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 28, 2008

 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 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 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 28, 2008, there were 201,372,272 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

 

 

  

 

 

 

 

 

 

PART I. FINANCIAL INFORMATION

 

 

 

 

 

   

 

ITEM 1.

Condensed Financial Statements (Unaudited)

 

 

 

 

 

Condensed Consolidated Statements of Income for the three and nine months ended September 28, 2008 and September 30, 2007

 

 

 

 

 

Condensed Consolidated Balance Sheets at September 28, 2008 and December 31, 2007

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 28, 2008 and September 30, 2007

 

 

 

 

 

Condensed Consolidated Statements of Shareholders' Equity for the nine months ended September 28, 2008 and September 30, 2007

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

 

 

 

ITEM 2.

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

 

 

   

 

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

 

 

   

 

ITEM 4.

Controls and Procedures

 

 

   

 

 

PART II. OTHER INFORMATION

 

 

 

 

ITEM 1.

Legal Proceedings

 

 

 

 

ITEM 1A.

Risk Factors

 

 

   

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

ITEM 5

Other Information  
     

ITEM 6.

Exhibits

 

 

   

 

 

Signatures

 

 

 

 


 


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 28,

 

September 30,

 

September 28,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

in millions
(except per share amounts)

 

NET SALES (a)

 

$

3,693

 

$

3,372

 

$

11,054

 

$

9,532

 

Cost of  sales

 

2,873

 

2,720

 

8,648

 

7,658

 

GROSS MARGIN

 

820

 

652

 

2,406

 

1,874

 

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES AND INCOME

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

388

 

340

 

1,109

 

937

 

Research, development and engineering expenses

 

113

 

82

 

320

 

236

 

Equity, royalty and interest income from investees (Note 5)

 

66

 

58

 

202

 

146

 

Flood damage expenses (Note 12)

 

 

 

6

 

 

Other operating (expense) income, net

 

(2

)

1

 

(3

)

6

 

 

 

 

 

 

 

 

 

 

 

OPERATING INCOME

 

383

 

289

 

1,170

 

853

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

4

 

9

 

14

 

27

 

Interest expense

 

10

 

14

 

33

 

44

 

Other (expense) income, net

 

(7

)

8

 

(20

)

23

 

INCOME BEFORE INCOME TAXES AND MINORITY INTERESTS

 

370

 

292

 

1,131

 

859

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

123

 

97

 

372

 

284

 

Minority interests in income of consolidated subsidiaries

 

18

 

11

 

47

 

34

 

NET INCOME

 

$

229

 

$

184

 

$

712

 

$

541

 

 

 

 

 

 

 

 

 

 

 

EARNINGS PER COMMON SHARE

 

 

 

 

 

 

 

 

 

Basic

 

$

1.18

 

$

0.93

 

$

3.65

 

$

2.71

 

Diluted

 

$

1.17

 

$

0.92

 

$

3.62

 

$

2.70

 

 

 

 

 

 

 

 

 

 

 

 

 

WEIGHTED AVERAGE SHARES OUTSTANDING

 

 

 

 

 

 

 

 

 

 

 

Basic

 

194.9

 

198.2

 

 

195.1

 

 

199.4

 

Dilutive effect of stock compensation awards

 

1.6

 

1.6

 

 

1.4

 

 

1.3

 

Diluted

 

196.5

 

199.8

 

 

196.5

 

 

200.7

 

 

 

 

 

 

 

 

 

 

 

 

 

CASH DIVIDENDS DECLARED PER COMMON SHARE

 

$

0.175

 

$

0.125

 

$

0.425

 

$

0.305

 


(a) Includes sales to nonconsolidated equity investees of $554 million and $1,636 million and $458 million and $1,280 million for the three and nine months ended September 28, 2008, and September 30, 2007, respectively.

 

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



 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

September 28,

 

December 31,

 

 

 

       2008       

 

       2007       

 

 

 

in millions
(except par value)

 

ASSETS

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

572

 

 

 

$

577

 

 

Marketable securities

 

 

83

 

 

 

120

 

 

Accounts and notes receivable, net

 

 

 

 

 

 

 

 

 

   Trade and other

 

 

2,072

 

 

 

1,754

 

 

   Nonconsolidated equity investees

 

 

231

 

 

 

244

 

 

Inventories (Note 6)

 

 

1,991

 

 

 

1,692

 

 

Deferred income taxes

 

 

308

 

 

 

276

 

 

Prepaid expenses and other current assets

 

 

191

 

 

 

152

 

 

Total current assets

 

 

5,448

 

 

 

4,815

 

 

Long-term assets

 

 

 

 

 

 

 

 

 

Property, plant and equipment

 

 

4,484

 

 

 

4,313

 

 

     Accumulated depreciation

 

 

(2,744

)

 

 

(2,668

)

 

     Property, plant and equipment, net

 

 

1,740

 

 

 

1,645

 

 

Investments and advances related to equity method investees

 

 

590

 

 

 

514

 

 

Goodwill and other intangible assets, net

 

 

577

 

 

 

538

 

 

Deferred income taxes and other assets

 

 

630

 

 

 

683

 

 

Total assets

 

 

$

8,985

 

 

 

$

8,195

 

 

LIABILITIES

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

Current portion of long-term debt and loans payable

 

 

$

80

 

 

 

$

119

 

 

Accounts payable (principally trade)

 

 

1,446

 

 

 

1,263

 

 

Current portion of accrued product warranty

 

 

376

 

 

 

337

 

 

Accrued compensation, benefits and retirement costs

 

 

404

 

 

 

441

 

 

Other accrued expenses

 

 

672

 

 

 

551

 

 

Total current liabilities

 

 

2,978

 

 

 

2,711

 

 

Long-term liabilities

 

 

 

 

 

 

 

 

 

Long-term debt

 

 

587

 

 

 

555

 

 

Pensions and other postretirement benefits

 

 

571

 

 

 

633

 

13 

Other liabilities and deferred revenue

 

 

704

 

 

 

594

 

 

Total liabilities

 

 

4,840

 

 

 

4,493

 

 

Commitments and contingencies (Note 9)

 

 

 

 

 

 

 

MINORITY INTERESTS

 

 

253

 

 

 

293

 

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

Common stock, $2.50 par value, 500 shares authorized, 221.5 and 220.4 shares issued

 

 

1,784

 

 

 

1,719

 

 

Retained earnings

 

 

3,281

 

 

 

2,660

 

 

Treasury stock, at cost, 20.2 and 18.2 shares

 

 

(711

)

 

 

(593

)

 

Common stock held by employee benefits trust, at cost, 5.6 and 6.5 shares

 

 

(68

)

 

 

(79

)

 

Unearned compensation

 

 

(6

)

 

 

(11

)

 

Accumulated other comprehensive loss

 

 

 

 

 

 

 

 

 

Defined benefit postretirement plans

 

 

(363

)

 

 

(378

)

 

Other

 

 

(25

)

 

 

91

 

 

Total accumulated other comprehensive loss

 

 

(388

)

 

 

(287

)

 

Total shareholders’ equity

 

 

3,892

 

 

 

3,409

 

 

Total liabilities, minority interests and shareholders’ equity

 

 

$

8,985

 

 

 

$

8,195

 

 

 

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



CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

Nine months ended

 

 

 

September 28,

 

September 30,

 

 

 

2008

 

2007

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

in millions

 

Net income

 

$

712

 

$

541

 

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

 

 

 

 

 

Depreciation and amortization

 

233

 

215

 

Net gain on disposal of property, plant and equipment

 

(3

)

(8

)

Deferred income taxes                                   

 

38

 

69

 

Equity in earnings of investees, net of dividends

 

(80

)

(55

)

Minority interest in income of consolidated subsidiaries

 

47

 

34

 

Pension expense (Note 4)

 

54

 

73

 

Pension contributions

 

(94

)

(144

)

Other post-retirement benefits expense, net of cash payments

 

(11

)

(22

)

Stock-based compensation expense

 

27

 

20

 

Excess tax benefits on stock-based awards

 

(12

)

(11

)

Translation and hedging activities

 

15

 

(19

)

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

 

 

 

 

 

Accounts and notes receivable

 

(310

)

(222

)

Inventories

 

(334

)

(329

)

Other current assets

 

(35

)

(22

)

Accounts payable

 

198

 

218

 

Accrued expenses

 

206

 

121

 

Changes in long-term liabilities

 

78

 

65

 

Other, net

 

(4

)

(1

)

Net cash provided by operating activities

 

725

 

523

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Capital expenditures

 

(330

)

(182

)

Investments in internal use software

 

(53

)

(46

)

Proceeds from disposals of property, plant and equipment

 

20

 

33

 

Investments in and advances to equity investees

 

(51

)

(27

)

Acquisition of businesses, net of cash acquired (Note 11)

 

(142

)

(20

)

Proceeds from the sale of an equity investment (Note 11)

 

64

 

 

Investments in marketable securities—acquisitions

 

(264

)

(307

)

Investments in marketable securities—liquidations

 

281

 

295

 

Purchases of other investments

 

(54

)

(52

)

Other, net

 

(23

)

(17

)

Net cash used in investing activities

 

(552

)

(323

)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from borrowings

 

91

 

3

 

Payments on borrowings and capital lease obligations

 

(111

)

(122

)

Net borrowings under short-term credit agreements

 

5

 

(14

)

Distributions to minority shareholders

 

(14

)

(15

)

Dividend payments on common stock

 

(86

)

(63

)

Proceeds from sale of common stock held by employee benefit trust

 

52

 

 

Repurchases of common stock

 

(123

)

(210

)

Excess tax benefits on stock-based awards

 

12

 

11

 

Other, net

 

3

 

(17

)

Net cash used in financing activities

 

(171

)

(427

)

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

 

(7

)

11

 

Net decrease in cash and cash equivalents

 

(5

)

(216

)

Cash and cash equivalents at beginning of year

 

577

 

840

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 

$

572

 

$

624

 

 

 

 

 

 

 

 

 

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

 



 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(Unaudited)

 

 

 

 

 

 

 

 

Accumulated

 

 

 

Common

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

Stock

 

 

 

Total

 

 

 

Common

 

paid-in

 

Retained

 

Comprehensive

 

Treasury

 

Held in

 

Unearned

 

Shareholders’

 

 

 

Stock

 

Capital

 

Earnings

 

 Loss

 

Stock

 

Trust

 

Compensation

 

Equity

 

 

 

in millions

 

BALANCE AT DECEMBER 31, 2006

 

$

137

 

$

1,500

 

$

2,009

 

$

(526

)

$

(212

)

$

(92

)

 $

(14

)

$

2,802

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Net income

 

 

 

 

 

541

 

 

 

 

 

 

 

 

 

541

 

   Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on marketable securities

 

 

 

 

 

 

 

3

 

 

 

 

 

 

 

3

 

Unrealized gain on derivatives

 

 

 

 

 

 

 

8

 

 

 

 

 

 

 

8

 

Foreign currency translation adjustments

 

 

 

 

 

 

 

100

 

 

 

 

 

 

 

100

 

Change in pensions and other postretirement defined benefit plans

 

 

 

 

 

 

 

(17

)

 

 

 

 

 

 

(17

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

635

 

Issuance of shares

 

1

 

6

 

 

 

 

 

5

 

 

 

 

 

12

 

Stock splits

 

138

 

(138

)

 

 

 

 

 

 

 

 

 

 

 

Employee benefits trust activity

 

 

 

42

 

 

 

 

 

(52

)

10

 

 

 

 

Acquisition of shares

 

 

 

 

 

 

 

 

 

(210

)

 

 

 

 

(210

)

Cash dividends on common stock

 

 

 

 

 

(63

)

 

 

 

 

 

 

 

 

(63

)

Stock option exercises

 

 

 

1

 

 

 

 

 

 

 

 

 

 

 

1

 

Other shareholder transactions

 

 

 

15

 

1

 

 

 

 

 

 

 

2

 

18

 

BALANCE AT SEPTEMBER 30, 2007

 

$

276

 

$

1,426

 

$

2,488

 

$

(432

)

$

(469

)

$

(82

)

$

(12

)

$

3,195

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE AT DECEMBER 31, 2007

 

$

551

 

$

1,168

 

$

2,660

 

$

(287

)

$

(593

)

$

(79

)

$

(11

)

$

3,409

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Net income

 

 

 

 

 

712

 

 

 

 

 

 

 

 

 

712

 

   Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss on marketable securities

 

 

 

 

 

 

 

(4

)

 

 

 

 

 

 

(4

)

Unrealized loss on derivatives

 

 

 

 

 

 

 

(7

)

 

 

 

 

 

 

(7

)

Foreign currency translation adjustments

 

 

 

 

 

 

 

(105

)

 

 

 

 

 

 

(105

)

Change in pensions and other postretirement defined benefit plans

 

 

 

 

 

 

 

17

 

 

 

 

 

 

 

17

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

613

 

Effect of changing pension plan measurement date pursuant to SFAS No. 158

 

 

 

 

 

(5

)

(2

)

 

 

 

 

 

 

(7

)

Issuance of shares

 

3

 

 

 

 

 

 

 

 

 

 

 

 

 

3

 

Employee benefits trust activity

 

 

 

41

 

 

 

 

 

 

 

11

 

 

 

52

 

Acquisition of shares

 

 

 

 

 

 

 

 

 

(123

)

 

 

 

 

(123

)

Cash dividends on common stock

 

 

 

 

 

(86

)

 

 

 

 

 

 

 

 

(86

)

Stock option exercises

 

 

 

(1

)

 

 

 

 

5

 

 

 

 

 

4

 

Other shareholder transactions

 

 

 

22

 

 

 

 

 

 

 

 

 

5

 

27

 

BALANCE AT SEPTEMBER 28, 2008

 

$

554

 

$

1,230

 

$

3,281

 

$

(388

)(1)

$

(711

)

$

(68

)

 $

(6

)

$

3,892

 

 

(1) Comprised of defined benefit postretirement plans of $(363) million, foreign currency translation adjustments of $(23) million, unrealized gain on marketable securities of $2 million and unrealized loss on derivatives of $(4) million.

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

 


 

CUMMINS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1.  NATURE OF OPERATIONS

 

Cummins Inc. (“Cummins,” “the Company,” “the registrant,” “we,” “our,” or “us”) is a global power leader that designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration 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 ends on the Sunday closest to the last day of the quarterly calendar period. The third quarter of 2008 and 2007 ended on September 28, and September 30, respectively. The interim periods for both 2008 and 2007 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.

 

Comprehensive income is comprised of net income, as well as adjustments for foreign currency translation, marketable securities, derivative instruments designated as cash flow hedges and pension and other postretirement defined benefits. Total comprehensive income for the three and nine months ended September 28, 2008, was $110 million and $613 million, respectively. Total comprehensive income for the three and nine months ended September 30, 2007, was $225 million and $635 million, respectively.

 

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, 2007. 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 balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.

 

NOTE 3.   RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

Accounting Pronouncements Recently Adopted

 

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 157, “Fair Value Measurements” (SFAS 157), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The adoption of SFAS 157, effective January 1, 2008, did not have a material impact on our Condensed Consolidated Financial Statements. See Note 10 for further information regarding the adoption of this standard.

 


Accounting Pronouncements Issued But Not Yet Effective

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS 141R), which is effective for fiscal years beginning after December 15, 2008. SFAS 141R makes significant changes to both the accounting and disclosures related to the acquisition of a business and could materially impact how we account for future business combination transactions. Because the standard will only impact transactions entered into after January 1, 2009, SFAS 141R will not impact our Condensed Consolidated Financial Statements upon adoption.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (SFAS 160), which is effective for fiscal years beginning after December 15, 2008. SFAS 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements” (ARB 51) and establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the accounting for future ownership changes with respect to those subsidiaries. For Cummins, the most significant impact of the standard, at adoption, will be to reclassify our minority interests ($253 million at September 28, 2008) to be included as a part of equity, which may affect certain performance and equity ratios. We are currently evaluating the potential additional impact that SFAS 160 may have on our Condensed Consolidated Financial Statements.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (SFAS 161), which is effective for fiscal years beginning after November 15, 2008. SFAS 161 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133) and requires enhanced disclosures about a company’s derivative and hedging activities. We do not expect the adoption of SFAS 161 to have a material impact on our Condensed Consolidated Financial Statements, but are still evaluating the additional disclosure requirements.

 

NOTE 4.  PENSION AND OTHER POSTRETIREMENT BENEFITS

 

We sponsor both funded and unfunded domestic and foreign defined benefit pension and other postretirement plans. Cash contributions to these plans for the three and nine month periods ended September 28, 2008 and September 30, 2007, respectively, were as follows:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 28,

 

September 30,

 

September 28,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Defined benefit pension and postretirement plans:

 

in millions

 

Voluntary

 

$

46

 

$

22

 

$

70

 

$

82

 

Mandatory

 

21

 

31

 

51

 

99

 

Total defined benefit plans

 

$

67

 

$

53

 

$

121

 

$

181

 

Defined contribution pension plans

 

$

6

 

$

4

 

$

24

 

$

19

 

 

We presently anticipate contributing $95 million to $105 million to our defined benefit pension plans in 2008 and paying approximately $60 million in claims and premiums for other postretirement benefits. The $95 million to $105 million of contributions for the full year include voluntary contributions of $70 million to $75 million. These contributions and payments include payments from Company funds either to increase pension assets or to make direct payments to plan participants.

 

We have adopted the measurement date provisions of SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (SFAS 158), effective January 1, 2008. The majority of our pension and other postretirement plans previously used a November 30 measurement date. All plans are now measured at December 31, consistent with the company’s fiscal year end. The non-cash effect of the adoption of the measurement date provisions of SFAS 158 decreased shareholders’ equity by approximately $7 million ($5 million after-tax) and increased long-term liabilities by approximately $10 million. There was no effect on our results of operations.

 


 


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

 

 

 

Pension

 

Other

Postretirement

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

Benefits

 

 

 

Three months ended

 

 

 

September 28,

 

September 30,

 

September 28,

 

September 30,

 

September 28,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

2008

 

2007

 

 

 

in millions

 

Service cost

 

$

12

 

$

12

 

$

6

 

$

8

 

$

 

$

 

Interest cost

 

28

 

26

 

17

 

16

 

8

 

8

 

Expected return on plan assets

 

(37

)

(35

)

(18

)

(18

)

 

 

Amortization of prior service cost (credit)

 

 

 

 

1

 

(2

)

(2

)

Recognized net actuarial loss (gain)

 

5

 

8

 

5

 

6

 

 

(1

)

Net periodic benefit cost

 

$

8

 

$

11

 

$

10

 

$

13

 

$

6

 

$

5

 

 

 

 

Pension

 

Other

Postretirement

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

Benefits

 

 

 

Nine months ended

 

 

 

September 28,

 

September 30,

 

September 28,

 

September 30,

 

September 28,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

2008

 

2007

 

 

 

in millions

 

Service cost

 

$

36

 

$

35

 

$

20

 

$

24

 

$

 

$

 

Interest cost

 

86

 

80

 

49

 

47

 

24

 

23

 

Expected return on plan assets

 

(113

)

(105

)

(56

)

(53

)

 

 

Amortization of prior service cost (credit)

 

 

(1

)

2

 

3

 

(7

)

(7

)

Recognized net actuarial loss (gain)

 

15

 

24

 

15

 

19

 

(1

)

(1

)

Net periodic benefit cost

 

$

24

 

$

33

 

$

30

 

$

40

 

$

16

 

$

15

 

 

NOTE 5.  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 28,

 

September 30,

 

September 28,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

in millions

 

North American distributors

 

$

26

 

$

22

 

$

72

 

$

59

 

Dongfeng Cummins Engine Company, Ltd

 

16

 

12

 

50

 

29

 

Chongqing Cummins Engine Company, Ltd

 

9

 

5

 

23

 

15

 

Shanghai Fleetguard Filter Co. Ltd.

 

2

 

1

 

7

 

4

 

Tata Cummins Ltd.

 

 

3

 

7

 

9

 

Cummins MerCruiser Diesel Marine LLC.

 

(1

)

2

 

5

 

9

 

All others

 

9

 

9

 

22

 

12

 

Cummins share of net earnings

 

61

 

54

 

186

 

137

 

Royalty and interest income

 

5

 

4

 

16

 

9

 

Equity, royalty and interest income from investees

 

$

66

 

$

58

 

$

202

 

$

146

 

 



NOTE 6.  INVENTORIES

 

Inventories included the following:

      

 

 

September 28,

 

December 31,

 

 

 

  2008  

 

  2007  

 

 

 

in millions

 

Finished products

 

$

958

 

$

770

 

Work-in-process and raw materials

 

1,126

 

1,007

 

Inventories at FIFO cost

 

2,084

 

1,777

 

Excess of FIFO over LIFO

 

(93

)

(85

)

Total inventories

 

$

1,991

 

$

1,692

 

 

NOTE 7.  REVOLVING CREDIT FACILITY

 

On June 30, 2008, we entered into a Three-Year Revolving Credit Agreement, (the “Credit Agreement”), with a syndicate of lenders and issuers named therein. The Credit Agreement provides a $1.1 billion senior unsecured revolving credit facility (the “Credit Facility”), the proceeds of which are to be used to provide for working capital or for other general corporate purposes of Cummins.

 

The Credit Facility matures on June 30, 2011. The Credit Facility is unsecured and amounts payable under it will rank pro rata with all other unsecured, unsubordinated indebtedness of Cummins. Borrowings under the Credit Facility will primarily be denominated in U.S. dollars. A portion of the Credit Facility, up to $200 million, is available for Letters of Credit denominated in U.S. dollars or Alternate Currencies. In addition, up to $200 million of the Revolving Credit Facility will be available in Pounds Sterling or Euros. A portion of the Credit Facility, up to $100 million, is available for swingline loans denominated in U.S. dollars. Loans will bear interest at (i) a base rate or (ii) a rate equal to LIBOR plus an applicable margin based on the credit ratings of Cummins outstanding senior unsecured long-term debt. Based on our current long-term debt ratings, the applicable margin on LIBOR loans will be 0.75 percent per annum as of September 28, 2008. Loans may be prepaid without premium or penalty, subject to customary breakage costs.

 

The Credit Facility replaces $650 million in aggregate principal amount of a revolving credit facility (Former Credit Agreement) maintained by Cummins which was terminated effective June 30, 2008.

 

The Credit Agreement includes covenants substantially similar to those in the Former Credit Agreement, including, among others, (a) a leverage ratio, (b) fixed charge coverage ratio, (c) limitations on priority indebtedness, (d) limitations on our ability to consummate a merger, consolidation or sale of all or substantially all of our assets and (e) limitations on our ability to change the nature of our business.

 

The obligation of Cummins to pay amounts outstanding under the Credit Facility may be accelerated upon the occurrence of an “Event of Default” as defined in the Credit Agreement. Such Events of Default include, among others, (a) Cummins failure to pay the principal of, or interest on, borrowings under the Credit Facility, (b) any representation or warranty of Cummins in the Credit Agreement proving to be materially false or misleading, (c) Cummins breach of any of its covenants contained in the Credit Agreement and (d) the bankruptcy or insolvency of Cummins.

 

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 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 28,

 

September 30,

 

 

 

2008

 

2007

 

 

 

in millions

Balance, beginning of period

 

$

749

 

$

652

 

Provision for warranties issued

 

319

 

298

 

Deferred revenue on extended warranty contracts sold

 

73

 

47

 

Payments

 

(258

)

(229

)

Amortization of deferred revenue on extended warranty contracts

 

(47

)

(37

)

Changes in estimates for pre-existing warranties

 

63

 

(14

)

Foreign currency translation

 

(10

)

5

 

Balance, end of period

 

$

889

 

$

722

 

 

The amount of deferred revenue related to extended coverage programs at September 28, 2008, was $212 million. At September 28, 2008, we had $15 million of receivables related to estimated supplier recoveries of which $6 million was included in “Trade and other” receivables and $9 million was included in “Deferred income taxes and other assets” on our Condensed Consolidated Balance Sheets.

 

NOTE 9.  COMMITMENTS AND CONTINGENCIES

 

We are defendants in a number of pending legal actions, including actions related to the use and performance of our products. We carry product liability insurance covering significant claims for damages involving personal injury and property damage. We also establish reserves for these and other matters in which losses are probable and can be reasonably estimated. In the event we are determined to be liable for damages in connection with actions and proceedings, the unaccrued portion of such liability is not expected to be material. We also have been identified as a potentially responsible party at several waste disposal sites under U.S. and related state environmental statutes and regulations and may have joint and several liability for any investigation and remediation costs incurred with respect to such sites. We deny liability with respect to many of these legal actions and environmental proceedings and are vigorously defending such actions or proceedings. We have established reserves that we believe are adequate for our expected future liability in such actions and proceedings where the nature and extent of such liability can be reasonably estimated based upon presently available information.

 

U.S. Distributor Guarantees

 

Since 1997 we have had an operating agreement with a financial institution that requires us to guarantee revolving loans, equipment term loans and leases, real property loans and letters of credit made by the financial institution to certain independent Cummins distributors in the United States, and to certain distributors in which we own an equity interest. In the first quarter of 2006, we amended, restated and simplified the terms of the operating agreement and removed the Cummins guarantee of distributor borrowings.

 

If any distributor defaults under its financing arrangement with the financial institution, and the maturity of amounts owed under the agreement is accelerated, then we are 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.

 

The operating agreement will continue to be in effect until February 7, 2009.

 

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 28, 2008, was $8 million.

 

Other Guarantees

 

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. The maximum potential loss related to these other guarantees is $36 million at September 28, 2008 ($33 million of which relates to the Beijing Foton discussion 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. At September 28, 2008, if we were to stop purchasing from each of these suppliers, the amount of the penalty would be approximately $103 million, of which $87 million relates to a six year contract with an engine parts supplier that extends from 2008 to 2013. Based on current forecasts, we do not anticipate paying any penalties under these contracts. This arrangement enables us to secure critical components important to our growth.

 

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 current exchange rates). As of September 30, 2008, outstanding borrowings under this agreement were $65 million and our guarantee was $33 million (at current exchange rates). We recorded a liability for the fair value of this guarantee in accordance with FASB Interpretation No. 45, “Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others—an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34.” 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.

 

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:

 

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 28, 2008, we have committed to invest $3 million into existing joint ventures. It is expected that $1 million will be funded in 2008, while $2 million will be funded in 2009.

 

NOTE 10.  FAIR VALUE OF FINANCIAL INSTRUMENTS

 

In September 2006, the FASB issued SFAS 157, which defines fair value, establishes a market-based framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value. SFAS 157 does not expand or require any new fair value measures. SFAS 157 is effective for financial assets and financial liabilities for fiscal years beginning after November 15, 2007. FASB Staff Position (FSP) 157-2 “Partial Deferral of the Effective Date of Statement No. 157” (FSP 157-2), deferred the effective date of SFAS 157 for most non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008. We adopted this statement prospectively for our fiscal year beginning January 1, 2008, except for non-financial assets and non-financial liabilities as deferred until January 1, 2009, by FSP 157-2. SFAS 157 does not require retroactive restatement of prior periods. The adoption of SFAS 157 did not materially impact our consolidated financial statements.

 


As defined in SFAS 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). We utilize market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. We primarily apply the market approach for recurring fair value measurements and utilize the best available information. Accordingly, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The company is able to classify fair value balances based on the observability of those inputs. SFAS 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurement). The three levels of the fair value hierarchy defined by SFAS 157 are as follows:

 

Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as exchange-traded derivatives, listed equities and publicly traded bonds.

 

Level 2 – Pricing inputs are other than quoted prices in active markets included in level 1, which are either directly or indirectly observable as of the reported date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Instruments in this category include non-exchange-traded derivatives such as over-the-counter forwards and options.

 

Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value. At each balance sheet date, the company performs an analysis of all instruments subject to SFAS 157 and includes, in level 3, all of those whose fair value is based on significant unobservable inputs. At September 28, 2008, we did not have any level 3 financial assets or liabilities.

 

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. We enter into hedging transactions with banking institutions that have strong credit ratings, and thus the credit risk associated with these contracts is not considered significant. For more discussion regarding our derivative instruments, see Note 18 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

The following table summarizes the fair value of our financial instruments at September 28, 2008:

 

 

 

Fair Value Measurements Using

 

 

Quoted Prices in Active Markets for Identical Assets (Level 1)

 

Significant Other Observable Inputs (Level 2)

 

Significant Unobservable Inputs (Level 3)

 

Total

 

 

 

in millions

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities

 

$

40

 

$

43

 

$

 

$

83

 

Net derivative asset (1)

 

 

7

 

 

7

 

Total

 

$

40

 

$

                50

 

$

 

$

90

 

 

(1) Includes approximately $16 million of Level 2 derivative liabilities, which are netted against derivative assets.

 

 

 

 

 

 

 

 

 

 


 

NOTE 11.  ACQUISITIONS AND INVESTMENTS

 

During the first nine months of 2008, we purchased a majority interest in three previously independent North American distributors in order to increase our ownership interests in key portions of the distribution channel. The acquisitions were accounted for under the purchase method of accounting and resulted in an aggregate purchase price of $81 million which we funded with $54 million of borrowings and $27 million of cash. The assets of the acquired businesses were primarily accounts receivable, inventory and fixed assets. There was less than $1 million of goodwill generated from these transactions. During the first three months of 2007, we purchased the remaining interest in a manufacturing joint venture and acquired ownership of an international independent distributor for approximately $20 million. We recorded goodwill of $13 million for these two transactions.

 

In July 2008, we entered into a transaction with two Fiat group companies to (1) sell our one-third interest in the European Engine Alliance (EEA) joint venture and simultaneously (2) purchase the remaining 50 percent interest in Consolidated Diesel Corporation (CDC). As a result, we now own 100 percent of CDC and no longer have an ownership interest in EEA. CDC was previously included in our consolidated results as we were considered the primary beneficiary under FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (FIN 46R). We sold our remaining interest in EEA for $64 million and subsequently purchased the remaining interest in CDC for $61 million, however, because the transactions were entered into simultaneously with the same counterparty, it is considered a non-monetary exchange for accounting purposes. Thus, we accounted for the transactions at fair value in accordance with FASB Statement 153 "Exchanges of Nonmonetary Assets." Because fair value and book value were reasonably close, there was no material gain or loss recorded on the sale of EEA. In addition, there were no significant adjustments from book value for any assets or liabilities of CDC recorded upon the acquisition of the remaining 50 percent interest.

 

NOTE 12.  FLOOD DAMAGE

 

In June 2008, Columbus, Indiana experienced significant flooding which impacted some of our facilities. One manufacturing facility was partially flooded. Our technical center, which houses engineering staff and contains dynamometer test cells and labs, was more severely impacted by the event which caused temporary displacement of the engineering workforce and suspension of testing for approximately five weeks. Critical testing was transferred to other Cummins facilities and external suppliers to minimize the interruption.

 

The physical damage to the facilities, costs of clean up and repair and business interruption were covered by insurance, subject to a deductible, which limited the economic impact of this event to the company. As of September 28, 2008, we recorded a net charge of $6 million for this event. The total clean up costs incurred as of September 28, 2008, were $26 million. The remaining clean up costs are estimated to range from $25 million to $35 million and will be spent during the next two quarters. We estimate the replacement value of assets impacted was approximately $90 million and we anticipate that asset replacements will be reflected in capital spending over the next five quarters. Most of these assets were fully depreciated at the time of the flood. Although this claim is significant, we believe we have sufficient insurance coverage after this claim for any future events. As of September 28, 2008, we have received $30 million in insurance recoveries.

 

We used our research and engineering facilities in other regions, not impacted by the flood, to continue our engineering and development activities while our research facilities in Columbus, Indiana were being repaired.

 

We are confident that our insurance coverage will limit the impact of this event.

 

NOTE 13.  OPERATING SEGMENTS

 

Our reportable operating segments consist of the following: Engine, Power Generation, Components and Distribution. This reporting structure is organized according to the products and markets each segment serves. We use segment EBIT (defined as earnings before interest expense, income taxes and minority interests) as the primary basis for the chief operating decision-maker to evaluate the performance of each operating segment.  



A summary of operating results by segment for the three and six month periods is shown below:

 

 

 

Engine

 

Power
Generation

 

Components

 


Distribution

 

Non-segment items(1)

 

Total

 

 

 

in millions

 

Three months ended September 28, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

External sales

 

$

1,927

 

 

$

653

 

 

$

535

 

 

$

578

 

 

$

 

 

$

3,693

 

Intersegment sales

 

 

352

 

 

 

235

 

 

 

266

 

 

 

3

 

 

 

(856

)

 

 

 

   Total sales

 

 

2,279

 

 

 

888

 

 

 

801

 

 

 

581

 

 

 

(856

)

 

 

3,693

 

Depreciation and amortization(2)

 

43

 

 

9

 

 

16

 

 

6

 

 

 

 

74

 

Research, development and engineering expense

 

75

 

 

11

 

 

27

 

 

 

 

 

 

113

 

Equity, royalty and interest income from investees

 

26

 

 

6

 

 

3

 

 

31

 

 

 

 

66

 

Interest income

 

2

 

 

1

 

 

1

 

 

 

 

 

 

4

 

Segment EBIT

 

160

 

 

108

 

 

61

 

 

61

 

 

(10

)

 

380

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

External sales

 

$

1,890

 

 

$

594

 

 

$

494

 

 

$

394

 

 

$

 

 

$

3,372

 

 

Intersegment sales

 

 

263

 

 

 

182

 

 

 

247

 

 

 

1

 

 

 

(693

)

 

 

 

 

   Total sales

 

 

2,153

 

 

 

776

 

 

 

741

 

 

 

395

 

 

 

(693

)

 

 

3,372

 

 

Depreciation and amortization(2)

 

45

 

 

11

 

 

14

 

 

3

 

 

 

 

73

 

Research, development and engineering expense

 

56

 

 

8

 

 

18

 

 

 

 

 

 

82

 

Equity, royalty and interest income from investees

 

24

 

 

5

 

 

3

 

 

26

 

 

 

 

58

 

Interest income

 

6

 

 

1

 

 

1

 

 

1

 

 

 

 

9

 

Segment EBIT

 

155

 

 

83

 

 

34

 

 

46

 

 

(12

)

 

306

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 28, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

External sales

 

$

5,842

 

 

$

1,926

 

 

$

1,686

 

 

$

1,600

 

 

$

 

 

$

11,054

 

Intersegment sales

 

 

1,032

 

 

 

687

 

 

 

790

 

 

 

7

 

 

 

(2,516

)

 

 

 

   Total sales

 

 

6,874

 

 

 

2,613

 

 

 

2,476

 

 

 

1,607

 

 

 

(2,516

)

 

 

11,054

 

Depreciation and amortization(2)

 

133

 

 

31

 

 

49

 

 

17

 

 

 

 

230

 

Research, development and engineering expense

 

215

 

 

31

 

 

74

 

 

 

 

 

 

320

 

Equity, royalty and interest income from investees

 

91

 

 

17

 

 

10

 

 

84

 

 

 

 

202

 

Interest income

 

7

 

 

3

 

 

3

 

 

1

 

 

 

 

14

 

Segment EBIT

 

575

 

 

301

 

 

175

 

 

178

 

 

(65

)

 

1,164

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

External sales

 

$

5,267

 

 

$

1,730

 

 

$

1,465

 

 

$

1,070

 

 

$

 

 

$

9,532

 

Intersegment sales

 

 

760

 

 

 

490

 

 

 

690

 

 

 

2

 

 

 

(1,942

)

 

 

 

   Total sales

 

 

6,027

 

 

 

2,220

 

 

 

2,155

 

 

 

1,072

 

 

 

(1,942

)

 

 

9,532

 

Depreciation and amortization(2)

 

132

 

 

31

 

 

43

 

 

8

 

 

 

 

214

 

Research, development and engineering expense

 

159

 

 

25

 

 

52

 

 

 

 

 

 

236

 

Equity, royalty and interest income from investees

 

66

 

 

12

 

 

1

 

 

67

 

 

 

 

146

 

Interest income

 

20

 

 

4

 

 

2

 

 

1

 

 

 

 

27

 

Segment EBIT

 

469

 

 

248

 

 

106

 

 

131

 

 

(51

)

 

903

 

 

(1) Includes intersegment sales and profit in inventory eliminations and unallocated corporate expenses including flood related expenses.

 

(2) Depreciation and amortization as shown on a segment basis excludes the amortization of debt discount that is included in the Condensed Consolidated Statements of Income as Interest expense.



 

A reconciliation of our segment information to the corresponding amounts in the Condensed Consolidated Statements of Income is shown in the table below:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 28,

 

September 30,

 

September 28,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

in millions

 

Segment EBIT

 

$

380

 

$

306

 

$

1,164

 

$

903

 

Less:

 

 

 

 

 

 

 

 

 

Interest expense

 

10

 

14

 

33

 

44

 

Income before income taxes and minority interests

 

$

370

 

$

292

 

$

1,131

 

$

859

 

 

 



 

ITEM 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Cummins Inc. and its consolidated subsidiaries are hereinafter sometimes referred to as “Cummins,” “the Company,” “the registrant,” “we,” “our,” or “us.”

 

CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION

 

Certain parts of this quarterly report contain forward-looking statements that are based on current expectations, estimates and projections about the industries in which we operate and management's beliefs and assumptions. Forward-looking statements are generally accompanied by words, such as “anticipates,” “expects,” “forecasts,” “intends,” “plans,” “believes,” “seeks,” “estimates” or similar expressions. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which we refer to as “future factors,” which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Future factors that could cause our results to differ materially from the results discussed in such forward-looking statements are discussed below. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Future factors that could affect the outcome of forward-looking statements include the following:

 

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



ORGANIZATION OF INFORMATION

 

The following Management's Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) was prepared to provide the reader with a view and perspective of our business through the eyes of management and should be read in conjunction with our Consolidated Financial Statements and related Notes to Consolidated Financial Statements in the “Financial Statements” section of our 2007 Annual Report on Form 10-K. Our MD&A is presented in the following sections:



EXECUTIVE SUMMARY

 

We are a global power leader that designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration and exhaust aftertreatment, fuel systems, controls and air handling systems. We sell our products to Original Equipment Manufacturers (OEMs), distributors and other customers worldwide. We have long-standing relationships with many of the leading manufacturers in the markets we serve, including Chrysler LLC, Daimler AG, Volvo AB, PACCAR Inc., International Truck and Engine Corporation (Navistar International Corporation), CNH Global N.V., Komatsu, Scania AB, Ford Motor Company and Volkswagen. We serve our customers through a network of more than 500 company-owned and independent distributor locations and approximately 5,200 dealer locations in more than 190 countries and territories.

 

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

 

Our financial performance depends, in large part, on varying conditions in the markets we serve, particularly the on-highway, construction and general industrial markets. Demand in these markets tends to fluctuate in response to overall economic conditions and is particularly sensitive to changes in interest rate levels and our customer’s access to credit. Our sales may also be impacted by OEM inventory levels and production schedules and stoppages. Economic downturns in markets we serve generally result in reductions in sales and pricing of our products. As a worldwide business, our operations are also affected by political, economic and regulatory matters, including environmental and emissions standards, in the countries we serve. However, our geographic diversity and broad product and service offerings have helped limit the impact of any one industry or customer and the economy of any single country on our consolidated results. In the first nine months of 2008, softness in the pick-up truck, recreational vehicle, and recreational marine markets worsened. Evidence of a downturn in the United States and European economies and softening in global markets became more evident. Despite these unfavorable conditions, we reported increased net sales and net income for the three and nine month periods ended September 28, 2008, over the same periods in 2007. Approximately 54 percent of our annual 2007 sales came from countries other than the United States and that trend grew to 61 percent and 60 percent for the three and nine months ended September 28, 2008, respectively. The diversity of our business portfolio has contributed to the significant organic growth we have experienced over the past several years and continued into 2008 despite more difficult economic conditions. While we expect the softness in certain markets to continue in the fourth quarter, we still believe 2008 will be a very strong year for Cummins.



RESULTS OF OPERATIONS

 

 

 

Three Months Ended

 

Favorable/

(Unfavorable)

 

Nine Months Ended

 

Favorable/ (Unfavorable)

 

 

 

September 28,

 

September 30,

 

 

 

 

 

September 28,

 

September, 30

 

 

 

 

 

 

 

2008

 

2007

 

Amount

 

Percent

 

2008

 

2007

 

Amount

 

Percent

 

 

 

$ in millions

 

 

 

$ in millions

 

 

 

Net sales

 

$

3,693

 

$

3,372

 

$

321

 

10

%

$

11,054

 

$

9,532

 

$

1,522

 

16

Cost of sales

 

2,873

 

2,720

 

(153

)

(6

)%

8,648

 

7,658

 

(990

)

(13

)%

Gross margin

 

820

 

652

 

168

 

26

%

2,406

 

1,874

 

532

 

28

%

Operating expenses and income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

388

 

340

 

(48

)

(14

)%

1,109

 

937

 

(172

)

(18

)%

Research, development and engineering expenses

 

113

 

82

 

(31

)

(38

)%

320

 

236

 

(84

)

(36

)%

Equity, royalty and interest income from investees

 

66

 

58

 

8

 

14

%

202

 

146

 

56

 

38

%

Flood damage expenses

 

 

 

 

NM

 

6

 

 

(6

)

NM

 

Other operating (expense) income, net

 

(2

)

1

 

(3

)

NM

 

(3

)

6

 

(9

)

NM

 

Operating income

 

383

 

289

 

94

 

33

%

1,170

 

853

 

317

 

37

%

Interest income

 

4

 

9

 

(5

)

(56

)%

14

 

27

 

(13

)

(48

)%

Interest expense

 

10

 

14

 

4

 

29

%

33

 

44

 

11

 

25

%

Other (expense) income, net

 

(7

)

8

 

(15

)

NM

 

(20

)

23

 

(43

)

NM

 

Income before income taxes and minority interests

 

370

 

292

 

78

 

27

%

1,131

 

859

 

272

 

32

%

Income tax expense

 

123

 

97

 

(26

)

(27

)%

372

 

284

 

(88

)

(31

)%

Minority interest in income of consolidated subsidiaries

 

18

 

11

 

(7

)

(64

)%

47

 

34

 

(13

)

(38

)%

Net income

 

$

229

 

$

184

 

$

45

 

24

 %

$

712

 

$

541

 

$

171

 

32

%     

Diluted earnings per share

 

$

1.17

 

$

0.92

 

$

0.25

 

27

%

$

3.62

 

$

2.70

 

$

0.92

 

34

%

 

Net Sales

 

Net sales for the three months ended September 28, 2008, increased in all segments over the same period in 2007, due to the following:

These increases in net sales were partially offset by softening in the U.S economy which has resulted in a significant reduction in demand in light-duty automotive and recreational markets.

Net sales for the nine months ended September 28, 2008, increased in all segments over the same period in 2007, due to the following:

 


 

These increases in net sales were partially offset by softening in the U.S economy which has resulted in a significant reduction in demand in light-duty automotive and recreational markets. 

A more detailed discussion of sales by segment is presented in the Operating Segments Results section.
 

Gross Margin
 

The following table presents the significant drivers impacting gross margins for the three and nine months ended September 28, 2008, to the comparable periods ended September 30, 2007:

 

 

 

Three months ended

 

Nine months ended

 

 

 

2008 vs. 2007

 

 

change in millions

Price

 

$

103

 

$

283

 

Product mix

 

73

 

149

 

Currency

 

21

 

56

 

Production costs

 

30

 

50

 

Warranty expense

 

2

 

(98

)

Volume

 

(5

)

175

 

Material costs

 

(56

)

(86

)

Other

 

 

3

 

Total

 

$

168

 

$

532

 

 

Gross margin as a percentage of sales for the three and nine month periods increased by 2.9 percentage points and 2.1 percentage points, respectively, as margin percentages increased in all four business segments. The provision for warranties issued for the three and nine months ended September 28, 2008, were 2.7 percent and 2.9 percent of consolidated sales, compared to 3.5 percent and 3.1 percent for the same periods in 2007.

 

A more detailed discussion of margin by segment is presented in the Operating Segments Results section.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses for the three and nine months ended September 28, 2008, increased compared to the same periods in 2007, primarily due to increased compensation and related expenses of $23 million and $61 million, respectively, the acquisition of a majority ownership interest in three previously independent North American distributors during the first nine months of 2008 and unfavorable foreign currency impacts. Increased headcount and compensation and related expenses included salaries, variable compensation and fringe benefits across the businesses in support of higher volumes and business growth. Overall, selling, general and administrative expenses increased slightly as a percent of sales to 10.5 percent and 10.0 percent in 2008 compared to 10.1 percent and 9.8 percent in 2007 for the three and nine month periods, respectively.

 

Research, Development and Engineering Expenses

 

Research, development and engineering expenses for the three and nine months ended September 28, 2008, increased compared to the same periods in 2007 primarily due to higher spending on development programs for future products as well as increased headcount and compensation expense and related expenses to support business growth. Compensation and related expenses include salaries, variable compensation, and fringe benefits. Fluctuations in other miscellaneous research, development and engineering expenses were not significant individually or in the aggregate.



Equity, Royalty and Interest Income From Investees

 

Equity, royalty and interest income from investees for the three and nine months ended September 28, 2008, increased compared to the same periods in 2007, primarily due to increases in earnings from Dongfeng Cummins Engine Company, Ltd. of $4 million and $21 million, North American distributors of $4 million and $13 million and Chongqing Cummins Engine Company Limited of $4 million and $8 million for the three and nine month periods, respectively. Shanghai Fleetguard Filter Co., Ltd also experienced increases for the three and nine months ended September 28, 2008, compared to the same periods in 2007. These increases were slightly offset by decreases from Tata Cummins Ltd. and Cummins MerCruiser Diesel Marine LLC.

 

Other Operating (Expense) Income, Net

 

Other operating (expense) income for the three and nine months ended September 28, 2008, decreased from income in 2007 to expense in 2008. The major components of other operating (expense) income are royalty income, amortization of intangible assets and gains and losses on sale of fixed assets. The decrease in other operating income for the three and nine months ended September 28, 2008, compared to the same periods for 2007, was primarily due to a decrease in gains on the sale of assets of $4 million and $9 million and an increase in the amortization of other intangibles of $4 million and $7 million. The fluctuations in gain on the sale of assets and amortization for the nine months ended September 28, 2008, were partially offset by an increase in royalty income of $5 million. Other fluctuations in other operating (expense) income were not significant individually or in the aggregate.

 

Interest Expense

 

Interest expense for the three and nine months ended September 28, 2008, decreased compared to the same periods in 2007 due to lower average debt balances.

 

Flood Damage Expenses

 

In June 2008, Columbus, Indiana experienced significant flooding which impacted some of our facilities. One manufacturing facility was partially flooded. Our technical center, which houses engineering staff and contains dynamometer test cells and labs, was more severely impacted by the event which caused temporary displacement of the engineering workforce and suspension of testing for approximately five weeks. Critical testing was transferred to other Cummins facilities and external suppliers to minimize the interruption.

 

The physical damage to the facilities, costs of clean up and repair and business interruption were covered by insurance, subject to a deductible, which limited the economic impact of this event to the company. As of September 28, 2008, we recorded a net charge of $6 million for this event. The total clean up costs incurred as of September 28, 2008, were $26 million. The remaining clean up costs are estimated to range from $25 million to $35 million and will be spent during the next two quarters. We estimate the replacement value of assets impacted was approximately $90 million and we anticipate that asset replacements will be reflected in capital spending over the next five quarters. Most of these assets were fully depreciated at the time of the flood. We will record an involuntary conversion gain for the difference between the insurance recovery of actual costs to replace the assets and the book value, which was approximately $8 million at the time of the flood. This gain will be recognized as the assets are replaced over the next five quarters, with the majority recognized in 2009. Although this claim is significant, we believe we have sufficient insurance coverage after this claim for any future events. As of September 28, 2008, we have received $30 million in insurance recoveries.

 

We used our research and engineering facilities in other regions, not impacted by the flood, to continue our engineering and development activities while our research facilities in Columbus, Indiana were being repaired.

 

We are confident that our insurance coverage will limit the impact of this event.

 

Other (Expense) Income, Net

 

Other (expense) income for the three months ended September 28, 2008, decreased from income in 2007 to expense in 2008. The major components of other (expense) income include foreign currency exchange gains and losses, bank charges and other miscellaneous income and expenses. The fluctuations in other (expense) income were due to foreign currency exchange losses of approximately $10 million for the three months ended September 28, 2008, compared to foreign currency exchange gains of $8 million for the same period in 2007. Other fluctuations in other (expense) income were not significant individually or in the aggregate.


Other (expense) income for the nine months ended September 28, 2008, decreased from income in 2007 to expense in 2008. The fluctuations in other (expense) income were due to foreign currency exchange losses of approximately $23 million for the nine months ended September 28, 2008, compared to foreign currency exchange gains of $16 million for the same period in 2007. Other fluctuations in other (expense) income were not significant individually or in the aggregate.

 

Income Tax Expense

 

Our effective tax rate for the three months and nine months ended September 28, 2008, was 33 percent, which is less than the 35 percent U.S. income tax rate primarily due to lower tax rates on foreign earnings. Our effective tax rate for the three months and nine months ended September 30, 2007, was also 33 percent and was less than the U.S. income tax rate primarily due to research tax credits and lower taxes on foreign earnings.

 

The effective tax rate for 2008 is expected to approximate 32 percent, considering the U.S. research tax credit which was retroactively reinstated during October 2008, absent any additional discrete period activity. We anticipate the benefit of the 2008 U.S. research tax credit to be approximately $10 million, which will be included in our fourth quarter 2008 results.

 

Minority Interests in Income of Consolidated Subsidiaries

 

Minority interests in income of consolidated subsidiaries for the three and nine months ended September 28, 2008, increased as compared to the same periods in 2007, primarily due to higher earnings at our consolidated subsidiaries in India and China. There were no individual fluctuations in the subsidiaries that were significant.

 

Net income and diluted earnings per share

 

Net income and diluted earnings per share increased for the three and nine months ended September 28, 2008, compared to the prior year periods primarily due to higher volumes, improved margins and higher equity earnings.

 

OPERATING SEGMENT RESULTS

 

Our reportable operating segments consist of the following: Engine, Power Generation, Components and Distribution. This reporting structure is organized according to the products and markets each segment serves. We use segment EBIT (defined as earnings before interest expense, income taxes and minority interests) as the primary basis for the chief operating decision-maker to evaluate the performance of each operating segment.

 

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



Engine

 

Financial data for the Engine segment was as follows:

 

 

 

Three Months Ended

 

Favorable/ (Unfavorable)

 

Nine Months Ended

 

Favorable/ (Unfavorable)

 

 

 

September 28,

 

September 30,

 

 

 

 

 

September 28,

 

September 30,

 

 

 

 

 

 

 

2008

 

2007

 

Amount

 

Percent

 

2008

 

2007

 

Amount

 

Percent

 

 

 

$ in millions

 

 

 

$ in millions

 

 

 

External sales

 

$

1,927

 

$

1,890

 

$

37

 

2

%

$

5,842

 

$

5,267

 

$

575

 

11

Intersegment sales

 

352

 

263

 

89

 

34

%

1,032

 

760

 

272

 

36

%

   Total sales

 

2,279

 

2,153

 

126

 

6

%

6,874

 

6,027

 

847

 

14

%

Depreciation and amortization

 

43

 

45

 

2

 

4

%

133

 

132

 

(1

)

(1

)%

Research, development and engineering expenses

 

75

 

56

 

(19

)

(34

)%

215

 

159

 

(56

)

(35

)%

Equity, royalty and interest income from investees

 

26

 

24

 

2

 

8

 %

91

 

66

 

25

 

38

%

Interest income

 

2

 

6

 

(4

)

(67

)%

7

 

20

 

(13

)

(65

)%

Segment EBIT

 

160

 

155

 

5

 

3

%

575

 

469

 

106

 

23

%

 

 

 

 

 

 

 

 

 

 

 

 

Segment EBIT as a percentage of net sales

 

7.0

%

7.2

%

(0.2) percentage points

8.4

%

7.8

%

0.6  percentage points

 

Sales

 

Engine segment sales increased for the three months ended September 28, 2008, over the same period in 2007, primarily due to:

These increases were partially offset by a 75 percent decline in units sold to Chrysler during the three months ended September 28, 2008, over the same period in 2007. This decline was due to the deteriorating demand for light duty trucks in North America as the result of the softening U.S. economy and concerns over fuel prices.

 

Total on-highway-related sales were 53 percent of total engine sales in 2008, compared to 59 percent in 2007 for the three month period.

 

Engine segment sales increased for the nine months ended September 28, 2008, over the same period in 2007, primarily due to:


 

These increases were partially offset by a 56 percent decline in units sold to Chrysler during the nine months ended September 28, 2008, over the same period in 2007. This decline was due to the deteriorating demand for light duty trucks in North America as the result of the softening U.S. economy and concerns over fuel prices. We do not expect a recovery in demand for light-duty trucks in North America in 2008.

 

Total on-highway-related sales were 54 percent of total engine sales in 2008, compared to 56 percent in 2007 for the nine month period.

 

Segment EBIT

 

Engine segment EBIT increased for the three months ended September 28, 2008, compared to the same period in 2007, primarily due to a more favorable sales mix in the on-highway markets and improved industrial engine and parts pricing, which was partially offset by increased material costs. Gross margin increased $50 million, or 15 percent, and gross margin percentage improved 1.3 percentage points for the three months ended September 28, 2008, as compared to the same period in 2007. Selling, general and administrative expenses increased $18 million, or 12 percent, and increased by 0.4 percentage points, as a percentage of sales, for the three months ended September 28, 2008, as compared to the same period in 2007. Research, development and engineering expenses increased $19 million, or 34 percent, and increased 0.7 percentage points, as a percentage of sales, for the three months ended September 28, 2008, as compared to the same period in 2007. The increase in research, development and engineering expenses was the result of increased spending on emissions related programs.

 

Engine segment EBIT increased for the nine months ended September 28, 2008, compared to the same period in 2007, primarily due to higher engine volumes across most on-highway markets, improved industrial engine and parts pricing and more favorable sales mix in the on-highway markets, which was partially offset by increased material cost and warranty expense. Gross margin increased $215 million, or 22 percent, and gross margin percentage improved by 1.1 percentage points for the nine months ended September 28, 2008, as compared to the same period in 2007. Selling, general and administrative expenses increased $51 million, or 12 percent, and remained relatively flat as a percentage of sales for the nine months ended September 28, 2008, as compared to the same period in 2007. Research, development and engineering expenses increased $56 million, or 35 percent, and increased 0.5 percentage points, as a percentage of sales, for the nine months ended September 28, 2008, as compared to the same period in 2007. The increase in research, development and engineering expenses was the result of increased spending on emissions related programs.

 

A summary of Engine sales by market follows:

 

 

 

Three Months Ended

 

Favorable/ (Unfavorable)

 

Nine Months Ended

 

Favorable/ (Unfavorable)

 

 

 

September 28,

 

September 30,

 

 

 

 

 

September 28,

 

September 30,

 

 

 

 

 

 

 

2008

 

2007

 

Amount

 

Percent

 

2008

 

2007

 

Amount

 

Percent

 

 

 

$ in millions

 

 

 

$ in millions

 

 

 

Heavy-duty truck

 

$

630

 

$

520

 

$

110

 

21

%

$

1,838

 

$

1,417

 

$

421

 

30

Medium-duty truck and bus

 

406

 

359

 

47

 

13

%

1,225

 

885

 

340

 

38

%

Light-duty automotive and RV

 

170

 

388

 

(218

)

(56

)%

650

 

1,094

 

(444

)

(41

)%

Total on-highway

 

1,206

 

1,267

 

(61

)

(5

)%

3,713

 

3,396

 

317

 

9

%

Industrial

 

788

 

661

 

127

 

19

%

2,325

 

1,943

 

382

 

20

%

Stationary power

 

285

 

225

 

60

 

27

%

836

 

688

 

148

 

22

%

Total sales

 

$

2,279

 

$

2,153

 

$

126

 

6

%

$

6,874

 

$

6,027

 

$

847

 

14

%



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

 

 

 

Three Months Ended

 

Favorable/ (Unfavorable)

 

Nine Months Ended

 

Favorable/ (Unfavorable)

 

 

 

September 28,

 

September 30,

 

 

 

 

 

September 28,

 

September 30,

 

 

 

 

 

 

 

2008

 

2007

 

Amount

 

Percent

 

2008

 

2007

 

Amount

 

Percent

 

Midrange

 

102,400

 

130,500

 

(28,100

)

(22

)%

331,400

 

371,200

 

(39,800

)

(11

)%

Heavy-duty

 

29,400

 

24,800

 

4,600

 

19

%

85,800

 

67,600

 

18,200

 

27

%

High-horsepower

 

5,300

 

4,600

 

700

 

15

%

15,400

 

13,600

 

1,800

 

13

%

Total unit shipments

 

137,100

 

159,900

 

(22,800

)

(14

)%

432,600

 

452,400

 

(19,800

)

(4

)%

 

Power Generation

 

Financial data for the Power Generation segment was as follows:

 

 

 

Three Months Ended

 

Favorable/ (Unfavorable)

 

Nine Months Ended

 

Favorable/ (Unfavorable)

 

 

 

September 28,

 

September 30,

 

 

 

 

 

September 28,

 

September 30,

 

 

 

 

 

 

 

2008

 

2007

 

Amount

 

Percent

 

2008

 

2007

 

Amount

 

Percent

 

 

 

$ in millions

 

 

 

$ in millions

 

 

 

External sales

 

$

653

 

$

594

 

$

59

 

10

%

$

1,926

 

$

1,730

 

$

196

 

11

Intersegment sales

 

235

 

182

 

53

 

29

%

687

 

490

 

197

 

40

%

   Total sales

 

888

 

776

 

112

 

14

%

2,613

 

2,220

 

393

 

18

%

Depreciation and amortization

 

9

 

11

 

2

 

18

%

31

 

31

 

 

NM

 

Research, development and engineering expenses

 

11

 

8

 

(3

)

(38

)%

31

 

25

 

(6

)

(24

)%

Equity, royalty and interest income from investees

 

6

 

5

 

1

 

20

 %

17

 

12

 

5

 

42

%

Interest income

 

1

 

1

 

 

NM

 

3

 

4

 

(1

)

(25

)%

Segment EBIT

 

108

 

83

 

25

 

30

%

301

 

248

 

53

 

21

%

 

 

 

 

 

 

 

 

 

 

 

 

Segment EBIT as a percentage of net sales

 

12.2

%

10.7

%

1.5 percentage points

11.5

%

11.2

%

0.3 percentage points

 

Our Power Generation segment includes the following businesses: commercial, consumer, rental, power electronics, energy solutions and alternators. Sales for our Power Generation segment by business were as follows:

 

 

 

Three months ended

 

Favorable/ (Unfavorable)

 

Nine months ended

 

Favorable/ (Unfavorable)

 

 

 

September 28, 2008

 

September 30, 2007

 

Amount

 

Percent

 

September 28,

2008

 

September 30, 2007

 

Amount

 

Percent

 

 

 

$ in millions

 

 

 

$ in millions

 

 

 

Commercial

 

$

572

 

$

458

 

$

114

 

25

%

$

1,648

 

$

1,289

 

$

359

 

28

%

Alternator

 

174

 

163

 

11

 

7

%

508

 

451

 

57

 

13

%

Consumer

 

57

 

87

 

(30

)

(34

)%

194

 

271

 

(77

)

(28

)%

Other

 

85

 

68

 

17

 

25

%

263

 

209

 

54

 

26

%

   Total sales

 

$

888

 

$

776

 

$

112

 

14

%

$

2,613

 

$

2,220

 

$

393

 

18

%

 

Sales

 

Power Generation segment sales increased for the three months ended, September 28, 2008, compared to the same period in 2007, primarily due to:

 


These increases were partially offset by a 34 percent decrease in our consumer business sales, primarily due to the softening U.S. economy.

 

Power Generation segment sales increased for the nine months ended, September 28, 2008, compared to the same period in 2007, primarily due to:

These increases were partially offset by a decrease of 28 percent in our consumer business sales, primarily due to the softening U.S. economy.

 

Segment EBIT

 

Power Generation segment EBIT increased for the three months ended, September 28, 2008, compared to the same period in 2007, due to significant price realization, increased volume, increased rental revenue and favorable product mix, which was partially offset by increased material costs, including increased engine and commodity prices. Gross margin improved $30 million, or 20 percent, and the gross margin percentage improved by one percentage point for the three month period, over the same period in 2007. Selling, general and administrative expenses increased by $1 million, or two percent, however, selling, general and administrative expenses improved by 0.9 percentage points, as a percentage of sales, for the three month period, as compared to the same period in 2007. Research, development and engineering expenses increased $3 million, or 38 percent, and increased by 0.2 percentage points, as a percentage of sales, for the three month period, as compared to the same period in 2007.

 

Power Generation segment EBIT increased for the nine months ended, September 28, 2008, compared to the same period in 2007, primarily due to significant price realization, increased volume and favorable product mix. This was partially offset by increased material costs, including increased engine and commodity prices. Gross margin improved $91 million, or 22 percent, and the gross margin percentage improved by 0.7 percentage points for the nine month period over the same period in 2007. Selling, general and administrative expenses increased by $24 million, or 13 percent, however, selling, general and administrative expenses improved by 0.3 percentage points, as a percentage of sales, for the nine month period, as compared to the same period in 2007. Research, development and engineering expenses increased $6 million, or 24 percent; however, research, development and engineering expenses remained relatively flat as a percentage of sales for the nine month period, compared to the same period in 2007.

 

A summary of Power Generation engine shipments (including engines sold in power generation units) during the quarter by engine category follows:

 

 

 

Three Months Ended

 

Favorable/ (Unfavorable)

 

Nine Months Ended

 

Favorable/ (Unfavorable)

 

 

 

September 28,

 

September 30,

 

 

 

 

 

September 28,

 

September 30,

 

 

 

 

 

 

 

2008

 

2007

 

Amount

 

Percent

 

2008

 

2007

 

Amount

 

Percent

 

Midrange

 

8,900

 

7,400

 

1,500

 

20

%

25,100

 

22,800

 

2,300

 

10

%

Heavy-duty

 

2,300

 

2,100

 

200

 

10

%

6,300

 

5,700

 

600

 

11

%

High-horsepower

 

2,800

 

2,600

 

200

 

8

%

8,600

 

7,700

 

900

 

12

%

Total unit shipments

 

14,000

 

12,100

 

1,900

 

16

%

40,000

 

36,200

 

3,800

 

10

%



Components

 

Financial data for the Components segment was as follows:

 

 

 

Three Months Ended

 

Favorable/ (Unfavorable)

 

Nine Months Ended

 

Favorable/ (Unfavorable)

 

 

 

September 28,

 

September 30,

 

 

 

 

 

September 28,

 

September 30,

 

 

 

 

 

 

 

2008

 

2007

 

Amount

 

Percent

 

2008

 

2007

 

Amount

 

Percent

 

 

 

$ in millions

 

 

 

$ in millions

 

 

 

External sales

 

$

535

 

$

494

 

$

41

 

8

%

$

1,686

 

$

1,465

 

$

221

 

15

Intersegment sales

 

266

 

247

 

19

 

8

%

790

 

690

 

100

 

14

%

   Total sales

 

801

 

741

 

60

 

8

%

2,476

 

2,155

 

321

 

15

%

Depreciation and amortization

 

16

 

14

 

(2

)

(14

)%

49

 

43

 

(6

)

(14

)%

Research, development and engineering expenses

 

27

 

18

 

(9

)

(50

)%

74

 

52

 

(22

)

(42

)%

Equity, royalty and interest income from investees

 

3

 

3

 

 

NM

 

10

 

1

 

9

 

NM

 

Interest income

 

1

 

1

 

 

NM

 

3

 

2

 

1

 

50

%

Segment EBIT

 

61

 

34

 

27

 

79

%

175

 

106

 

69

 

65

%

 

 

 

 

 

 

 

 

 

 

 

 

Segment EBIT as a percentage of net sales

 

7.6

%

4.6

%

3.0 percentage points

7.1

%

4.9

%

2.2  percentage points

 

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

 

 

 

Three months ended

 

Favorable/ (Unfavorable)

 

Nine months ended

 

Favorable/ (Unfavorable)

 

 

 

September 28, 2008

 

September 30, 2007

 

Amount

 

Percent

 

September 28,

2008

 

September 30, 2007

 

Amount

 

Percent

 

 

 

$ in millions

 

 

 

$ in millions

 

 

 

Filtration

 

$

304

 

$

302

 

$

2

 

1

%

$

921

 

$

911

 

$

10

 

1

%

Turbochargers

 

246

 

225

 

21

 

9

%

786

 

623

 

163

 

26

%

Emission solutions

 

141

 

111

 

30

 

27

%

423

 

318

 

105

 

33

%

Fuel systems

 

110

 

103

 

7

 

7

%

346

 

303

 

43

 

14

%

   Total sales

 

$

801

 

$

741

 

$

60

 

8

%

$

2,476

 

$

2,155

 

$

321

 

15

%

 

Sales

 

Components segment sales increased for the three months ended, September 28, 2008, compared to the same period in 2007, primarily due to:

 

These increases were partially offset by the sale of Universal Silencer, which contributed $20 million in sales in the three months ended September 30, 2007.

 


Components segment sales increased for the nine months ended, September 28, 2008, compared to the same period in 2007, primarily due to:

These increases were partially offset by the sale of Universal Silencer and the discontinuance of a product line in 2007, which contributed a combined $67 million in sales in the nine months ended September 30, 2007.

 

Segment EBIT

 

Components segment EBIT increased for the three months ended, September 28, 2008, compared to the same period in 2007, primarily due to price realization in our turbocharger, filtration and emission solution businesses, increased volumes and manufacturing efficiencies in all of our businesses. Gross margin increased $41 million, or 40 percent, and gross margin percentage increased over four percentage points for the three month period ended September 28, 2008, compared to the same period in 2007. Selling, general and administrative expenses increased $8 million, or 15 percent, and increased 0.4 percentage points, as a percentage of sales, for the three months ended September 28, 2008, compared to the same period in 2007. Research, development and engineering expenses increased $9 million, or 50 percent, and increased one percentage point, as a percentage of sales, for the three months ended September 28, 2008, compared to the same period in 2007.

 

Components segment EBIT increased for the nine months ended, September 28, 2008, compared to the same period in 2007, primarily due to increased volumes in most of our businesses, price realization in our turbocharger business and manufacturing efficiencies in all of our businesses. Gross margin increased $115 million, or 38 percent, and gross margin percentage increased nearly three percentage points for the nine month period ended September 28, 2008, as compared to the same period in 2007. Selling, general and administrative expenses increased $27 million, or 18 percent, and increased 0.2 percentage points, as a percentage of sales, for the nine months ended September 28, 2008, compared to the same period in 2007. Research, development and engineering expenses increased $22 million, or 42 percent, and increased 0.6 percentage points, as a percentage of sales, for the nine months ended September 28, 2008, compared to the same period in 2007. The increased research and development spending is focused on developing new products for us and other OEMs to meet future emissions standards for both developed and emerging markets.

 

Distribution

 

Financial data for the Distribution segment was as follows:

 

 

 

Three Months Ended

 

Favorable/ (Unfavorable)

 

Nine Months Ended

 

Favorable/ (Unfavorable)

 

 

 

September 28,

 

September 30,

 

 

 

 

 

September 28,

 

September 30,

 

 

 

 

 

 

 

2008

 

2007

 

Amount

 

Percent

 

2008

 

2007

 

Amount

 

Percent

 

 

 

$ in millions

 

 

 

$ in millions

 

 

 

External sales

 

$

578

 

$

394

 

$

184

 

47

%

$

1,600

 

$

1,070

 

$

530

 

50

Intersegment sales

 

3

 

1

 

2

 

NM

 

7

 

2

 

5

 

NM

 

   Total sales

 

581

 

395

 

186

 

47

%

1,607

 

1,072

 

535

 

50

%

Depreciation and amortization

 

6

 

3

 

(3

)

NM

 

17

 

8

 

(9

)

NM

 

Equity, royalty and interest income from investees

 

31

 

26

 

5

 

19

%

84

 

67

 

17

 

25

%

Interest income

 

 

1

 

(1

)

NM

 

1

 

1

 

 

NM

 

Segment EBIT

 

61

 

46

 

15

 

33

%

178

 

131

 

47

 

36

%

 

 

 

 

 

 

 

 

 

 

 

 

Segment EBIT as a percentage of net sales

 

10.5

%

11.6

%

(1.1) percentage points

11.1

%

12.2

%

(1.1)  percentage points

 

Sales

 

Distribution segment sales increased for the three months ended, September 28, 2008, compared to the same period in 2007, as a result of:

 


The higher sales were led by increases in power generation, parts and engine, followed by service.

 

Distribution segment sales increased for the nine months ended, September 28, 2008, compared to the same period in 2007, as a result of:

 

The higher sales were led by increases in power generation, engine and parts, followed by service.

 

Segment EBIT

 

Distribution segment EBIT improved for the three months ended, September 28, 2008, compared to the same period in 2007, primarily due to increased sales volumes for power generation, parts and engine, followed by service, and improved pricing. However, segment EBIT decreased as a percentage of sales primarily due to unfavorable currency translation adjustments which negatively impacted our EBIT as a percentage of sales by 1.2 percentage points. Excluding the $7 million impact of three new distributors consolidated during the year and one new North American joint venture, EBIT was $54 million for the three month period and decreased 0.8 percentage points as a percentage of sales. Gross margin increased by $45 million, or 56 percent, and increased as a percentage of sales by 1.2 percentage points for the three month period, as compared to the same period in 2007. The increase in gross margin was primarily due to the increase in sales volumes and improved pricing. Selling, general and administrative expenses increased $21 million, or 31 percent, however, selling, general and administrative expenses improved by 1.9 percentage points as a percentage of sales for the three months ended September 28, 2008, compared to the same period in 2007.
 

Distribution segment EBIT improved for the nine months ended, September 28, 2008, compared to the same period in 2007, primarily due to increased sales volumes for power generation, parts and engines followed by service. However, segment EBIT decreased as a percentage of sales, primarily due to unfavorable currency translation adjustments which negatively impacted our EBIT as a percentage of sales by 0.5 percentage points. Excluding the $8 million impact of three new distributors consolidated during the year and one new North American joint venture, EBIT was $170 million for the nine month period and decreased 0.3 percentage points as a percentage of sales. Gross margin increased by $122 million, or 54 percent, and improved 0.5 percentage points as a percentage of sales for the nine month period, as compared to the same period in 2007. The increase in gross margin was primarily due to the increase in sales volumes and improved pricing. Selling, general and administrative expenses increased $70 million, or 39 percent, however, selling, general and administrative expenses improved by 1.2 percent as a percentage of sales for the nine months ended September 28, 2008, compared to the same period in 2007.



Reconciliation of Segment EBIT to Income Before Income Taxes and Minority Interests

 

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

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 28,

 

September 30,

 

September 28,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

in millions

 

 

 

 

 

 

 

 

 

 

 

Total segment EBIT

 

$

390

 

$

318

 

$

1,229

 

$

954

 

Non-segment EBIT (1)

 

(10

)

(12

)

(65

)

(51

)

Total EBIT

 

$

380

 

$

306

 

$

1,164

 

$

903

 

Less:

 

 

 

 

 

 

 

 

 

Interest expense

 

10

 

14

 

33

 

44

 

Income before income taxes and minority interests

 

$

370

 

$

292

 

$

1,131

 

$

859

 

(1) Includes intersegment profit in inventory eliminations and unallocated corporate expenses including flood related expenses.

 

Geographic Markets

 

Sales to international markets for the three and nine months ended September 28, 2008, were 61 percent and 60 percent of total net sales, compared with 52 percent of total net sales for the same periods in 2007.

 

A summary of net sales (dollar amount and percentage of total) by geographic territory follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 28, 2008

 

September 30, 2007

 

September 28, 2008

 

September 30, 2007

 

 

 

$ in millions

United States

 

$

1,447

 

39

%

$

1,603

 

48

%

$

4,471

 

40

%

$

4,524

 

48

%

Asia/Australia

 

799

 

22

%

621

 

18

%

2,339

 

21

%

1,727

 

18

%

Europe/CIS

 

622

 

17

%

550

 

16

%

2,013

 

18

%

1,656

 

17

%

Mexico/Latin America

 

411

 

11

%

309

 

9

%

1,166

 

11

%

844

 

9

%

Africa/Middle East

 

242

 

6

%

185

 

6

%

633

 

6

%

493

 

5

%

Canada

 

172

 

5

%

104

 

3

%

432

 

4

%

288

 

3

%

Total international

 

2,246

 

61

%

1,769

 

52

%

6,583

 

60

%

5,008

 

52

%

Total consolidated net sales

 

$

3,693

 

100

%

$

3,372

 

100

%

$

11,054

 

100

%

$

9,532

 

100

%



LIQUIDITY AND CAPITAL RESOURCES

 

Management's Assessment of Liquidity

 

We believe our financial condition and liquidity remain strong despite the downturn in the U.S. economy. Our strong balance sheet and improved credit ratings enabled us to secure a new Three-Year Revolving Credit Facility in the third quarter.

 

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

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


We have considered the impact of recent market instability and credit availability in assessing the adequacy of our liquidity and capital resources. We expect that general market conditions could impact the rate at which we realize our receivables in the future, however, we expect our cash flow from operations to remain strong.
We will continue to diligently monitor our receivables for potential slowing in collections that could occur as a result of softening economic conditions and our customer's access to credit. We continue to have full access to our revolving credit facility and our exposure to failed financial institutions is limited to immaterial write-offs within our pension trusts.  The overall decline in market valuations has impacted the current value of our pension trusts as discussed in more detail below. 

 

A significant portion of our cash flows is generated outside the U.S. More than half of our cash and cash equivalents and most of our marketable securities at September 28, 2008, are denominated in foreign currencies. We manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct our business and the cost effectiveness with which those funds can be accessed. The repatriation of cash balances from certain subsidiaries could have adverse tax consequences; however, those balances are generally available without legal restrictions to fund ordinary business operations at the local level. We have and will continue to transfer cash from those subsidiaries to us and to other international subsidiaries when it is cost effective to do so.

 

Working Capital Summary

 

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

 

 

 

September 28,

 

December 31,

 

September 30,

 

 

 

2008

 

2007

 

2007

 

 

 

in millions

 

Current assets

 

$

5,448

 

$

4,815

 

$

4,947

 

Current liabilities

 

2,978

 

2,711

 

2,704

 

Working capital

 

$

2,470

 

$

2,104

 

$

2,243

 

Current ratio

 

1.83

 

1.78

 

1.83

 

Days’ sales in receivables

 

53

 

53

 

55

 

Inventory turnover

 

6.0

 

6.5

 

6.1

 

 

Current assets increased $633 million, primarily due to a $305 million increase in accounts and notes receivable, net driven by the increase in net sales and a $299 million increase in inventories as the businesses prepare to meet increasing demand and continue to expand into new markets. These increases were partially offset by a $37 million decline in marketable securities (see Cash Flows below).

 

Current liabilities increased $267 million, primarily due to an increase in accounts payable of $183 million and increases in other accrued expenses of $121 million due to business expansions. These increases were partially offset by a decrease in the current portion of long-term debt and loans payable of $39 million and a decline in accrued compensation, benefits and retirement costs of $37 million.


 

Cash Flows

 

The following table summarizes the key elements of our cash flows for the nine month period:

 

 

 

September 28,  2008

 

September 30, 2007

 

 

 

in millions

 

Net cash provided by operating activities

 

$

725

 

$

523

 

Net cash used in investing activities

 

(552

)

(323

)

Net cash used in financing activities

 

(171

)

(427

)

Effect of exchange rate changes on cash

 

 

(7

)

 

11

 

Net decrease in cash and cash equivalents

 

$

(5

)

$

(216

)

 

Operating Activities

 

Net cash provided by operating activities increased $202 million in the first nine months of 2008, compared to the same period in 2007. The improvement was primarily due to higher net income of $171 million, a $50 million decrease in pension contributions and a $34 million favorable impact from translation and hedging activities, partially offset by a $41 million negative change associated with working capital and a $31 million decrease in the deferred income tax provision. The major components of the change in working capital are as follows: an $85 million net increase in accrued expenses driven by increased warranty accruals and timing of various other expenses, partially offset by an $88 million increase in receivables primarily as a result of higher net sales.

 

The funded status of our pension plans is dependent upon a variety of variables and assumptions including return on invested assets, market interest rates and levels of voluntary contributions to the plans. Better than expected investment returns in recent years and additional voluntary contributions have improved the funded status of all plans; however, as the result of the ongoing credit crisis and the related market turmoil, our pension assets have experienced some deterioration. Through the nine months ended September 28, 2008, short-term returns for both our U.S. and U.K. pension plans are significantly below our long-term expected rate of return of 8.25 percent used in our assumptions due to adverse conditions in the equity markets. As a result of losses experienced in global equity markets, our pension funds are likely to have a negative return for 2008, which would result in a charge to shareholders’ equity in the fourth quarter and thus create increased pension costs in 2009.  Approximately 92 percent of our pension plan assets are invested in highly liquid investments such as equity and fixed income securities. The remaining eight percent of our plan assets are invested in less liquid but market valued investments, including real estate and private equity. We made pension contributions of $94 million to our pension plans in the first nine months of 2008. We anticipate making additional contributions of $1 million to $10 million to our pension plans in the fourth quarter.  Claims and premiums for other postretirement benefits are expected to approximate $60 million. The $94 million of pension contributions in the first nine months of 2008 included voluntary contributions of $70 million. These contributions and payments include payments from Company funds either to increase pension plan assets or to make direct payments to plan participants.

 

Investing Activities

 

Net cash used in investing activities increased $229 million in the first nine months of 2008, compared to the first nine months of 2007. The increase was primarily due to a $148 million increase in capital expenditures, higher investments in businesses of $122 million and higher investments in and advances to equity investees of $24 million, which was partially offset by a $64 million increase in the proceeds from the sale of an equity investment in European Engine Alliance and a net decrease of $29 million in the acquisition/disposition of investments in marketable securities. 

 

Capital expenditures for the first nine months of 2008 increased 81 percent over the same period in 2007 to support our growth, and included investments to increase capacity and to fund development of our new products. Our investments in capacity improvements and development of new products are accelerating across all of our businesses. We continue to invest approximately 40 percent of our capital in low-cost regions of the world to further leverage our opportunities for cost reduction and future growth opportunities. Capital expenditures for the first nine months of 2008 were $330 million. In 2008, we expect capital expenditures to total approximately $550 million to $600 million. This spending excludes any assets that may need to be purchased as a result of the flood. We anticipate these expenditures will range from $85 million to $95 million and will occur over the next five quarters.

 


 

Financing Activities

 

Net cash used in financing activities decreased $256 million in the first nine months of 2008, compared to the first nine months of 2007. The majority of the decrease in cash outflows was due to the $88 million increase in proceeds from borrowings, the decrease in repurchase of common stock of $87 million and the $52 million increase in proceeds from sale of stock held by employee benefit trust.

 

In December 2007, the Board of Directors authorized the acquisition of up to $500 million of Cummins common stock. We began making purchases under the plan in March 2008 and have purchased $123 million of stock as of September 28, 2008. The share repurchase program, along with investments in our growth, are expected to be a significant use of our cash flows in 2008 and future years, however, total repurchases may vary quarter to quarter depending on other investing and financing activities, market conditions, or restrictions.

 

Our total debt was $667 million as of September 28, 2008, compared with $664 million at September 30, 2007. Total debt as a percent of our total capital, including total long-term debt, was 14.6 percent at September 28, 2008, compared to 17.2 percent at September 30, 2007.

 

On July 8, 2008, the Board of Directors approved an increase in the quarterly cash dividend on our common stock from $0.125 per share to $0.175 per share. The dividend was paid on September 2, 2008, to shareholders of record on August 22, 2008.

 

On June 30, 2008, we entered into a Three-Year Revolving Credit Agreement, dated as of June 30, 2008 (the “Credit Agreement”), with a syndicate of lenders and issuers named therein. The Credit Agreement provides a $1.1 billion senior unsecured revolving credit facility (the “Credit Facility”), the proceeds of which are to be used to provide working capital or for other general corporate purposes of Cummins.

 

The Credit Facility matures on June 30, 2011. The Credit Facility is unsecured and amounts payable under it will rank pro rata with all other unsecured, unsubordinated indebtedness of Cummins. Borrowings under the Credit Facility will primarily be denominated in U.S. dollars. A portion of the Credit Facility, up to $200 million, is available for Letters of Credit denominated in U.S. dollars or Alternate Currencies. In addition, up to $200 million of the Revolving Credit Facility will be available in Pounds Sterling or Euros. A portion of the Credit Facility, up to $100 million, is available for swingline loans denominated in U.S. dollars. Loans will bear interest at (i) a base rate or (ii) a rate equal to LIBOR plus an applicable margin based on the credit ratings of Cummins outstanding senior unsecured long-term debt. Based on our current long-term debt ratings, the applicable margin on LIBOR loans was 0.75 percent per annum as of September 28, 2008. However, due to global credit issues that rate has risen and the minimum applicable rate is 0.75 percent per annum to 2 percent per annum as of this filing. Loans may be prepaid without premium or penalty, subject to customary breakage costs.

 

The Credit Facility replaces $650 million in aggregate principal amount of a revolving credit facility (Former Credit Agreement) maintained by Cummins which was terminated effective June 30, 2008.

 

The Credit Agreement includes covenants substantially similar to those in the Former Credit Agreement, including, among others, (a) a leverage ratio, (b) fixed charge coverage ratio, (c) limitations on priority indebtedness, (d) limitations on our ability to consummate a merger, consolidation or sale of all or substantially all of our assets and (e) limitations on our ability to change the nature of our business.

 

The obligation of Cummins to pay amounts outstanding under the Credit Facility may be accelerated upon the occurrence of an “Event of Default” as defined in the Credit Agreement. Such Events of Default include, among others, (a) Cummins failure to pay the principal of, or interest on, borrowings under the Credit Facility, (b) any representation or warranty of Cummins in the Credit Agreement proving to be materially false or misleading, (c) Cummins breach of any of its covenants contained in the Credit Agreement and (d) the bankruptcy or insolvency of Cummins.

 


There are no material relationships between Cummins or its affiliates and any of the Lenders, other than as described above.

 

On June 17, 2008, Fitch upgraded our senior unsecured debt ratings from “BBB” to “BBB+” citing Cummins’ recent market share gains and improving credit profile, including improvement in Cummins’ geographic and business diversification.

 

Our current ratings and outlook from each of the credit rating agencies are shown in the table below.

 

 

Credit Rating Agency

 

 

Senior L-T
Debt Rating

 

S-T Debt
Rating

 

Outlook

 

Moody's Investors Service, Inc.

 

Baa3

 

 

Non-Prime

 

Stable

 

Standard & Poor's

 

BBB

 

 

NR

 

Stable

 

Fitch

 

BBB+

 

 

BBB+

 

Stable

 

 

At the May 13, 2008, annual meeting, shareholders voted to increase our total authorized common shares by 200 million shares to a total of 500 million shares.

 

OFF BALANCE SHEET FINANCING

 

A discussion of our off balance sheet financing arrangements may be found in Item 7 of our 2007 Annual Report on Form 10-K. There have been no material changes in this information since the filing of our 2007 Annual Report on Form 10-K.

 

APPLICATION OF CRITICAL ACCOUNTING ESTIMATES

 

A summary of our significant accounting policies is included in Note 1 to the Consolidated Financial Statements of our 2007 Annual Report on Form 10-K which discusses accounting policies that we have selected from acceptable alternatives.

 

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

 

Critical accounting estimates are defined as follows: the estimates require management to make assumptions about matters that were highly uncertain at the time the estimates were made; different estimates reasonably could have been used; or if changes in the estimates are reasonably likely to occur from period to period and the change would have a material impact on our financial condition or results of operations. Our senior management has discussed the development and selection of our accounting policies, related accounting estimates and the disclosures set forth below with the Audit Committee of the Board of Directors. We believe our critical accounting estimates include those addressing the estimation of liabilities for warranty programs, accounting for income taxes, pension benefits and annual assessment of recoverability of goodwill. A discussion of these critical accounting estimates may be found in the "Management's Discussion and Analysis" section of our 2007 Annual Report on Form 10-K under the caption “APPLICATION OF CRITICAL ACCOUNTING ESTIMATES.” Within the context of these critical accounting estimates, we are not currently aware of any reasonably likely events or circumstances that would result in different policies or estimates being reported in the first nine months of 2008.

 

RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

See Note 3 “Recently Adopted and Recently Issued Accounting Pronouncements” in the Notes to Condensed Consolidated Financial Statements.

 


ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk

 

A discussion of quantitative and qualitative disclosures about market risk may be found in Item 7A of our 2007 Annual Report on Form 10-K. There have been no material changes in this information since the filing of our 2007 Annual Report on Form 10-K.

 

ITEM 4.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is (1) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and (2) accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

There has been no change in the Company's internal control over financial reporting during the quarter ended September 28, 2008, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.



PART II.  OTHER INFORMATION

 

ITEM 1.  Legal Proceedings

 

We are at any one time party to a number of lawsuits or subject to claims arising out of the ordinary course of our business, including actions related to product liability, patent, trademark or other intellectual property infringement, contractual liability, workplace safety and environmental claims and cases, some of which involve claims for substantial damages. We and our subsidiaries are currently defendants in a number of pending legal actions, including actions related to use and performance of our products. While we carry product liability insurance covering significant claims for damages involving personal injury and property damage, we cannot assure you that such insurance would be adequate to cover the costs associated with a judgment against us with respect to these claims. We also establish reserves for matters in which losses are probable and can be reasonably estimated. We have also been identified as a potentially responsible party at several waste disposal sites under federal and state environmental statutes, as more fully described in Item 1 of our 2007 Annual Report on Form 10-K under "Environmental Compliance-Other Environmental Statutes and Regulations.” We deny liability with respect to many of these legal actions and environmental proceedings and are vigorously defending such actions or proceedings. While we believe we have established adequate accruals for our expected future liability with respect to our pending legal actions and proceedings, we cannot assure you that our liability with respect to any such action or proceeding would not exceed our established accruals. Further, we cannot assure that litigation having a material adverse affect on our financial condition will not arise in the future. The information in Item 1 "Other Environmental Statutes and Regulations" referred to above should be read in conjunction with this disclosure. See also Note 13, "Commitments and Contingencies" of the Notes to Consolidated Financial Statements included in our 2007 Annual Report on Form 10-K. There has been no material change in this information since the filing of our 2007 Annual Report on Form 10-K.

 

ITEM 1A.  Risk Factors

 

In addition to other information set forth in this report, you should consider other risk factors discussed in Part I, “Item 1A. Risk Factors Relating to our Business” in our Annual Report on Form 10-K for the year ended December 31, 2007, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K or the Disclosure Regarding Forward-Looking Statements in this Quarterly Report are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently judge to be immaterial also may materially adversely affect our business, financial condition or operating results.

 

ITEM 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

The following information is provided pursuant to Item 701 of Regulation S-K.

 

In the third quarter of 2008, our Employee Benefits Trust (Trust) sold approximately 0.9 million shares of common stock in the open market pursuant to SEC Rule 144 of the general rules and regulations under the Securities Act of 1933, representing a portion of the Trust’s shares.  The Trust was established and funded with these and other common shares in 1997 to be used in meeting certain obligations under our employee benefit and compensation plans.  The Trust used the $52 million of cash proceeds from the sale to fund certain non-qualified benefit obligations permitted to be satisfied by the Trust, but that could not be satisfied in-kind with the shares.


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

 

 

 

Issuer Purchases of Equity Securities

 

Period

 

 

 

(a) Total
Number of
Shares
Purchased
(1)

 

(b) Average
Price Paid
per Share

 

(c) Total Number of
Shares Purchased
as Part of Publicly
Announced
Plans or Programs

 

(d) Maximum
Number of Shares
that May Yet Be
Purchased Under the
Plans or Programs
(2)

 

June 30 – August 3, 2008

 

 

 

 

 

$

 

 

 

 

 

 

62,034

 

 

August 4 – August 31, 2008

 

 

307,238

 

 

 

65.43

 

 

 

305,000

 

 

 

60,449

 

 

September 1 – September 28, 2008

 

 

1,068,000

 

 

 

54.98

 

 

 

1,068,000

 

 

 

67,672

 

 

Total

 

 

1,375,238

 

 

 

$

57.31

 

 

 

1,373,000

 

 

 

 

 

 

 

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

 

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

 

In December 2007, the Board of Directors authorized the acquisition of up to $500 million worth of Cummins common stock in addition to what had been acquired under previous authorizations. As of September 28, 2008, we had purchased $123 million of common stock and can purchase an additional $377 million under the board authorization.

 

During the third quarter of 2008, we repurchased 2,238 shares from employees in connection with the Key Employee Stock Investment Plan which allows certain employees, other than officers, to purchase shares of common stock on an installment basis up to an established credit limit. Loans are issued for five-year terms at a fixed interest rate established at the date of purchase and may be refinanced after its initial five-year period for an additional five-year period. Participants must hold shares for a minimum of six months from date of purchase and after shares are sold must wait six months before another share purchase may be made. There is no maximum amount of shares that we may purchase under this plan.

 

During the third quarter of 2008, we issued 2,960 shares of restricted stock as compensation to our non-employee directors, all of whom are accredited investors. These shares were not registered under the Securities Act of 1933 (the “Securities Act”) pursuant to the exemption from the registration provided by Section 4(2) of the Securities Act.

 

According to our bylaws, we are not subject to the provisions of the Indiana Control Share Act. However, we are governed by certain other laws of the State of Indiana applicable to transactions involving a potential change of control of the company.

 

ITEM 5.  Other Information

 

In October 2008, we entered into a commitment with Irwin Financial Corporation (Irwin) to purchase up to $25 million of their common shares. Under the terms of the agreement, the actual amount of the shares to be purchased will be determined at the conclusion of a potential rights offering being planned by Irwin.  Cummins and several other parties have agreed to purchase any unsubscribed shares from the rights offering subject to a maximum commitment. Our commitment will be limited to the lesser of (1) the amount of unsubscribed shares from the rights offering that are allocated to us, (2) $25 million, or (3) an amount which will ensure that our ownership percentage does not exceed 19.9 percent. William I. Miller, Chairman and Chief Executive Officer of Irwin, is currently a member of the board of directors of Cummins and has agreed to resign from that position if the company exercises its standby commitment in full or in part. Mr. Miller has no effective control over the Company's exercise of its standby commitment.

 

ITEM 6.  Exhibits

12 Calculation of Ratio of Earnings to Fixed Charges.

31(a) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31(b) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Cummins Inc.

Date:  October 31, 2008

 

 

 

 

By:

/s/ Patrick J. Ward

By:

/s/ Marsha L. Hunt

 

PATRICK J. WARD
Vice President and Chief Financial Officer (Principal Financial Officer)

 

MARSHA L. HUNT
Vice President-Corporate Controller
 (Principal Accounting Officer)