Edgar Filing: CUMMINS INC

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2013

Commission File Number 1-4949

CUMMINS INC.

(Exact name of registrant as specified in its charter)

Indiana
(State of Incorporation)

35-0257090
(IRS Employer Identification No.)

500 Jackson Street

Box 3005

Columbus, Indiana 47202-3005

(Address of principal executive offices)

Telephone (812) 377-5000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of June 30, 2013, there were 187,229,083 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.

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CUMMINS INC. AND SUBSIDIARIES

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QUARTERLY REPORT ON FORM 10-Q

		Page
	PART I. FINANCIAL INFORMATION

ITEM 1.	Condensed Consolidated Financial Statements (Unaudited)	3

	Condensed Consolidated Statements of Income for the three and six months ended June 30, 2013 and July 1, 2012	3

	Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2013 and July 1, 2012	4

	Condensed Consolidated Balance Sheets at June 30, 2013 and December 31, 2012	5

	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and July 1, 2012	6

	Condensed Consolidated Statements of Changes in Equity for the six months ended June 30, 2013 and July 1, 2012	7

	Notes to Condensed Consolidated Financial Statements	8

ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26

ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	48

ITEM 4.	Controls and Procedures	48

	PART II. OTHER INFORMATION

ITEM 1.	Legal Proceedings	48

ITEM 1A.	Risk Factors	49

ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49

ITEM 3.	Defaults Upon Senior Securities	49

ITEM 4.	Mine Safety Disclosures	49

ITEM 5.	Other Information	49

ITEM 6.	Exhibits	49

	Signatures	50

	Cummins Inc. Exhibit Index	51

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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	June 30, 2013		July 1, 2012		June 30, 2013		July 1, 2012
NET SALES (a)	$	4,525	$	4,452	$	8,447	$	8,924
Cost of sales	3,372		3,242		6,337		6,516
GROSS MARGIN	1,153		1,210		2,110		2,408

OPERATING EXPENSES AND INCOME
Selling, general and administrative expenses	484		487		928		962
Research, development and engineering expenses	177		187		359		368
Equity, royalty and interest income from investees (Note 5)	108		104		190		208
Other operating income (expense), net	10		8		11		10
OPERATING INCOME	610		648		1,024		1,296

Interest income	10		7		15		15
Interest expense	8		8		14		16
Other income (expense), net	1		14		19		16
INCOME BEFORE INCOME TAXES	613		661		1,044		1,311

Income tax expense (Note 6)	172		166		291		341
CONSOLIDATED NET INCOME	441		495		753		970

Less: Net income attributable to noncontrolling interests	27		26		57		46
NET INCOME ATTRIBUTABLE TO CUMMINS INC.	$	414	$	469	$	696	$	924

EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CUMMINS INC.
Basic	$	2.20	$	2.47	$	3.70	$	4.86
Diluted	$	2.20	$	2.47	$	3.69	$	4.85

WEIGHTED AVERAGE SHARES OUTSTANDING
Basic	187.8		189.8		188.1		190.1
Dilutive effect of stock compensation awards	0.4		0.3		0.4		0.4
Diluted	188.2		190.1		188.5		190.5

CASH DIVIDENDS DECLARED PER COMMON SHARE	$	0.50	$	0.40	$	1.00	$	0.80

(a) Includes sales to nonconsolidated equity investees of $576 million and $1,128 million and $622 million and $1,291 million for the three and six months ended June 30, 2013 and July 1, 2012, respectively.

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

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CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

	Three months ended						Six months ended
	June 30,			July 1,			June 30,			July 1,
In millions	2013			2012			2013			2012
CONSOLIDATED NET INCOME	$	441		$	495		$	753		$	970
Other comprehensive income (loss), net of tax (Note 14)
Foreign currency translation adjustments	(46		)	(159		)	(196		)	(53		)
Unrealized gain (loss) on derivatives	(6		)	(8		)	(12		)	11
Change in pension and other postretirement defined benefit plans	21			10			40			21
Unrealized gain (loss) on marketable securities	7			—			(3		)	(1		)
Total other comprehensive income (loss), net of tax	(24		)	(157		)	(171		)	(22		)
COMPREHENSIVE INCOME	417			338			582			948
Less: Comprehensive income attributable to noncontrolling interest	7			2			35			32
COMPREHENSIVE INCOME ATTRIBUTABLE TO CUMMINS INC.	$	410		$	336		$	547		$	916

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	June 30, 2013			December 31, 2012
ASSETS
Current assets
Cash and cash equivalents	$	1,382		$	1,369
Marketable securities (Note 7)	205			247
Total cash, cash equivalents and marketable securities	1,587			1,616
Accounts and notes receivable, net
Trade and other	2,479			2,235
Nonconsolidated equity investees	266			240
Inventories (Note 9)	2,475			2,221
Prepaid expenses and other current assets	597			855
Total current assets	7,404			7,167
Long-term assets
Property, plant and equipment	6,077			5,876
Accumulated depreciation	(3,195		)	(3,152		)
Property, plant and equipment, net	2,882			2,724
Investments and advances related to equity method investees	924			897
Goodwill	450			445
Other intangible assets, net	360			369
Other assets	1,028			946
Total assets	$	13,048		$	12,548

LIABILITIES
Current liabilities
Loans payable	$	40		$	16
Accounts payable (principally trade)	1,669			1,339
Current maturities of long-term debt (Note 10)	43			61
Current portion of accrued product warranty (Note 11)	393			386
Accrued compensation, benefits and retirement costs	348			400
Deferred revenue	243			215
Taxes payable (including taxes on income)	159			173
Other accrued expenses	567			546
Total current liabilities	3,462			3,136
Long-term liabilities
Long-term debt (Note 10)	754			698
Postretirement benefits other than pensions	414			432
Other liabilities and deferred revenue	1,325			1,308
Total liabilities	5,955			5,574

Commitments and contingencies (Note 12)	—			—

EQUITY
Cummins Inc. shareholders’ equity
Common stock, $2.50 par value, 500 shares authorized, 222.3 and 222.4 shares issued	2,082			2,058
Retained earnings	7,850			7,343
Treasury stock, at cost, 35.0 and 32.6 shares	(2,112		)	(1,830		)
Common stock held by employee benefits trust, at cost, 1.4 and 1.5 shares	(17		)	(18		)
Accumulated other comprehensive loss (Note 14)
Defined benefit postretirement plans	(754		)	(794		)
Other	(345		)	(156		)
Total accumulated other comprehensive loss	(1,099		)	(950		)
Total Cummins Inc. shareholders’ equity	6,704			6,603
Noncontrolling interests	389			371
Total equity	7,093			6,974
Total liabilities and equity	$	13,048		$	12,548

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

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CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six months ended
In millions	June 30, 2013			July 1, 2012
CASH FLOWS FROM OPERATING ACTIVITIES
Consolidated net income	$	753		$	970
Adjustments to reconcile consolidated net income to net cash provided by operating activities
Restructuring payments, net(Note 15)	(23		)	—
Depreciation and amortization	200			171
Gain on sale of businesses	—			(6		)
Gain on fair value adjustment for consolidated investees (Note 3)	(12		)	—
Deferred income taxes	20			(39		)
Equity in income of investees, net of dividends	(57		)	(25		)
Pension contributions in excess of expense (Note 4)	(78		)	(52		)
Other post-retirement benefits payments in excess of expense (Note 4)	(15		)	(7		)
Stock-based compensation expense	19			21
Excess tax benefits on stock-based awards	(8		)	(11		)
Translation and hedging activities	3			7
Changes in current assets and liabilities, net of acquisitions:
Accounts and notes receivable	(265		)	(116		)
Inventories	(184		)	(439		)
Other current assets	214			(47		)
Accounts payable	310			61
Accrued expenses	(87		)	(173		)
Changes in other liabilities and deferred revenue	100			103
Other, net	70			(21		)
Net cash provided by operating activities	960			397

CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures	(275		)	(266		)
Investments in internal use software	(24		)	(40		)
Investments in and advances to equity investees	(4		)	(40		)
Acquisition of businesses, net of cash acquired (Note 3)	(134		)	(12		)
Investments in marketable securities—acquisitions (Note 7)	(243		)	(276		)
Investments in marketable securities—liquidations (Note 7)	280			280
Cash flows from derivatives not designated as hedges	(23		)	1
Other, net	12			3
Net cash used in investing activities	(411		)	(350		)

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings	2			46
Payments on borrowings and capital lease obligations	(51		)	(75		)
Net borrowings under short-term credit agreements	56			3
Distributions to noncontrolling interests	(28		)	(32		)
Dividend payments on common stock	(189		)	(152		)
Repurchases of common stock	(289		)	(196		)
Excess tax benefits on stock-based awards	8			11
Other, net	18			9
Net cash used in financing activities	(473		)	(386		)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS	(63		)	—
Net increase (decrease) in cash and cash equivalents	13			(339		)
Cash and cash equivalents at beginning of year	1,369			1,484
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	1,382		$	1,145

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

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CUMMINS INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

								Accumulated						Common			Total
			Additional					Other						Stock			Cummins Inc.
	Common		paid-in		Retained			Comprehensive			Treasury			Held in			Shareholders’			Noncontrolling			Total
In millions	Stock		Capital		Earnings			Loss			Stock			Trust			Equity			Interests			Equity
BALANCE AT DECEMBER 31, 2011	$	555	$	1,446	$	6,038		$	(938	)	$	(1,587	)	$	(22	)	$	5,492		$	339		$	5,831
Net income					924												924			46			970
Other comprehensive income (loss)								(8		)							(8		)	(14		)	(22		)
Issuance of shares	1		3														4			—			4
Employee benefits trust activity			17											2			19			—			19
Acquisition of shares											(196		)				(196		)	—			(196		)
Cash dividends on common stock					(152		)										(152		)	—			(152		)
Distribution to noncontrolling interests																	—			(52		)	(52		)
Stock option exercises											6						6			—			6
Other shareholder transactions			14														14			15			29
BALANCE AT JULY 1, 2012	$	556	$	1,480	$	6,810		$	(946	)	$	(1,777	)	$	(20	)	$	6,103		$	334		$	6,437

BALANCE AT DECEMBER 31, 2012	$	556	$	1,502	$	7,343		$	(950	)	$	(1,830	)	$	(18	)	$	6,603		$	371		$	6,974
Net income					696												696			57			753
Other comprehensive income (loss)								(149		)							(149		)	(22		)	(171		)
Issuance of shares			3														3			—			3
Employee benefits trust activity			13											1			14			—			14
Acquisition of shares											(289		)				(289		)	—			(289		)
Cash dividends on common stock					(189		)										(189		)	—			(189		)
Distribution to noncontrolling interests																	—			(28		)	(28		)
Stock option exercises			1								7						8			—			8
Other shareholder transactions			7														7			11			18
BALANCE AT JUNE 30, 2013	$	556	$	1,526	$	7,850		$	(1,099	)	$	(2,112	)	$	(17	)	$	6,704		$	389		$	7,093

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

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CUMMINS INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. NATURE OF OPERATIONS

Cummins Inc. (“Cummins,” “we,” “our” or “us”) was founded in 1919 as a corporation in Columbus, Indiana, as one of the first diesel engine manufacturers. We are a global power leader that designs, manufactures, distributes and services diesel and natural gas engines and engine-related component products, including filtration, aftertreatment, turbochargers, fuel systems, controls systems, air handling systems and electric power generation systems. We sell our products to original equipment manufacturers (OEMs), distributors and other customers worldwide. We serve our customers through a network of approximately 600 company-owned and independent distributor locations and approximately 6,500 dealer locations in more than 190 countries and territories.

NOTE 2. BASIS OF PRESENTATION

The unaudited Condensed Consolidated Financial Statements reflect all adjustments which, in the opinion of management, are necessary for a fair statement of the results of operations, financial position and cash flows. All such adjustments are of a normal recurring nature. The Condensed Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted as permitted by such rules and regulations. Certain reclassifications have been made to prior period amounts to conform to the presentation of the current period condensed financial statements.

Our reporting period usually ends on the Sunday closest to the last day of the quarterly calendar period. The second quarters of 2013 and 2012 ended on June 30 and July 1, respectively. The interim period for both 2013 and 2012 contained 13 weeks, while the six month periods both contained 26 weeks. Our fiscal year ends on December 31, regardless of the day of the week on which December 31 falls.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts in the Condensed Consolidated Financial Statements. Significant estimates and assumptions in these Condensed Consolidated Financial Statements require the exercise of judgment and are used for, but not limited to, allowance for doubtful accounts, estimates of future cash flows and other assumptions associated with goodwill and long-lived asset impairment tests, useful lives for depreciation and amortization, warranty programs, determination of discount and other rate assumptions for pension and other postretirement benefit expenses, income taxes and deferred tax valuation allowances, lease classifications and contingencies. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be different from these estimates.

The weighted-average diluted common shares outstanding exclude the anti-dilutive effect of certain stock options since such options had an exercise price in excess of the monthly average market value of our common stock. The options excluded from diluted earnings per share for the three and six month periods ended June 30, 2013 and July 1, 2012, were as follows:

	Three months ended		Six months ended
	June 30, 2013	July 1, 2012	June 30, 2013	July 1, 2012
Options excluded	693,550	439,328	626,527	332,802

You should read these interim condensed financial statements in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2012. Our interim period financial results for the three and six month interim periods presented are not necessarily indicative of results to be expected for any other interim period or for the entire year. The year-end Condensed Consolidated Balance Sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.

NOTE 3. ACQUISITIONS

Cummins Rocky Mountain LLC

In May 2013, we acquired the remaining 67 percent interest in Cummins Rocky Mountain LLC (Rocky Mountain) from the former principal for consideration of approximately $62 million in cash and an additional $74 million in cash paid to creditors to eliminate all debt related to the entity. The purchase price was approximately $136 million as presented below. The intangible assets are primarily

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customer related and are being amortized over periods ranging from 1 to 4 years. The acquisition was accounted for as a business combination, with the results of the acquired entity included in the Distribution operating segment in the second quarter of 2013.

Distribution segment results also included a $5 million gain, as we were required to re-measure our pre-existing 33 percent ownership interest in Rocky Mountain to fair value in accordance with GAAP. Net sales for Rocky Mountain were $384 million for the 12 months ended December 31, 2012. This amount is not fully incremental to Cummins Inc. as the amount would be reduced by the elimination of sales to the previously unconsolidated entity. Approximately $14 million of the purchase price will be distributed in future quarters.

The preliminary purchase price allocation, subject to finalization, was as follows:

In millions
Accounts receivable	$	48
Inventory	99
Fixed assets	34
Intangible assets	7
Goodwill	6
Other assets	9
Current liabilities	(36		)
Total business valuation	167
Fair value of pre-existing 33 percent interest	(31		)
Purchase price	$	136

Cummins Northwest LLC

In January 2013, we acquired an additional 50 percent interest in Cummins Northwest LLC (Northwest) from the former principal for consideration of approximately $18 million. We formed a new partnership with a new distributor principal. We own 79.99 percent of Northwest and the new distributor principal owns 20.01 percent. The acquisition was accounted for as a business combination, with the results of the acquired entity included in the Distribution operating segment in the first quarter of 2013. Distribution segment results also included a $7 million gain, as we were required to re-measure our pre-existing 50 percent ownership interest in Northwest to fair value in accordance with GAAP. The transaction generated $3 million of goodwill. Net sales for Northwest were $137 million for the 12 months ended December 31, 2012. This amount is not fully incremental to Cummins Inc. as the amount would be reduced by the elimination of sales to the previously unconsolidated entity.

NOTE 4. 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
	June 30,		July 1,		June 30,		July 1,
In millions	2013		2012		2013		2012
Defined benefit pension and other postretirement plans
Voluntary contribution	$	38	$	35	$	77	$	73
Mandatory contribution	7		6		44		11
Defined benefit pension contributions	45		41		121		84
Other postretirement plans	12		8		26		17
Total defined benefit plans	$	57	$	49	$	147	$	101

Defined contribution pension plans	$	14	$	17	$	36	$	44

We made $121 million of pension contributions in the six months ended June 30, 2013 and we anticipate making an additional $49 million of contributions during the remainder of 2013. We paid $26 million of claims and premiums for other postretirement benefits in the six months ended June 30, 2013; payments for the remainder of 2013 are expected to be $21 million. The $170 million of pension contributions for the full year include voluntary contributions of approximately $115 million. These contributions and payments may be made from trusts or company funds either to increase pension assets or to make direct benefit payments to plan

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participants. Our expected pension expense for 2013 has been reduced $10 million, to $87 million, from the amount we had expected at December 31, 2012, due to a remeasurement of the U.S. plan for changes in employee census data in the first quarter of 2013.

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

	Pension
	U.S. Plans						U.K. Plans						Other Postretirement Benefits
	Three months ended
	June 30,			July 1,			June 30,			July 1,			June 30,		July 1,
In millions	2013			2012			2013			2012			2013		2012
Service cost	$	18		$	15		$	5		$	5		$	—	$	—
Interest cost	23			26			14			15			4		5
Expected return on plan assets	(42		)	(39		)	(18		)	(21		)	—		—
Amortization of prior service credit	—			—			—			—			—		(1		)
Recognized net actuarial loss	15			11			6			4			1		1
Net periodic benefit cost	$	14		$	13		$	7		$	3		$	5	$	5

	Pension
	U.S. Plans						U.K. Plans						Other Postretirement Benefits
	Six months ended
	June 30,			July 1,			June 30,			July 1,			June 30,		July 1,
In millions	2013			2012			2013			2012			2013		2012
Service cost	$	35		$	29		$	10		$	11		$	—	$	—
Interest cost	47			52			28			29			8		10
Expected return on plan assets	(84		)	(78		)	(36		)	(41		)	—		—
Amortization of prior service credit	—			—			—			—			—		(2		)
Recognized net actuarial loss	31			23			12			7			3		2
Net periodic benefit cost	$	29		$	26		$	14		$	6		$	11	$	10

NOTE 5. EQUITY, ROYALTY AND INTEREST INCOME FROM INVESTEES

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

	Three months ended					Six months ended
	June 30,		July 1,			June 30,		July 1,
In millions	2013		2012			2013		2012
Distribution Entities
North American distributors	$	29	$	38		$	64	$	78
Komatsu Cummins Chile, Ltda.	6		6			11		11
All other distributors	—		2			—		3
Manufacturing Entities
Dongfeng Cummins Engine Company, Ltd.	20		17			32		33
Chongqing Cummins Engine Company, Ltd.	17		17			29		35
Beijing Foton Cummins Engine Co., Ltd.	9		2			10		—
Shanghai Fleetguard Filter Co., Ltd.	4		4			7		7
Komatsu manufacturing alliances	4		1			3		—
Cummins Westport, Inc.	3		4			3		9
Valvoline Cummins, Ltd.	2		2			5		4
Tata Cummins, Ltd.	2		3			3		7
Xian Cummins Engine Company Ltd.	1		(5		)	1		(6		)
All other manufacturers	1		4			3		6
Cummins share of net income	98		95			171		187
Royalty and interest income	10		9			19		21
Equity, royalty and interest income from investees	$	108	$	104		$	190	$	208

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NOTE 6. INCOME TAXES

Our effective tax rate for the year is expected to approximate 29.1 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 research tax credits. The tax rates for the three and six month periods ended June 30, 2013, were 28.1 percent and 27.9 percent, respectively. These tax rates include a discrete tax benefit in the first quarter of 2013 of $28 million attributable to the reinstatement of the research credit back to 2012 as well as a discrete tax expense in the first quarter of 2013 of $17 million, which primarily relates to the write-off of a deferred tax asset deemed unrecoverable. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law and reinstated the research tax credit. As tax law changes are accounted for in the period of enactment, we recognized the discrete tax benefit in the first quarter of 2013.

Our tax rates for the three and six month periods ended July 1, 2012, were 25.1 percent and 26.0 percent, respectively. The increase in the 2013 effective tax rates compared to 2012 is due primarily to an unfavorable change in the pre-tax mix of income taxed in higher rate jurisdictions, partially offset by $11 million of net discrete tax benefits in the first quarter of 2013.

NOTE 7. MARKETABLE SECURITIES

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

	June 30, 2013						December 31, 2012
In millions	Cost		Gross unrealized gains/(losses)		Estimated fair value		Cost		Gross unrealized gains/(losses)		Estimated fair value
Available-for-sale
Debt mutual funds(1)	$	116	$	1	$	117	$	139	$	3	$	142
Bank debentures	12		—		12		45		—		45
Certificates of deposit	51		—		51		47		—		47
Government debt securities-non-U.S.	3		—		3		3		—		3
Corporate debt securities	1		—		1		1		—		1
Equity securities and other(2)	12		9		21		—		9		9
Total marketable securities	$	195	$	10	$	205	$	235	$	12	$	247

(1) Contractual maturities are only applicable to debt mutual funds that utilize a Level 2 fair value.

(2) In the first quarter of 2013 we realized a $9 million gain on the sale of equity securities.

At June 30, 2013, the fair value of available-for-sale investments with contractual maturities was as follows:

Maturity date
In millions	Fair value
1 year or less	$	82
1-5 years	5
5-10 years	1
Total	$	88

NOTE 8. FAIR VALUE OF FINANCIAL INSTRUMENTS

The majority of the assets and liabilities we carry at fair value are available-for-sale (AFS) securities and derivatives. AFS securities are derived from Level 1 or Level 2 inputs. Derivative assets and liabilities are derived from Level 2 inputs. The predominance of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services. When material, we adjust the values of our derivative contracts for counter-party or our credit risk. There were no transfers into or out of Levels 2 or 3 in the first six months of 2013 and 2012.

The following table summarizes our financial instruments recorded at fair value in our Condensed Consolidated Balance Sheets at June 30, 2013:

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	Fair Value Measurements Using
	Quoted prices in active markets for identical assets		Significant other observable inputs		Significant unobservable inputs
In millions	(Level 1)		(Level 2)		(Level 3)		Total
Available-for-sale debt securities
Debt mutual funds	$	96	$	21	$	—	$	117
Bank debentures	—		12		—		12
Certificates of deposit	—		51		—		51
Government debt securities-non-U.S.	—		3		—		3
Corporate debt securities	—		1		—		1

Available-for-sale equity securities
Information technology industry	21		—		—		21

Derivative assets
Interest rate contracts	—		60		—		60
Foreign currency forward contracts	—		1		—		1
Commodity call option contracts	—		1		—		1
Total assets	$	117	$	150	$	—	$	267

Derivative liabilities
Commodity swap contracts	—		11		—		11
Foreign currency forward contracts	—		7		—		7
Commodity put option contracts	—		4		—		4
Total liabilities	$	—	$	22	$	—	$	22

The following table summarizes our financial instruments recorded at fair value in our Condensed Consolidated Balance Sheets at December 31, 2012:

	Fair Value Measurements Using
	Quoted prices in active markets for identical assets		Significant other observable inputs		Significant unobservable inputs
In millions	(Level 1)		(Level 2)		(Level 3)		Total
Available-for-sale debt securities
Debt mutual funds	$	100	$	42	$	—	$	142
Bank debentures	—		45		—		45
Certificates of deposit	—		47		—		47
Government debt securities-non-U.S.	—		3		—		3
Corporate debt securities	—		1		—		1

Available-for-sale equity securities
Financial services industry	9		—		—		9

Derivative assets
Interest rate contracts	—		88		—		88
Foreign currency forward contracts	—		3		—		3
Commodity swap contracts	—		1		—		1
Commodity call option contracts	—		1		—		1
Total assets	$	109	$	231	$	—	$	340

Derivative liabilities
Commodity swap contracts	—		2		—		2
Commodity put option contracts	—		1		—		1
Total liabilities	$	—	$	3	$	—	$	3

The substantial majority of our assets were valued utilizing a market approach. A description of the valuation techniques and inputs used for our level 2 fair value measures are as follows:

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· Debt mutual funds — Assets in Level 2 consist of exchange traded mutual funds that lack sufficient trading volume to be classified at Level 1. The fair value measure for these investments is the daily net asset value published on a regulated governmental website. Daily quoted prices are available from the issuing brokerage and are used on a test basis to corroborate this Level 2 input.

· Bank debentures and Certificates of deposit — These investments provide us with a fixed rate of return and generally range in maturity from six months to five years. The counter-parties to these investments are reputable financial institutions with investment grade credit ratings. Since these instruments are not tradable and must be settled directly by us with the respective financial institution, our fair value measure is the financial institutions’ month-end statement.

· Government debt securities-non-U.S. and Corporate debt securities — The fair value measure for these securities are 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.

· Foreign currency forward contracts — The fair value measure for these contracts are determined based on forward foreign exchange rates received from third-party pricing services. These rates are based upon market transactions and are periodically corroborated by comparing to third-party broker quotes.

· Commodity swap contracts — The fair value measure for these contracts are current spot market data adjusted for the appropriate current forward curves provided by external financial institutions. The current spot price is the most significant component of this valuation and is based upon market transactions. We use third-party pricing services for the spot price component of this valuation which is periodically corroborated by market data from broker quotes.

· Commodity call and put option contracts — We utilize the month-end statement from the issuing financial institution as our fair value measure for this investment. We corroborate this valuation through the use of a third-party pricing service for similar assets and liabilities.

· Interest rate contracts — We currently have only one interest rate contract. We utilize the month-end statement from the issuing financial institution as our fair value measure for this investment. We corroborate this valuation through the use of a third-party pricing service for similar assets and liabilities.

Fair Value of Other Financial Instruments

Based on borrowing rates currently available to us for bank loans with similar terms and average maturities, considering our risk premium, the fair value and carrying value of total debt, including current maturities, at June 30, 2013 and December 31, 2012, are set forth in the table below. The carrying values of all other receivables and liabilities approximated fair values. The fair value of financial instruments is derived from Level 2 inputs.

	June 30,		December 31,
In millions	2013		2012
Fair value of total debt	$	947	$	926
Carrying value of total debt	837		775

NOTE 9. INVENTORIES

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

	June 30,			December 31,
In millions	2013			2012
Finished products	$	1,561		$	1,393
Work-in-process and raw materials	1,026			939
Inventories at FIFO cost	2,587			2,332
Excess of FIFO over LIFO	(112		)	(111		)
Total inventories	$	2,475		$	2,221

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NOTE 10. DEBT

A summary of long-term debt was as follows:

	June 30,			December 31,
In millions	2013			2012
Long-term debt
Export financing loan, 4.5%, due 2013	—			23
Debentures, 6.75%, due 2027	58			58
Debentures, 7.125%, due 2028	250			250
Debentures, 5.65%, due 2098 (effective interest rate 7.48%)	165			165
Credit facilities related to consolidated joint ventures	125			88
Other	75			69
	673			653
Unamortized discount	(35		)	(35		)
Fair value adjustments due to hedge on indebtedness	60			88
Capital leases	99			53
Total long-term debt	797			759
Less: Current maturities of long-term debt	(43		)	(61		)
Long-term debt	$	754		$	698

Principal payments required on long-term debt during the next five years are the following:

	Required Principal Payments
In millions	2013		2014		2015		2016		2017
Payment	$	23	$	46	$	76	$	82	$	14

NOTE 11. PRODUCT WARRANTY LIABILITY

We charge the estimated costs of warranty programs, other than product recalls, to income at the time products are shipped to customers. We use historical claims experience to develop the estimated liability. We review product recall programs on a quarterly basis and, if necessary, record a liability when we commit to an action, or when they become probable and estimable, which is reflected in the provision for warranties issued line. We also sell extended warranty coverage on several engines. The following is a tabular reconciliation of the product warranty liability, including the deferred revenue related to our extended warranty coverage and accrued recall programs:

	Six months ended
	June 30,			July 1,
In millions	2013			2012
Balance, beginning of year	$	1,088		$	1,014
Provision for warranties issued	227			227
Deferred revenue on extended warranty contracts sold	93			98
Payments	(210		)	(196		)
Amortization of deferred revenue on extended warranty contracts	(56		)	(51		)
Changes in estimates for pre-existing warranties	(13		)	(27		)
Foreign currency translation	(6		)	(3		)
Balance, end of period	$	1,123		$	1,062

Warranty related deferred revenue, supplier recovery receivables and the long-term portion of the warranty liability on our June 30, 2013, balance sheet were as follows:

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	June 30,
In millions	2013		Balance Sheet Location
Deferred revenue related to extended coverage programs
Current portion	$	124	Deferred revenue
Long-term portion	333		Other liabilities and deferred revenue
Total	$	457

Receivables related to estimated supplier recoveries
Current portion	$	5	Trade and other receivables
Long-term portion	5		Other assets
Total	$	10

Long-term portion of warranty liability	$	273	Other liabilities and deferred revenue

NOTE 12. COMMITMENTS AND CONTINGENCIES

We are subject to numerous lawsuits and claims arising out of the ordinary course of our business, including actions related to product liability; personal injury; the use and performance of our products; warranty matters; patent, trademark or other intellectual property infringement; contractual liability; the conduct of our business; tax reporting in foreign jurisdictions; distributor termination; workplace safety; and environmental matters. We also have been identified as a potentially responsible party at multiple waste disposal sites under U.S. federal and related state environmental statutes and regulations and may have joint and several liability for any investigation and remediation costs incurred with respect to such sites. We have denied liability with respect to many of these lawsuits, claims and proceedings and are vigorously defending such lawsuits, claims and proceedings. We carry various forms of commercial, property and casualty, product liability and other forms of insurance; however, such insurance may not be applicable or adequate to cover the costs associated with a judgment against us with respect to these lawsuits, claims and proceedings. We do not believe that these lawsuits are material individually or in the aggregate. While we believe we have also established adequate accruals for our expected future liability with respect to pending lawsuits, claims and proceedings, where the nature and extent of any such liability can be reasonably estimated based upon then presently available information, there can be no assurance that the final resolution of any existing or future lawsuits, claims or proceedings will not have a material adverse effect on our business, results of operations, financial condition or cash flows.

We conduct significant business operations in Brazil that are subject to the Brazilian federal, state and local labor, social security, tax and customs laws. While we believe we comply with such laws, they are complex, subject to varying interpretations and we are often engaged in litigation regarding the application of these laws to particular circumstances.

U.S. Distributor Commitments

Our distribution agreements with independent and partially-owned distributors generally have a renewable three-year term and are restricted to specified territories. Our distributors develop and maintain a network of dealers with which we have no direct relationship. Our distributors are permitted to sell other, noncompetitive products only with our consent. We license all of our distributors to use our name and logo in connection with the sale and service of our products, with no right to assign or sublicense the trademarks, except to authorized dealers, without our consent. Products are sold to the distributors at standard domestic or international distributor net prices, as applicable. Net prices are wholesale prices we establish to permit our distributors an adequate margin on their sales. Subject to local laws, we can generally refuse to renew these agreements upon expiration or terminate them upon written notice for inadequate sales, change in principal ownership and certain other reasons. Distributors also have the right to terminate the agreements upon 60-day notice without cause, or 30-day notice for cause. Upon termination or failure to renew, we are required to purchase the distributor’s current inventory, signage and special tools and may, at our option purchase other assets of the distributor, but are under no obligation to do so.

Other Guarantees and Commitments

In addition to the matters discussed above, from time to time we periodically enter into other guarantee arrangements, including guarantees of non-U.S. distributor financing, residual value guarantees on equipment under operating leases and other miscellaneous guarantees of third-party obligations. As of June 30, 2013, the maximum potential loss related to these other guarantees is summarized as follows (where the guarantee is in a foreign currency the amount below represents the amount in U.S. dollars at current exchange rates):

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In millions
Cummins Olayan Energy Limited debt guarantee	$	8
Residual value guarantees	1
Other debt guarantees	3
Maximum potential loss	$	12

The amount of liabilities related to the above guarantees was less than $1 million.

We have arrangements with certain suppliers that require us to purchase minimum volumes or be subject to monetary penalties. The penalty amounts are less than our purchase commitments and essentially allow the supplier to recover their tooling costs in most instances. As of June 30, 2013, if we were to stop purchasing from each of these suppliers, the aggregate amount of the penalty would be approximately $118 million, of which $80 million relates to a contract with an engine parts supplier that extends to 2016. These arrangements enable us to secure critical components. We do not currently anticipate paying any penalties under these contracts.

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 $68 million at June 30, 2013 and $70 million at December 31, 2012.

Indemnifications

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

· product liability and license, patent or trademark indemnifications,

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

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

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

Joint Venture Commitments

As of June 30, 2013, we have committed to invest an additional $64 million into existing joint ventures, of which $19 million is expected to be funded in 2013.

NOTE 13. DERIVATIVES

We are exposed to financial risk resulting from volatility in foreign exchange rates, commodity prices and interest rates. This risk is closely monitored and managed through the use of financial derivative instruments including foreign currency forward contracts, commodity swap contracts, commodity zero-cost collars and interest rate swaps. As stated in our policies and procedures, financial derivatives are used expressly for hedging purposes and under no circumstances are they used for speculative purposes. When material, we adjust the value of our derivative contracts for counter-party or our credit risk. None of our derivative instruments are subject to collateral requirements. Substantially all of our derivative contracts are subject to master netting arrangements which provide us with the option to settle certain contracts on a net basis when they settle on the same day with the same currency. In addition, these arrangements provide for a net settlement of all contracts with a given counterparty in the event that the arrangement is terminated due to the occurrence of default or a termination event.

Foreign Exchange Rates

As a result of our international business presence, we are exposed to foreign currency exchange risks. We transact business in foreign currencies and, as a result, our income experiences some volatility related to movements in foreign currency exchange rates. To help manage our exposure to exchange rate volatility, we use foreign currency forward contracts on a regular basis to hedge forecasted

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intercompany and third-party sales and purchases denominated in non-functional currencies. Our internal policy allows for managing

anticipated foreign currency cash flows for up to one year. These foreign currency forward contracts are designated and qualify as foreign currency cash flow hedges under GAAP. The effective portion of the unrealized gain or loss on the forward contract is deferred and reported as a component of “Accumulated other comprehensive loss” (AOCL). When the hedged forecasted transaction (sale or purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income. The ineffective portion of the hedge, if any, is recognized in current income during the period of change. As of June 30, 2013, the amount we expect to reclassify from AOCL to income over the next year is an unrealized net loss of $3 million. For the six month periods ended June 30, 2013 and July 1, 2012, there were no circumstances that would have resulted in the discontinuance of a foreign currency cash flow hedge.

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

The table below summarizes our outstanding foreign currency forward contracts. Only the U.S. dollar forward contracts are designated and qualify for hedge accounting as of each period presented below. The currencies in this table represent 92 percent and 95 percent of the notional amounts of contracts outstanding as of June 30, 2013 and December 31, 2012, respectively.

	Notional amount in millions
	June 30,	December 31,
Currency denomination	2013	2012
United States Dollar (USD)	109	110
British Pound Sterling (GBP)	207	227
Euro (EUR)	18	28
Indian Rupee (INR)	2,401	1,943
Japanese Yen (JPY)	1,151	384
Canadian Dollar (CAD)	59	59
South Korea Won (KRW)	31,938	35,266
Chinese Renmimbi (CNY)	66	45
Singapore Dollar (SGD)	—	3

Commodity Price Risk

We are exposed to fluctuations in commodity prices due to contractual agreements with component suppliers. In order to protect ourselves against future price volatility and, consequently, fluctuations in gross margins, we periodically enter into commodity swap contracts with designated banks to fix the cost of certain raw material purchases with the objective of minimizing changes in inventory cost due to market price fluctuations. Certain commodity swap contracts are derivative contracts that are designated as cash flow hedges under GAAP. We also have commodity swap contracts that represent an economic hedge, but are not designated for hedge accounting and are marked to market through earnings. For those contracts that qualify for hedge accounting, the effective portion of the unrealized gain or loss is deferred and reported as a component of AOCL. When the hedged forecasted transaction (purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income. The ineffective portion of the hedge, if any, is recognized in current income in the period in which the ineffectiveness occurs. As of June 30, 2013, we expect to reclassify an unrealized net loss of $6 million from AOCL to income over the next year. Our internal policy allows for managing these cash flow hedges for up to three years.

The following table summarizes our outstanding commodity swap contracts that were entered into to hedge the cost of certain raw material purchases:

Dollars in millions		June 30, 2013					December 31, 2012
Commodity		Notional Amount