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

FORM 10-Q

 Commission File Number 1-4949

CUMMINS INC.

(Exact name of registrant as specified in its charter)

          

 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 o 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 March 29, 2009, there were 201,816,557 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

 

 

 

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PART I.  FINANCIAL INFORMATION

 

ITEM 1. Condensed Financial Statements

 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

(a) Includes sales to nonconsolidated equity investees of $429 million and $512 million for the three months ended March 29, 2009 and March 30, 2008, respectively.

 

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)

 

 

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)

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

 

CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

 

(1) Comprised of defined benefit postretirement plans of $(801) million, foreign currency translation adjustments of $(215) million, unrealized gain on marketable securities of $2 million and unrealized loss on derivatives of $(38) 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 leading global power provider that designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration and emissions solutions, turbochargers, 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 first quarter of 2009 and 2008 ended on March 29, and March 30, respectively.  The interim periods for both 2009 and 2008 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.

The weighted-average diluted common shares outstanding as of March 29, 2009, and March 30, 2008, excludes the effect of approximately 58,050 and 9,513 weighted-average shares of common stock, respectively, since such options had an exercise price in excess of the monthly average market value of our common stock during both three month periods.

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, 2008.  Our interim period financial results for the three-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 Consolidated 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.

In September 2006, the FASB issued SFAS No. 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).  This statement requires balance sheet recognition of the overfunded or underfunded status of pension and postretirement benefit plans.  In addition, the measurement date (the date at which plan assets and the benefit obligation are measured) is required to be the company’s fiscal year end.  During 2006, we adopted the provisions (except for the measurement date change) 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)," which resulted in a $94 million noncash charge to equity.  We adopted the measurement date provisions of SFAS 158 effective January 1, 2008.  The majority of our pension and 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 noncash effect of the adoption of the measurement date provisions of SFAS 158 decreased shareholders’ equity by approximately $10 million ($7 million after-tax) and increased long-term liabilities by approximately $10 million.  There was no effect on our results of operations.

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.  This standard defines a noncontrolling interest, previously called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent.  SFAS 160 requires, among other items, that a noncontrolling interest be included in the consolidated balance sheet within equity separate from the parent’s equity; consolidated net income to be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares and, separately, the amounts of consolidated net income attributable to the parent and noncontrolling interest all on the consolidated statements of income; and if a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value.  We adopted SFAS 160 effective January 1, 2009, and applied it retrospectively.  As a result, we reclassified noncontrolling interests in amounts of $246 million and $307 million from the mezzanine section to equity in the December 31, 2008 and March 30, 2008, balance sheets, respectively.  Certain reclassifications have been made to prior period amounts to conform to the presentation of the current period under SFAS 160.

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.  The new disclosures required by this standard are included in Note 11.

 

Accounting Pronouncements Issued But Not Yet Effective

In April 2009, the FASB issued three new FASB Staff Positions (FSPs) all of which impact the accounting and disclosure related to certain financial instruments.  FSP FAS 157-4, "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly" (FSP FAS 157-4) provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased.  It also includes guidance on identifying circumstances that indicate a transaction is not orderly.  FSP FAS 115-2 and FAS 124-2, "Recognition of Other-Than-Temporary Impairment" (FSP FAS 115-2 and FAS 124-2) amends the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements.  FSP FAS 107-1 and APB 28-1 "Interim Disclosures about Fair Value of Financial Instruments" (FSP FAS 107-1 and APB 28-1) amends FASB Statement No. 107 to require disclosures about the fair value of financial instruments on an interim basis in addition to the annual disclosure requirements.  All three FSPs are required to be adopted for interim periods ending after June 15, 2009.  We do not expect adoption of these staff positions to have a material impact on our Condensed Consolidated Financial Statements.

 

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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 month periods ended March 29, 2009 and March 30, 2008, respectively, were as follows:

We presently anticipate contributing $125 million to $135 million to our defined benefit pension plans in 2009 and paying approximately $53 million in claims and premiums for other postretirement benefits.  The $125 million to $135 million of contributions for the full year include voluntary contributions of $100 million to $105 million.  These contributions and payments include payments from Company funds either to increase pension assets or to make direct payments to plan participants.

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

 

 

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:

 

 

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NOTE 6.  RESTRUCTURING CHARGES

 

2009 Restructuring Actions

In the first quarter of 2009, we executed restructuring actions in response to a reduction in orders in most of our U.S. and foreign markets due to the continuing deterioration in the global economy.  We reduced our global workforce by approximately 800 professional employees.  In addition, we took numerous employee actions at many of our manufacturing locations, including significant downsizing at numerous facilities and complete closure of two facilities and several branch distributor locations.  Employee termination and severance costs were recorded based on approved plans developed by the businesses and corporate management which specified positions to be eliminated, benefits to be paid under existing severance plans, union contracts or statutory requirements and the expected timetable for completion of the plan.  Estimates of restructuring were made based on information available at the time charges were recorded.  Due to the inherent uncertainty involved, actual amounts paid for such activities may differ from amounts initially recorded and we may need to revise previous estimates.  Total workforce reductions as of March 29, 2009 were as follows:

In response to closures and downsizing noted above, we incurred $1 million of restructuring expenses for lease terminations and $5 million of restructuring expenses for asset impairments.  During the first quarter of 2009 we recorded a total pre-tax restructuring charge of $66 million in “Restructuring charges” in the Condensed Consolidated Statements of Income related to the 2009 actions. These restructuring actions included:

The following table summarizes the balance of accrued restructuring charges by expense type and the changes in the accrued amounts for the applicable periods.  The restructuring related accruals were recorded in “Other accrued expenses” in the Condensed Consolidated Balance Sheets.

We do not include restructuring charges in our operating segment results.  The pretax impact of allocating restructuring charges to the segment results would have been as follows:
 

 

2008 Restructuring Actions

In 2008 we executed restructuring actions in response to the continued deterioration in our U.S. businesses and most key markets around the world in the second half of 2008, as well as a reduction in orders in most U.S. and foreign markets for 2009.  In 2008 we announced reductions of our global workforce by approximately 650 professional employees.  In addition, we took numerous employee actions at many of our manufacturing locations, including approximately 800 hourly employees.  Total workforce reductions as of March 29, 2009 were as follows:

 

The charges recorded during the year ended December 31, 2008, included severance costs related to both voluntary and involuntary terminations.  During 2008, we incurred a pretax charge related to the professional and hourly restructuring initiatives of $37 million.  The following table summarizes the balance of accrued restructuring charges and the changes in the accrued amounts for the applicable periods.  The restructuring related accruals were recorded in “Other accrued expenses” in the Condensed Consolidated Balance Sheets.

 

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NOTE 7.  INVENTORIES

Inventories included the following:

      

 

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:

The amount of deferred revenue related to extended coverage programs at March 29, 2009, was $233 million.  At March 29, 2009, we had $13 million of receivables related to estimated supplier recoveries of which $7 million was included in “Trade and other” receivables and $6 million was included in “Deferred income taxes and other assets” on our Condensed Consolidated Balance Sheets.

 

NOTE 9.  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 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.  Some of these lawsuits, claims and proceedings involve substantial amounts.  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 operation, financial condition or cash flows.

 

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U.S. Distributor Commitments

We have an operating agreement with a financial institution that provides financing to certain independent Cummins and Onan distributors in the U.S., and to certain distributors in which we own an equity interest. Under this agreement, 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, 2010 and is subject to an automatic one year renewal without requiring the action of either party.

 

Residual Value Guarantees

We have various residual value guarantees on equipment leased under operating leases.  The total amount of these residual value guarantees at March 29, 2009, was $8 million.

 

Other Guarantees and Commitments

In addition to the guarantees discussed above, from time to time we enter into other guarantee arrangements, including guarantees of non-U.S. distributor financing and other miscellaneous guarantees of third-party obligations. The maximum potential loss related to these other guarantees is $47 million ($45 million of which relates to the Beijing Foton discussion below) at March 29, 2009.

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 March 29, 2009, if we were to stop purchasing from each of these suppliers, the amount of the penalty would be approximately $93 million, of which $79 million relates to a six year contract with an engine parts supplier that extends from 2008 to 2013.  This arrangement enables us to secure critical components.  We do not anticipate paying any penalties under these contracts.  

In July 2008, Beijing Foton Cummins Engine Company, a 50 percent owned entity accounted for under the equity method, entered into a line of credit agreement with a borrowing capacity of up to $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 March 29, 2009, outstanding borrowings under this agreement were $90 million and our guarantee was $45 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.

We have a standby commitment with Irwin Financial Corporation (Irwin) to purchase up to $25 million of its common shares in connection with a potential rights offering being planned by Irwin.  Our commitment is subject to the satisfaction of several conditions.  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 makes any investment in Irwin.  The decision by us to enter into our commitment or to make any investment in Irwin has been and will continue to be made by our Board of Directors without the participation of Mr. Miller.

 

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Indemnifications

Periodically, we enter into various contractual arrangements where we agree to indemnify a third-party against certain types of losses.  Common types of indemnifications include:

• product liability and license, patent or trademark indemnifications,

• asset sale agreements where we agree to indemnify the purchaser against future environmental exposures related to the asset sold, and

• any contractual agreement where we agree to indemnify the counter-party for losses suffered as a result of a misrepresentation in the contract.

We regularly evaluate the probability of having to incur costs associated with these indemnifications and accrue for expected losses that are probable.  Because the indemnifications are not related to specified known liabilities and due to their uncertain nature, we are unable to estimate the maximum amount of the potential loss associated with these indemnifications.

 

NOTE 10.  FAIR VALUE OF FINANCIAL INSTRUMENTS

The majority of the assets and liabilities we carry at fair value are available-for-sale (AFS) securities and derivatives.  AFS securities are derived from level 1 or level 2 inputs.  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.  When material, we adjust the values of our derivative contracts for counter-party or our credit risk.

The following table summarizes our financial instruments recorded at fair value in our Condensed Consolidated Balance Sheets at March 29, 2009:

 

 

NOTE 11.  DERIVATIVES

We are exposed to financial risk resulting from volatility in foreign exchange rates, commodity prices and interest rates.  This risk is closely monitored and managed through the use of financial derivative instruments including foreign currency forward contracts, commodity forward contracts and interest rate swaps.  As stated in our policies and procedures, financial derivatives are used expressly for hedging purposes, and under no circumstances are they used for speculative purposes.  When material, we adjust the value of our derivative contracts for counter-party or our credit risk.  The results and status of our hedging transactions are reported to senior management on a monthly and quarterly basis.

 

Foreign Currency Exchange Rate Risk

As a result of our international business presence, we are exposed to foreign currency exchange risks.  We transact business in foreign currencies and, as a result our income experiences some volatility related to movements in foreign currency exchange rates.  To help manage our exposure to exchange rate volatility, we use foreign exchange forward contracts on a regular basis to hedge forecasted intercompany and third-party sales and purchases denominated in non-functional currencies.  Our internal policy allows for managing anticipated foreign currency cash flow for up to one year.  These foreign currency forward contracts are designated and qualify as foreign currency cash flow hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133).  The effective portion of the unrealized gain or loss on the forward contract is deferred and reported as a component of “Accumulated other comprehensive loss” (AOCL).  When the hedged forecasted transaction (sale or purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income.  The ineffective portion of the hedge, unrealized gain or loss, if any, is recognized in current income during the period of change.  As of March 29, 2009, the amount expected to be reclassified to income over the next twelve months is not material.  For the three month periods ended March 29, 2009 and March 30, 2008, there were no circumstances that would have resulted in the discontinuance of a cash flow hedge.

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To minimize the income volatility resulting from the remeasurement of net monetary assets and payables denominated in a currency other than the functional currency, we enter into foreign currency forward contracts, which are considered economic hedges.  The objective is to offset the gain or loss from remeasurement with the gain or loss from the fair market valuation of the forward contract.  These derivative instruments are not designated as hedges under SFAS 133.

The table below summarizes our outstanding foreign currency forward contracts.  The currencies in this table represent 91% and 97% of the notional amounts of contracts outstanding for the three month periods ended March 29, 2009 and March 30, 2008, respectively.

 

  

Commodity Price Risk

We are exposed to fluctuations in commodity prices due to contractual agreements with component suppliers.  In order to protect ourselves against future price volatility and, consequently, fluctuations in gross margins, we periodically enter into commodity forward contracts with designated banks to fix the cost of certain raw material purchases with the objective of minimizing changes in inventory cost due to market price fluctuations.  The forward contracts are derivative contracts that are designated as cash flow hedges under SFAS 133.  The effective portion of the unrealized gain or loss is deferred and reported as a component of AOCL.  When the hedged forecasted transaction (purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income.  The ineffective portion of the hedge, if any, is recognized in current income in the period in which the ineffectiveness occurs.  As of March 29, 2009, we expect to reclassify unrealized net loss of $15 million from AOCL to income over the next twelve months.  For the three month period ended March 29, 2009, we discontinued hedge accounting on certain contracts where the forecasted transactions were no longer probable.  The amount reclassified to income as a result of this action was less than $1 million.  For the three month period ended March 30, 2008, there were no circumstances that would have resulted in the discontinuance of a cash flow hedge.

Our internal policy allows for managing these cash flow hedges for up to three years.  The following table summarizes our outstanding commodity forward contracts that were entered into to hedge the cost of certain raw material purchases:

 

Interest Rate Risk

We are exposed to market risk from fluctuations in interest rates.  We manage our exposure to interest rate fluctuations through the use of interest rate swaps.  The objective of the swaps is to more effectively balance our borrowing costs and interest rate risk. Currently, we have one interest rate swap outstanding.

In November 2005, we entered into an interest rate swap to effectively convert our $250 million, due in 2028, debt from a fixed rate of 7.125% to a floating rate based on a LIBOR spread.  The terms of the swap mirror those of the debt, with interest paid semi-annually.  This swap qualifies as a fair value hedge under SFAS 133.  The gain or loss on this derivative instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in current income as “Interest expense”.

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The following table summarizes the location and fair value of derivative instruments on our Condensed Consolidated Balance Sheets:

 

 

 

The table below summarizes the effect on our Condensed Consolidated Statements of Income for derivative instruments classified as cash flow hedges for the three month interim reporting periods presented below.  The table does not include amounts related to ineffectiveness as it was not material for the periods presented.

 

 

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The following table summarizes the effect on our Condensed Consolidated Statements of Income for derivative instruments that are not classified as hedges for the three month interim reporting periods presented below:

 

 

 

 

 

 

NOTE 12.  LEASE AMENDMENT AND EXTENSION

During 2001, we entered into a sale-leaseback transaction with a financial institution with regard to certain heavy-duty engine manufacturing equipment.  The lease was classified as an operating lease with a lease term of 11.5 years, expiring June 28, 2013.  The financial institution created a grantor trust to act as the lessor in the arrangement.  The financial institution owns 100 percent of the equity in the trust.  The grantor trust has no assets other than the equipment and its rights to the lease agreement with us.  On the initial sale, we received $125 million from the financial institution which was financed with $99 million of non-recourse debt and $26 million of equity. Our obligations to the grantor trust consisted of the payments due under the lease and a $9 million guarantee of the residual value of the equipment.  In addition, we had a fixed price purchase option that was exercisable on January 14, 2009, for approximately $35 million; however, we decided not to exercise this option.   

In December 2003, the grantor trust which acts as the lessor in the sale and leaseback transaction described above was consolidated due to the adoption of FIN 46(R), due primarily to the existence of the residual value guarantee.  As a result of the consolidation, the manufacturing equipment and the trust’s obligations under its non-recourse debt arrangement was included in our Condensed Consolidated Balance Sheets as property, plant and equipment and long-term debt, respectively.  The equity in the trust held by the financial institution was reported as noncontrolling interest.  The non-recourse debt arrangement is more fully discussed in Note 10 to our annual Consolidated Financial Statements included in our 2008 Form 10-K.  In addition, our Condensed Consolidated Statements of Income included interest expense on the lessor’s debt obligations and depreciation expense on the manufacturing equipment rather than rent expense under the lease agreement.  In April 2008, we made the final payment on the non-recourse debt.

In February 2009, we amended the lease agreement to (1) extend the lease for an additional 2 years to June 2015, and (2) remove the residual value guarantee.  As a result of removing the residual value guarantee, we have determined that we are no longer required to consolidate the grantor trust and deconsolidated the trust in the first quarter of 2009.  With the deconsolidation, we are now required to account for the leasing arrangement with the trust.  We evaluated the amended lease and determined that the lease qualified as a capital lease.  The deconsolidation of the trust had minimal impact on our Condensed Consolidated Financial Statements as the present value of the minimum lease payments (including the extension) approximated the amount that was reported as noncontrolling interest as of the date of the amendment.  The reduction in noncontrolling interests and increase in our capital lease liabilities was $35 million.

The future lease payments required under the amended lease are $8 million in 2009, $0 million in 2010, $0 million in 2011, $12 million in 2012, $10 million in 2013 and $18 million thereafter.  The lease agreement includes certain default provisions requiring us to make timely rent payments, maintain, service, repair and insure the equipment, procure residual value insurance and maintain minimum debt ratings for our long-term senior unsecured debt obligations.

 

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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 or loss before interest expense, income taxes and noncontrolling 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 month period is shown below:

 

(1) Includes intersegment sales and profit in inventory eliminations and unallocated corporate expenses.  For the three months ended March 29, 2009, unallocated corporate expenses include $66 million of restructuring charges and a $6 million gain related to flood damage insurance recoveries.  There were no significant unallocated corporate expenses for the three months ended March 30, 2008.

(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:

 

 

 

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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:

• price and product competition by foreign and domestic competitors, including new entrants;

• rapid technological developments of diesel engines;

• the ability to continue to introduce competitive new products in a timely, cost-effective manner;

• the sales mix of products;

• the continued achievement of lower costs and expenses;

• domestic and foreign governmental and public policy changes, including environmental regulations;

• protection and validity of patent and other intellectual property rights;

• reliance on large customers;

• technological, implementation and cost/financial risks in increasing use of large, multi-year contracts;

• the cyclical nature of some of our markets;

• the outcome of pending and future litigation and governmental proceedings;

• continued availability of financing, financial instruments and financial resources in the amounts, at the times and on the terms required to support our future business;

• the overall stability of global economic markets and conditions; and

• other risk factors described in Part II of this report under the caption “Risk Factors Relating to Our Business.”

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, commodity prices and other future factors.

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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 2008 Form 10-K.  Our MD&A is presented in the following sections:

• Executive Summary and Financial Highlights

• Results of Operations

• Restructuring Charges

• Outlook

• Operating Segment Results

• Liquidity and Capital Resources

• Off Balance Sheet Financing

• Application of Critical Accounting Estimates

• Recently Adopted and Recently Issued Accounting Pronouncements

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EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS

We are a leading global power provider that designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration and exhaust aftertreatment, turbochargers, 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 PACCAR Inc., International Truck and Engine Corporation (Navistar International Corporation), Chrysler LLC, Volvo AB, Daimler Trucks North America (formerly Freightliner), Ford Motor Company, Case New Holland, Komatsu, 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.  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 customers’ 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 three months of 2009 most global markets experienced additional declines from those levels experienced in the fourth quarter of 2008.  We expect demand to remain weak in most of our markets through 2009.  As a result, we took targeted restructuring actions in the first quarter of 2009, including global workforce reductions and closing or slowing certain local manufacturing operations to align our businesses with reduced customer demand.  These restructuring actions, in conjunction with the significantly reduced demand negatively impacted our first quarter operating results.  Should our future performance for the remainder of the year differ adversely from our projections, we could be required to take additional actions as local conditions require.

While global demand for our products is expected to continue to decline in 2009, the actions that were initiated in the fourth quarter of 2008 and the first quarter of 2009 will enable us to navigate through the downturn and position us to emerge a stronger company.  In 2009, management will work toward the following goals:

• Align costs and capacity with the real demand for our products, so that we maintain a solid profit through the downturn;
• Manage the business in such a way that generates positive cash flow; and
• Continue to invest in critical technologies and products for 2010 and beyond.

Net income attributable to Cummins was $7 million, or $0.04 per diluted share, on sales of $2.4 billion for the first quarter of 2009, compared to the first quarter of 2008 with net income attributable to Cummins of $190 million, or $0.97 per diluted share, on sales of $3.5 billion.  The decrease in income was driven by a 30 percent decrease in net sales and a 37 percent decrease in gross margin, as we were impacted by lower demand across most of our businesses.  Focused cost reduction efforts helped mitigate the impact of lower volumes.  Restructuring actions in the first quarter of 2009 were $66 million ($44 million after-tax, or $0.22 per diluted share).  For a detailed discussion of restructuring see “Restructuring Charges” and Note 6 to the Condensed Consolidated Financial Statements.

 

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RESULTS OF OPERATIONS

 

 

Net Sales

Net sales for the three months ended March 29, 2009, decreased in all segments versus the comparable period in 2008, due to the following drivers.

• Demand decreased in all of our segments due to the global economic downturn.

• We experienced unfavorable foreign currency translation in all of our operating segments.

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

 

Gross Margin

Significant drivers of the change in gross margins for the three months ended March 29, 2009, compared to the period ended March 30, 2008, were as follows:

Gross margin decreased by $262 million, and decreased as a percentage of sales by 2.2 percentage points.  The decrease was led by lower volumes followed by increased materials costs.  These decreases in margin were partially offset by improved pricing.  The decrease in volumes was mainly due to lower sales resulting from the global economic downturn.  The increased materials costs were primarily due to increased commodity costs.  The provision for warranties issued as a percent of sales was 3.1% in both periods.

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

 

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Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ended March 29, 2009, decreased versus the comparable period in 2008, primarily due to a $26 million decrease in discretionary spending, in order to conserve cash, and a $19 million decrease in compensation and related expenses.  Compensation and related expenses include salaries, fringe benefits and variable compensation.  Variable compensation was reduced due to lower sales and income compared to the prior year period.  Selling, general and administrative expenses also decreased due to cost savings from restructuring actions.  Overall selling, general and administrative expenses as a percentage of sales increased to 12.3 percent in 2009 compared to 10.1 percent in 2008 for the three month period.

 

Research, Development and Engineering Expenses

Research, development and engineering expenses for the three months ended March 29, 2009, decreased versus the comparable period in 2008, primarily due to increased reimbursements for engineering projects and decreased discretionary spending to conserve cash.  Overall, research, development and engineering expenses as a percentage of sales increased to 3.5 percent in 2009 from 3.0 percent in 2008 for the three month period.  Research activities continue to focus on development of new products to meet future environmental standards around the world.

 

Equity, Royalty and Interest Income From Investees

Equity, royalty and interest income from investees for the three months ended March 29, 2009, decreased significantly versus the comparable period in 2008, primarily due to decreased income from Dongfeng Cummins Engine Company, Ltd. (DCEC) of $14 million, Tata Cummins Ltd. (TCL) of $7 million, Cummins MerCruiser Diesel Marine LLC of $5 million and other manufacturing entities of $10 million.  These decreases were due to lower demand as a result of the global economic conditions.  These decreases were partially offset by the increase in income from our North American distributors of $4 million.

 

Other Operating Income (Expense), net

 

 

Interest Income

Interest income for the three months ended March 29, 2009, decreased versus the comparable period in 2008, primarily due to lower average cash balances and interest rates in 2009 compared to 2008.

 

Interest Expense

Interest expense for the three months ended March 29, 2009, decreased versus the comparable period in 2008, primarily due to declining short-term interest rates.

 

Other (Expense) Income, Net

 

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Income Tax Expense

Our effective tax rate for the year is expected to approximate 30 percent, absent any additional discrete period activity.  This is less than the 35 percent U.S. income tax rate primarily due to lower tax rates on foreign income and research tax credits.  The rate for the three months ended March 29, 2009, was 33 percent as a tax benefit was not provided for certain entities with estimated operating losses.  Our effective tax rate for the three months ended March 30, 2008, was 34 percent and was less than the U.S. income tax rate primarily due to lower taxes on foreign income.

 

Noncontrolling Interests

Noncontrolling interests eliminate the income or loss attributable to non-Cummins ownership interests in our consolidated entities.  Noncontrolling interests in income of consolidated subsidiaries for the three months ended March 29, 2009, decreased versus the comparable period in 2008, primarily due to lower income at Cummins India Limited reflecting the declines in both the domestic and export markets for industrial and power generation equipment as a result of the global economic downturn.

 

Net income and diluted earnings per share attributable to Cummins Inc.

Net income and diluted earnings per share attributable to Cummins Inc. for the three months ended March 29, 2009, decreased versus the comparable period in 2008, primarily due to significantly lower volumes, restructuring charges and lower equity income.  These decreases were partially offset by decreased selling, general and administrative expenses and lower income tax expense.

 

RESTRUCTURING CHARGES

 

2009 Restructuring Actions

In the first quarter of 2009, we executed restructuring actions in response to a reduction in orders in most of our U.S. and foreign markets due to the continuing deterioration in the global economy.  We reduced our global workforce by approximately 800 professional employees.  In addition, we took numerous employee actions at many of our manufacturing locations, including significant downsizing at numerous facilities and complete closure of two facilities and several branch distributor locations.  Employee termination and severance costs were recorded based on approved plans developed by the businesses and corporate management which specified positions to be eliminated, benefits to be paid under existing severance plans, union contracts or statutory requirements and the expected timetable for completion of the plan.  Estimates of restructuring were made based on information available at the time charges were recorded.  Due to the inherent uncertainty involved, actual amounts paid for such activities may differ from amounts initially recorded and we may need to revise previous estimates.  Total workforce reductions as of March 29, 2009 were as follows:

In response to closures and downsizing noted above, we incurred $1 million of restructuring expenses for lease terminations and $5 million of restructuring expenses for asset impairments.  During the first quarter of 2009 we recorded a total pre-tax restructuring charge of $66 million in “Restructuring charges” in the Condensed Consolidated Statements of Income related to the 2009 actions. These restructuring actions included:

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The following table summarizes the balance of accrued restructuring charges by expense type and the changes in the accrued amounts for the applicable periods.  The restructuring related accruals were recorded in “Other accrued expenses” in the Condensed Consolidated Balance Sheets.

 

We do not include restructuring charges in our operating segment results.  The pretax impact of allocating restructuring charges to the segment results would have been as follows:

If the restructuring actions are successfully implemented, we expect the annualized savings from the professional actions to be approximately $50 million.  Our charge related to these actions was approximately $30 million.  Approximately 40 percent of the savings from the restructuring actions will be realized in cost of sales, 45 percent in selling, general and administrative expenses, and 15 percent in research, development and engineering expenses.  We expect all of the pretax charge, except for asset impairment amounts, to be paid in cash which will be funded with cash generated from operations.

 

2008 Restructuring Actions

In 2008 we executed restructuring actions in response to the continued deterioration in our U.S. businesses and most key markets around the world in the second half of 2008, as well as a reduction in orders in most U.S. and foreign markets for 2009.  We reduced our global workforce by approximately 650 professional employees.  In addition, we took numerous employee actions at many of our manufacturing locations, including approximately 800 hourly employees.  Total workforce reductions as of March 29, 2009, were as follows:

 

The charges recorded during the year ended December 31, 2008, included severance costs related to both voluntary and involuntary terminations.  During 2008, we incurred a pretax charge related to the professional and hourly restructuring initiatives of $37 million.  The following table summarizes the balance of accrued restructuring charges and the changes in the accrued amounts for the applicable periods.  The restructuring related accruals were recorded in “Other accrued expenses” in the Condensed Consolidated Balance Sheets.

There were no material changes to the estimated savings, or periods under which we expect to recognize the savings, for the 2008 actions.

 

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OUTLOOK

Near-Term:

We expect sales and profits to be lower in 2009 given the economic outlook.  Many of the markets we serve are slowing significantly as a result of the credit crisis and softening global economic environment and we expect 2009 sales will be down significantly from 2008 levels.  Forecasting for 2009 is a significant challenge with these uncertain market conditions.  Our operating results in 2009 will depend on how the current global economic recession impacts the markets we serve.  In response to anticipated market conditions we initiated voluntary and involuntary separation actions in December of 2008 and the first quarter of 2009.  We also initiated certain exit activities during the first quarter of 2009.  We expect to continue to focus on cost reductions and scaling production to meet current demand.  If uncertainties in the credit and capital markets continue, the overall impact on our customers as well as end user demand for our products could have a significant adverse impact on our near-term results.  In light of current economic conditions, if demand continues to worsen in 2009, it is reasonably possible that we may be required to take additional restructuring actions and incur additional costs as we decrease production.  These costs could have a material impact on our results of operations and financial position.  At this time we cannot estimate these potential charges.

Long-Term:

While there is uncertainty in the near-term market as a result of the current economic conditions, we continue to be confident that opportunities for long-term growth and profitability will continue in the future.

 

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 or loss before interest expense, income taxes and noncontrolling 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 Segment Results

Financial data for the Engine segment was as follows:

A summary and discussion of Engine segment net sales by market follows:

 

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

 

Sales

Engine segment sales for the three months ended March 29, 2009, experienced significant deterioration across all major markets, versus the comparable period in 2008, as a result of the global economic downturn.  The following are the primary drivers by market.

• Industrial market sales decreased due to deterioration in units sold in the construction and marine markets by 69 percent and 31 percent, respectively.

• Medium-duty truck sales decreased significantly due to a 42 percent decline in global truck units sold.

• Heavy-duty sales declined sharply as international units sold were down 80 percent and North American (includes the U.S. and Canada and excludes Mexico) unit sales declined 15 percent.  The decrease in heavy-duty sales was due to global truck fleets continuing to experience financial challenges due to a lack of freight and limited access to credit.  The decrease in Mexican heavy-duty sales was due to an increase in heavy-duty truck sales in the first three months of 2008 resulting from the pre-buy activity ahead of Mexico’s July 1, 2008, new emissions requirements, appreciation of the U.S. dollar and an influx of used trucks into the market from the U.S. and Canada permitted under a new law.

• Light-duty automotive sales decreased significantly due to a 45 percent decline in units sold to Chrysler LLC (Chrysler).

• Recreational vehicle sales decreased significantly due to a 67 percent decline in units sold as the industry experienced significant weakness.