Document
Table of Contents

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

cumminsca06.jpg
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended July 2, 2017
 
Commission File Number 1-4949 

CUMMINS INC.
(Exact name of registrant as specified in its charter)
Indiana
(State of Incorporation)
 
35-0257090
 (IRS Employer Identification No.)
500 Jackson Street
Box 3005
Columbus, Indiana 47202-3005
(Address of principal executive offices)
 
Telephone (812) 377-5000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files).  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 July 2, 2017, there were 167,620,608 shares of common stock outstanding with a par value of $2.50 per share.
 
Website Access to Company’s Reports
 
Cummins maintains an internet website at www.cummins.com.  Investors can obtain copies of our filings from this website free of charge as soon as reasonably practicable after they are electronically filed with, or furnished, to the Securities and Exchange Commission. Cummins is not including the information provided on the website as part of, or incorporating such information by reference into, this Quarterly Report on Form 10-Q.
 

Table of Contents

CUMMINS INC. AND SUBSIDIARIES
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
 
 
 
Page
 
 
 
Condensed Consolidated Statements of Income for the three and six months ended July 2, 2017 and July 3, 2016
 
Condensed Consolidated Statements of Comprehensive Income for the three and six months ended July 2, 2017 and July 3, 2016
 
Condensed Consolidated Balance Sheets at July 2, 2017 and December 31, 2016
 
Condensed Consolidated Statements of Cash Flows for the six months ended July 2, 2017 and July 3, 2016
 
Condensed Consolidated Statements of Changes in Equity for the six months ended July 2, 2017 and July 3, 2016
 
 
 
 
 

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Table of Contents

PART I.  FINANCIAL INFORMATION 
ITEM 1.  Condensed Consolidated Financial Statements 
CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
 
Three months ended
 
Six months ended
In millions, except per share amounts 
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
NET SALES (a)
 
$
5,078

 
$
4,528

 
$
9,667

 
$
8,819

Cost of sales
 
3,829

 
3,331

 
7,290

 
6,566

GROSS MARGIN
 
1,249

 
1,197

 
2,377

 
2,253

OPERATING EXPENSES AND INCOME
 
 

 
 

 
 

 
 

Selling, general and administrative expenses
 
596

 
524

 
1,133

 
1,014

Research, development and engineering expenses
 
174

 
155

 
332

 
321

Equity, royalty and interest income from investees (Note 4)
 
98

 
88

 
206

 
160

Loss contingency (Note 9)
 
—

 
39

 
—

 
39

Other operating income (expense), net
 
18

 
—

 
23

 
(2
)
OPERATING INCOME
 
595

 
567

 
1,141

 
1,037

Interest income
 
5

 
6

 
7

 
12

Interest expense (Note 7)
 
21

 
16

 
39

 
35

Other income (expense), net
 
20

 
18

 
38

 
26

INCOME BEFORE INCOME TAXES
 
599

 
575

 
1,147

 
1,040

Income tax expense
 
158

 
148

 
301

 
280

CONSOLIDATED NET INCOME
 
441

 
427

 
846

 
760

Less: Net income attributable to noncontrolling interests
 
17

 
21

 
26

 
33

NET INCOME ATTRIBUTABLE TO CUMMINS INC.
 
$
424

 
$
406

 
$
820

 
$
727

 
 
 
 
 
 
 
 
 
EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CUMMINS INC.
 
 

 
 

 
 

 
 

Basic
 
$
2.53

 
$
2.41

 
$
4.90

 
$
4.27

Diluted
 
$
2.53

 
$
2.40

 
$
4.88

 
$
4.26

 
 
 
 
 
 
 
 
 
WEIGHTED AVERAGE SHARES OUTSTANDING
 
 

 
 

 
 

 
 

Basic
 
167.3

 
168.8

 
167.4

 
170.3

Dilutive effect of stock compensation awards
 
0.5

 
0.2

 
0.5

 
0.2

Diluted
 
167.8

 
169.0

 
167.9

 
170.5

 
 
 
 
 
 
 
 
 
CASH DIVIDENDS DECLARED PER COMMON SHARE
 
$
1.025

 
$
0.975

 
$
2.05

 
$
1.95

____________________________________
(a) Includes sales to nonconsolidated equity investees of $283 million and $550 million and $276 million and $518 million for the three and six months ended July 2, 2017 and July 3, 2016, respectively.
 
The accompanying notes are an integral part of the Condensed Consolidated Financial Statements.

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Table of Contents

CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 
 
Three months ended
 
Six months ended
In millions 
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
CONSOLIDATED NET INCOME
 
$
441

 
$
427

 
$
846

 
$
760

Other comprehensive income (loss), net of tax (Note 10)
 
 

 
 

 
 

 
 

Foreign currency translation adjustments
 
102

 
(213
)
 
182

 
(270
)
Unrealized gain (loss) on derivatives
 
—

 
(6
)
 
1

 
(27
)
Change in pension and other postretirement defined benefit plans
 
15

 
9

 
36

 
18

Unrealized gain (loss) on marketable securities
 
1

 
1

 
1

 
1

Total other comprehensive income (loss), net of tax
 
118

 
(209
)
 
220

 
(278
)
COMPREHENSIVE INCOME
 
559

 
218

 
1,066

 
482

Less: Comprehensive income attributable to noncontrolling interests
 
18

 
15

 
40

 
27

COMPREHENSIVE INCOME ATTRIBUTABLE TO CUMMINS INC.
 
$
541

 
$
203

 
$
1,026

 
$
455

 
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
 
July 2,
2017
 
December 31,
2016
ASSETS
 
 

 
 

Current assets
 
 

 
 

Cash and cash equivalents
 
$
1,293

 
$
1,120

Marketable securities (Note 5)
 
174

 
260

Total cash, cash equivalents and marketable securities
 
1,467

 
1,380

Accounts and notes receivable, net
 
 
 
 
Trade and other
 
3,237

 
2,803

Nonconsolidated equity investees
 
316

 
222

Inventories (Note 6)
 
2,982

 
2,675

Prepaid expenses and other current assets
 
600

 
627

Total current assets
 
8,602

 
7,707

Long-term assets
 
 

 
 

Property, plant and equipment
 
7,804

 
7,635

Accumulated depreciation
 
(4,017
)
 
(3,835
)
Property, plant and equipment, net
 
3,787

 
3,800

Investments and advances related to equity method investees
 
1,162

 
946

Goodwill
 
488

 
480

Other intangible assets, net
 
339

 
332

Pension assets
 
852

 
731

Other assets
 
1,030

 
1,015

Total assets
 
$
16,260

 
$
15,011

 
 
 
 
 
LIABILITIES
 
 

 
 

Current liabilities
 
 

 
 

Accounts payable (principally trade)
 
$
2,300

 
$
1,854

Loans payable (Note 7)
 
54

 
41

Commercial paper (Note 7)
 
134

 
212

Accrued compensation, benefits and retirement costs
 
475

 
412

Current portion of accrued product warranty (Note 8)
 
392

 
333

Current portion of deferred revenue
 
520

 
468

Other accrued expenses
 
974

 
970

Current maturities of long-term debt (Note 7)
 
45

 
35

Total current liabilities
 
4,894

 
4,325

Long-term liabilities
 
 

 
 

Long-term debt (Note 7)
 
1,564

 
1,568

Postretirement benefits other than pensions
 
318

 
329

Pensions
 
327

 
326

Other liabilities and deferred revenue
 
1,335

 
1,289

Total liabilities
 
$
8,438

 
$
7,837

 
 
 
 
 
Commitments and contingencies (Note 9)
 


 


 
 
 

 
 

EQUITY
 
 
 
 
Cummins Inc. shareholders’ equity
 
 

 
 

Common stock, $2.50 par value, 500 shares authorized, 222.3 and 222.4 shares issued
 
$
2,184

 
$
2,153

Retained earnings
 
11,517

 
11,040

Treasury stock, at cost, 54.7 and 54.2 shares
 
(4,586
)
 
(4,489
)
Common stock held by employee benefits trust, at cost, 0.6 and 0.7 shares
 
(7
)
 
(8
)
Accumulated other comprehensive loss (Note 10)
 
(1,615
)
 
(1,821
)
Total Cummins Inc. shareholders’ equity
 
7,493

 
6,875

Noncontrolling interests
 
329

 
299

Total equity
 
$
7,822

 
$
7,174

Total liabilities and equity
 
$
16,260

 
$
15,011


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

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Table of Contents

CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
Six months ended
In millions
 
July 2,
2017
 
July 3,
2016
CASH FLOWS FROM OPERATING ACTIVITIES
 
 

 
 

Consolidated net income
 
$
846

 
$
760

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

 
 

Depreciation and amortization
 
284

 
259

Deferred income taxes
 
—

 
2

Equity in income of investees, net of dividends (Note 4)
 
(132
)
 
(87
)
Pension contributions in excess of expense (Note 3)
 
(44
)
 
(82
)
Other post-retirement benefits payments in excess of expense (Note 3)
 
(8
)
 
(17
)
Stock-based compensation expense
 
23

 
20

Restructuring payments
 
—

 
(42
)
Loss contingency (Note 9)
 
—

 
39

Translation and hedging activities
 
31

 
(45
)
Changes in current assets and liabilities
 
 
 
 

Accounts and notes receivable
 
(488
)
 
(252
)
Inventories
 
(264
)
 
(101
)
Other current assets
 
21

 
189

Accounts payable
 
403

 
143

Accrued expenses
 
132

 
(209
)
Changes in other liabilities and deferred revenue
 
103

 
129

Other, net
 
(81
)
 
32

Net cash provided by operating activities
 
826

 
738

 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 

 
 

Capital expenditures
 
(182
)
 
(189
)
Investments in internal use software
 
(40
)
 
(27
)
Investments in and advances to equity investees
 
(64
)
 
(17
)
Investments in marketable securities—acquisitions (Note 5)
 
(69
)
 
(379
)
Investments in marketable securities—liquidations (Note 5)
 
162

 
237

Cash flows from derivatives not designated as hedges
 
19

 
(21
)
Other, net
 
14

 
5

Net cash used in investing activities
 
(160
)
 
(391
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 

 
 

Proceeds from borrowings
 
2

 
109

Net (payments) borrowings of commercial paper (Note 7)
 
(78
)
 
200

Payments on borrowings and capital lease obligations
 
(29
)
 
(133
)
Distributions to noncontrolling interests
 
(10
)
 
(24
)
Dividend payments on common stock
 
(343
)
 
(333
)
Repurchases of common stock (Note 2)
 
(120
)
 
(695
)
Other, net
 
34

 
(20
)
Net cash used in financing activities
 
(544
)
 
(896
)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
 
51

 
(117
)
Net increase (decrease) in cash and cash equivalents
 
173

 
(666
)
Cash and cash equivalents at beginning of year
 
1,120

 
1,711

CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
1,293

 
$
1,045


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

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Table of Contents

CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Unaudited)
 
In millions
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Treasury
Stock
 
Common
Stock
Held in
Trust
 
Accumulated
Other
Comprehensive
Loss
 
Total
Cummins Inc.
Shareholders’
Equity
 
Noncontrolling
Interests
 
Total
Equity
BALANCE AT DECEMBER 31, 2015
$
556

 
$
1,622

 
$
10,322

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

 
$
344

 
$
7,750

Net income


 


 
727

 


 


 


 
727

 
33

 
760

Other comprehensive income (loss), net of tax (Note 10)


 


 


 


 


 
(272
)
 
(272
)
 
(6
)
 
(278
)
Issuance of common stock


 
4

 


 


 


 


 
4

 
—

 
4

Employee benefits trust activity


 
14

 


 


 
2

 


 
16

 
—

 
16

Repurchases of common stock (Note 2)


 


 


 
(695
)
 


 


 
(695
)
 
—

 
(695
)
Cash dividends on common stock


 


 
(333
)
 


 


 


 
(333
)
 
—

 
(333
)
Distributions to noncontrolling interests


 


 


 


 


 


 
—

 
(31
)
 
(31
)
Stock based awards


 
(6
)
 


 
8

 


 


 
2

 
—

 
2

Other shareholder transactions


 
6

 


 


 


 


 
6

 
(6
)
 
—

BALANCE AT JULY 3, 2016
$
556

 
$
1,640

 
$
10,716

 
$
(4,422
)
 
$
(9
)
 
$
(1,620
)
 
$
6,861

 
$
334

 
$
7,195

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE AT DECEMBER 31, 2016
$
556

 
$
1,597

 
$
11,040

 
$
(4,489
)
 
$
(8
)
 
$
(1,821
)
 
$
6,875

 
$
299

 
$
7,174

Net income


 


 
820

 


 


 


 
820

 
26

 
846

Other comprehensive income (loss), net of tax (Note 10)


 


 


 


 


 
206

 
206

 
14

 
220

Issuance of common stock


 
3

 


 


 


 


 
3

 
—

 
3

Employee benefits trust activity


 
12

 


 


 
1

 


 
13

 
—

 
13

Repurchases of common stock


 


 


 
(120
)
 


 


 
(120
)
 
—

 
(120
)
Cash dividends on common stock


 


 
(343
)
 


 


 


 
(343
)
 
—

 
(343
)
Distributions to noncontrolling interests


 


 


 


 


 


 
—

 
(10
)
 
(10
)
Stock based awards


 


 


 
23

 


 


 
23

 
—

 
23

Other shareholder transactions


 
16

 


 


 


 


 
16

 
—

 
16

BALANCE AT JULY 2, 2017
$
556

 
$
1,628

 
$
11,517

 
$
(4,586
)
 
$
(7
)
 
$
(1,615
)
 
$
7,493

 
$
329

 
$
7,822

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

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Table of Contents

CUMMINS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 1. NATURE OF OPERATIONS
Cummins Inc. (“Cummins,” “we,” “our” or “us”) was founded in 1919 as Cummins Engine Company, a corporation in Columbus, Indiana, as one of the first diesel engine manufacturers. We changed our name to Cummins Inc. in 2001. We are a global power leader that designs, manufactures, distributes and services diesel and natural gas engines and engine-related component products, including filtration, aftertreatment, turbochargers, fuel systems, controls systems, air handling systems and electric power generation systems. We sell our products to original equipment manufacturers (OEMs), distributors and other customers worldwide. We serve our customers through a network of approximately 600 wholly-owned and independent distributor locations and over 7,400 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 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, 2016. Our interim period financial results for the three and six 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 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 rate and other assumptions for pension and other postretirement benefit costs, income taxes and deferred tax valuation allowances, lease classification and contingencies. 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 second quarters of 2017 and 2016 ended on July 2 and July 3, 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:

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Table of Contents

 
 
Three months ended
 
Six months ended
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
Options excluded
6,155

 
1,262,469

 
61,345

 
1,475,068

Accelerated Share Repurchase
On February 9, 2016, we entered into an accelerated share repurchase (ASR) agreement with a third party financial institution to repurchase $500 million of our common stock under our previously announced share repurchase plans. Pursuant to the terms of the agreement, we paid the full $500 million purchase price and initially received approximately 4.1 million shares representing approximately 80 percent of the shares expected to be repurchased. The unsettled portion of the ASR met the criteria to be accounted for as a forward contract indexed to our stock and qualified as an equity transaction. This resulted in a $100 million reduction to additional paid-in capital during the first quarter of 2016. In the second quarter of 2016, the ASR was completed, and we received approximately 0.6 million additional shares, based on our volume-weighted average stock price during the term of the transaction, less a discount, for a total of 4.7 million shares purchased under the ASR at an average purchase price of $105.50 per share. The settlement resulted in the reclassification of the $100 million reduction of additional paid-in capital recognized in the first quarter of 2016 to treasury stock.
The delivery of shares resulted in a reduction to our common stock outstanding used to calculate earnings per share in the quarter the shares were received and subsequent quarters.
NOTE 3. PENSION AND OTHER POSTRETIREMENT BENEFITS
We sponsor funded and unfunded domestic and foreign defined benefit pension and other postretirement plans. Contributions to these plans were as follows:
 
 
 
Three months ended
 
Six months ended
In millions
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
Defined benefit pension plans
 
 

 
 

 
 

 
 

Voluntary contribution
 
$
41

 
$
37

 
$
84

 
$
85

Mandatory contribution
 
—

 
6

 
—

 
18

Defined benefit pension contributions
 
$
41

 
$
43

 
$
84

 
$
103

 
 
 
 
 
 
 
 
 
Other postretirement plans
 
$
3

 
$
15

 
$
18

 
$
28

 
 
 
 
 
 
 
 
 
Defined contribution pension plans
 
$
19

 
$
14

 
$
48

 
$
35

We anticipate making additional defined benefit pension contributions during the remainder of 2017 of $50 million for our U.S. and U.K. pension plans. Approximately $133 million of the estimated $134 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 2017 net periodic pension cost to approximate $83 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
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
Service cost
 
$
26

 
$
23

 
$
7

 
$
6

 
$
—

 
$
—

Interest cost
 
27

 
28

 
10

 
13

 
4

 
4

Expected return on plan assets
 
(52
)
 
(51
)
 
(17
)
 
(19
)
 
—

 
—

Recognized net actuarial loss
 
9

 
7

 
10

 
4

 
1

 
2

Net periodic benefit cost
 
$
10

 
$
7

 
$
10

 
$
4

 
$
5

 
$
6


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Table of Contents

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Pension
 
 
 
 
 
 
U.S. Plans
 
U.K. Plans
 
Other Postretirement Benefits
 
 
Six months ended
In millions
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
Service cost
 
$
53

 
$
46

 
$
13

 
$
11

 
$
—

 
$
—

Interest cost
 
53

 
56

 
20

 
26

 
7

 
8

Expected return on plan assets
 
(103
)
 
(102
)
 
(34
)
 
(38
)
 
—

 
—

Recognized net actuarial loss
 
18

 
14

 
20

 
8

 
3

 
3

Net periodic benefit cost
 
$
21

 
$
14

 
$
19

 
$
7

 
$
10

 
$
11

NOTE 4. EQUITY, ROYALTY AND INTEREST INCOME FROM INVESTEES
Equity, royalty and interest income from investees included in our Condensed Consolidated Statements of Income for the reporting periods was as follows: 
 
 
Three months ended
 
Six months ended
In millions
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
Distribution entities
 
 
 
 
 
 
 
 
Komatsu Cummins Chile, Ltda.
 
$
8

 
$
8

 
$
15

 
$
18

North American distributors
 
—

 
6

 
—

 
11

All other distributors
 
—

 
1

 
—

 
1

Manufacturing entities
 
 
 
 
 
 

 
 

Beijing Foton Cummins Engine Co., Ltd.
 
22

 
22

 
55

 
40

Dongfeng Cummins Engine Company, Ltd.
 
19

 
15

 
41

 
22

Chongqing Cummins Engine Company, Ltd.
 
10

 
9

 
19

 
17

All other manufacturers
 
27

 
16

 
51

 
32

Cummins share of net income
 
86

 
77

 
181

 
141

Royalty and interest income
 
12

 
11

 
25

 
19

Equity, royalty and interest income from investees
 
$
98

 
$
88

 
$
206

 
$
160

NOTE 5. MARKETABLE SECURITIES
A summary of marketable securities, all of which are classified as current, was as follows:
 
 
 
July 2, 2017
 
December 31, 2016
In millions
 
Cost
 
Gross unrealized
gains/(losses)
 
Estimated
fair value
 
Cost
 
Gross unrealized
gains/(losses)
 
Estimated
fair value
Available-for-sale (1)
 
 

 
 

 
 

 
 

 
 

 
 

Debt mutual funds
 
$
157

 
$
—

 
$
157

 
$
132

 
$
—

 
$
132

Bank debentures
 
3

 
—

 
3

 
114

 
—

 
114

Equity mutual funds
 
12

 
1

 
13

 
12

 
—

 
12

Government debt securities
 
1

 
—

 
1

 
2

 
—

 
2

Total marketable securities
 
$
173

 
$
1

 
$
174

 
$
260

 
$
—

 
$
260

____________________________________
(1) All marketable securities are classified as Level 2 securities. 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 half of 2017 and for the year ended 2016.
A description of the valuation techniques and inputs used for our Level 2 fair value measures was as follows:

10

•
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.
•
Bank debentures— 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 institutions’ month-end statement.
•
Equity mutual funds— The fair value measure for these investments is the net asset value published by the issuing brokerage. Daily quoted prices are available from reputable third party pricing services and are used on a test basis to corroborate this Level 2 input measure.
•
Government debt securities— The fair value measure for these securities is broker quotes received from reputable firms. These securities are infrequently traded on a national stock exchange and these values are used on a test basis to corroborate our Level 2 input measure.
The proceeds from sales and maturities of marketable securities and gross realized gains and losses from the sale of available-for-sale securities were as follows:
 
 
Three months ended
 
Six months ended
In millions
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
Proceeds from sales and maturities of marketable securities (1)
 
$
15

 
$
202

 
$
162

 
$
237

____________________________________
(1) Gross realized gains and losses from the sale of available-for-sale securities were immaterial.
The fair value of available-for-sale investments in debt securities that utilize a Level 2 fair value measure is shown by contractual maturity below:
 
Contractual Maturity (In millions)
 
July 2,
2017
1 year or less
 
$
160

1 - 5 years
 
1

Total
 
$
161

NOTE 6. INVENTORIES
Inventories are stated at the lower of cost or market. Inventories included the following:
 
In millions
 
July 2,
2017
 
December 31,
2016
Finished products
 
$
1,905

 
$
1,779

Work-in-process and raw materials
 
1,192

 
1,005

Inventories at FIFO cost
 
3,097

 
2,784

Excess of FIFO over LIFO
 
(115
)
 
(109
)
Total inventories
 
$
2,982

 
$
2,675


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NOTE 7. DEBT
Loans Payable and Commercial Paper
Loans payable, commercial paper and the related weighted-average interest rates were as follows:
In millions
 
July 2, 2017
 
December 31, 2016
Loans payable (1)
 
$
54

 
$
41

Commercial paper (2)
 
134

 
212

____________________________________
(1) Loans payable consist primarily of notes payable to various domestic and international financial institutions. It is not practical to aggregate these notes and calculate a quarterly weighted-average interest rate.
(2) The weighted average interest rate, inclusive of all brokerage fees, was 1.20 percent and 0.79 percent at July 2, 2017 and December 31, 2016, respectively.
Long-term Debt
A summary of long-term debt was as follows:
 
In millions
 
July 2,
2017
 
December 31,
2016
Long-term debt
 
 

 
 

Senior notes, 3.65%, due 2023
 
$
500

 
$
500

Debentures, 6.75%, due 2027
 
58

 
58

Debentures, 7.125%, due 2028
 
250

 
250

Senior notes, 4.875%, due 2043
 
500

 
500

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

 
165

Other debt
 
56

 
51

Unamortized discount
 
(55
)
 
(56
)
Fair value adjustments due to hedge on indebtedness
 
45

 
47

Capital leases
 
90

 
88

Total long-term debt
 
1,609

 
1,603

Less: Current maturities of long-term debt
 
45

 
35

Long-term debt
 
$
1,564

 
$
1,568

Principal payments required on long-term debt during the next five years are as follows:
In millions
 
2017
 
2018
 
2019
 
2020
 
2021
Principal payments
 
$
18

 
$
45

 
$
36

 
$
10

 
$
4

Fair Value of Debt
Based on borrowing rates currently available to us for bank loans with similar terms and average maturities, considering our risk premium, the fair values and carrying values of total debt, including current maturities, were as follows:
 
In millions
 
July 2,
2017
 
December 31,
2016
Fair value of total debt (1)
 
$
2,036

 
$
2,077

Carrying value of total debt
 
1,797

 
1,856

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

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NOTE 8. PRODUCT WARRANTY LIABILITY
A tabular reconciliation of the product warranty liability, including the deferred revenue related to our extended warranty coverage and accrued recall programs was as follows:
 
In millions 
 
July 2,
2017
 
July 3,
2016
Balance, beginning of year
 
$
1,414

 
$
1,404

Provision for warranties issued
 
239

 
181

Deferred revenue on extended warranty contracts sold
 
101

 
116

Payments
 
(199
)
 
(199
)
Amortization of deferred revenue on extended warranty contracts
 
(109
)
 
(98
)
Changes in estimates for pre-existing warranties
 
74

 
12

Foreign currency translation
 
1

 
(5
)
Balance, end of period
 
$
1,521

 
$
1,411

Warranty related deferred revenues and the long-term portion of the warranty liabilities on our July 2, 2017, balance sheet were as follows:
In millions
 
July 2,
2017
 
Balance Sheet Location
Deferred revenue related to extended coverage programs
 
 

 
 
Current portion
 
$
232

 
Current portion of deferred revenue
Long-term portion
 
505

 
Other liabilities and deferred revenue
Total
 
$
737

 
 
 
 
 
 
 
Long-term portion of warranty liability
 
$
392

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

13
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quality issue in certain of these third party aftertreatment systems caused some of our inter-related engines to fail in-use emission testing. In the fourth quarter of 2015, the vehicle manufacturer made a request that we assist in the design and bear the financial cost of a field campaign (Campaign) to address the technical issue purportedly causing some vehicles to fail the in-use testing.
While we are not responsible for the warranty issues related to a component that we did not manufacture or sell, as the emission compliance certificate holder, we are responsible for proposing a remedy to the EPA and CARB. As a result, we have proposed actions to the agencies that we believe will address the emission failures. As the certificate holder, we expect to participate in the cost of the proposed voluntary Campaign and recorded a charge of $60 million in 2015. The Campaign design was finalized with our OEM customer, reviewed with the EPA and submitted for final approval in 2016. We concluded based upon additional in-use emission testing performed in 2016, that the Campaign should be expanded to include a larger population of vehicles manufactured by this one OEM. We recorded additional charges of $39 million and $99 million in the second and third quarter, respectively, in 2016 to reflect the estimated cost of our participation in the Campaign. We continue to work with our OEM customer to resolve the allocation of costs for the Campaign, including pending litigation between the parties. The Campaign is not expected to be completed for some time and our final cost could differ from the amount we have recorded.
We do not currently expect any fines or penalties from the EPA or CARB related to this matter.
We are funding the Campaign, which began in the fourth quarter of 2016, with a combination of cash and credit memos. The remaining accrual of $159 million is included in ''Other accrued expenses'' in our Condensed Consolidated Balance Sheets.
Guarantees and Commitments
Periodically, we enter into guarantee arrangements, including guarantees of non-U.S. distributor financings, residual value guarantees on equipment under operating leases and other miscellaneous guarantees of joint ventures or third-party obligations. At July 2, 2017, the maximum potential loss related to these guarantees was $43 million.
We have arrangements with certain suppliers that require us to purchase minimum volumes or be subject to monetary penalties. At July 2, 2017, if we were to stop purchasing from each of these suppliers, the aggregate amount of the penalty would be approximately $107 million, of which $35 million relates to a contract with a components supplier that extends to 2018 and $28 million relates to a contract with a power systems supplier that extends to 2019. Most of these arrangements enable us to secure critical components. We do not currently anticipate paying any penalties under these contracts.
We enter into physical forward contracts with suppliers of platinum, palladium and copper to purchase minimum volumes of the commodities at contractually stated prices for various periods, not to exceed two years. At July 2, 2017, the total commitments under these contracts were $43 million. These arrangements enable us to fix the prices of these commodities, which otherwise are subject to market volatility.
We have guarantees with certain customers that require us to satisfactorily honor contractual or regulatory obligations, or compensate for monetary losses related to nonperformance. These performance bonds and other performance-related guarantees were $82 million at July 2, 2017.
Indemnifications
Periodically, we enter into various contractual arrangements where we agree to indemnify a third-party against certain types of losses. Common types of indemnities include:
•
product liability and license, patent or trademark indemnifications;
•
asset sale agreements where we agree to indemnify the purchaser against future environmental exposures related to the asset sold; and
•
any contractual agreement where we agree to indemnify the counterparty for losses suffered as a result of a misrepresentation in the contract.
We regularly evaluate the probability of having to incur costs associated with these indemnities and accrue for expected losses that are probable. Because the indemnifications are not related to specified known liabilities and due to their uncertain nature, we are unable to estimate the maximum amount of the potential loss associated with these indemnifications.

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Table of Contents

NOTE 10. ACCUMULATED OTHER COMPREHENSIVE LOSS
Following are the changes in accumulated other comprehensive income (loss) by component for the three months ended:
 
 
Three months ended
In millions
 
Change in
pensions and
other
postretirement
defined benefit
plans
 
Foreign
currency
translation
adjustment
 
Unrealized gain
(loss) on
marketable
securities
 
Unrealized gain
(loss) on
derivatives
 
Total
attributable to
Cummins Inc.
 
Noncontrolling
interests
 
Total other comprehensive income (loss)
Balance at April 3, 2016
 
$
(645
)
 
$
(753
)
 
$
(2
)
 
$
(17
)
 
$
(1,417
)
 
 

 
 

Other comprehensive income before reclassifications
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Before tax amount
 
—

 
(207
)
 
1

 
(10
)
 
(216
)
 
$
(6
)
 
$
(222
)
Tax benefit (expense)
 
—

 
—

 
—

 
2

 
2

 
—

 
2

After tax amount
 
—

 
(207
)
 
1

 
(8
)
 
(214
)
 
(6
)
 
(220
)
Amounts reclassified from accumulated other comprehensive loss(1)(2)
 
9

 
—

 
—

 
2

 
11

 
—

 
11

Net current period other comprehensive income (loss)
 
9

 
(207
)
 
1

 
(6
)
 
(203
)
 
$
(6
)
 
$
(209
)
Balance at July 3, 2016
 
$
(636
)
 
$
(960
)
 
$
(1
)
 
$
(23
)
 
$
(1,620
)
 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at April 2, 2017
 
$
(664
)
 
$
(1,060
)
 
$
(1
)
 
$
(7
)
 
$
(1,732
)
 
 

 
 

Other comprehensive income before reclassifications
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Before tax amount
 
—

 
105

 
1

 
(2
)
 
104

 
$
1

 
$
105

Tax benefit (expense)
 
—

 
(4
)
 
(1
)
 
1

 
(4
)
 
—

 
(4
)
After tax amount
 
—

 
101

 
—

 
(1
)
 
100

 
1

 
101

Amounts reclassified from accumulated other comprehensive loss(1)(2)
 
15

 
—

 
1

 
1

 
17

 
—

 
17

Net current period other comprehensive income (loss)
 
15

 
101

 
1

 
—

 
117

 
$
1

 
$
118

Balance at July 2, 2017
 
$
(649
)
 
$
(959
)
 
$
—

 
$
(7
)
 
$
(1,615
)
 
 

 
 

____________________________________
(1) Amounts are net of tax.  
(2) Reclassifications out of accumulated other comprehensive income (loss) and the related tax effects are immaterial for separate disclosure.














15
Table of Contents

Following are the changes in accumulated other comprehensive income (loss) by component for the six months ended:
 
 
 
Six months ended
In millions
 
Change in
pensions and
other
postretirement
defined benefit
plans
 
Foreign
currency
translation
adjustment
 
Unrealized gain
(loss) on
marketable
securities
 
Unrealized gain
(loss) on
derivatives
 
Total
attributable to
Cummins Inc.
 
Noncontrolling
interests
 
Total other comprehensive income (loss)
Balance at December 31, 2015
 
$
(654
)
 
$
(696
)
 
$
(2
)
 
$
4

 
$
(1,348
)
 
 

 
 

Other comprehensive income before reclassifications
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Before tax amount
 
—

 
(265
)
 
1

 
(36
)
 
(300
)
 
$
(6
)
 
$
(306
)
Tax benefit (expense)
 
—

 
1

 
—

 
6

 
7

 
—

 
7

After tax amount
 
—

 
(264
)
 
1

 
(30
)
 
(293
)
 
(6
)
 
(299
)
Amounts reclassified from accumulated other comprehensive loss(1)(2)
 
18

 
—

 
—

 
3

 
21

 
—

 
21

Net current period other comprehensive income (loss)
 
18

 
(264
)
 
1

 
(27
)
 
(272
)
 
$
(6
)
 
$
(278
)
Balance at July 3, 2016
 
$
(636
)
 
$
(960
)
 
$
(1
)
 
$
(23
)
 
$
(1,620
)
 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
$
(685
)
 
$
(1,127
)
 
$
(1
)
 
$
(8
)
 
$
(1,821
)
 
 

 
 

Other comprehensive income before reclassifications
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Before tax amount
 
8

 
180

 
2

 
(8
)
 
182

 
$
14

 
$
196

Tax benefit (expense)
 
(3
)
 
(12
)
 
(1
)
 
3

 
(13
)
 
—

 
(13
)
After tax amount
 
5

 
168

 
1

 
(5
)
 
169

 
14

 
183

Amounts reclassified from accumulated other comprehensive loss(1)(2)
 
31

 
—

 
—

 
6

 
37

 
—

 
37

Net current period other comprehensive income (loss)
 
36

 
168

 
1

 
1

 
206

 
$
14

 
$
220

Balance at July 2, 2017
 
$
(649
)
 
$
(959
)
 
$
—

 
$
(7
)
 
$
(1,615
)
 
 

 
 

____________________________________
(1) Amounts are net of tax.  
(2) Reclassifications out of accumulated other comprehensive income (loss) and the related tax effects are immaterial for separate disclosure.

16
Table of Contents

NOTE 11. ACQUISITION

In April 2017, we entered into an agreement to form a joint venture with Eaton Corporation PLC and we closed the transaction on July 31, 2017. We purchased a 50 percent interest in the new venture named Eaton Cummins Automated Transmission Technologies for $600 million in cash. The joint venture will design, assemble, sell and support medium-duty and heavy-duty automated transmissions for the commercial vehicle market, including new product launches. We will consolidate the results of the joint venture in our Components segment as we have a majority voting interest in the venture by virtue of a tie-breaking vote on the board of directors. We expect to record total assets of approximately $1.2 billion upon consolidation, the substantial majority of which will be intangible assets and goodwill.
NOTE 12. OPERATING SEGMENTS
Operating segments under GAAP are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (CODM), or decision-making group, in deciding how to allocate resources and in assessing performance. Our CODM is the President and Chief Operating Officer.
Our reportable operating segments consist of Engine, Distribution, Components and Power Systems. This reporting structure is organized according to the products and markets each segment serves. The Engine segment produces engines (15 liters and less in size) and associated parts for sale to customers in on-highway and various off-highway markets. Our engines are used in trucks of all sizes, buses and recreational vehicles, as well as in various industrial applications, including construction, agriculture, power generation systems and other off-highway applications. The Distribution segment includes wholly-owned and partially-owned distributorships engaged in wholesaling engines, generator sets and service parts, as well as performing service and repair activities on our products and maintaining relationships with various OEMs throughout the world. The Components segment sells filtration products, aftertreatment systems, turbochargers and fuel systems. The Power Systems segment is an integrated power provider, which designs, manufactures and sells engines (16 liters and larger) for industrial applications (including mining, oil and gas, marine and rail), standby and prime power generator sets, alternators and other power components.
We use segment EBIT (defined as earnings before interest expense, income taxes and noncontrolling interests) as a primary basis for the CODM to evaluate the performance of each of our operating segments. Segment amounts exclude certain expenses not specifically identifiable to segments.
The accounting policies of our operating segments are the same as those applied in our Condensed Consolidated Financial Statements. We prepared the financial results of our operating segments on a basis that is consistent with the manner in which we internally disaggregate financial information to assist in making internal operating decisions. We allocate certain common costs and expenses, primarily corporate functions, among segments differently than we would for stand-alone financial information prepared in accordance with GAAP. These include certain costs and expenses of shared services, such as information technology, human resources, legal, finance and supply chain management. We do not allocate debt-related items, actuarial gains or losses, prior service costs or credits, changes in cash surrender value of corporate owned life insurance or income taxes to individual segments. Segment EBIT may not be consistent with measures used by other companies.

17
Table of Contents

Summarized financial information regarding our reportable operating segments is shown in the table below:
In millions
 
Engine
 
Distribution
 
Components
 
Power Systems
 
Intersegment Eliminations (1)
 
Total
Three months ended July 2, 2017
 
 

 
 
 
 

 
 

 
 

 
 

External sales
 
$
1,711

 
$
1,716

 
$
1,064

 
$
587

 
$
—

 
$
5,078

Intersegment sales
 
596

 
6

 
390

 
430

 
(1,422
)
 
—

Total sales
 
2,307

 
1,722

 
1,454

 
1,017

 
(1,422
)
 
5,078

Depreciation and amortization (2)
 
46

 
31

 
38

 
29

 
—

 
144

Research, development and engineering expenses
 
63

 
4

 
57

 
50

 
—

 
174

Equity, royalty and interest income from investees
 
56

 
13

 
15

 
14

 
—

 
98

Interest income
 
2

 
1

 
1

 
1

 
—

 
5

Segment EBIT
 
277

 
96

 
190

 
61

 
(4
)
 
620

 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended July 3, 2016
 
 
 
 
 
 
 
 
 
 
 
 
External sales
 
$
1,504

 
$
1,538

 
$
933

 
$
553

 
$
—

 
$
4,528

Intersegment sales
 
498

 
6

 
346

 
368

 
(1,218
)
 
—

Total sales
 
2,002

 
1,544

 
1,279

 
921

 
(1,218
)
 
4,528

Depreciation and amortization (2)
 
41

 
29

 
32

 
29

 
—

 
131

Research, development and engineering expenses
 
53

 
3

 
51

 
48

 
—

 
155

Equity, royalty and interest income from investees
 
46

 
19

 
12

 
11

 
—

 
88

Loss contingency (3)
 
39

 
—

 
—

 
—

 
—

 
39

Interest income
 
3

 
1

 
1

 
1

 
—

 
6

Segment EBIT
 
206

 
87

 
190

 
90

 
18

 
591

 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended July 2, 2017
 
 

 
 

 
 

 
 

 
 

 
 

External sales
 
$
3,168

 
$
3,353

 
$
2,044

 
$
1,102

 
$
—

 
$
9,667

Intersegment sales
 
1,162

 
14

 
754

 
797

 
(2,727
)
 
—

Total sales
 
4,330

 
3,367

 
2,798

 
1,899

 
(2,727
)
 
9,667

Depreciation and amortization(2)
 
90

 
61

 
75

 
57

 
—

 
283

Research, development and engineering expenses
 
117

 
8

 
107

 
100

 
—

 
332

Equity, royalty and interest income from investees
 
128

 
24

 
28

 
26

 
—

 
206

Interest income
 
3

 
2

 
1

 
1

 
—

 
7

Segment EBIT
 
506

 
196

 
369

 
118

 
(3
)
 
1,186

 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended July 3, 2016
 
 

 
 

 
 

 
 

 
 

 
 

External sales
 
$
2,993

 
$
2,996

 
$
1,830

 
$
1,000

 
$
—

 
$
8,819

Intersegment sales
 
985

 
11

 
686

 
729

 
(2,411
)
 
—

Total sales
 
3,978

 
3,007

 
2,516

 
1,729

 
(2,411
)
 
8,819

Depreciation and amortization(2)
 
80

 
57

 
63

 
58

 
—

 
258

Research, development and engineering expenses
 
110

 
7

 
107

 
97

 
—

 
321

Equity, royalty and interest income from investees
 
82

 
37

 
20

 
21

 
—

 
160

Loss contingency (3)
 
39

 
—

 
—

 
—

 
—

 
39

Interest income
 
5

 
2

 
2

 
3

 
—

 
12

Segment EBIT
 
403

 
174

 
353

 
136

 
9

 
1,075

____________________________________
(1) Includes intersegment sales, intersegment profit in inventory eliminations and unallocated corporate expenses. There were no significant unallocated corporate expenses for the three and six months ended July 2, 2017 and July 3, 2016.
(2) Depreciation and amortization as shown on a segment basis excludes the amortization of debt discount and deferred costs included in the Condensed Consolidated Statements of Income as "Interest expense." The amortization of debt discount and deferred costs were $1 million and $1 million for the six months ended July 2, 2017 and July 3, 2016, respectively.
(3) See Note 9, "COMMITMENTS AND CONTINGENCIES," for additional information.


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A reconciliation of our segment information to the corresponding amounts in the Condensed Consolidated Statements of Income is shown in the table below:
 
 
Three months ended
 
Six months ended
In millions
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
Total segment EBIT
 
$
620

 
$
591

 
$
1,186

 
$
1,075

Less: Interest expense
 
21

 
16

 
39

 
35

Income before income taxes
 
$
599

 
$
575

 
$
1,147

 
$
1,040

NOTE 13. RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Accounting Pronouncements Recently Adopted
In March 2016, the Financial Accounting Standards Board (FASB) amended its standards related to accounting for stock compensation, which became effective for us beginning January 1, 2017. The amendment replaced the requirement to record excess tax benefits and certain tax deficiencies in additional paid-in capital by recording all excess tax benefits and tax deficiencies as income tax expense / benefit in the Condensed Consolidated Statements of Income and was adopted prospectively. Excess tax benefits and deficiencies are required to be recorded as discrete items in the period in which they occur and were not material for the three and six months ended July 2, 2017. In addition, the standard impacted our Condensed Consolidated Statements of Cash Flows retrospectively, as excess tax benefits are now required to be presented as an operating activity and the cash paid to tax authorities is required to be presented as a financing activity. This resulted in a net reclassification of $4 million from operating to financing activities for the six months ended July 2, 2017. Finally, in accordance with the standard, we elected to continue our historical approach of estimating forfeitures during the award's vesting period and adjusting our estimate when it is no longer probable that the employee will fulfill the service condition. The adoption of the standard was not material to our diluted earnings per common share.
Accounting Pronouncements Issued But Not Yet Effective
In March 2017, the FASB amended its standards related to the presentation of pension and other postretirement benefit costs in the financial statements. Under the new standard, we will be required to separate service costs from all other elements of pension costs and reflect the other elements of pension costs outside of operating income in our Consolidated Statements of Income. In addition, the standard will limit the amount eligible for capitalization (into inventory or self-constructed assets) to the amount of service cost. This portion of the standard will be applied on a prospective basis. The remainder of the new standard is effective for us on a retrospective basis beginning January 1, 2018. While we are still evaluating the impact of this standard, the change in presentation will likely result in a decrease in operating income primarily due to the requirement to present the expected return on plan assets outside of operating income.
In August 2016, the FASB amended its standards related to the classification of certain cash receipts and cash payments. The new standard will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. The standard is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The new standard will require adoption on a retrospective basis unless it is impracticable to apply, in which case it would be required to apply the amendments prospectively as of the earliest date practicable. We are in the process of evaluating the impact this standard will have on our Consolidated Statements of Cash Flows.
In June 2016, the FASB amended its standards related to accounting for credit losses on financial instruments. This amendment introduces new guidance for accounting for credit losses on instruments including trade receivables and held-to-maturity debt securities. The new rules are effective for annual and interim periods beginning after December 15, 2019. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are in the process of evaluating the impact the amendment will have on our Consolidated Financial Statements.
In February 2016, the FASB amended its standards related to the accounting for leases. Under the new standard, lessees will now be required to recognize substantially all leases on the balance sheet as both a right-of-use-asset and a liability. The standard will continue to have two types of leases for income statement recognition purposes: operating leases and finance leases. Operating leases will result in the recognition of a single lease expense on a straight-line basis over the lease term

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similar to the treatment for operating leases under today's standards. Finance leases will result in an accelerated expense similar to the accounting for capital leases under today's standards. The determination of a lease classification as operating or finance will occur in a manner similar to today's 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. The new standard is effective on January 1, 2019, with early adoption permitted. We are still evaluating the impact the standard could have on our Consolidated Financial Statements, including our internal controls over financial reporting. While we have not yet quantified the amount, we do expect the standard will have a material impact on our Consolidated Balance Sheets due to the recognition of additional assets and liabilities for operating leases.
In January 2016, the FASB amended its standards related to the accounting for certain financial instruments. This amendment addresses certain aspects of recognition, measurement, presentation and disclosure. The new rules will become effective for annual and interim periods beginning after December 15, 2017. Early adoption is not permitted. We are in the process of evaluating the impact the amendment will have on our Consolidated Financial Statements.
In May 2014, the FASB amended its standards related to revenue recognition. This amendment replaces all existing revenue recognition guidance and provides a single, comprehensive revenue recognition model for all contracts with customers. The standard contains principles that we will apply to determine the measurement of revenue and timing of when it is recognized. The underlying principle is that we will recognize revenue in a manner that depicts the transfer of goods or services to customers at an amount that we expect to be entitled to in exchange for those goods or services. The guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. Other major provisions include capitalization of certain contract costs, consideration of the time value of money in the transaction price and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. The amendment also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in those judgments and assets recognized from costs incurred to fulfill a contract. The standard allows either full or modified retrospective adoption effective for annual and interim periods beginning January 1, 2018. We are in the process of evaluating the impact the amendment will have on our Consolidated Financial Statements, including our internal controls over financial reporting. We expect to adopt the standard using the modified retrospective approach. While we have not yet completed our evaluation process, we have identified that a change will be required related to our accounting for remanufactured product sales that include an exchange of the used product, referred to as core. Revenue is not currently recognized related to the core component unless the used product is not returned. Under the new standard, the transaction will be accounted for as a gross sale and a purchase of inventory. As a result, the exchange will increase both sales and cost of sales, in equal amounts, related to core. This will not impact gross margin dollars, but will impact the gross margin percentage. We are still quantifying the amount of this change. We have also identified transactions where revenue recognition is currently limited to the amount of billings not contingent on our future performance. With the allocation provisions of the new model, we expect to accelerate the timing of revenue recognition for amounts related to satisfied performance obligations that would have been delayed under the current guidance. We do not expect the impact of this change to be material, but we are still quantifying the impact. Using the modified retrospective adoption method, we will record an adjustment to our opening equity balance at January 1, 2018, to account for the differences between existing revenue recorded and revenue that would have been recorded under the new standard related to contracts for which we have begun to recognize revenue prior to the adoption date. We are still quantifying the potential amount of this adjustment.

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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,” “we,” “our” or “us.”
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION
Certain parts of this quarterly report contain forward-looking statements intended to qualify for the safe harbors from liability established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements include those 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," "could," "should" or words of similar meaning. 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. Some future factors that could cause our results to differ materially from the results discussed in such forward-looking statements are discussed below and shareholders, potential investors and other readers are urged to consider these future factors carefully in evaluating forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. Future factors that could affect the outcome of forward-looking statements include the following:
•
a sustained slowdown or significant downturn in our markets;
•
changes in the engine outsourcing practices of significant customers;
•
a major customer experiencing financial distress;
•
lower than expected acceptance of new or existing products or services;
•
any significant problems in our new engine platforms;
•
a further slowdown in infrastructure development and/or continuing depressed commodity prices;
•
unpredictability in the adoption, implementation and enforcement of emission standards around the world;
•
foreign currency exchange rate changes;
•
the actions of, and income from, joint ventures and other investees that we do not directly control;
•
the integration of our previously partially-owned United States and Canadian distributors;
•
our plan to reposition our portfolio of product offerings through exploring strategic acquisitions and divestitures and related uncertainties of entering such transactions;
•
supply shortages and supplier financial risk, particularly from any of our single-sourced suppliers;
•
variability in material and commodity costs;
•
product recalls;
•
competitor activity;
•
increasing competition, including increased global competition among our customers in emerging markets; 
•
exposure to potential security breaches or other disruptions to our information technology systems and data security;
•
political, economic and other risks from operations in numerous countries;
•
changes in taxation;
•
global legal and ethical compliance costs and risks;
•
aligning our capacity and production with our demand;
•
product liability claims;
•
increasingly stringent environmental laws and regulations;
•
the price and availability of energy;
•
the performance of our pension plan assets and volatility of discount rates;

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•
labor relations;
•
changes in accounting standards;
•
future bans or limitations on the use of diesel-powered vehicles;
•
our sales mix of products;
•
protection and validity of our patent and other intellectual property rights;
•
technological implementation and cost/financial risks in our increasing use of large, multi-year contracts;
•
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; and
•
other risk factors described in our 2016 Form 10-K, Part I, Item 1A under the caption “Risk Factors.”
Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are made only as of the date of this quarterly report and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.


22
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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 Management's Discussion and Analysis of Financial Condition and Results of Operations section of our 2016 Form 10-K. Our MD&A is presented in the following sections:
•Executive Summary and Financial Highlights
•Outlook
•Results of Operations
•Operating Segment Results
•Liquidity and Capital Resources
•Application of Critical Accounting Estimates
•Recently Adopted and Recently Issued Accounting Pronouncements

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Table of Contents

EXECUTIVE SUMMARY AND FINANCIAL HIGHLIGHTS
We are a global power leader that designs, manufactures, distributes and services diesel and natural gas engines and engine-related component products, including filtration, aftertreatment, turbochargers, fuel systems, controls systems, air handling systems and electric power generation systems. We sell our products to original equipment manufacturers (OEMs), distributors and other customers worldwide. We have long-standing relationships with many of the leading manufacturers in the markets we serve, including PACCAR Inc, Daimler Trucks North America, Navistar International Corporation and Fiat Chrysler Automobiles. We serve our customers through a network of approximately 600 wholly-owned and independent distributor locations and over 7,400 dealer locations in more than 190 countries and territories.
Our reportable operating segments consist of Engine, Distribution, Components and Power Systems. This reporting structure is organized according to the products and markets each segment serves. The Engine segment produces engines (15 liters and less in size) and associated parts for sale to customers in on-highway and various off-highway markets. Our engines are used in trucks of all sizes, buses and recreational vehicles, as well as in various industrial applications, including construction, agriculture, power generation systems and other off-highway applications. The Distribution segment includes wholly-owned and partially-owned distributorships engaged in wholesaling engines, generator sets and service parts, as well as performing service and repair activities on our products and maintaining relationships with various OEMs throughout the world. The Components segment sells filtration products, aftertreatment systems, turbochargers and fuel systems. The Power Systems segment is an integrated power provider, which designs, manufactures and sells engines (16 liters and larger) for industrial applications (including mining, oil and gas, marine and rail), standby and prime power generator sets, alternators and other power components.
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. Our sales may also be impacted by OEM inventory levels, production schedules and stoppages. Economic downturns in markets we serve generally result in reduced sales of our products and can result in price reductions in certain products and/or markets. As a worldwide business, our operations are also affected by currency, political, economic and regulatory matters, including adoption and enforcement of environmental and emission standards, in the countries we serve. As part of our growth strategy, we invest in businesses in certain countries that carry high levels of these risks such as China, Brazil, India, Mexico, Russia and countries in the Middle East and Africa. At the same time, our geographic diversity and broad product and service offerings have helped limit the impact from a drop in demand in any one industry or customer or the economy of any single country on our consolidated results.
Worldwide revenues increased 12 percent in the three months ended July 2, 2017, as compared to the same period in 2016, with all operating segments reporting higher revenue. Revenue in the U.S. and Canada improved by 13 percent primarily due to increased demand in the North American on-highway markets and increased industrial demand (especially in the oil and gas market). International demand growth (excludes the U.S. and Canada) improved revenues by 11 percent, with sales up in most of our markets (especially in China, India and Russia). The increase in international sales was primarily due to increased demand in industrial markets (especially construction markets in China and mining markets in Europe) and increased demand in all Components businesses (especially on-highway truck demand in China and product sales to meet new emission requirements for trucks in India), partially offset by unfavorable foreign currency impacts of 2 percent (primarily in the Chinese renminbi and British pound).
Worldwide revenues increased 10 percent in the six months ended July 2, 2017, as compared to the same period in 2016, with all operating segments reporting higher revenue. International demand growth (excludes the U.S. and Canada) in 2017 improved revenues by 12 percent, with sales up in most of our markets, especially in China, India, Russia and the U.K. The increase in international sales was primarily due to increased demand in industrial markets (especially construction markets in China and mining markets in Europe) and increased demand in all Components businesses (especially on-highway truck demand in China and product sales to meet new emission requirements for trucks in India), partially offset by unfavorable foreign currency impacts of 3 percent (primarily in the British pound and Chinese renminbi). Revenue in the U.S. and Canada improved by 8 percent primarily due to increased demand in the North American on-highway markets and increased industrial demand (especially in the construction, oil and gas and argiculture markets).
The following tables contain sales and earnings before interest expense, income tax expense and noncontrolling interests (EBIT) by operating segment for the three and six months ended July 2, 2017 and July 3, 2016. Refer to the section titled “OPERATING SEGMENT RESULTS” for a more detailed discussion of sales and EBIT by operating segment, including the reconciliation of segment EBIT to net income attributable to Cummins Inc.

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Three months ended
Operating Segments
 
July 2, 2017
 
July 3, 2016
 
Percent change
 
 
 
 
Percent
 
 
 
 
 
Percent
 
 
 
2017 vs. 2016
In millions
 
Sales
 
of Total
 
EBIT
 
Sales
 
of Total
 
EBIT
 
Sales
 
EBIT
Engine
 
$
2,307

 
45
 %
 
$
277

 
$
2,002

 
44
 %
 
$
206

 
15
%
 
34
 %
Distribution
 
1,722

 
34
 %
 
96

 
1,544

 
34
 %
 
87

 
12
%
 
10
 %
Components
 
1,454

 
29
 %
 
190

 
1,279

 
28
 %
 
190

 
14
%
 
—
 %
Power Systems
 
1,017

 
20
 %
 
61

 
921

 
21
 %
 
90

 
10
%
 
(32
)%
Intersegment eliminations
 
(1,422
)
 
(28
)%
 
—

 
(1,218
)
 
(27
)%
 
—

 
17
%
 
—

Non-segment
 
—

 
—

 
(4
)
 
—

 
—

 
18

 
—

 
NM

Total
 
$
5,078

 
100
 %
 
$
620

 
$
4,528

 
100
 %
 
$
591

 
12
%
 
5
 %
 
______________________________________
"NM" - not meaningful information
Net income attributable to Cummins was $424 million, or $2.53 per diluted share, on sales of $5.1 billion for the three months ended July 2, 2017, versus the comparable prior year period net income attributable to Cummins of $406 million, or $2.40 per diluted share, on sales of $4.5 billion. The increase in net income and earnings per diluted share was driven by significantly higher net sales, higher gross margin, the absence of an accrual for a loss contingency recorded in the second quarter of 2016, higher equity, royalty and interest income from investees, partially offset by increased selling, general and administrative expenses, higher research, development and engineering expenses and a higher effective tax rate. The increase in gross margin was primarily due to higher volumes, improved Distribution segment margins related to the acquisition of North American distributors since December 31, 2015 and lower material costs, partially offset by higher warranty costs ($87 million primarily due to changes in estimates in the Engine and Component segments and campaigns in the Power Systems segment) and increased variable compensation expense of $93 million. Diluted earnings per share for the three months ended July 2, 2017, benefited $0.01 from fewer weighted average shares outstanding due to purchases under the stock repurchase program.
 
 
 
Six months ended
Operating Segments
 
July 2, 2017
 
July 3, 2016
 
Percent change
 
 
 
 
Percent
 
 
 
 
 
Percent
 
 
 
2017 vs. 2016
In millions
 
Sales
 
of Total
 
EBIT
 
Sales
 
of Total
 
EBIT
 
Sales
 
EBIT
Engine
 
$
4,330

 
45
 %
 
$
506

 
$
3,978

 
45
 %
 
$
403

 
9
%
 
26
 %
Distribution
 
3,367

 
35
 %
 
196

 
3,007

 
34
 %
 
174

 
12
%
 
13
 %
Components
 
2,798

 
29
 %
 
369

 
2,516

 
28
 %
 
353

 
11
%
 
5
 %
Power Systems
 
1,899

 
19
 %
 
118

 
1,729

 
20
 %
 
136

 
10
%
 
(13
)%
Intersegment eliminations
 
(2,727
)
 
(28
)%
 
—

 
(2,411
)
 
(27
)%
 
—

 
13
%
 
—

Non-segment
 
—

 
—

 
(3
)
 
—

 
—

 
9

 
—

 
NM

Total
 
$
9,667

 
100
 %
 
$
1,186

 
$
8,819

 
100
 %
 
$
1,075

 
10
%
 
10
 %
______________________________________
"NM" - not meaningful information
Net income attributable to Cummins was $820 million, or $4.88 per diluted share, on sales of $9.7 billion for the six months ended July 2, 2017, versus the comparable prior year period net income attributable to Cummins of $727 million, or $4.26 per diluted share, on sales of $8.8 billion. The increase in net income and earnings per diluted share was driven by significantly higher net sales, higher gross margin, higher equity, royalty and interest income from investees, the absence of an accrual for a loss contingency recorded in the second quarter of 2016 and a lower effective tax rate, partially offset by increased selling, general and administrative expenses and higher research, development and engineering expenses. The increase in gross margin was primarily due to higher volumes, lower material costs, improved Distribution segment margins related to the acquisition of North American distributors since December 31, 2015, favorable pricing and favorable foreign currency fluctuations (primarily the British pound, South African rand and Brazilian real), partially offset by higher warranty costs ($120 million primarily due to changes in estimates in the Engine and Component segments and campaigns in the Power Systems segment) and increased variable compensation expense of $109 million. Diluted earnings per share for the six months ended July 2, 2017, benefited $0.01 from fewer weighted average shares outstanding, primarily due to purchases under the stock repurchase program.

We generated $826 million of operating cash flows for the six months ended July 2, 2017, compared to $738 million for the comparable period in 2016. Refer to the section titled "Cash Flows" in the "LIQUIDITY AND CAPITAL RESOURCES" section for a discussion of items impacting cash flows.

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During the first half of 2017, we repurchased $120 million, or 0.8 million shares of common stock.
Our debt to capital ratio (total capital defined as debt plus equity) at July 2, 2017, was 18.7 percent, compared to 20.6 percent at December 31, 2016. At July 2, 2017, we had $1.5 billion in cash and marketable securities on hand and access to our $1.75 billion credit facilities, if necessary, to meet currently anticipated investment and funding needs.
 
In July 2017, our Board of Directors authorized an increase to our quarterly dividend of 5.4 percent from $1.025 per share to $1.08 per share.
We expect our effective tax rate for the full year of 2017 to approximate 26.0 percent, excluding any one-time tax items.
In April 2017, we entered into an agreement to form a joint venture with Eaton Corporation PLC and we closed the transaction on July 31, 2017. We purchased a 50 percent interest in the new venture named Eaton Cummins Automated Transmission Technologies for $600 million in cash. The joint venture will design, assemble, sell and support medium-duty and heavy-duty automated transmissions for the commercial vehicle market, including new product launches. We will consolidate the results of the joint venture in our Components segment as we have a majority voting interest in the venture by virtue of a tie-breaking vote on the board of directors. We are still in the process of finalizing the purchase accounting and we do not expect this new venture to have a significant impact on our consolidated results in 2017.

26
Table of Contents

OUTLOOK
Our outlook reflects the following positive trends and challenges to our business that we expect could impact our revenue and earnings potential for the remainder of 2017.
Positive Trends
•
Demand for pick-up trucks in North America remains strong.
•
Market demand in off-highway markets in China and India remains strong.
•
Industry production of medium-duty trucks in North America should remain strong.
•
North American construction markets may stabilize.
•
Market demand may continue to improve in global mining.
•
North American heavy-duty truck demand may stabilize.
Challenges
•
Power generation markets may remain soft.
•
Weak economic conditions in Brazil may continue to negatively impact demand across our businesses.
•
Foreign currency could continue to put pressure on our results.
•
Marine markets are expected to remain weak.
Demand has improved in certain markets and we expect demand will continue to improve over time, as in prior economic cycles. We are well positioned to benefit as market conditions improve.

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RESULTS OF OPERATIONS
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
2017
 
July 3,
2016
 
(Unfavorable)
 
July 2,
2017
 
July 3,
2016
 
(Unfavorable)
In millions, except per share amounts
 
 
Amount
 
Percent
 
 
 
Amount
 
Percent
NET SALES
$
5,078

 
$
4,528

 
$
550

 
12
 %
 
$
9,667

 
$
8,819

 
$
848

 
10
 %
Cost of sales
3,829

 
3,331

 
(498
)
 
(15
)%
 
7,290

 
6,566

 
(724
)
 
(11
)%
GROSS MARGIN
1,249

 
1,197

 
52

 
4
 %
 
2,377

 
2,253

 
124

 
6
 %
OPERATING EXPENSES AND INCOME
 

 
 

 
 

 


 
 

 
 

 
 

 


Selling, general and administrative expenses
596

 
524

 
(72
)
 
(14
)%
 
1,133

 
1,014

 
(119
)
 
(12
)%
Research, development and engineering expenses
174

 
155

 
(19
)
 
(12
)%
 
332

 
321

 
(11
)
 
(3
)%
Equity, royalty and interest income from investees
98

 
88

 
10

 
11
 %
 
206

 
160

 
46

 
29
 %
Loss contingency
—

 
39

 
39

 
100
 %
 
—

 
39

 
39

 
100
 %
Other operating income (expense), net
18

 
—

 
18

 
NM

 
23

 
(2
)
 
25

 
NM

OPERATING INCOME
595

 
567

 
28

 
5
 %
 
1,141

 
1,037

 
104

 
10
 %
Interest income
5

 
6

 
(1
)
 
(17
)%
 
7

 
12

 
(5
)
 
(42
)%
Interest expense
21

 
16

 
(5
)
 
(31
)%
 
39

 
35

 
(4
)
 
(11
)%
Other income (expense), net
20

 
18

 
2

 
11
 %
 
38

 
26

 
12

 
46
 %
INCOME BEFORE INCOME TAXES
599

 
575

 
24

 
4
 %
 
1,147

 
1,040

 
107

 
10
 %
Income tax expense
158

 
148

 
(10
)
 
(7
)%
 
301

 
280

 
(21
)
 
(8
)%
CONSOLIDATED NET INCOME
441

 
427

 
14

 
3
 %
 
846

 
760

 
86

 
11
 %
Less: Net income attributable to noncontrolling interests
17

 
21

 
4

 
19
 %
 
26

 
33

 
7

 
21
 %
NET INCOME ATTRIBUTABLE TO CUMMINS INC.
$
424

 
$
406

 
$
18

 
4
 %
 
$
820

 
$
727

 
$
93

 
13
 %
Diluted Earnings Per Common Share Attributable to Cummins Inc.
$
2.53

 
$
2.40

 
$
0.13

 
5
 %
 
$
4.88

 
$
4.26

 
$
0.62

 
15
 %
______________________________________
"NM" - not meaningful information
 
 
Three months ended
 
Favorable/
(Unfavorable)
 
Six months ended
 
Favorable/
(Unfavorable)
 
 
July 2,
2017
 
July 3,
2016
 
 
July 2,
2017
 
July 3,
2016
 
Percent of sales
 
 
 
Percentage Points
 
 
 
Percentage Points
Gross margin
 
24.6
%
 
26.4
%
 
(1.8
)
 
24.6
%
 
25.5
%
 
(0.9
)
Selling, general and administrative expenses
 
11.7
%
 
11.6
%
 
(0.1
)
 
11.7
%
 
11.5
%
 
(0.2
)
Research, development and engineering expenses
 
3.4
%
 
3.4
%
 
—

 
3.4
%
 
3.6
%
 
0.2

Net Sales
Net sales for the three months ended July 2, 2017, increased by $550 million versus the comparable period in 2016. The primary drivers were as follows:
•
Engine segment sales increased 15 percent primarily due to higher demand in North American medium-duty truck and bus, North American heavy-duty truck markets and improved demand in global off-highway markets.
•
Distribution segment sales increased 12 percent primarily due to an increase in organic sales and higher sales related to the acquisition of North American distributors since December 31, 2015.
•
Components segment sales increased 14 percent primarily due to higher demand across all lines of businesses, primarily in China, North America and India.
•
Power Systems segment sales increased 10 percent primarily due to higher demand in industrial markets.
These increases were unfavorably impacted by foreign currency fluctuations of approximately 1 percent, primarily in the Chinese renminbi and British pound.
Net sales for the six months ended July 2, 2017, increased $848 million versus the comparable period in 2016. The primary drivers were as follows:

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•
Distribution segment sales increased 12 percent primarily due to an increase in organic sales and higher sales related to the acquisition of North American distributors since December 31, 2015.
•
Engine segment sales increased 9 percent primarily due to higher demand in off-highway markets, North American medium-duty truck and bus and North American heavy-duty truck markets.
•
Components segment sales increased 11 percent primarily due to higher demand across all lines of businesses, primarily in China and India.
•
Power Systems segment sales increased 10 percent primarily due to higher demand in industrial markets, especially global mining, North American oil and gas markets and North American rail markets.
These increases were unfavorably impacted by foreign currency fluctuations of approximately 1 percent, primarily in the British pound and Chinese renminbi.
Sales to international markets (excluding the U.S. and Canada), based on location of customers, for the three and six months months ended July 2, 2017, were 42 percent and 42 percent of total net sales, respectively, compared with 42 percent and 41 percent of total net sales for the comparable periods in 2016. A more detailed discussion of sales by segment is presented in the “OPERATING SEGMENT RESULTS” section.
Gross Margin
Gross margin increased $52 million for the three months ended July 2, 2017, versus the comparable period in 2016 and decreased 1.8 points as a percentage of sales. The increase in gross margin dollars was primarily due to higher volumes, improved Distribution segment margins related to the acquisition of North American distributors since December 31, 2015 and lower material costs, partially offset by higher warranty costs ($87 million primarily due to changes in estimates in the Engine and Component segments and campaigns in the Power Systems segment) and increased variable compensation expense of $93 million.
Gross margin increased $124 million for the six months ended July 2, 2017, versus the comparable period in 2016 and decreased 0.9 points as a percentage of sales. The increase in gross margin dollars was primarily due to higher volumes, lower material costs, improved Distribution segment margins related to the acquisition of North American distributors since December 31, 2015, favorable pricing and favorable foreign currency fluctuations (primarily the British pound, South African rand and Brazilian real), partially offset by higher warranty costs ($120 million primarily due to changes in estimates in the Engine and Component segments and campaigns in the Power Systems segment) and increased variable compensation expense of $109 million.
The provision for base warranties issued, excluding campaigns, as a percent of sales for the three and six months ended July 2, 2017, was 1.8 percent and 1.9 percent, respectively, compared to 1.8 percent and 1.9 percent for the comparable periods in 2016. A detailed discussion of margin by segment is presented in the “OPERATING SEGMENT RESULTS” section.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $72 million for the three months ended July 2, 2017, versus the comparable period in 2016, primarily due to higher variable compensation expenses ($49 million) and higher consulting expenses ($10 million). Compensation and related expenses include salaries, fringe benefits and variable compensation. Overall, selling, general and administrative expenses, as a percentage of sales, increased to 11.7 percent in the three months ended July 2, 2017, from 11.6 percent in the comparable period in 2016.
Selling, general and administrative expenses increased $119 million for the six months ended July 2, 2017, versus the comparable period in 2016, primarily due to higher variable compensation expenses ($64 million) and higher consulting expenses ($30 million). Overall, selling, general and administrative expenses, as a percentage of sales, increased to 11.7 percent in the six months ended July 2, 2017, from 11.5 percent in the comparable period in 2016.
Research, Development and Engineering Expenses
Research, development and engineering expenses increased $19 million for the three months ended July 2, 2017, versus the comparable period in 2016, primarily due to increased variable compensation expenses ($13 million) and lower expense recovery from customers ($5 million). Overall, research, development and engineering expenses remained flat as a percentage of sales, versus the comparable period in 2016 .
Research, development and engineering expenses increased $11 million for the six months ended July 2, 2017, versus the comparable period in 2016, primarily due to increased variable compensation expense ($13 million), partially offset by higher

29
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expense recovery from customers ($2 million). Overall, research, development and engineering expenses, as a percentage of sales, decreased to 3.4 percent in the six months ended July 2, 2017, from 3.6 percent in the comparable period in 2016.
Research activities continue to focus on development of new products to meet future emission standards around the world and improvements in fuel economy performance of diesel and natural gas powered engines.
Equity, Royalty and Interest Income from Investees
Equity, royalty and interest income from investees increased $10 million for the three months ended July 2, 2017, versus the comparable period in 2016, primarily due to higher earnings at Dongfeng Cummins Engine Company, Ltd.
Equity, royalty and interest income from investees increased $46 million for the six months ended July 2, 2017, versus the comparable period in 2016, primarily due to higher earnings at Dongfeng Cummins Engine Company, Ltd. and Beijing Foton Cummins Engine Co., Ltd.
 
 
 
 
 
 
Other Operating Income (Expense), Net
Other operating income (expense), net was as follows:
 
 
Three months ended
 
Six months ended
In millions
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
Royalty income, net
 
$
11

 
$
6

 
$
20

 
$
13

Amortization of intangible assets
 
(1
)
 
(2
)
 
(3
)
 
(5
)
Loss on write off of assets
 
(1
)
 
(4
)
 
(2
)
 
(9
)
Other, net
 
9

 
—

 
8

 
(1
)
Total other operating income (expense), net
 
$
18

 
$
—

 
$
23

 
$
(2
)
Interest Income
Interest income for the three months ended July 2, 2017, remained relatively flat versus the comparable period in 2016. Interest income for the six months ended July 2, 2017, decreased $5 million versus the comparable period in 2016, primarily due to lower short-term investments.
Interest Expense
Interest expense for the three months ended July 2, 2017, increased $5 million versus the comparable period in 2016, primarily due to hedge ineffectiveness on our interest rate swap. Interest expense for the six months ended July 2, 2017, increased $4 million versus the comparable period in 2016, primarily due to hedge ineffectiveness on our interest rate swap.
Other Income (Expense), Net
Other income (expense), net was as follows:
 
 
Three months ended
 
Six months ended
In millions
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
Change in cash surrender value of corporate owned life insurance
 
$
16

 
$
15

 
$
29

 
$
23

Dividend income
 
2

 
1

 
3

 
2

Foreign currency gain (loss), net
 
1

 
(8
)
 
3

 
(11
)
Bank charges
 
(2
)
 
(1
)
 
(5
)
 
(4
)
Other, net
 
3

 
11

 
8

 
16

Total other income (expense), net
 
$
20

 
$
18

 
$
38

 
$
26

Income Tax Expense
Our effective tax rate for the year is expected to approximate 26.0 percent, excluding any one-time items that may arise. Our tax rate is generally less than the 35 percent U.S. statutory income tax rate primarily due to lower tax rates on foreign income and the research tax credit.

30
Table of Contents

Our effective tax rate for the three and six months ended July 2, 2017, was 26.4 percent and 26.2 percent, respectively, and contained only immaterial discrete items.
Our effective tax rate for the three and six months ended July 3, 2016, was 25.7 percent and 26.9 percent, respectively, and contained only immaterial discrete items.
The changes in the effective tax rate for the three and six months ended July 2, 2017, versus the comparable periods in 2016, were primarily due to differences in the jurisdictional mix of pre-tax 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 July 2, 2017, decreased $4 million versus the comparable period in 2016, primarily due to the acquisition of the remaining interest in Wuxi Cummins Turbo Technologies Co. Ltd, in the fourth quarter of 2016.
Noncontrolling interests in income of consolidated subsidiaries for the six months ended July 2, 2017, decreased $7 million versus the comparable period in 2016, primarily due to the acquisition of the remaining interest in Wuxi Cummins Turbo Technologies Co. Ltd, in the fourth quarter of 2016.
Net Income Attributable to Cummins Inc. 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 July 2, 2017, increased $18 million and $0.13 per share, respectively versus the comparable period in 2016, primarily due to significantly higher net sales, higher gross margin, the absence of an accrual for a loss contingency recorded in the second quarter of 2016, higher equity, royalty and interest income from investees, partially offset by increased selling, general and administrative expenses, higher research, development and engineering expenses and a higher effective tax rate. Diluted earnings per share for the three months ended July 2, 2017, benefited $0.01 from fewer weighted average shares outstanding due to purchases under the stock repurchase program.
Net income and diluted earnings per share attributable to Cummins Inc. for the six months ended July 2, 2017, increased $93 million and $0.62 per share, respectively versus the comparable period in 2016, primarily due to significantly higher net sales, higher gross margin, higher equity, royalty and interest income from investees, the absence of an accrual for a loss contingency recorded in the second quarter of 2016 and a lower effective tax rate, partially offset by increased selling, general and administrative expenses and higher research, development and engineering expenses. Diluted earnings per share for the six months ended July 2, 2017, benefited $0.01 from fewer weighted average shares outstanding, primarily due to purchases under the stock repurchase program.

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Table of Contents

Comprehensive Income - Foreign Currency Translation Adjustment
The foreign currency translation adjustment was a net gain of $102 million and $182 million, respectively, for the three and six months ended July 2, 2017, compared to a net loss of $213 million and $270 million for the three and six months ended July 3, 2016, and was driven by the following:
 
 
Three months ended
 
 
July 2, 2017
 
July 3, 2016
In millions
 
Translation adjustment
 
Primary currency driver vs. U.S. dollar
 
Translation adjustment
 
Primary currency driver vs. U.S. dollar
Wholly-owned subsidiaries
 
$
90

 
British pound, Chinese renminbi
 
$
(193
)
 
British pound, Chinese renminbi offset by Brazilian real
Equity method investments
 
11

 
Chinese renminbi
 
(14
)
 
Chinese renminbi, Indiana rupee offset by Japanese yen
Consolidated subsidiaries with a noncontrolling interest
 
1

 
Indian rupee
 
(6
)
 
Indian rupee, Chinese renminbi
Total
 
$
102

 
 
 
$
(213
)
 
 

 
 
 
 
 
 
 
 
 
 
 
Six months ended
 
 
July 2, 2017
 
July 3, 2016
In millions
 
Translation adjustment
 
Primary currency driver vs. U.S. dollar
 
Translation adjustment
 
Primary currency driver vs. U.S. dollar
Wholly-owned subsidiaries
 
$
147

 
British pound, Indian rupee, Chinese renminbi

 
$
(255
)
 
British pound, Chinese renminbi offset by Brazilian real
Equity method investments
 
21

 
Chinese renminbi, Indian rupee
 
(9
)
 
Chinese renminbi, Indian rupee offset by Japanese yen, Mexican peso
Consolidated subsidiaries with a noncontrolling interest
 
14

 
Indian rupee
 
(6
)
 
Indian rupee, Chinese renminbi
Total
 
$
182

 
 
 
$
(270
)
 
 
.



32
Table of Contents

OPERATING SEGMENT RESULTS
Our reportable operating segments consist of the Engine, Distribution, Components and Power Systems segments. This reporting structure is organized according to the products and markets each segment serves. We use segment EBIT as a primary basis for the CODM to evaluate the performance of each of our operating segments. Segment amounts exclude certain expenses not specifically identifiable to segments. See Note 12, "OPERATING SEGMENTS," to the Condensed Consolidated Financial Statements for additional information.
Following is a discussion of results for each of our operating segments.
Engine Segment Results
Financial data for the Engine segment was as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
In millions
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
External sales (1)
 
$
1,711

 
$
1,504

 
$
207

 
14
 %
 
$
3,168

 
$
2,993

 
$
175

 
6
 %
Intersegment sales (1)
 
596

 
498

 
98

 
20
 %
 
1,162

 
985

 
177

 
18
 %
Total sales
 
2,307

 
2,002

 
305

 
15
 %
 
4,330

 
3,978

 
352

 
9
 %
Depreciation and amortization
 
46

 
41

 
(5
)
 
(12
)%
 
90

 
80

 
(10
)
 
(13
)%
Research, development and engineering expenses
 
63

 
53

 
(10
)
 
(19
)%
 
117

 
110

 
(7
)
 
(6
)%
Equity, royalty and interest income from investees
 
56

 
46

 
10

 
22
 %
 
128

 
82

 
46

 
56
 %
Loss contingency
 
—

 
39

 
39

 
100
 %
 
—

 
39

 
39

 
100
 %
Interest income
 
2

 
3

 
(1
)
 
(33
)%
 
3

 
5

 
(2
)
 
(40
)%
Segment EBIT
 
277

 
206

 
71

 
34
 %
 
506

 
403

 
103

 
26
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 

 
Percentage Points
 
 

 
 

 
Percentage Points
Segment EBIT as a percentage of total sales
 
12.0
%
 
10.3
%
 
 

 
1.7

 
11.7
%
 
10.1
%
 
 

 
1.6

____________________________________
(1) Due to the acquisitions of North American distributors, sales previously recognized as external sales are now included in intersegment sales.
Sales for our Engine segment by market were as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
In millions
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
Heavy-duty truck
 
$
714

 
$
622

 
$
92

 
15
%
 
$
1,334

 
$
1,253

 
$
81

 
6
%
Medium-duty truck and bus
 
701

 
600

 
101

 
17
%
 
1,245

 
1,149

 
96

 
8
%
Light-duty automotive
 
429

 
394

 
35

 
9
%
 
852

 
827

 
25

 
3
%
Total on-highway
 
1,844

 
1,616

 
228

 
14
%
 
3,431

 
3,229

 
202

 
6
%
Off-highway
 
463

 
386

 
77

 
20
%
 
899

 
749

 
150

 
20
%
Total sales
 
$
2,307

 
$
2,002

 
$
305

 
15
%
 
$
4,330

 
$
3,978

 
$
352

 
9
%
Unit shipments by engine classification (including unit shipments to Power Systems and off-highway engine units included in their respective classification) were as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
 
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
Heavy-duty
 
24,100

 
20,700

 
3,400

 
16
%
 
43,300

 
40,400

 
2,900

 
7
%
Medium-duty
 
71,600

 
62,300

 
9,300

 
15
%
 
131,900

 
117,700

 
14,200

 
12
%
Light-duty
 
65,600

 
57,100

 
8,500

 
15
%
 
128,700

 
118,800

 
9,900

 
8
%
Total unit shipments
 
161,300

 
140,100

 
21,200

 
15
%
 
303,900

 
276,900

 
27,000

 
10
%

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Table of Contents

Sales
Engine segment sales for the three months ended July 2, 2017, increased $305 million versus the comparable period in 2016, driven by:
•
Medium-duty truck and bus sales increased $101 million primarily due to higher demand in North American medium-duty truck markets with increased engine shipments of 35 percent.
•
Heavy-duty truck sales increased $92 million primarily due to higher demand in North American heavy-duty truck markets with increased shipments of 19 percent.
•
Off-highway sales increased $77 million primarily due to improved demand in global industrial markets, especially in international construction markets, with increased unit shipments of 45 percent in China.
Total on-highway-related sales for the three months ended July 2, 2017, were 80 percent of total engine segment sales, compared to 81 percent for the comparable period in 2016.
Engine segment sales for the six months ended July 2, 2017, increased $352 million versus the comparable period in 2016. The following were primary drivers:
•
Off-highway sales increased $150 million primarily due to improved demand in global industrial markets, especially in international construction markets, with increased unit shipments of 54 percent in China and Australia.
•
Medium-duty truck and bus sales increased $96 million primarily due to higher demand in North American medium-duty truck markets with increased engine shipments of 12 percent.
•
Heavy-duty truck sales increased $81 million primarily due to higher demand in North American heavy-duty truck markets.
Total on-highway-related sales for the six months ended July 2, 2017, were 79 percent of total engine segment sales, compared to 81 percent for the comparable period in 2016.
Segment EBIT
Engine segment EBIT for the three months ended July 2, 2017, increased $71 million versus the comparable period in 2016, primarily due to higher gross margin and the absence of a loss contingency recorded in the second quarter of 2016, partially offset by higher selling, general and administrative expenses.
Engine segment EBIT for the six months ended July 2, 2017, increased $103 million versus the comparable period in 2016 primarily due to higher equity, royalty and interest income from investees, improved gross margin and the absence of a loss contingency recorded in the second quarter of 2016, partially offset by higher selling, general and administrative expenses. Major components of EBIT and related changes to segment EBIT and EBIT as a percentage of sales were as follows:
 
 
Three months ended
 
Six months ended
 
 
July 2, 2017 vs. July 3, 2016
 
July 2, 2017 vs. July 3, 2016
 
 
Favorable/(Unfavorable) Change
 
Favorable/(Unfavorable) Change
In millions
 
Amount
 
Percent
 
Percentage point
change as a percent
of total sales
 
Amount
 
Percent
 
Percentage point
change as a percent
of total sales
Gross margin
 
$
44

 
11
 %
 
(0.7
)
 
$
44

 
6
 %
 
(0.5
)
Selling, general and administrative expenses
 
(19
)
 
(13
)%
 
0.1

 
(32
)
 
(12
)%
 
(0.2
)
Research, development and engineering expenses
 
(10
)
 
(19
)%
 
(0.1
)
 
(7
)
 
(6
)%
 
0.1

Equity, royalty and interest income from investees
 
10

 
22
 %
 
0.1

 
46

 
56
 %
 
0.9

Loss contingency (1)
 
39

 
NM

 
NM

 
39

 
NM

 
NM

____________________________________
"NM" - not meaningful information
(1) See Note 9, "COMMITMENTS AND CONTINGENCIES," to the Condensed Consolidated Financial Statements for additional information.
The increase in gross margin dollars for the three months ended July 2, 2017, versus the comparable period in 2016, was primarily due to higher volumes and favorable mix, partially offset by increased warranty costs related to claims for certain 2013 and 2014 engines and higher variable compensation expense. The increases in selling, general and administrative expenses and research, development and engineering expenses were primarily due to higher variable compensation expenses. The increase in equity, royalty and interest income from investees was primarily due to higher earnings at Dongfeng Cummins Engine Company, Ltd.

34
Table of Contents

The increase in gross margin dollars for the six months ended July 2, 2017, versus the comparable period in 2016, was primarily due to higher volumes, favorable mix and improved pricing, partially offset by increased warranty costs related to claims for certain 2013 and 2014 engines and higher variable compensation expense. The increase in selling, general and administrative expenses was primarily due to higher variable compensation expense and higher consulting expenses. The increase in research, development and engineering expenses was primarily due to higher variable compensation expense. The increase in equity, royalty and interest income from investees was primarily due to higher earnings at Dongfeng Cummins Engine Company, Ltd. and Beijing Foton Cummins Engine Co.
Distribution Segment Results 
Financial data for the Distribution segment was as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
In millions
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
External sales
 
$
1,716

 
$
1,538

 
$
178

 
12
 %
 
$
3,353

 
$
2,996

 
$
357

 
12
 %
Intersegment sales
 
6

 
6

 
—

 
—
 %
 
14

 
11

 
3

 
27
 %
Total sales
 
1,722

 
1,544

 
178

 
12
 %
 
3,367

 
3,007

 
360

 
12
 %
Depreciation and amortization
 
31

 
29

 
(2
)
 
(7
)%
 
61

 
57

 
(4
)
 
(7
)%
Research, development and engineering expenses
 
4

 
3

 
(1
)
 
(33
)%
 
8

 
7

 
(1
)
 
(14
)%
Equity, royalty and interest income from investees
 
13

 
19

 
(6
)
 
(32
)%
 
24

 
37

 
(13
)
 
(35
)%
Interest income
 
1

 
1

 
—

 
—
 %
 
2

 
2

 
—

 
—
 %
Segment EBIT
 
96

 
87

 
9

 
10
 %
 
196

 
174

 
22

 
13
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Percentage Points
 
 
 
 
 
Percentage Points
Segment EBIT as a percentage of total sales
 
5.6
%
 
5.6
%
 
 

 
—

 
5.8
%
 
5.8
%
 
 

 
—

In the first quarter of 2017, our Distribution segment reorganized its regions to align with how the segment is managed. All prior year amounts have been reclassified to conform to our new regional structure. Sales for our Distribution segment by region were as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
In millions
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
North America
 
$
1,131

 
$
975

 
$
156

 
16
 %
 
$
2,244

 
$
1,920

 
$
324

 
17
 %
Asia Pacific
 
187

 
187

 
—

 
—
 %
 
357

 
356

 
1

 
—
 %
Europe
 
107

 
111

 
(4
)
 
(4
)%
 
204

 
212

 
(8
)
 
(4
)%
Africa and Middle East
 
86

 
100

 
(14
)
 
(14
)%
 
181

 
189

 
(8
)
 
(4
)%
China
 
75

 
55

 
20

 
36
 %
 
133

 
114

 
19

 
17
 %
India
 
52

 
46

 
6

 
13
 %
 
95

 
87

 
8

 
9
 %
Latin America
 
43

 
38

 
5

 
13
 %
 
78

 
71

 
7

 
10
 %
Russia
 
41

 
32

 
9

 
28
 %
 
75

 
58

 
17

 
29
 %
Total sales
 
$
1,722

 
$
1,544

 
$
178

 
12
 %
 
$
3,367

 
$
3,007

 
$
360

 
12
 %

35
Table of Contents

Sales for our Distribution segment by product line were as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
In millions
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
Parts
 
$
759

 
$
642

 
$
117

 
18
%
 
$
1,504

 
$
1,290

 
$
214

 
17
%
Power generation
 
329

 
326

 
3

 
1
%
 
635

 
601

 
34

 
6
%
Service
 
320

 
297

 
23

 
8
%
 
639

 
596

 
43

 
7
%
Engines
 
314

 
279

 
35

 
13
%
 
589

 
520

 
69

 
13
%
Total sales
 
$
1,722

 
$
1,544

 
$
178

 
12
%
 
$
3,367

 
$
3,007

 
$
360

 
12
%
Sales
Distribution segment sales for the three months ended July 2, 2017, increased $178 million versus the comparable period in 2016, primarily due to an increase in organic sales of $113 million (primarily in North America) and $88 million of sales related to the acquisition of North American distributors since December 31, 2015, partially offset by unfavorable foreign currency fluctuations (primarily in the Chinese renminbi, Canadian dollar and British pound).
Distribution segment sales for the six months ended July 2, 2017, increased $360 million versus the comparable period in 2016 primarily due to an increase in organic sales of $214 million (primarily in North America) and $177 million of segment sales related to the acquisition of North American distributors since December 31, 2015, partially offset by unfavorable foreign currency fluctuations (primarily in the Chinese renminbi and British pound).
Segment EBIT
Distribution segment EBIT for the three months ended July 2, 2017, increased $9 million versus the comparable period in 2016, primarily due to higher gross margin, partially offset by higher selling, general and administrative expenses (mainly related to the acquisition of North American distributors since December 31, 2015).
Distribution segment EBIT for the six months ended July 2, 2017, increased $22 million versus the comparable period in 2016, primarily due to higher gross margin, partially offset by higher selling, general and administrative expenses (mainly related to the acquisition of North American distributors since December 31, 2015). Major components of EBIT and related changes to segment EBIT and EBIT as a percentage of sales were as follows:
 
 
Three months ended
 
Six months ended
 
 
July 2, 2017 vs. July 3, 2016
 
July 2, 2017 vs. July 3, 2016
 
 
Favorable/(Unfavorable) Change
 
Favorable/(Unfavorable) Change
In millions
 
Amount
 
Percent
 
Percentage point
change as a percent
of total sales
 
Amount
 
Percent
 
Percentage point
change as a percent
of total sales
Gross margin
 
$
35

 
13
 %
 
0.3

 
$
68

 
13
 %
 
0.1

Selling, general and administrative expenses
 
(27
)
 
(14
)%
 
(0.3
)
 
(42
)
 
(11
)%
 
0.1

Equity, royalty and interest income from investees
 
(6
)
 
(32
)%
 
(0.4
)
 
(13
)
 
(35
)%
 
(0.5
)
The increase in gross margin dollars for the three months ended July 2, 2017, versus the comparable period in 2016, was primarily due to higher volumes, the acquisition of North American distributors since December 31, 2015 and improved pricing, partially offset by higher product costs. The increase in selling, general and administrative expenses was primarily due to higher variable compensation expense and increased compensation expenses related to the acquisition of North American distributors. The decrease in equity, royalty and interest income from investees was primarily due to the acquisition of North American distributors.
The increase in gross margin for the six months ended July 2, 2017, versus the comparable period in 2016, was primarily due to improved pricing, the acquisition of North American distributors since December 31, 2015 and higher volumes, partially offset by higher product costs. The increase in selling, general and administrative expenses was primarily due to higher variable compensation expense, increased compensation expenses related to the acquisition of North American distributors and higher consulting expenses. The decrease in equity, royalty and interest income from investees was primarily due to the acquisition of North American distributors.

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Components Segment Results
Financial data for the Components segment was as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
In millions
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
External sales (1)
 
$
1,064

 
$
933

 
$
131

 
14
 %
 
$
2,044

 
$
1,830

 
$
214

 
12
 %
Intersegment sales (1)
 
390

 
346

 
44

 
13
 %
 
754

 
686

 
68

 
10
 %
Total sales
 
1,454

 
1,279

 
175

 
14
 %
 
2,798

 
2,516

 
282

 
11
 %
Depreciation and amortization
 
38

 
32

 
(6
)
 
(19
)%
 
75

 
63

 
(12
)
 
(19
)%
Research, development and engineering expenses
 
57

 
51

 
(6
)
 
(12
)%
 
107

 
107

 
—

 
—
 %
Equity, royalty and interest income from investees
 
15

 
12

 
3

 
25
 %
 
28

 
20

 
8

 
40
 %
Interest income
 
1

 
1

 
—

 
—
 %
 
1

 
2

 
(1
)
 
(50
)%
Segment EBIT
 
190

 
190

 
—

 
—
 %
 
369

 
353

 
16

 
5
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Percentage Points
 
 
 
 
 
Percentage Points
Segment EBIT as a percentage of total sales
 
13.1
%
 
14.9
%
 
 

 
(1.8
)
 
13.2
%
 
14.0
%
 
 

 
(0.8
)
____________________________________
(1) Due to the acquisitions of North American distributors, sales previously recognized as external sales are now included in intersegment sales.
In the first quarter of 2017, our Components segment reorganized its reporting structure to move an element of the emission solutions business to the fuel systems business to enhance operational, administrative and product development efficiencies. Prior year sales were reclassified to conform with this change.
Sales for our Components segment by business were as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
In millions
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
Emission solutions
 
$
674

 
$
603

 
$
71

 
12
%
 
$
1,290

 
$
1,192

 
$
98

 
8
%
Turbo technologies
 
307

 
276

 
31

 
11
%
 
594

 
541

 
53

 
10
%
Filtration
 
291

 
262

 
29

 
11
%
 
568

 
514

 
54

 
11
%
Fuel systems
 
182

 
138

 
44

 
32
%
 
346

 
269

 
77

 
29
%
Total sales
 
$
1,454

 
$
1,279

 
$
175

 
14
%
 
$
2,798

 
$
2,516

 
$
282

 
11
%
Sales
Components segment sales for the three months ended July 2, 2017, increased $175 million, across all lines of business, versus the comparable period in 2016. The following were the primary drivers:
•
Emission solutions sales increased $71 million primarily due to higher demand to meet new emission requirements in India and on-highway truck demand in China.
•
Fuel systems sales increased $44 million primarily due to higher demand in China and Mexico.
•
Turbo technologies sales increased $31 million primarily due to higher demand in North America and China.
•
Filtration sales increased $29 million primarily due to higher demand in North America and China.
These increases were partially offset by unfavorable foreign currency fluctuations (primarily in the Chinese renminbi, British pound and euro).
Components segment sales for the six months ended July 2, 2017, increased $282 million, across all lines of business, versus the comparable period in 2016. The following were the primary drivers:
•
Emission solutions sales increased $98 million primarily due to higher demand in China on-highway truck markets and higher demand to meet new emission requirements in India, partially offset by unfavorable pricing in North America.

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Table of Contents

•
Fuel systems sales increased $77 million primarily due to higher demand in China.
•
Filtration sales increased $54 million primarily due to higher demand in North America and China.
•
Turbo technologies sales increased $53 million primarily due to higher demand in China and North America.
These increases were partially offset by unfavorable foreign currency fluctuations (primarily in the Chinese renminbi, British pound and euro).
Segment EBIT 
Components segment EBIT for the three months ended July 2, 2017, was flat versus the comparable period in 2016, as higher gross margin and higher equity, royalty and interest income from investees were offset by higher selling, general and administrative expenses and higher research, development and engineering expenses.
Components segment EBIT for the six months ended July 2, 2017, increased $16 million versus the comparable period in 2016 primarily due to higher gross margin and higher equity, royalty and interest income from investees, partially offset by higher selling, general and administrative expenses. Major components of EBIT and related changes to segment EBIT and EBIT as a percentage of sales were as follows:
 
 
Three months ended
 
Six months ended
 
 
July 2, 2017 vs. July 3, 2016
 
July 2, 2017 vs. July 3, 2016
 
 
Favorable/(Unfavorable) Change
 
Favorable/(Unfavorable) Change
In millions
 
Amount
 
Percent
 
Percentage point
change as a percent
of total sales
 
Amount
 
Percent
 
Percentage point
change as a percent
of total sales
Gross margin
 
$
10

 
3
 %
 
(2.3
)
 
$
28

 
5
 %
 
(1.4
)
Selling, general and administrative expenses
 
(18
)
 
(20
)%
 
(0.4
)
 
(34
)
 
(20
)%
 
(0.5
)
Research, development and engineering expenses
 
(6
)
 
(12
)%
 
0.1

 
—

 
—
 %
 
0.5

Equity, royalty and interest income from investees
 
3

 
25
 %
 
0.1

 
8

 
40
 %
 
0.2

The increase in gross margin for the three months ended July 2, 2017, versus the comparable period in 2016, was primarily due to higher volumes and lower material costs, partially offset by higher warranty costs driven by changes in estimates and unfavorable pricing in North America. The increase in selling, general and administrative expenses was primarily due to higher variable compensation expense and higher consulting expenses. The increase in research, development and engineering expenses was primarily due to lower expense recovery from customers and higher variable compensation expense.
The increase in gross margin for the six months ended July 2, 2017, versus the comparable period in 2016, was primarily due to higher volumes and lower material costs, partially offset by unfavorable pricing in North America and higher warranty costs driven by changes in estimates. The increase in selling, general and administrative expenses was primarily due to higher variable compensation expense and higher consulting expenses. The increase in equity, royalty and interest income from investees was primarily due to higher earnings at Dongfeng Cummins Emission Solutions Co., Ltd., Shanghai Fleetguard Filter Co. and Fleetguard Filtration Systems India Pvt.

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Table of Contents

Power Systems Segment Results
Financial data for the Power Systems segment was as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
In millions
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
External sales (1)
 
$
587

 
$
553

 
$
34

 
6
 %
 
$
1,102

 
$
1,000

 
$
102

 
10
 %
Intersegment sales (1)
 
430

 
368

 
62

 
17
 %
 
797

 
729

 
68

 
9
 %
Total sales
 
1,017

 
921

 
96

 
10
 %
 
1,899

 
1,729

 
170

 
10
 %
Depreciation and amortization
 
29

 
29

 
—

 
—
 %
 
57

 
58

 
1

 
2
 %
Research, development and engineering expenses
 
50

 
48

 
(2
)
 
(4
)%
 
100

 
97

 
(3
)
 
(3
)%
Equity, royalty and interest income from investees
 
14

 
11

 
3

 
27
 %
 
26

 
21

 
5

 
24
 %
Interest income
 
1

 
1

 
—

 
—
 %
 
1

 
3

 
(2
)
 
(67
)%
Segment EBIT
 
61

 
90

 
(29
)
 
(32
)%
 
118

 
136

 
(18
)
 
(13
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Percentage Points
 
 
 
 
 
Percentage Points
Segment EBIT as a percentage of total sales
 
6.0
%
 
9.8
%
 
 

 
(3.8
)
 
6.2
%
 
7.9
%
 
 

 
(1.7
)
____________________________________
(1) Due to the acquisitions of North American distributors, sales previously recognized as external sales are now included in intersegment sales.
In the first quarter of 2017, our Power Systems segment reorganized its product lines to better reflect how the segment is managed. Prior year sales were reclassified to reflect these changes. Sales for our Power Systems segment by product line were as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
In millions
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
Power generation
 
$
570

 
$
602

 
$
(32
)
 
(5
)%
 
$
1,096

 
$
1,120

 
$
(24
)
 
(2
)%
Industrial
 
353

 
236

 
117

 
50
 %
 
628

 
451

 
177

 
39
 %
Generator technologies
 
94

 
83

 
11

 
13
 %
 
175

 
158

 
17

 
11
 %
Total sales
 
$
1,017

 
$
921

 
$
96

 
10
 %
 
$
1,899

 
$
1,729

 
$
170

 
10
 %
High-horsepower unit shipments by engine classification were as follows:
 
 
Three months ended
 
Favorable/
 
Six months ended
 
Favorable/
 
 
July 2,
 
July 3,
 
(Unfavorable)
 
July 2,
 
July 3,
 
(Unfavorable)
Units
 
2017
 
2016
 
Amount
 
Percent
 
2017
 
2016
 
Amount
 
Percent
Power generation
 
2,100

 
2,200

 
(100
)
 
(5
)%
 
4,000

 
4,000

 
—

 
—
%
Industrial
 
1,700

 
1,100

 
600

 
55
 %
 
3,000

 
2,100

 
900

 
43
%
Total engine shipments
 
3,800

 
3,300

 
500

 
15
 %
 
7,000

 
6,100

 
900

 
15
%
Sales
Power Systems segment sales for the three months ended July 2, 2017, increased $96 million versus the comparable period in 2016 primarily due to increased industrial sales of $117 million principally due to higher demand in international mining markets and North American oil and gas markets.
These increases were partially offset by the following:
•
Power generation sales decreased $32 million primarily due to lower demand in the Middle East, China and Africa, partially offset by higher demand in Western Europe.
•
Foreign currency fluctuations negatively impacted sales, primarily due to the British pound.

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Table of Contents

Power Systems segment sales for the six months ended July 2, 2017, increased $170 million versus the comparable period in 2016. The following were the primary drivers:
•
Industrial sales increased $177 million primarily due to higher demand in global mining markets, North American oil and gas markets and North American rail markets.
•
Generator technologies sales increased $17 million primarily due to higher demand in Western Europe and China.
These increases were partially offset by the following:
•
Power generation sales decreased $24 million primarily due to lower demand in the Middle East, Brazil and Other Asia/Australia, partially offset by higher demand in Western Europe.
•
Foreign currency fluctuations negatively impacted sales, primarily due to the British pound.
Segment EBIT
Power Systems segment EBIT for the three months ended July 2, 2017, decreased $29 million versus the comparable period in 2016, primarily due to lower gross margin and higher selling, general and administrative expenses, partially offset by higher equity, royalty and interest income from investees and favorable foreign currency fluctuations (primarily due to the British pound).
Power Systems segment EBIT for the six months ended July 2, 2017, decreased $18 million versus the comparable period in 2016 primarily due to higher selling, general and administrative expenses and higher research, development and engineering expenses, partially offset by higher equity, royalty and interest income from investees. Major components of EBIT and related changes to segment EBIT and EBIT as a percentage of sales were as follows:
 
 
Three months ended
 
Six months ended
 
 
July 2, 2017 vs. July 3, 2016
 
July 2, 2017 vs. July 3, 2016
 
 
Favorable/(Unfavorable) Change
 
Favorable/(Unfavorable) Change
In millions
 
Amount
 
Percent
 
Percentage point
change as a percent
of total sales
 
Amount
 
Percent
 
Percentage point
change as a percent
of total sales
Gross margin
 
$
(15
)
 
(7
)%
 
(3.7
)
 
$
—

 
—
 %
 
(2.1
)
Selling, general and administrative expenses
 
(8
)
 
(8
)%
 
0.3

 
(11
)
 
(6
)%
 
0.4

Research, development and engineering expenses
 
(2
)
 
(4
)%
 
0.3

 
(3
)
 
(3
)%
 
0.3

Equity, royalty and interest income from investees
 
3

 
27
 %
 
0.2

 
5

 
24
 %
 
0.2

The decrease in gross margin for the three months ended July 2, 2017, versus the comparable period in 2016, was primarily due to higher warranty cost related to a campaign accrual, unfavorable mix and increased material costs, partially offset by increased volumes and favorable foreign currency fluctuations (primarily in the British pound). The increase in selling, general and administrative expenses was primarily due to higher variable compensation expense and higher consulting expenses. The increase in equity, royalty and interest income from investees was primarily due to higher earnings at Chongqing Cummins Engine Co.
Gross margin was flat for the six months ended July 2, 2017, versus the comparable period in 2016, primarily due to higher warranty cost related to a campaign accrual, unfavorable mix and higher material costs, offset by increased volumes and favorable foreign currency fluctuations (primarily in the British pound). The increase in selling, general and administrative expenses was primarily due to higher variable compensation expense and higher consulting expenses. The increase in equity, royalty and interest income from investees was primarily due to higher earnings at Chongqing Cummins Engine Co.

40
Table of Contents

Reconciliation of Segment EBIT to Net Income Attributable to Cummins Inc.
The table below reconciles the segment information to the corresponding amounts in the Condensed Consolidated Statements of Income:
 
 
Three months ended
 
Six months ended
In millions
 
July 2,
2017
 
July 3,
2016
 
July 2,
2017
 
July 3,
2016
TOTAL SEGMENT EBIT
 
$
624

 
$
573

 
$
1,189

 
$
1,066

Non-segment EBIT (1)
 
(4
)
 
18

 
(3
)
 
9

TOTAL EBIT
 
620

 
591

 
1,186

 
1,075

Less: Interest expense
 
21

 
16

 
39

 
35

INCOME BEFORE INCOME TAXES
 
599

 
575

 
1,147

 
1,040

Less: Income tax expense
 
158

 
148

 
301

 
280

CONSOLIDATED NET INCOME
 
441

 
427

 
846

 
760

Less: Net income attributable to noncontrolling interest
 
17

 
21

 
26

 
33

NET INCOME ATTRIBUTABLE TO CUMMINS INC.
 
$
424

 
$
406

 
$
820

 
$
727

____________________________________
(1) Includes intersegment sales, intersegment profit in inventory eliminations and unallocated corporate expenses. There were no significant unallocated corporate expenses for the three and six months ended July 2, 2017 and July 3, 2016.

41
Table of Contents

LIQUIDITY AND CAPITAL RESOURCES
Key Working Capital and Balance Sheet Data
We fund our working capital with cash from operations and short-term borrowings, including commercial paper, when necessary. Various assets and liabilities, including short-term debt, can fluctuate significantly from month to month depending on short-term liquidity needs. As a result, working capital is a prime focus of management attention. Working capital and balance sheet measures are provided in the following table:
Dollars in millions
 
July 2,
2017
 
December 31,
2016
Working capital (1)
 
$
3,708

 
$
3,382

Current ratio
 
1.76

 
1.78

Accounts and notes receivable, net
 
$
3,553

 
$
3,025

Days’ sales in receivables
 
62

 
61

Inventories
 
$
2,982

 
$
2,675

Inventory turnover
 
4.9

 
4.7

Accounts payable (principally trade)
 
$
2,300

 
$
1,854

Days' payable outstanding
 
52

 
51

Total debt
 
$
1,797

 
$
1,856

Total debt as a percent of total capital
 
18.7
%
 
20.6
%
____________________________________
(1) Working capital includes cash and cash equivalents.
Cash Flows
Cash and cash equivalents were impacted as follows:
 
 
Six months ended
 
 
In millions
 
July 2,
2017
 
July 3,
2016
 
Change
Net cash provided by operating activities
 
$
826

 
$
738

 
$
88

Net cash used in investing activities
 
(160
)
 
(391
)
 
231

Net cash used in financing activities
 
(544
)
 
(896
)
 
352

Effect of exchange rate changes on cash and cash equivalents
 
51

 
(117
)
 
168

Net increase (decrease) in cash and cash equivalents
 
$
173

 
$
(666
)
 
$
839

 
Net cash provided by operating activities increased $88 million for the six months ended July 2, 2017, versus the comparable period in 2016, primarily due to higher consolidated net income, the absence of restructuring payments and lower working capital levels, partially offset by higher equity in income of investees and the absence of loss contingency charges. During the first six months of 2017, the lower working capital requirements resulted in a cash outflow of $196 million compared to a cash outflow of $230 million in the comparable period in 2016. 
Net cash used in investing activities decreased $231 million for the six months ended July 2, 2017, versus the comparable period in 2016, primarily due to lower net investments in marketable securities of $235 million.
Net cash used in financing activities decreased $352 million for the six months ended July 2, 2017, versus the comparable period in 2016, primarily due to lower repurchases of common stock of $575 million and lower payments on borrowings and capital lease obligations of $104 million, partially offset by lower net borrowings of commercial paper of $278 million and lower proceeds from borrowings of $107 million.
The effect of exchange rate changes on cash and cash equivalents for the six months ended July 2, 2017, versus the comparable period in 2016, increased $168 million primarily due to the British pound, which increased cash and cash equivalents by $150 million.
Sources of Liquidity 
We generate significant ongoing cash flow. Cash provided by operations is our principal source of liquidity with $826 million provided in the six months ended July 2, 2017.

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Table of Contents

At July 2, 2017, our other sources of liquidity included:
 
 
July 2, 2017
In millions
 
Total
 
U.S.
 
International
 
Primary location of international balances
Cash and cash equivalents
 
$
1,293

 
$
245

 
$
1,048

 
U.K., Singapore, China, Canada,
Australia
Marketable securities (1)
 
174

 
41

 
133

 
India
Total
 
$
1,467

 
$
286

 
$
1,181

 
 
Available credit capacity
 

 
 
 
 
 
 
Revolving credit facility (2)
 
$
1,616

 
 
 
 
 
 
International and other uncommitted domestic credit facilities (3)
 
$
170

 
 
 
 
 
 
____________________________________
(1) The majority of marketable securities could be liquidated into cash within a few days.
(2) The revolving credit facility is maintained primarily to provide backup liquidity for our commercial paper borrowings and general corporate purposes. At July 2, 2017, we had $134 million of commercial paper outstanding, which effectively reduced the available capacity under our revolving credit facility to $1.62 billion.
(3) The available capacity is net of letters of credit.
Cash, Cash Equivalents and Marketable Securities
A significant portion of our cash flows is generated outside the U.S. We manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct our business and the cost effectiveness with which those funds can be accessed. As a result, we do not anticipate any local liquidity restrictions to preclude us from funding our operating needs with local resources.
Debt Facilities and Other Sources of Liquidity
We can issue up to $1.75 billion of unsecured short-term promissory notes ("commercial paper") pursuant to a commercial paper program. The program facilitates the private placement of unsecured short-term debt through third party brokers. We intend to use the net proceeds from the commercial paper program for general corporate purposes and acquisitions.
We have a $1.75 billion revolving credit facility, the proceeds of which can be used for general corporate purposes. This facility expires on November 13, 2020. The revolving credit facility is maintained primarily to provide backup liquidity for our commercial paper borrowings, letters of credit and general corporate purposes. The total combined borrowing capacity under the revolving credit facility and commercial paper program should not exceed $1.75 billion.
As a well-known seasoned issuer, we filed an automatic shelf registration for an undetermined amount of debt and equity securities with the Securities and Exchange Commission on February 16, 2016. Under this shelf registration we may offer, from time to time, debt securities, common stock, preferred and preference stock, depositary shares, warrants, stock purchase contracts and stock purchase units.
Uses of Cash
Share Repurchases
In December 2016, our Board of Directors authorized the acquisition of up to $1 billion of additional common stock upon completion of the 2015 repurchase plan. In the first six months of 2017, we made the following purchases under the 2015 stock repurchase program:
In millions, except per share amounts
 
Shares
Purchased
 
Average Cost
Per Share
 
Total Cost of
Repurchases
 
Remaining
Authorized
Capacity (1)
April 2
 
0.3

 
$
151.32

 
$
51

 
$
445

July 2
 
0.5

 
153.95

 
69

 
376

Total
 
0.8

 
$
152.82

 
$
120

 
 
____________________________________
(1) The remaining authorized capacity under the 2015 Plan was calculated based on the cost to purchase the shares but excludes commission expenses in accordance with the authorized Plan.

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Table of Contents

We may continue to repurchase outstanding shares from time to time during 2017 to enhance shareholder value and to offset the dilutive impact of employee stock based compensation plans.
Dividends
In July 2017, our Board of Directors authorized an increase to our quarterly dividend of 5.4 percent from $1.025 per share to $1.08 per share. We paid dividends of $343 million during the six months ended July 2, 2017.
Agreement to Form a Joint Venture
In April 2017, we entered into an agreement to form a joint venture with Eaton Corporation PLC and we closed the transaction on July 31, 2017. We purchased a 50 percent interest in the new venture named Eaton Cummins Automated Transmission Technologies for $600 million, which we funded with a combination of cash and short-term debt. We are still in the process of finalizing the purchase accounting and we do not expect this new venture to have a significant impact on our consolidated results in 2017.
Capital Expenditures
Capital expenditures, including spending on internal use software, for the six months ended July 2, 2017, were $222 million compared to $216 million in the comparable period in 2016. We continue to invest in new product lines and targeted capacity expansions. We plan to spend between $500 million and $530 million in 2017 on capital expenditures as we continue with product launches and facility improvements. Approximately 50 percent of our capital expenditures are expected to be invested outside of the U.S. in 2017.
Pensions
Our global pension plans, including our unfunded and non-qualified plans, were 110 percent funded at December 31, 2016. Our U.S. qualified plans, which represent approximately 56 percent of the worldwide pension obligation, were 118 percent funded and our U.K. plans were 121 percent funded. The funded status of our pension plans is dependent upon a variety of variables and assumptions including return on invested assets, market interest rates and levels of voluntary contributions to the plans. In the first six months of 2017, the investment return on our U.S. pension trust was 7.1 percent while our U.K. pension trust return was 0.8 percent. Approximately 76 percent of our pension plan assets are held in highly liquid investments such as fixed income and equity securities. The remaining 24 percent of our plan assets are held in less liquid, but market valued investments, including real estate, private equity, venture capital, opportunistic credit and insurance contracts. We anticipate making additional defined benefit pension contributions during the remainder of 2017 of $50 million for our U.S. and U.K. pension plans. Approximately $133 million of the estimated $134 million of U.S. and U.K. 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 2017 net periodic pension cost to approximate $83 million.
Current Maturities of Short and Long-Term Debt
We had $134 million of commercial paper outstanding at July 2, 2017, that matures in less than one year. The maturity schedule of our existing long-term debt does not require significant cash outflows in the intermediate term. Required annual principal payments range from $4 million to $45 million over the next five years (including the remainder of 2017). See Note 7 "DEBT," to the Condensed Consolidated Financial Statements for additional information.
Credit Ratings
Our ratings and outlook from each of the credit rating agencies as of the date of filing are shown in the table below.
 
 
Long-Term
 
Short-Term
 
 
Credit Rating Agency (1)
 
Senior Debt Rating
 
Debt Rating
 
Outlook
Standard & Poor’s Rating Services
 
A+
 
A1
 
Stable
Moody’s Investors Service, Inc.
 
A2
 
P1
 
Stable
____________________________________
(1) Credit ratings are not recommendations to buy, are subject to change and each rating should be evaluated independently of any other rating. In addition, we undertake no obligation to update disclosures concerning our credit ratings, whether as a result of new information, future events or otherwise.

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Management's Assessment of Liquidity

Our financial condition and liquidity remain strong. Our solid balance sheet and credit ratings enable us to have ready access to credit and the capital markets. We assess our liquidity in terms of our ability to generate adequate cash to fund our operating, investing and financing activities. We believe our operating cash flow and liquidity provides us with the financial flexibility needed to fund working capital, common stock repurchases, acquisitions, capital expenditures, dividend payments, projected pension obligations and debt service obligations. We continue to generate cash from operations and maintain access to our revolving credit facility as noted above.


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APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
A summary of our significant accounting policies is included in Note 1, “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,” of the Notes to the Consolidated Financial Statements of our 2016 Form 10-K, which discusses accounting policies that we have selected from acceptable alternatives.
Our Condensed Consolidated Financial Statements are prepared in accordance with generally accepted accounting principles that often require management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts presented and disclosed in the financial statements. Management reviews these estimates and assumptions based on historical experience, changes in business conditions and other relevant factors they believe to be reasonable under the circumstances. In any given reporting period, our actual results may differ from the estimates and assumptions used in preparing our Condensed Consolidated Financial Statements.
Critical accounting estimates are defined as follows: the estimate requires management to make assumptions about matters that were highly uncertain at the time the estimate was made; different estimates reasonably could have been used; or if changes in the estimate are reasonably likely to occur from period to period and the change would have a material impact on our financial condition or results of operations. Our senior management has discussed the development and selection of our accounting policies, related accounting estimates and the disclosures set forth below with the Audit Committee of our Board of Directors. Our critical accounting estimates disclosed in the Form 10-K address the estimation of liabilities for warranty programs, accounting for income taxes and pension benefits.
A discussion of our critical accounting estimates may be found in the “Management’s Discussion and Analysis” section of our 2016 Form 10-K under the caption “APPLICATION OF CRITICAL ACCOUNTING ESTIMATES.” Within the context of these critical accounting estimates, we are not currently aware of any reasonably likely events or circumstances that would result in different policies or estimates being reported in the first six months of 2017.
RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 13, "RECENTLY ADOPTED AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS," in the Notes to Condensed Consolidated Financial Statements for additional information.
ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk
A discussion of quantitative and qualitative disclosures about market risk may be found in Item 7A of our 2016 Form 10-K. There have been no material changes in this information since the filing of our 2016 Form 10-K. 
ITEM 4.  Controls and Procedures
Evaluation of Disclosure Controls and Procedures 
As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended July 2, 2017, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 

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PART II.  OTHER INFORMATION
ITEM 1.  Legal Proceedings
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; product recalls; patent, trademark or other intellectual property infringement; contractual liability; the conduct of our business; tax reporting in foreign jurisdictions; distributor termination; workplace safety; and environmental matters. We also have been identified as a potentially responsible party at multiple waste disposal sites under U.S. federal and related state environmental statutes and regulations and may have joint and several liability for any investigation and remediation costs incurred with respect to such sites. We have denied liability with respect to many of these lawsuits, claims and proceedings and are vigorously defending such lawsuits, claims and proceedings. We carry various forms of commercial, property and casualty, product liability and other forms of insurance; however, such insurance may not be applicable or adequate to cover the costs associated with a judgment against us with respect to these lawsuits, claims and proceedings. We do not believe that these lawsuits are material individually or in the aggregate. While we believe we have also established adequate accruals pursuant to U.S. generally accepted accounting principles for our expected future liability with respect to pending lawsuits, claims and proceedings, where the nature and extent of any such liability can be reasonably estimated based upon then presently available information, there can be no assurance that the final resolution of any existing or future lawsuits, claims or proceedings will not have a material adverse effect on our business, results of operations, financial condition or cash flows.
We conduct significant business operations in Brazil that are subject to the Brazilian federal, state and local labor, social security, tax and customs laws. While we believe we comply with such laws, they are complex, subject to varying interpretations and we are often engaged in litigation regarding the application of these laws to particular circumstances.
The disclosure set forth under "Loss Contingency" in Note 9, "COMMITMENTS AND CONTINGENCIES," to the Condensed Consolidated Financial Statements is incorporated herein by reference.
ITEM 1A.  Risk Factors
In addition to other information set forth in this report, you should consider other risk factors discussed in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2016, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K or the "CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION" in this Quarterly report are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently judge to be immaterial also may materially adversely affect our business, financial condition or operating results.
ITEM 2.  Unregistered Sales of Equity Securities and Use of Proceeds
The following information is provided pursuant to Item 703 of Regulation S-K:
 
 
 
Issuer Purchases of Equity Securities
Period
 
Total
Number of
Shares
Purchased(1)
 
Average
Price Paid
per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced
Plans or Programs
 
Maximum
Number of Shares
that May Yet Be
Purchased Under the
Plans or Programs(2)
April 3 - May 7
 
71,242

 
$
145.27

 
69,028

 
35,513

May 8 - June 4
 
349,431

 
155.49

 
346,899

 
35,681

June 5 - July 2
 
38,124

 
157.82

 
33,283

 
33,273

Total
 
458,797

 
154.09

 
449,210

 
 

____________________________________
(1)  Shares purchased represent shares under our Key Employee Stock Investment Plan established in 1969 (there is no maximum repurchase limitation in this plan) and our Board of Directors authorized share repurchase programs.
(2)  These values reflect the sum of shares held in loan status under our Key Employee Stock Investment Plan. The repurchase programs authorized by the Board of Directors do not limit the number of shares that may be purchased and were excluded from this column. The dollar value remaining available for future purchases under such programs as of July 2, 2017, was $1.4 billion.
In December 2016, our Board of Directors authorized the acquisition of up to $1 billion of additional common stock upon completion of the 2015 repurchase plan. In November 2015, our Board of Directors authorized the acquisition of up to $1 billion of additional common stock upon the completion of the 2014 repurchase plan. During the three months ended July 2, 2017, we repurchased $69 million of common stock under the 2015 Board of Directors authorized plan.

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During the three months ended July 2, 2017, we repurchased 9,587 shares from employees in connection with the Key Employee Stock Investment Plan which allows certain employees, other than officers, to purchase shares of common stock on an installment basis up to an established credit limit. Loans are issued for five-year terms at a fixed interest rate established at the date of purchase and may be refinanced after their initial five-year period for an additional five-year period. Participants must hold shares for a minimum of six months from date of purchase. If the shares are sold before the loan is paid off, the employee must wait six months before another share purchase may be made. We hold participants’ shares as security for the loans and would, in effect repurchase shares if the participant defaulted in repayment of the loan. There is no maximum amount of shares that we may purchase under this plan.  
ITEM 3.  Defaults Upon Senior Securities
Not applicable. 
ITEM 4.  Mine Safety Disclosures
Not applicable. 
ITEM 5.  Other Information
Not applicable. 
ITEM 6. Exhibits
See Exhibit Index at the end of this Quarterly Report on Form 10-Q.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Cummins Inc.
 
 
 
Date:
August 1, 2017
 
 
 
 
 
 
 
 
 
 
By:
/s/ PATRICK J. WARD
 
By:
/s/ CHRISTOPHER C. CLULOW
 
 
Patrick J. Ward
 
 
Christopher C. Clulow
 
 
Vice President and Chief Financial Officer
 
 
Vice President-Corporate Controller
 
 
(Principal Financial Officer)
 
 
(Principal Accounting Officer)

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CUMMINS INC.
EXHIBIT INDEX
 
Exhibit No.
 
Description of Exhibit
3.1
 
By-Laws, as amended and restated effective as of May 9, 2017 (incorporated by reference to Annex B to the Company’s definitive proxy statement filed with the Securities and Exchange Commission on Schedule 14A on March 27, 2017 (File No. 001-04949))

10.1
 
Cummins Inc. 2012 Omnibus Incentive Plan, as amended and restated (incorporated by reference to Annex A to the Company’s definitive proxy statement filed with the Securities and Exchange Commission on Schedule 14A on March 27, 2017 (File No. 001-04949))
 
 
 
 
101.INS
 
XBRL Instance Document.
101.SCH
 
XBRL Taxonomy Extension Schema Document.
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document.

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