Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 

cumminsca06.jpg
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended October 2, 2016
 
Commission File Number 1-4949 

CUMMINS INC.
(Exact name of registrant as specified in its charter)
Indiana
(State of Incorporation)
 
35-0257090
 (IRS Employer Identification No.)
500 Jackson Street
Box 3005
Columbus, Indiana 47202-3005
(Address of principal executive offices)
 
Telephone (812) 377-5000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files).  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
Large accelerated filer x
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No x
 
As of October 2, 2016, there were 168,275,116 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 is not including the information provided on the website as part of, or incorporating such information by reference into, this Quarterly Report on Form 10-Q.
 

Table of Contents

CUMMINS INC. AND SUBSIDIARIES
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
 
 
 
Page
 
 
 
Condensed Consolidated Statements of Income for the three and nine months ended October 2, 2016 and September 27, 2015
 
Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended October 2, 2016 and September 27, 2015
 
Condensed Consolidated Balance Sheets at October 2, 2016 and December 31, 2015
 
Condensed Consolidated Statements of Cash Flows for the nine months ended October 2, 2016 and September 27, 2015
 
Condensed Consolidated Statements of Changes in Equity for the nine months ended October 2, 2016 and September 27, 2015
 
 
 
 
 

2
Table of Contents

PART I.  FINANCIAL INFORMATION 
ITEM 1.  Condensed Consolidated Financial Statements 
CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
 
Three months ended
 
Nine months ended
In millions, except per share amounts 
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
NET SALES (a)
 
$
4,187

 
$
4,620

 
$
13,006

 
$
14,344

Cost of sales
 
3,108

 
3,412

 
9,674

 
10,609

GROSS MARGIN
 
1,079

 
1,208

 
3,332

 
3,735

OPERATING EXPENSES AND INCOME
 
 

 
 

 
 

 
 

Selling, general and administrative expenses
 
513

 
530

 
1,527

 
1,584

Research, development and engineering expenses
 
157

 
197

 
478

 
558

Equity, royalty and interest income from investees (Note 4)
 
74

 
78

 
234

 
240

Loss contingency (Note 10)
 
99

 
—

 
138

 
—

Other operating expense, net
 
—

 
(2
)
 
(2
)
 
(5
)
OPERATING INCOME
 
384

 
557

 
1,421

 
1,828

Interest income
 
6

 
9

 
18

 
20

Interest expense (Note 8)
 
16

 
16

 
51

 
47

Other income, net
 
8

 
11

 
34

 
12

INCOME BEFORE INCOME TAXES
 
382

 
561

 
1,422

 
1,813

Income tax expense (Note 5)
 
82

 
169

 
362

 
521

CONSOLIDATED NET INCOME
 
300

 
392

 
1,060

 
1,292

Less: Net income attributable to noncontrolling interests
 
11

 
12

 
44

 
54

NET INCOME ATTRIBUTABLE TO CUMMINS INC.
 
$
289

 
$
380

 
$
1,016

 
$
1,238

 
 
 
 
 
 
 
 
 
EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CUMMINS INC.
 
 

 
 

 
 

 
 

Basic
 
$
1.72

 
$
2.15

 
$
5.99

 
$
6.92

Diluted
 
$
1.72

 
$
2.14

 
$
5.99

 
$
6.90

 
 
 
 
 
 
 
 
 
WEIGHTED AVERAGE SHARES OUTSTANDING
 
 

 
 

 
 

 
 

Basic
 
167.8

 
177.0

 
169.5

 
178.9

Dilutive effect of stock compensation awards
 
0.4

 
0.4

 
0.2

 
0.4

Diluted
 
168.2

 
177.4

 
169.7

 
179.3

 
 
 
 
 
 
 
 
 
CASH DIVIDENDS DECLARED PER COMMON SHARE
 
$
1.025

 
$
0.975

 
$
2.975

 
$
2.535

____________________________________
(a) Includes sales to nonconsolidated equity investees of $275 million and $793 million and $274 million and $956 million for the three and nine months ended October 2, 2016 and September 27, 2015, respectively.
 
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

3
Table of Contents

CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 
 
Three months ended
 
Nine months ended
In millions 
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
CONSOLIDATED NET INCOME
 
$
300

 
$
392

 
$
1,060

 
$
1,292

Other comprehensive (loss) income, net of tax (Note 11)
 
 

 
 

 
 

 
 

Foreign currency translation adjustments
 
(29
)
 
(221
)
 
(299
)
 
(252
)
Unrealized gain (loss) on derivatives
 
7

 
7

 
(20
)
 
15

Change in pension and other postretirement defined benefit plans
 
13

 
15

 
31

 
43

Unrealized gain (loss) on marketable securities
 
—

 
(1
)
 
1

 
(1
)
Total other comprehensive loss, net of tax
 
(9
)
 
(200
)
 
(287
)
 
(195
)
COMPREHENSIVE INCOME
 
291

 
192

 
773

 
1,097

Less: Comprehensive income (loss) attributable to noncontrolling interests
 
14

 
(1
)
 
41

 
39

COMPREHENSIVE INCOME ATTRIBUTABLE TO CUMMINS INC.
 
$
277

 
$
193

 
$
732

 
$
1,058

 
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

4
Table of Contents

CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
In millions, except par value
 
October 2,
2016
 
December 31,
2015
ASSETS
 
 

 
 

Current assets
 
 

 
 

Cash and cash equivalents
 
$
1,251

 
$
1,711

Marketable securities (Note 6)
 
250

 
100

Total cash, cash equivalents and marketable securities
 
1,501

 
1,811

Accounts and notes receivable, net
 
 
 
 
Trade and other
 
2,680

 
2,640

Nonconsolidated equity investees
 
193

 
180

Inventories (Note 7)
 
2,820

 
2,707

Prepaid expenses and other current assets
 
600

 
609

Total current assets
 
7,794

 
7,947

Long-term assets
 
 

 
 

Property, plant and equipment
 
7,460

 
7,322

Accumulated depreciation
 
(3,783
)
 
(3,577
)
Property, plant and equipment, net
 
3,677

 
3,745

Investments and advances related to equity method investees
 
1,077

 
975

Goodwill
 
482

 
482

Other intangible assets, net
 
319

 
328

Pension assets
 
773

 
735

Other assets
 
1,014

 
922

Total assets
 
$
15,136

 
$
15,134

 
 
 
 
 
LIABILITIES
 
 

 
 

Current liabilities
 
 

 
 

Accounts payable (principally trade)
 
$
1,781

 
$
1,706

Loans payable (Note 8)
 
48

 
24

Commercial paper (Note 8)
 
273

 
—

Accrued compensation, benefits and retirement costs
 
393

 
409

Current portion of accrued product warranty (Note 9)
 
333

 
359

Current portion of deferred revenue
 
460

 
403

Other accrued expenses
 
985

 
863

Current maturities of long-term debt (Note 8)
 
35

 
39

Total current liabilities
 
4,308

 
3,803

Long-term liabilities
 
 

 
 

Long-term debt (Note 8)
 
1,593

 
1,576

Postretirement benefits other than pensions
 
326

 
349

Pensions
 
301

 
298

Other liabilities and deferred revenue
 
1,344

 
1,358

Total liabilities
 
$
7,872

 
$
7,384

 
 
 
 
 
Commitments and contingencies (Note 10)
 


 


 
 
 

 
 

EQUITY
 
 
 
 
Cummins Inc. shareholders’ equity
 
 

 
 

Common stock, $2.50 par value, 500 shares authorized, 222.4 and 222.4 shares issued
 
$
2,209

 
$
2,178

Retained earnings
 
10,833

 
10,322

Treasury stock, at cost, 54.1 and 47.2 shares
 
(4,468
)
 
(3,735
)
Common stock held by employee benefits trust, at cost, 0.7 and 0.9 shares
 
(8
)
 
(11
)
Accumulated other comprehensive loss (Note 11)
 
(1,632
)
 
(1,348
)
Total Cummins Inc. shareholders’ equity
 
6,934

 
7,406

Noncontrolling interests
 
330

 
344

Total equity
 
$
7,264

 
$
7,750

Total liabilities and equity
 
$
15,136

 
$
15,134


The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

5
Table of Contents

CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
Nine months ended
In millions
 
October 2,
2016
 
September 27,
2015
CASH FLOWS FROM OPERATING ACTIVITIES
 
 

 
 

Consolidated net income
 
$
1,060

 
$
1,292

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

 
 

Restructuring payments (Note 12)
 
(53
)
 
—

Loss contingency (Note 10)
 
138

 
—

Depreciation and amortization
 
391

 
383

Gain on fair value adjustment for consolidated investees
 
—

 
(17
)
Deferred income taxes
 
60

 
(120
)
Equity in income of investees, net of dividends
 
(94
)
 
(68
)
Pension contributions in excess of expense (Note 3)
 
(92
)
 
(119
)
Other post-retirement benefits payments in excess of expense (Note 3)
 
(16
)
 
(18
)
Stock-based compensation expense
 
28

 
24

Translation and hedging activities
 
(39
)
 
22

Changes in current assets and liabilities, net of acquisitions
 
 
 
 

Accounts and notes receivable
 
(112
)
 
(163
)
Inventories
 
(150
)
 
(179
)
Other current assets
 
138

 
133

Accounts payable
 
97

 
(52
)
Accrued expenses
 
(279
)
 
(153
)
Changes in other liabilities and deferred revenue
 
188

 
219

Other, net
 
45

 
(53
)
Net cash provided by operating activities
 
1,310

 
1,131

 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 

 
 

Capital expenditures
 
(312
)
 
(393
)
Investments in internal use software
 
(42
)
 
(38
)
Investments in and advances to equity investees
 
(29
)
 
(9
)
Acquisitions of businesses, net of cash acquired
 
(1
)
 
(102
)
Investments in marketable securities—acquisitions (Note 6)
 
(447
)
 
(175
)
Investments in marketable securities—liquidations (Note 6)
 
291

 
228

Cash flows from derivatives not designated as hedges
 
(64
)
 
17

Other, net
 
14

 
(5
)
Net cash used in investing activities
 
(590
)
 
(477
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 

 
 

Proceeds from borrowings
 
111

 
24

Net borrowings of commercial paper (Note 8)
 
273

 
—

Payments on borrowings and capital lease obligations
 
(156
)
 
(64
)
Net borrowings (payments) under short-term credit agreements
 
25

 
(38
)
Distributions to noncontrolling interests
 
(42
)
 
(35
)
Dividend payments on common stock
 
(505
)
 
(452
)
Repurchases of common stock
 
(745
)
 
(650
)
Other, net
 
(2
)
 
—

Net cash used in financing activities
 
(1,041
)
 
(1,215
)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
 
(139
)
 
(52
)
Net decrease in cash and cash equivalents
 
(460
)
 
(613
)
Cash and cash equivalents at beginning of year
 
1,711

 
2,301

CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
1,251

 
$
1,688


 The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

6
Table of Contents

CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Unaudited)
 
In millions
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Common
Stock
Held in
Trust
 
Accumulated
Other
Comprehensive
Loss
 
Total
Cummins Inc.
Shareholders’
Equity
 
Noncontrolling
Interests
 
Total
Equity
BALANCE AT DECEMBER 31, 2014
$
556

 
$
1,583

 
$
9,545

 
$
(2,844
)
 
$
(13
)
 
$
(1,078
)
 
$
7,749

 
$
344

 
$
8,093

Net income


 


 
1,238

 


 


 


 
1,238

 
54

 
1,292

Other comprehensive (loss) income, net of tax (Note 11)


 


 


 


 


 
(180
)
 
(180
)
 
(15
)
 
(195
)
Issuance of shares


 
7

 


 


 


 


 
7

 
—

 
7

Employee benefits trust activity


 
21

 


 


 
2

 


 
23

 
—

 
23

Acquisition of shares


 


 


 
(650
)
 


 


 
(650
)
 
—

 
(650
)
Cash dividends on common stock


 


 
(452
)
 


 


 


 
(452
)
 
—

 
(452
)
Distributions to noncontrolling interests


 


 


 


 


 


 
—

 
(46
)
 
(46
)
Stock based awards


 
(4
)
 


 
8

 


 


 
4

 
—

 
4

Other shareholder transactions


 
10

 


 


 


 


 
10

 
(5
)
 
5

BALANCE AT SEPTEMBER 27, 2015
$
556

 
$
1,617

 
$
10,331

 
$
(3,486
)
 
$
(11
)
 
$
(1,258
)
 
$
7,749

 
$
332

 
$
8,081

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE AT DECEMBER 31, 2015
$
556

 
$
1,622

 
$
10,322

 
$
(3,735
)
 
$
(11
)
 
$
(1,348
)
 
$
7,406

 
$
344

 
$
7,750

Net income


 


 
1,016

 


 


 


 
1,016

 
44

 
1,060

Other comprehensive (loss) income, net of tax (Note 11)


 


 


 


 


 
(284
)
 
(284
)
 
(3
)
 
(287
)
Issuance of shares


 
5

 


 


 


 


 
5

 
—

 
5

Employee benefits trust activity


 
19

 


 


 
3

 


 
22

 
—

 
22

Acquisition of shares (Note 2)


 


 


 
(745
)
 


 


 
(745
)
 
—

 
(745
)
Cash dividends on common stock


 


 
(505
)
 


 


 


 
(505
)
 
—

 
(505
)
Distributions to noncontrolling interests


 


 


 


 


 


 
—

 
(49
)
 
(49
)
Stock based awards


 
(7
)
 


 
12

 


 


 
5

 
—

 
5

Other shareholder transactions


 
14

 


 


 


 


 
14

 
(6
)
 
8

BALANCE AT OCTOBER 2, 2016
$
556

 
$
1,653

 
$
10,833

 
$
(4,468
)
 
$
(8
)
 
$
(1,632
)
 
$
6,934

 
$
330

 
$
7,264

 
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

7
Table of Contents

CUMMINS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 1. NATURE OF OPERATIONS
Cummins Inc. (“Cummins,” “we,” “our” or “us”) was founded in 1919 as a corporation in Columbus, Indiana, as one of the first diesel engine manufacturers. We are a global power leader that designs, manufactures, distributes and services diesel and natural gas engines and engine-related component products, including filtration, aftertreatment, turbochargers, fuel systems, controls systems, air handling systems and electric power generation systems. We sell our products to original equipment manufacturers (OEMs), distributors and other customers worldwide. We serve our customers through a network of approximately 600 company-owned and independent distributor locations and over 7,200 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 in accordance with accounting principles generally accepted in the United States of America (GAAP) pursuant to the rules and regulations of the Securities and Exchange Commission 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.
These interim condensed financial statements should be read in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2015. Our interim period financial results for the three and nine month periods presented are not necessarily indicative of results to be expected for any other interim period or for the entire year. The year-end Condensed Consolidated Balance Sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.
Preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts presented and disclosed in our 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, useful lives for depreciation and amortization, estimates of future cash flows and other assumptions associated with goodwill and long-lived asset impairment tests, determination of discount rates and other assumptions for pension and other postretirement benefit costs, warranty programs, income taxes and deferred tax valuation allowances, lease classification, contingencies and restructuring costs. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be different from these estimates.
Our reporting period usually ends on the Sunday closest to the last day of the quarterly calendar period. The third quarters of 2016 and 2015 ended on October 2 and September 27, respectively. Our fiscal year ends on December 31, regardless of the day of the week on which December 31 falls.
The weighted-average diluted common shares outstanding excludes the anti-dilutive effect of certain stock options since such options had an exercise price in excess of the monthly average market value of our common stock. The options excluded from diluted earnings per share for the three and nine months ended October 2, 2016 and September 27, 2015, were as follows:
 
 
Three months ended
 
Nine months ended
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
Options excluded
936,857

 
950,345

 
1,295,664

 
593,436

In 2016, we entered into an accelerated share repurchase agreement with a third party financial institution to repurchase $500 million of our common stock under our previously announced share repurchase plans and received 4.7 million shares at an average purchase price of $105.50 per share.

8
Table of Contents

NOTE 3. PENSION AND OTHER POSTRETIREMENT BENEFITS
We sponsor funded and unfunded domestic and foreign defined benefit pension and other postretirement plans. Contributions to these plans were as follows:
 
 
 
Three months ended
 
Nine months ended
In millions
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
Defined benefit pension plans
 
 

 
 

 
 

 
 

Voluntary contribution
 
$
16

 
$
7

 
$
101

 
$
79

Mandatory contribution
 
5

 
5

 
23

 
87

Defined benefit pension contributions
 
$
21

 
$
12

 
$
124

 
$
166

 
 
 
 
 
 
 
 
 
Other postretirement plans
 
$
4

 
$
8

 
$
32

 
$
33

 
 
 
 
 
 
 
 
 
Defined contribution pension plans
 
$
17

 
$
14

 
$
53

 
$
56

We anticipate making additional defined benefit pension contributions during the remainder of 2016 of $22 million for our U.S. and U.K pension plans. The estimated $146 million of pension contributions for the full year include voluntary contributions of approximately $103 million. These contributions may be made from trusts or company funds either to increase pension assets or to make direct benefit payments to plan participants. We expect our 2016 net periodic pension cost to approximate $42 million.
The components of net periodic pension and other postretirement benefit costs under our plans were as follows:
 
 
Pension
 
 
 
 
 
 
U.S. Plans
 
U.K. Plans
 
Other Postretirement Benefits
 
 
Three months ended
In millions
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
Service cost
 
$
22

 
$
20

 
$
5

 
$
7

 
$
—

 
$
—

Interest cost
 
26

 
25

 
13

 
14

 
4

 
4

Expected return on plan assets
 
(50
)
 
(47
)
 
(17
)
 
(23
)
 
—

 
—

Recognized net actuarial loss
 
9

 
11

 
3

 
8

 
1

 
1

Net periodic benefit cost
 
$
7

 
$
9

 
$
4

 
$
6

 
$
5

 
$
5

 
 
Pension
 
 
 
 
 
 
U.S. Plans
 
U.K. Plans
 
Other Postretirement Benefits
 
 
Nine months ended
In millions
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
Service cost
 
$
68

 
$
60

 
$
16

 
$
20

 
$
—

 
$
—

Interest cost
 
82

 
76

 
39

 
42

 
12

 
12

Expected return on plan assets
 
(152
)
 
(142
)
 
(55
)
 
(68
)
 
—

 
—

Recognized net actuarial loss
 
23

 
34

 
11

 
25

 
4

 
3

Net periodic benefit cost
 
$
21

 
$
28

 
$
11

 
$
19

 
$
16

 
$
15



9
Table of Contents

NOTE 4. EQUITY, ROYALTY AND INTEREST INCOME FROM INVESTEES
Equity, royalty and interest income from investees included in our Condensed Consolidated Statements of Income for the reporting periods was as follows: 
 
 
Three months ended
 
Nine months ended
In millions
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
Distribution entities
 
 
 
 
 
 
 
 
Komatsu Cummins Chile, Ltda.
 
$
8

 
$
8

 
$
26

 
$
23

North American distributors
 
7

 
9

 
18

 
27

All other distributors
 
1

 
1

 
2

 
2

Manufacturing entities
 
 
 
 
 
 

 
 

Beijing Foton Cummins Engine Co., Ltd.
 
19

 
18

 
59

 
47

Chongqing Cummins Engine Company, Ltd.
 
11

 
9

 
28

 
32

Dongfeng Cummins Engine Company, Ltd.
 
10

 
11

 
32

 
40

All other manufacturers
 
8

 
13

 
40

 
41

Cummins share of net income
 
64

 
69

 
205

 
212

Royalty and interest income
 
10

 
9

 
29

 
28

Equity, royalty and interest income from investees
 
$
74

 
$
78

 
$
234

 
$
240

NOTE 5. INCOME TAXES
Our effective tax rate for the year is expected to approximate 25.5 percent, excluding any one-time items that may arise. Our tax rate is generally less than the 35 percent U.S. statutory income tax rate primarily due to lower tax rates on foreign income and the research tax credit.
Our effective tax rate for the three and nine months ended October 2, 2016, was 21.5 percent and 25.5 percent, respectively.
Our effective tax rate for the three and nine months ended September 27, 2015, was 30.1 percent and 28.7 percent, respectively. The tax rate for the nine months ended September 27, 2015, included an $18 million discrete tax benefit to reflect the release of reserves for uncertain tax positions related to a favorable federal audit settlement.
The decrease in the effective tax rate for the three and nine months ended October 2, 2016, versus the comparable periods in 2015 was primarily due to favorable changes in the jurisdictional mix of pre-tax income.
It is reasonably possible that our existing liabilities for uncertain tax benefits may decrease in an amount ranging from $20 million to $26 million within the next 12 months for U.S. and non-U.S. audits that are in progress.
NOTE 6. MARKETABLE SECURITIES
A summary of marketable securities, all of which are classified as current, was as follows:
 
 
 
October 2, 2016
 
December 31, 2015
In millions
 
Cost
 
Gross unrealized
gains/(losses)
 
Estimated
fair value
 
Cost
 
Gross unrealized
gains/(losses)
 
Estimated
fair value
Available-for-sale
 
 

 
 

 
 

 
 

 
 

 
 

Level 2(1)
 
 
 
 
 
 
 
 
 
 
 
 
Bank debentures
 
$
118

 
$
—

 
$
118

 
$
—

 
$
—

 
$
—

Debt mutual funds
 
118

 
—

 
118

 
88

 
—

 
88

Equity mutual funds
 
12

 
—

 
12

 
11

 
(1
)
 
10

Government debt securities
 
2

 
—

 
2

 
2

 
—

 
2

Total marketable securities
 
$
250

 
$
—

 
$
250

 
$
101

 
$
(1
)
 
$
100

____________________________________
(1) The fair value of Level 2 securities is estimated using actively quoted prices for similar instruments from brokers and observable inputs where available, including market transactions and third-party pricing services, or net asset values provided to investors. We do not currently have any Level 3 securities and there were no transfers between Level 2 or 3 during the first nine months of 2016 or for the year ended December 31, 2015.

10

A description of the valuation techniques and inputs used for our Level 2 fair value measures was as follows:
•
Bank debentures— These investments provide us with a contractual rate of return and generally range in maturity from three months to one year. The counter-parties to these investments are reputable financial institutions with investment grade credit ratings. Since these instruments are not tradable and must be settled directly by us with the respective financial institution, our fair value measure is the financial institutions’ month-end statement.
•
Debt mutual funds— The fair value measure for these investments is the daily net asset value published on a regulated governmental website. Daily quoted prices are available from the issuing brokerage and are used on a test basis to corroborate this Level 2 input.
•
Equity mutual funds— The fair value measure for these investments is the net asset value published by the issuing brokerage. Daily quoted prices are available from reputable third party pricing services and are used on a test basis to corroborate this Level 2 input measure.
•
Government debt securities-non-U.S.— The fair value measure for these securities is broker quotes received from reputable firms. These securities are infrequently traded on a national stock exchange and these values are used on a test basis to corroborate our Level 2 input measure.
The proceeds from sales and maturities of marketable securities and gross realized gains and losses from the sale of available-for-sale securities were as follows:
 
 
Three months ended
 
Nine months ended
In millions
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
Proceeds from sales and maturities of marketable securities
 
$
54

 
$
73

 
$
291

 
$
228

Gross realized gains from the sale of marketable securities(1)
 
—

 
—

 
—

 
1

____________________________________
(1) Gross realized losses from the sale of available-for-sale securities were immaterial.
At October 2, 2016, the fair value of available-for-sale investments in debt securities that utilize a Level 2 fair value measure is shown by contractual maturity below:
 
Contractual Maturity
 
(In millions)
1 year or less
 
$
237

5 - 10 years
 
1

Total
 
$
238

NOTE 7. INVENTORIES
Inventories are stated at the lower of cost or market. Inventories included the following:
 
In millions
 
October 2,
2016
 
December 31,
2015
Finished products
 
$
1,779

 
$
1,796

Work-in-process and raw materials
 
1,146

 
1,022

Inventories at FIFO cost
 
2,925

 
2,818

Excess of FIFO over LIFO
 
(105
)
 
(111
)
Total inventories
 
$
2,820

 
$
2,707


11
Table of Contents

NOTE 8. DEBT
Loans Payable and Commercial Paper
Loans payable, commercial paper and the related weighted-average interest rates were as follows:
 
 
October 2, 2016
 
December 31, 2015
Dollars in millions
 
Amount
 
Weighted Average Interest Rate
 
Amount
 
Weighted Average Interest Rate
Loans payable (1)
 
$
48

 
 
 
$
24

 
 
Commercial paper (2)
 
273

 
0.47
%
(3) 
—

 
—

____________________________________
(1) Loans payable consist primarily of notes payable to various domestic and international financial institutions. It is not practical to aggregate these notes and calculate a quarterly weighted-average interest rate.
(2) In February 2016, the Board of Directors authorized the issuance of up to $1.75 billion of unsecured short-term promissory notes ("commercial paper") pursuant to a commercial paper program. The program will facilitate the private placement of unsecured short-term debt through third party brokers. We intend to use the net proceeds from the commercial paper program for general corporate purposes.
(3) The weighted average interest rate is inclusive of all brokerage fees.
Long-term Debt
A summary of long-term debt was as follows:
 
In millions
 
October 2,
2016
 
December 31,
2015
Long-term debt
 
 

 
 

Senior notes, 3.65%, due 2023
 
$
500

 
$
500

Debentures, 6.75%, due 2027
 
58

 
58

Debentures, 7.125%, due 2028
 
250

 
250

Senior notes, 4.875%, due 2043
 
500

 
500

Debentures, 5.65%, due 2098 (effective interest rate 7.48%)
 
165

 
165

Other debt
 
49

 
55

Unamortized discount
 
(56
)
 
(57
)
Fair value adjustments due to hedge on indebtedness
 
77

 
63

Capital leases
 
85

 
81

Total long-term debt
 
1,628

 
1,615

Less: Current maturities of long-term debt
 
35

 
39

Long-term debt
 
$
1,593

 
$
1,576

Principal payments required on long-term debt during the next five years are as follows:
 
 
Required Principal Payments
In millions
 
2016
 
2017
 
2018
 
2019
 
2020
Principal payments
 
$
9

 
$
28

 
$
31

 
$
24

 
$
7

Fair Value of Debt
Based on borrowing rates currently available to us for bank loans with similar terms and average maturities, considering our risk premium, the fair value and carrying value of total debt, including current maturities, was as follows:
 
In millions
 
October 2,
2016
 
December 31,
2015
Fair value of total debt(1)
 
$
2,292

 
$
1,821

Carrying value of total debt
 
1,949

 
1,639

_________________________________________________
(1) The fair value of debt is derived from Level 2 inputs.

12
Table of Contents

NOTE 9. PRODUCT WARRANTY LIABILITY
A tabular reconciliation of the product warranty liability, including the deferred revenue related to our extended warranty coverage and accrued recall programs was as follows:
 
In millions 
 
October 2,
2016
 
September 27,
2015
Balance, beginning of year
 
$
1,404

 
$
1,283

Provision for warranties issued
 
256

 
326

Deferred revenue on extended warranty contracts sold
 
179

 
217

Payments
 
(291
)
 
(282
)
Amortization of deferred revenue on extended warranty contracts
 
(148
)
 
(132
)
Changes in estimates for pre-existing warranties
 
22

 
18

Foreign currency translation
 
(6
)
 
(10
)
Balance, end of period
 
$
1,416

 
$
1,420

Warranty related deferred revenue and the long-term portion of the warranty liability on our October 2, 2016, balance sheet were as follows:
In millions
 
October 2,
2016
 
Balance Sheet Location
Deferred revenue related to extended coverage programs
 
 

 
 
Current portion
 
$
210

 
Current portion of deferred revenue
Long-term portion
 
537

 
Other liabilities and deferred revenue
Total
 
$
747

 
 
 
 
 
 
 
Long-term portion of warranty liability
 
$
336

 
Other liabilities and deferred revenue
NOTE 10. COMMITMENTS AND CONTINGENCIES
We are subject to numerous lawsuits and claims arising out of the ordinary course of our business, including actions related to product liability; personal injury; the use and performance of our products; warranty matters; patent, trademark or other intellectual property infringement; contractual liability; the conduct of our business; tax reporting in foreign jurisdictions; distributor termination; workplace safety; and environmental matters. We also have been identified as a potentially responsible party at multiple waste disposal sites under U.S. federal and related state environmental statutes and regulations and may have joint and several liability for any investigation and remediation costs incurred with respect to such sites. We have denied liability with respect to many of these lawsuits, claims and proceedings and are vigorously defending such lawsuits, claims and proceedings. We carry various forms of commercial, property and casualty, product liability and other forms of insurance; however, such insurance may not be applicable or adequate to cover the costs associated with a judgment against us with respect to these lawsuits, claims and proceedings. We do not believe that these lawsuits are material individually or in the aggregate. While we believe we have also established adequate accruals for our expected future liability with respect to pending lawsuits, claims and proceedings, where the nature and extent of any such liability can be reasonably estimated based upon then presently available information, there can be no assurance that the final resolution of any existing or future lawsuits, claims or proceedings will not have a material adverse effect on our business, results of operations, financial condition or cash flows.
We conduct significant business operations in Brazil that are subject to the Brazilian federal, state and local labor, social security, tax and customs laws. While we believe we comply with such laws, they are complex, subject to varying interpretations and we are often engaged in litigation regarding the application of these laws to particular circumstances.
Loss Contingency
Engine systems sold in the U.S. must be certified to comply with the Environmental Protection Agency (EPA) and California Air Resources Board (CARB) emission standards. EPA and CARB regulations require that in-use testing be performed on vehicles by the emission certificate holder and reported to the EPA and CARB in order to ensure ongoing compliance with these emission standards. We are the holder of this emission certificate for our engines, including engines installed in certain vehicles with one customer on which we did not also manufacture or sell the emission aftertreatment system. During 2015, a

13
Table of Contents

quality issue in certain of these third party aftertreatment systems caused some of our inter-related engines to fail in-use emission testing. In the fourth quarter of 2015, the vehicle manufacturer made a request that we assist in the design and bear the financial cost of a field campaign (Campaign) to address the technical issue purportedly causing some vehicles to fail the in-use testing.
While we are not responsible for the warranty issues related to a component that we did not manufacture or sell, as the emission compliance certificate holder, we are responsible for proposing a remedy to the EPA and CARB. As a result, we have proposed actions to the agencies that we believe will address the emission failures. As the certificate holder, we expect to participate in the cost of the proposed voluntary Campaign and recorded a charge of $60 million in 2015. The Campaign design was finalized with our OEM customer, reviewed with the EPA and submitted for final approval in the second quarter of 2016, and we recorded an additional accrual of $39 million. We have concluded based upon additional in-use emission testing performed in the third quarter of 2016, that the Campaign should be expanded to include a larger population of vehicles manufactured by this one OEM. As a result, we recorded an additional accrual of $99 million in the third quarter to reflect the estimated cost of our participation in the expanded Campaign. We continue to work with our OEM customer to resolve the allocation of costs for the Campaign, including pending litigation between the parties. The Campaign is not expected to be completed for some time and our final cost could differ from the amount we have recorded.
We do not currently expect any fines or penalties from the EPA or CARB related to this matter.

The accrual related to the Campaign is included in "Other accrued expenses" in our Condensed Consolidated Balance Sheets.
Guarantees and Commitments
From time to time we enter into guarantee arrangements, including guarantees of non-U.S. distributor financings, residual value guarantees on equipment under operating leases and other miscellaneous guarantees of joint ventures or third-party obligations. At October 2, 2016, the maximum potential loss related to these guarantees was $24 million.
We have arrangements with certain suppliers that require us to purchase minimum volumes or be subject to monetary penalties. At October 2, 2016, if we were to stop purchasing from each of these suppliers, the aggregate amount of the penalty would be approximately $108 million, of which $55 million relates to a contract with a components supplier that extends to 2018. Most of these arrangements enable us to secure critical components. We do not currently anticipate paying any penalties under these contracts.
We enter into physical forward contracts with suppliers of platinum, palladium and copper to purchase minimum volumes of the commodities at contractually stated prices for various periods, not to exceed two years. At October 2, 2016, the total commitments under these contracts were $27 million. These arrangements enable us to fix the prices of these commodities, which otherwise are subject to market volatility.
We have guarantees with certain customers that require us to satisfactorily honor contractual or regulatory obligations, or compensate for monetary losses related to nonperformance. These performance bonds and other performance-related guarantees were $79 million at October 2, 2016.
Indemnifications
Periodically, we enter into various contractual arrangements where we agree to indemnify a third-party against certain types of losses. Common types of indemnities include:
•
product liability and license, patent or trademark indemnifications;
•
asset sale agreements where we agree to indemnify the purchaser against future environmental exposures related to the asset sold; and
•
any contractual agreement where we agree to indemnify the counter-party for losses suffered as a result of a misrepresentation in the contract.
We regularly evaluate the probability of having to incur costs associated with these indemnities 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.

14
Table of Contents

NOTE 11. ACCUMULATED OTHER COMPREHENSIVE LOSS
Following are the changes in accumulated other comprehensive (loss) income by component for the three and nine months ended:
 
 
Three months ended
In millions
 
Change in
pensions and
other
postretirement
defined benefit
plans
 
Foreign
currency
translation
adjustment
 
Unrealized gain
(loss) on
marketable
securities
 
Unrealized gain
(loss) on
derivatives
 
Total
attributable to
Cummins Inc.
 
Noncontrolling
interests
 
Total other comprehensive income (loss)
Balance at June 28, 2015
 
$
(641
)
 
$
(435
)
 
$
(1
)
 
$
6

 
$
(1,071
)
 
 

 
 

Other comprehensive income before reclassifications
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Before tax amount
 
—

 
(239
)
 
(1
)
 
13

 
(227
)
 
$
(13
)
 
$
(240
)
Tax benefit (expense)
 
—

 
31

 
—

 
(1
)
 
30

 
—

 
30

After tax amount
 
—

 
(208
)
 
(1
)
 
12

 
(197
)
 
(13
)
 
(210
)
Amounts reclassified from accumulated other comprehensive income(1)(2)
 
15

 
—

 
—

 
(5
)
 
10

 
—

 
10

Net current period other comprehensive income (loss)
 
15

 
(208
)
 
(1
)
 
7

 
(187
)
 
$
(13
)
 
$
(200
)
Balance at September 27, 2015
 
$
(626
)
 
$
(643
)
 
$
(2
)
 
$
13

 
$
(1,258
)
 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at July 3, 2016
 
$
(636
)
 
$
(960
)
 
$
(1
)
 
$
(23
)
 
$
(1,620
)
 
 

 
 

Other comprehensive income before reclassifications
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Before tax amount
 
5

 
(51
)
 
—

 
(4
)
 
(50
)
 
$
3

 
$
(47
)
Tax (expense) benefit
 
(1
)
 
19

 
—

 
1

 
19

 
—

 
19

After tax amount
 
4

 
(32
)
 
—

 
(3
)
 
(31
)
 
3

 
(28
)
Amounts reclassified from accumulated other comprehensive income(1)(2)
 
9

 
—

 
—

 
10

 
19

 
—

 
19

Net current period other comprehensive income (loss)
 
13

 
(32
)
 
—

 
7

 
(12
)
 
$
3

 
$
(9
)
Balance at October 2, 2016
 
$
(623
)
 
$
(992
)
 
$
(1
)
 
$
(16
)
 
$
(1,632
)
 
 

 
 

____________________________________
(1) Amounts are net of tax.  
(2) See reclassifications out of accumulated other comprehensive (loss) income disclosure below for further details.  

15
Table of Contents

 
 
Nine months ended
In millions
 
Change in
pensions and
other
postretirement
defined benefit
plans
 
Foreign
currency
translation
adjustment
 
Unrealized gain
(loss) on
marketable
securities
 
Unrealized gain
(loss) on
derivatives
 
Total
attributable to
Cummins Inc.
 
Noncontrolling
interests
 
Total other comprehensive income (loss)
Balance at December 31, 2014
 
$
(669
)
 
$
(406
)
 
$
(1
)
 
$
(2
)
 
$
(1,078
)
 
 

 
 

Other comprehensive income before reclassifications
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Before tax amount
 
(3
)
 
(290
)
 
—

 
23

 
(270
)
 
$
(15
)
 
$
(285
)
Tax benefit (expense)
 
1

 
53

 
—

 
(3
)
 
51

 
—

 
51

After tax amount
 
(2
)
 
(237
)
 
—

 
20

 
(219
)
 
(15
)
 
(234
)
Amounts reclassified from accumulated other comprehensive income(1)(2)
 
45

 
—

 
(1
)
 
(5
)
 
39

 
—

 
39

Net current period other comprehensive income (loss)
 
43

 
(237
)
 
(1
)
 
15

 
(180
)
 
$
(15
)
 
$
(195
)
Balance at September 27, 2015
 
$
(626
)
 
$
(643
)
 
$
(2
)
 
$
13

 
$
(1,258
)
 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
 
$
(654
)
 
$
(696
)
 
$
(2
)
 
$
4

 
$
(1,348
)
 
 

 
 

Other comprehensive income before reclassifications
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Before tax amount
 
5

 
(316
)
 
1

 
(40
)
 
(350
)
 
$
(3
)
 
$
(353
)
Tax (expense) benefit
 
(1
)
 
20

 
—

 
7

 
26

 
—

 
26

After tax amount
 
4

 
(296
)
 
1

 
(33
)
 
(324
)
 
(3
)
 
(327
)
Amounts reclassified from accumulated other comprehensive income(1)(2)
 
27

 
—

 
—

 
13

 
40

 
—

 
40

Net current period other comprehensive income (loss)
 
31

 
(296
)
 
1

 
(20
)
 
(284
)
 
$
(3
)
 
$
(287
)
Balance at October 2, 2016
 
$
(623
)
 
$
(992
)
 
$
(1
)
 
$
(16
)
 
$
(1,632
)
 
 

 
 

____________________________________
(1) Amounts are net of tax.  
(2) See reclassifications out of accumulated other comprehensive (loss) income disclosure below for further details.  


16
Table of Contents

Following are the items reclassified out of accumulated other comprehensive (loss) income and the related tax effects:
In millions
 
Three months ended
 
Nine months ended
 
 
(Gain)/Loss Components
 
October 2,
2016
 
September 27,
2015
 
October 2,
2016
 
September 27,
2015
 
Statement of Income Location
 
 
 
 
 
 
 
 
 
 
 
Change in pensions and other postretirement defined benefit plans
 
 

 
 
 
 

 
 
 
 
Recognized actuarial loss