| CUMMINS INC Item 1A Risk Factors Relating to Our Business Set forth below and elsewhere in this Annual Report on Form 10-K are some of the principal risks and uncertainties that could cause our actual business results to differ materially from any forward-looking statements contained in this Report |
| In addition, future results could be materially affected by general industry and market conditions, changes in laws or accounting rules, general US and non-US economic and political conditions, including a global economic slow-down, fluctuation of interest rates or currency exchange rates, terrorism, political unrest or international conflicts, political instability or major health concerns, natural disasters or other disruptions of expected economic and business conditions |
| These risk factors should be considered in addition to our cautionary comments concerning forward-looking statements in this Report, including statements related to markets for our products and trends in our business that involve a number of risks and uncertainties |
| Our separate section in Item 7 below, “Disclosure Regarding Forward-Looking Statements,” should be considered in addition to the following statements |
| Our business is affected by the cyclical nature of the markets we serve |
| Our financial performance depends, in large part, on varying conditions in the markets and geographies that we serve |
| Demand in these markets and geographies fluctuates in response to overall economic conditions and is particularly sensitive to changes in interest rate levels and fuel costs |
| Our sales are also impacted by OEM inventory levels and production schedules and stoppages |
| Economic downturns in the markets we serve generally result in reductions in sales and pricing of our products, which could reduce future earnings and cash flow |
| Our products are subject to substantial government regulation |
| Our engines are subject to extensive statutory and regulatory requirements governing emissions and noise, including standards imposed by the EPA, state regulatory agencies, such as the CARB, and other regulatory agencies around the world |
| In some cases, we may be required to develop new products to comply with new regulations, particularly those relating to air emissions |
| For example, under the terms of a consent decree that we and a number of other engine manufacturers entered into with the DOJ, the CARB and the EPA, we were required to develop new engines to comply with stringent emissions standards by October 1, 2002 |
| While we were able to meet this deadline, our ability to comply with other existing and future regulatory standards will be essential for us to maintain our position in the engine markets we serve |
| Currently, we believe we are on schedule to meet all deadlines for known future regulatory standards |
| We have made, and will be required to continue to make, significant capital and research expenditures to comply with these regulatory standards |
| Further, the successful development and introduction of new and enhanced products are subject to risks, such as delays in product development, cost over-runs and unanticipated technical and manufacturing difficulties |
| Any failure to comply with regulatory standards affecting our products could subject us to fines or penalties, and could require us to cease production of any non-compliant engine or to recall any engines produced and sold in violation of the applicable standards |
| See “Business—Environmental Compliance—Product Environmental Compliance” for a complete discussion of the environmental laws and regulations that affect our products |
| We are at risk for product recall costs |
| Product recall costs are costs incurred when we decide, either voluntarily or involuntarily, to recall a product through a formal campaign to solicit the return of specific products due to a known or suspected performance issue |
| Costs typically include the cost of the product, part or component being replaced, customer cost of the recall and labor to remove and replace the defective part or component |
| When a recall decision is made, we estimate the cost of the recall and record a charge to earnings in that period in accordance with FASB Statement of Financial Accounting Standards (SFAS) Nodtta 5, “Accounting for Contingencies |
| ” In making this estimate, judgment is required as to the quantity or volume to be recalled, the total cost of the recall campaign, the ultimate negotiated sharing of the cost between us and the customer and, in some cases, the extent to which the supplier of the part or component will share in the recall cost |
| We cannot assure that our truck manufacturers and OEM customers will continue to outsource their engine supply needs |
| Some of our engine customers, including Volvo and DaimlerChrysler, are truck manufacturers or OEMs that manufacture engines for their own products |
| Despite their engine manufacturing abilities, these customers have chosen to outsource certain types of engine production to us due to the quality of our engine products and in order to reduce costs, eliminate production risks and maintain company focus |
| However, we cannot assure that these customers will continue to outsource engine production in the future |
| Increased levels of production insourcing could result from a number of factors, such as shifts in our customers’ business strategies, acquisition by a customer of another engine manufacturer, the inability of third-party suppliers to meet product specifications and the emergence of low-cost production opportunities in foreign countries |
| Any significant reduction in the level of engine production outsourcing from our truck manufacturer or OEM customers could significantly impact our revenues and, accordingly, have a material adverse affect on our business, results of operations and financial condition |
| Our largest customer accounts for a significant share of our business |
| Sales to DaimlerChrysler accounted for approximately 12 percent of our consolidated net sales for 2005, primarily relating to sales of our ISB engine for use in the Dodge Ram truck and sales of our heavy-and medium-duty engines to its Freightliner division |
| While a significant amount of our sales to DaimlerChrysler are under long-term supply agreements, these agreements provide for the supply of DaimlerChrysler’s engine requirements for particular models and not a specific number of engines |
| Accordingly, the loss of DaimlerChrysler as a customer or a significant decline in the production levels for the vehicles in which DaimlerChrysler uses our products would have an adverse effect on our business, results of operations and financial condition |
| Our manufacturing operations are dependent upon third-party suppliers, making us vulnerable to supply shortages |
| A significant number of our suppliers representing 75 to 85 percent of our total raw material and component purchasers in 2005 are the sole source for a particular supply item, although the majority of these materials and components can be obtained from other suppliers |
| Any delay in our suppliers’ abilities to provide us with necessary materials and components may affect our capabilities at a number of our manufacturing locations, or may require us to seek alternative supply sources |
| Delays in obtaining supplies may result from a number of factors affecting our suppliers including capacity constraints, labor disputes, the impaired financial condition of a particular supplier, suppliers’ allocations to other purchasers, weather emergencies or acts of war or terrorism |
| Any delay in receiving supplies could impair our ability to deliver products to our customers and, accordingly, could have a material adverse effect on our business, results of operations and financial condition |
| 20 ______________________________________________________________________ We may be adversely impacted by work stoppages and other labor matters |
| As of December 31, 2005, we employed approximately 33cmam500 persons worldwide |
| Approximately 12cmam500 of our employees worldwide are represented by various unions under collective bargaining agreements with various unions that expire between 2006 and 2010 |
| While we have no reason to believe that we will be impacted by work stoppages and other labor matters, we cannot assure that future issues with our labor unions will be resolved favorably or that we will not encounter future strikes, further unionization efforts or other types of conflicts with labor unions or our employees |
| Any of these factors may have an adverse effect on us or may limit our flexibility in dealing with our workforce |
| Work stoppages or slow-downs experienced by our customers could result in slow-downs or closures at vehicle assembly plants where our engines are installed |
| If one or more of our customers experience a material work stoppage, it could have a material adverse effect on our business, results of operations and financial condition |
| Our products involve risks of exposure to product liability claims |
| We face an inherent business risk of exposure to product liability claims in the event that our products’ failure to perform to specifications results, or is alleged to result, in property damage, bodily injury and/or death |
| We may experience material product liability losses in the future |
| While we maintain insurance coverage with respect to certain product liability claims, we may not be able to obtain such insurance on acceptable terms in the future, if at all, and any such insurance may not provide adequate coverage against product liability claims |
| In addition, product liability claims can be expensive to defend and can divert the attention of management and other personnel for significant periods of time, regardless of the ultimate outcome |
| An unsuccessful defense of a product liability claim could have a material adverse affect on our business, results of operations and financial condition and cash flows |
| In addition, even if we are successful in defending against a claim relating to our products, claims of this nature could cause our customers to lose confidence in our products and our Company |
| Our operations are subject to extensive environmental laws and regulations |
| Our plants and operations are subject to increasingly stringent environmental laws and regulations in all of the countries in which we operate, including laws and regulations governing emissions to air, discharges to water and the generation, handling, storage, transportation, treatment and disposal of waste materials |
| While we believe that we are in compliance in all material respects with these environmental laws and regulations, we cannot assure that we will not be adversely impacted by costs, liabilities or claims with respect to existing or subsequently acquired operations, under either present laws and regulations or those that may be adopted or imposed in the future |
| We are also subject to laws requiring the cleanup of contaminated property |
| If a release of hazardous substances occurs at or from any of our current or former properties or at a landfill or another location where we have disposed of hazardous materials, we may be held liable for the contamination, and the amount of such liability could be material |
| We are exposed to political, economic and other risks that arise from operating a multinational business |
| Approximately 51 percent of our net sales for 2005 were derived from sources outside the United States |
| Accordingly, our business is subject to the political, economic and other risks that are inherent in operating in numerous countries |
| These risks include: · the difficulty of enforcing agreements and collecting receivables through foreign legal systems; · trade protection measures and import or export licensing requirements; · tax rates in certain foreign countries that exceed those in the United States and the imposition of withholding requirements on foreign earnings; · the imposition of tariffs, exchange controls or other restrictions; 21 ______________________________________________________________________ · difficulty in staffing and managing widespread operations and the application of foreign labor regulations; · required compliance with a variety of foreign laws and regulations; and · changes in general economic and political conditions in countries where we operate, particularly in emerging markets |
| As we continue to expand our business globally, our success will depend, in part, on our ability to anticipate and effectively manage these and other risks |
| We cannot assure that these and other factors will not have a material adverse affect on our international operations or on our business as a whole |
| We are subject to currency exchange rate and other related risks |
| We conduct operations in many areas of the world involving transactions denominated in a variety of currencies |
| We are subject to currency exchange rate risk to the extent that our costs are denominated in currencies other than those in which we earn revenues |
| In addition, since our financial statements are denominated in US dollars, changes in currency exchange rates between the US dollar and other currencies have had, and will continue to have, an impact on our earnings |
| While we customarily enter into financial transactions to address these risks, we cannot assure that currency exchange rate fluctuations will not adversely affect our results of operations and financial condition |
| In addition, while the use of currency hedging instruments may provide us with protection from adverse fluctuations in currency exchange rates, by utilizing these instruments we potentially forego the benefits that might result from favorable fluctuations in currency exchange rates |
| We also face risks arising from the imposition of exchange controls and currency devaluations |
| Exchange controls may limit our ability to convert foreign currencies into US dollars or to remit dividends and other payments by our foreign subsidiaries or businesses located in or conducted within a country imposing controls |
| Currency devaluations result in a diminished value of funds denominated in the currency of the country instituting the devaluation |
| Actions of this nature, if they occur or continue for significant periods of time, could have an adverse effect on our results of operations and financial condition in any given period |
| We face significant competition in the markets we serve |
| The markets in which we operate are highly competitive |
| We compete worldwide with a number of other manufacturers and distributors that produce and sell similar products |
| Our products primarily compete on the basis of price, performance, fuel economy, speed of delivery, quality and customer support |
| There can be no assurance that our products will be able to compete successfully with the products of these other companies |
| Any failure by us to compete effectively in the markets we serve could have a material adverse effect on our business, results of operations and financial condition |
| For a more complete discussion of the competitive environment in which each of our segments operates, see “Business—Our Operating Segments |