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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 March 31, 2019

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 every Interactive Data File required to be submitted 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 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth 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	Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 March 31, 2019, there were 157,492,272 shares of common stock outstanding with a par value of $2.50 per share.

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CUMMINS INC. AND SUBSIDIARIES

TABLE OF CONTENTS

QUARTERLY REPORT ON FORM 10-Q



		Page
	PART I. FINANCIAL INFORMATION
ITEM 1.	Condensed Consolidated Financial Statements (Unaudited)	3
	Condensed Consolidated Statements of Net Income for the three months ended March 31, 2019 and April 1, 2018	3
	Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2019 and April 1, 2018	4
	Condensed Consolidated Balance Sheets at March 31, 2019 and December 31, 2018	5
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2019 and April 1, 2018	6
	Condensed Consolidated Statements of Changes in Equity for the three months ended March 31, 2019 and April 1, 2018	7
	Notes to Condensed Consolidated Financial Statements	8
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	45
ITEM 4.	Controls and Procedures	45
	PART II. OTHER INFORMATION
ITEM 1.	Legal Proceedings	46
ITEM 1A.	Risk Factors	46
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
ITEM 3.	Defaults Upon Senior Securities	47
ITEM 4.	Mine Safety Disclosures	47
ITEM 5.	Other Information	47
ITEM 6.	Exhibits	48
	Signatures	49

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PART I. FINANCIAL INFORMATION

ITEM 1. Condensed Consolidated Financial Statements

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF NET INCOME

(Unaudited)



	Three months ended
In millions, except per share amounts	March 31, 2019		April 1, 2018
NET SALES ^(a)(Note 3)	$	6,004	$	5,570
Cost of sales	4,472		4,370
GROSS MARGIN	1,532		1,200
OPERATING EXPENSES AND INCOME
Selling, general and administrative expenses	593		577
Research, development and engineering expenses	237		210
Equity, royalty and interest income from investees (Note 5)	92		115
Other operating income (expense), net	5		2
OPERATING INCOME	799		530
Interest income	12		7
Interest expense	32		24
Other income, net	66		10
INCOME BEFORE INCOME TAXES	845		523
Income tax expense	176		198
CONSOLIDATED NET INCOME	669		325
Less: Net income attributable to noncontrolling interests	6		—
NET INCOME ATTRIBUTABLE TO CUMMINS INC.	$	663	$	325

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CUMMINS INC.
Basic	$	4.22	$	1.97
Diluted	$	4.20	$	1.96

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic	157.2		164.9
Dilutive effect of stock compensation awards	0.5		0.8
Diluted	157.7		165.7

____________________________________

^(a)Includes sales to nonconsolidated equity investees of $285 million and $297 million for the three months ended March 31, 2019 and April 1, 2018, respectively.

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

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CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)



	Three months ended
In millions	March 31, 2019			April 1, 2018
CONSOLIDATED NET INCOME	$	669		$	325
Other comprehensive income (loss), net of tax (Note 13)
Change in pension and other postretirement defined benefit plans	(11		)	8
Foreign currency translation adjustments	84			84
Unrealized (loss) gain on derivatives	(1		)	7
Unrealized loss on marketable securities	(1		)	—
Total other comprehensive (loss) income, net of tax	71			99
COMPREHENSIVE INCOME	740			424
Less: Comprehensive income (loss) attributable to noncontrolling interests	9			(7		)
COMPREHENSIVE INCOME ATTRIBUTABLE TO CUMMINS INC.	$	731		$	431

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

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CUMMINS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

In millions, except par value	March 31, 2019			December 31, 2018
ASSETS
Current assets
Cash and cash equivalents	$	1,328		$	1,303
Marketable securities (Note 6)	246			222
Total cash, cash equivalents and marketable securities	1,574			1,525
Accounts and notes receivable, net
Trade and other	3,765			3,635
Nonconsolidated equity investees	260			231
Inventories (Note 7)	3,893			3,759
Prepaid expenses and other current assets	599			668
Total current assets	10,091			9,818
Long-term assets
Property, plant and equipment	8,349			8,319
Accumulated depreciation	(4,283		)	(4,223		)
Property, plant and equipment, net	4,066			4,096
Investments and advances related to equity method investees	1,303			1,222
Goodwill	1,125			1,126
Other intangible assets, net	895			909
Pension assets	939			929
Other assets	1,427			962
Total assets	$	19,846		$	19,062

LIABILITIES
Current liabilities
Accounts payable (principally trade)	$	3,018		$	2,822
Loans payable (Note 9)	70			54
Commercial paper (Note 9)	709			780
Accrued compensation, benefits and retirement costs	364			679
Current portion of accrued product warranty (Note 10)	762			654
Current portion of deferred revenue (Note 3)	509			498
Other accrued expenses (Note 11)	958			852
Current maturities of long-term debt (Note 9)	37			45
Total current liabilities	6,427			6,384
Long-term liabilities
Long-term debt (Note 9)	1,605			1,597
Pensions and other postretirement benefits	520			532
Accrued product warranty (Note 10)	682			740
Deferred revenue (Note 3)	697			658
Other liabilities (Note 11)	1,188			892
Total liabilities	$	11,119		$	10,803

Commitments and contingencies (Note 12)

EQUITY
Cummins Inc. shareholders’ equity
Common stock, $2.50 par value, 500 shares authorized, 222.4 and 222.4 shares issued	$	2,273		$	2,271
Retained earnings	13,401			12,917
Treasury stock, at cost, 64.9 and 64.4 shares	(6,111		)	(6,028		)
Common stock held by employee benefits trust, at cost, 0.3 and 0.4 shares	(4		)	(5		)
Accumulated other comprehensive loss (Note 13)	(1,739		)	(1,807		)
Total Cummins Inc. shareholders’ equity	7,820			7,348
Noncontrolling interests	907			911
Total equity	$	8,727		$	8,259
Total liabilities and equity	$	19,846		$	19,062

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

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CUMMINS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Three months ended
In millions	March 31, 2019			April 1, 2018
CASH FLOWS FROM OPERATING ACTIVITIES
Consolidated net income	$	669		$	325
Adjustments to reconcile consolidated net income to net cash provided by (used in) operating activities
Depreciation and amortization	157			154
Deferred income taxes	11			(27		)
Equity in income of investees, net of dividends	(64		)	(95		)
Pension contributions (in excess of) under expense, net (Note 4)	(17		)	13
Other postretirement benefits payments in excess of expense, net (Note 4)	(12		)	(5		)
Stock-based compensation expense	9			9
(Gain) loss on corporate owned life insurance	(37		)	3
Foreign currency remeasurement and transaction exposure	79			38
Changes in current assets and liabilities
Accounts and notes receivable	(135		)	(217		)
Inventories	(107		)	(259		)
Other current assets	67			56
Accounts payable	166			246
Accrued expenses	(293		)	(337		)
Changes in other liabilities	64			27
Other, net	(145		)	(48		)
Net cash provided by (used in) operating activities	412			(117		)

CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures	(109		)	(72		)
Investments in internal use software	(20		)	(15		)
Investments in and advances to equity investees	(10		)	(16		)
Investments in marketable securities—acquisitions (Note 6)	(121		)	(67		)
Investments in marketable securities—liquidations (Note 6)	103			82
Cash flows from derivatives not designated as hedges	55			27
Other, net	31			25
Net cash used in investing activities	(71		)	(36		)

CASH FLOWS FROM FINANCING ACTIVITIES
Net (payments) borrowings of commercial paper (Note 9)	(71		)	295
Payments on borrowings and finance lease obligations	(10		)	(16		)
Distributions to noncontrolling interests	(13		)	(11		)
Dividend payments on common stock	(179		)	(178		)
Repurchases of common stock	(100		)	(163		)
Other, net	26			21
Net cash used in financing activities	(347		)	(52		)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS	31			43
Net increase (decrease) in cash and cash equivalents	25			(162		)
Cash and cash equivalents at beginning of year	1,303			1,369
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	1,328		$	1,207

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

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CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)



In millions, except per share amounts	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, 2017	$	556	$	1,654		$	11,464		$	(4,905	)	$	(7	)	$	(1,503	)	$	7,259		$	905		$	8,164
Adoption of new accounting standards ⁽¹⁾						30												30			—			30
Net income						325												325			—			325
Other comprehensive income (loss), net of tax (Note 13)															106			106			(7		)	99
Issuance of common stock			3															3			—			3
Employee benefits trust activity			6									1						7			—			7
Repurchases of common stock									(163		)							(163		)	—			(163		)
Cash dividends on common stock, $1.08 per share						(178		)										(178		)	—			(178		)
Distributions to noncontrolling interests																		—			(11		)	(11		)
Stock based awards			(4		)				7									3			—			3
Other shareholder transactions			2															2			15			17
BALANCE AT APRIL 1, 2018	$	556	$	1,661		$	11,641		$	(5,061	)	$	(6	)	$	(1,397	)	$	7,394		$	902		$	8,296

BALANCE AT DECEMBER 31, 2018	$	556	$	1,715		$	12,917		$	(6,028	)	$	(5	)	$	(1,807	)	$	7,348		$	911		$	8,259
Net income						663												663			6			669
Other comprehensive income, net of tax (Note 13)															68			68			3			71
Issuance of common stock			1															1			—			1
Employee benefits trust activity			13									1						14			—			14
Repurchases of common stock									(100		)							(100		)	—			(100		)
Cash dividends on common stock, $1.14 per share						(179		)										(179		)	—			(179		)
Distributions to noncontrolling interests																		—			(13		)	(13		)
Stock based awards			(11		)				17									6			—			6
Other shareholder transactions			(1		)													(1		)	—			(1		)
BALANCE AT MARCH 31, 2019	$	556	$	1,717		$	13,401		$	(6,111	)	$	(4	)	$	(1,739	)	$	7,820		$	907		$	8,727

____________________________________

⁽¹⁾ Includes $28 million related to adoption of the revenue recognition standard and $2 million related to adoption of the accounting for certain financial instruments standard. See Note 1, “SUMMARY OF

SIGNIFICANT ACCOUNTING POLICIES - Recently Adopted and Recently Issued Accounting Pronouncements” of the Notes to the Consolidated Financial Statements of our

2018 Form 10-K for additional information.

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

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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 Cummins Engine Company, a corporation in Columbus, Indiana, and one of the first diesel engine manufacturers. In 2001, we changed our name to Cummins Inc. We are a global power leader that designs, manufactures, distributes and services diesel and natural gas engines and powertrain-related component products, including filtration, aftertreatment, turbochargers, fuel systems, controls systems, air handling systems, transmissions, electric power generation systems, batteries and electrified power systems. We sell our products to original equipment manufacturers (OEMs), distributors, dealers and other customers worldwide. We serve our customers through a network of approximately 600 wholly-owned and independent distributor locations and over 7,600 dealer locations in more than 190 countries and territories.

NOTE 2. BASIS OF PRESENTATION

Interim Condensed Financial Statements

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 in the United States of America (GAAP) pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) 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.

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, 2018. Our interim period financial results for the three 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.

Reclassifications

Certain amounts for prior year periods have been reclassified to conform to the presentation of the current year.

Use of Estimates in Preparation of Financial Statements

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. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be different from these estimates.

Reporting Period

Our reporting period usually ends on the Sunday closest to the last day of the quarterly calendar period. The first quarters of 2019 and 2018 ended on March 31 and April 1, respectively. Our fiscal year ends on December 31, regardless of the day of the week on which December 31 falls.

Weighted-Average Diluted Shares Outstanding

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 were as follows:



	Three months ended
	March 31, 2019	April 1, 2018
Options excluded	783,576	6,867

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NOTE 3. REVENUE RECOGNITION

Long-term Contracts

Most of our contracts are for a period of less than one year. We have certain long-term maintenance agreements, construction contracts and extended warranty coverage arrangements that span a period in excess of one year. The aggregate amount of the transaction price for long-term maintenance agreements and construction contracts allocated to performance obligations that have not been satisfied as of March 31, 2019, was $705 million. We expect to recognize the related revenue of $205 million over the next 12 months and $500 million over periods up to 10 years. See NOTE 10, "PRODUCT WARRANTY LIABILITY," for additional disclosures on extended warranty coverage arrangements. Our other contracts generally are for a duration of less than one year, include payment terms that correspond to the timing of cost incurred when providing goods and services to our customers or represent sale-based royalties.

Deferred and Unbilled Revenue

The following is a summary of our unbilled and deferred revenue and related activity:



In millions	March 31, 2019		December 31, 2018
Unbilled revenue	$	46	$	64
Deferred revenue, primarily extended warranty	1,206		1,156

Revenue recognized was $109 million and $128 million for the three months ended March 31, 2019 and April 1, 2018, respectively. These amounts relate to year-to-date revenues recognized from amounts included in deferred revenue at the beginning of the year. We did not record any impairment losses on our unbilled revenues during the three months ended March 31, 2019.

Disaggregation of Revenue

Consolidated Revenue

The table below presents our consolidated sales by geographic area. Net sales attributed to geographic areas were based on the location of the customer.



	Three months ended
In millions	March 31, 2019		April 1, 2018
United States	$	3,436	$	3,038
China	573		550
India	224		235
Other international	1,771		1,747
Total net sales	$	6,004	$	5,570

Segment Revenue

Engine segment external sales by market were as follows:



	Three months ended
In millions	March 31, 2019		April 1, 2018
Heavy-duty truck	$	723	$	614
Medium-duty truck and bus	610		627
Light-duty automotive	330		323
Total on-highway	1,663		1,564
Off-highway	321		249
Total sales	$	1,984	$	1,813

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Distribution segment external sales by region were as follows:



	Three months ended
In millions	March 31, 2019		April 1, 2018
North America	$	1,392	$	1,274
Asia Pacific	220		187
Europe	123		131
China	81		77
Africa and Middle East	55		61
India	47		44
Latin America	40		38
Russia	35		35
Total sales	$	1,993	$	1,847

Distribution segment external sales by product line were as follows:



	Three months ended
In millions	March 31, 2019		April 1, 2018
Parts	$	841	$	803
Power generation	401		325
Engines	389		368
Service	362		351
Total sales	$	1,993	$	1,847

Components segment external sales by business were as follows:



	Three months ended
In millions	March 31, 2019		April 1, 2018
Emission solutions	$	749	$	684
Filtration	259		257
Turbo technologies	190		197
Automated transmissions	149		117
Electronics and fuel systems	54		58
Total sales	$	1,401	$	1,313

Power Systems segment external sales by product line were as follows:



	Three months ended
In millions	March 31, 2019		April 1, 2018
Power generation	$	308	$	310
Industrial	231		201
Generator technologies	84		84
Total sales	$	623	$	595

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NOTE 4. PENSIONS AND OTHER POSTRETIREMENT BENEFITS

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



	Three months ended
In millions	March 31, 2019		April 1, 2018
Defined benefit pension plans
Voluntary contribution	$	26	$	3
Mandatory contribution	7		6
Defined benefit pension contributions	$	33	$	9

Other postretirement benefit plans
Benefit payments, net	$	14	$	7

Defined contribution pension plans	$	39	$	40

We anticipate making additional defined benefit pension contributions during the remainder of 2019 of $90 million for our U.S. and U.K. pension plans. Approximately $91 million of the estimated $123 million of pension contributions for the full year are voluntary. 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 2019 net periodic pension cost to approximate $64 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	March 31, 2019			April 1, 2018			March 31, 2019			April 1, 2018			March 31, 2019		April 1, 2018
Service cost	$	29		$	30		$	7		$	8		$	—	$	—
Interest cost	27			25			11			11			2		2
Expected return on plan assets	(47		)	(49		)	(18		)	(18		)	—		—
Recognized net actuarial loss	4			8			3			7			—		—
Net periodic benefit cost	$	13		$	14		$	3		$	8		$	2	$	2

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NOTE 5. EQUITY, ROYALTY AND INTEREST INCOME FROM INVESTEES

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



	Three months ended
In millions	March 31, 2019			April 1, 2018
Manufacturing entities
Beijing Foton Cummins Engine Co., Ltd.	$	21		$	21
Dongfeng Cummins Engine Company, Ltd.	14			17
Chongqing Cummins Engine Company, Ltd.	12			17
All other manufacturers	27			36
Distribution entities
Komatsu Cummins Chile, Ltda.	6			7
All other distributors	(1		)	—
Cummins share of net income	79			98
Royalty and interest income	13			17
Equity, royalty and interest income from investees	$	92		$	115

NOTE 6. MARKETABLE SECURITIES

A summary of marketable securities, all of which were classified as current, was as follows:



	March 31, 2019						December 31, 2018
In millions	Cost		Gross unrealized gains/(losses)⁽¹⁾		Estimated fair value		Cost		Gross unrealized gains/(losses)⁽¹⁾		Estimated fair value
Equity securities
Certificates of deposit	$	137	$	—	$	137	$	101	$	—	$	101
Debt mutual funds	85		1		86		103		1		104
Equity mutual funds	20		2		22		16		—		16
Debt securities	1		—		1		1		—		1
Total marketable securities	$	243	$	3	$	246	$	221	$	1	$	222

____________________________________

⁽¹⁾ Unrealized gains and losses for debt securities are recorded in other comprehensive income while unrealized gains and losses for equity securities are recorded in "Other income, net" in our Condensed Consolidated Statements of Net Income.

All debt securities are classified as available-for-sale. All marketable securities presented use a Level 2 fair value measure. 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 three months of 2019 or for the year ended December 31, 2018.

A description of the valuation techniques and inputs used for our Level 2 fair value measures is as follows:

•

Certificates of deposit — These investments provide us with a contractual rate of return and generally range in maturity from three months to five years. The counterparties 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 institution's month-end statement.


•	Debt mutual funds — The fair value measure for the vast majority of 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.


•	Debt securities — 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 were as follows:



	Three months ended
In millions	March 31, 2019		April 1, 2018
Proceeds from sales of marketable securities	$	63	$	69
Proceeds from maturities of marketable securities	40		13
Investments in marketable securities - liquidations	$	103	$	82

NOTE 7. INVENTORIES

Inventories are stated at the lower of cost or market. Inventories included the following:



In millions	March 31, 2019			December 31, 2018
Finished products	$	2,427		$	2,405
Work-in-process and raw materials	1,598			1,487
Inventories at FIFO cost	4,025			3,892
Excess of FIFO over LIFO	(132		)	(133		)
Total inventories	$	3,893		$	3,759

NOTE 8. LEASES

Lease Accounting Pronouncement Adoption

In February 2016, the Financial Accounting Standards Board (FASB) amended its standards related to the accounting for leases. Under the new standard, lessees are now required to recognize substantially all leases on the balance sheet as both a right-of-use (ROU) asset and a liability. The standard continues to have two types of leases for income statement recognition purposes: operating leases and finance leases. Operating leases result in the recognition of a single lease expense on a straight-line basis over the lease term, similar to the treatment for operating leases under the old standard. Finance leases result in an accelerated expense similar to the accounting for capital leases under the old standard. The determination of a lease classification as operating or finance will occur in a manner similar to the old standard. The new standard also contains amended guidance regarding the identification of embedded leases in service contracts and the identification of lease and non-lease components of an arrangement.

We adopted the new standard on January 1, 2019, using a modified retrospective approach and as a result did not adjust prior periods. Adoption of the standard resulted in the recording of $450 million of operating lease right-of-use assets and operating lease liabilities, but did not have a material impact on our net income or cash flows. The cumulative effect adjustment of adopting the new standard was not material. We elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward the historical lease classification and to not re-evaluate existing contracts as to whether or not they contained a lease.

Lease Policies

We determine if an arrangement contains a lease in whole or in part at the inception of the contract. ROU assets represent our right to use an underlying asset for the lease term while lease liabilities represent our obligation to make lease payments arising from the lease. All leases greater than 12 months result in the recognition of a ROU asset and a liability at the lease commencement date based on the present value of the lease payments over the lease term. As most of our leases do not provide the information required to determine the implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. This rate is determined considering factors such as the lease term, our credit standing and the economic environment of the location of the lease. We use the implicit rate when readily determinable.

Table of Contents

Our lease terms include all non-cancelable periods and may include options to extend (or to not terminate) the lease when it is reasonably certain that we will exercise that option. Leases that have a term of 12 months or less at the commencement date are expensed on a straight-line basis over the lease term and do not result in the recognition of an asset or a liability.

Lease expense for operating leases is recognized on a straight-line basis over the lease term. Lease expense for finance leases are generally front-loaded as the finance lease ROU asset is depreciated on a straight-line basis, but interest expense on the liability is recognized utilizing the interest method that results in more expense during the early years of the lease. We have lease agreements with lease and non-lease components, primarily related to real estate, vehicle and Information Technology (IT) leases. For vehicle and real estate leases, we account for the lease and non-lease components as a single lease component. For IT leases, we allocate the payment between the lease and non-lease components based on the relative value of each component.

Leases

Our lease portfolio consists primarily of real estate and equipment leases. Our real estate leases primarily consist of office, distribution, warehousing and manufacturing facilities. These leases typically range in term from 20 to 30 years and may contain renewal options for periods up to 2 years at our discretion. Our equipment lease portfolio consists primarily of vehicles (including service vehicles), forktrucks and IT equipment. These leases typically range in term from two years to three years and may contain renewal options for periods up to one year at our discretion. Our leases generally do not contain variable lease payments other than (1) certain foreign real estate leases which have payments indexed to inflation and (2) certain real estate executory costs (such as taxes, insurance and maintenance) which are paid based on actual expenses incurred by the lessor during the year. Our leases generally do not include residual value guarantees other than our service vehicle fleet which has a residual guarantee based on a percentage of the original cost declining over the lease term.

The components of our lease expense were as follows:



In millions	March 31, 2019
Operating lease cost	$	50
Finance lease cost
Amortization of right-of-use asset	5
Interest expense	2
Short-term lease cost	1
Variable lease cost	1