CMI

Cummins Inc. 10-Q Summary: Period Ended September 30, 2007

Business Context and Reporting Period

Cummins Inc. is a global power leader designing, manufacturing, and servicing diesel and natural gas engines, electric power generation systems, and related components. This report covers the quarterly period ended September 30, 2007 (three months) and the nine-month period ended September 30, 2007. All share and per-share amounts have been retroactively adjusted to reflect a two-for-one stock split distributed on April 9, 2007.

Key Financial Metrics

Note: Net debt is calculated as Total Debt less Cash, Cash Equivalents, and Marketable Securities.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 20% ($563 million) for the quarter and 14% ($1,203 million) for the nine months compared to the prior year periods. Growth was driven by record sales in the Engine, Power Generation, and Distribution segments.
• Profitability: Net earnings rose 8% ($13 million) for the quarter and 3% ($15 million) for the nine months. Operating earnings increased 4% and 2%, respectively.
• Segment Performance:
  • Engine: Earnings declined 15% due to lower volumes in the North American heavy-duty truck market (impacted by 2007 emissions standards changes), higher material costs, and increased warranty expenses.
  • Power Generation: Earnings surged 46% (quarter) and 57% (nine months) driven by strong commercial generator and alternator demand.
  • Components: Earnings increased 79% (quarter) and 26% (nine months), led by a 219% sales increase in emissions solutions.
  • Distribution: Earnings grew 21% (quarter) and 25% (nine months), supported by strong international demand.
• Balance Sheet: Total debt decreased significantly from $1,061 million (Oct 1, 2006) to $664 million (Sep 30, 2007). The company achieved a net cash position of $80 million.

Guidance, Outlook, and Risks

• Full Year 2007 Outlook:
  • Engine: Net sales expected to increase ~7%; earnings targeted at 7-10% of sales.
  • Power Generation: Net sales expected to grow ~27%; earnings expected to exceed the top end of the 7-9% target range.
  • Components: Net sales expected to grow ~25%; earnings targeted at ~7% of sales.
  • Distribution: Net sales expected to grow ~22% (excluding deconsolidation); earnings expected to exceed the top end of the 8-10% target range.
• Capital Allocation: The company repurchased $210 million of common stock in the first nine months. Capital expenditures for 2007 are projected between $320 million and $340 million. Pension contributions for the full year are expected to be $240-$250 million.
• Risks and Contingencies:
  • Warranty Costs: Increased warranty expense (3.4% of sales in Q3) is expected as the mix of new 2007 emissions-compliant engines increases.
  • Market Conditions: Sensitivity to economic downturns, interest rates, and OEM inventory levels, particularly in the North American heavy-duty truck market.
  • Legal/Environmental: Ongoing litigation regarding product liability and environmental remediation; management believes reserves are adequate.

Investor Verification Checklist

• Verify the sustainability of the 20% sales growth in the Engine segment given the 18% decline in heavy-duty truck sales in North America.
• Monitor warranty expense trends as a percentage of sales, which rose to 3.4% in Q3 2007 due to new product launches.
• Confirm the execution of the $240-$250 million pension contribution plan to achieve 90% funded status by year-end.
• Review the impact of foreign currency translation on international sales, which comprised 52% of total net sales.
• Assess the progress of the share repurchase program, with approximately 1.1 million shares remaining available under the current authorization.