UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the Quarterly Period Ended September 27, 2009

 

Commission File Number 1-4949

 


 

CUMMINS INC.

(Exact name of registrant as specified in its charter)

 

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

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files).  Yes x No 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 x

Accelerated filer o

 

 

Non-accelerated filer o

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 x

 

As of September 27, 2009, there were 201,792,780 shares of common stock outstanding with a par value of $2.50 per share.

 

Website Access to Company’s Reports

 

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

 

 

 



 

CUMMINS INC. AND SUBSIDIARIES

TABLE OF CONTENTS

QUARTERLY REPORT ON FORM 10-Q

 

 

 

 

Page

 

 

 

 

 

PART I. FINANCIAL INFORMATION

 

 

 

 

 

 

ITEM 1.

Condensed Consolidated Financial Statements (Unaudited)

 

3

 

 

 

 

 

Condensed Consolidated Statements of Income for the three and nine months ended September 27, 2009, and September 28, 2008

 

3

 

 

 

 

 

Condensed Consolidated Balance Sheets at September 27, 2009, and December 31, 2008

 

4

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 27, 2009, and September 28, 2008

 

5

 

 

 

 

 

Condensed Consolidated Statements of Changes in Equity for the nine months ended September 27, 2009, and September 28, 2008

 

6

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7

 

 

 

 

ITEM 2.

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

 

24

 

 

 

 

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

 

44

 

 

 

 

ITEM 4.

Controls and Procedures

 

44

 

 

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

 

ITEM 1.

Legal Proceedings

 

45

 

 

 

 

ITEM 1A.

Risk Factors Relating to Our Business

 

45

 

 

 

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

52

 

 

 

 

ITEM 6.

Exhibits

 

52

 

 

 

 

 

Signatures

 

53

 

2



 

PART I.  FINANCIAL INFORMATION

 

ITEM 1.  Condensed Financial Statements

 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 27,

 

September 28,

 

September 27,

 

September 28,

 

In millions (except per share amounts)

 

2009

 

2008

 

2009

 

2008

 

NET SALES (a)

 

$

2,530

 

$

3,693

 

$

7,400

 

$

11,054

 

Cost of sales

 

2,027

 

2,873

 

6,004

 

8,648

 

GROSS MARGIN

 

503

 

820

 

1,396

 

2,406

 

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES AND INCOME

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

304

 

388

 

891

 

1,109

 

Research, development and engineering expenses

 

90

 

113

 

254

 

320

 

Equity, royalty and interest income from investees (Note 4)

 

57

 

66

 

147

 

202

 

Restructuring and other charges (Note 5)

 

22

 

 

95

 

 

Other operating income (expense), net

 

3

 

(2

)

(6

)

(9

)

OPERATING INCOME

 

147

 

383

 

297

 

1,170

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

2

 

4

 

5

 

14

 

Interest expense

 

9

 

10

 

26

 

33

 

Other income (expense), net

 

6

 

(7

)

(10

)

(20

)

INCOME BEFORE INCOME TAXES

 

146

 

370

 

266

 

1,131

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

36

 

123

 

72

 

372

 

NET INCOME

 

110

 

247

 

194

 

759

 

 

 

 

 

 

 

 

 

 

 

Less: net income attributable to noncontrolling interests

 

15

 

18

 

36

 

47

 

NET INCOME ATTRIBUTABLE TO CUMMINS INC.

 

$

95

 

$

229

 

$

158

 

$

712

 

 

 

 

 

 

 

 

 

 

 

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CUMMINS INC.

 

 

 

 

 

 

 

 

 

Basic

 

$

0.48

 

$

1.18

 

$

0.80

 

$

3.65

 

Diluted

 

$

0.48

 

$

1.17

 

$

0.80

 

$

3.62

 

 

 

 

 

 

 

 

 

 

 

WEIGHTED AVERAGE SHARES OUTSTANDING

 

 

 

 

 

 

 

 

 

Basic

 

197.4

 

194.9

 

197.1

 

195.1

 

Dilutive effect of stock compensation awards

 

0.4

 

1.6

 

0.3

 

1.4

 

Diluted

 

197.8

 

196.5

 

197.4

 

196.5

 

 

 

 

 

 

 

 

 

 

 

CASH DIVIDENDS DECLARED PER COMMON SHARE

 

$

0.175

 

$

0.175

 

$

0.525

 

$

0.425

 

 


(a)          Includes sales to nonconsolidated equity investees of $428 million and $1,279 million and $554 million and $1,636 million for the three and nine months ended September 27, 2009 and September 28, 2008, respectively.

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

3



 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

September 27,

 

December 31,

 

In millions (except par value)

 

2009

 

2008

 

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

686

 

$

426

 

Marketable securities

 

148

 

77

 

Accounts and notes receivable, net

 

 

 

 

 

Trade and other

 

1,534

 

1,551

 

Nonconsolidated equity investees

 

197

 

231

 

Inventories (Note 7)

 

1,461

 

1,783

 

Deferred income taxes

 

363

 

347

 

Prepaid expenses and other current assets

 

254

 

298

 

Total current assets

 

4,643

 

4,713

 

Long-term assets

 

 

 

 

 

Property, plant and equipment

 

4,736

 

4,539

 

Accumulated depreciation

 

(2,877

)

(2,698

)

Property, plant and equipment, net

 

1,859

 

1,841

 

Investments and advances related to equity method investees

 

538

 

588

 

Goodwill

 

363

 

362

 

Other intangible assets, net

 

229

 

223

 

Deferred income taxes

 

400

 

491

 

Other assets

 

323

 

301

 

Total assets

 

$

8,355

 

$

8,519

 

LIABILITIES

 

 

 

 

 

Current liabilities

 

 

 

 

 

Current portion of long-term debt and loans payable

 

$

60

 

$

69

 

Accounts payable (principally trade)

 

875

 

1,009

 

Current portion of accrued product warranty (Note 8)

 

422

 

434

 

Accrued compensation, benefits and retirement costs

 

335

 

364

 

Other accrued expenses

 

619

 

763

 

Total current liabilities

 

2,311

 

2,639

 

Long-term liabilities

 

 

 

 

 

Long-term debt

 

621

 

629

 

Pensions

 

425

 

574

 

Postretirement benefits other than pensions

 

455

 

452

 

Other liabilities and deferred revenue

 

740

 

745

 

Total liabilities

 

4,552

 

5,039

 

Commitments and contingencies (Note 9)

 

 

 

EQUITY

 

 

 

 

 

Cummins Inc. shareholders’ equity

 

 

 

 

 

Common stock, $2.50 par value, 500 shares authorized, 222.1 and 221.7 shares issued

 

1,842

 

1,793

 

Retained earnings

 

3,340

 

3,288

 

Treasury stock, at cost, 20.3 and 20.4 shares

 

(713

)

(715

)

Common stock held by employee benefits trust, at cost, 3.5 and 5.1 shares

 

(43

)

(61

)

Unearned compensation

 

(1

)

(5

)

Accumulated other comprehensive loss

 

 

 

 

 

Defined benefit postretirement plans

 

(741

)

(798

)

Other

 

(121

)

(268

)

Total accumulated other comprehensive loss

 

(862

)

(1,066

)

Total Cummins Inc. shareholders’ equity

 

3,563

 

3,234

 

Noncontrolling interests

 

240

 

246

 

Total equity

 

3,803

 

3,480

 

Total liabilities and equity

 

$

8,355

 

$

8,519

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

4



 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Nine months ended

 

 

 

September 27,

 

September 28,

 

In millions

 

2009

 

2008

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net income

 

$

194

 

$

759

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Restructuring charges, net of cash payments (Note 5)

 

21

 

 

Depreciation and amortization

 

238

 

233

 

Deferred income taxes

 

(11

)

38

 

Equity in income of investees, net of dividends

 

56

 

(80

)

Pension expense, net of pension contributions (Note 6)

 

(49

)

(40

)

Other post-retirement benefits expense, net of cash payments (Note 6)

 

(18

)

(11

)

Stock-based compensation expense

 

16

 

27

 

Excess tax deficiencies (benefits) on stock-based awards

 

2

 

(12

)

Translation and hedging activities

 

33

 

15

 

Changes in current assets and liabilities, net of acquisitions and dispositions:

 

 

 

 

 

Accounts and notes receivable

 

89

 

(310

)

Inventories

 

360

 

(334

)

Other current assets

 

32

 

(35

)

Accounts payable

 

(155

)

198

 

Accrued expenses

 

(185

)

206

 

Changes in long-term liabilities

 

103

 

78

 

Other, net

 

4

 

(7

)

Net cash provided by operating activities

 

730

 

725

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Capital expenditures

 

(204

)

(330

)

Investments in internal use software

 

(24

)

(53

)

Proceeds from disposals of property, plant and equipment

 

8

 

20

 

Investments in and advances to equity investees

 

(5

)

(51

)

Acquisition of businesses, net of cash acquired

 

(2

)

(142

)

Proceeds from the sale of an equity investment

 

 

64

 

Investments in marketable securities—acquisitions

 

(234

)

(264

)

Investments in marketable securities—liquidations

 

171

 

281

 

Purchases of other investments

 

(54

)

(54

)

Cash flows from derivatives not designated as hedges

 

(21

)

(24

)

Other, net

 

1

 

1

 

Net cash used in investing activities

 

(364

)

(552

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from borrowings

 

11

 

91

 

Payments on borrowings and capital lease obligations

 

(60

)

(111

)

Net borrowings under short-term credit agreements

 

(4

)

5

 

Distributions to noncontrolling interests

 

(16

)

(14

)

Dividend payments on common stock

 

(106

)

(86

)

Proceeds from sale of common stock held by employee benefit trust

 

54

 

52

 

Repurchases of common stock

 

 

(123

)

Excess tax (deficiencies) benefits on stock-based awards

 

(2

)

12

 

Other, net

 

3

 

3

 

Net cash used in financing activities

 

(120

)

(171

)

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

 

14

 

(7

)

Net increase (decrease) in cash and cash equivalents

 

260

 

(5

)

Cash and cash equivalents at beginning of year

 

426

 

577

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 

$

686

 

$

572

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

5



 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

Common

 

 

 

Total
Cummins

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

Stock

 

 

 

Inc.

 

 

 

 

 

 

 

Common

 

paid-in

 

Retained

 

Comprehensive

 

Treasury

 

Held in

 

Unearned

 

Shareholders’

 

Noncontrolling

 

Total

 

In millions

 

Stock

 

Capital

 

Earnings

 

Loss

 

Stock

 

Trust

 

Compensation

 

Equity

 

Interests

 

Equity

 

BALANCE AT DECEMBER 31, 2007

 

$

551

 

$

1,168

 

$

2,660

 

$

(286

)

$

(593

)

$

(79

)

$

(11

)

$

3,410

 

$

292

 

$

3,702

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

712

 

 

 

 

 

 

 

 

 

712

 

47

 

759

 

Other comprehensive income (loss) (Note 13)

 

 

 

 

 

 

 

(96

)

 

 

 

 

 

 

(96

)

(26

)

(122

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

616

 

21

 

637

 

Effect of changing pension plan measurement date

 

 

 

 

 

(5

)

(2

)

 

 

 

 

 

 

(7

)

 

(7

)

Issuance of shares

 

3

 

 

 

 

 

 

 

 

 

 

 

 

 

3

 

8

 

11

 

Employee benefits trust activity

 

 

 

41

 

 

 

 

 

 

 

11

 

 

 

52

 

 

52

 

Acquisition of shares

 

 

 

 

 

 

 

 

 

(123

)

 

 

 

 

(123

)

 

(123

)

Purchase of equity from noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(54

)

(54

)

Cash dividends on common stock

 

 

 

 

 

(86

)

 

 

 

 

 

 

 

 

(86

)

 

(86

)

Distribution to noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(14

)

(14

)

Stock option exercises

 

 

 

(1

)

 

 

 

 

5

 

 

 

 

 

4

 

 

4

 

Other shareholder transactions

 

 

 

22

 

 

 

 

 

 

 

 

 

5

 

27

 

(4

)

23

 

BALANCE AT SEPTEMBER 28, 2008

 

$

554

 

$

1,230

 

$

3,281

 

$

(384

)

$

(711

)

$

(68

)

$

(6

)

$

3,896

 

$

249

 

$

4,145

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE AT DECEMBER 31, 2008

 

$

554

 

$

1,239

 

$

3,288

 

$

(1,066

)

$

(715

)

$

(61

)

$

(5

)

$

3,234

 

$

246

 

$

3,480

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

158

 

 

 

 

 

 

 

 

 

158

 

36

 

194

 

Other comprehensive income (loss) (Note 13)

 

 

 

 

 

 

 

204

 

 

 

 

 

 

 

204

 

9

 

213

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

362

 

45

 

407

 

Issuance of shares

 

1

 

6

 

 

 

 

 

 

 

 

 

 

 

7

 

 

7

 

Cash dividends on common stock

 

 

 

 

 

(106

)

 

 

 

 

 

 

 

 

(106

)

 

(106

)

Employee benefits trust activity

 

 

 

40

 

 

 

 

 

 

 

18

 

 

 

58

 

 

58

 

Distribution to noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(16

)

(16

)

Stock option exercises

 

 

 

(1

)

 

 

 

 

2

 

 

 

 

 

1

 

 

1

 

Conversion to capital lease (Note 12)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(35

)

(35

)

Other shareholder transactions

 

 

 

3

 

 

 

 

 

 

 

 

 

4

 

7

 

 

7

 

BALANCE AT SEPTEMBER 27, 2009

 

$

555

 

$

1,287

 

$

3,340

 

$

(862

)(1)

$

(713

)

$

(43

)

$

(1

)

$

3,563

 

$

240

 

$

3,803

 

 


(1)          Comprised of defined benefit postretirement plans of $(741) million, foreign currency translation adjustments of $(121) million, unrealized gain on marketable securities of $2 million and unrealized loss on derivatives of $(2) million.

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

6



 

CUMMINS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1NATURE OF OPERATIONS

 

Cummins Inc. (“Cummins,” “the Company,” “the registrant,” “we,” “our,” or “us”) is a leading global power provider that designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration and emissions solutions, turbochargers, fuel systems, controls and air handling systems.  We were founded in 1919 as one of the first manufacturers of diesel engines and are headquartered in Columbus, Indiana.  We sell our products to Original Equipment Manufacturers (OEMs), distributors and other customers worldwide.  We serve our customers through a network of more than 500 company-owned and independent distributor locations and approximately 5,200 dealer locations in more than 190 countries and territories.

 

NOTE 2.  BASIS OF PRESENTATION

 

The unaudited Condensed Consolidated Financial Statements reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the results of operations, financial position and cash flows.  All such adjustments are of a normal recurring nature.  The Condensed Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted as permitted by such rules and regulations.  Certain reclassifications have been made to prior period amounts to conform to the presentation of the current period condensed financial statements.

 

Our reporting period ends on the Sunday closest to the last day of the quarterly calendar period.  The third quarters of 2009 and 2008 ended on September 27, and September 28, respectively.  The interim periods for both 2009 and 2008 contain 13 weeks.  Our fiscal year ends on December 31, regardless of the day of the week on which December 31 falls.

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts in the Condensed Consolidated Financial Statements.  Significant estimates and assumptions in these Condensed Consolidated Financial Statements require the exercise of judgment and are used for, but not limited to, allowance for doubtful accounts, estimates of future cash flows and other assumptions associated with goodwill and long-lived asset impairment tests, useful lives for depreciation and amortization, warranty programs, determination of discount and other rate assumptions for pension and other postretirement benefit expenses, income taxes and deferred tax valuation allowances and contingencies.  Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be different from these estimates.

 

The weighted-average diluted common shares outstanding exclude the anti-dilutive effect of certain stock options since such options had an exercise price in excess of the monthly average market value of our common stock.  The options excluded from diluted earnings per share for the three and nine month periods ended September 27, 2009, and September 28, 2008, were as follows:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 27,
2009

 

September 28,
2008

 

September 27,
2009

 

September 28,
2008

 

Options excluded

 

28,717

 

5,950

 

61,585

 

6,885

 

 

You should read these interim condensed financial statements in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2008.  Our interim period financial results for the three and nine month interim periods presented are not necessarily indicative of results to be expected for any other interim period or for the entire year.  The year-end Condensed Consolidated Balance Sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.

 

7



 

NOTE 3.  RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

Accounting Pronouncements Recently Adopted

 

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

 

In March 2008, the FASB amended its existing standards for disclosures about derivative instruments and hedging activities, which was effective for interim and annual fiscal periods beginning after November 15, 2008.  The new standards require enhanced disclosures about a company’s derivative and hedging activities.  We adopted the new standard effective January 1, 2009, and applied it prospectively.  The new disclosures required are included in Note 11.

 

In April 2009, the FASB amended its existing standards for accounting and disclosures related to certain financial instruments including: (a) providing additional rules for estimating fair value when the volume and level of activity for the asset or liability has significantly decreased; (b) identifying circumstances that indicate a transaction is not orderly; (c) amending the other-than-temporary impairment rules for debt securities to make it more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements; and (d) requiring enhanced disclosures about the fair value of financial instruments on an interim basis in addition to the annual disclosure requirements (Note 10).  The new standards were required to be adopted for interim periods ending after June 15, 2009.  The adoption of the new standards did not have a material impact on our Condensed Consolidated Financial Statements.

 

In June 2009, the FASB amended its existing standards for subsequent events, which was effective for interim and annual fiscal periods ending after June 15, 2009, and established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  The new standard established the period after the balance sheet date during which we should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which we should recognize events or transactions occurring after the balance sheet date and the disclosures that should be made about events or transactions that occurred after the balance sheet date.  In preparing our Condensed Consolidated Financial Statements, we evaluated subsequent events through October 30, 2009, which is the date our quarterly report was filed with the Securities and Exchange Commission.

 

Accounting Pronouncements Issued But Not Yet Effective

 

In June 2009, the FASB amended its standards for accounting for transfers of financial assets, which is effective for interim and annual fiscal periods beginning after November 15, 2009.  The new standard removes the concept of a qualifying special-purpose entity from GAAP.  The new standard modifies the financial-components approach used in previous standards and limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized.  The new standard also requires enhanced disclosure regarding transfers of financial interests and a transferor’s continuing involvement with transferred assets.  The new standard will require us to report any future activity under our sale of receivables program as secured borrowings as of January 1, 2010.

 

8



 

In June 2009, the FASB amended its existing standards related to the consolidation of variable interest entities, which is effective for interim and annual fiscal periods beginning after November 15, 2009.  The new standard requires entities to analyze whether their variable interests give it a controlling financial interest of a variable interest entity (VIE) and outlines what defines a primary beneficiary.  The new standard amends GAAP by: (a) changing certain rules for determining whether an entity is a VIE; (b) replacing the quantitative approach previously required for determining the primary beneficiary with a more qualitative approach; and (c) requiring entities to continuously analyze whether they are the primary beneficiary of a VIE among other amendments.  The new standard also requires enhanced disclosures regarding an entity’s involvement in a VIE.  It is possible that application of this new standard will change our assessment of whether or not we are the primary beneficiary of any VIEs with which we are involved.  We are currently evaluating the impact of this standard on our Condensed Consolidated Financial Statements.

 

NOTE 4.  EQUITY, ROYALTY AND INTEREST INCOME FROM INVESTEES

 

Equity, royalty and interest income from investees included in our Condensed Consolidated Statements of Income for the interim reporting periods was as follows:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 27,

 

September 28,

 

September 27,

 

September 28,

 

In millions

 

2009

 

2008

 

2009

 

2008

 

Distribution Entities

 

 

 

 

 

 

 

 

 

North American distributors

 

$

25

 

$

 26

 

$

 74

 

$

 72

 

Komatsu Cummins Chile, Ltda.

 

3

 

2

 

9

 

5

 

All other distributors

 

1

 

2

 

2

 

3

 

 

 

 

 

 

 

 

 

 

 

Manufacturing Entities

 

 

 

 

 

 

 

 

 

Dongfeng Cummins Engine Company, Ltd

 

11

 

16

 

18

 

50

 

Chongqing Cummins Engine Company, Ltd

 

8

 

9

 

28

 

23

 

Valvoline Cummins, Ltd.

 

3

 

1

 

5

 

2

 

Shanghai Fleetguard Filter Co. Ltd.

 

2

 

2

 

5

 

7

 

Tata Cummins Ltd.

 

2

 

 

2

 

7

 

Cummins MerCruiser Diesel Marine LLC.

 

(2

)

(1

)

(5

)

5

 

All other manufacturers

 

 

4

 

(2

)

12

 

Cummins share of net income

 

53

 

61

 

136

 

186

 

Royalty and interest income

 

4

 

5

 

11

 

16

 

Equity, royalty and interest income from investees

 

$

57

 

$

 66

 

$

 147

 

$

 202

 

 

NOTE 5.  RESTRUCTURING AND OTHER CHARGES

 

2009 Restructuring Actions

 

In 2009, we executed restructuring actions in response to a reduction in orders in most of our U.S. and foreign markets due to the continuing deterioration in the global economy.  We reduced our global workforce by approximately 1,000 professional employees.  In addition, we took numerous employee actions at many of our manufacturing locations, including approximately 3,150 hourly employees, significant downsizing at numerous facilities and complete closure of several facilities and branch distributor locations.  Employee termination and severance costs were recorded based on approved plans developed by the businesses and corporate management which specified positions to be eliminated, benefits to be paid under existing severance plans, union contracts or statutory requirements and the expected timetable for completion of the plan.  Estimates of restructuring were made based on information available at the time charges were recorded.  Due to the inherent uncertainty involved, actual amounts paid for such activities may differ from amounts initially recorded and we may need to revise previous estimates.

 

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 $83 million, comprising $85 million of charges related to 2009 actions net of the $2 million favorable change in estimate related to 2008 actions, in “Restructuring and other charges” in the Condensed

 

9



 

Consolidated Statements of Income.  The estimated completion date for the workforce reductions and the exit activities is March 2010.  These restructuring actions included:

 

 

 

September 27, 2009

 

In millions

 

Three months ended

 

Nine months ended

 

Workforce reductions

 

$

11

 

$

79

 

Exit activities

 

 

7

 

Changes in estimate

 

(1

)

(3

)

Total restructuring charges

 

10

 

83

 

Curtailment loss

 

12

 

12

 

Total restructuring and other charges

 

$

22

 

$

95

 

 

In addition, as a result of the restructuring actions described above, we also recorded a $12 million curtailment loss in the third quarter of 2009 in our pension and other postretirement plans.  See Note 6 for additional detail.

 

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 the Condensed Consolidated Balance Sheets.

 

In millions

 

Severance
Costs

 

Exit
Activities

 

Total

 

2009 Restructuring charges

 

$

79

 

$

7

 

$

86

 

Cash payments for 2009 actions

 

(61

)

(1

)

(62

)

Noncash items

 

 

(5

)

(5

)

Changes in estimates

 

(1

)

 

(1

)

Translation

 

1

 

 

1

 

Balance at September 27, 2009

 

$

18

 

$

1

 

$

19

 

 

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

 

 

 

September 27, 2009

 

In millions

 

Three months
ended

 

Nine months
ended

 

Engine

 

$

11

 

$

47

 

Power Generation

 

4

 

11

 

Components

 

8

 

34

 

Distribution

 

(1

)

3

 

Total restructuring charges

 

$

22

 

$

95

 

 

2008 Restructuring Actions

 

In 2008, we executed restructuring actions in response to the continued deterioration in our U.S. businesses and most key markets around the world in the second half of 2008, as well as a reduction in orders in most U.S. and foreign markets for 2009.  In 2008, we announced reductions of our global workforce by approximately 650 professional employees.  In addition, we took numerous employee actions at many of our manufacturing locations, including approximately 800 hourly employees.  Total workforce reductions as of September 27, 2009, were substantially completed.

 

The charges recorded during the year ended December 31, 2008, included severance costs related to both voluntary and involuntary terminations.  During 2008, we incurred a pretax charge related to the professional and hourly restructuring initiatives of $37 million.  The following table summarizes the balance of accrued restructuring charges and the changes in the accrued amounts for the applicable periods.  The restructuring related accruals were recorded in “Other accrued expenses” in the Condensed Consolidated Balance Sheets.

 

10



 

In millions

 

Severance Costs

 

Balance at December 31, 2008

 

$

34

 

Cash payments for 2008 actions

 

(30

)

Change in estimate

 

(2

)

Balance at September 27, 2009

 

$

2

 

 

NOTE 6.  PENSION AND OTHER POSTRETIREMENT BENEFITS

 

We sponsor funded and unfunded domestic and foreign defined benefit pension and other postretirement plans.  Cash contributions to these plans were as follows:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 27,

 

September 28,

 

September 27,

 

September 28,

 

In millions

 

2009

 

2008

 

2009

 

2008

 

Defined benefit pension and postretirement plans:

 

 

 

 

 

 

 

 

 

Voluntary

 

$

55

 

$

46

 

$

100

 

$

70

 

Mandatory

 

21

 

21

 

62

 

51

 

Total defined benefit plans

 

$

76

 

$

67

 

$

162

 

$

121

 

Defined contribution pension plans

 

$

9

 

$

6

 

$

32

 

$

24

 

 

We presently anticipate contributing $130 million to $135 million to our defined benefit pension plans in 2009 and paying approximately $53 million in claims and premiums for other postretirement benefits.  The $130 million to $135 million of contributions for the full year include voluntary contributions of $100 million to $105 million.  These contributions and payments include payments from Company funds either to increase pension assets or to make direct payments to plan participants.

 

The components of net periodic pension and other postretirement benefit cost under our plans consisted of the following:

 

 

 

 

 

Other

 

 

 

Pension

 

Postretirement

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

Benefits

 

 

 

Three months ended

 

 

 

September 27,

 

September 28,

 

September 27,

 

September 28,

 

September 27,

 

September 28,

 

In millions

 

2009

 

2008

 

2009

 

2008

 

2009

 

2008

 

Service cost

 

$

11

 

$

12

 

$

5

 

$

6

 

$

 

$

 

Interest cost

 

28

 

28

 

15

 

17

 

7

 

8

 

Expected return on plan assets

 

(34

)

(37

)

(16

)

(18

)

 

 

Amortization of prior service cost (credit)

 

 

 

1

 

 

(2

)

(2

)

Recognized net actuarial loss

 

8

 

5

 

5

 

5

 

 

 

Net periodic benefit costs

 

13

 

8

 

10

 

10

 

5

 

6

 

Curtailment loss

 

6

 

 

 

 

6

 

 

Net periodic benefit cost after curtailment losses

 

$

19

 

$

8

 

$

10

 

$

10

 

$

11

 

$

6

 

 

11



 

 

 

 

 

Other

 

 

 

Pension

 

Postretirement

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

Benefits

 

 

 

Nine months ended

 

 

 

September 27,

 

September 28,

 

September 27,

 

September 28,

 

September 27,

 

September 28,

 

In millions

 

2009

 

2008

 

2009

 

2008

 

2009

 

2008

 

Service cost

 

$

34

 

$

36

 

$

13

 

$

20

 

$

 

$

 

Interest cost

 

85

 

86

 

42

 

49

 

22

 

24

 

Expected return on plan assets

 

(104

)

(113

)

(44

)

(56

)

 

 

Amortization of prior service (credit) cost

 

(1

)

 

3

 

2

 

(6

)

(7

)

Recognized net actuarial loss (gain)

 

23

 

15

 

15

 

15

 

 

(1

)

Other

 

1

 

 

 

 

 

 

Net periodic benefit cost

 

38

 

24

 

29

 

30

 

16

 

16

 

Curtailment loss

 

6

 

 

 

 

6

 

 

Net periodic benefit cost after curtailment losses

 

$

44

 

$

24

 

$

29

 

$

30

 

$

22

 

$

16

 

 

As disclosed in Note 5, we have executed many restructuring actions over the past four quarters.  As a result, our U.S. pension and other postretirement benefit plans were remeasured and we recognized curtailment losses as prescribed under U.S. GAAP pension and other postretirement benefit standards due to the significant reduction in the expected aggregate years of future service of the employees affected by the actions.  In the third quarter of 2009, we recorded net curtailment losses of $6 million and $6 million related to the pension and other postretirement plans, respectively.  The curtailment losses include recognition of the change in the projected benefit obligation (PBO) or accumulated postretirement benefit obligation (APBO) and a portion of the previously unrecognized prior service cost reflecting the reduction in expected future service.

 

The remeasurement of these pension and other postretirement benefit plans generated a decrease in the 2009 annual net periodic benefit cost for pension plans of $3 million and a zero net change in the 2009 annual net periodic benefit cost for other postretirement benefit plans.  The decrease will be recognized in the fourth quarter of 2009.  Further, the pension plans' PBO and plan assets increased from December 31, 2008 by $22 million and $181 million, respectively (net of $138 million in benefit payments and plan assets reflecting a contribution of $100 million).  The other postretirement benefit plans' APBO increased by $3 million, due to the remeasurement.

 

Additionally, in the third quarter of 2009, we recorded a credit of $87 million for pension plans and a charge of $11 million for other postretirement benefit plans to accumulated other comprehensive loss in accordance with the provisions of U.S. GAAP pension and other postretirement benefit standards due to the remeasurement of the curtailed plans.

 

NOTE 7.  INVENTORIES

 

Inventories included the following:

 

 

 

September 27,

 

December 31,

 

In millions

 

2009

 

2008

 

Finished products

 

$

833

 

$

860

 

Work-in-process and raw materials

 

716

 

1,021

 

Inventories at FIFO cost

 

1,549

 

1,881

 

Excess of FIFO over LIFO

 

(88

)

(98

)

Total inventories

 

$

1,461

 

$

1,783

 

 

NOTE 8.  PRODUCT WARRANTY LIABILITY

 

We charge the estimated costs of warranty programs, other than product recalls, to income at the time products are shipped to customers.  We use historical claims experience to develop the estimated liability.  We review product recall programs on a quarterly basis and, if necessary, record a liability when we commit to an action.  We also sell extended

 

12



 

warranty coverage on several engines.  The following is a tabular reconciliation of the product warranty liability, including the deferred revenue related to our extended warranty coverage:

 

 

 

Nine months ended

 

 

 

September 27,

 

September 28,

 

In millions

 

2009

 

2008

 

Balance, beginning of period

 

$

962

 

$

749

 

Provision for warranties issued

 

241

 

319

 

Deferred revenue on extended warranty contracts sold

 

77

 

73

 

Payments

 

(352

)

(258

)

Amortization of deferred revenue on extended warranty contracts

 

(54

)

(47

)

Changes in estimates for pre-existing warranties

 

67

 

63

 

Foreign currency translation

 

12

 

(10

)

Balance, end of period

 

$

953

 

$

889

 

 

The amount of deferred revenue related to extended coverage programs as of September 27, 2009, was $247 million.  As of September 27, 2009, we had $11 million of receivables related to estimated supplier recoveries of which $5 million was included in “Trade and other” receivables and $6 million was included in “Other assets” in our Condensed Consolidated Balance Sheets.

 

During 2008 and 2009, actual cost trends for certain midrange engine products, including product launched in 2007 and for which warranty periods can extend to five years, indicated higher per claim repair cost than the product on which the initial accrual rate was developed.  These products include more electronic parts than historical models, contributing to the higher cost per claim.  In addition, certain products introduced in 2003 and sold prior to 2007 for which the warranty period extended five years also demonstrated higher cost per claim than that of predecessor products.  We increased our liability in 2008 and 2009 as these experience trends became evident.

 

NOTE 9.  COMMITMENTS AND CONTINGENCIES

 

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 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.  Some of these lawsuits, claims and proceedings involve substantial amounts.  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 operation, financial condition or cash flows.

 

In June 2008, four Cummins sites in Southern Indiana, including our Technical Center, experienced extensive damage caused by flood water from an unusually high amount of rainfall.  We have been in ongoing discussions with our insurance carriers regarding our claim.  In May 2009, our insurance carriers filed a lawsuit seeking a declaratory judgment that a lower policy sublimit applies to the Technical Center based upon an allegation that the site is located in a flood plain.  In addition, they allege that certain other damages and losses claimed by Cummins are not covered by insurance.  Cummins has also filed suit seeking a declaratory judgment that all losses suffered by Cummins are covered under the insurance policies, as well as a claim that the insurance companies have acted in bad faith.  We have finalized the documentation of Cummins’ $199 million claim ($116 million expense and $83

 

13



 

million capital), which does not include an additional claim amount related to business interruption.  We remain confident that we will recover a majority of the amounts due to us under the insurance policies.  We have incurred approximately $99 million in expense and $51 million in capital of our $199 million claim through September 27, 2009.  We recorded gains on insurance recoveries related to flood damage of $8 million and $5 million for the three and nine months ended September 27, 2009, respectively.  These gains were included in “Other operating (expense) income” in the Condensed Consolidated Statements of Income.

 

U.S. Distributor Commitments

 

We had an operating agreement with a financial institution that provided financing to certain independent Cummins and Onan distributors in the U.S., and to certain distributors in which we own an equity interest.  Under this agreement, if any distributor defaulted under its financing arrangement with the financial institution, and the maturity of amounts owed under the agreement were accelerated, then we were required to purchase from the financial institution, at amounts approximating fair market value, certain property, inventory and rental generator sets manufactured by Cummins that are secured by the distributor’s financing agreement.

 

In May 2009, the distributor agreement with the financial institution was refinanced and Cummins did not make any new commitments, thereby relieving Cummins of responsibility to purchase any assets from the financial institution in event of default by the distributors.

 

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

 

Residual Value Guarantees

 

We have various residual value guarantees on equipment leased under operating leases.  The total amount of these residual value guarantees at September 27, 2009, was $8 million.

 

Other Guarantees and Commitments

 

In addition to the guarantees discussed above, from time to time we enter into other guarantee arrangements, including guarantees of non-U.S. distributor financing and other miscellaneous guarantees of third-party obligations.  As of September 27, 2009, the maximum potential loss related to these other guarantees is $74 million ($72 million of which relates to the Beijing Foton agreement discussed below).

 

We have arrangements with certain suppliers that require us to purchase minimum volumes or be subject to monetary penalties.  The penalty amounts are less than our purchase commitments and essentially allow the supplier to recover their tooling costs in most instances.  As of September 27, 2009, if we were to stop purchasing from each of these suppliers, the amount of the penalty would be approximately $82 million, of which $68 million relates to a contract with an engine parts supplier that extends to 2013.  This arrangement enables us to secure critical components.  We do not currently anticipate paying any penalties under these contracts.

 

In July 2008, Beijing Foton Cummins Engine Company, a 50 percent owned entity accounted for under the equity method, entered into a line of credit agreement with a borrowing capacity of up to $176 million (at current exchange rates).  The line will be used primarily to fund equipment purchases for a new manufacturing plant.  As a part of this transaction, we guaranteed 50 percent of any outstanding borrowings up to a maximum guarantee of $88 million (at

 

14



 

current exchange rates).  As of September 27, 2009, outstanding borrowings under this agreement were $144 million and our guarantee was $72 million (at current exchange rates).  We recorded a liability for the fair value of this guarantee.  The amount of the liability was less than $1 million.  The offset to this liability was an increase in our investment in the joint venture.

 

We had a standby commitment with Irwin Financial Corporation (Irwin) to purchase up to $25 million of its common shares in connection with a potential rights offering being planned by Irwin.  Our commitment was subject to the satisfaction of several conditions.  On September 18, 2009, Irwin Union Bank and Trust Company, Columbus, Indiana, was placed into receivership by the Indiana Department of Financial Institutions and Irwin Union Bank, F.S.B., Louisville, Kentucky, was placed into receivership by the Office of Thrift Supervision.  In light of these actions, Cummins terminated the Standby Purchase Agreement on September 21, 2009, and no further commitments to Irwin remain.

 

Indemnifications

 

Periodically, we enter into various contractual arrangements where we agree to indemnify a third-party against certain types of losses.  Common types of indemnifications include:

 

·  product liability and license, patent or trademark indemnifications,

 

· asset sale agreements where we agree to indemnify the purchaser against future environmental exposures related to the asset sold and

 

· any contractual agreement where we agree to indemnify the counter-party for losses suffered as a result of a misrepresentation in the contract.

 

We regularly evaluate the probability of having to incur costs associated with these indemnifications and accrue for expected losses that are probable.  Because the indemnifications are not related to specified known liabilities and due to their uncertain nature, we are unable to estimate the maximum amount of the potential loss associated with these indemnifications.

 

Joint Venture Commitments

 

As of September 27, 2009, we have committed to invest $8 million into existing joint ventures.  It is expected that $4 million will be funded in 2009.

 

NOTE 10.  FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The majority of the assets and liabilities we carry at fair value are available-for-sale (AFS) securities and derivatives.  AFS securities are derived from level 1 or level 2 inputs.  The predominance of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.

 

The fair value measurement of derivatives results primarily from level 2 inputs.  Many of our derivative contracts are valued utilizing publicly available pricing data of contracts with similar terms.  In other cases, the contracts are valued using current spot market data adjusted for the appropriate current forward curves provided by external financial institutions.  We participate in commodity swap contracts, currency forward contracts, and interest rate swaps.  When material, we adjust the values of our derivative contracts for counter-party or our credit risk.

 

15


 


 

The following table summarizes our financial instruments recorded at fair value in our Condensed Consolidated Balance Sheets at September 27, 2009:

 

 

 

Fair Value Measurements Using

 

In millions

 

Quoted prices in active
markets for identical assets
(Level 1)

 

Significant other
observable inputs
(Level 2)

 

Significant
unobservable inputs
(Level 3)

 

Total

 

Available-for-sale securities

 

$

138

 

$

10

 

$

 

$

148

 

Derivative assets

 

 

49

 

 

49

 

Derivative liabilities

 

 

(13

)

 

(13

)

Total

 

$

138

 

$

46

 

$

 

$

184

 

 

Fair Value of Other Financial Instruments

 

Based on borrowing rates currently available to us for bank loans with similar terms and average maturities, considering our risk premium, the fair value of total debt, including current maturities, at September 27, 2009, was approximately $628 million.  The carrying value at that date was $681 million.  At December 31, 2008, the fair and carrying values of total debt, including current maturities, were $567 million and $698 million, respectively.  The carrying values of all other receivables and liabilities approximated fair values.

 

NOTE 11.  DERIVATIVES

 

We are exposed to financial risk resulting from volatility in foreign exchange rates, commodity prices and interest rates.  This risk is closely monitored and managed through the use of financial derivative instruments including foreign currency forward contracts, commodity swap contracts and interest rate swaps.  As stated in our internal policies and procedures, financial derivatives are used expressly for hedging purposes, and under no circumstances are they used for speculative purposes.  When material, we adjust the value of our derivative contracts for counter-party or our credit risk.  The results and status of our hedging transactions are reported to senior management on a monthly and quarterly basis.

 

Foreign Currency Exchange Rate Risk

 

Due to our international business presence, we are exposed to foreign currency exchange risks.  We transact business in foreign currencies and, as a result, our income experiences some volatility related to movements in foreign currency exchange rates.  To help manage our exposure to exchange rate volatility, we use foreign exchange forward contracts on a regular basis to hedge forecasted intercompany and third-party sales and purchases denominated in non-functional currencies.  Our internal policy allows for managing anticipated foreign currency cash flows for up to one year.  These foreign currency forward contracts are designated and qualify as foreign currency cash flow hedges under GAAP.  The effective portion of the unrealized gain or loss on the forward contract is deferred and reported as a component of “Accumulated other comprehensive loss” (AOCL).  When the hedged forecasted transaction (sale or purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income.  The ineffective portion of the hedge, unrealized gain or loss, if any, is recognized in current income during the period of change.  As of September 27, 2009, we expect to reclassify an unrealized net gain of $1 million from AOCL to income over the next year.  For the nine month periods ended September 27, 2009, and September 28, 2008, there were no circumstances that would have resulted in the discontinuance of a foreign currency cash flow hedge.

 

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

 

16



 

The table below summarizes our outstanding foreign currency forward contracts.  The currencies in this table represent 90% of the notional amounts of contracts outstanding as of September 27, 2009.

 

In millions

 

Currency Denomination

 

Currency

 

September 27, 2009

 

United States Dollar (USD)

 

21

 

British Pound Sterling (GBP)

 

93

 

Euro (EUR)

 

8

 

Singapore Dollar (SGD)

 

26

 

Indian Rupee (INR)

 

550

 

Romanian Leu (RON)

 

40

 

Chinese Renminbi (CNY)

 

35

 

 

Commodity Price Risk

 

We are exposed to fluctuations in commodity prices due to contractual agreements with component suppliers.  In order to protect ourselves against future price volatility and, consequently, fluctuations in gross margins, we periodically enter into commodity swap contracts with designated banks to fix the cost of certain raw material purchases with the objective of minimizing changes in inventory cost due to market price fluctuations.  The swap contracts are derivative contracts that are designated as cash flow hedges under GAAP.  The effective portion of the unrealized gain or loss is deferred and reported as a component of AOCL.  When the hedged forecasted transaction (purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income.  The ineffective portion of the hedge, if any, is recognized in current income in the period in which the ineffectiveness occurs.  As of September 27, 2009, we expect to reclassify an unrealized net loss of $4 million from AOCL to income over the next year.  For the nine month period ended September 27, 2009, we discontinued hedge accounting on certain contracts where the forecasted transactions were no longer probable.  The amount reclassified to income as a result of this action was a loss of $4 million.

 

Our internal policy allows for managing these cash flow hedges for up to three years.  The following table summarizes our outstanding commodity swap contracts that were entered into to hedge the cost of certain raw material purchases:

 

Dollars in millions

 

September 27, 2009

 

Commodity

 

Notional Amount

 

Quantity

 

Copper

 

$

100

 

14,670 metric tons

(1)

Platinum

 

17

 

19,468 troy ounces

(2)

Palladium

 

1

 

3,822 troy ounces

(2)

 


(1) A metric ton is a measurement of mass equal to 1,000 kilograms.

(2) A troy ounce is a measurement of mass equal to approximately 31 grams.

 

Interest Rate Risk

 

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

 

17



 

In November 2005, we entered into an interest rate swap to effectively convert our $250 million debt, due in 2028, from a fixed rate of 7.125% to a floating rate based on a LIBOR spread.  The terms of the swap mirror those of the debt, with interest paid semi-annually.  This swap qualifies as a fair value hedge under GAAP.  The gain or loss on this derivative instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in current income as “Interest expense.”  These gains and losses for the three and nine month periods ended September 27, 2009, were as follows:

 

 

 

September 27, 2009

 

 

 

Three months ended

 

Nine months ended

 

In millions
Income Statement Classification

 

Gain/(Loss)
on Swaps

 

Gain/(Loss) on
Borrowings

 

Gain/(Loss)
on Swaps

 

Gain/(Loss) on
Borrowings

 

Interest expense

 

$

6

 

$

(6

)

$

(40

)

$

40

 

 

Cash Flow Hedging

 

The tables below summarize the effect on our Condensed Consolidated Statements of Income for derivative instruments classified as cash flow hedges for the three and nine month interim reporting periods presented below.  The tables do not include amounts related to ineffectiveness as it was not material for the periods presented.

 

 

 

Three months ended September 27, 2009

 

 

 

In millions
Derivatives in Cash Flow Hedging
Relationships

 

Amount of Gain/(Loss)
Recognized in AOCL on
Derivative (Effective
Portion)

 

Amount of Gain/(Loss)
Reclassified from AOCL
into Income (Effective
Portion)

 

Location of Gain/(Loss)
Reclassified into Income
(Effective Portion)

 

Foreign currency forward contracts

 

$

(1

)

$

5

 

Sales

 

Commodity swap contracts

 

14

 

(5

)

Cost of sales

 

Total

 

$

13

 

$

 

 

 

 

 

 

Nine months ended September 27, 2009

 

-

 

In millions
Derivatives in Cash Flow Hedging
Relationships

 

Amount of Gain/(Loss)
Recognized in AOCL on
Derivative (Effective
Portion)

 

Amount of Gain/(Loss)
Reclassified from AOCL
into Income (Effective
Portion)

 

Location of Gain/(Loss)
Reclassified into Income
(Effective Portion)

 

Foreign currency forward contracts

 

$

8

 

$

(3

)

Sales

 

Commodity swap contracts

 

43

 

(22

)

Cost of sales

 

Total

 

$

51

 

$

(25

)

 

 

 

Derivatives Not Designated as Hedging Instruments

 

The following table summarizes the effect on our Condensed Consolidated Statements of Income for derivative instruments that are not classified as hedges for the three and nine month interim reporting periods ended September 27, 2009.

 

 

 

 

 

Amount of Gain/(Loss) Recognized in

 

In millions

 

 

 

Income on Derivatives

 

Derivatives Not Designated as Hedging

 

Location of Gain/(Loss) Recognized

 

September 27, 2009

 

Instruments

 

in Income on Derivatives

 

Three months ended

 

Nine months ended

 

Foreign currency forward contracts

 

Cost of sales

 

$

2

 

$

2

 

Foreign currency forward contracts

 

Other (expense) income, net

 

(8

)

10

 

 

18



 

Fair Value Amount and Location of Derivative Instruments

 

The following tables summarize the location and fair value of derivative instruments on our Condensed Consolidated Balance Sheets:

 

 

 

Asset Derivatives

 

 

 

Fair Value

 

 

 

In millions

 

September 27, 2009

 

Balance Sheet Location

 

Derivatives Designated as Hedging Instruments

 

 

 

 

 

Foreign currency forward contracts

 

$

2

 

Prepaid expenses and other current assets

 

Commodity swap contracts

 

5

 

Prepaid expenses and other current assets

 

Commodity swap contracts

 

3

 

Other assets

 

Interest rate contract

 

39

 

Other assets

 

Total Derivatives Designated as Hedging Instruments

 

$

49

 

 

 

 

 

 

 

 

 

Total asset derivatives

 

$

49

 

 

 

 

 

 

Liability Derivatives

 

 

 

Fair Value

 

 

 

In millions

 

September 27, 2009

 

Balance Sheet Location

 

Derivatives Designated as Hedging Instruments

 

 

 

 

 

Commodity swap contracts

 

$

10

 

Other accrued expenses

 

Commodity swap contracts

 

2

 

Other liabilities and deferred revenue

 

Total Derivatives Designated as Hedging Instruments

 

$

12

 

 

 

 

 

 

 

 

 

Derivatives Not Designated as Hedging Instruments

 

 

 

 

 

Foreign currency forward contracts

 

$

1

 

Other accrued expenses

 

Total Derivatives Not Designated as Hedging Instruments

 

$

1

 

 

 

 

 

 

 

 

 

Total liability derivatives

 

$

13

 

 

 

 

NOTE 12.  LEASE AMENDMENT AND EXTENSION

 

During 2001, we entered into a sale-leaseback transaction with a financial institution with regard to certain heavy-duty engine manufacturing equipment.  The lease was classified as an operating lease with a lease term of 11.5 years, expiring June 28, 2013.  The financial institution created a grantor trust to act as the lessor in the arrangement.  The financial institution owns all of the equity in the trust.  The grantor trust has no assets other than the equipment and its rights to the lease agreement with us.  On the initial sale, we received $125 million from the financial institution which was financed with $99 million of non-recourse debt and $26 million of equity.  Our obligations to the grantor trust consisted of the payments due under the lease and a $9 million guarantee of the residual value of the equipment.  In addition, we had a fixed price purchase option that was exercisable on January 14, 2009, for approximately $35 million; however, we decided not to exercise this option.

 

In December 2003, the grantor trust which acts as the lessor in the sale and leaseback transaction described above was consolidated as a result of the adoption of new accounting standards for variable interest entities, due primarily to the existence of the residual value guarantee.  As a result of the consolidation, the manufacturing equipment and the trust’s obligations under its non-recourse debt arrangement was included in our Condensed Consolidated Balance Sheets as property, plant and equipment and long-term debt, respectively.  The equity in the trust held by the financial institution was reported as noncontrolling interest.  The non-recourse debt arrangement is more fully discussed in Note 10, “DEBT” to our annual Consolidated Financial Statements included in our 2008 Form 10-K.  In addition, our Condensed Consolidated Statements of Income included interest expense on the lessor’s debt

 

19



 

obligations and depreciation expense on the manufacturing equipment rather than rent expense under the lease agreement.  In April 2008, the trust made the final payment on the non-recourse debt.

 

In February 2009, we amended the lease agreement to extend the lease for an additional two years to June 2015, and we removed the residual value guarantee.  As a result of removing the residual value guarantee, we are no longer required to consolidate the grantor trust and we deconsolidated the trust in the first quarter of 2009.  With the deconsolidation, we are now required to account for the leasing arrangement with the trust which qualifies as a capital lease.  The deconsolidation of the trust had minimal impact on our Condensed Consolidated Financial Statements as the present value of the minimum lease payments (including the extension) approximated the amount that was reported as noncontrolling interest as of the date of the amendment.  The reduction in noncontrolling interests and increase in our capital lease liabilities was $35 million.

 

The future lease payments required under the amended lease are as follows:

 

In millions

 

Payment

 

Due date

 

amount

 

2009

 

$

1

 

2010

 

 

2011

 

 

2012

 

12

 

2013

 

10

 

Thereafter

 

18

 

 

The lease agreement includes certain default provisions requiring us to make timely rent payments, maintain, service, repair and insure the equipment and maintain minimum debt ratings for our long-term senior unsecured debt obligations.

 

NOTE 13.  COMPREHENSIVE INCOME

 

The tables below represent a reconciliation of our net income to comprehensive income for the three and nine month periods ended September 27, 2009, and September 28, 2008.

 

 

 

Three months ended September 27, 2009

 

Three months ended September 28, 2008

 

 

 

Attributable to

 

Attributable to
Noncontrolling

 

Total

 

Attributable to

 

Attributable to
Noncontrolling

 

Total

 

In millions

 

Cummins Inc.

 

Interests

 

Consolidated

 

Cummins Inc.

 

Interests

 

Consolidated

 

Net income

 

$

95

 

$

15

 

$

110

 

$

229

 

$

18

 

$

247

 

Other comprehensive income (loss), net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on marketable securities

 

 

 

 

1

 

1

 

2

 

Unrealized (loss) gain on derivatives

 

21

 

 

21

 

(25

)

 

(25

)

Foreign currency translation adjustments

 

(5

)

3

 

(2

)

(99

)

(14

)

(113

)

Change in pensions and other postretirement defined benefit plans

 

53

 

 

53

 

5

 

 

5

 

Total other comprehensive income (loss)

 

69

 

3

 

72

 

(118

)

(13

)

(131

)

Total comprehensive income

 

$

164

 

$

18

 

$

182

 

$

111

 

$

5

 

$

116

 

 

20



 

 

 

Nine months ended September 27, 2009

 

Nine months ended September 28, 2008

 

 

 

Attributable to

 

Attributable to Noncontrolling

 

Total

 

Attributable to

 

Attributable to Noncontrolling

 

Total

 

In millions

 

Cummins Inc.

 

Interests