Table of Contents

 

 

 

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 26, 2010

 

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 26, 2010, there were 197,809,683 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.

 

 

 



Table of Contents

 

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 26, 2010, and September 27, 2009

3

 

 

 

 

Condensed Consolidated Balance Sheets at September 26, 2010, and December 31, 2009

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 26, 2010, and September 27, 2009

5

 

 

 

 

Condensed Consolidated Statements of Changes in Equity for the nine months ended September 26, 2010, and September 27, 2009

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

44

 

 

 

ITEM 1A.

Risk Factors

45

 

 

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

45

 

 

 

ITEM 6.

Exhibits

46

 

 

 

 

Signatures

47

 

2



Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

ITEM 1.  Condensed Consolidated Financial Statements

 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

 

Three months ended

 

Nine months ended

 

In millions, except per share amounts

 

September 26, 
2010

 

September 27,
 2009

 

September 26, 
2010

 

September 27, 
2009

 

NET SALES (a)

 

$

3,401

 

$

2,530

 

$

9,087

 

$

7,400

 

Cost of sales

 

2,571

 

2,027

 

6,903

 

6,004

 

GROSS MARGIN

 

830

 

503

 

2,184

 

1,396

 

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES AND INCOME

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

375

 

304

 

1,064

 

891

 

Research, development and engineering expenses

 

103

 

90

 

291

 

254

 

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

 

88

 

57

 

261

 

147

 

Restructuring and other charges (Note 14)

 

 

22

 

 

95

 

Other operating (expense) income, net

 

(5

)

3

 

(13

)

(6

)

OPERATING INCOME

 

435

 

147

 

1,077

 

297

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

6

 

2

 

14

 

5

 

Interest expense

 

11

 

9

 

29

 

26

 

Other income (expense), net

 

8

 

6

 

25

 

(10

)

INCOME BEFORE INCOME TAXES

 

438

 

146

 

1,087

 

266

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

129

 

36

 

338

 

72

 

CONSOLIDATED NET INCOME

 

309

 

110

 

749

 

194

 

 

 

 

 

 

 

 

 

 

 

Less: Net income attributable to noncontrolling interests

 

26

 

15

 

71

 

36

 

NET INCOME ATTRIBUTABLE TO CUMMINS INC.

 

$

283

 

$

95

 

$

678

 

$

158

 

 

 

 

 

 

 

 

 

 

 

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CUMMINS INC.

 

 

 

 

 

 

 

 

 

Basic

 

$

1.45

 

$

0.48

 

$

3.44

 

$

0.80

 

Diluted

 

$

1.44

 

$

0.48

 

$

3.43

 

$

0.80

 

 

 

 

 

 

 

 

 

 

 

WEIGHTED AVERAGE SHARES OUTSTANDING

 

 

 

 

 

 

 

 

 

Basic

 

$

195.8

 

$

197.4

 

$

197.0

 

$

197.1

 

Dilutive effect of stock compensation awards

 

$

0.5

 

$

0.4

 

$

0.4

 

$

0.3

 

Diluted

 

$

196.3

 

$

197.8

 

$

197.4

 

$

197.4

 

 

 

 

 

 

 

 

 

 

 

CASH DIVIDENDS DECLARED PER COMMON SHARE

 

$

0.2625

 

$

0.175

 

$

0.6125

 

$

0.525

 

 


(a) Includes sales to nonconsolidated equity investees of $580 million and $1,524 million and $428 million and $1,279 million for the three and nine months ended September 26, 2010 and September 27, 2009, respectively.

 

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

 

3



Table of Contents

 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

September 26,

 

December 31,

 

In millions, except par value

 

2010

 

2009

 

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

937

 

$

930

 

Marketable securities

 

308

 

190

 

Accounts and notes receivable, net

 

 

 

 

 

Trade and other

 

1,938

 

1,730

 

Nonconsolidated equity investees

 

297

 

274

 

Inventories (Note 6)

 

1,910

 

1,341

 

Deferred income taxes

 

328

 

295

 

Prepaid expenses and other current assets

 

260

 

243

 

Total current assets

 

5,978

 

5,003

 

Long-term assets

 

 

 

 

 

Property, plant and equipment

 

4,838

 

4,765

 

Accumulated depreciation

 

(2,947

)

(2,879

)

Property, plant and equipment, net

 

1,891

 

1,886

 

Investments and advances related to equity method investees

 

689

 

574

 

Goodwill

 

365

 

364

 

Other intangible assets, net

 

219

 

228

 

Deferred income taxes

 

313

 

436

 

Other assets

 

417

 

325

 

Total assets

 

$

9,872

 

$

8,816

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Current liabilities

 

 

 

 

 

Loans payable

 

$

98

 

$

37

 

Accounts payable (principally trade)

 

1,339

 

957

 

Current portion of accrued product warranty (Note 7)

 

396

 

426

 

Accrued compensation, benefits and retirement costs

 

452

 

366

 

Deferred revenue

 

166

 

128

 

Other accrued expenses

 

620

 

518

 

Total current liabilities

 

3,071

 

2,432

 

Long-term liabilities

 

 

 

 

 

Long-term debt

 

732

 

637

 

Pensions

 

362

 

514

 

Postretirement benefits other than pensions

 

448

 

453

 

Other liabilities and deferred revenue

 

765

 

760

 

Total liabilities

 

5,378

 

4,796

 

 

 

 

 

 

 

Commitments and contingencies (Note 8)

 

 

 

 

 

 

 

 

 

EQUITY

 

 

 

 

 

Cummins Inc. shareholders’ equity

 

 

 

 

 

Common stock, $2.50 par value, 500 shares authorized, 221.8 and 222.0 shares issued

 

1,922

 

1,860

 

Retained earnings

 

4,135

 

3,575

 

Treasury stock, at cost, 24.0 and 20.7 shares

 

(967

)

(731

)

Common stock held by employee benefits trust, at cost, 2.2 and 3.0 shares

 

(27

)

(36

)

Accumulated other comprehensive loss

 

 

 

 

 

Defined benefit postretirement plans

 

(778

)

(788

)

Other

 

(86

)

(107

)

Total accumulated other comprehensive loss

 

(864

)

(895

)

Total Cummins Inc. shareholders’ equity

 

4,199

 

3,773

 

Noncontrolling interests

 

295

 

247

 

Total equity

 

4,494

 

4,020

 

Total liabilities and equity

 

$

9,872

 

$

8,816

 

 

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

 

4



Table of Contents

 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Nine months ended

 

 

 

September 26,

 

September 27,

 

In millions

 

2010

 

2009

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Consolidated net income

 

$

749

 

$

194

 

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

 

 

 

 

 

Restructuring and other charges, net of cash payments

 

 

21

 

Depreciation and amortization

 

239

 

238

 

Gain on fair value adjustment for consolidated investee (Note 15)

 

(12

)

 

Deferred income taxes

 

83

 

(11

)

Equity in income of investees, net of dividends

 

(95

)

56

 

Pension contributions in excess of expense

 

(114

)

(49

)

Other post-retirement benefits payments in excess of expense

 

(22

)

(18

)

Stock-based compensation expense

 

17

 

16

 

Translation and hedging activities

 

10

 

33

 

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

 

 

 

 

 

Accounts and notes receivable

 

(198

)

89

 

Inventories

 

(524

)

360

 

Other current assets

 

(16

)

32

 

Accounts payable

 

336

 

(155

)

Accrued expenses

 

102

 

(185

)

Changes in long-term liabilities

 

97

 

103

 

Other, net

 

(33

)

6

 

Net cash provided by operating activities

 

619

 

730

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Capital expenditures

 

(170

)

(204

)

Investments in internal use software

 

(28

)

(24

)

Proceeds from disposals of property, plant and equipment

 

46

 

8

 

Investments in and advances to equity investees

 

(17

)

(5

)

Acquisition of businesses, net of cash acquired (Note 15)

 

(77

)

(2

)

Investments in marketable securities—acquisitions

 

(560

)

(234

)

Investments in marketable securities—liquidations

 

452

 

171

 

Purchases of other investments

 

(54

)

(54

)

Cash flows from derivatives not designated as hedges

 

2

 

(21

)

Other, net

 

 

1

 

Net cash used in investing activities

 

(406

)

(364

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from borrowings

 

163

 

11

 

Payments on borrowings and capital lease obligations

 

(64

)

(60

)

Net borrowings under short-term credit agreements

 

(4

)

(4

)

Distributions to noncontrolling interests

 

(21

)

(16

)

Dividend payments on common stock

 

(120

)

(106

)

Proceeds from sale of common stock held by employee benefit trust

 

52

 

54

 

Repurchases of common stock

 

(241

)

 

Other, net

 

25

 

1

 

Net cash used in financing activities

 

(210

)

(120

)

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

 

4

 

14

 

Net increase in cash and cash equivalents

 

7

 

260

 

Cash and cash equivalents at beginning of year

 

930

 

426

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 

$

937

 

$

686

 

 

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

 

5



Table of Contents

 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

Common

 

 

 

Total

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

Stock

 

 

 

Cummins 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, 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 11)

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(35

)

(35

)

Other shareholder transactions

 

 

 

3

 

 

 

 

 

 

 

 

 

4

 

7

 

 

7

 

BALANCE AT SEPTEMBER 27, 2009

 

$

555

 

$

1,287

 

$

3,340

 

$

(862

)

$

(713

)

$

(43

)

$

(1

)

$

3,563

 

$

240

 

$

3,803

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE AT DECEMBER 31, 2009

 

$

555

 

$

1,306

 

$

3,575

 

$

(895

)

$

(731

)

$

(36

)

$

(1

)

$

3,773

 

$

247

 

$

4,020

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

678

 

 

 

 

 

 

 

 

 

678

 

71

 

749

 

Other comprehensive income (loss) (Note 11)

 

 

 

 

 

 

 

31

 

 

 

 

 

 

 

31

 

9

 

40

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

709

 

80

 

789

 

Issuance of shares

 

 

 

5

 

 

 

 

 

 

 

 

 

 

 

5

 

 

5

 

Employee benefits trust activity

 

 

 

58

 

 

 

 

 

 

 

9

 

 

 

67

 

 

67

 

Acquisition of shares

 

 

 

 

 

 

 

 

 

(241

)

 

 

 

 

(241

)

 

(241

)

Cash dividends on common stock

 

 

 

 

 

(120

)

 

 

 

 

 

 

 

 

(120

)

 

(120

)

Distribution to noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(23

)

(23

)

Stock option exercises

 

 

 

 

 

 

 

 

 

5

 

 

 

 

 

5

 

 

5

 

Deconsolidation of variable interest entity (Note 3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(11

)

(11

)

Other shareholder transactions

 

 

 

(2

)

2

 

 

 

 

 

 

 

1

 

1

 

2

 

3

 

BALANCE AT SEPTEMBER 26, 2010

 

$

555

 

$

1,367

 

$

4,135

 

$

(864

)(1)

$

(967

)

$

(27

)

$

 

$

4,199

 

$

295

 

$

4,494

 

 


(1)Comprised of defined benefit postretirement plans of $(778) million, foreign currency translation adjustments of $(98) million, unrealized gain on marketable securities of $4 million and unrealized gain on derivatives of $8 million.

 

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

 

6



Table of Contents

 

CUMMINS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1NATURE OF OPERATIONS

 

Cummins Inc. (“Cummins,” “the Company,” “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, 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 usually ends on the Sunday closest to the last day of the quarterly calendar period.  The third quarters of 2010 and 2009 ended on September 26, and September 27, respectively.  The interim periods for both 2010 and 2009 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, restructuring costs, income taxes and deferred tax valuation allowances, lease classifications and contingencies.  Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be different from these estimates.

 

In preparing our Condensed Consolidated Financial Statements, we evaluated subsequent events through the date our quarterly report was filed with the Securities and Exchange Commission.

 

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 26, 2010, and September 27, 2009, were as follows:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 26,

 

September 27,

 

September 26,

 

September 27,

 

 

 

2010

 

2009

 

2010

 

2009

 

Options excluded

 

3,795

 

28,717

 

9,993

 

61,585

 

 

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, 2009.  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 Consolidated Balance Sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.

 

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NOTE 3.  RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

Accounting Pronouncements Recently Adopted

 

In January 2010, the Financial Accounting Standards Board (FASB) amended its standards related to fair value measurements and disclosures, which are effective for interim and annual fiscal periods beginning after December 15, 2009, except for disclosures about certain Level 3 activity which will not become effective until interim and annual periods beginning after December 15, 2010.  The new standard requires us to disclose transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers as well as activity in Level 3 fair value measurements.  The new standard also requires a more detailed level of disaggregation of the assets and liabilities being measured as well as increased disclosures regarding inputs and valuation techniques of the fair value measurements.  Our disclosures related to the new standard are included in Note 9.

 

In June 2009, the FASB amended its standards for accounting for transfers of financial assets, which was 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 requires us to report any activity under our receivable sales program as secured borrowings.  As of September 26, 2010, there were no outstanding amounts under our receivable sales program and there was no significant activity during the quarter.

 

In June 2009, the FASB amended its existing standards related to the consolidation of variable interest entities, which was 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.  The only significant impact of the adoption of this standard was to deconsolidate Cummins Komatsu Engine Corporation (CKEC) as of January 1, 2010 and to account for CKEC under GAAP accounting for equity method investees.  The impact of the deconsolidation on our Condensed Consolidated Statements of Income was minimal as all sales were eliminated in consolidation in the past.  The most significant impacts on our Condensed Consolidated Balance Sheets were to decrease current assets by $9 million, decrease long-term assets by $10 million, increase investments and advances related to equity method investees by $11 million and decrease noncontrolling interest by $11 million.

 

Accounting Pronouncements Issued But Not Yet Effective

 

In July 2010, the FASB amended its standards regarding the disclosures for credit quality of financing receivables and the allowance for credit losses.  The objective of the amendment is to provide a greater level of disaggregated information about the credit quality of financing receivables, the allowance for credit losses, and timely recognition of such losses.  Specifically, the amendment requires an entity to disclose credit quality indicators, past due information and modifications of its financing receivables.  The new rules are effective for us beginning December 31, 2010.  We are in the process of evaluating the impact that this amendment will have on our Consolidated Financial Statements.

 

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

 

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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 26,

 

September 27,

 

September 26,

 

September 27,

 

In millions

 

2010

 

2009

 

2010

 

2009

 

Distribution Entities

 

 

 

 

 

 

 

 

 

North American distributors

 

$

 26

 

$

 25

 

$

 72

 

$

 74

 

All other distributors

 

5

 

4

 

13

 

11

 

 

 

 

 

 

 

 

 

 

 

Manufacturing Entities

 

 

 

 

 

 

 

 

 

Dongfeng Cummins Engine Company, Ltd.

 

24

 

11

 

76

 

18

 

Chongqing Cummins Engine Company, Ltd.

 

12

 

8

 

35

 

28

 

Tata Cummins, Ltd.

 

4

 

2

 

11

 

2

 

Shanghai Fleetguard Filter Co., Ltd.

 

3

 

2

 

9

 

5

 

Valvoline Cummins, Ltd.

 

2

 

3

 

7

 

5

 

All other manufacturers

 

5

 

(2

)

16

 

(7

)

Cummins share of net income

 

81

 

53

 

239

 

136

 

Royalty and interest income

 

7

 

4

 

22

 

11

 

Equity, royalty and interest income from investees

 

$

 88

 

$

 57

 

$

 261

 

$

 147

 

 

NOTE 5. 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 26,

 

September 27,

 

September 26,

 

September 27,

 

In millions

 

2010 

 

2009 

 

2010 

 

2009

 

Defined benefit pension and other postretirement plans:

 

 

 

 

 

 

 

 

 

Voluntary pension

 

$

11

 

$

  55

 

$

  106

 

$

  100

 

Mandatory pension

 

5

 

8

 

61

 

22

 

Defined benefit pension contributions

 

16

 

63

 

167

 

122

 

Other postretirement plans

 

20

 

13

 

37

 

40

 

Total defined benefit plans

 

$

  36

 

$

  76

 

$

  204

 

$

  162

 

Defined contribution pension plans

 

$

  10

 

$

  9

 

$

  33

 

$

  32

 

 

We presently anticipate contributing approximately $220 million to our defined benefit pension plans in 2010 and paying approximately $53 million in claims and premiums for other postretirement benefits.  The $220 million of contributions for the full year include voluntary contributions of approximately $108 million.  These contributions and payments may be made from trusts or company funds either to increase pension assets or to make direct benefit payments to plan participants.

 

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

 

 

 

Pension

 

 

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

Other Postretirement Benefits

 

 

 

Three months ended

 

 

 

September 26,

 

September 27,

 

September 26,

 

September 27,

 

September 26,

 

September 27,

 

In millions

 

2010

 

2009

 

2010

 

2009

 

2010

 

2009

 

Service cost

 

$

11

 

$

11

 

$

5

 

$

5

 

$

 

$

 

Interest cost

 

29

 

28

 

14

 

15

 

7

 

7

 

Expected return on plan assets

 

(36

)

(34

)

(18

)

(16

)

 

 

Amortization of prior service (credit) cost

 

(1

)

 

1

 

1

 

(2

)

(2

)

Recognized net actuarial loss

 

9

 

8

 

4

 

5

 

 

 

Net periodic benefit cost

 

12

 

$

13

 

$

6

 

$

10

 

$

5

 

$

5

 

Curtailment loss

 

 

6

 

 

 

 

6

 

Net periodic benefit cost after curtailment losses

 

$

12

 

$

19

 

$

6

 

$

10

 

$

5

 

$

11

 

 

 

 

Pension

 

 

 

 

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

Other Postretirement Benefits

 

 

 

Nine months ended

 

 

 

September 26,

 

September 27,

 

September 26,

 

September 27,

 

September 26,

 

September 27,

 

In millions

 

2010

 

2009

 

2010

 

2009

 

2010

 

2009

 

Service cost

 

$

34

 

$

34

 

$

14

 

$

13

 

$

 

$

 

Interest cost

 

84

 

85

 

43

 

42

 

21

 

22

 

Expected return on plan assets

 

(110

)

(104

)

(53

)

(44

)

 

 

Amortization of prior service (credit) cost

 

(1

)

(1

)

2

 

3

 

(6

)

(6

)

Recognized net actuarial loss

 

27

 

23

 

13

 

15

 

 

 

Other

 

 

1

 

 

 

 

 

Net periodic benefit cost

 

34

 

38

 

19

 

29

 

15

 

16

 

Curtailment loss

 

 

6

 

 

 

 

6

 

Net periodic benefit cost after curtailment losses

 

$

34

 

$

44

 

$

19

 

$

29

 

$

15

 

$

22

 

 

As disclosed in Note 14, we have executed many restructuring actions in 2008 and 2009.  As a result, our U.S. pension and other postretirement benefit plans were remeasured at September 27, 2009 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 was  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.

 

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NOTE 6.  INVENTORIES

 

Inventories included the following:

 

 

 

September 26,

 

December 31,

 

In millions

 

2010

 

2009

 

Finished products

 

$

964

 

$

785

 

Work-in-process and raw materials

 

1,036

 

638

 

Inventories at FIFO cost

 

2,000

 

1,423

 

Excess of FIFO over LIFO

 

(90

)

(82

)

Total inventories

 

$

1,910

 

$

1,341

 

 

NOTE 7.  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 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 26,

 

September 27,

 

In millions

 

2010

 

2009

 

Balance, beginning of period

 

$

989

 

$

962

 

Provision for warranties issued

 

250

 

241

 

Deferred revenue on extended warranty contracts sold

 

78

 

77

 

Payments

 

(310

)

(352

)

Amortization of deferred revenue on extended warranty contracts

 

(64

)

(54

)

Changes in estimates for pre-existing warranties

 

(16

)

67

 

Foreign currency translation

 

 

12

 

Balance, end of period

 

$

927

 

$

953

 

 

Warranty related deferred revenue, supplier recovery receivables and the long-term portion of the warranty liability on our September 26, 2010, balance sheet were as follows:

 

 

 

September 26,

 

 

 

In millions

 

2010

 

Balance Sheet Locations

 

Deferred revenue related to extended coverage programs:

 

 

 

 

 

Current portion

 

$

86

 

Deferred revenue

 

Long-term portion

 

189

 

Other liabilities and deferred revenue

 

Total

 

$

275

 

 

 

 

 

 

 

 

 

Receivables related to estimated supplier recoveries:

 

 

 

 

 

Current portion

 

$

7

 

Trade and other receivables

 

Long-term portion

 

5

 

Other assets

 

Total

 

$

12

 

 

 

 

 

 

 

 

 

Long-term portion of warranty liability

 

$

256

 

Other liabilities and deferred revenue

 

 

NOTE 8.  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 U.S. federal and related state environmental statutes and regulations and may have joint and several liability for any investigation and remediation costs incurred

 

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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 are complex, subject to varying interpretations and we are often engaged in litigation regarding the application of these laws to particular circumstances.  In the third quarter of 2010, it was determined that we overpaid a Brazilian revenue based tax during the period 2004-2008.  Our results include a pre-tax recovery of $32 million recorded in cost of sales ($21 million after-tax) related to tax credits on imported products arising from an overpayment. This recovery has been excluded from segment results as it was not considered by management in its evaluation of operating results for the quarter.

 

In June 2008, four of our sites in Southern Indiana, including our Technical Center, experienced extensive flood damage.  We have submitted a claim for $220 million to our insurance carriers, which includes a claim for business interruption.  As of September 26, 2010, we have received $92 million in recoveries from the insurance carriers.  Our insurance carriers have disputed certain aspects of our claim and the parties have filed suit against each other.  Although we believe that we are insured against the full amount of our claim, there is no assurance that we will be successful recovering the amounts we believe are due under the policies.

 

U.S. Distributor Commitments

 

Our distribution 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 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.

 

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 26, 2010, 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 26, 2010, the maximum potential loss related to these other guarantees is $79 million ($46 million of which relates to the Beijing Foton guarantee discussed below and $32 million relates to the Cummins Olayan Energy Limited guarantee 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 26, 2010, if we were to stop purchasing from each of these suppliers, the amount of the penalty would be approximately $65 million, of which $59 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 $180 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 $90 million (at current exchange rates).  As of September 26, 2010, outstanding borrowings under this agreement

 

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were $92 million and our guarantee was $46 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.

 

In February 2010, Cummins Olayan Energy Limited, a 49 percent owned entity accounted for under the equity method, executed a four-year $101 million (at current exchange rates) debt financing arrangement to acquire certain rental equipment assets.  As a part of this transaction, we guaranteed 49 percent of the total outstanding loan amount or $49 million (at current exchange rates).  As of September 26, 2010, outstanding borrowings under this agreement were $65 million and our guarantee was $32 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 have guarantees with certain customers that require us to satisfactorily honor contractual or regulatory obligations, or compensate for monetary losses related to nonperformance.  These performance bonds and other performance-related guarantees at September 26, 2010, were $75 million.

 

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 26, 2010, we have committed to invest an additional $54 million into existing joint ventures of which $29 million will be funded in 2010.

 

NOTE 9.  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.  Derivative assets and liabilities are derived from 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.  When material, we adjust the values of our derivative contracts for counter-party or our credit risk.  There were no transfers into or out of Levels 2 or 3 in the first nine months of  2010.

 

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The following table summarizes our financial instruments recorded at fair value in our Condensed Consolidated Balance Sheets at September 26, 2010:

 

 

 

Fair Value Measurements Using

 

 

 

Quoted prices in 
active markets for
identical assets

 

Significant other
observable inputs

 

Significant 
unobservable inputs

 

 

 

In millions

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Available-for-sale debt securities:

 

 

 

 

 

 

 

 

 

Debt mutual funds

 

$

103

 

$

54

 

$

 

$

157

 

Bank debentures

 

 

80

 

 

80

 

Certificates of deposit

 

 

56

 

 

56

 

Government debt securities-non-U.S.

 

 

3

 

 

3

 

Corporate debt securities

 

 

2

 

 

2

 

Total available-for-sale debt securities

 

103

 

195

 

 

298

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale equity securities:

 

 

 

 

 

 

 

 

 

Financial services industry

 

10

 

 

 

10

 

Total available-for-sale equity securities

 

10

 

 

 

10

 

 

 

 

 

 

 

 

 

 

 

Derivative assets:

 

 

 

 

 

 

 

 

 

Commodity swap contracts

 

 

15

 

 

15

 

Foreign currency forward contracts

 

 

1

 

 

1

 

Interest rate contracts

 

 

61

 

 

61

 

Total derivative assets

 

 

77

 

 

77

 

Total

 

$

113

 

$

272

 

$

 

$

385

 

 

The substantial majority of our assets were valued utilizing a market approach.  A description of the valuation techniques and inputs used for our level 2 fair value measures are as follows:

 

Debt mutual funds — Assets in level 2 consist of exchange traded mutual funds that lack sufficient trading volume to be classified at level 1.  The fair value measure for these investments is the daily net asset value published on a regulated governmental website.  Daily quoted prices are available from the issuing brokerage and are used on a test basis to corroborate this level 2 input.

 

Bank debentures and Certificates of deposit — These investments provide us with a fixed rate of return and generally range in maturity from six months to one year.  The counter-parties to these investments are reputable financial institutions with investment grade credit ratings.  Since these instruments are not tradable and must be settled directly by Cummins with the respective financial institution, our fair value measure is the financial institutions’ month-end statement.

 

Government debt securities-non-U.S. and Corporate debt securities — The fair value measure for these securities are broker quotes received from reputable firms.  These securities are infrequently traded on a national stock exchange and these values are used on a test basis to corroborate our level 2 input measure.

 

Foreign currency forward contracts — The fair value measure for these contracts are determined based on forward foreign exchange rates received from third-party pricing services.  These rates are based upon market transactions and are periodically corroborated by comparing to third-party broker quotes.

 

Commodity swap contracts — The fair value measure for these contracts are current spot market data adjusted for the appropriate current forward curves provided by external financial institutions.  The current spot price is the most significant component of this valuation and is based upon market transactions.  We use third-party pricing services for the spot price component of this valuation which is periodically corroborated by market data from broker quotes.

 

Interest rate contracts — We currently have only one interest rate contract.  We utilize the month-end statement from the issuing financial institution as our fair value measure for this investment.  We corroborate this valuation through the use of a third-party pricing service for similar assets and liabilities.

 

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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 and carrying value of total debt, including current maturities, at September 26, 2010 and December 31, 2009, was as follows:

 

 

 

September 26,

 

December 31,

 

In millions

 

2010

 

2009

 

Fair value of total debt

 

$

920

 

$

674

 

Carrying value of total debt

 

853

 

703

 

 

NOTE 10.  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 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 Exchange Rates

 

As a result of our international business presence, we are exposed to foreign currency exchange risks.  We transact business in foreign currencies and, as a result, our income experiences some volatility related to movements in foreign currency exchange rates.  To help manage our exposure to exchange rate volatility, we use foreign exchange forward contracts on a regular basis to hedge forecasted intercompany and third-party sales and purchases denominated in non-functional currencies.  Our internal policy allows for managing anticipated foreign currency cash 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 26, 2010, the amount we expect to reclassify from AOCL to income over the next year is less than $1 million.  For the nine month periods ended September 26, 2010 and September 27, 2009, 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.

 

The table below summarizes our outstanding foreign currency forward contracts.  Only the U.S. dollar forward contracts are designated and qualify for hedge accounting as of each period presented below.  The currencies in this table represent 97 percent and 96 percent of the notional amounts of contracts outstanding  as of September 26, 2010 and December 31, 2009, respectively.

 

 

 

Notional amount in millions

 

 

 

September 26,

 

December 31,

 

Currency denomination

 

2010

 

2009

 

United States Dollar (USD)

 

170

 

107

 

British Pound Sterling (GBP)

 

113

 

70

 

Euro (EUR)

 

32

 

12

 

Singapore Dollar (SGD)

 

15

 

15

 

Indian Rupee (INR)

 

2,127

 

616

 

Japanese Yen (JPY)

 

4,067

 

1,335

 

Romanian Leu (RON)

 

 

44

 

Canadian Dollar (CAD)

 

22

 

 

South Korea Won (KRW)

 

19,443

 

2,115

 

Chinese Renmimbi (CNY)

 

129

 

39

 

 

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Table of Contents

 

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 26, 2010, we expect to reclassify an unrealized net gain of $9 million from AOCL to income over the next year.  For the nine month period ended September 26, 2010, there were no material circumstances that would have resulted in the discontinuance of a cash flow hedge.  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 for the nine months ended September 27, 2009.  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 26, 2010

 

December 31, 2009

 

Commodity

 

Notional Amount

 

Quantity

 

Notional Amount

 

Quantity

 

Copper

 

$

48

 

7,216 metric tons

(1)

$

77

 

11,372 metric tons

(1)

Platinum

 

8

 

8,442 troy ounces

(2)

14

 

15,986 troy ounces

(2)

Palladium

 

1

 

1,678 troy ounces

(2)

1

 

3,161 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.

 

In November 2005, we entered into an interest rate swap to effectively convert our $250 million debt issue, 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.”  The following table summarizes these gains and losses for the three and nine month interim reporting periods presented below:

 

 

 

Three months ended

 

Nine months ended

 

In millions

 

September 26, 2010

 

September 27, 2009

 

September 26, 2010

 

September 27, 2009

 

Income Statement 
Classification

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Interest expense

 

$

14

 

$

(14

)

$

6

 

$

(6

)

$

36

 

$

(36

)

$

(40

)

$

40

 

 

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Table of Contents

 

Cash Flow Hedging

 

The following table summarizes 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 table does not include amounts related to ineffectiveness as it was not material for the periods presented.

 

 

 

 

 

Three months ended

 

Nine months ended

 

In millions
Derivatives in Cash

 

Location of 
Gain/(Loss) 
Reclassified 
into Income 

 

Amount of Gain/(Loss) 
Recognized in

AOCL on Derivative 
(Effective Portion)

 

Amount of Gain/(Loss) 
Reclassified from

AOCL into Income 
(Effective Portion)

 

Amount of Gain/(Loss) 
Recognized in

AOCL on Derivative 
(Effective Portion)

 

Amount of Gain/(Loss) 
Reclassified from

AOCL into Income 
(Effective Portion)

 

Flow Hedging

 

(Effective 

 

September 26,

 

September 27,

 

September 26,

 

September 27,

 

September 26,

 

September 27,

 

September 26,

 

September 27,

 

Relationships

 

Portion)

 

2010

 

2009

 

2010

 

2009

 

2010

 

2009

 

2010

 

2009

 

Foreign currency forward contracts

 

Net sales

 

$

2

 

$

(1

)

$

(1

)

$

5

 

$

(5

)

$

8

 

$

(5

)

$

(3

)

Commodity swap contracts

 

Cost of sales

 

8

 

14

 

1

 

(5

)

4

 

43

 

5

 

(22

)

Total

 

 

 

$

10

 

$

13

 

$

 

$

 

$

(1

)

$

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 presented below.

 

 

 

 

 

Three months ended

 

Nine months ended

 

In millions

 

Location of Gain/(Loss)

 

Amount of Gain/(Loss) Recognized 
in Income on Derivatives

 

Amount of Gain/(Loss) Recognized 
in Income on Derivatives

 

Derivatives Not Designated as

 

Recognized in Income

 

September 26,

 

September 27,

 

September 26,

 

September 27,

 

Hedging Instruments

 

on Derivatives

 

2010

 

2009

 

2010

 

2009

 

Foreign currency forward contracts

 

Cost of sales

 

$

(6

)

$

2

 

$

(4

)

$

2

 

Foreign currency forward contracts

 

Other income (expense), net

 

12

 

(8

)

6

 

10

 

 

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:

 

 

 

 

Derivative assets

 

 

 

Fair Value

 

 

 

 

 

September 26,

 

December 31,

 

 

 

In millions

 

2010

 

2009

 

Balance Sheet Location

 

Derivatives Designated as Hedging Instruments

 

 

 

 

 

 

 

Commodity swap contracts

 

$

14

 

$

9

 

Prepaid expenses and other current assets

 

Commodity swap contracts

 

1

 

8

 

Other assets

 

Interest rate contract

 

61

 

25

 

Other assets

 

Total Derivatives Designated as Hedging Instruments

 

76

 

42

 

 

 

 

 

 

 

 

 

 

 

Derivatives Not Designated as Hedging Instruments

 

 

 

 

 

 

 

Foreign currency forward contracts

 

1

 

 

Prepaid expenses and other current assets

 

Total Derivatives Not Designated as Hedging Instruments

 

1

 

 

 

 

 

 

 

 

 

 

 

 

Total derivative assets

 

$

77

 

$

42

 

 

 

 

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Table of Contents

 

NOTE 11.  COMPREHENSIVE INCOME

 

The table below provides a summary of total comprehensive income and the allocation of total comprehensive income between the shareholders of Cummins Inc. and the non-controlling interests for the three and nine month periods ended September 26, 2010 and September 27, 2009.

 

 

 

Three months ended

 

 

 

September 26, 2010

 

September 27, 2009

 

In millions

 

Attributable to 
Cummins Inc.

 

Attributable to 
Noncontrolling 
Interests

 

Total 
Consolidated

 

Attributable to 
Cummins Inc.

 

Attributable to 
Noncontrolling 
Interests

 

Total 
Consolidated

 

Net income

 

$

283

 

$

26

 

$

309

 

$

95

 

$

15

 

$

110

 

Other comprehensive income (loss), net of tax