UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2004

Commission File Number 1-4949

CUMMINS INC.

Indiana	35-0257090
(State of Incorporation)	(IRS Employer Identification No.)

500 Jackson Street
Box 3005
Columbus, Indiana 47202-3005

(Address of principal executive offices)

Telephone (812) 377-5000

Securities registered pursuant to Section 12(b) of the Act:

	Title of each class		Name of each exchange on which registered
Common Stock, $2.50 par value		New York Stock Exchange
		Pacific Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None.

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No o

The aggregate market value of the voting stock held by non-affiliates was approximately $2.8 billion at June 27, 2004.

As of February 27, 2005, there were 46,324,016 shares of $2.50 par value per share common stock outstanding.

Documents Incorporated by Reference

Portions of the registrant’s definitive Proxy Statement filed with the Securities and Exchange Commission pursuant to Regulation 14A are incorporated by reference in Part III of this Form 10-K.

TABLE OF CONTENTS

Part	Item		Page
I	1	Business	3
		Overview	3
		Available Information.	3
		Competitive Strengths	4
		Business Strategy	5
		Our Business Segments	7
		Engine Business	7
		Power Generation Business	9
		Filtration and Other Business	10
		International Distributor Business	11
		Segment Financial Information	11
		Supply	12
		Patents and Trademarks	12
		Seasonality	12
		Largest Customer	12
		Backlog	13
		Distribution	13
		Research and Engineering	14
		Joint Ventures and Alliances	15
		Employees	17
		Environmental Compliance	17
		Risk Factors Relating to Our Business	18
	2	Properties	22
	3	Legal Proceedings	22
	4	Submission of Matters to a Vote of Security Holders	22
II	5	Market for the Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities	23
	6	Selected Financial Data	24
	7	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
	7A	Quantitative and Qualitative Disclosures About Market Risk	60
	8	Financial Statements and Supplementary Data	61
	9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	61
	9A	Controls and Procedures	61
	9B	Other Information	62
III	10	Directors and Executive Officers of the Registrant	63
	11	Executive Compensation	64
	12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	64
	13	Certain Relationships and Related Transactions	64
	14	Principal Accountant Fees and Services	64
IV	15	Exhibits, Financial Statement Schedules and Reports on Form 8-K	64
		Index to Financial Statements	64
		Reports on Form 8-K	65
		Signatures	120
		Index to Exhibits	121

PART I

Item 1. Business

OVERVIEW

Cummins Inc. (“Cummins,” “the Company,” “we,” “our,” or “us”) is a global power leader that designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related products, including filtration and emissions solutions, fuel systems, controls and air handling systems. We were founded in 1919 as one of the first manufacturers of diesel engines and are headquartered in Columbus, Indiana. We sell our products to Original Equipment Manufacturers (OEMs), distributors and other customers worldwide. We have long-standing relationships with many of the leading manufacturers in the markets we serve, including DaimlerChryslerAG (DaimlerChrysler), Volvo AB, PACCAR Inc., International Truck and Engine Corporation (Navistar International Corporation), CNH Global N.V., Komatsu and Scania AB. We serve our customers through a network of more than 550 company-owned and independent distributor locations and approximately 5,000 dealer locations in more than 160 countries and territories.

Our financial performance depends, in large part, on varying conditions in the markets we serve, particularly the automotive, construction and general industrial markets. Demand in these markets tends to fluctuate in response to overall economic conditions and is particularly sensitive to changes in interest rate levels and the price of crude oil (fuel costs). OEM inventory levels, production schedules and work stoppages also impact our sales. Economic downturns in the markets we serve generally result in reduced sales, which affect our profits and cash flow.

AVAILABLE INFORMATION

Cummins files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). You may read and copy any document we file with the SEC at the SEC’s public reference room at 450 Fifth Street, NW, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an internet site that contains annual, quarterly and current reports, proxy and information statements and other information that issuers (including Cummins) file electronically with the SEC. The SEC’s internet site is www.sec.gov.

Cummins internet site is www.cummins.com. You can access Cummins Investor Information webpage through our internet site, by clicking on the “Annual Reports” link to the heading “Investor Information.” Cummins makes available free of charge, on or through our Investor Information website, its proxy statements, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Cummins also makes available, through our Investor Information webpage, under the link SEC filings, statements of beneficial ownership of Cummins equity securities filed by its directors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act.

Cummins also has a Corporate Governance webpage. You can access Cummins Corporate Governance webpage through our internet site, www.cummins.com, by clicking on the “Annual Report” link to the heading “Corporate Governance”. Cummins posts the following on its Corporate Governance webpage:

· ISS Corporate Governance Rating

· Code of Conduct

· Corporate Governance Principles

· By-laws of Cummins

· Audit Committee Charter

· Governance and Nominating Committee Charter

· Compensation Committee Charter

Cummins Code of Conduct applies to all our employees, regardless of their position or the country in which they work. We will post any amendments to the Code of Conduct, and any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange, Inc. (“NYSE”), on our internet site. The information on Cummins internet site is not incorporated by reference into this report.

You may request a copy of these documents at no cost, by contacting Cummins Inc. Investor Relations at 500 Jackson Street, Mail Code 60115, Columbus, IN 47201 (812-377-3121).

COMPETITIVE STRENGTHS

We believe the following competitive strengths are instrumental to our success:

· Leading Brands. Our product portfolio includes products marketed under the following brands, each of which holds a leading position in its respective market:

· Cummins engines, electric power generation systems, components and parts;

· Onan generator sets; Newage AVK/SEG products sold under the Stamford, AvK and Markon brands;

· Fleetguard filtration systems and components;

· Nelson intake and exhaust systems and components;

· Kuss automotive in-tank fuel filtration;

· Universal Silencer filtration systems and silencers; and

· Holset turbochargers.

While our portfolio of brands contains a number of market leaders, we operate in a highly competitive sector and our brands compete with the brands of other manufacturers and distributors that produce and sell similar products.

· Customers and Partners. To maintain technology leadership and a global presence in a cost-effective manner, we have established strategic alliances with a number of our leading customers. These partnerships provide us with a knowledge and understanding of our customers’ technology and business needs, and enable us to develop products and services which better meet their requirements at lower costs. For example, we have both customer and supplier arrangements with Komatsu, Ltd., including multiple manufacturing joint ventures and a product development joint venture through which we have partnered in the development of several engines. We are also the exclusive supplier of engines for Komatsu mining equipment. In addition, we have been the exclusive diesel engine supplier to DaimlerChrysler for its Dodge Ram truck since 1988, and in 2003 our exclusivity agreement was extended beyond model year 2007. We have long-term agreements with Volvo, PACCAR and International Truck and Engine Corporation for the supply of heavy-duty truck engines. These agreements afford us long-term price stability and eliminate certain dealer and end-user discounts as well as offer closer integration on product development. We also have multiple international joint ventures to manufacture heavy-duty and midrange engines,

including partnerships with the Tata Group whose member company is the leading truck manufacturer in India, and Dongfeng Automotive Corporation, an engine supplier to the second largest truck manufacturer in China.

· Global Presence. We have a strong global presence including a world class distribution system, manufacturing and engineering facilities around the world and a network of global supply sources. Our worldwide presence has enabled us to take advantage of growth opportunities in international markets, with sales outside the U.S. growing from 39 percent of total sales in 1999 to 48 percent of total sales in 2004. In the last 45 years, we have developed a distribution and service network that includes more than 550 company-owned and independent distributor locations and 5,000 independent dealers located throughout 160 countries and territories. We also have manufacturing operations and product engineering centers around the world, with facilities in the United Kingdom (UK), Brazil, Mexico, Canada, France, Australia, China, India, South Africa and Singapore. In addition, we have developed a global network of high-quality, low-cost supply sources to support our manufacturing base.

· Leading Technology. We have an established reputation for delivering high-quality, technologically advanced products. We continuously work with our customers to develop new products to improve the performance of their vehicles, equipment or systems at competitive cost levels. We are a leader in developing technologies to reduce diesel engine emissions, a key concern of our customers and regulators around the world. We were the first company to develop engines that were certified to meet new emissions standards governing on-highway heavy-duty diesel engines. These standards went into effect for Cummins in the U.S. on October 1, 2002. We were also the first manufacturer to receive a Tier III Certificate of Conformity from the EPA for our QSM off-highway engine that meets the January 2005 emissions standards. We have also developed low-emission, high-performance natural gas engines as an alternative fuel option for the on-highway, industrial and power generation markets. Our technology leadership enables us to develop integrated product solutions for the power generation and filtration markets, allowing our customers to use a single high-performance, low-cost system as opposed to multiple components from different suppliers.

BUSINESS STRATEGY

The four key elements of our business strategy are as follows:

· Aggressively Pursue Cost Leadership. In many of our markets, product or system cost is a critical performance parameter for our customers. To achieve cost leadership, we will continue to leverage our innovative technology, economies of scale, global presence and customer partnerships. Beginning in 2000, we have continuously focused on dramatically reducing costs and lowering our breakeven point to maintain a competitive advantage and to deliver quality products to our customers. The following key initiatives are integral to this strategy:

· Six Sigma. Since the program’s inception five years ago, Cummins has not only applied Six Sigma to manufacturing processes and in the initial design of new products, but also expanded the program to include processes with customers, suppliers and distributors. Six Sigma yields not only significant cost savings and improved quality, it strengthens the relationships with these important stakeholders and yields long-term relationships.

· Global Sourcing. Cummins cost reduction efforts in supply chain management and global procurement from less expensive international markets such as China, India, Eastern Europe and Brazil have resulted in significantly reducing the cost of purchased materials and services during the last five years.

· Technical Productivity. Cummins is maximizing its technical productivity for less by conducting off-shore research and development at its technical center in India, by sharing development cost with its customer OEM and joint venture partnerships, and by using analysis-led design to eliminate capital-intensive prototypes through virtual computer modeling. In 2004, we signed an agreement with Dongfeng Cummins Engine Co., Ltd. for a technical center facility in China that is scheduled to open in the first quarter of 2006.

· Expand into Related Markets. We will continue to focus growth initiatives in related businesses where we can use our existing investments in products or technology, leading brand names or market presence to establish a competitive advantage. Furthermore, we will target related markets that offer higher rates of growth, attractive returns and more stable cash flows through product and end market diversity. Specific growth opportunities are outlined below.

· Cummins Engine Business has made a significant investment in the Company’s North American distributors; engines for the growing oil and gas markets; service and maintenance contracts and progress toward our strategy to meet 2007 and 2010 on-highway emissions standards.

· Cummins Power Generation Business is focused on increasing sales of standby power, mobile and auxiliary power, distributed generation, alternators and power electronics and controls, such as transfer switches and switchgear.

· Cummins Filtration and Other Business will leverage the Company’s filtration, exhaust and engine technologies to provide integrated solutions for its customers and meet increasingly stringent emissions requirements.

· Cummins International Distributor Business is growing through the expansion of the aftermarket parts and service business by capitalizing on its global customer base and fast growth markets in China, India and Russia.

· Maximize Return on Capital. Return on capital, specifically return on average net assets (ROANA), is our primary measure of financial performance. Each of our business segments use ROANA measurement targets, and we allocate capital based on segment performance against those targets. We calculate ROANA as segment EBIT divided by segment average net assets. Segment EBIT is earnings before interest, loss on early retirement of debt, taxes, minority interests, preferred dividends and cumulative effect of accounting changes and segment average net assets is net assets excluding debt, taxes and adjustments to the minimum pension liability.

· Leverage Complementary Businesses. Strong synergies and relationships exist between Cummins businesses in the following areas:

· Shared technology: In addition to common platforms of base product technology, our businesses have technical capabilities which can be applied commercially to provide integrated solutions for our customers. The businesses also realize synergies in the development and application of broader technology tools (such as information technology).

· Common channels and distribution: All business units utilize a common distribution channel which provides access to a full range of our products and also provides economies of scale.

· Shared customers and partners: There is substantial commonality in customers and partners between business units, which allows us to build strong customer relationships and provides opportunity for expanded product offerings.

· Corporate brand and image: All business units benefit from the established, respected corporate brand.

· Ensuring and Reinforcing a Strong Performance Ethic. This means doing what we say we will do, in terms of financial performance, meeting customer and partner expectations and demonstrating our corporate core values.

As a result of our intense focus on ROANA, we have been able to reduce capital spending while still funding key development programs, including the completion of a full range of emission-compliant engines. During 2002 – 2004, our average annual capital spending was lower compared to the average capital spending during the 1999 – 2001 period. Prior to 2001, our annual capital expenditures were significant as we launched new engine platforms. Capital expenditures for 2005 will increase to support our growth, including investments to increase capacity and to fund our new products. Our investments in capacity improvement are very focused, cut across all of our businesses and are designed for rapid return on investment. We continue to invest more of our capital in low-cost regions of the world to further leverage our opportunities for cost reduction. In total, we expect capital expenditures to be in the range of $220 million to $240 million dollars to support these initiatives, while still remaining below depreciation and amortization.

One of our goals is to regain an investment grade credit rating from the rating agencies. To achieve this goal, we have put significant management focus on increasing earnings, improving cash flow and reducing debt levels.

OUR BUSINESS SEGMENTS

We operate four complementary business segments that share technology, customers, strategic partners, brands and our distribution network to gain a competitive advantage in their respective markets. With our size and global presence, we provide world-class products, service and support to our customers in a cost-effective manner. In each of our business segments, 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.

Engine Business

Our Engine Business manufactures and markets a broad range of diesel and natural gas-powered engines under the Cummins brand name for the heavy-and medium-duty truck, bus, recreational vehicle (RV), light-duty automotive, agricultural, construction, mining, marine, oil and gas, rail and governmental equipment markets. We offer a wide variety of engine products with displacement from 1.4 to 91 liters and horsepower ranging from 31 to 3,500. In addition, we provide a full range of new parts and service, as well as remanufactured parts and engines, through our extensive distribution network. The Engine Business is our largest business segment, accounting for approximately 57 percent of total sales in 2004.

The principal customers of our heavy-and medium-duty truck engines include truck manufacturers, such as International Truck and Engine Corporation (Navistar International Corporation), Volvo Trucks North America, PACCAR and Freightliner, manufacturers of school, transit and shuttle buses and manufacturers of construction, agricultural and marine equipment. The principal customers of our light-duty automotive engines are DaimlerChrysler and manufacturers of recreational vehicles (RVs).

In the markets served by our Engine Business, we compete with independent engine manufacturers as well as OEMs who manufacture engines for their own products. Our primary competitors in North America are Caterpillar, Inc., Detroit Diesel Corporation, Mack Trucks, Inc. and International Truck and Engine Corporation (Engine Division). Our primary competitors in international markets vary from country to country, with local manufacturers generally predominant in each geographic market. Other engine manufacturers in international markets include Mercedes Benz, Volvo, Renault Vehicules Industriels, Scania and Nissan Diesel Motor Co., Ltd.

Our Engine Business organizes its engine, parts and service businesses around the following end-user focused groups:

Heavy-duty truck

We manufacture a complete line of diesel engines that range from 310 horsepower to 565 horsepower serving the worldwide heavy-duty truck market. We offer the ISM and ISX engines and in Australia, the Signature 620 series engines, which we believe comprise the most modern product engine line in our industry. Most major heavy-duty truck manufacturers in North America offer our diesel engines as standard or optional power. In 2004, we held a 27 percent share of the Group II engine market for NAFTA heavy-duty trucks. We also have significant market share overseas, including the U.K. and Latin America, and are the market leader in Mexico, South Africa and Australia. Our largest customer for heavy-duty truck engines in 2004 was International Truck and Engine Corporation (Navistar International Corporation) with sales representing 7 percent of consolidated net sales.

In recent years we entered into long-term supply agreements with three key customers to reduce our cost structure, improve customer service and increase market share. In 2000, we entered into a long-term agreement with Volvo Trucks North America, Inc. under which we act as its sole external engine supplier. In 2001, we entered into long-term supply agreements with PACCAR and International Truck and Engine Corporation (Navistar International Corporation) covering our heavy-duty engine product line. These supply agreements provide long-term, stable pricing for engines and eliminate certain dealer and end-user discounts, in order to provide our customers with full responsibility for total vehicle cost and pricing. In addition, these agreements provide for joint work on engine/vehicle integration with a focus on reducing product proliferation. These efforts are expected to reduce product cost while creating enhanced value for end-users through better product quality and performance. The joint sales and service efforts also will provide better customer support at a significantly reduced cost to the partners.

Medium-Duty Truck and Bus

We manufacture a product line of medium-duty diesel engines ranging from 185 horsepower to 315 horsepower serving medium-duty and inter-city delivery truck customers worldwide. We believe that our ISB, ISC and ISL series diesel engines comprise the most advanced product line in the industry. We sell our ISB and ISC series engines and engine components to medium-duty truck manufacturers in Asia, Europe and South America. In 1990, we entered the North American medium-duty truck market and for the year ended 2004 our market share for diesel powered medium-duty trucks had grown to approximately 15 percent. Freightliner LLC, (a division of DaimlerChrysler), PACCAR, Ford and Volkswagen AG are our major customers in this worldwide market.

We also offer our ISB and ISC diesel engines and alternative-fuel engines for school buses, transit buses and shuttle buses and our B and C series engines for natural gas applications, which are focused primarily on transit and school bus markets. The demand for alternative-fuel products continues to grow both domestically and internationally. Cummins Westport Inc., a joint venture formed in 2001 with Westport Innovations, Inc., offers low emission, propane and natural gas engines that are currently used in municipal transportation markets in Los Angeles, Boston, Salt Lake City, Vancouver, BC and Beijing, China.

Light Duty Automotive

We are the exclusive provider of diesel engines used by DaimlerChrysler in its Dodge Ram trucks. Our relationship with DaimlerChrysler extends over 15 years, and in 2004 we shipped approximately 157,000 engines for use in Dodge Ram trucks. In 2004, DaimlerChrysler was our largest customer for midrange engines. In 2003, our selection as the exclusive diesel power provider for Dodge Ram truck

models was extended to include the 2007 model year. The Dodge Ram Heavy-Duty Cummins Turbo offers best in class 610 lb-ft of torque and 325 horsepower, and we expect this popular engine will continue to result in strong sales volumes with the scheduled availability of our engine in the new Dodge Ram Mega Cab model.

We are the leading manufacturer of diesel engines for use in the Class A motorhome market, with a market share representing over 50 percent of the diesel engines in retail Class A motorhome sales. Sales of diesel engines to the recreational vehicle market have increased significantly during the last five years, and approximately 47 percent of Class A motorhomes were diesel powered in 2004, indicating strong growth in the use of diesel power for these applications.

In 2004, our contract was renewed with the U.S. Department of Energy to develop a light-duty automotive engine suitable for use in light pickup truck and sport utility vehicles. Prototype engines are currently undergoing testing and development. We believe that we are well positioned to take advantage of the growing interest in diesel engines for use in these vehicles.

Industrial

Our medium-duty, heavy-duty and high-horsepower engines power a wide variety of equipment in the construction, agricultural, mining, rail, government, oil and gas, power generation, commercial and recreational marine applications throughout the world. Our major construction OEM customers are in North America, Europe, South Korea, Japan and China. These OEMs manufacture approximately one million pieces of equipment per year for a diverse set of applications and use engines from our complete product range. Agricultural OEM customers are primarily in North America, South America and Europe, serving end-use markets that span the globe. In the marine markets, our joint venture, Cummins MerCruiser Diesel Marine, is the market share leader in the North American and Australia recreational boat segment. Our engines are sold to both recreational and commercial boat builders, primarily in North America, Europe and Asia. We offer a full product line of high-horsepower engines for mining applications that compete in all segments from small underground mining equipment to 400-ton haul trucks. The launch of our QSK78 engine at MINExpo 2000 extended our mining products up to 3,500 horsepower, the largest in the mining industry, where we occupy the number two market position. In this market, we are the exclusive external supplier of engines to Komatsu, a large construction and mining equipment OEM. Our sales to the rail market are primarily to railcar builders in Europe and Asia, and we are a leader in the worldwide railcar market. With our new QSK60 and QSK78 engines, we expect to move into a larger proportion of the locomotive and railcar markets outside North America and commercial marine markets worldwide. Government sales represent a small portion of the high-horsepower market and are primarily to defense contractors in North America and Europe. Our new high-horsepower engines allow us to offer our customers in the oil and gas business a full line of high-horsepower products.

Power Generation Business

The Power Generation Business is our second largest business segment, representing 19 percent of our total sales in 2004. This business is one of the most integrated providers of power solutions in the world, designing or manufacturing most of the components that make up power generation systems, including engines, controls, alternators, transfer switches and switchgear. This business is a global provider of power generation systems, components and services for a diversified customer base to meet the needs for standby power, distributed generation power, as well as auxiliary power needs in specialty mobile applications. Standby power solutions are provided to customers who rely on uninterrupted sources of power to meet the needs of their customers. Distributed generation power solutions are provided to customers with less reliable electrical power infrastructures, typically in developing countries. In addition, it provides an alternative source of generating capacity which is purchased by utilities, independent power

producers and large power customers for use as prime or peaking power and is located close to its point of use. Mobile power provides a secondary source of power (other than drive power) for mobile applications.

Our power generation products are marketed principally under the Cummins Power Generation, Onan, and Cummins Power Rent brands and include diesel-and alternative-fuel electrical generator sets for commercial, institutional and consumer applications, such as office buildings, hospitals, factories, municipalities, utilities, universities, recreational vehicles, boats and homes. We are the worldwide leader in auxiliary generator sets for RVs, commercial vehicles and recreational marine applications. Our Rental business provides power equipment on a rental basis for both standby and prime power purposes. Our Energy Solutions Business provides full service power solutions for customers including generating equipment, long-term maintenance contracts and turnkey power solutions.

Our Newage AVK/SEG (Newage) division is a leader in the alternator industry and supplies its products internally as well as to other generator set assemblers. Newage products are sold under the Stamford, AVK and Markon brands and range in output from 0.6 kVA to 30,000 kVA. We also sell reciprocating generator drive engines across a large power range to other generator set assemblers.

This business segment continuously explores emerging technologies, such as microturbines and fuel cells, and provides integrated power generation products utilizing technologies other than reciprocating engines. We use our own research and development capabilities as well as leveraging business partnerships to develop cost-effective and environmentally sound power solutions.

Our customer base for power generation products is highly diversified, with customer groups varying based on their power needs. China, India, the Middle East and Brazil are four of our largest geographic markets outside of North America.

This business competes with a variety of engine manufacturers and generator set assemblers across the world. Caterpillar remains our primary competitor as a result of its acquisition of MAK Americas Inc., Perkins Engines Inc. and FG Wilson Inc. Volvo, as well as DaimlerChrysler, through its acquisition of Detroit Diesel Corporation, are other major engine manufacturers with a presence in the high-speed generation segment of the market. We also compete with Kohler, Generac, SDMO and other regional generator set assemblers. Newage competes globally with Emerson Electric Co., Marathon Electric and Meccalte, among others.

Filtration and Other Business

Our Filtration and Other Business produces filters, silencers and intake and exhaust systems under the Fleetguard, Nelson, Kuss and Universal Silencer brand names and is the largest worldwide supplier of turbochargers for commercial applications through our Holset brand. This segment manufactures filtration and exhaust systems for on-and off-highway heavy-duty equipment and is a supplier of filtration products for industrial and passenger car applications, exhaust systems for small engine equipment and silencing systems for gas turbines. In addition, we operate an Emission Solutions business through which we develop systems to help our customers meet increasingly stringent emissions standards. In 2004, our Filtration and Other Business segment accounted for approximately 15 percent of our total sales.

Fleetguard is the world’s leading supplier of filtration and exhaust products offering over 12,000 products including air, coolant, fuel and hydraulic filters, antifreeze and coolant additives, catalysts, particulate filters, controllers and other filtration systems to OEMs, dealer/distributor and end user markets. Its products are produced and sold in global markets, including Europe, North America, South America, India, China, Australia and the Far East. In a recent North America on-highway truck market survey published by a leading independent market research company, Fleetguard ranked as the top brand preference for diesel engine air, oil, fuel and coolant filtration products. Our Filtration and Other Business also makes products for the automotive specialty filtration market and the industrial filtration market

through our Kuss subsidiary, located in Findlay, OH, and Universal Silencer, located in Stoughton, WI. Our Filtration and Other Business revenue is split between first-fit OEM customers (approximately 48 percent) and replacement part business (approximately 52 percent).

Holset designs, manufactures and markets turbochargers with manufacturing facilities in five countries and sales and distribution worldwide. Holset provides critical technologies for engines to meet challenging performance requirements and worldwide emissions standards, including variable geometry turbochargers, and is the market leader in turbochargers for heavy-duty equipment. Holset’s joint venture in India with Tata Motors Ltd., assembled and shipped its first turbochargers in 1996. A joint venture with Wuxi Power Engineering Company Ltd. in China also began production in 1996. In 2001, Holset completed consolidation of its U.S. manufacturing facilities into one site located in Charleston, SC.

Customers of our Filtration and Other Business segment generally include truck manufacturers and other OEMs that are also customers of our Engine Business, such as CNH Global N.V., and other manufacturers that use Fleetguard filtration products in their product platforms, such as Honda. Our customer base for replacement filtration parts is highly fragmented, and primarily consists of various end-users of filtration systems.

Our Filtration and Other Business competes with other manufacturers of filtration systems and components and turbochargers. Our primary competitors in these markets include Donaldson Company, Inc., Clarcor Inc., Mann+Hummel Group, Tokyo Roki Co., Ltd. and Honeywell International.

International Distributor Business

In the fourth quarter of 2001, we realigned our reporting structure and created the International Distributor Business as a result of the growing size and importance of the retail distribution business. In 2004, International Distributor Business sales accounted for 9 percent of our total sales. Our International Distributor Business consists of 17 company-owned distributors and one joint venture that distribute the full range of our products and services to end-users at 116 locations in 77 countries and territories. Through this network, our trained personnel provide parts and service to our customers, as well as full-service solutions, including maintenance contracts, engineering services, and integrated products where we customize our products to cater to specific end-users. Our company-owned distributors are located in key markets, including India, China, Japan, Australia, the U.K. and South Africa. Our distributors also serve the dealers and end-users in their territories by providing product maintenance, repair and overhaul services.

Our International Distributor Business serves a highly diverse customer base consisting of various end-users in the specific geographic markets in which our distributors are located.

In our International Distributor Business, each distributor that we own or operate in a particular geographic region competes with other distributors and dealers that offer similar products within that region. In many cases, competing distributors and dealers are owned by, or affiliated with, OEMs of those competing products.

SEGMENT FINANCIAL INFORMATION

Financial information about our business segments is incorporated by reference from Note 21 to the Consolidated Financial Statements.

SUPPLY

We have developed and maintain a world class supply base in terms of technology, quality and cost. We source our materials and manufactured components from leading suppliers both domestically and internationally. We have adequate sources of supply of raw materials and components. We machine and assemble some of the components used in our engines and power generation units, including blocks, heads, rods, turbochargers, camshafts, crankshafts, filters, exhaust systems, alternators and fuel systems. We also have arrangements with certain suppliers who are the sole source for specific products or supply items. Between 75 and 85 percent of our total raw material and component purchases in 2004 were purchased from suppliers who are the sole source of supply for a particular supply item. Although we elect to source a relatively high proportion of our total raw materials and component requirements from sole suppliers, the majority of these supply items can be purchased from alternate suppliers with the appropriate sourcing plan. In addition, we maintain dual sourcing at a commodity level on many of our sole sourced part numbers. Our supply agreements vary according to the particular part number sourced. However, these agreements typically include standard terms relating to cost (including cost reduction targets), quality and delivery. Our supply agreements also typically include customary intellectual property provisions that contain prohibitions on the use of our intellectual property by the suppliers for any purpose other than their performance of the supply agreements, and indemnity covenants from suppliers for breach by them of intellectual property rights of third parties in performance of the agreements. The duration of our more important supply agreements varies but typically ranges between three and five years and some extend through 2010. Many of our supply agreements include early termination provisions related to failure to meet quality and delivery requirements. In order to reduce the risk of dependency, the raw materials and components from single source suppliers are reviewed periodically to ensure a second source or alternative exists to guarantee supply.

PATENTS AND TRADEMARKS

We own or control a significant number of patents and trademarks relating to the products we manufacture. These have been granted and registered over a period of years. Although these patents and trademarks are generally considered beneficial to our operations, we do not believe any patent, group of patents, or trademark (other than our leading brand house trademarks) is considered significant in relation to our business.

SEASONALITY

While individual product lines may experience modest seasonal declines in production, there is no material effect on the demand for the majority of our products on a quarterly basis. However, our Power Generation Business normally experiences seasonal declines in the first quarter of the fiscal year due to general declines in construction spending and our International Distributor Business normally experiences seasonal declines in first quarter business activity due to holiday periods in Asia and Australia.

LARGEST CUSTOMER

We have thousands of customers around the world and have developed long-standing business relationships with many of them. DaimlerChrysler is our largest customer, accounting for approximately 13 percent of our consolidated net sales in 2004, primarily relating to sales of our ISB engine for use in Dodge Ram trucks and sales of our medium-duty engines to the Freightliner division of DaimlerChrysler. While a significant number of our sales to DaimlerChrysler are under long-term supply agreements, these agreements provide for the supply of DaimlerChrysler’s engine requirements for particular vehicle models and not a specific volume of engines. DaimlerChrysler is our only customer accounting for more than 10 percent of our net sales in 2004. The loss of this customer or a significant decline in the production level of DaimlerChrysler vehicles that use our engines would have an adverse effect on our business, results of

operations and financial condition. We have been an engine supplier to DaimlerChrysler for more than 15 years. A summary of principal customers for each business segment is included in our segment discussion.

In addition to our agreements with DaimlerChrysler, we have long-term heavy-duty engine supply agreements with International Truck and Engine Corporation, PACCAR and Volvo Trucks North America. Collectively, our net sales to these three customers was less than 18% of consolidated net sales in 2004 and individually, was less than 9% of consolidated net sales for each customer. As with DaimlerChrysler, these agreements contain standard purchase and sale agreement terms covering engine and engine parts pricing, quality and delivery commitments, as well as engineering product support obligations. The basic nature of our agreements with OEM customers is that they are long-term (generally five years or longer) price and operations agreements that assure the availability of our products to each customer through the duration of the respective agreements. There are no guarantees or commitments by these customers of any kind regarding volumes or market shares, except in the case of DaimlerChrysler which has committed that Cummins will be its exclusive diesel engine supplier for the Dodge Ram heavy-duty pickup truck. Agreements with OEMs contain bilateral termination provisions giving either party the right to terminate in the event of a material breach, change of control or insolvency or bankruptcy of the other party.

BACKLOG

While we have supply agreements with some truck and off-highway equipment OEMs, most of our business is transacted through open purchase orders. These open orders are historically subject to month-to-month releases and are subject to cancellation on reasonable notice without cancellation charges and therefore are not considered firm.

DISTRIBUTION

Over the last 45 years, we have developed a distribution and service network that includes more than 550 distributor locations and 5,000 dealers in 160 countries and territories. This network is comprised of independent distributors, North American distributors that are partially-owned by us and international distributors that are wholly-owned. Each distributor sells the full range of our products, as well as complementary products and services. Our International Distributor Business operates within this network with 17 company-owned distributors and one joint venture in 116 locations across 77 countries and territories.

Our agreements with independent and partially-owned distributors generally have a three-year term and are exclusive with respect to specified territories. Our distributors develop and maintain the network of dealers with which we have no direct relationship. The distributors are permitted to sell other, non-competitive 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 marks, 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. We can refuse to renew these agreements at will, and we may terminate them upon 90-day 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 and may, at our option purchase other assets of the distributor, but are under no obligation to do so.

Our distribution capability is a key element of our business strategy and competitive position, particularly in our efforts to increase customer access to aftermarket replacement parts and repair service.

There are more than 5,000 locations in North America, primarily owned and operated by OEMs or their dealers, at which Cummins trained service personnel and parts are available to service, maintain and repair our engines. We also have parts distribution centers located strategically throughout the world in order to serve our customers and distributors.

Financial information about wholly-owned distributors, partially-owned distributors consolidated under FIN46R and distributors accounted for under the equity method are incorporated by reference to Notes 1, 2 and 3 to the Consolidated Financial Statements.

RESEARCH AND ENGINEERING

Our research and engineering program is focused on product improvements, innovations and cost reductions for our customers. In 2004, our research and engineering expenditures were $241 million compared to $200 million in 2003. Of this amount, approximately 8 percent, or $20 million, was directly related to the development of heavy-duty and medium-duty engines that are designed to comply with the 2007 emissions standards.

In the Engine Business, we continue to invest in system integration and in technologies to meet increasingly more stringent emissions standards. We have focused our engine technology development on five critical subsystems: combustion, air handling, fuel systems, electronic controls and exhaust aftertreatment. We were the first diesel engine manufacturer to have an engine certified by the EPA as being in compliance with the current EPA standards. We also were the first engine manufacturer to announce a low-cost combustion-only emission solution for Tier III industrial diesel engines that does not require exhaust gas recirculation nor exhaust aftertreatment. In addition, we were the first company to demonstrate a prototype vehicle that meets EPA 2007 gasoline-equivalent “Tier II Bin 5” emission levels.

In Power Generation, our product engineering focus is best performance at lowest cost for our customers. Our Power Electronics technology development is aimed at applying digital electronics to eliminate multiple gen-set controllers and achieve higher levels of system integration and control. We meet the most advanced emission standards around the world, employing both combustion and exhaust aftertreatment technologies. Looking to future low-emission power generation technologies, we have a DOE-funded program to develop a solid oxide fuel cell system for vehicle auxiliary power generation and for smaller stationary power generation applications.

In Filtration, we are building on our strengths in design integration to develop modules that integrate multiple filtration functions into a single engine subsystem component. We are developing new filter media and technologies that support low emission engines, including exhaust aftertreatment, closed crankcase ventilation and centrifugal soot removal.

In 2003, we established Cummins Research and Technology Indian Private Ltd. (CRTI). This partially-owned subsidiary provides analytical services such as structural dynamics, computational fluid dynamics, and design to all Cummins entities. CRTI has selected Satyam Computer Services Limited to provide start-up services in the form of engineering staff and leased work space. CRTI is located in Pune, India. In 2004, we signed a joint venture agreement with Dongfeng Cummins Engine Co. Ltd. for a research facility in China that is expected to open in the first quarter of 2006. The Cummins East Asia Tech Center will provide engineering and technical services for the full range of Cummins products manufactured in China, including diesel and natural gas engines, power generators, turbochargers and filtration products.

JOINT VENTURES AND ALLIANCES

We have entered into the following joint venture agreements and alliances with business partners and affiliates in various areas of the world to increase our market penetration, expand our product lines, streamline our supply chain management and develop new technologies:

· Cummins India Ltd. We are the majority owner of Cummins India Ltd., which is a publicly listed company on the Bombay Stock Exchange. This business entity developed from a partnership established in 1962 with the Kirloskar family and eventually expanded to include other local partners. Cummins India Ltd. produces midrange, heavy-duty and high-horsepower engines for the Indian and export markets. We consolidate the results of Cummins India Ltd. in our Consolidated Financial Statements.

· Consolidated Diesel Company. Consolidated Diesel Company, located in the U.S., is a joint venture with CNH Global N.V. that began with Case Corporation in 1980. This partnership produces Cummins B series, C series and ISL Series engines and engine products for automotive and industrial markets in North America and Europe. Effective March 28, 2004, we adopted the provisions of FIN 46R for this entity and its results are now consolidated in our Consolidated Financial Statements (see Note 2 to the Consolidated Financial Statements).

· Cummins/Komatsu Arrangements. We have formed a broad relationship with Komatsu Ltd., including three joint ventures and numerous exclusive supply arrangements. Two joint ventures were formed in 1992, one to manufacture Cummins B Series engines in Japan, the other to build high-horsepower Komatsu-designed engines in the U.S., Cummins Komatsu Engine Corporation (CKEC). In 1997, we established a third joint venture in Japan to design the next generation of industrial engines. Effective March 28, 2004, we adopted the provisions of FIN 46R for CKEC and its results are now consolidated in our Consolidated Financial Statements (see Note 2 to the Consolidated Financial Statements).

· Cummins/Dongfeng Joint Ventures. In 1985, we licensed Dongfeng Motor Company (Dongfeng), the second largest truck manufacturer in China, to manufacture Cummins B Series engines. In 1993, Dongfeng established a subsidiary, Dongfeng Automotive Corporation (DFAC), which became the licensee. In 1995, we partnered with DFAC and formed a joint venture, Dongfeng Cummins Engine Co. Ltd. (DCEC), for the production of our C Series engines. In 1998, we established a wholly-owned subsidiary, Cummins (Xiangfan) Machining Company Ltd. (CXMC), in an adjacent facility to DCEC to manufacture B Series cylinder blocks and cylinder heads. In April 2003, the assets of DFAC’s B series manufacturing entity and the assets of CXMC were invested into the existing joint venture, DCEC. The expanded joint venture, with annual capacity of approximately 130,000 units, produces Cummins B, C and L series four-to nine-liter mechanical and will produce full-electronic diesel engines with a power range from 100 to 370 horsepower in 2005. In 2004, Cummins invested a B series connecting rod machining line into CXMC to supply DCEC. We also have a joint venture with Dongfeng that manufactures filtration systems, Shanghai Fleetguard Filter Co., Ltd. In 2003, Nissan Motor Co., Ltd. acquired 50% ownership of Dongfeng. In 2004, we signed a joint venture agreement with DCEC for a research facility in China that is expected to open in the first quarter of 2006. The facility will provide engineering and technical services for the full range of Cummins products manufactured in China, including diesel and natural gas engines, power generators, turbochargers and filtration products.

· Tata Group Joint Ventures. In 1992, we formed a joint venture with Tata Engineering and Locomotive Company, the largest automotive company in India and a member of the Tata group of companies. The joint venture, Tata Cummins Limited, manufactures the Cummins B Series engine in India for use in trucks manufactured by Tata. Holset Engineering Company Ltd., one of our

wholly-owned subsidiaries, also formed a joint venture with Tata for the manufacturer of turborchargers, Tata Holset Ltd..

· Cummins/China National Heavy-Duty Truck Joint Venture. In 1995, we formed a joint venture with China National Heavy-duty Truck Corporation in Chongqing, China. The shares of this venture are now owned jointly by us and the Chongqing Heavy Duty Vehicle Group. The joint venture, Chongqing Cummins Engine Company Ltd., manufactures several models of our heavy-duty and high-horsepower diesel engines in China.

· The European Engine Alliance (EEA). The EEA was established in 1996 as a joint venture between our Company and two Fiat Group companies, Iveco N.V. (trucks and buses) and CNH Global (agricultural and construction equipment), to develop a new generation of 4, 5 and 6-liter engines based on our 4B and 6B Series engines.

· Cummins/Scania Joint Venture. In 1999, we formed a joint venture with Scania to produce fuel systems for heavy-duty diesel engines. We own 70 percent of this joint venture and its results are included in our Consolidated Financial Statements.

· Cummins/Westport Joint Venture. In 2001, we formed a joint venture with Westport Innovations Inc., located in British Columbia, Canada, to develop and market low-emissions, high-performance natural gas engines for on-highway, industrial and power generation markets. In 2003, the joint venture agreement was modified to focus the joint ventures’ efforts on the marketing and sale of automotive spark ignited natural gas engines worldwide. The new agreement also provides for joint technology projects between Westport and Cummins on low-emission technologies of mutual interest.

· NewageAVK/SEG Joint Venture. In 2001, Newage International Ltd., which operates within our Power Generation Business, formed a joint venture with AVK/SEG Holding GmbH & Co. KG, a German holding company that directly owned shares of AVK and SEG, which manufactured alternators and power electronics, respectively. Effective March 28, 2004, we adopted the provisions of FIN 46R for AVK/SEG and its results are now consolidated in our Consolidated Financial Statements. In the second quarter of 2004, AVK/SEG was liquidated and we now own 100 percent of AVK and 25 percent of SEG. SEG continues to be consolidated under FIN 46R (see Note 2 to the Consolidated Financial Statements).

· Cummins MerCruiser Diesel Marine LLC. In 2002, we formed a joint venture with Mercury Marine, a division of Brunswick Corporation, to develop, manufacture and sell recreational marine diesel products, including engines, sterndrive packages, inboard packages, instrument and controls, service systems and replacement and service parts and assemblies, complete integration systems and other related products.

In addition to these key joint ventures and agreements, we also have equity interests in several of our North American distributors who distribute the full range of our products and services to customers and end-users. We have also entered into numerous joint ventures around the world where we provide engine components, such as turbochargers, alternators and filtration products. In Turkey, we have a license agreement with BMC Sanayi that provides for the manufacture and sale of our B and C Series engines. We will continue to evaluate joint venture and partnership opportunities in order to penetrate new markets, develop new products and generate manufacturing and operational efficiencies.

Financial information about our investments in joint ventures and alliances that are not consolidated and those that are consolidated is incorporated by reference from Notes 1, 2 and 3 to the Consolidated Financial Statements. Financial information about geographic areas is incorporated by reference from Note 21 to the Consolidated Financial Statements.

EMPLOYEES

ENVIRONMENTAL COMPLIANCE

Product Environmental Compliance

Our engines are subject to extensive statutory and regulatory requirements that directly or indirectly impose standards governing emissions and noise. Our products comply with emissions standards that the Environmental Protection Agency (EPA), the California Air Resources Board (CARB) and other state regulatory agencies, as well as other regulatory agencies around the world, have established for heavy-duty on-highway diesel and gas engines and off-highway engines produced through 2005. Our ability to comply with these and future emissions standards is an essential element in maintaining our leadership position in regulated markets. We have made, and will continue to make, significant capital and research expenditures to comply with these standards. Failure to comply with these standards could result in adverse effects on our future financial results.

EPA Engine Certifications

In the fourth quarter 2002, we implemented new on-road emissions standards. These were implemented in accordance with the terms of a 1998 consent decree that we and a number of other engine manufacturers entered into with the EPA, the U.S. Department of Justice (DOJ) and CARB. The consent decree was in response to concerns raised by these agencies regarding the level of nitrogen oxide emissions from heavy-duty diesel engines.

The consent decree also requires us to pull forward by one year (to January 1, 2005) the implementation of Tier III emissions standards for off-road engines in the 300 to 749 horsepower range. This development was finished early in the year and all testing and EPA/CARB certification was concluded so that these engines could be sold commencing January 1, 2005.

Federal and California regulations require manufacturers to report failures of emissions-related components to the EPA and CARB when the failure rate reaches a specified level. At higher failure rates, a product recall may be required. In 2004, we submitted one report to the EPA relating to incorrect or missing data plates on 39 engines.

Emissions standards in international markets, including Europe and Japan, are becoming more stringent. We believe that our experience in meeting U.S. emissions standards leaves us well positioned to take advantage of opportunities in these markets as the need for emissions control capability grows.

In December 2003, we announced that we will meet the 2007 U.S. EPA heavy-duty on-highway emissions standards by combining our existing cooled Exhaust Gas Recirculation technology with particulate matter (PM) filters. Cooled EGR is the same technology that we have used since April 2002 and was selected after reviewing other aftertreatment technologies such as NOx adsorbers and selective catalytic reduction (SCR). Our experience with particulate filters and the availability of ultra-low-sulfur diesel fuel combine to give us the confidence in meeting these tough standards in the U.S. Additionally, while the EGR/PM filter combination is the right solution for 2007 in the U.S., we have selected SCR as the right technology to meet on-highway Euro IV emissions standards and certain off-highway applications.

Other Environmental Statutes and Regulations

We believe we are in compliance in all material respects with laws and regulations applicable to our plants and operations. During the last five years, expenditures for environmental control activities and environmental remediation projects at our facilities in the U.S. have not been a substantial portion of annual capital outlays and are not expected to be material in 2005.

Pursuant to notices received from federal and state agencies and/or defendant parties in site environmental contribution actions, we have been identified as a Potentially Responsible Party (PRP) under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended or similar state laws, at approximately 14 waste disposal sites. Based upon our experiences at similar sites we believe that our aggregate future remediation costs will not be significant. We have established accruals that we believe are adequate for our expected future liability with respect to these sites.

RISK FACTORS RELATING TO OUR BUSINESS

Set forth below and elsewhere in this Annual Report on Form 10-K and in other documents we file with the SEC are some of the principal risks and uncertainties that could cause our actual business results to differ materially from any forward-looking statements or other projections 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 U.S. and non-U.S. economic and political conditions, including a global economic slowdown, 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 that we serve, particularly the automotive, construction and general industrial markets. Demand in these markets 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 standards but we cannot assure that we will be able to achieve the technological advances that may be necessary for us to continue to comply with evolving 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.

Our products are subject to recall for performance related issues.

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 Financial Accounting Standards Board Statement of Financial Accounting Standards (SFAS) No. 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. As a result, these estimates are subject to change.

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, which could result from the acquisition 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 13 of our net sales for 2004, 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 is 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 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.

We obtain materials and manufactured components from third-party suppliers. A significant number of our suppliers representing 75 to 85 percent of our total raw material and component purchasers in 2004

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.

We may be adversely impacted by work stoppages and other labor matters.

As of December 31, 2004, we employed approximately 28,100 persons worldwide. Approximately 10,300 of our employees are represented by various unions under collective bargaining agreements that expire between 2005 and 2008. We cannot assure you 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. In addition, many of our customers have unionized work forces. 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 you 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 48 percent of our net sales for 2004 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;

· 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 U.S. dollars, changes in currency exchange rates between the U.S. 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 U.S. 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. Some of our competitors are companies, or divisions or operating units of companies that have greater financial and other resources than we do. 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 business segments operates, see “Business—Our Business Segments.”

Item 2. Properties

Our worldwide manufacturing facilities occupy approximately 15 million square feet, including approximately nine million square feet in the U.S. Principal manufacturing facilities in the U.S. include our plants in Southern Indiana, Wisconsin, New York, Iowa, Tennessee, Georgia, Ohio and Minnesota, as well as an engine manufacturing facility in North Carolina, which is operated in partnership with CNH Global N. V.

Manufacturing facilities outside of the U.S. include facilities located in the U.K., Brazil, India, Mexico, Canada, France, China and Australia. In addition, engines and engine components are manufactured by joint ventures or independent licensees at manufacturing plants in the U.K., France, China, India, Japan, Pakistan, South Korea, Turkey and Indonesia.

Item 3. Legal Proceedings

We are, at any one time, party to a number of lawsuits or subject to claims arising out of the ordinary course of our business, including actions related to product liability, patent, trademark or other intellectual property infringement, contractual liability, workplace safety and environmental claims and cases, some of which involve claims for substantial damages. We and our subsidiaries are currently defendants in a number of pending legal actions, including actions related to use and performance of our products. While we carry product liability insurance covering significant claims for damages involving personal injury and property damage, we cannot assure you that such insurance would be adequate to cover the costs associated with a judgment against us with respect to these claims. We have also been identified as a Potentially Responsible Party (PRP) at several waste disposal sites under federal and state environmental statutes, only one of which we expect could result in monetary sanctions, exclusive of interest and costs, of $100,000 or more (in the vicinity of $137,000) based upon our estimated proportional volume of waste disposed at this site in Oklahoma City, OK (Double Eagle Refinery site). In addition to this site, we have been contacted as a possible PRP at sites in Toledo, OH (Stickney Avenue and Tyler Street Dump site, and XXKem site), Green County, OH (Lammers site) Jacksonville, FL (White House Waste Oil Pits site), Memphis, TN (North Hollywood Dump site), Cookeville, TN (Putnam County Landfill site), Vadnis Heights, MN (Vadnis Heights site), South Bend, IN (Schumann site), Culver, IN (Four County Landfill site), Columbus, IN (Miller Salvage/Marr-Glick Wellfield Site); Santa Barbara, CA (Casmalia Site), Buffalo, NY (ENRX site) and Los Angeles, CA (Operating Industries, Inc. site). At several of these sites, we have had no follow-up contact from the relevant regulatory agencies since an initial communication in the early to mid-1990s. Other than in connection with the Double Eagle Refinery site in Oklahoma City referenced above, we believe our liability at these sites would be de minimis absent the imposition of liabilities that otherwise would be the responsibility of other PRPs. More information with respect to our environmental exposure can be found under “Environmental Compliance Other Environmental Statutes and Regulations.” We deny liability with respect to many of these legal actions and environmental proceedings and are vigorously defending such actions or proceedings. While we have established accruals that we believe are adequate for our expected future liability with respect to our pending legal actions and proceedings, we cannot assure that our liability with respect to any such action or proceeding would not exceed our established accruals. Further, we cannot assure that litigation having a material adverse affect on our financial condition will not arise in the future.

Item 4. Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of our security holders during the last quarter of the fiscal year ended December 31, 2004.

PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

(a) Our common stock, par value $2.50 per share, is listed on the NYSE and the Pacific Stock Exchange under the symbol “CMI.” For information about the quoted market prices of our common stock, information regarding dividend payments and the number of common stock shareholders, see Selected Quarterly Financial Data on page 118 of this report. For other matters related to our common stock and shareholders’ equity, see Notes 14 and 17 to the Consolidated Financial Statements.

(b) Use of proceeds—not applicable.

	ISSUER PURCHASES OF EQUITY SECURITIES
Period	(a) Total Number of Shares Purchased		(b) Average Price Paid per Share			(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
October		1,369		$	73.65		—		43,861
November		3,812		76.94			—		40,464
December		9,282		79.67			—		31,245
Total		14,463		$	78.38		—

These shares were repurchased from employees in connection with the Company’s Key Employee Stock Investment Plan which allows certain employees, other than officers, to purchase shares of common stock of the Company on an installment basis up to an established credit limit. Loans are issued for five-year terms at a fixed interest rate established at the date of purchase and may be re-financed after its initial five-year period for an additional five-year period. Participants must hold shares for a minimum of six months from date of purchase and after shares are sold, must wait six months before another share purchase may be made.

According to our bylaws, we are not subject to the provisions of the Indiana Control Share Act. However, we are governed by certain other laws of the State of Indiana applicable to transactions involving a potential change of control of the Company.

Item 6. Selected Financial Data.

The selected financial information presented below for the five year period ended December 31, 2004, was derived from our Consolidated Financial Statements. This information should be read in conjunction with the Consolidated Financial Statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations.

	For the years ended December 31,
	2004		2003			2002			2001			2000
	$ Millions, except per share
Statements of Earnings Data
Net sales	$	8,438	$	6,296		$	5,853		$	5,681		$	6,597
Gross margin	1,680		1,123			1,045			1,013			1,267
Equity, royalty and other income from investees	111		70			22			10			7
Restructuring, impairment and other charges and (credits)	—		—			(8		)	126			154
Interest expense	113		90			61			77			87
Dividends on preferred securities of subsidiary trust	—		11			21			11			—
Cumulative effect of change in accounting principles, net of tax	—		(4		)	3			—			—
Net earnings (loss)	350		50			82			(103		)	14
Net earnings (loss) per share:
Basic	$	8.30	$	1.28		$	2.13		$	(2.70	)	$	0.35
Diluted	7.39		1.27			2.13			(2.70		)	0.35
Dividends declared per share	1.20		1.20			1.20			1.20			1.20
Balance Sheet Data
Total assets	$	6,527	$	5,126		$	4,837		$	4,311		$	4,448
Long-term debt	1,299		1,380			999			915			1,032
Mandatorily redeemable preferred securities	—		—			291			291			—
Shareholders’ equity	1,401		949			841			983			1,280

See Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Notes to Consolidated Financial Statements for a discussion of “Restructuring, impairment and other charges and (credits),” “Dividends on preferred securities of subsidiary trust,” “Long-term debt and short-term borrowings” and the “Cumulative effect of change in accounting principles.”

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is management’s discussion of the financial results, liquidity and capital resources, contractual obligations and commercial commitments, financial covenants and credit ratings, off balance sheet arrangements, financial guarantees, critical accounting estimates and other key items related to our business and performance. This section should be read in conjunction with our Consolidated Financial Statements and related notes in the “Financial Statements” section of this Annual Report on Form 10-K. Certain prior year amounts included in this section have been reclassified to conform to the current year presentation. All references to per share amounts are diluted per share amounts. Our discussion contains forward looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “RISK FACTORS RELATING TO OUR BUSINESS” included in Part I of this report and “Disclosure Regarding Forward-Looking Statements” presented at the end of this section.

OVERVIEW

Cummins is a global power leader comprised of four reportable complementary business segments: Engine, Power Generation, Filtration and Other and International Distributors. Our businesses design, manufacture, distribute and service diesel and natural gas engines and related technologies, including fuel systems, controls, air handling, and filtration, emissions solutions and electrical power generation systems. Our products are sold to original equipment manufacturers (OEMs), distributors and other customers worldwide. Major OEM customers include DaimlerChrysler, PACCAR, International Truck and Engine Corporation (Navistar), Volvo, Komatsu, Ford, Volkswagen, CNH Global and our joint venture partners in China (Dongfeng Cummins Engine Co. Ltd.) and India (Tata Cummins Limited). We serve our customers through a network of more than 550 company-owned and independent distributor locations and approximately 5,000 dealer locations in more than 160 countries and territories. Our business units share technology, customers, strategic partners, brands and our distribution network.

Our financial performance is affected by the cyclical nature and varying conditions of the markets we serve, particularly the automotive, construction and general industrial markets. Demand in these markets fluctuates in response to overall economic conditions and is particularly sensitive to changes in the price of crude oil (fuel costs), volume of freight tonnage, interest rate levels, non-residential construction spending and general industrial capital spending. Economic downturns in the markets we serve generally result in reductions in sales volume and pricing of our products and reduce earnings and cash flow. Although cyclicality is a factor in our business, the financial impact of it has been reduced somewhat by our geographical expansion, growth in our distributor business and improvements in our fixed cost structure that have resulted in a lower break-even point of our production costs.

FINANCIAL OVERVIEW

The table below sets forth our Consolidated Statements of Earnings data as a percentage of net sales for the years ended December 31:

	2004		2003		2002
Net sales	100.0	%	100.0	%	100.0	%
Cost of sales	80.1		82.2		82.1
Gross margin	19.9		17.8		17.9
Selling and administrative expenses	12.0		13.2		12.6
Research and engineering expenses	2.9		3.2		3.4
Equity, royalty and other income from investees	(1.3	)	(1.1	)	(0.4	)
Restructuring, impairment and other charges and (credits)	—		—		(0.1	)
Interest expense	1.3		1.4		1.0
Loss on early retirement of debt	—		—		0.1
Other income, net	(0.1	)	(0.3	)	(0.2	)
Earnings before income taxes, minority interests, dividends on preferred securities of subsidiary trust and cumulative effect of change in accounting principles	5.1		1.4		1.3
Provision (benefit) for income taxes	0.7		0.2		(0.7	)
Minority interests in earnings of consolidated subsidiaries	0.3		0.2		0.3
Dividends on preferred securities of subsidiary trust	—		0.1		0.4
Earnings before cumulative effect of change in accounting principles	4.1		0.9		1.3
Cumulative effect of change in accounting principles, net of tax	—		(0.1	)	0.1
Net earnings	4.1		0.8		1.4

Cummins experienced very strong performance in 2004 with record sales and earnings. Net earnings were $350 million, or $7.39 per share, on sales of $8.4 billion, compared to 2003 net earnings of $50 million, or $1.27 per share, on sales of $6.3 billion. The earnings improvement was driven by a 34 percent increase in net sales, primarily from our Engine Business and record sales at our Power Generation Business. Both segments experienced strong demand across respective automotive and industrial markets, with particularly strong demand in the North American heavy-duty truck market where engine sales were up 94 percent from the prior year and our market share increased significantly. Sales also increased in the Filtration and Other and International Distributor Businesses in 2004 compared to 2003 reflecting substantial improvement in demand and business conditions. Our joint ventures contributed $111 million in earnings in 2004 compared to $70 million in 2003, with the largest increase from our expanded joint venture in China, Dongfeng Cummins Engine Company (DCEC). Overall, 2004 was an exceptionally strong financial year for Cummins and we believe the programs we have in place position us for another good year in 2005.

BUSINESS OUTLOOK

Our Engine Business experienced much stronger than expected volumes in virtually all of its markets in 2004 and most economic indicators point toward continued improvement at a moderate pace in the North American heavy-duty truck market in 2005. We currently expect North American heavy-duty truck production levels to increase a minimum of 15 percent, from an estimated 245,000 units in 2004 to approximately 280,000 to 285,000 units in 2005. While 2004 demand was driven partially from fleets adding capacity as freight volume increased, the majority of the increase resulted from the replacement of aging vehicles. In 2005, we expect demand will be driven primarily by the economy as manufacturing and consumer spending levels increase and trucking fleets expand their capacity by adding equipment. We also expect sales of our midrange engines to the medium-duty markets to increase in 2005, as economic indicators for this market historically correlate with those of the heavy-duty market. Currently, we estimate

our engine volumes for the worldwide medium-duty truck market to increase 20 percent in 2005, including an increase in market share. Sales of our 5.9 liter turbo diesel engine to Daimler Chrysler for the Dodge Ram truck reached record levels in 2004 and we expect 2005 volumes will increase with the scheduled availability of our engine in the new Dodge Ram Mega Cab. We expect the Dodge Ram Heavy-Duty Cummins Turbo will continue to result in strong sales volumes as demand for diesel-powered light vehicles increases. Our industrial markets also experienced a strong recovery in 2004 and continued growth is expected through 2005, particularly overall demand from construction and mining OEMs.

Our Power Generation Business struggled financially in 2002 and 2003 as demand for global power generation declined, resulting in high inventory levels, over-capacity and market pricing pressures. In 2004, profitability returned to this segment based upon strong demand for commercial products in China and the Middle East, a significant increase in alternator sales to generator set OEMs, record sales of Onan branded generator sets to RV OEMs, our focus on cost reduction initiatives, benefits from restructuring and new product introductions. In 2005, we expect continued growth in commercial international markets for power generation and alternators and stronger growth in domestic markets. In our consumer business, we expect two new product launches, a portable generator set and a residential standby generator set, to offset a slight volume decline in RV generator sets. Overall, Power Generation revenues are expected to increase in 2005 with improved profitability for this segment.

In our Filtration and Other Business, our long term agreements with key customers executed in 2003 and 2004 provided excellent revenue growth in 2004 although our financial results were impacted by the dramatic rise in steel prices and capacity constraints in our exhaust manufacturing. We expect revenue growth to continue in 2005 and we also expect some growth in aftermarket revenues from new products released in 2004. Revenue from our Emission Solutions business is expected to increase in 2005 as we continue to gain market share in the domestic retrofit business. Overall, Filtration and Other Business revenues are expected to increase approximately 7 percent in 2005, and profitability is expected to improve as a result of cost reduction initiatives and the impact of pricing actions to offset steel cost increases.

In 2004, revenues improved in every geographic region and profitability was up significantly in our International Distributor Business. As the worldwide economy continues to improve and our engine population increases, we expect sales growth in engines, parts, service and power generation equipment and solid profit margins to continue in this business as we capitalize on a growing global customer base. We expect revenues to increase over 10 percent in 2005 from economic growth and increased profitability from higher sales volume, managed expenses and planned consolidations.

Income from our joint ventures is expected to continue to be strong in 2005, particularly in Asia, through our partnership, DCEC, which is a supplier to the second largest truck manufacturer in China, and in North America through our distributorship joint ventures.

We expect our businesses to generate sufficient cash from operations in 2005 to fund capital expenditures, research and development, pension funding, debt service costs and dividend payments. In addition, we expect cash outflows to fund our joint ventures will approximate $25 - $30 million in 2005. We have available various short and long-term credit arrangements, which are discussed below and disclosed in Note 11 to the Consolidated Financial Statements. These credit arrangements and other programs, such as our accounts receivable program, provide the financial flexibility, when needed, to satisfy future short-term funding requirements of our debt service obligations and projected working capital requirements. On March 1, 2005, we repaid our $225 million 6.45% notes on their maturity date from cash and cash equivalents on hand. With the exception of payments required under various operating and capital leases, principal and interest payments on notes issued by a consolidated VIE and our pension funding commitments, there are no major fixed cash payment obligations occurring until 2010 when our 9.5% Notes with principal amount of $250 million mature.

SIGNIFICANT EVENTS, TRANSACTIONS AND FINANCIAL TRENDS

Throughout this Management’s Discussion and Analysis we have disclosed significant events or transactions that had a material impact on our net earnings or segment EBIT, financial position and cash flows. In 2004, our net earnings benefited from significant tax events that likely will not recur with similar materiality or impact on our effective tax rate. Our 2004 tax expense was reduced by the following nonrecurring benefits:

· We reassessed the treatment of foreign tax credits previously recognized as tax deductions and used them as tax credits ($25 million),

· We amended prior years U.S. income tax returns and claimed additional export tax benefits ($11 million),

· We reversed valuation allowances related to state tax net operating losses that were no longer needed ($16 million), and

· We reduced our tax expense for a change in the estimated state income tax rate used to value deferred tax assets ($9 million).

Other significant events and transactions that occurred during 2004 were:

· We adopted certain provisions of FIN 46R as of March 28, 2004, which required us to consolidate the assets and liabilities of three variable interest entities previously accounted for under the equity method of accounting. As of April 25, 2004, we consolidated another entity under the provisions of FIN 46R. After eliminating intercompany transactions, our assets and liabilities as of December 31, 2004, increased $319 million and $251 million, respectively, and our net sales, gross margin and net earnings increased $145 million, $60 million and $0 million, respectively, for the year ended December 31, 2004 (see Note 2 to the Consolidated Financial Statements).

· Our gross margin and net earnings were negatively affected by the rising cost of steel and other commodities, primarily copper, manufacturing and logistics inefficiencies due to significant increases in production and supplier constraints to meet growing demand. Steel prices increased 50-60 percent during 2004 and it is likely they will remain high in the first half of 2005 although we expect increases to be less significant than those experienced in 2004. While our primary focus remains on controlling our costs through cost reduction efforts and Six Sigma projects, we have implemented pricing actions in our businesses to offset our current estimate of the impact of commodity prices in 2005. In addition, we have engaged in detailed capacity and throughput analysis work with many of our key suppliers to help them manage capacity constraint issues and have also developed a recovery plan to address our manufacturing and logistics inefficiencies.

· During 2004 we amended the master lease agreements related to two leases representing a majority of equipment leased in our PowerRent program. One of the lease amendments required us to retain full residual risk on the equipment and the other required us to repurchase the equipment at the end of the two-year non-cancelable lease terms. As a result, both leases are now classified as capital leases. The total addition to our Consolidated Balance Sheets as property, plant and equipment relating to the capital leases was $104 million and the balance of the capital lease obligations at December 31, 2004, was $103 million. (See Note 18 to the Consolidated Financial Statements).

· $6 million pre-tax gain amortization related to the early termination of interest rate swaps in 2001 and 2002.

Significant transactions included in 2003 earnings were:

· $7 million pre-tax gain amortization related to the early termination of interest rate swaps in 2001 and 2002, and

· $4 million after-tax charge for the cumulative effect of a change in accounting principle resulting from the consolidation of a variable interest entity.

Significant transactions included in 2002 earnings were:

· $57 million tax adjustment credit related to the settlement of U.S. income tax audits for the years 1992 through 1999,

· $8 million credit for excess costs of restructuring actions,

· $8 million pre-tax charge related to early extinguishment of debt,

· $4 million pre-tax gain amortization related to the early termination of interest rate swaps in 2001 and 2002, and

· $3 million after-tax credit for the cumulative effect of a change in accounting principle related to changing our pension measurement date.

RESULTS OF OPERATIONS

Net Sales

Net sales of our business segments for the years ended December 31, follows:

	2004			2003			2002
	$ Millions
Engine	$	5,500		$	3,631		$	3,435
Power Generation	1,877			1,329			1,226
Filtration and Other	1,484			1,056			951
International Distributor	856			669			574
Elimination of intersegment sales	(1,279		)	(389		)	(333		)
Total consolidated net sales	$	8,438		$	6,296		$	5,853

· Sales of our Engine Business increased $1,869 million, or 51 percent (38 percent excluding the change in transfer pricing discussed below under Business Segment Results), compared to the prior year, primarily due to strong demand from heavy- and medium-duty truck OEMs, increased shipments to Chrysler of light-duty engines for the Dodge Ram truck and higher engine shipments to industrial OEMs. Engine and part sales to automotive markets were 42 percent higher than 2003 with increased shipments in all market segments, except bus applications.

· Power Generation sales increased $548 million, or 41 percent, (45 percent excluding the change in transfer pricing discussed below under Business Segment Results) compared to the prior year, buoyed by strong demand for generator sets and alternators in international markets and continued robust demand for RV and other consumer power generation products.

· Sales in the Filtration and Other Business were up $428 million, or 41 percent, (21 percent excluding the change in transfer pricing discussed below under Business Segment Results) compared to the prior year, with improvements in most markets, but primarily driven by North American OEMs.

· Sales in our International Distributor Business increased $187 million, or 28 percent, compared to 2003, with moderate growth in engine, parts and service and strong demand for power generation products.

· Total sales in 2004 increased approximately $145 million from the consolidation of entities under FIN 46R (see Note 2 to the Consolidated Financial Statements).

Sales increased in all of our business segments in 2003 compared to 2002, with a majority of the increase occurring in the second half of the year as economic conditions strengthened and overall demand for our products improved.

· Engine Business sales increased $196 million, or 6 percent, primarily from higher engine sales to DaimlerChrysler for the Dodge Ram truck.

· Power Generation sales increased $103 million, or 8 percent, compared to the prior year, buoyed by strong fourth quarter demand.

· Sales in the Filtration and Other Business exceeded the $1 billion level, up $105 million, or 11 percent year-over-year, reflecting demand improvement and increased market penetration.

· Sales in our International Distributor Business increased $95 million, or 17 percent, compared to 2002, primarily from strong sales of engines and parts at our distributorships in Australia, Dubai and South Africa.

Gross Margin

Our gross margin was $1,680 million in 2004 compared to $1,123 million in 2003, with related gross margin percentages of 19.9 and 17.8, respectively. The majority of the change in year-over-year gross margin was a result of the following:

· higher engine shipments, particularly to the North American automotive and industrial markets, higher sales across our other three businesses ($525 million), and related absorption benefits on fixed manufacturing costs ($125 million),

· increased product coverage costs due to higher volumes ($69 million),

· higher material costs for copper and steel, net of price realization ($53 million),

· supplier inefficiencies resulting from higher volumes, including premium freight charges and overtime ($40 million),

· the impact of favorable currency exchange rates ($18 million), and

· one-time charge for inventory valuation ($9 million).

Approximately 11 percent of the increase in 2004 gross margin was a result of consolidating entities under FIN 46R (see Note 2 to the Consolidated Financial Statements).

Product coverage expense as a percent of net sales was 3.1 percent in 2004 compared to 3.0 percent in 2003. In the fourth quarter we revised our definition of product coverage expense to include only the cost of base engine warranty and exclude the costs of other marketing and extended warranty programs, the majority of which are purchased by customers. In our view, this definition is a more relevant and preferable measure than previously used and accordingly, we have presented base engine warranty expense as a percent of net sales for 2003 and 2002 on a comparable basis.

Gross margin increased $78 million in 2003, compared to 2002, on a net sales increase of $443 million and the related gross margin percentages were relatively flat at 17.8 percent. The gross margin on our new emissions compliant engine models was essentially flat compared to the pre-emission engines as the higher price of the new engine models was offset by incremental costs of new parts and components and higher accrual for product coverage costs. The gross margin percentage in 2003, however, appears lower as the gross margin dollar amount was measured against a higher sales value due to the pricing action. Base

engine warranty expense as a percentage of net sales was essentially flat year-over-year at 3.0 percent in 2003 and 3.1 percent in 2002.

Selling and Administrative Expenses

Selling and administrative expenses were $1,015 million, or 12.0 percent of net sales in 2004 compared to $830 million, or 13.2 percent of net sales in 2003, or an increase of $185 million, or 22 percent, year-over-year. The increase was comprised of $107 million for selling expenses (including $25 million from unfavorable foreign currency exchange rates) and $78 million for administrative expenses (including $9 million from unfavorable foreign currency exchange rates). The year-over-year increase in selling expenses was a result of the following:

· higher compensation expense and fringe benefits from incremental staffing ($47 million),

· increases in marketing program expenses including travel and entertainment ($18 million) and other volume variable expenses that individually were not significant, and

· increased variable compensation from improved financial performance ($14 million).

The increase in administrative expenses was attributable to the following:

· increased variable compensation from improved financial performance ($35 million),

· higher compensation and fringe benefits from incremental staffing ($15 million), and

· increased consulting expenses, primarily Sarbanes-Oxley implementation costs ($14 million).

Fluctuations in foreign exchange rates had an unfavorable impact on 2004 selling and administrative expenses, primarily due to changes in the Pound Sterling ($16 million), Australian dollar ($7 million) and the Euro ($5 million). Approximately $34 million, or 18 percent, of the increase in selling and administrative expenses resulted from consolidating entities under FIN 46R (see Note 2 to the Consolidated Financial Statements).

In 2003, selling and administrative expenses were $830 million (13.2 percent of net sales) compared to $736 million (12.6 percent of net sales) in 2002. Included in the increase was $28 million from the impact of foreign exchange rate changes at our foreign entities. Of the total increase, approximately $56 million was related to selling expenses and $38 million to administrative expenses. The increase in selling expense was attributable to the following:

· higher compensation expense from incremental sales staffing ($13 million),

· funding of growth initiatives including outside consulting services ($11 million),

· increases in fringe expenses including pensions ($9 million),

· increases in variable incentive compensation due to improved segment financial performance ($7 million), and

· other volume variable expenses that individually were not significant.

The increase in administrative expenses resulted from the following:

· higher fringe benefit expenses, primarily pensions ($9 million),

· increases in audit and non-audit services ($9 million) resulting from a reaudit of the 2001 and 2000 Consolidated Financial Statements,

· increases in legal fees ($7 million),

· higher salaries and wages from staffing increases ($5 million), and

· and other miscellaneous items that individually are not significant.

Research and Engineering Expenses

Research and engineering expenses were $241 million (2.9 percent of net sales) in 2004 compared to $200 million (3.2 percent of net sales) in 2003, or an increase of $41 million or 21 percent. A majority of the increase was a result of the following:

· increased variable compensation from improved earnings ($13 million),

· higher spending on 2005 and 2007 product development programs ($11 million),

· increased compensation and fringe benefit expenses from incremental staffing ($9 million), and

· other general research and developmental expenses, none of which were individually significant.

The increase includes $3 million unfavorable impact from foreign currency exchange rates and $4 million from consolidating entities under the provisions of FIN 46R (see Note 2 to the Consolidated Financial Statements).

Research and engineering expenses were $200 million (3.2 percent of net sales) in 2003 compared to $201 million (3.4 percent of net sales) in 2002, or a decrease of $1 million. Significant items comprising the year-over-year change follows:

· decreased salary and wages ($10 million),

· reduced spending on heavy-duty development program following the introductory launch of our new emissions compliant engines in 2002 ($14 million),

· decreased expenses related to development costs of our European Engine Alliance joint venture ($10 million),

· partially offset by increased development work and testing on Euro emissions and on Tier II and III industrial emissions engines ($20 million),

· increased fringe expenses, primarily pension expense ($5 million), and

· other expenses that individually were not material.

Equity, Royalty and Other Income from Investees

Earnings from our joint ventures and equity method investees were $111 million in 2004 compared to $70 million in 2003, an increase of $41 million, or 59 percent. The year-over-year increase was attributable to improved earnings across most of our joint ventures, including the following:

· our expanded joint venture in China, DCEC ($20 million),

· our North American distributor joint ventures ($9 million),

· our joint venture in India, Tata Cummins Ltd ($2 million), and

· Cummins MerCruiser, our marine joint venture ($2 million).

Income from royalties and technical fees, which included a one-time $2 million fee from a China joint venture, was $12 million in 2004 compared to $5 million in 2003.

Earnings from our joint ventures and alliances were $70 million in 2003 compared to $22 million in 2002, an increase of $48 million. The year-over-year increase was attributable to improved earnings at most of our joint ventures including the following:

· DCEC ($20 million),

· North American distributor joint ventures ($9 million),

· The European Engine Alliance ($5 million),

· Chongqing Cummins Engine Company Ltd. ($4 million),

· Tata Holset and Tata Cummins Ltd. ($4 million), and

· Cummins MerCruiser ($3 million).

Royalty income from joint ventures and alliances increased $3 million in 2003 compared to 2002.

Restructuring, Impairment and Other Charges and (Credits)

Through the end of 2002, we continued a restructuring program initiated in 1998 to improve our cost structure. The charges related to this program included staffing reductions and reorganizations in various business segments, asset impairment write-downs for manufacturing equipment, facility closure and consolidation costs, dissolution costs and restructuring actions related to joint venture operations, cancellation of a new engine development program and exit costs related to several small business operations.

Our 2002 results included a net $8 million credit related to restructuring programs comprised of a net $2 million charge in the second quarter and a $10 million reversal of excess accruals in the fourth quarter. The second quarter charge included $16 million for restructuring actions recognized in the quarter, offset by a $14 million reversal of excess accruals. The excess accruals resulted from realigning or canceling restructuring actions taken in 2001 and 2000. The $16 million second quarter charge included the following:

· $11 million attributable to workforce reductions,

· $3 million for asset impairment, and

· $2 million related to facility closures and consolidations.

The workforce reduction included severance costs and related benefits of terminating approximately 220 salaried and 350 hourly employees and was based on amounts pursuant to established benefit programs or statutory requirements of the affected operations. The overall workforce reductions were a result of closing operations and moving production to available capacity. The asset impairment charge related to equipment available for disposal. The carrying value of the equipment and the effect of suspending depreciation on the equipment were not significant. In the fourth quarter of 2002, the number and mix of employees terminated under this program differed from our original estimate and we reversed approximately $1 million of excess accruals for severance costs and benefits. Approximately 210 salaried and 350 hourly employees were terminated under this plan.

Note 19 to the Consolidated Financial Statements includes a schedule that presents by major cost component, activities related to the 2002 restructuring action, including adjustments to the original charges. All restructuring actions were completed as of December 31, 2003.

Interest Expense

Interest expense was $113 million in 2004, an increase of $23 million compared to $90 million in 2003. The increase was primarily due to the following:

· the consolidation of entities under the provisions of FIN 46R ($12 million), and

· interest related to certain capital leases for power generation equipment ($2 million).

In addition to the above, the adoption of SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” required prospective classification of dividends on our preferred securities as interest expense in our Consolidated Statement of Earnings effective July 1, 2003. Including dividends on our preferred securities, interest expense increased $11 million in 2004 compared to 2003. The preferred securities are no longer reported as an obligation in our Consolidated Balance Sheet due to the adoption of FIN 46R (see Notes 2 and 11 to the Consolidated Financial Statements), rather, the convertible subordinated debentures issued by us and representing the sole assets of the trust issuing the securities, are now classified as long-term debt in our Consolidated Balance Sheets.

Interest expense was $90 million in 2003 compared to $61 million in 2002. Most of the increase resulted from the following:

· higher debt levels ($15 million),

· higher borrowing rates ($7 million) on our 9.5% Senior Notes issued in November 2002, and

· required presentation of dividends on our preferred securities as interest expense ($11 million) effective July 1, 2003, in accordance with a new accounting standard (see Note 11 to the Consolidated Financial Statements).

The amount of interest paid in 2004, 2003 and 2002 was $113 million, $90 million and $52 million, respectively.

Other Income, net

Other income, net was $10 million, $18 million and $9 million income in 2004, 2003 and 2002, respectively and includes losses on asset sales, impairment losses, foreign currency exchange, interest income, royalty income and other miscellaneous income and expense items. Other income decreased in 2004 compared to 2003 primarily due to losses on the sale of fixed assets and investment write-downs, partially offset by higher royalties from increased sales volumes and higher technology income from joint venture partners. The major components of other income and expense, segregated between operating items and non-operating items, are disclosed in Note 20 to the Consolidated Financial Statements.

Provision (Benefit) for Income Taxes

Our income tax provision was $56 million in 2004, compared to a $12 million provision in 2003 and a $38 million income tax benefit in 2002. The higher 2004 tax provision reflects the increase in profit before taxes. Our effective tax rate is normally below the U.S. corporate income tax rate of 35 percent, primarily because of research tax credits and reduced taxes on export earnings. Our 2004 effective tax rate of 13 percent is unusually low not only because of the normal favorable effects of research credits and export tax benefits, but also because of the following nonrecurring benefits:

· As a result of continued earnings improvement and improved economic outlook, we reassessed the treatment of 2002 and 2003 foreign tax credits previously recognized as tax deductions and determined they could be used as full tax credits. The more favorable treatment of these credits reduced our 2004 income tax provision by $25 million.

· As a result of improved cash flow during 2004, we filed amended U.S. income tax returns to claim additional export tax benefits related to prior years which we had previously forgone to avoid the associated tax payments required on the non-exempt export income of our foreign sales corporation. These additional export tax benefits related to prior years reduced our 2004 income tax provision by $11 million.

· The 2004 earnings improvement also caused us to reassess our ability to realize state tax benefits from net operating losses generated in prior years. Previously, we had provided a valuation allowance to reduce the recorded tax value of these loss carryforwards to a lower estimated realizable value. Our reassessment determined that $16 million of this allowance was no longer needed and was recorded as a reduction of our 2004 income tax expense.

· In conjunction with our reassessment of the realizable value of state tax benefits, we also recognized a change in the estimated average state income tax rate used to value our deferred tax assets. This rate change reduced our 2004 income tax expense by $9 million.

Excluding the unusual or nonrecurring benefits described above, our 2004 effective tax rate was 27 percent. This rate was lower than the 35 percent U.S. tax rate, primarily because of export tax benefits and research tax credits generated by 2004 operations. We expect our 2005 effective tax rate to be higher than this, but still well below 35 percent. The American Jobs Creation Act of 2004 phases out the export tax benefits (reduced 20 percent for 2005) that have been a key factor in our low tax rate. However, those benefits are replaced with a new U.S. manufacturer’s tax deduction which phases in beginning in 2005. The Jobs Act also includes a special one-year 85 percent deduction for qualifying dividends repatriated from foreign operations. Generally, the special 2005 repatriation rules are only beneficial on very low-taxed foreign earnings. We are reviewing the possible application of the rules to some foreign joint venture repatriations that could potentially reduce our 2005 income tax provision by $5 million to $10 million.

The 2002 income tax benefit included a one-time, $57 million favorable tax adjustment credit related to the settlement of U.S. Internal Revenue Service income tax audits for tax years 1994 through 1999.

The amount of income taxes paid in 2004, 2003 and 2002 was $87 million, $50 million and $30 million, respectively. Note 9 to the Consolidated Financial Statements contains a complete disclosure of our income taxes including a reconciliation of the income tax provision (benefit) that would be expected using the 35 percent U.S. Federal income tax rate to the actual income tax provision (benefit) recorded.

Minority Interests in Earnings of Consolidated Subsidiaries

Minority interests in our consolidated operations were $26 million in 2004, compared to $14 million in 2003 and $16 million in 2002. Approximately one-half of the increase in 2004 compared to 2003 resulted from higher earnings at Wuxi Holset Ltd ($3 million), a 55 percent owned subsidiary, and Cummins India Limited ($4 million), a 51 percent owned-subsidiary. The remainder of the increase in minority interests is attributable to consolidating the results of four entities under the provisions of FIN 46R (See Note 2 to the Consolidated Financial Statements). The decrease in 2003 compared to 2002 is a result of lower earnings at Wuxi Holset and Cummins India Limited, partially offset by income from our 60 percent-owned subsidiary in Brazil, Cummins Powerent Comericio e Locação, Ltda.

Dividends on Preferred Securities

Dividends on our preferred securities were $11 million in 2003 and $21 million in 2002. Effective July 1, 2003, these dividends were prospectively classified as interest expense in our Consolidated Statements of Earnings in accordance with SFAS 150. A description of our obligation relating to these preferred securities is provided in Note 11 to the Consolidated Financial Statements.

Cumulative Effect of Change in Accounting Principles

Consolidation of a Variable Interest Entity—2003

In 2001, we entered into a sale-leaseback agreement whereby we sold and leased back heavy-duty engine manufacturing equipment from a grantor trust wholly-owned by a financial institution. In December 2003, the grantor trust, which acts as a lessor in the sale-leaseback transaction, was consolidated

when we adopted FIN 46R. Under FIN 46R, the lessor trust was deemed a variable interest entity (VIE) and we were deemed the primary beneficiary of the trust by virtue of our guaranteeing the leased equipment’s residual value. Accordingly, we recorded the cumulative effect of consolidating the VIE in our Consolidated Financial Statements as a change in accounting principle as of December 31, 2003, with the following impact:

· reduced earnings $6 million ($4 million after-tax, or $0.09 per share) which represents the reversal of the original sale-leaseback transaction (as if it had not occurred), and the consolidation of the VIE from the inception of the lease, and

· increased property, plant and equipment by a net $92 million (current carrying value as if it had been depreciated since the beginning of the lease) and increased long-term debt, other liabilities and minority interests by a net $98 million.

Our Consolidated Statement of Earnings in 2004 also included interest expense on the lessor’s debt of $7 million and depreciation expense on the equipment of $11 million rather than rent expense. The effect of consolidating this VIE in 2004 reduced our pre-tax earnings by approximately $5 million which represents the difference between the sum of interest and depreciation expense recorded in 2004 and rent expense that would have been recorded prior to consolidation. See Note 2 to the Consolidated Financial Statements for a description of the change in accounting and Note 18 for a description of the original leasing transaction. The consolidation of the VIE did not impact 2003 Consolidated Statements of Earnings, other than the cumulative effect at December 31, 2003, nor did it affect compliance with any of our debt covenants.

Change in Pension Measurement Date—2002

During the fourth quarter of 2002, we changed the measurement date for measuring the return on assets invested in our pension plans and the minimum liability for pension plan obligations from September 30 to November 30. This change in measurement date aligns more closely with our fiscal year-end, and we believe provides a more current measurement of plan obligations and investment return on plan assets than previously presented. In accordance with GAAP, we have reported this change in our Consolidated Statements of Earnings as a change in accounting principle. The cumulative after-tax effect of the change increased 2002 earnings $3 million, or $0.07 per share, and was recorded as of January 1, 2002. See Note 12 to the Consolidated Financial Statements for a further discussion of this accounting change.

BUSINESS SEGMENT RESULTS

We have four reportable business segments: Engine, Power Generation, Filtration and Other and International Distributors. This reporting structure is organized according to the products and markets served by each segment and allows management to focus its efforts on providing enhanced service to a wide range of customers. We evaluate the performance of each of our business segments based on earnings before interest, taxes, minority interests, and cumulative effect of accounting changes (Segment EBIT) and return on average net assets (excluding debt, taxes and adjustments to the minimum pension liability).

Prior to January 1, 2004, intersegment transfers between the Engine segment and the Power Generation segment and between the Filtration and Other segment and the Engine segment were recorded at cost and a sale was not recorded by the transferor segment. Effective January 1, 2004, all intersegment sales of the transferor segments were recorded at a market-based transfer price discounted for certain items. Unit shipments are now also reflected in the sales volumes of the transferor segments. Certain intersegment cost allocations to the transferor segments have also been eliminated. In addition, certain engines manufactured by the Engine segment and sold to International Distributors through Power Generation were previously recorded as a sale by Power Generation; however, under the new methodology Power Generation now records a sale commission on such sales. We believe this change allows our

segment management to focus on those pricing decisions and cost structuring actions within their control. The impact of this change in methodology to 2004 segment results follows:

· Engine Business sales increased $502 million,

· Filtration and Other Business sales increased $205 million,

· Power Generation sales decreased $44 million, and

· Intersegment sales eliminations increased $663 million.

The net impact of this change did not have a material effect on segment EBIT for any of our segments. Segment results for 2003 and 2002 were not restated to reflect the change to market-based transfer pricing as it was impracticable to do so.

Engine

The net sales and segment EBIT for the Engine Business for the years ended December 31, were as follows:

	2004		2003		2002
	$ Millions
Net sales	$	5,500	$	3,631	$	3,435
Segment EBIT	$	341	$	70	$	49

Net sales for this business increased $1,869 million, or 51 percent, in 2004 compared to 2003. The increase was primarily due to the economic recovery evidenced by strong demand across all market sectors, particularly the North American heavy-duty and medium-duty truck markets and the light-duty automotive market with record engine sales to DaimlerChrysler for the Dodge Ram truck. Total automotive-related engine sales were 67 percent of Engine Business sales in 2004 compared to 71 percent in 2003.

Net sales for this business increased $196 million, or 6 percent in 2003 compared to 2002. The increase was primarily due to strong sales of ISB engines to DaimlerChrysler for the Dodge Ram truck.

Segment EBIT increased $271 million in 2004, to almost five times segment EBIT in 2003. The year-over-year improvement was primarily a net result of the following:

· Improved gross margin resulting from higher engine volumes and service part sales and the accompanying benefits of fixed cost absorption at our manufacturing plants along with the consolidation of heavy-duty test and assembly operations ($458 million),

· increased selling and administrative expenses ($96 million) and research and engineering expenses ($29 million),

· higher product coverage expense from increased sales volumes ($59 million),

· steel surcharges ($28 million) from higher steel prices, and

· premium freight costs ($17 million).

In addition, income from joint ventures increased $34 million compared to 2003, primarily from higher volumes and earnings at our China joint venture, DCEC, and earnings from our North American distributorships.

In 2003, segment EBIT increased $21 million, or 43 percent, compared to 2002. The year-over-year improvement in earnings was primarily a net result of the following:

· higher earnings from joint ventures and alliances ($41 million) resulting from higher sales volumes from DCEC and North American distributors,

· increased selling and administrative expenses ($38 million) resulting from higher pension cost and higher variable compensation as a consequence of earnings improvement,

· higher engine volumes and the accompanying benefits of fixed cost absorption at our manufacturing plants and our consolidation of heavy-duty test and assembly operations ($20 million), and

· reduced spending for research and development following the launch of our 2002 emissions-compliant engines ($7 million).

A summary and discussion of Engine Business net sales by market for the years ended December 31, follows:

	2004		2003		2002
	$ Millions
Heavy-Duty Truck	$	1,741	$	1,100	$	1,069
Medium-Duty Truck and Bus	773		560		599
Light-Duty Automotive	1,176		935		781
Total Automotive	3,690		2,595		2,449
Industrial	1,288		1,036		986
Stationary Power	522		n/a		n/a
Total net sales	$	5,500	$	3,631	$	3,435

Unit shipments increased 98,600 units, or 31 percent, in 2004 compared to unit shipments a year earlier. Unit shipments in 2003 increased 9,600 units, or 3 percent, compared to 2002 shipments. A summary of unit shipments by engine category for the three years ended December 31, follows:

	2004	2003	2002
Midrange	331,200	266,800	251,100
Heavy-Duty	80,500	47,400	53,600
High-Horsepower	4,700	3,600	3,500
Total unit shipments	416,400	317,800	308,200

Heavy-Duty Truck

Sales to the heavy-duty truck market increased significantly in 2004, up $641 million, or 58 percent, compared to 2003. The increase resulted from strong demand in the North American truck industry driven primarily by economic growth and related increase in freight tonnage and higher replacement demand for trucks. Unit shipments of heavy-duty truck engines were up 84 percent in 2004 compared to 2003 with North American shipments up 97 percent and international shipments up 26 percent.

In 2003, sales to the heavy-duty truck market increased $31 million, or 3 percent, compared to 2002 sales. The increase was primarily attributable to a modest recovery in the North American truck industry evidenced by strong demand at the end of the year as fourth quarter sales increased 15 percent compared to the previous quarter. Unit shipments of heavy-duty truck engines declined 14 percent in 2003 compared 2002. The decline was a result of significant pre-buy activity prior to the North American October 1, 2002, EPA emissions standards. The volume decline in 2003 unit shipments was more than offset by higher unit pricing for our new ISX and ISM emissions compliant engines and higher part sales.

Medium-Duty Truck and Bus

Medium-duty truck and bus revenues increased $213 million, or 38 percent, in 2004 compared to 2003. Shipments of medium-duty truck engines were up 93 percent to North American OEMs and up 36 percent to international OEMs compared to 2003. The increase in medium-duty truck engine shipments was driven primarily by economic growth as demand in this market typically correlates with demand in the heavy-duty market. Worldwide shipments of bus engines were down 10 percent in 2004 compared to 2003. Most of the decline occurred in international markets with some demand recovery in China where volumes were up compared to 2003. However, lower sales to India and Europe/CIS more than offset the increase.

In 2003, medium-duty truck and bus revenues declined $39 million, or 7 percent, compared to 2002. The majority of the decrease resulted from declining bus engine sales as engine sales for medium-duty trucks were essentially flat compared to 2002. Worldwide bus engine sales declined 37 percent in 2003 and unit shipments were down 39 percent, primarily in North America, due to declining market share from a major bus OEM and also lower engine sales to China where sales were replaced by sales from one of our joint ventures in China.

Light-Duty Automotive

Sales of light-duty automotive engines increased $241 million, or 26 percent, in 2004 compared to 2003. Total unit shipments were 178,000 in 2004, an increase of 18 percent compared to 2003. Most of the increase in light-duty automotive sales was driven by strong demand from DaimlerChrysler for Dodge Ram truck engines with record shipments of 154,300 units, or a 20 percent increase compared to 2003. Engine shipments to recreational vehicle OEMs decreased slightly, down 3 percent in 2004 compared to 2003, partially as a result of higher shipments in 2003 in advance of new product introductions and slightly lower market share in 2004.

In 2003, sales from our light-duty automotive engines increased $154 million, or 20 percent, compared to 2002. Total unit shipments in 2003 were 150,300, an increase of 21 percent compared to the prior year. Engine shipments to DaimlerChrysler for the Dodge Ram truck set a record in 2003, increasing 28 percent, compared to the prior year, primarily driven by increased demand and market share improvement. Unit shipments of medium-duty engines to the recreational vehicle market declined 13 percent year-over-year, reflecting a pre-buy of engine models in 2002 prior to the new emissions standards.

Industrial

Total industrial sales to the construction, agricultural, mining, marine, government, oil and gas and rail markets increased $252 million, or 24 percent, in 2004 compared to 2003. Unit shipments increased 26 percent year-over-year reflecting a slight change in sales mix to lower-priced engines. Approximately 42 percent of the shipments were to North American markets and 58 percent to international markets compared to 39 percent and 61 percent, respectively, in 2003. Overall growth in industrial markets was driven by strong demand in 2004 as the capital goods sector of the economy experienced a significant recovery. The year-over-year increase in sales resulted primarily from the following:

· Engine sales to the construction market increased 25 percent year-over-year with shipments to North American OEMs up 41 percent and shipments to international OEMs up 20 percent,

· Engine sales to agricultural equipment OEMs increased 18 percent in 2004 compared to 2003 with a 15 percent increase in North American shipments and a 1 percent increase in shipments to international OEMs,

· Engine sales to the mining equipment market, comprised mostly of high-horsepower engines, were up 56 percent in 2004, driven primarily by higher coal and metal prices. Engine shipments to mining OEMs in North America increased 59 percent and were up 44 percent to international OEMs,

· Engine sales to the commercial marine market increased 24 percent year-over-year while shipments increased 9 percent evidencing a higher mix of sales to higher priced engines,

· Engine sales to government markets, primarily for military use, were relatively flat year-over-year,

· Engine shipments to the OEMs in the oil and gas market were up significantly in 2004 compared to a low base in 2003 as our QSK engine continues to be well received in this relatively new market, and,

· Engine sales to rail equipment OEMs, primarily railcar builders in international locations, increased 64 percent in 2004 compared to 2003, indicating strong demand for this market segment.

In 2003, total industrial sales increased $50 million, or 5 percent compared to 2002, while shipments were down 2 percent year-over-year, reflecting a change in sales mix to higher-priced engines. The year-over-year increase was attributable to the following:

· Sales to construction equipment OEMs increased 9 percent in 2003 compared to 2002 with shipments to North American OEMs down 10 percent and shipments to international OEMs up 9 percent,

· Total 2003 engine shipments to the agricultural equipment market increased 9 percent compared to 2002 with a 32 percent increase to international OEMs due to strong demand in Latin America,

· Engine shipments to mining equipment OEMs, primarily K and Q series high-horsepower engines, were down 6 percent to OEMs in North America but were more than offset by a 44 percent increase from international OEMs, primarily due to market share gain,

· Engine shipments to the marine market declined 20 percent in 2003 compared to 2002, partially as a result of our new joint venture with Brunswick Corporation, Cummins MerCruiser Diesel Marine LLC, which records sales of our midrange and heavy-duty engines for recreational marine applications,

· Engine sales to government markets increased 59 percent in 2003,

· Engine shipments to the recently entered oil and gas equipment market were up significantly in 2003, primarily from market share gains in North America, and

· Shipments of engines to railcar builders declined 30 percent in 2003, as a result of weak demand.

Stationary Power

Engine Business sales to stationary power markets were $522 million in 2004. This new sales category arose from a change in 2004 where all intersegment engine sales from the Engine Business to the Power Generation Business are recorded at a market-based transfer price. Prior to 2004, intersegment transfers were recorded at cost and a sale was not recorded by the Engine Business. Segment financial results for 2003 and 2002 were not restated to reflect this change as it was impracticable to do so.

Power Generation

The net sales and segment EBIT for Power Generation for the years ended December 31, were as follows:

	2004		2003			2002
	$ Millions
Net sales	$	1,877	$	1,329		$	1,226
Segment EBIT	$	69	$	(15	)	$	(25	)

Net sales for this business increased $548 million, or 41 percent, compared to 2003 (excludes $44 million attributable to the change in intersegment transfer pricing). A majority of the sales increase was driven by improved economic conditions in the commercial, consumer and alternator product markets as follows:

· Unit shipments of commercial generator drives (g-drives) and generator sets (gen sets), alternators, and gen sets for the consumer and mobile/RV markets increased significantly in 2004 as a result of strong demand,

· Year-over-year gen set sales increased 38 percent,

· G-drive sales were up 47 percent,

· Revenues from alternators increased 110 percent, and

· Sales in the consumer mobile/RV market increased 20 percent.

Approximately $90 million of the sales increase resulted from the consolidation of new entities, including those consolidated under the provisions of FIN 46R.

Net sales in our Power Generation Business increased $103 million, or 8 percent, in 2003 compared to 2002. A majority of the sales increase occurred in the second half of the year, as general economic conditions improved and demand for commercial power equipment began to recover. Overall, sales of generator drives increased 22 percent, alternator sales increased 24 percent, sales of small generator sets to the consumer mobile/RV market increased 8 percent and sales of commercial generator sets were flat year-over-year.

A summary of engine shipments used in power generation equipment by engine category for the years ended December 31, follows:

	2004	2003	2002
Midrange	16,800	14,000	14,000
Heavy-duty	6,700	5,300	4,300
High-horsepower	7,400	5,200	5,400
Total unit shipments	30,900	24,500	23,700

Total Power Generation shipments increased 6,400 units, or 26 percent, compared to 2003.

· Unit shipments of power generation equipment with midrange engines increased 20 percent:

· g-drive midrange powered units increased 8 percent in 2004 compared to 2003, and

· midrange powered g-sets increased 35 percent with strong demand in East Asia.

· Unit shipments of power generation equipment with heavy-duty engines increased 1,400 units, or 26 percent compared to 2003:

· g-drive heavy-duty powered units increased 27 percent, and

· heavy-duty powered g-sets increased 31 percent with strong demand in Asia, the Middle East and Europe.

· Unit shipments of power generation equipment with high-horsepower engines that typically have higher sales values, increased 2,200 units, or 42 percent, in 2004 compared to 2003:

· high-horsepower g-drive units increased 36 percent, and

· high-horsepower g-sets increased 53 percent year-over-year, primarily due to strong demand in Middle East, India and China.

Total unit sales for Power Generation increased 800 units, or 3 percent, in 2003 compared to 2002.

· Unit shipments of power generation equipment with midrange engines were unchanged compared to 2002.

· Unit shipments of power generation equipment with heavy-duty engines increased 1,000 units, or 23 percent compared to 2002:

· g-drive units increased 23 percent, and

· g-sets increased 17 percent.