Cummins Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

OPERATING SEGMENTS

OPERATING SEGMENTS

12 Months Ended

Dec. 31, 2018

NOTE 20. OPERATING SEGMENTS

Operating segments under GAAP are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (CODM), or decision-making group, in deciding how to allocate resources and in assessing performance. Our CODM is the President and Chief Operating Officer.

Our reportable operating segments consist of Engine, Distribution, Components, Power Systems and Electrified Power. This reporting structure is organized according to the products and markets each segment serves. The Engine segment produces engines (15 liters and less in size) and associated parts for sale to customers in on-highway and various off-highway markets. Our engines are used in trucks of all sizes, buses and recreational vehicles, as well as in various industrial applications, including construction, agriculture, power generation systems and other off-highway applications. The Distribution segment includes wholly-owned and partially-owned distributorships engaged in wholesaling engines, generator sets and service parts, as well as performing service and repair activities on our products and maintaining relationships with various OEMs throughout the world. The Components segment sells filtration products, aftertreatment systems, turbochargers, electronics, fuel systems and transmissions. The Power Systems segment is an integrated power provider, which designs, manufactures and sells engines (16 liters and larger) for industrial applications (including mining, oil and gas, marine and rail), standby and prime power generator sets, alternators and other power components.

We formed the Electrified Power segment, effective January 1, 2018, which designs, manufactures, sells and supports electrified power systems ranging from fully electric to hybrid solutions along with innovative components and subsystems to serve all our markets as they adopt electrification, meeting the needs of our OEM partners and end customers. We currently offer the Cummins PowerDrive series of fully electric and hybrid powertrain systems targeting various applications in the Class 4-8 commercial vehicle markets and are developing the Cummins Battery Electric System and the Cummins Hybrid Power Plug-In System for the urban bus market, which are expected to launch in 2019 and 2020, respectively. We also design and manufacture battery modules, packs and systems for commercial, industrial and material handling applications. We use a range of cell chemistries which are suitable for pure electric, hybrid and plug-in hybrid applications. In addition to electrified powertrains for urban buses, we intend to deliver product offerings to other markets as they adopt electric solutions, including, but not limited to, pick-up and delivery applications and industrial markets. We invest in and utilize our internal research and development capabilities, along with strategic acquisitions and partnerships, to meet our objectives.

Effective January 1, 2018, we changed our segment measure of profitability to EBITDA (defined as earnings before interest expense, income taxes, noncontrolling interests, depreciation and amortization) as the primary basis for the CODM to evaluate the performance of each of our reportable operating segments. EBITDA assists investors and debt holders in comparing our performance on a consistent basis without regard for depreciation and amortization, which can vary significantly depending upon many factors. Prior periods have been revised to reflect the current presentation. Segment amounts exclude certain expenses not specifically identifiable to segments.

The accounting policies of our operating segments are the same as those applied in our Consolidated Financial Statements. We prepared the financial results of our operating segments on a basis that is consistent with the manner in which we internally disaggregate financial information to assist in making internal operating decisions. We allocate certain common costs and expenses, primarily corporate functions, among segments differently than we would for stand-alone financial information prepared in accordance with GAAP. These include certain costs and expenses of shared services, such as information technology, human resources, legal, finance and supply chain management. We do not allocate changes in cash surrender value of corporate owned life insurance to individual segments. EBITDA may not be consistent with measures used by other companies.Summarized financial information regarding our reportable operating segments at December 31, is shown in the table below:



In millions	Engine		Distribution		Components ⁽¹⁾		Power Systems		Electrified Power			Total Segments		Intersegment Eliminations ⁽²⁾			Total
2018
External sales	$	8,002	$	7,807	$	5,331	$	2,625	$	6		$	23,771	$	—		$	23,771
Intersegment sales	2,564		21		1,835		2,001		1			6,422		(6,422		)	—
Total sales	10,566		7,828		7,166		4,626		7			30,193		(6,422		)	23,771
Research, development and engineering expenses	311		20		272		230		69			902		—			902
Equity, royalty and interest income from investees	238		46		54		56		—			394		—			394
Interest income	11		13		5		6		—			35		—			35
Segment EBITDA	1,446		563		1,030		614		(90		)	3,563		(87		)	3,476
Depreciation and amortization ⁽³⁾	190		109		185		119		6			609		—			609
Net assets ⁽⁴⁾	1,265		2,677		2,878		2,262		138			9,220		—			9,220
Investments and advances to equity investees	561		278		206		177		—			1,222		—			1,222
Capital expenditures	254		133		182		129		11			709		—			709
2017
External sales	$	6,661	$	7,029	$	4,363	$	2,375	$	—		$	20,428	$	—		$	20,428
Intersegment sales	2,292		29		1,526		1,683		—			5,530		(5,530		)	—
Total sales	8,953		7,058		5,889		4,058		—			25,958		(5,530		)	20,428
Research, development and engineering expenses	280		19		241		214		—			754		—			754
Equity, royalty and interest income from investees ⁽⁵⁾	219		44		40		54		—			357		—			357
Interest income	6		6		3		3		—			18		—			18
Loss contingency ⁽⁶⁾	5		—		—		—		—			5		—			5
Segment EBITDA	1,143		500		917		411		—			2,971		55			3,026
Depreciation and amortization ⁽³⁾	184		116		163		117		—			580		—			580
Net assets ⁽⁴⁾	1,180		2,446		2,811		2,137		—			8,574		—			8,574
Investments and advances to equity investees	531		267		194		164		—			1,156		—			1,156
Capital expenditures	188		101		127		90		—			506		—			506

(Table continued on next page)



In millions	Engine		Distribution			Components		Power Systems			Electrified Power		Total Segments		Intersegment Eliminations ⁽²⁾			Total
2016
External sales	$	5,774	$	6,157		$	3,514	$	2,064		$	—	$	17,509	$	—		$	17,509
Intersegment sales	2,030		24			1,322		1,453			—		4,829		(4,829		)	—
Total sales	7,804		6,181			4,836		3,517			—		22,338		(4,829		)	17,509
Research, development and engineering expenses	227		13			208		189			—		637		—			637
Equity, royalty and interest income from investees	148		70			41		42			—		301		—			301
Interest income	10		4			4		5			—		23		—			23
Loss contingency ⁽⁶⁾	138		—			—		—			—		138		—			138
Segment EBITDA	849		508		⁽⁷⁾	774		378		⁽⁸⁾	—		2,509		17			2,526
Depreciation and amortization ⁽³⁾	163		116			133		115			—		527		—			527
Net assets ⁽⁴⁾	1,334		2,157			1,643		2,202			—		7,336		—			7,336
Investments and advances to equity investees	427		204			176		139			—		946		—			946
Capital expenditures	200		96			143		92			—		531		—			531

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⁽¹⁾	Includes Eaton Cummins Automated Transmission Technologies joint venture results consolidated during the third quarter of 2017. See Note 19, "ACQUISITIONS," for additional information.


⁽²⁾	Includes intersegment sales, intersegment profit in inventory eliminations and unallocated corporate expenses. There were no significant unallocated corporate expenses for the years ended 2018, 2017 and 2016, respectively.

⁽³⁾

Depreciation and amortization as shown on a segment basis excludes the amortization of debt discount and deferred costs that are included in the Consolidated Statements of Income as "Interest expense." The amortization of debt discount and deferred costs were $2 million, $3 million and $3 million for the years ended 2018, 2017 and 2016, respectively. A portion of depreciation expense is included in "Research, development and engineering expense."

⁽⁴⁾

In 2018, we reevaluated our net asset allocation methodology and realigned it to both simplify and better represent our reportable segments consistent with how the Chief Operating Decision Maker evaluates them. In accordance with the realignment, we reclassified historical segment net assets for 2016 and 2017 to be consistent with our 2018 presentation. Key changes during the realignment were to remove cash equivalents and marketable securities from segment net assets as these corporate items are not managed and evaluated at the segment level.


⁽⁵⁾	U.S. tax legislation passed in December 2017 decreased our equity earnings at certain equity investees, negatively impacting our equity, royalty and interest income from investees by $23 million, $4 million and $12 million for the Engine, Distribution and Components segments, respectively. See Note 4, "INCOME TAXES," for additional information.


⁽⁶⁾	See Note 9, "PRODUCT WARRANTY LIABILITY," for additional information.


⁽⁷⁾	Distribution segment EBITDA included gains on the fair value adjustment resulting from the acquisition of controlling interests in North American distributors of $15 million for the year ended December 31, 2016. See Note 19, "ACQUISITIONS," for additional information.

⁽⁸⁾

Power Systems segment EBITDA included a $17 million gain on the sale of an equity investee for the year ended December 31, 2016. See Note 3, "INVESTMENTS IN EQUITY INVESTEES," for additional information.A reconciliation of our segment information to the corresponding amounts in the Consolidated Statements of Income is shown in the table below:



	Years ended December 31,
In millions	2018		2017		2016
Total EBITDA	$	3,476	$	3,026	$	2,526
Less:
Depreciation and amortization	609		$	580	527
Interest expense	114		$	81	$	69
Income before income taxes	$	2,753	$	2,365	$	1,930

A reconciliation of our segment net assets to the corresponding amounts in the Consolidated Balance Sheets is shown in the table below:



	December 31,
In millions	2018		2017			2016
Net assets for operating segments ⁽¹⁾	$	9,220	$	8,574		$	7,336
Cash, cash equivalents and marketable securities	1,525		1,567			1,380
Brammo Inc. assets	—		72		⁽²⁾	—
Liabilities deducted in arriving at net assets	7,836		7,398			6,157
Pension and other postretirement benefit adjustments excluded from net assets	68		156			(284		)
Deferred tax assets not allocated to segments	410		306			420
Deferred debt costs not allocated to segments	3		2			2
Total assets	$	19,062	$	18,075		$	15,011

____________________________________________________

⁽¹⁾


⁽²⁾	Assets associated with the Brammo Inc. acquisition were presented as a reconciling item as Brammo Inc. had not yet been assigned to a reportable segment at December 31, 2017. See Note 19, "ACQUISITIONS," for additional information.

See Note 2, "DISAGGREGATION OF REVENUE," for segment net sales by geographic area.

Long-lived assets include property, plant and equipment, net of depreciation, investments and advances to equity investees and other assets, excluding deferred tax assets, refundable taxes and deferred debt expenses. Long-lived segment assets by geographic area were as follows:



	December 31,
In millions	2018		2017		2016
United States	$	3,174	$	3,157	$	3,092
China	823		795		652
India	577		563		475
United Kingdom	337		339		254
Netherlands	234		221		197
Mexico	171		136		131
Canada	114		116		132
Brazil	104		149		149
Other international countries	329		293		236
Total long-lived assets	$	5,863	$	5,769	$	5,318

Our largest customer is PACCAR Inc. Worldwide sales to this customer were $3,643 million, $2,893 million and $2,359 million for the years ended December 31, 2018, 2017 and 2016, representing 15 percent, 14 percent and 13 percent, respectively, of our consolidated net sales. No other customer accounted for more than 10 percent of consolidated net sales.