements in international construction markets, increased demand in global mining markets and significant increases in oil and gas markets. The following are the primary drivers by market:

        Total on-highway-related sales for 2011 were 56 percent of total engine segment sales, compared to 50 percent in 2010.

Segment EBIT

        Engine segment EBIT increased significantly versus 2010, primarily due to higher gross margin, partially offset by increased selling, general and administrative expenses and research, development and engineering expenses. Changes in Engine segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31, 2011 vs.
2010 Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ 864     55 %   1.7  

Selling, general and administrative expenses

    (142 )   (22 )%   1.2  

Research, development and engineering expenses

    (134 )   (51 )%   (0.2 )

Equity, royalty and interest income from investees

    5     3 %   (0.5 )

        The increase in gross margin versus 2010, was primarily due to higher volumes, improved price realization and favorable mix, partially offset by higher commodity costs and higher base warranty costs due to increased volumes and increasing mix of EPA 2010 products. Although our warranty costs increased, our warranty cost as a percentage of sales decreased as actual accrual rates for engines sold this year were generally lower than rates charged in prior years as our warranty costs for EPA 2010 engines have been lower than expected. The increases in selling, general and administrative expenses and research, development and engineering expenses were primarily due to new product development spending and increased headcount to support our strategic growth initiatives. The increase in equity, royalty and interest income from investees was primarily due to strong demand for power generation and mining products in China with CCEC and strong export sales to Russia and Brazil in the midrange on-highway market with Beijing Foton Cummins Engine Co., Ltd., which was partially offset by lower sales at DCEC due to weaker demand in the on-highway heavy-duty and medium-duty truck market in China.

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2010 vs. 2009

Sales

        Engine segment sales increased versus 2009, due to improved sales in most markets, especially the industrial, stationary power, light-duty automotive and medium-duty truck markets, which were partially offset by decreases in the North American heavy-duty truck market. The following are the primary drivers by market.

        These increases were partially offset by a decline in heavy-duty truck engine sales. Consistent with prior emission standards changes, North American (includes the U.S and Canada and excludes Mexico) unit sales declined 61 percent due to higher engine purchases by OEMs in late 2009, ahead of the Environmental Protection Agency's (EPA)'s 2010 emission standards change, as part of the OEM's transition plan.

        Total on-highway-related sales for 2010 were 50 percent of total engine segment sales, compared to 61 percent in 2009.

Segment EBIT

        Engine segment EBIT increased significantly versus 2009, primarily due to higher gross margin and equity, royalty and interest income from investees which were partially offset by increased selling, general and administrative expenses and research, development and engineering expenses. Changes in Engine segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31, 2010 vs. 2009
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a percent
of sales
 

Gross margin

  $ 539     53 %   3.8  

Selling, general and administrative expenses

    (88 )   (16 )%   0.5  

Research, development and engineering expenses

    (22 )   (9 )%   0.5  

Equity, royalty and interest income from investees

    107     NM     1.2  

        The increase in gross margin versus 2009, was primarily due to higher volumes, improved price realization, decreased warranty expense and cost structure improvements from actions taken in late 2008 and early 2009, partially offset by an unfavorable mix. The increase in selling, general and administrative expenses was primarily due to higher variable compensation which resulted from the segment's strong performance. Equity, royalty and interest income from investees increased in most

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unconsolidated joint ventures. The increase was led by higher demand in emerging markets, especially at DCEC and Komatsu-Cummins Engine Company (KCEC).

Components Segment Results

        Financial data for the Components segment was as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009   Amount   Percent   Amount   Percent  

External sales

  $ 2,886   $ 2,171   $ 1,562   $ 715     33 % $ 609     39 %

Intersegment sales

    1,177     875     793     302     35 %   82     10 %
                                   

Total sales

    4,063     3,046     2,355     1,017     33 %   691     29 %

Depreciation and amortization

    73     79     73     6     8 %   (6 )   (8 )%

Research, development and engineering expenses

    175     114     88     (61 )   (54 )%   (26 )   (30 )%

Equity, royalty and interest income from investees

    31     23     13     8     35 %   10     77 %

Interest income

    5     2     1     3     NM     1     100 %

Segment EBIT

    470     278     95     192     69 %   183     NM  

                     

Percentage Points
   

Percentage Points
 

Segment EBIT as a percentage of total sales

    11.6 %   9.1 %   4.0 %         2.5           5.1  

        Sales for our Components segment by business were as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009   Amount   Percent   Amount   Percent  

Emission solutions

  $ 1,262   $ 750   $ 495   $ 512     68 % $ 255     52 %

Turbo technologies

    1,223     948     704     275     29 %   244     35 %

Filtration

    1,113     1,011     851     102     10 %   160     19 %

Fuel systems

    465     337     305     128     38 %   32     10 %
                                   

Total sales

  $ 4,063   $ 3,046   $ 2,355   $ 1,017     33 % $ 691     29 %
                                   

2011 vs. 2010

Sales

        Components segment sales increased in all businesses versus 2010. The following are the primary regional drivers by business:

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Segment EBIT

        Components segment EBIT increased versus 2010, primarily due to the improved gross margin which was partially offset by increased research, development and engineering expenses and higher selling, general and administrative expenses. Changes in Components segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31, 2011 vs. 2010
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ 295     51 %   2.5  

Selling, general and administrative expenses

    (44 )   (19 )%   0.8  

Research, development and engineering expenses

    (61 )   (54 )%   (0.6 )

Equity, royalty and interest income from investees

    8     35 %    

        The increase in gross margin was primarily due to higher volumes for all businesses and increased product content on 2010 North American truck engines. The increases in research, development and engineering expenses and selling, general and administrative expenses were primarily due to new product development spending and increased headcount to support our strategic growth initiatives. The increase in equity, royalty and interest income from investees was driven by improved joint venture income from both the filtration business in China and India and the fuel systems business.

        In 2011, we sold certain assets and liabilities of our exhaust business and light-duty filtration business and recognized $68 million and $53 million, respectively, in pre-tax gain on the sales. The gains have been excluded from Components results as they were not considered in our evaluation of Components operating results for the year ended 2011. See Note 2, "DIVESTITURES AND ACQUISITIONS," to the Consolidated Financial Statements.

2010 vs. 2009

Sales

        Components segment sales increased in all businesses versus 2009. The following are the primary regional drivers by business.

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Segment EBIT

        Components segment EBIT almost tripled versus 2009, primarily due to the improved gross margin which was partially offset by increased selling, general and administrative expenses 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, 2010 vs. 2009
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ 233     67 %   4.3  

Selling, general and administrative expenses

    (44 )   (24 )%   0.3  

Research, development and engineering expenses

    (26 )   (30 )%    

Equity, royalty and interest income from investees

    10     77 %   0.2  

        The increase in gross margin was due to higher volumes for all businesses, increased aftertreatment content on 2010 North American truck engines and efficiencies gained from restructuring actions partially offset by higher commodity costs and warranty expenses. The increase in selling, general and administrative expenses and research, development and engineering expenses were primarily due to increased variable compensation which resulted from the segment's strong performance; other people costs and new product development program spending. The increase in equity, royalty and interest income from investees was driven by improved joint venture income from the filtration business in China and India.

Power Generation Segment Results

        Financial data for the Power Generation segment was as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009   Amount   Percent   Amount   Percent  

External sales

  $ 2,492   $ 2,150   $ 1,879   $ 342     16 % $ 271     14 %

Intersegment sales

    1,006     769     538     237     31 %   231     43 %
                                   

Total sales

    3,498     2,919     2,417     579     20 %   502     21 %

Depreciation and amortization

    42     41     49     (1 )   (2 )%   8     16 %

Research, development and engineering expenses

    54     36     33     (18 )   (50 )%   (3 )   (9 )%

Equity, royalty and interest income from investees

    47     35     22     12     34 %   13     59 %

Interest income

    8     5     3     3     60 %   2     67 %

Segment EBIT

    373     299     167     74     25 %   132     79 %

                     

Percentage Points

   

Percentage Points

 

Segment EBIT as a percentage of total sales

    10.7 %   10.2 %   6.9 %         0.5           3.3  

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        Sales for our Power Generation segment by business were as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009   Amount   Percent   Amount   Percent  

Commercial products

  $ 2,230   $ 1,831   $ 1,456   $ 399     22 % $ 375     26 %

Generator technologies

    673     549     512     124     23 %   37     7 %

Commercial projects

    243     222     177     21     9 %   45     25 %

Consumer

    200     186     140     14     8 %   46     33 %

Power electronics

    152     131     132     21     16 %   (1 )   (1 )%
                                   

Total sales

  $ 3,498   $ 2,919   $ 2,417   $ 579     20 % $ 502     21 %
                                   

2011 vs. 2010

Sales

        Power Generation segment sales increased in all businesses, versus 2010, primarily due to increased demand in the commercial products and generator technologies businesses. The following are the primary drivers by business:

Segment EBIT

        Power Generation segment EBIT increased versus 2010, primarily due to higher gross margins, partially offset by higher selling, general and administrative expenses 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, 2011 vs. 2010
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ 135     25 %   0.7  

Selling, general and administrative expenses

    (56 )   (22 )%   (0.2 )

Research, development and engineering expenses

    (18 )   (50 )%   (0.3 )

Equity, royalty and interest income from investees

    12     34 %   0.1  

        The increase in gross margin was due to higher volumes and improved price realization, which was partially offset by increased commodity and material costs. The increases in selling, general and administrative expenses and research, development and engineering expenses were primarily due to increased headcount to support our strategic growth initiatives. Equity, royalty and interest income from investees increased at CCEC primarily as a result of improved power generation markets in China.

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2010 vs. 2009

Sales

        Power Generation segment sales improved in most businesses, versus 2009, primarily due to increased demand. The following are the primary drivers by business.

Segment EBIT

        Power Generation segment EBIT increased versus 2009, primarily due to higher gross margins and equity, royalty and interest income from investees which were partially offset by increased selling general and administrative expenses. Changes in Power Generation segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31,
2010 vs. 2009
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ 151     38 %   2.4  

Selling, general and administrative expenses

    (31 )   (14 )%   0.5  

Research, development and engineering expenses

    (3 )   (9 )%   0.2  

Equity, royalty and interest income from investees

    13     59 %   0.3  

        The increase in gross margin was due to higher volumes, partially offset by increased warranty expenses and increased variable compensation. The increase in selling general and administrative expenses was primarily due to higher variable compensation expense which resulted from the strong improvement over 2009. Equity, royalty and interest income from investees increased due to higher demand, especially at Cummins Olayan Energy and CCEC.

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Distribution Segment Results

        Financial data for the Distribution segment was as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009   Amount   Percent   Amount   Percent  

External sales

  $ 3,021   $ 2,311   $ 1,777   $ 710     31 % $ 534     30 %

Intersegment sales

    23     13     7     10     77 %   6     86 %
                                   

Total sales

    3,044     2,324     1,784     720     31 %   540     30 %

Depreciation and amortization

    25     25     17             (8 )   (47 )%

Equity, royalty and interest income from investees

    172     132     125     40     30 %   7     6 %

Interest income

    3     2     1     1     50 %   1     100 %

Segment EBIT

    386     297     235     89     30 %   62     26 %

                     

Percentage Points

   

Percentage Points

 

Segment EBIT as a percentage of total sales

    12.7 %   12.8 %   13.2 %         (0.1 )         (0.4 )

        Sales for our Distribution segment by region were as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009   Amount   Percent   Amount   Percent  

Asia Pacific

  $ 1,170   $ 904   $ 755   $ 266     29 % $ 149     20 %

Europe and Middle East

    808     683     598     125     18 %   85     14 %

North and Central America

    797     539     278     258     48 %   261     94 %

Africa

    151     111     94     40     36 %   17     18 %

South America

    118     87     59     31     36 %   28     47 %
                                   

Total sales

  $ 3,044   $ 2,324   $ 1,784   $ 720     31 % $ 540     30 %
                                   

        Sales for our Distribution segment by product were as follows:

 
   
   
   
  Favorable/(Unfavorable)  
 
  Years ended December 31,   2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009   Amount   Percent   Amount   Percent  

Parts and filtration

  $ 1,085   $ 882   $ 665   $ 203     23 % $ 217     33 %

Power generation

    722     516     457     206     40 %   59     13 %

Engines

    703     466     324     237     51 %   142     44 %

Service

    534     460     338     74     16 %   122     36 %
                                   

Total sales

  $ 3,044   $ 2,324   $ 1,784   $ 720     31 % $ 540     30 %
                                   

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2011 vs. 2010

Sales

        Distribution segment sales increased for all product lines versus 2010. The following were the primary drivers by line of business:

Segment EBIT

        Distribution segment EBIT increased versus 2010, primarily due to improved gross margin and equity, royalty and interest income from investees, which was partially offset by increased selling, general and administrative expenses. Segment EBIT was also unfavorably impacted by the absence of a one-time gain of $12 million from the acquisition of Cummins Western Canada in 2010. Changes in Distribution segment EBIT and EBIT as a percentage of sales were as follows:

 
  Year ended December 31,
2011 vs. 2010
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Gross margin

  $ 161     31 %   0.1  

Selling, general and administrative expenses

    (108 )   (30 )%   0.1  

Equity, royalty and interest income from investees

    40     30 %    

        The increase in gross margin versus 2010, was primarily due to higher volumes in most products, favorable foreign currency impacts and the acquisition of a previously independent distributor in 2010. The increase in selling, general and administrative expenses was mainly due to higher headcount to support our strategic growth initiatives and unfavorable foreign currency impacts. The increase in equity, royalty and interest income from investees was primarily due to higher income from North American distributors, especially in the oil and gas markets, and increased parts sales.

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2010 vs. 2009

Excluding Acquisitions

        Selected financial information for our Distribution segment excluding the impact of acquisitions was as follows:

 
  Years ended
December 31,
  Favorable/
(Unfavorable)
 
In millions
  2010   2009   Amount   Percent  

Excluding acquisitions(1)

                         

Sales

  $ 2,038   $ 1,784   $ 254     14 %

EBIT

    267 (2)   235     32     14 %

(1)
The acquisitions represent the purchase of the majority interest in Cummins Western Canada (CWC), an equity investee, in the first quarter of 2010 and the purchase of a majority interest in a previously independent North American distributorship, as explained in Note 2, "DIVESTITURES AND ACQUISITIONS," to the Consolidated Financial Statements. The acquisition of CWC and the majority interest in the distributorship increased sales by $286 million and EBIT by $30 million in 2010. The 2009 data does not exclude the acquisition which occurred in 2009.

(2)
This amount includes $13 million of equity earnings which would have been our share of CWC's income for 2010 if we had not consolidated them.

Sales

        Distribution segment sales, excluding the acquisitions, increased versus 2009, due to increased parts and service revenues, increased engine sales driven by sales in Europe and the South Pacific and favorable foreign currency impacts in most regions.

Segment EBIT

        Distribution segment EBIT increased versus 2009, primarily due to increased gross margin and a one-time gain from an acquisition that occurred in the first quarter, 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,
2010 vs. 2009
Favorable/(Unfavorable) Change
 
In millions
  Amount   Percent   Percentage point
change as a
percent of sales
 

Including acquisitions

                   

Gross margin

  $ 129     34 %   0.5  

Selling, general and administrative expenses

    (85 )   (31 )%    

Other (expense) income

    12 (1)   NM     0.4  

Excluding acquisitions

                   

Gross margin

    66     17 %   0.5  

Selling, general and administrative expenses

    (59 )   (21 )%   (0.9 )

(1)
The primary increase in other income represents the purchase of the majority interest in an equity investee in the first quarter of 2010, which resulted in a gain of $12 million as explained in Note 2, "DIVESTITURES AND ACQUISITIONS," to the Consolidated Financial Statements.

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        Excluding acquisitions, the increase in gross margin versus 2009, was primarily due to higher volumes and favorable foreign currency impacts. Excluding effects from acquisitions, the increase in selling, general and administrative expenses was mainly due to higher salaries and unfavorable foreign currency impacts.

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
  2011   2010   2009  

Total segment EBIT

  $ 2,613   $ 1,683   $ 749  

Non-segment EBIT(1)

    102     (26 )   (74 )
               

Total EBIT

  $ 2,715   $ 1,657   $ 675  

Less:

                   

Interest expense

    44     40     35  
               

Income before income taxes

  $ 2,671   $ 1,617   $ 640  
               

(1)
Includes intersegment sales and profit in inventory eliminations and unallocated corporate expenses. The year ended December 31, 2011, includes a $68 million gain ($37 million after-tax) related to the sale of certain assets and liabilities of our exhaust business and a $53 million gain ($33 million after-tax) recorded for the sale of certain assets and liabilities of our light-duty filtration business, both from the Components segment, and a $38 million gain ($24 million after-tax) related to flood damage recoveries from the insurance settlement regarding a June 2008 flood in Southern Indiana. The gains have been excluded from segment results as they were not considered in our evaluation of operating results for the year ended December 31, 2011. For the year ended December 31, 2010, unallocated corporate expenses include $32 million in Brazil tax recoveries ($21 million after-tax) and $2 million in flood damage expenses. The Brazil tax recovery has been excluded from segment results as it was not considered in our evaluation of operating results for the year ended December 31, 2010. For the year ended December 31, 2009, unallocated corporate expenses included $99 million in restructuring and other charges and a gain of $12 million related to flood damage recoveries.

LIQUIDITY AND CAPITAL RESOURCES

Management's Assessment of Liquidity

        Our financial condition and liquidity continue to strengthen. Our solid balance sheet and credit ratings enable us to have ready access to credit.

        We assess our liquidity in terms of our ability to generate adequate cash to fund our operating, investing and financing activities. We generate significant ongoing cash flow, which has been used, in part, to fund repurchases of common stock, capital expenditures and pay dividends on our common stock. Our cash flow from operations in 2011 more than doubled the 2010 cash flow from operations. Cash provided by operations is our principal source of liquidity. As of December 31, 2011, other sources of liquidity included:

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        We believe our liquidity provides us with the financial flexibility needed to fund working capital, capital expenditures, projected pension obligations, dividend payments, common stock repurchases and debt service obligations.

        Our revolving credit agreement provides us with a $1.24 billion unsecured revolving credit facility, the proceeds of which are to be used for our general corporate purposes. See Note 10, "DEBT" to our Consolidated Financial Statements for further information. The credit agreement includes two financial covenants: a leverage ratio and an interest coverage ratio. The required leverage ratio, which measures the sum of total debt plus securitization financing to consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) for the four fiscal quarters may not exceed 3.0 to 1. At December 31, 2011, our leverage ratio was 0.26 to 1. The required interest coverage ratio, which is consolidated EBITDA minus capital expenditures to consolidated interest expense, in each case for the prior four quarters, may not be less than 1.50 to 1. At December 31, 2011, our interest coverage ratio was 53.62 to 1.

        A significant portion of our cash flows is generated outside the U.S. As of December 31, 2011, the total of cash, cash equivalents and marketable securities held by foreign subsidiaries was $1.3 billion, the vast majority of which was located in the U.K., China, India, Brazil and Singapore. The geographic location of our cash and marketable securities aligns well with our business growth strategy. 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. As a result, we do not anticipate any local liquidity restrictions to preclude us from funding our expansion or operating needs with local resources. If the foreign cash balances were repatriated to the U.S. we could be required to accrue and pay U.S. taxes for earnings primarily from our U.K. domiciled subsidiaries, as we have asserted that these earnings are permanently reinvested outside of the U.S. At present we do not foresee an immediate need to repatriate any earnings from these subsidiaries in the near future. However, we do anticipate repatriating available cash from foreign subsidiaries to help fund U.S. cash needs as they arise, and we have transferred and will continue to transfer cash from these subsidiaries to the U.S. and to other international subsidiaries when it is cost effective to do so. Earnings from our China operations will be considered permanently reinvested beginning in 2012, while earnings generated prior to 2012, for which U.S. deferred tax liabilities have already been recorded, will be repatriated in future years.

        We continuously monitor our pension assets and believe that we have limited exposure to the European debt crisis. No sovereign debt instruments of crisis countries are held in the trusts, while any equities are held with large well-diversified multinational firms or are de minimis amounts in large index funds. In addition, we rebalanced our asset portfolios in the U.S. and the U.K. in 2010 with equities representing a smaller segment of the total portfolios and we continue to rebalance as necessary to maintain our target range. Our pension plans have not experienced any significant impact on liquidity or counterparty exposure due to the volatility in the credit markets.

        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 $97 million over each of the next five years.

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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.

 
   
   
  Favorable/
(Unfavorable)
2011 vs. 2010
 
In millions
  2011   2010   Amount   Percent  

Cash and cash equivalents

  $ 1,484   $ 1,023   $ 461     45 %

Marketable securities

    277     339     (62 )   (18 )%

Accounts and notes receivable

    2,526     2,243     283     13 %

Inventories

    2,141     1,977     164     8 %

Other current assets

    663     707     (44 )   (6 )%
                     

Current assets

    7,091     6,289     802     13 %

Accounts and loans payable

   
1,574
   
1,444
   
130
   
9

%

Current portion of accrued product warranty

    422     421     1      

Accrued compensation, benefits and retirement costs

    511     468     43     9 %

Taxes payable (including taxes on income)

    282     202     80     40 %

Other accrued expenses

    868     725     143     20 %
                     

Current liabilities

    3,657     3,260     397     12 %

Working capital

 
$

3,434
 
$

3,029
             
                       

Current ratio

    1.94     1.93              
                       

Days' sales in receivables

    48     59              

Inventory turnover

    6.3     5.8              

        Current assets increased 13 percent primarily due to an increase in cash and cash equivalents, an increase in accounts receivable due to higher sales and an increase in inventory levels to meet anticipated demand. Despite the increases in accounts receivable and inventories, we were able to lower days' sales in receivables in a challenging environment by 11 days through improved collections and we increased our inventory turns by 0.5 through higher demand.

        Current liabilities increased 12 percent primarily due to higher accounts and loans payable, increased taxes payable due to higher income and higher other accrued expenses, which was the result of increased purchasing requirements to support higher sales volume in the businesses.

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Cash Flows

        Cash and cash equivalents increased $461 million during the year ended December 31, 2011, compared to a $93 million increase in cash and cash equivalents during the comparable period in 2010. The change in cash and cash equivalents was as follows:

Operating Activities

 
   
   
   
  Change  
 
  Years ended December 31,  
 
  2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009  

Consolidated net income

  $ 1,946   $ 1,140   $ 484   $ 806   $ 656  

Restructuring and other charges, net of cash payments

            16         (16 )

Depreciation and amortization

    325     320     326     5     (6 )

Gain on sale of businesses

    (121 )           (121 )    

Gain on fair value adjustment for consolidated investee

        (12 )       12     (12 )

Deferred income taxes

    85     56     5     29     51  

Equity in income of investees, net of dividends

    (23 )   (147 )   23     124     (170 )

Pension contributions in excess of expense

    (131 )   (151 )   (36 )   20     (115 )

Other post-retirement benefits payments in excess of expense

    (31 )   (35 )   (24 )   4     (11 )

Stock-based compensation expense

    42     22     20     20     2  

Excess tax (benefits) deficiencies on stock-based awards

    (5 )   (10 )   1     5     (11 )

Translation and hedging activities

    4     13     41     (9 )   (28 )

Changes in:

                               

Accounts and notes receivable

    (350 )   (195 )   (181 )   (155 )   (14 )

Inventories

    (225 )   (574 )   482     349     (1,056 )

Other current assets

    (21 )   (54 )   33     33     (87 )

Accounts payable

    208     345     (75 )   (137 )   420  

Accrued expenses

    234     233     (132 )   1     365  

Changes in other liabilities and deferred revenue

    139     133     155     6     (22 )

Other, net

    (3 )   (78 )   (1 )   75     (77 )
                       

Net cash provided by operating activities

  $ 2,073   $ 1,006   $ 1,137   $ 1,067   $ (131 )
                       

2011 vs. 2010

        Net cash provided by operating activities increased versus 2010, primarily due to significantly higher consolidated net income, excluding the gain on the sale of certain assets and liabilities of our exhaust business and our light-duty filtration business, as a result of higher sales volumes, higher dividends from equity investees and favorable working capital fluctuations. During 2011, the net increase in working capital resulted in a cash outflow of $154 million compared to a cash outflow of $245 million in 2010. This decrease of $91 million was primarily driven by a smaller increase in inventory in 2011 as we significantly increased inventory levels in 2010 to meet anticipated post-recession demand.

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

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plans. In the second half of 2011, financial markets in Europe declined significantly, reversing the prior quarters' gains in our U.K. trust investments; while the U.S. trust's liability driven fixed income investments were able to maintain the return trends from the first half of the year. As a result, for 2011 the return for our U.S. plan was 13 percent while our U.K. plan return was approximately six percent. Our U.K. pension plan remains in an over funded position. 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 $199 million of pension contributions in 2011 (including voluntary contributions of $108 million). We anticipate making total contributions of $130 million to our defined benefit pension plans in 2012. Expected contributions to our defined benefit pension plans in 2012 will meet or exceed the current funding requirements.

2010 vs. 2009

        Net cash provided by operating activities decreased versus 2009, primarily due to significantly higher inventory levels to meet anticipated demand, increased equity in income of investees net of dividends and higher pension contributions made in the year. This was partially offset by significantly higher consolidated net income and increases in accounts payable and accrued expenses as the result of increased purchasing to support higher sales volumes.

Investing Activities

 
   
   
   
  Change  
 
  Years ended December 31,  
 
  2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009  

Capital expenditures

  $ (622 ) $ (364 ) $ (310 ) $ (258 ) $ (54 )

Investments in internal use software

    (60 )   (43 )   (35 )   (17 )   (8 )

Proceeds from disposals of property, plant and equipment

    8     55     10     (47 )   45  

Investments in and advances to equity investees

    (81 )   (2 )   (3 )   (79 )   1  

Proceeds from sale of businesses, net of cash sold

    199             199      

Acquisition of businesses, net of cash acquired

        (104 )   (2 )   104     (102 )

Investments in marketable securities-acquisitions

    (729 )   (823 )   (431 )   94     (392 )

Investments in marketable securities-liquidations

    750     690     335     60     355  

Purchases of other investments

        (62 )   (62 )   62      

Cash flows from derivatives not designated as hedges

    (18 )   2     (18 )   (20 )   20  

Other, net

    1         7     1     (7 )
                       

Net cash used in investing activities

  $ (552 ) $ (651 ) $ (509 ) $ 99   $ (142 )
                       

2011 vs. 2010

        Net cash used in investing activities decreased versus 2010, primarily due to proceeds received from the sale of certain assets and liabilities of our exhaust business and our light-duty filtration business (See Note 2, "DIVESTITURES AND ACQUISITIONS" to our Consolidated Financial Statements), decreased acquisitions and increased liquidations of marketable securities, the acquisition of CWC in 2010 and decreased purchases of other investments. These drivers were partially offset by increased capital expenditures, additional investments in and advances to equity investees and lower proceeds from dispositions of property, plant and equipment.

        Capital expenditures were $622 million compared to $364 million in the comparable period in 2010. We continue to invest in the development of new products and we plan to spend approximately

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$800 million to $850 million in 2012 as we continue with product launches and facility improvements and prepare for future emission standards. Approximately 50 percent of our capital expenditures will be invested outside of the U.S. in 2012.

2010 vs. 2009

        Net cash used in investing activities increased versus 2009, primarily due to acquisitions (See Note 2, "DIVESTITURES AND ACQUISITIONS" to our Consolidated Financial Statements), higher capital expenditures and increased investments in marketable securities, which were partially offset by higher proceeds from the disposal of property, plant and equipment. Capital expenditures were $364 million compared to $310 million in 2009.

Financing Activities

 
   
   
   
  Change  
 
  Years ended December 31,  
 
  2011 vs. 2010   2010 vs. 2009  
In millions
  2011   2010   2009  

Proceeds from borrowings

  $ 127   $ 214   $ 76   $ (87 ) $ 138  

Payments on borrowings and capital lease obligations

    (237 )   (143 )   (97 )   (94 )   (46 )

Net borrowings (payments) under short-term credit agreements

    6     9     (2 )   (3 )   11  

Distributions to noncontrolling interests

    (56 )   (28 )   (34 )   (28 )   6  

Dividend payments on common stock

    (255 )   (172 )   (141 )   (83 )   (31 )

Proceeds from sale of common stock held by employee benefit trust

        58     72     (58 )   (14 )

Repurchases of common stock

    (629 )   (241 )   (20 )   (388 )   (221 )

Excess tax benefits (deficiencies) on stock-based awards

    5     10     (1 )   (5 )   11  

Other, net

    14     26     6     (12 )   20  
                       

Net cash used in financing activities

  $ (1,025 ) $ (267 ) $ (141 ) $ (758 ) $ (126 )
                       

2011 vs. 2010

        Net cash used in financing activities increased versus 2010, primarily due to significantly higher repurchases of common stock, increased payments on borrowings and capital lease obligations, decreased proceeds from borrowings and higher dividend payments.

        Our total debt was $783 million as of December 31, 2011, compared with $843 million as of December 31, 2010. Total debt as a percent of our total capital, including total long-term debt, was 11.8 percent at December 31, 2011, compared with 14.4 percent at December 31, 2010.

2010 vs. 2009

        Net cash used in financing activities increased versus 2009, primarily due to increased repurchases of common stock, which was partially offset by higher proceeds from borrowings primarily related to the acquisition of CWC and borrowings in Brazil.

        Our total debt was $843 million as of December 31, 2010, compared with $703 million at December 31, 2009. Total debt as a percent of our total capital, including total long-term debt, was 14.4 percent at December 31, 2010, compared to 14.9 percent at December 31, 2009. The increase in total debt was principally due to acquisitions and borrowings in Brazil which were subsequently invested in marketable securities.

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Repurchase of Common Stock

        In December 2007, the Board of Directors authorized the acquisition of up to $500 million of our common stock, which was completed in February 2011.

        Repurchases under this plan by year were as follows:

In millions (except per share amounts)
  Shares
Purchased
  Average Cost
Per Share
  Total Cost of
Repurchases
  Remaining
Authorized
Capacity
 

2008

    2.3   $ 55.49   $ 128   $ 372  

2009

    0.4     46.52     20     352  

2010

    3.5     68.57     241     111  

2011

    1.1     104.47     111      
                       

Total

    7.3         $ 500        
                       

        In February 2011, the Board of Directors approved a new share repurchase program and authorized the acquisition of up to $1 billion of our common stock upon completion of the $500 million program. In 2011, we made the following quarterly purchases under the repurchase programs as indicated:

In millions (except per share amounts)
For each quarter ended
  2011
Shares
Purchased
  Average Cost
Per Share
  Total Cost of
Repurchases
  Remaining
Authorized
Capacity
 

December 2007, $500 million repurchase program

                         

March 27

    1.1   $ 104.47   $ 111   $  

February 2011, $1 billion repurchase program

                         

March 27

    0.8   $ 99.14   $ 79   $ 921  

June 26

    1.6     110.49     183     738  

September 25

    1.9     89.55     173     565  

December 31

    1.0     88.17     83     482  
                     

Subtotal

    5.3   $ 97.26   $ 518   $ 482  
                     

Total

    6.4   $ 98.46   $ 629   $ 482  
                     

Quarterly Dividends

        In July 2011, the Board of Directors approved a 52 percent increase to our quarterly cash dividend on our common stock from $0.2625 per share to $0.40 per share. In July 2010, our Board of Directors approved a 50 percent increase in our quarterly cash dividend on our common stock from $0.175 per share to $0.2625 per share. Cash dividends per share paid to common shareholders for the last three years were as follows:

 
  Quarterly Dividends  
 
  2011   2010   2009  

First quarter

  $ 0.2625   $ 0.175   $ 0.175  

Second quarter

    0.2625     0.175     0.175  

Third quarter

    0.40     0.2625     0.175  

Fourth quarter

    0.40     0.2625     0.175  
               

Total

  $ 1.325   $ 0.875   $ 0.70  
               

        Total dividends paid to common shareholders in 2011, 2010 and 2009 were $255 million, $172 million and $141 million, respectively. Declaration and payment of dividends in the future

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depends upon our income and liquidity position, among other factors, and is subject to declaration by our Board of Directors, who meet quarterly to consider our dividend payment. We expect to fund dividend payments with cash from operations.

Credit Ratings

        A number of our contractual obligations and financing agreements, such as our revolving credit facility, 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 2011. In September 2011, Standard & Poor's Rating Services upgraded our rating to 'A' and changed our outlook to stable. In June 2011, Fitch Ratings upgraded our rating and changed our outlook to stable. In November 2011, Fitch Ratings affirmed our rating and revised our outlook to positive. In November 2011, Moody's Investors Service, Inc. raised our rating to Baa1 and changed our outlook to positive.

        Credit ratings are not recommendations to buy, 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 from each of the credit rating agencies as of the date of filing are shown in the table below.

Credit Rating Agency
  Senior L-T
Debt Rating
  Outlook

Moody's Investors Service, Inc. 

  Baa1   Positive

Standard & Poor's Rating Services

  A   Stable

Fitch Ratings

  A-   Positive

CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS

        A summary of payments due for our contractual obligations and commercial commitments, as of December 31, 2011, is shown in the tables below:

Contractual Cash Obligations
  2012   2013 - 2014   2015 - 2016   After 2016   Total  

In millions

                               

Loans payable

  $ 28   $   $   $   $ 28  

Long-term debt and capital lease obligations(1)

    167     168     110     1,454     1,899  

Operating leases

    136     153     87     121     497  

Capital expenditures

    430     238     56         724  

Purchase commitments for inventory

    584     39             623  

Other purchase commitments

    227     41     1         269  

Pension funding(2)

        124     62         186  

Other postretirement benefits

    51     93     86     253     483  
                       

Total

  $ 1,623   $ 856   $ 402   $ 1,828   $ 4,709  
                       

(1)
Includes principal payments and expected interest payments based on the terms of the obligations.

(2)
We are contractually obligated in the U.K. to fund $62 million per year from 2013 to 2015; however our expected total pension contributions for 2012 is approximately $130 million.

        The contractual obligations reported above exclude our unrecognized tax benefits of $86 million as of December 31, 2011. We are not able to reasonably estimate the 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.

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        Our other commercial commitments as of December 31, 2011, are as follows:

Other Commercial Commitments
  2012   2013 - 2014   2015 - 2016   After 2016   Total  

In millions

                               

Standby letters of credit under revolving credit agreement

  $ 37   $   $   $   $ 37  

International and other domestic letters of credit

    21     5         2     28  

Performance and excise bonds

    21     56     4         81  

Guarantees, indemnifications and other commitments

    7     20     18         45  
                       

Total

  $ 86   $ 81   $ 22   $ 2   $ 191  
                       

APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

        A summary of our significant accounting policies is included in Note 1, "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES," of 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. 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.

        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 estimation of liabilities for warranty programs, recoverability of investment related to new products, accounting for income taxes and pension benefits.

Warranty Programs

        We estimate and record a liability for base warranty programs 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 or when a recall becomes probable and estimable, which generally occurs when it is announced. Our warranty liability is generally affected by component failure rates, repair costs and the point of failure within the product life cycle. 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 preceding product's warranty history and a multiplicative factor based upon preceding similar product experience and new product assessment until sufficient new product data is available for warranty estimation. We then use a blend of actual new product experience and preceding product

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historical experience for several subsequent quarters, and new 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 2011 and 2010 including adjustments to pre-existing warranties.

Recoverability of Investment Related to New Products

        At December 31, 2011, we have capitalized $221 million associated with the future launch of our light-duty diesel engine product. Development of this product began in 2006. Market uncertainty related to the global recession that began in 2008 resulted in some customers delaying or cancelling their vehicle programs. At December 31, 2009, we reviewed our investment of $216 million for possible impairment. 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 required 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 were recoverable. Customers that are expected to purchase sufficient quantities to recover our investment in the light-duty diesel engine products remained active with the development of this product through 2011 and there were no significant changes to the assumptions used in 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.

Accounting for Income Taxes

        We determine our income tax expense 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 realize our net deferred tax assets. At December 31, 2011, we recorded net deferred tax assets of $417 million. These assets included $128 million for the value of tax loss and credit carryforwards. A valuation allowance of $71 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

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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. 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, 2011, based upon our target asset allocations it is anticipated that our U.S. investment policy will generate an average annual return over the 10-year projection period equal to or in excess of 7.5 percent approximately 50 percent of the time while returns of 10.0 percent or greater are anticipated 25 percent of the time. We expect additional positive returns from active investment management. The 2011 one year return was 13 percent, combined with the very favorable returns in 2010 has eliminated the significant deterioration in pension assets experienced in 2008 as a result of the credit crisis and related market recession. Based on the historical returns and forward-looking return expectations, we believe an investment return assumption of 8.0 percent per year in 2012 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. As of December 31, 2011, based upon our target asset allocations, it is anticipated that our U.K. investment policy will generate an average annual return over the 20-year projection period equal to or in excess of 6.0 percent approximately 50 percent of the time while returns of 6.9 percent or greater are anticipated 25 percent of the time. We expect additional positive returns from active investment management. The one year return for our U.K. plan was approximately six percent for 2011 and similar to our U.S. plan, the 2008 market related deterioration in our plan assets has been eliminated. 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. Based on the historical returns and forward-looking return expectations, we believe an investment return assumption of 6.5 percent in 2012 for U.K. pension assets is reasonable. Our pension plan asset allocation at December 31, 2011 and 2010 and target allocation for 2012 are as follows:

 
  U.S. Plans   U.K. Plans  
 
   
  Percentage of Plan
Assets at
December 31,
   
  Percentage of Plan
Assets at
December 31,
 
 
  Target
Allocation
2012
  Target
Allocation
2012
 
Investment description
  2011   2010   2011   2010  

Equity securities

    45.0 %   44.2 %   46.8 %   40.0 %   45.0 %   57.0 %