CMI 9.30.2013 10-Q
Table of Contents

 
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 September 29, 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 September 29, 2013, there were 187,364,208 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.
 

Table of Contents

CUMMINS INC. AND SUBSIDIARIES
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 

2
Table of Contents

PART I.  FINANCIAL INFORMATION
 
ITEM 1.  Condensed Consolidated Financial Statements
 
CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
 
 
Three months ended
 
Nine months ended
In millions, except per share amounts 
 
September 29, 2013
 
September 30, 2012
 
September 29, 2013
 
September 30, 2012
NET SALES (a)
 
$
4,266

 
$
4,118

 
$
12,713

 
$
13,042

Cost of sales
 
3,157

 
3,076

 
9,494

 
9,592

GROSS MARGIN
 
1,109

 
1,042

 
3,219

 
3,450

 
 
 
 
 
 
 
 
 
OPERATING EXPENSES AND INCOME
 
 

 
 

 
 

 
 

Selling, general and administrative expenses
 
492

 
456

 
1,420

 
1,418

Research, development and engineering expenses
 
173

 
186

 
532

 
554

Equity, royalty and interest income from investees (Note 5)
 
91

 
94

 
281

 
302

Gain on sale of businesses (Note 3)
 
—

 
—

 
—

 
6

Other operating income (expense), net
 
(11
)
 
(1
)
 
—

 
3

OPERATING INCOME
 
524

 
493

 
1,548

 
1,789

 
 
 
 
 
 
 
 
 
Interest income
 
6

 
5

 
21

 
20

Interest expense
 
8

 
9

 
22

 
25

Other income (expense), net
 
6

 
(2
)
 
25

 
14

INCOME BEFORE INCOME TAXES
 
528

 
487

 
1,572

 
1,798

 
 
 
 
 
 
 
 
 
Income tax expense (Note 6)
 
154

 
117

 
445

 
458

CONSOLIDATED NET INCOME
 
374

 
370

 
1,127

 
1,340

 
 
 
 
 
 
 
 
 
Less: Net income attributable to noncontrolling interests
 
19

 
18

 
76

 
64

NET INCOME ATTRIBUTABLE TO CUMMINS INC.
 
$
355

 
$
352

 
$
1,051

 
$
1,276

 
 
 
 
 
 
 
 
 
EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CUMMINS INC.
 
 

 
 

 
 

 
 

Basic
 
$
1.91

 
$
1.87

 
$
5.61

 
$
6.73

Diluted
 
$
1.90

 
$
1.86

 
$
5.60

 
$
6.72

 
 
 
 
 
 
 
 
 
WEIGHTED AVERAGE SHARES OUTSTANDING
 
 

 
 

 
 

 
 

Basic
 
186.0

 
188.6

 
187.4

 
189.6

Dilutive effect of stock compensation awards
 
0.5

 
0.4

 
0.4

 
0.4

Diluted
 
186.5

 
189.0

 
187.8

 
190.0

 
 
 
 
 
 
 
 
 
CASH DIVIDENDS DECLARED PER COMMON SHARE
 
$
0.625

 
$
0.50

 
$
1.625

 
$
1.30

_______________________________________________________
(a) Includes sales to nonconsolidated equity investees of $553 million and $1,681 million and $579 million and $1,870 million for the three and nine month periods ended September 29, 2013 and September 30, 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
 
Nine months ended
In millions 
 
September 29,
2013
 
September 30,
2012
 
September 29,
2013
 
September 30,
2012
CONSOLIDATED NET INCOME
 
$
374

 
$
370

 
$
1,127

 
$
1,340

Other comprehensive income (loss), net of tax (Note 14)
 
 

 
 

 
 

 
 

Foreign currency translation adjustments
 
95

 
131

 
(101
)
 
78

Unrealized gain (loss) on derivatives
 
10

 
13

 
(2
)
 
24

Change in pension and other postretirement defined benefit plans
 
16

 
9

 
56

 
30

Unrealized gain (loss) on marketable securities
 
1

 
2

 
(2
)
 
1

Total other comprehensive income (loss), net of tax
 
122

 
155

 
(49
)
 
133

COMPREHENSIVE INCOME
 
496

 
525

 
1,078

 
1,473

Less: Comprehensive income attributable to noncontrolling interest
 
10

 
35

 
45

 
67

COMPREHENSIVE INCOME ATTRIBUTABLE TO CUMMINS INC.
 
$
486

 
$
490

 
$
1,033

 
$
1,406

 
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
 
September 29, 2013
 
December 31, 2012
ASSETS
 
 

 
 

Current assets
 
 

 
 

Cash and cash equivalents
 
$
2,499

 
$
1,369

Marketable securities (Note 7)
 
162

 
247

Total cash, cash equivalents and marketable securities
 
2,661

 
1,616

Accounts and notes receivable, net
 
 

 
 

Trade and other
 
2,449

 
2,235

Nonconsolidated equity investees
 
260

 
240

Inventories (Note 9)
 
2,513

 
2,221

Prepaid expenses and other current assets
 
643

 
855

Total current assets
 
8,526

 
7,167

Long-term assets
 
 

 
 

Property, plant and equipment
 
6,182

 
5,876

Accumulated depreciation
 
(3,234
)
 
(3,152
)
Property, plant and equipment, net
 
2,948

 
2,724

Investments and advances related to equity method investees
 
966

 
897

Goodwill
 
457

 
445

Other intangible assets, net
 
362

 
369

Other assets
 
1,077

 
946

Total assets
 
$
14,336

 
$
12,548

 
 
 
 
 
LIABILITIES
 
 

 
 

Current liabilities
 
 

 
 

Loans payable
 
$
15

 
$
16

Accounts payable (principally trade)
 
1,613

 
1,339

Current maturities of long-term debt (Note 10)
 
47

 
61

Current portion of accrued product warranty (Note 11)
 
374

 
386

Accrued compensation, benefits and retirement costs
 
413

 
400

Deferred revenue
 
269

 
215

Taxes payable (including taxes on income)
 
112

 
173

Other accrued expenses
 
547

 
546

Total current liabilities
 
3,390

 
3,136

Long-term liabilities
 
 

 
 

Long-term debt (Note 10)
 
1,731

 
698

Postretirement benefits other than pensions
 
407

 
432

Other liabilities and deferred revenue
 
1,344

 
1,308

Total liabilities
 
6,872

 
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
 
2,095

 
2,058

Retained earnings
 
8,089

 
7,343

Treasury stock, at cost, 34.9 and 32.6 shares
 
(2,104
)
 
(1,830
)
Common stock held by employee benefits trust, at cost, 1.3 and 1.5 shares
 
(16
)
 
(18
)
Accumulated other comprehensive loss (Note 14)
 
 

 
 

Defined benefit postretirement plans
 
(738
)
 
(794
)
Other
 
(230
)
 
(156
)
Total accumulated other comprehensive loss
 
(968
)
 
(950
)
Total Cummins Inc. shareholders’ equity
 
7,096

 
6,603

Noncontrolling interests
 
368

 
371

Total equity
 
7,464

 
6,974

Total liabilities and equity
 
$
14,336

 
$
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)
 
 
Nine months ended
In millions
 
September 29, 2013
 
September 30, 2012
CASH FLOWS FROM OPERATING ACTIVITIES
 
 

 
 

Consolidated net income
 
$
1,127

 
$
1,340

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

 
 

Depreciation and amortization
 
305

 
262

Restructuring payments, net (Note 15)
 
(25
)
 
—

Gain on sale of businesses (Note 3)
 
—

 
(6
)
Gain on fair value adjustment for consolidated investees (Note 3)
 
(12
)
 
(7
)
Deferred income taxes
 
78

 
91

Equity in income of investees, net of dividends
 
(98
)
 
(51
)
Pension contributions in excess of expense (Note 4)
 
(96
)
 
(74
)
Other post-retirement benefits payments in excess of expense (Note 4)
 
(20
)
 
(16
)
Stock-based compensation expense
 
29

 
29

Excess tax benefits on stock-based awards
 
(13
)
 
(12
)
Translation and hedging activities
 
26

 
16

Changes in current assets and liabilities, net of acquisitions:
 
 

 
 

Accounts and notes receivable
 
(216
)
 
66

Inventories
 
(206
)
 
(367
)
Other current assets
 
182

 
(54
)
Accounts payable
 
252

 
(145
)
Accrued expenses
 
(146
)
 
(398
)
Changes in other liabilities and deferred revenue
 
147

 
154

Other, net
 
19

 
(41
)
Net cash provided by operating activities
 
1,333

 
787

 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 

 
 

Capital expenditures
 
(417
)
 
(424
)
Investments in internal use software
 
(43
)
 
(62
)
Investments in and advances to equity investees
 
(12
)
 
(92
)
Acquisition of businesses, net of cash acquired (Note 3)
 
(145
)
 
(215
)
Proceeds from sale of business, net of cash sold
 
—

 
10

Investments in marketable securities—acquisitions (Note 7)
 
(360
)
 
(433
)
Investments in marketable securities—liquidations (Note 7)
 
433

 
475

Cash flows from derivatives not designated as hedges
 
(15
)
 
13

Other, net
 
14

 
9

Net cash used in investing activities
 
(545
)
 
(719
)
 
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 

 
 

Proceeds from borrowings (Note 10)
 
987

 
64

Payments on borrowings and capital lease obligations
 
(62
)
 
(120
)
Net borrowings under short-term credit agreements
 
34

 
5

Distributions to noncontrolling interests
 
(53
)
 
(50
)
Dividend payments on common stock
 
(305
)
 
(246
)
Repurchases of common stock
 
(289
)
 
(231
)
Excess tax benefits on stock-based awards
 
13

 
12

Other, net
 
19

 
16

Net cash provided by (used in) financing activities
 
344

 
(550
)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
 
(2
)
 
31

Net increase (decrease) in cash and cash equivalents
 
1,130

 
(451
)
Cash and cash equivalents at beginning of year
 
1,369

 
1,484

CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
2,499

 
$
1,033

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

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CUMMINS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Unaudited)
 
In millions
Common
Stock
 
Additional
paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Treasury
Stock
 
Common
Stock
Held in
Trust
 
Total
Cummins Inc.
Shareholders’
Equity
 
Noncontrolling
Interests
 
Total
Equity
BALANCE AT DECEMBER 31, 2011
$
555

 
$
1,446

 
$
6,038

 
$
(938
)
 
$
(1,587
)
 
$
(22
)
 
$
5,492

 
$
339

 
$
5,831

Net income
 

 
 

 
1,276

 
 

 
 

 
 

 
1,276

 
64

 
1,340

Other comprehensive income (loss)
 

 
 

 
 

 
130

 
 

 
 

 
130

 
3

 
133

Issuance of shares
1

 
5

 
 

 
 

 
 

 
 

 
6

 
—

 
6

Employee benefits trust activity
 

 
22

 
 

 
 

 
 

 
3

 
25

 
—

 
25

Acquisition of shares
 

 
 

 
 

 
 

 
(231
)
 
 

 
(231
)
 
—

 
(231
)
Cash dividends on common stock
 

 
 

 
(246
)
 
 

 
 

 
 

 
(246
)
 
—

 
(246
)
Distribution to noncontrolling interests
 

 
 

 
 

 
 

 
 

 
 

 
—

 
(71
)
 
(71
)
Stock option exercises
 

 
 

 
 

 
 

 
9

 
 

 
9

 
—

 
9

Other shareholder transactions
 

 
17

 
 

 
 

 
 

 
 

 
17

 
21

 
38

BALANCE AT SEPTEMBER 30, 2012
$
556

 
$
1,490

 
$
7,068

 
$
(808
)
 
$
(1,809
)
 
$
(19
)
 
$
6,478

 
$
356

 
$
6,834

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE AT DECEMBER 31, 2012
$
556

 
$
1,502

 
$
7,343

 
$
(950
)
 
$
(1,830
)
 
$
(18
)
 
$
6,603

 
$
371

 
$
6,974

Net income
 

 
 

 
1,051

 
 

 
 

 
 

 
1,051

 
76

 
1,127

Other comprehensive income (loss)
 

 
 

 
 

 
(18
)
 
 

 
 

 
(18
)
 
(31
)
 
(49
)
Issuance of shares
 

 
5

 
 

 
 

 
 

 
 

 
5

 
—

 
5

Employee benefits trust activity
 

 
18

 
 

 
 

 
 

 
2

 
20

 
—

 
20

Acquisition of shares
 

 
 

 
 

 
 

 
(289
)
 
 

 
(289
)
 
—

 
(289
)
Cash dividends on common stock
 

 
 

 
(305
)
 
 

 
 

 
 

 
(305
)
 
—

 
(305
)
Distribution to noncontrolling interests
 

 
 

 
 

 
 

 
 

 
 

 
—

 
(53
)
 
(53
)
Stock option exercises
 

 
1

 
 

 
 

 
15

 
 

 
16

 
—

 
16

Other shareholder transactions
 

 
13

 
 

 
 

 
 

 
 

 
13

 
5

 
18

BALANCE AT SEPTEMBER 29, 2013
$
556

 
$
1,539

 
$
8,089

 
$
(968
)
 
$
(2,104
)
 
$
(16
)
 
$
7,096

 
$
368

 
$
7,464

 
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 third quarters of 2013 and 2012 ended on September 29 and September 30, respectively.  The interim periods for both 2013 and 2012 contained 13 weeks, while the nine month periods both contained 39 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 nine month periods ended September 29, 2013 and September 30, 2012, were as follows:
 
 
Three months ended
 
Nine months ended
 
September 29, 2013
 
September 30, 2012
 
September 29, 2013
 
September 30, 2012
Options excluded
184,775

 
599,637

 
479,276

 
412,318

 
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 nine 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.
 

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NOTE 3. ACQUISITIONS AND DIVESTITURES  

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 customer related and are being amortized over periods ranging from one to four 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 $11 million of the $14 million deferred purchase price was distributed in the third quarter of 2013. The remaining balance is expected to be paid in future quarters.
 
The updated purchase price allocation at September 29, 2013, was as follows:
 
In millions
 
Accounts receivable
$
48

Inventory
100

Fixed assets
34

Intangible assets
8

Goodwill
9

Other assets
8

Current liabilities
(40
)
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 owned 79.99 percent of Northwest and the new distributor principal owned 20.01 percent. The acquisition was accounted for as a business combination, with the results of the acquired entity included in the Distribution 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.

In July 2013, we acquired the remaining 20.01 percent from the former distributor principal for an additional $4 million. Since the entity was already consolidated, this was accounted for as an equity transaction.
 
Hilite Germany GmbH

In July 2012, we purchased the doser technology and business assets from Hilite Germany GmbH (Hilite) in a cash transaction. Dosers are products that enable compliance with emission standards in certain aftertreatment systems and complement our current product offerings. The purchase price was $176 million and is summarized below. There was no contingent consideration associated with this transaction. During the first nine months of 2012, we expensed approximately $4 million of acquisition related costs.


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The acquisition of Hilite was accounted for as a business combination, with the results of the acquired entity and the goodwill included in the Components segment in the third quarter of 2012. The majority of the purchase price was allocated to technology and customer related intangible assets and goodwill, most of which was fully deductible for tax purposes. We expect the Hilite acquisition to strengthen our aftertreatment product offerings. This acquisition enhances our technical capabilities and keeps us in a strong position to meet the needs of current customers and grow into new markets, especially as an increasing number of regions around the world adopt tougher emission standards.

Intangible assets by asset class, including weighted average amortization life, were as follows:

Dollars in millions
 
Purchase price allocation
 
Weighted average amortization life in years
Technology
 
$
52

 
10.6
Customer
 
23

 
4.5
License arrangements
 
8

 
6.0
Total intangible assets
 
$
83

 
8.5

The purchase price allocation was as follows:

In millions
 
Inventory
$
5

Fixed assets
5

Intangible assets
83

Goodwill
91

Liabilities
(8
)
Total purchase price
$
176


Cummins Central Power

In July 2012, we acquired an additional 45 percent interest in Cummins Central Power from the former principal for consideration of approximately $20 million. The acquisition was accounted for as a business combination, with the results of the acquired entity included in the Distribution segment in the third quarter of 2012. Distribution segment results also included a $7 million gain, as we were required to re-measure our pre-existing 35 percent ownership interest in Cummins Central Power to fair value in accordance with GAAP. Net sales for Cummins Central Power were $209 million for the 12 months ended December 31, 2011. 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.

Divestitures

In the second quarter of 2012, we recorded an additional $6 million gain ($4 million after-tax) related to final purchase price adjustments for our 2011 divestitures. The gain was excluded from segment results as it was not considered in our evaluation of operating results for the nine months ended September 30, 2012.

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:
 

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Three months ended
 
Nine months ended
In millions
 
September 29,
2013
 
September 30,
2012
 
September 29,
2013
 
September 30,
2012
Defined benefit pension and other postretirement plans
 
 

 
 

 
 

 
 

Voluntary contribution
 
$
33

 
$
34

 
$
110

 
$
107

Mandatory contribution
 
7

 
4

 
51

 
15

Defined benefit pension contributions
 
40

 
38

 
161

 
122

Other postretirement plans
 
11

 
14

 
37

 
31

Total defined benefit plans
 
$
51

 
$
52

 
$
198

 
$
153

 
 
 
 
 
 
 
 
 
Defined contribution pension plans
 
$
14

 
$
15

 
$
50

 
$
59

 
We made $161 million of pension contributions in the nine months ended September 29, 2013 and we anticipate making an additional $9 million of contributions during the remainder of 2013.  We paid $37 million of claims and premiums for other postretirement benefits in the nine months ended September 29, 2013; payments for the remainder of 2013 are expected to be $10 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 participants.  Our expected pension expense for 2013 was reduced by $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 costs under our plans were as follows:
 
 
 
Pension
 
 
 
 
 
 
U.S. Plans
 
U.K. Plans
 
Other Postretirement Benefits
 
 
Three months ended
In millions
 
September 29,
2013
 
September 30,
2012
 
September 29,
2013
 
September 30,
2012
 
September 29,
2013
 
September 30,
2012
Service cost
 
$
17

 
$
15

 
$
5

 
$
5

 
$
—

 
$
—

Interest cost
 
23

 
25

 
14

 
15

 
4

 
6

Expected return on plan assets
 
(42
)
 
(40
)
 
(17
)
 
(20
)
 
—

 
—

Amortization of prior service credit
 
—

 
—

 
—

 
—

 
—

 
(1
)
Recognized net actuarial loss
 
16

 
12

 
6

 
4

 
2

 
—

Net periodic benefit cost
 
$
14

 
$
12

 
$
8

 
$
4

 
$
6

 
$
5

 
 
 
Pension
 
 
 
 
 
 
U.S. Plans
 
U.K. Plans
 
Other Postretirement Benefits
 
 
Nine months ended
In millions
 
September 29,
2013
 
September 30,
2012
 
September 29,
2013
 
September 30,
2012
 
September 29,
2013
 
September 30,
2012
Service cost
 
$
52

 
$
44

 
$
15

 
$
16

 
$
—

 
$
—

Interest cost
 
70

 
77

 
42

 
44

 
12

 
16

Expected return on plan assets
 
(126
)
 
(118
)
 
(53
)
 
(61
)
 
—

 
—

Amortization of prior service credit
 
—

 
—

 
—

 
—

 
—

 
(3
)
Recognized net actuarial loss
 
47

 
35

 
18

 
11

 
5

 
2

Net periodic benefit cost
 
$
43

 
$
38

 
$
22

 
$
10

 
$
17

 
$
15

 

11
Table of Contents

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
 
Nine months ended
In millions
 
September 29,
2013
 
September 30,
2012
 
September 29,
2013
 
September 30,
2012
Distribution Entities
 
 
 
 
 
 
 
 
North American distributors
 
$
34

 
$
37

 
$
98

 
$
115

Komatsu Cummins Chile, Ltda.
 
6

 
9

 
17

 
20

All other distributors
 
1

 
—

 
1

 
3

Manufacturing Entities
 
 
 
 
 
 

 
 

Chongqing Cummins Engine Company, Ltd.
 
15

 
14

 
44

 
49

Dongfeng Cummins Engine Company, Ltd.
 
13

 
9

 
45

 
42

Beijing Foton Cummins Engine Co., Ltd.
 
4

 
3

 
14

 
3

Shanghai Fleetguard Filter Co., Ltd.
 
4

 
3

 
11

 
10

Cummins Westport, Inc.
 
2

 
2

 
5

 
11

Tata Cummins, Ltd.
 
1

 
—

 
4

 
7

Komatsu manufacturing alliances
 
—

 
(1
)
 
3

 
(1
)
Valvoline Cummins, Ltd.
 
—

 
2

 
5

 
6

Xian Cummins Engine Company Ltd.
 
—

 
1

 
1

 
(5
)
All other manufacturers
 
3

 
6

 
6

 
12

Cummins share of net income
 
83

 
85

 
254

 
272

Royalty and interest income
 
8

 
9

 
27

 
30

Equity, royalty and interest income from investees
 
$
91

 
$
94

 
$
281

 
$
302


NOTE 6. INCOME TAXES
 
Our effective tax rate for the year is expected to approximate 28.5 percent, excluding any one-time items that may arise.  Our tax rate is generally less than the 35 percent U.S. statutory income tax rate primarily due to lower tax rates on foreign income and research tax credits.  The tax rates for the three and nine month periods ended September 29, 2013, were 29.2 percent and 28.3 percent, respectively.  These tax rates include a $7 million discrete net tax expense for the third quarter tax adjustments: $4 million expense attributable to prior year tax return true-up adjustments, $1 million benefit related to release of prior year tax reserves and a discrete tax charge for $4 million related to a third quarter enactment of U.K. tax law changes. In addition, the nine month tax rate includes 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 nine month periods ended September 30, 2012, were 24.1 percent and 25.5 percent, respectively. These tax rates include a $16 million tax benefit for third quarter discrete tax adjustments, $6 million of which related to a dividend distribution of accumulated foreign income earned in prior years. These discrete tax adjustments also included a discrete tax benefit of $13 million for prior year tax return true-up adjustments and a discrete tax charge of $3 million related to the third quarter enactment of U.K. tax law changes. The increase in the 2013 effective tax rates compared to 2012 is primarily due to unfavorable changes in the pre-tax mix of income taxed in higher rate jurisdictions and discrete tax items.

In September 2013, the Internal Revenue Service released final tangible personal property regulations regarding the deduction and capitalization of expenditures related to tangible property. The new rules will become effective for taxable years beginning on or after January 1, 2014. While we are still finalizing our analysis, we do not believe that these regulations will have a material impact on our Consolidated Financial Statements.


12
Table of Contents

NOTE 7. MARKETABLE SECURITIES
 
A summary of marketable securities, all of which are classified as current, was as follows:
 
 
 
September 29, 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)
 
$
91

 
$
1

 
$
92

 
$
139

 
$
3

 
$
142

Bank debentures
 
9

 
—

 
9

 
45

 
—

 
45

Certificates of deposit
 
36

 
—

 
36

 
47

 
—

 
47

Government debt securities-non-U.S.
 
3

 
—

 
3

 
3

 
—

 
3

Corporate debt securities
 
—

 
—

 
—

 
1

 
—

 
1

Equity securities and other(2)
 
12

 
10

 
22

 
—

 
9

 
9

Total marketable securities
 
$
151

 
$
11

 
$
162

 
$
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.
 
The proceeds from sales and maturities of marketable securities and gross realized gains and losses from the sale of available-for-sale securities were as follows:
 
 
Three months ended
 
Nine months ended
In millions
 
September 29, 2013
 
September 30,
2012
 
September 29, 2013
 
September 30,
2012
Proceeds from sales and maturities of marketable securities
 
$
153

 
$
195

 
$
433

 
$
475

Gross realized gains from the sale of available-for-sale securities
 
1

 
1

 
12

 
4


At September 29, 2013, the fair value of available-for-sale investments with contractual maturities was as follows:
 
 
 
Fair value
Maturity date
 
(in millions)
1 year or less
 
$
68

1-5 years
 
1

5-10 years
 
10

Total
 
$
79

 
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 nine months of 2013 and 2012.
 

13
Table of Contents

The following table summarizes our financial instruments recorded at fair value in our Condensed Consolidated Balance Sheets at September 29, 2013:
 
 
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
 
$
61

 
$
31

 
$
—

 
$
92

Bank debentures
 
—

 
9

 
—

 
9

Certificates of deposit
 
—

 
36

 
—

 
36

Government debt securities-non-U.S.
 
—

 
3

 
—

 
3


 


 


 


 
 
Available-for-sale equity securities
 
 

 
 

 
 

 
 

Information technology industry
 
22

 
—

 
—

 
22


 


 


 


 
 
Derivative assets
 
 

 
 

 
 

 
 

Interest rate contracts
 
—

 
54

 
—

 
54

Foreign currency forward contracts
 
—

 
5

 
—

 
5

Commodity call option contracts
 
—

 
1

 
—

 
1

Total assets
 
$
83

 
$
139

 
$
—

 
$
222


 
 
 
 
 
 
 
 
Derivative liabilities
 
 

 
 

 
 

 
 

Commodity swap contracts
 
—

 
5

 
—

 
5

Foreign currency forward contracts
 
—

 
2

 
—

 
2

Commodity put option contracts
 
—

 
1

 
—

 
1

Total liabilities
 
$
—

 
$
8

 
$
—

 
$
8

 

14
Table of Contents

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 was as follows:

•
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

15
Table of Contents

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 September 29, 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.
 
In millions
 
September 29,
2013
 
December 31,
2012
Fair value of total debt
 
$
1,952

 
$
926

Carrying value of total debt
 
1,793

 
775

 
NOTE 9. INVENTORIES
 
Inventories are stated at the lower of cost or market.  Inventories included the following:
 
In millions
 
September 29,
2013
 
December 31,
2012
Finished products
 
$
1,581

 
$
1,393

Work-in-process and raw materials
 
1,045

 
939

Inventories at FIFO cost
 
2,626

 
2,332

Excess of FIFO over LIFO
 
(113
)
 
(111
)
Total inventories
 
$
2,513

 
$
2,221


16
Table of Contents

NOTE 10. DEBT
 
As a well-known seasoned issuer, we filed an automatic shelf registration for an undetermined amount of debt and equity securities with the SEC on September 16, 2013. 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.

In September 2013, we issued $1 billion aggregate principal amount of senior notes consisting of $500 million aggregate principal amount of 3.65% senior unsecured notes due in 2023 and $500 million aggregate principal amount of 4.875% senior unsecured notes due in 2043. We received net proceeds of $979 million. The senior notes pay interest semi-annually on April 1 and October 1, commencing on April 1, 2014. The indenture governing the senior notes contains covenants that, among other matters, limit (i) our ability to consolidate or merge into, or sell, assign, convey, lease, transfer or otherwise dispose of all or substantially all of our and our subsidiaries' assets to another person, (ii) our and certain of our subsidiaries' ability to create or assume liens and (iii) our and certain of our subsidiaries' ability to engage in sale and leaseback transactions.

A summary of long-term debt was as follows:
 
In millions
 
September 29,
2013
 
December 31,
2012
Long-term debt
 
 

 
 

Export financing loan, 4.5%, due 2013
 
$
—

 
$
23

Senior notes, 3.65%, due 2023
 
500

 
—

Debentures, 6.75%, due 2027
 
58

 
58

Debentures, 7.125%, due 2028 (1)
 
250

 
250

Senior notes, 4.875%, due 2043
 
500

 
—

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

 
165

Credit facilities related to consolidated joint ventures
 
129

 
88

Other
 
73

 
69

 
 
1,675

 
653

Unamortized discount
 
(48
)
 
(35
)
Fair value adjustments due to hedge on indebtedness
 
54

 
88

Capital leases
 
97

 
53

Total long-term debt
 
1,778

 
759

Less: Current maturities of long-term debt
 
(47
)
 
(61
)
Long-term debt
 
$
1,731

 
$
698

___________________________________________________
(1) In November 2005, we entered into an interest rate swap to effectively convert our $250 million debt issue, due in 2028, from a fixed rate of 7.125 percent to a floating rate based on a LIBOR spread (see Note 13).
 
Principal payments required on long-term debt during the next five years are as follows:
 
 
 
Required Principal Payments
In millions
 
2013
 
2014
 
2015
 
2016
 
2017
Payment
 
$
16

 
$
45

 
$
85

 
$
63

 
$
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:
 

17
Table of Contents

 
 
Nine months ended
In millions 
 
September 29,
2013
 
September 30, 2012
Balance, beginning of year
 
$
1,088

 
$
1,014

Provision for warranties issued
 
317

 
320

Deferred revenue on extended warranty contracts sold
 
138

 
154

Payments
 
(312
)
 
(294
)
Amortization of deferred revenue on extended warranty contracts
 
(84
)
 
(77
)
Changes in estimates for pre-existing warranties
 
(26
)
 
(36
)
Foreign currency translation
 
(3
)
 
2

Balance, end of period
 
$
1,118

 
$
1,083

 
Warranty related deferred revenue, supplier recovery receivables and the long-term portion of the warranty liability on our September 29, 2013, balance sheet were as follows:
In millions
 
September 29, 2013
 
Balance Sheet Location
Deferred revenue related to extended coverage programs
 
 

 
 
Current portion
 
$
133

 
Deferred revenue
Long-term portion
 
341

 
Other liabilities and deferred revenue
Total
 
$
474

 
 
 
 
 
 
 
Receivables related to estimated supplier recoveries
 
 

 
 
Current portion
 
$
6

 
Trade and other receivables
Long-term portion
 
5