UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.20549

FORM 10-Q

 Commission File Number 1-4949

CUMMINS INC.

(Exact name of registrant as specified in its charter)

            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 oX   No Xo

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

            As of June 27,September 26, 2004, there were 44.3 million45,517,087 shares of $2.50 par value per share common stock outstanding.

CUMMINS INC. AND CONSOLIDATED SUBDIARIESSUBSIDIARIES
TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 27,SEPTEMBER 26, 2004

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PART 1.I.  FINANCIAL INFORMATION

   ItemITEM 1. Financial Statements

The accompanying notes are an integral part of the consolidated financial statements.

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 * Derived from audited financial statements.  

The accompanying notes are an integral part of the consolidated financial statements.

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The accompanying notes are an integral part of the consolidated financial statements.

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CUMMINS INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1.  Basis of Presentation

                General

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 have prepared our Consolidated Financial Statements for the three-monththird quarter and six-monthnine month interim periods ended June 27,September 26, 2004 and June 29,September 28, 2003, in conformity with accounting principles generally accepted in the United States of America (GAAP) and the rules and regulations of the Securities and Exchange Commission (the "SEC").  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted as permitted by such rules and regulations.  Each three-monththird quarter and six-monthnine month interim periodperiods contains 13 weeks and 2639 weeks, respectively.

Our interim financial statements are unaudited and include estimates and assumptions that affect reported amounts based upon currently available information and management's judgment of current conditions and circumstances. GAAP requires management to make certain estimates and judgments that are reflected in the reported amounts of assets, liabilities, revenues and expenses and also in the disclosure of contingent liabilities.  The actual results may differ from the estimates.  Management exercises judgment and makes estimates for allowance for bad debts, inventory obsolescence, product warranty, asset impairment, depreciation, pension and post retirement benefits, income taxes, litigation and other contingencies. Management reviews these estimates on a systematic basis and, if necessary, any material adjustments are reflected in the Consolidated Financial StatementsStatements.   .   You should read these interim financial statements in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2003.  Our interim period financial results for the three-monththird quarter and six-monthnine month periods presented are not necessarily indicative of results to be expected for any other interim period or for the entire year. 

We believe our Consolidated Financial Statements include all adjustments of a normal recurring nature, necessary for a fair statement of our financial position, results of operations and cash flows for the interim periods presented. 

We have reclassified certain amounts in prior period financial statements to conform to the presentation of the current period financial statements.

Shipping and Handling Costs 

Our shipping and handling costs are expensed as incurred.  The majority of these costs are associated with operations of our inventory distribution centers and warehouse facilities and are classified as "Selling and administrative expenses" in our Consolidated Statements of Earnings.  For the three-monthsthird quarter ended June 27,September 26, 2004 and June 29,September 28, 2003, these costs were approximately $31$30 million and $23$22 million, respectively.  For the sixnine months ended June 27,September 26, 2004 and June 29,September 28, 2003, these costs were approximately $57$87 million and $42$64 million, respectively.

Employee Stock Plans       

We changed our method of accounting on January 1, 2003, for stock-based employee awards to the fair value method preferred by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-based Compensation" (SFAS 123). We made this change on a prospective basis only for option grants or other stock awards made on or after January 1, 2003.  For awards granted prior to January 1, 2003, we follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), as allowed under SFAS 123.  Under APB 25, we did not record compensation expense upon the issuance of stock options because the exercise price of stock options granted equaled the market price of the common stock on the grant date.  The pro forma compensation expense for stock awards granted prior to January 1, 2003, using the fair market value approach was not significant for the three-monthsthird quarter and six-monthsnine months ended June 27,September 26, 2004 and June 29,September 28, 2003. 

Note 2.  Variable Interest Entities

In January 2003, the FASBFinancial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities," an Interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements" (FIN 46). In December 2003, the FASB issued a revised version of FIN 46 (FIN 46R).  FIN 46R provides guidance related to evaluating, identifying and reporting of variable interest entities (VIEs), including entities commonly referred to as SPEs.  FIN 46R requires us to consolidate certain VIEs if we are deemed to be the primary beneficiary, defined in FIN 46R, as the entity that absorbs a majority of the VIEs expected losses, receives a majority of the entity's expected residual returns, or both.   We adopted FIN 46R as of December 31, 2003, for entities previously considered to be SPEs under GAAP and for new entities created on or after February 1, 2003.  The adoption of FIN 46R in 2003 required us to consolidate a VIE that was previously unconsolidated and to deconsolidate a VIE that was previously consolidated in our Consolidated Financial Statements. The impact of adopting FIN 46R as of December 31, 2003 was discussed in Note 2 to the Consolidated Financial Statements included in our 2003 Annual Report on Form 10-K.

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In addition to the VIEs discussed in Note 2 of our Annual Report on Form 10-K, we have variable interests in other businesses including businesses accounted for under the equity method of accounting and certain North American distributors that are deemed VIEs and are subject to the provisions of FIN 46R.  We adopted FIN 46R for these entities as of March 28, 2004.  The adoption of those FIN 46R provisions in 2004 required us to consolidate the assets and liabilities of three entities that were previously included in our Consolidated Balance Sheets as "Investments in and advances to equity investees."  First quarter results for these entities are reflected as "Equity, royalty and other income from investees" in our Consolidated Statements of Earnings.Earnings. 

Two of the three VIEs that were consolidated, Consolidated Diesel Corporation (CDC) and Cummins Komatsu Engine Corporation (CKEC), are engine manufacturing entities jointly owned and operated by us and our equity partners.  We were deemed the primary beneficiary of these VIEs due to the pricing arrangements of purchases and the substantial volume of purchases we made from these VIEs.  Our arrangements with CDC are more fully described in Note 5 to the Consolidated Financial Statements of our 2003 Annual Report on Form 10-K.  As of June 27,September 26, 2004, CDC has approximately $85 million of debt which is collateralized by substantially all of its inventory and fixed assets with a current book value of $24$31 million and $186$190 million, respectively.  CKEC has approximately $6 million of unsecured debt, which is due the other equity partner.  Creditors of these entities have no recourse to the general credit of Cummins. 

The other VIE that was consolidated was AVK/SEG, a German holding company that directly owned shares of AVK and SEG and was jointly owned by Cummins (50 percent) and other equity partners.  AVK manufactures alternators and SEG manufactures power electronic components.  We were deemed the primary beneficiary of this VIE due to the existence of a call/guarantee arrangement on an additional 13 percent ownership interest in the entity and our guarantee on portions of the entity's subordinated debt.  During the second quarter, AVK/SEG was liquidated and its shares in AVK and SEG were distributed directly to Cummins and the other equity partners.  As a result of the liquidation, Cummins owns 100 percent of AVK and 25 percent of SEG.  This transaction was accounted for as an acquisition of a minority interest in AVK (via a non-monetary exchange of shares) and was recorded at fair value, resulting in a nominal gain (less than $1 million after-tax).  SEG continues to be consolidated under FIN 46R due to the existence of the call/guarantee arrangement discussed above and loans provided by Cummins to SEG.  An agreement with the other equity holder of SEG could cause our ownership interest in SEG to change in the future based upon the timing of SEG's repayment of certain intercompany loans to us.  As a result, we could either (1) increase our ownership percentage to obtain voting control of  SEG or (2) reduce our ownership percentage to such a level that could result in the deconsolidation of SEG.  Included in our June 27,September 26, 2004, Consolidated Balance Sheets is approximately $13$11 million of SEG debt of which $7 million is collateralized by assets with a current book value of $9 million.   Creditors of SEG have no recourse to the general credit of Cummins.     

In April 2004, Cummins Eastern Canada (CEC), a distributor previously accounted for under the equity method, acquired another Cummins distributor in Canada.  The acquisition price of the distributor was $18.8$19 million, which was funded by the addition of $15 million of debt and an additional $3.8$4 million equity investment by Cummins.  The additional equity contributed by Cummins increased our ownership percentage in CEC to 67 percent (50 percent prior to the acquisition.)  At the same time, we reached an agreement to sell a 16 percent ownership interest in CEC to another equity holder.  This sale which is expected to occur inwas completed during the third quarter, will reducequarter.  As a result of this sale our ownership percentage in CEC was reduced from 67 percent to 51 percent.  We agreed to accept a note from the equity holder for its purchase of the 16 percent ownership interest.  The note will be repaid from distributions of future CEC earnings.  We also agreed with the other shareholders to maintain our voting interest at 50 percent.  CEC is consolidated in our second quarter Consolidated Financial Statements due to our current 67 percent economic interest.  Although we willWe do not have management or voting control over CEC.  In accordance with FIN 46R, CEC after the sale of the 16 percent interest is completed, CEC will continue to be consolidated in our financial statements under FIN 46R third quarter Consolidated Financial Statements due to our current 51 percent ownershipeconomic interest and deemed interest of 16 percent resulting from our financing of the other equity holder's purchase.  As of June 27,September 26, 2004, CEC has approximately $26.3$25 million of debt which is collateralized by various current and fixed assets with a current book value of $56.3$59 million.   Creditors of CEC have no recourse to the general credit of Cummins.     

Results of these entities for the secondthird quarter ending June 27,September 26, 2004, are consolidated in our Consolidated Statements of Earnings and a significant amount of their sales are eliminated in consolidation.  The table below shows the increase in our assets and liabilities from consolidating these entities after eliminating intercompany items as of June 27,September 26, 2004.

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We also have variable interests in certain of our North American distributors that were deemed to be VIEs in accordance with FIN 46R, but we were not deemed to be the primary beneficiary since we do not absorb a majority of the entities' expected losses.  Our ownership percentage in these entities ranges from zero percent to 50 percent.  For two of the entities, our equity ownership represents our only variable interest in the entity and thus we would not be deemed the primary beneficiary.  For the two entities where we also guarantee a portion of the entities' debt, our ownership percentage does not exceed 30 percent and the combination of our equity ownership, debt guarantees and other variable interests does not result in Cummins being considered the primary beneficiary. 

The principal business of the distributors is to sell Cummins engines and related service parts as well as provide repair and maintenance services on engines, including warranty repairs.  Our maximum potential loss related to these four distributors consisted of our ownership interest in three of the distributors totaling $9$11 million as of June 27,September 26, 2004, and our guarantee of the debt offor two distributors totaling $15$6 million as of June 27,September 26, 2004.  Our involvement with these distributors as equity holders began in 2002 (two distributors) and 2003 (one distributor).  Our debt guarantees have been in place since 1987 and 2001, respectively.  Selected financial information for these distributors as of and for the year ended December 31, 2003, is as follows:

Note 3.  Inventories

Our inventories at interim reporting dates include estimates for adjustments related to annual physical inventory results and for inventory cost changes under the LIFO cost method. Due to significant movements of partially-manufactured components and parts between manufacturing plants, we do not internally measure nor do our accounting systems provide a meaningful segregation between raw materials and work-in-process.  Inventories were as follows at:

SEC regulations require that summarized financial information about unconsolidated subsidiaries and 50 percent or less owned equity investees be included in the footnotes to our Consolidated Financial Statements if, in the aggregate, they meet certain tests of a significant subsidiary. Dongfeng Cummins Engine Company Limited ("DCEC") is a 50 percent-owned unconsolidated subsidiary accounted for under the equity method of accounting that meets the test of a significant subsidiary.  DCEC financial results are reported one month in arrears of our normal reporting structure.

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Summary financial information for DCEC was as follows:

Note 5.  Accrued Product Coverage and Product Liability

Product Coverage

We charge the estimated costs of product coverage programs, other than product recalls, to earnings at the time products are shipped to customers. We use historical experience of product coverage programs to estimate the remaining liability for various product coverage programs. The estimated liability for product recalls is recorded when the recall program is announced due to the uncertainty surrounding the nature and frequency of such programs.  We review and assess the liability for all product coverage programs each quarter.

Below is a summary of the activity in our product coverage liability account for the six-monthnine month periods ended:

          Product Liability

From time to time, we issue indemnifications to our customers and joint venture partners which indicate that we will indemnify them against any loss suffered as a result of a defective product we have sold them. In addition, periodically, we enter into license agreements or joint venture agreements where we license a patent, trademark or other similar intangible asset and agree to indemnify the licensee against any losses suffered should the patent, trademark or intangible asset infringe upon a third party asset. We provide reserves for these exposures when it is probable that we have suffered a loss and the loss is reasonably estimable.  Below is a summary of the activity in our product liability accrual for the six-monthnine month reporting periods ended:

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Note 6.  Borrowing Arrangements

As discussed in Note 2, our total debt includes $130$127 million as of June 27,September 26, 2004, related to the consolidation of four joint ventures under FIN 46R.  Included in this amount is an $85 million term loan at CDC with a financial institution.  The loan is due in annual installments, with a final payment due in 2008.  Interest is payable semi-annually at a rate of 6.92 percent.  The note is collateralized by substantially all of CDC's inventory and fixed assets with a current book value of $24$31 million and $186$190 million, respectively, as of June 27,September 26, 2004.

In June 2004, we amended the master lease agreement relating to a portion of our PowerRent rental fleet that is described in Note 18, "Leases","Leases," of our Consolidated Financial Statementsin our 2003 Annual Report on Form 10-K.  The amendment requires us to retain full residual risk on equipment value at the end of the lease.  In addition, we were able to negotiate flexibility with regard to the geographic deployment of leased equipment in countries other than the U.S.  As a result of the amendment, the leases were classified as capital leases as of June 27, 2004.leases.  The financial impact of this transaction increased our property, plant and equipment by $52 million (net of $5 million of deferred gains associated with the original sale-leaseback of the units to the lessor), our current maturities of long-term debt by $9 million and our long-term debt by $48 million.  The equipment will be depreciated over its estimated useful life.  We do not expect the reclassification of the leases to have a material impact on net earnings.   

Note 7.  Pension and Other Postretirement Benefits

We have several contributory and noncontributory pension plans covering our U.S. employees and employees in certain foreign countries.  Generally, hourly employee pension benefits are earned based on years of service and compensation during active employment while future benefits for salaried employees are determined using a cash balance formula. The level of benefits and terms of vesting, however, may vary among plans. Pension plan assets are administered by trustees and are principally invested in equity securities and fixed income securities.  It is our policy to make contributions to the various plans in accordance with statutory funding requirements and any additional funding that may be deemed appropriate. Plan liabilities and the market-related value of our plan assets are determined based on a November 30 measurement date.

On January 1, 2004, we merged eleven defined benefit pension plans into a single plan.  The merger did not have a  material impact to our results of operations, financial position or cash flows.

Our other postretirement benefit plans provide various health care and life insurance benefits to eligible employees who retire and satisfy certain age and service requirements and their dependents. The plans are contributory and contain cost-sharing features such as deductibles, coinsurance and spousal contributions. Company contributions are limited by formulas in each plan.  Retiree contributions for health care benefits are adjusted annually and we reserve the right to change benefits covered under these plans. There were no plan assets for the postretirement benefit plans as our policy is to fund benefits and expenses for these plans as claims and premiums are incurred. Plan liabilities are determined based on a November 30 measurement date.

Effective December 31, 2003, we adopted Statement of Financial Accounting Standard No. 132 "Employers Disclosures about Pensions and Other Postretirement Benefits" (SFAS 132R).  This standard requires the disclosure of components of net periodic benefit costs recognized during interim periods. 

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During the secondthird quarter and first six-monthsnine months of 2004, we contributed approximately $30$62 million and $53$115 million, respectively, to our pension plans and paid $ 6$25 million and $14$39 million, respectively, of postretirement benefits.  We presently anticipate contributing an additional $75$17 million to $85$23 million to our pension plans and paying an additional $45$23 million to $50$28 million in claims and premiums for postretirement benefits during the remainder of 2004.  These contributions and payments include payments from Company funds to either increase pension plan assets or to make direct payments to plan participants.   

In May 2004, the FASB issued FASB Staff Position No. 106-2 , "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 20032003" (FSP 106-2) in response to a new law regarding prescription drug benefits under Medicare  providing a federal subsidy to certain sponsors of retiree health care benefit plans.  This FSP requires that the effects of the subsidy be accounted for currently as an actuarial experience gain to be recognized over the average remaining service lives of the plan participants and allows for several alternative choices for implementation.  As a result, we may be required to remeasure our liability associated with our post-retirement medical plans as of December 31, 2003 or May 31, 2004, unlessWe have determined the effects of the plan are deemed not material to our Consolidated Financial Statements and have concluded the adoption of FSP 106-2 does not require remeasurement of our liability or expense in which case we can delay accounting for2004.  We will consider the effects of the subsidy untilAct at our next regularly scheduledregular pension measurement date (November 30, 2004).date.   

A small grandfathered portion of our population qualifies for the Medicare Part D subsidy under our current retiree health care plans.   We estimate the subsidy would lower our accumulated postretirement benefit obligation (APBO) by approximately 3 percent.  The effects of an earlier remeasurement (if any) will be reflectedparticipation in our financial statements beginning June 28, 2004 (the beginningplans could decrease as participants opt for the Medicare coverage.  We have modeled the sensitivity of our fiscal third quarter).  DueAPBO to cost caps in place under manyparticipation changes.  If as a result of the legislation, 10 percent of our plans, we currently do not expect the effectsretiree population were to leave our plan and enroll in Medicare Part D that would reduce our APBO an additional 3 percent.  The net impact of the subsidy and the 10 percent decrement on enrollment to our 2004 expense would have a significant effect on our post-retirement medical liability.  As a result, we expect to defer accounting for the subsidy until our next regularly scheduled measurement date (November 30, 2004).  However, we are still in the process of completing our evaluation and will make a final determination in the third quarter.          been immaterial.

Note 8.  Contingencies, Guarantees and Environmental Compliance

We are defendants in a number of pending legal actions, including actions related to the use and performance of our products.  We also have been identified as a potentially responsible party at several waste disposal sites under U.S. and related state environmental statutes and regulations and have joint and several liability for any investigation and remediation costs incurred with respect to such sites. We deny liability with respect to many of these legal actions and environmental proceedings and are vigorously defending such actions or proceedings. We have established reserves that we believe are adequate for our expected future liability in such actions and proceedings where the nature and extent of such liability can be reasonably estimated based upon presently available information.

Our engine products are also subject to extensive statutory and regulatory requirements that directly or indirectly impose standards with respect to emissions and noise. In April 2002, we received certification from the U.S. Environmental Protection Agency (EPA) for our ISX heavy-duty diesel truck engine. In May 2002, we received certification from the EPA for our medium-duty 5.9-litre ISB engine that is used in trucks, buses, RV's, step vans and other medium-duty applications. In September 2002, the EPA certified our ISM heavy-duty diesel truck engine. These certifications affirm our compliance with stringent new emission standards that became effective October 1, 2002, and permit us to produce and sell these engines under the new emissions standards. The standards were established in a consent decree that we entered into with the EPA, the U.S. Department of Justice and the California Air Resources Board (CARB) in October 1998 along with other diesel engine manufacturers.  In issuing our certifications, the EPA also affirmed the use of Auxiliary Emissions Control Devices (AECD) that we submitted.

In May 2004, the EPA certified our QSM heavy-duty industrial engine to the standards that become effective January 1, 2005, under the provisions of the consent decree discussed above.  We believe we are on schedule to meet the requirements to pull forward the reduction of emissions levels of our other off-highway engines in the 300 to 750 horsepower range as well.  The standards were established in a consent decree that we entered into with the EPA, the U.S. Department of Justice and the CARB in October 1998 along with other diesel engine manufacturers.  We believe meeting this requirement has been facilitated by our development work for the on-highway heavy-duty and medium-duty engines.

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We believe we are on schedule to meet the requirements to pull forward the reduction of emissions levels for off-highway engines of 300 to 750 horsepower that become effective under the consent decree on January 1, 2005.  The standards were established in a consent decree that we entered into with the EPA, the U.S. Department of Justice and the CARB in October 1998 along with other diesel engine manufacturers.  We believe meeting this requirement has been facilitated by our development work for the on-highway heavy-duty and medium-duty engines.

U.S. Distributor Guarantees

We               Since 1997 we have entered intohad an operating agreement with a financial institution that requires us to guarantee revolving loans, equipment term loans and leases, real property loans and letters of credit made by the financial institution to certain independent Cummins and Onan distributors in the United States, and to certain distributors in which we own an equity interest.  UnderThe agreement has been amended, supplemented or otherwise modified several times since 1997 and in the third quarter of 2004, we amended, restated and simplified the terms of the operating agreement,agreement. 

              Under the amended and restated terms, our guarantee of any particular distributor financing is limited to the amount of the financing in excess of a particularthe distributor's "borrowing base." The "borrowing base" is equal to the amount that the distributor could borrow from the financial institution without Cumminsour guarantee.

Under the terms of the operating agreement, if any distributor is in default under any financing or if we default under the financial covenants of our $385 million revolving credit agreement, we will be required to guarantee the entire amount of each distributor financing. If our senior unsecured debt has a credit rating of less than "Ba2" from Moody's or less than "BB" from Standard & Poor's, we will be required to pay to the financial institution a monthly fee equal to 0.50 percent per annum on the daily average outstanding balance of each financing arrangement. Further, Furthermore, if any distributor defaults under anyits financing arrangement with the financial institution, and the maturity of amounts owed under the agreement is accelerated, then we will also beare required to purchase the assets of that distributor.

In January 2004, we issued letters of credit tofrom the financial institution inat amounts approximating fair market value certain property, inventory and rental generator sets manufactured by Cummins that are secured by the aggregate amount of $30 million, covering distributor borrowings in excess of their borrowing base.distributor's financing agreement.  As a result of the amendment and restatement, we are no longer subjectrequired to the credit ratings trigger contained in the operating agreement provided we maintain and annually renew this letterbackstop our financial guaranty with letters of credit.

The operating agreement will continue in effect until February 7, 2007, and may be renewed for additional one-year terms. As of June 27,September 26, 2004, we had $25$13 million of guarantees and $25 million of letters of credit outstanding under the operating agreement relating to distributor borrowings of $86$74 million.

Residual Value Guarantees

As more fully discussed in our 2003 Annual Report on Form 10-K, we have various residual value guarantees on equipment leased under operating leases.  The amounts of those guarantees at June 27,September 26, 2004, are summarized as follows:

$Millions
Power rent lease program	$  49
Other residual guarantees	12
Total residual guarantees	$  61

Other Guarantees and Contingencies

In addition to the guarantees discussed above, from time to time we enter into other guarantee arrangements, including non-U.S. distributor financing, guarantees of third party debt and other miscellaneous guarantees. The maximum potential loss related to these other guarantees is $21$22 million at June 27,September 26, 2004.   

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We have arrangements with certain suppliers that require us to purchase minimum volumes or be subject to monetary penalties.  The penalty amounts are less than our purchase commitments and essentially allow the supplier to recover their tooling costs.  At September 26, 2004, if we were to stop purchasing from each of these suppliers, the amount of the penalty would be approximately $42 million.  However, based on current forecasts, we do not anticipate paying any penalties under these contracts.

Note 9.  Other (Income) Expense,Income, net

                The major components of other (income) expense included in the Consolidated Statements of Earnings are shown below:

Note 10.  Comprehensive Earnings

A reconciliation of our net earnings (loss) to comprehensive earnings was as follows:

Note 11.  Earnings (Loss) Per Share

We calculate basic earnings per share (EPS) of common stock by dividing net earnings (loss) available to common shareholders by the weighted-average number of common shares outstanding for the period. The calculation of diluted EPS reflects the potential dilution that occurs if options or securities are exercised or converted into common stock and the effect of the exercise or conversion reduces EPS.  We exclude shares of common stock held by our Retirement Savings Plan in the Employee Benefits Trust from the calculation of the weighted-average common shares outstanding until those shares are distributed from the Trust.  Following is a reconciliation of net earnings (loss) and weighted average common shares outstanding for purposes of calculating basic and diluted net earnings (loss) per share:

 

	Third Quarter Ended		Nine Months Ended
	September 26,	September 28,	September 26,	September 28,
$ Millions, except per share amounts	2004	2003	2004	2003
Net earnings for basic EPS:	$    116.0	$       24.3	$    231.3	$     6.9
Dilutive effect of preferred securities dividends,   net of tax	3.3	3.4	9.8	-
Net earnings for diluted  EPS	$    119.3	$           27.7	$    241.1	$     6.9
Weighted average shares outstanding:
Basic EPS	42.8	39.4	41.8	39.0
Dilutive effect of stock compensation awards	.7	.2	.6	.2
Dilutive effect of preferred securities conversion	6.3	6.3	6.3	-
Diluted EPS	49.8	45.9	48.7	39.2
Net earnings per share:
Basic	$       2.71	$   0.62	$     5.54	$      0.18
Diluted	$       2.40	$   0.60	$     4.95	$      0.18

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The weighted average diluted common shares outstanding at June 27,for the third quarter ended September 26, 2004 and June 29,September 28, 2003, excludesexclude the effect of approximately 0.1 million8,000 and 4.92.0 million common stock options respectively, since such options have an exercise price in excess of the average market value of Cummins common stock for those quarters.the respective periods.

The weighted average diluted common shares outstanding for the three-monthsnine months ended September 26, 2004 and six-monthsSeptember 28, 2003, exclude the effect of approximately 440,000 and 4.1 million common stock options respectively, since such options have an exercise price in excess of the average market value of Cummins common stock for the respective periods.

The weighted average diluted common shares outstanding for the nine months ended June 29,September 28, 2003, exclude the effect of 6.3 million shares attributable to the conversion of our Preferred Securities of Subsidiary Trust since the impact would have been anitdilutive. 

We define operating segments as components of an enterprise about which separate financial information is available that is evaluated regularly by our chief operating decision maker (CODM), or decision making group, in deciding how to allocate resources and in assessing performance. Our CODM is the Chief Executive Officer.

Our reportable operating segments consist of the following: Engine, Power Generation, Filtration and Other and International Distributors. This reporting structure is organized according to the products and markets each segment serves. This type of reporting structure allows management to focus its efforts on providing enhanced service to a wide range of customers.   A description of each operating segment is included in Part I of our 2003 Annual Report on Form 10-K.

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 reported at cost and no sale reported by the transferor segment did not report a sale.segment.  Beginning January 1, 2004, this intersegment activity is reflected in the sales and unit shipments of the transferor segments at a market-based transfer price discounted for certain items; further, certain intersegment cost allocations to the transferor segments have been eliminated.  We believe this change allows our segment management to focus on those pricing decisions and cost structuring actions that are within their control.  As a result of the change, secondfor the third quarter and first halfnine month periods ended September 26, 2004, Engine segment sales increased $128$140 million and $217$357 million, respectively, Filtration and Other segment sales increased $53 million and $100$153 million, respectively, Power Generation segment sales decreased $8$14 million and $17$31 million, respectively, and sales eliminations increased $172$179 million and $299$479 million, respectively.  In addition, certain engines made by the Engine segment and sold to International Distributors through Power Generation were previously recorded as sales to Power Generation; however under the new methodology Power Generation records a sales commission.  The net impact of this change did not have a material effect on segment EBIT for any of our segments.  Due to impracticability, segmentSegment results for the prior year periods have not been restated for this change.change as it would be impracticable to do so.

We use segment EBIT (defined as earnings (loss) before interest, taxes, minority interests, preferred dividends and cumulative effects of change in accounting principles) as the primary basis for our CODM to evaluate the performance of each operating segment. Segment amounts exclude certain expenses not specifically identifiable to segments.

The accounting policies of our operating segments are the same as those applied in the Consolidated Financial Statements. We prepared the financial information of our operating segments on a basis that is consistent with the manner in which we internally disaggregate financial information to assist in making internal operating decisions. We have allocated certain common costs and expenses, primarily corporate functions, among segments differently than we would for stand-alone financial information prepared in accordance with GAAP. These include certain costs and expenses of shared services, such as information technology, human resources, legal and finance. We also do not allocate debt-related items, minimum pension liabilities or income taxes to individual segments.  Our definition of segment EBIT may not be consistent with measures used by other companies.

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A summary of operating results and net assets by segment for the three and six-monthnine month periods are shown below:

The tables below reconcile the segment information to the corresponding amounts in the Consolidated Financial Statements:Statements:                   

Note 13.  (Benefit) Provision for Income Taxes

 15Our 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 sales.  During the first half of 2004, our financial results reflected an estimated effective tax rate of 28 percent.  During the third quarter, as a result of continued earnings improvement and improved outlook, we reassessed the treatment of certain foreign tax credits previously recognized as tax deductions and determined they could be used as future tax credits.  The favorable treatment of these tax credits resulted in reducing our 2004 estimated annual effective tax rate from 28 percent to 21 percent.  The retroactive effect of reducing the tax rate favorably impacted our third quarter tax expense by $12 million.  In addition, the improved earnings also resulted in a reassessment of our ability to realize state tax benefits from net operating losses generated in prior years.  Previously, we had provided a $16 million valuation allowance to reduce the recorded tax value of these losses.  We have now determined this allowance is no longer needed and the $16 million was recorded as a reduction of our third quarter income tax expense as required by U.S. GAAP.    

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

The following is management's discussion and analysis of the interim financial results, liquidity and  capital resources, financial covenants and credit ratings, off balance sheet arrangements, financial guarantees, critical accounting policies and other key items related to our business and performance. Our objective is to provide investors and readers with an understanding of the key variables and other qualitative and quantitative factors that are unique to our business and that management focuses on in evaluating and measuring our financial performance and financial condition. We will discuss and analyze significant known trends, demands, commitments, events and uncertainties that we believe are important to an understanding of our business. In addition, we will provide a quarter-over-quarter discussion and analysis of our consolidated operating results and a similar discussion of our business segment results and sales to geographic markets. This section should be read in conjunction with our Consolidated Financial Statements and related notes in the "Financial Statements" section of our 2003 Annual Report on Form 10-K.  As discussed below underin the Business Segment Results section and in Note 12 to the Consolidated Financial Statements, all secondfor the third quarter and first halfnine- month periods ended September 26, 2004, all intersegment activity reflects a change to market-based transfer pricing effective January 1, 2004.  Due to impracticability,  Business Segment results for the prior year periods have not been restated for this change.change as it would be impracticable to do so.   All references to earnings per share amounts are reported on a diluted per share amounts.basis.   Certain prior year amounts included in this section have been reclassified to conform to the current year presentation.  At the end of this section, weWe have also provided a business outlook.outlook at the end of this section.

EXECUTIVE SUMMARY

      Cummins isWe are 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, combustion 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, and CNH Global. We serve our customers through more than 680 company-owned and independent distributor locations in 137 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 prices (fuel costs), 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 our earnings and cash flow.

InOur net earnings in the secondthird quarter of 2004 our earnings were $82$116 million, or $1.76$2.40 per share, on record sales of $2.124$2.194 billion, compared to net earnings of $14$24 million, or $0.34$0.60 per share, on sales of $1.539$1.634 billion in the secondsame period last year.  Net earnings for the current quarter benefited from a reduction in the estimated annual effective tax rate from 28 percent to 21 percent and also included a one-time $16 million reversal of 2003.valuation allowances related to state net operating losses.  The improvement in earnings in the second quarter of 2004 compared to the prior year quarter was driven by a 34 percent sales increase, primarily achieved by the performance offrom our Engine Business and record sales at our Power Generation Business whichBusiness.  Both segments experienced increasedcontinued strong demand across nearly allrespective automotive and industrial markets, with particularly strong demand in the North American heavy-duty truck market.market where sales were double those from the same period last year.  Sales in the secondthird quarter of 2004 also increased in each of our other business unitsthe Filtration and Other and International Distributor businesses compared to the second quarter of 2003same period last year reflecting substantial improvement in demand and business conditions.

We now have over 56,000 EPA-certified heavy-duty engines in service that have accumulated over 3.6 billion miles of experience.  These new engines have continued to perform well for our customers and our share of the North American heavy-duty truck market has increased from 21.5 percent to 26.9 percent through June 2004, based upon data published by an independent market research firm.  This is the highest market share Cummins has experienced since 1999.  We believe this improvement demonstrates the continued confidence our customers have in the technology, performance and reliability of our engines.   

Our Power Generation Business has been adversely affected by excess inventory in the market coupled with extreme pricing pressure and low volumes during the past two years.  During the secondthird quarter and first halfnine months of 2004, progress in the domestic economic recovery particularly internationally,and commercial demand in China and the Middle East resulted in solid growth in the commercial markets with increased demand for mid-sized and large generator sets and alternators providing improved performance in this business segment.  The consumer business, especially sales of generator sets for Recreational Vehicles, has also been very strong throughout 2004. 

Our Filtration and Other Business achieved significant sales growth in the secondthird quarter of 2004, primarily in North America, and our International Distributor Business reported recordstrong sales with increased revenue in nearlyat all of itsour distributor locations.  Earnings of our joint ventures and alliancesequity method investees also increased significantly in the secondthird quarter of 2004 compared to 2003,the same period last year, primarily from the expansion of our joint venture in China, DCEC, in the second quarter of 2003 and from higher earnings at our North American distributors.

During the second quarter, the first of our off-highway engines slated for the January 2005 emission standards were certified by the Environmental Protection Agency (EPA) as compliant to the Tier 3 standards for oxides and nitrogen (NOx) and particulate matter.  Cummins was the first manufacturer to receive a Tier 3 Certificate of Conformity from the EPA.  This certification was subsequently followed up with a Stage IIIA European Union Index Approval from the Vehicle Certification Agency as compliant to the standards for NOx and particulate matter.  Our investment in the appropriate emissions related technology has enabled us to meet the stringent regulations of the U.S. EPA and the European Union ahead of schedule.

                In May, we announced that our existing $225 million Notes that mature in March 2005 would be repaid with available cash and, if necessary, borrowings from existing short-term credit facilities.  We anticipate strong cash flow generation in 2004 and beyond as a result of increased sales and improved earnings and combined with working capital management should allow us to earmark cash flow primarily for debt repayment.  Also during the second quarter, two credit rating agencies, Standard & Poor's and Fitch, revised their outlook for Cummins to Stable from Negative, reflecting our improved operating performance and positive economic developments.  

On March 28, 2004, we adopted certain provisions of Financial Accounting Standards Board (FASB) Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities," (FIN 46R) which were effective in the first quarter of 2004.  The adoption of this interpretation resulted in the first quarter balance sheet consolidation of three joint venture entities previously reported under the equity method of accounting.  In addition, the ownership of a distributor previously accounted for under the equity method of accounting was restructured during the second quarter resulting in its consolidation under FIN 46.46R.  The financial impact of consolidating these entities in the second quarter increased total assets by $296$321 million, total debt by $130$127 million and total sales by $27$83 million but had no impact on net earnings.  We do not expect the consolidation of these entities will have a materialto significantly impact on future period net earnings or affect any of our debt covenants. 

RESULTS OF OPERATIONS

Net Sales

Net sales for each of our keyfour business segments during the comparative interim periods follow:

EachThree of our four business segments had record sales in the secondthird quarter of 2004 with increased demand across nearly every market segment.  Almost one-half of the increase occurred in the Engine Business up 57sales increased 53 percent compared to the prior year period.  Engine sales increasedperiod (38 percent excluding the change in transfer pricing) primarily due to higher heavy-and medium-duty truck engine shipments, increased shipments to Chrysler of light-duty engines for the Dodge Ram truck and higher engine volumes for industrial and stationary power applications.  EnginesEngine sales to automotive markets were 48up 41 percent higher than secondcompared to third quarter last year with increased demand in all market segments except for the bus market.recreational vehicles.  Power Generation sales increased 5238 percent compared to the prior year's quarter, buoyed by strong demand for generator sets and alternators in international markets and continued robust demand for RV and other consumer power generation products.  Filtration and Other sales increased 3945 percent (19(24 percent afterexcluding the change in transfer pricing) with improvement across most markets, but primarily from North American OEMs.  Sales in the International Distributor Business increased 3024 percent compared to the secondthird quarter last year with moderate increases in parts and service and strong demand for power generation products.  

For the first sixnine months of 2004, Engine sales were up 4950 percent (36 percent excluding the change in transfer pricing) compared to the priorsame period of 2003, acrosslast year, as most market segments withexperienced strong demand in all automotive markets except the bus market.markets.  Power Generation sales were up 4643 percent for the first halfnine months of 2004 with recovery in most markets occurring sooner than expected.  Sales in Filtration and Other increased 3840 percent in the first halfnine months of 2004 (20 percent excluding the change in transfer pricing) compared to a year earlier reflecting strong demand and increased market share.  Sales in International Distributor increased 2827 percent year-over-year with improvement across most geographic regions andincluding increased demand for power generation products internationally.

Gross Margin

Our gross margin was $428$434 million in the secondthird quarter of 2004 compared to $276$293 million in the second quarter of 2003,same period last year, with related gross margin percentages of 20.219.8 percent and 17.9 percent, respectively.  The increase in gross margin was primarily a result of the increasedresulted from higher volumes across all of our business segments, ($142 million),including the absorption impact on fixed manufacturing costs from higher North American automotive shipments ($26 million), and the favorable impact of currency exchange ratescost reductions ($3199 million).  The improvement in gross margin was partially offset by the impact of higher commodity prices, primarily steel and copper, net of price realization ($1517 million) and, increased product coverage expense ($25 million) although product coverage expense was relatively flat as a percentresult of net sales when compared to the second quarter of 2003.higher volumes ($12 million), inefficiencies resulting from higher volumes, including premium freight charges and overtime ($23 million) and a one-time charge for inventory valuation ($9 million).      

Gross margin for the first halfnine months of 2004 was $773 million,$1.207 billion, or 19.8 percent of net sales, compared to $494$787 million, or 16.917.3 percent of net sales, in the first half of 2003.same period last year.  Most of the increase in gross margin year-over-year was a result of higher engine shipments, particularly to North American automotive markets and the related absorption benefit and increased volumeshigher sales across our other three business segmentsbusinesses ($383 million), related absorption benefit on fixed manufacturing costs ($104 million), and the impact of favorable currency exchange rates ($15 million) partially offset by increased product coverage expense ($42 million) although product coverage expense was relatively flatcosts as a percentresult of higher volumes ($54 million),  higher material costs for copper and steel, net sales when compared to the first half of 2003.    price realization ($32 million), inefficiencies resulting from higher volumes, including premium freight charges and overtime ($23 million) and a one-time charge for inventory valuation ($9 million).        

Selling and Administrative  

Total selling and administrative expenses were $251was $260 million (11.8(11.9 percent of net sales) in the secondthird quarter of 2004 compared to $200$208 million (13.0(12.7 percent of net sales) in the second quarter of 2003,same period last year, or an increase of $51 million.  Of$52 million (25 percent).  Approximately $28 million of the total increase approximately $27 million was selling expenses (including $6$5 million of unfavorablefrom foreign currency rate changes)translation) and $24 million ofwas administrative expenses (including $2 million of unfavorablefrom foreign currency rate changes)translation).  The increase in selling expense was primarily attributable toexpenses resulted from higher compensation expense from incremental sales staffing and initiativesfringe benefit costs, including variable compensation ($721 million), increases in fringe benefit costs,marketing program expenses including pension costs ($5 million), increase in variable compensation as a result of higher earnings ($6 million), increases in travel and entertainment ($24 million) and other volume variable expenses that individually arewere not significant.  The increase in administrative expenses primarily results from increased salariescompensation and fringe benefit expenses ($5 million), increased variable compensation due to higher earnings ($13 million), increased insurance expense ($7 million) primarily resulting from favorable experience and lower expense in 2003, partially offset by lowerother expenses including consulting fees that individually were not significant.  Foreign currency translation driven primarily by the Pound Sterling and Euro increased selling and administrative expenses $7 million in the third quarter of 2004 compared to 2003.    Approximately $18 million of the increase in selling and administrative expenses resulted from consolidating entities under the provisions of FIN 46R (see Note 2 to the Consolidated Financial Statements).    

Selling and administrative expenses during the first nine months of 2004 were $734 million (12.1 percent of net sales), compared to $603 million (13.2 percent of net sales), in the same period last year.  The increase of $131 million, or 22 percent, resulted from higher compensation expense and fringe benefits from incremental staffing, including variable compensation ($284 million), recovery of bad debtincreased program marketing expense from a customer emerging from bankruptcyincluding travel and entertainment ($211 million), increased outside consulting services driven primarily by Sarbanes-Oxley project costs ($10 million) and other expenses that individually were not significant.

Selling  Foreign currency translation driven primarily by the Pound Sterling, Euro and Australian dollar increased selling and administrative expenses duringby $26 million for the first halfnine months of 2004 were $474 million (12.2 percent of net sales), compared to $395 million (13.5 percent of net sales), in the first half of 2003. The increase of $79 million is primarily attributable to higher compensation expense and fringe benefits from incremental staffing ($24 million), increased variable compensation as a result of improved earnings ($27 million), increased insurance expense ($4 million) and other expenses that individually were not significant.

Research and Engineering Expenses

Total research and engineering expenses were $59$60 million (2.8(2.7 percent of net sales) in the secondthird quarter of 2004, compared to $50$51 million (3.2(3.1 percent of net sales) in the second quarter of 2003.same period last year.  A majority of the increase was a result of higherincreased compensation and fringe benefit expenses, including variable compensation expense due to improved earnings ($513 million) and higher spending on heavy-duty 2007 emissionsproduct development programs ($14 million), partially offset by lower compensation expensedecreases in other general research and fringe benefitsdevelopment expenses, none of which were individually significant ($28 million) and other expenses that individually are not significant..  The increase includes a $1 million unfavorable impact from foreign currency rate changes.    translation and $2 million from consolidating entities under the provisions of FIN 46R (see Note 2 to the Consolidated Financial Statements.)    

Research and engineering expenses during the first halfnine months of 2004 were $115$175 million (3.0(2.9 percent of net sales) compared to $97$148 million (3.3(3.2 percent of net sales) in the first half of 2003,same period last year, or an increase of $18 million.$27 million, or 18 percent.  A majority of the increase was attributable to increased compensation and fringe benefit expense, including variable compensation expense as a result of improved earnings ($1021 million), planned project expenses related to thehigher spending on prototype development of exhaust aftertreatmentfor future products for our Emissions Solutions business ($23 million) and other expenses that individually were not significant.  Included in the year-to-date increase was approximately $2$3 million attributable to the impact of foreign currency rate changes at foreign locations. translation and $2 million from consolidating entities under the provisions of FIN 46R (see Note 2 to the Consolidated Financial Statements). 

Equity, Royalty and Other Income from Investees

Our earnings from joint ventures and equity method investees were $29$26 million in the secondthird quarter of 2004, compared to earnings of $17$20 million in the priorsame period last year, period, or an increase of $12$6 million.  The increase was attributable to improved earnings across most of our joint ventures, primarily DCEC, a supplier to China's second largest truck manufacturer, ($6 million) where demand remains strong after expanding the joint venture agreement in the second quarter of 2003, our North American distributor joint ventures ($23 million), Chongqing Cummins Engine Company Ltd. ($1 million) and, our European Engine Alliancemarine joint venture, Cummins Mercruiser ($1 million).   Income from royalties and technical fees were $6 million in the second quarter of 2004 compared to $3 million in the prior year period, including a $2 million one-time accrual for royalty fees from a joint venture in China.    

Tata Cummins Limited ($1 million).     

Year-to-date earnings from joint ventures and equity method investees were $47$73 million in the first halfnine months of 2004, compared to $24$44 million in the first half of 2003,same period last year, or a $23$29 million increase.  The increase results from earnings improvement at most of our joint ventures, primarily from our expanded joint venture in China, DCEC, ($13 million) and our North American distributor joint ventures ($58 million).  Income from royalties and technical fees during the first sixnine months of 2004 were $7$8 million compared to $ 3$4 million in the first six months of 2003,same period last year, including a one-time $2 million accrual for royalty fees from a one-time accrual discussed above. China joint venture in the second quarter of 2004. 

Interest Expense

Interest expense was $27$28 million in the secondthird quarter of 2004, an increase of $7$3 million compared to $20$25 million in the second quartersame period last year.  Interest expense for the first halfnine months of 2004 was $54$82 million compared to $40$65 million in the first half of 2003,same period last year, or an increase of $14$17 million.  MostThe increase in interest expense for the third quarter was primarily from interest on capital leases related to information technology equipment ($2 million) and the consolidation of entities under the provisions of FIN 46R ($2 million).  The year-to-date increase was mostly attributable to the adoption of Statement of Financial Accounting Standards No.No 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" (SFAS 150).  Effective July 1, 2003, thisEquity."  This standard requiresrequired prospective classification of dividends on our preferred securities to be prospectively classified as interest expense in our Consolidated StatementsStatement of Earnings.   Earnings effective July 1, 2003.  Including dividends on our preferred securities, interest expense increased $2 million in the second quarter of 2004 compared to the prior year's quarter, and $3$6 million in the first sixnine months of 2004 compared to the prior year period.  The increase in second quarter and year-to-date interest expenseincrease was primarily from interest on capital leases for($4 million) and the leaseconsolidation of information technology equipment.entities under FIN 46R ($3 million).  The preferred securities are no longer reported as an obligation in our balance sheetConsolidated Balance Sheet due to the adoption of FIN 4646R (see Notes 2 and 9 of our 2003 Annual Report on Form 10-K), rather, the convertible subordinated debentures that were issued by us and which are the sole assets of the trust that issued the securities, are now classified as long-term debt in our balance sheet.Consolidated Balance Sheet.   

Cash payments of interest in the first half of 2004 and 2003 were $54 million and $43 million, respectively. 

Other (Income) ExpenseIncome, net 

Other income and expense was a net $6 million of income in the third quarter of 2004 compared to a net $7 million of income in the same period last year.  On a year-to-date basis, other income and expense was a net $1 million of income in the second quarter of 2004 compared to a net $3 million of income in the second quarter 2003, or a $2 million decrease.  On a year-to-date basis, other income and expense was a net $5 million expense in the first sixnine months of 2004 compared with a net $10$17 million of income in the first six months of 2003,same period last year, or a $15$16 million decrease.  The major components of other income and expense, classified as either operating or non-operating, are disclosed in Note 9 to the Consolidated Financial Statements.      

 (Benefit)  Provision (Benefit) for Income Taxes

Our income tax provisionbenefit in the secondthird quarter of 2004 was $34$4 million, compared to an income tax provision of $9 million in the same period last year.  For the first nine months of 2004, our income tax provision was $44 million compared to an income tax provision of $5 million infor the second quarter of 2003.  Forsame period last year. 

Our effective tax rate is normally below the first six months of 2004, ourU.S. corporate income tax provision was $48 million compared to an incomerate of 35 percent primarily because of research tax benefit of $4 million incredits and reduced taxes on export sales.  During the first six months of 2003.  The second quarter and first half of 2004, reflectour financial results reflected an estimated effective tax rate of 28 percent.  During the third quarter, as a result of continued earnings improvement and improved outlook, we reassessed the treatment of certain foreign tax credits previously recognized as tax deductions and determined they could be used as future tax credits.  The favorable treatment of these tax credits resulted in reducing our 2004 estimated annual effective tax rate offrom 28 percent onto 21 percent.  The retroactive effect of reducing the tax rate favorably impacted our third quarter tax expense by $12 million.  In addition, the improved earnings before income taxes after deducting dividends onalso resulted in a reassessment of our preferred securities comparedability to an effectiverealize state tax benefits from net operating losses generated in prior years.  Previously, we had provided a $16 million valuation allowance to reduce the recorded tax value of these losses.  We have now determined this allowance is no longer needed and the $16 million was recorded as a reduction of our third quarter income tax rate of 25 percent for the prior year periods.  Our effective income tax rate for both 2004 and 2003 was lower than the 35 percentexpense as required by U.S. corporate income tax rate primarily because of reduced taxes on export sales and research tax credits.generally accepted accounting principles.     

Minority Interests in Earnings of Consolidated Subsidiaries

Minority interestsinterest in our consolidated operations were $5was $6 million in the secondthird quarter of 2004 compared to $2$3 million in the second quarter of 2003, an increase of $3 million.same period last year.  For the first halfnine months of 2004, minority interests were $9interest was $15 million compared to $6$9 million in the first half of 2003.same period last year.  The increase in minority interests iswas primarily from higher earnings at Wuxi Holset, a 55 percent owned-subsidiary, and Cummins India Limited, a 51 percent owned-subsidiary, withand Usina Termelectrica de Anapolis Ltda, a small increase from the effects50.1 percent owned-subsidiary of consolidating certain entities in accordance with FIN 46 (see Note 2 of the NotesCummins Brasil that provides energy to the Consolidated Financial Statements).Brazilian government.

Dividends on Preferred Securities 

            Dividends on our preferred securities were $5 million in the second quarter of 2003 and $11 million for the first sixnine months of 2003.  Effective July 1, 2003, these dividends were prospectively classified as interest expense in our Consolidated Statements of Earnings in accordance with a new accounting standard, SFAS No. 150.  A description of the preferred securities is provided in Note 9, "Convertible Preferred Securities of Subsidiary Trust" of our Consolidated Financial Statements in our 2003 Annual Report on Form 10-K.

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 each segment serves 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).   

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 reported at cost and the transferor segment did not report a sale.  Effective January 1, 2004, this intersegment activity is reflected in the sales and unit shipments of the transferor segments at a market-based transfer price discounted for certain items.  Unit shipments are also reflected in the sales volumes of the transferor segments.  Certain intersegment cost allocations to the transferor segments have also been eliminated.  We believe this change allows our segment management to focus on those pricing decisions and cost structuring actions that are within their control.  As a result of the change, secondthird quarter and first halfyear-to-date 2004 Engine Business sales increased $128$140 million and $217$357 million, respectively, Filtration and Other Business sales increased $53 million and $100$153 million, respectively, Power Generation Business sales decreased $8$14 million and $17$31 million, respectively, and sales eliminations increased $172$179 million and $299$479 million, respectively.  The net impact of this change did not have a material effect on segment EBIT for any of our segments.

A discussion of business results for our business segments follows.  Financial information related to our business segments can also be found in Note 12 to the Consolidated Financial Statementsalso contains financial information relating to our business segments..   

Engine

                 Net sales and segment EBIT for the Engine Business were as follows:

               Total net sales for the Engine Business increased $504$496 million, or 5753 percent, (includes $128$140 million attributable to the change in intersegment transfer pricing in 2004) compared to sales in the secondthird quarter of 2003.  NearlyOver one-third of the sales improvement was from engine sales to North American heavy-duty truck OEMs.  Sales also increased to the medium-duty truck market (up 29 percent) and strong sales demand continued for shipments of our ISB engine to Chrysler for the Dodge Ram truck.truck (up 26 percent).  Total automotive-related engine sales were 6841 percent higher than third quarter a year ago and represented 67 percent of total Engine Business sales compared to 72 percent in the secondsame period last year.

Segment EBIT for the Engine Business was $96 million in the third quarter of 2004 compared to 71 percent$36 million in the prior year quarter.

A summary and discussion of net sales for the Engine Business by market application follows:

The Engine Business shipped 116,600 engines in the second quarter of 2004, an increase of 32,000 units, or 38 percent compared to the second quarter of 2003.  Unit shipments to automotive related markets increased 38 percent, shipments to industrial markets were up 41 percent and shipments to power generation markets increased 27 percent.  For the first six months of 2004, shipments for the Engine Business increased 48,200 compared to the first six months of 2003 with automotive shipments up 32 percent, industrial shipments up 33 percent and shipments to power generation markets up 21 percent.

A summary of shipments by engine classification (including unit shipments to Power Generation in 2004) is shown in the table below:

Heavy-duty Truck

Sales to the heavy-duty truck market increased $179 million, or 67 percent, in the second quarter of 2004 compared to sales in the second quarter of 2003.  The increase was primarily attributable to a strong recovery in the North American truck market with increased second quarter demand and higher market share.  Total unit shipments of heavy-duty truck engines increased 95 percent in the second quarter of 2004 compared to the prior year period.  Unit shipments to the North American OEMs were up 105 percent compared to the prior year's quarter driven by higher demand and higher market share while unit shipment of heavy-duty engines to international locations were up 47 percent, with higher sales to OEMs in Mexico and Europe.  The variance between the sales percentage increase and the volume percentage increase results primarily from the mix of engine sales versus service part sales.  Part sales increased 35 percent in the second quarter 2004 compared to the second quarter of 2003 but were a lower percentage of total sales in the second quarter of 2004.   

Sales to the heavy-duty truck market in the first half of 2004 increased $284 million, or 57 percent compared to the first half of 2003.  Total shipments of heavy-duty truck engines increased 82 percent in the first half of 2004 compared to the prior year period with unit shipments to the North American heavy-duty truck market up 91 percent and shipments to international markets up 36 percent.  The sales increase is primarily driven by improved market share and the recovery in the North American truck market as OEMs raise build rates to meet growing demand from truck fleets replacing aging equipment.   

Medium-duty Truck and Bus

Medium-duty truck and bus revenues increased $51 million, or 36 percent, in the second quarter of 2004 compared to the prior year quarter, reflecting strong demand from OEMs.  Unit shipments to the North American medium-duty truck market were up 100 percent above the prior year quarter, while shipments to international markets increased 26 percent, primarily to OEMs in Latin America.  Bus engine shipments in the second quarter of 2004 were down 19 percent worldwide compared to the prior year period, with a 12 percent decline in shipments to North American OEMs, primarily due to lower market share and reduced municipal spending, and a 21 percent decline in international shipments, with higher demand in most of Asia offset by lower shipments to India and Europe.

Medium-duty truck and bus revenues in the first half of 2004 were up $94 million, or 36 percent, compared with the prior year period, driven primarily from increased demand in the North American truck market.  Shipments of medium-duty truck engines were up 107 percent to North American OEMs and up 17 percent to international OEMs during the same period while shipments of bus engines were down 19 percent in North America and 14 percent to international locations.     

Light-duty Automotive

Sales of light-duty automotive engines increased $76 million, or 33 percent, in the second quarter of 2004 compared to the second quarter of 2003.  Total shipments increased 28 percent, compared to the prior year's quarter.  Sales to Daimler Chrysler for the Dodge Ram truck were a record high in the second quarter of 2004 with shipments of 40,500 engines, an increase of 30 percent compared to the prior year quarter, driven by strong demand and market share improvement in diesel powered truck sales.  Sales to recreational vehicle OEMs increased 29 percent in the second quarter of 2004 compared to the second quarter of 2003 with shipments up 10 percent compared to the prior year period, also driven by increased demand. 

Sales of light-duty automotive engines increased $128 million, or 28 percent in the first six months of 2004 compared to 2003.  Most of the increase was driven by strong demand for Dodge Ram truck engines with shipments up 25 percent in the first six months compared to the prior year period.  Engine shipments to recreational vehicle (RV) OEMs increased 15 percent in the first half of 2004 compared to the first half of 2003 as demand continues in this market.        

Industrial and Power Generation

Engine sales to the construction, mining, marine, agricultural, oil and gas, government, and rail markets and to  Power Generation were up $198 million, or 78 percent, in the second quarter of 2004 compared to the second quarter of 2003.  Approximately 40 percent of total industrial engine shipments were to North American markets and 60 percent to international markets compared to 37 percent and 63 percent, respectively, a year ago.  Engine sales to the construction equipment market increased 45 percent year-over-year with engine shipments to North American OEMs up 56 percent and shipments to international OEMs up 40 percent, primarily in Korea and East Asia.  Engine shipments to the agricultural equipment market increased 11 percent in the second quarter of 2004 compared to the prior year quarter, with a 29 percent increase in shipments to North American OEMs that was partially offset by a 3 percent decrease in shipments to international OEMs.  Sales of our high-horsepower QSK series engines to manufacturers of mine equipment increased 66 percent in the second quarter of 2004 compared to the prior year quarter, primarily due to higher metal and coal prices, with shipments in North America up 60 percent and international shipments up 39 percent, primarily to Russia and CIS.  Engine sales to the commercial marine market increased 20 percent in the second quarter of 2004 compared to the prior year quarter, while unit shipments were up 21 percent.  Engine shipments to the recently entered oil and gas market increased significantly in the second quarter of 2004 compared to a low base in the prior year quarter, primarily due to market share penetration in North America with our QSK series engine.  Sales of high-horsepower engines to the government market, primarily V series military applications, decreased 15 percent in the second quarter of 2004 compared to the prior year quarter.  Engine sales to the rail equipment market, primarily international railcar builders, increased 127 percent in the second quarter of 2004 compared to the prior year quarter, indicating strong demand in this sector.

For the first six months of 2004, Industrial and Power Generation sales were up 66 percent compared to the same period in 2003, primarily due to strong demand across most market segments as the capital goods sector of the economy recovers.last year.  The sales increase, excluding sales to Power Generation, was split almost evenly between domestic and international with sales to domestic OEMs up 32 percent and sales to international OEMs up 34 percent, with strong sales to construction OEMs in both markets, up 39 percent compared to 2003.      

Segment EBIT

Segment EBIT for Engine was $91 million in the second quarter of 2004 compared to $24 million in the prior year quarter.  The improvement inimproved earnings was primarily a result ofresulted from higher gross margin ($100 million) from increased engine volumes and the accompanying benefits of fixed cost absorption at our manufacturing plants ($109 million), partially offset by higher product coverage expense from the increased volumes ($12 million) and a one-time adjustment related to a charge for inventory valuation ($9 million), higher earnings from joint ventures ($85 million), partially offset by increases in selling and administrative expenses ($2728 million), and research and development expenses ($86 million) and other income and expense (net $6 million expense).    The increase in joint venture income was attributable to higher royalties, primarily from joint ventures in China, and earnings from our North American distributorships. The increase in selling and administrative expenses is primarily from higher incentivecompensation and fringe benefits, including variable compensation ($810 million) and consolidation of a distributorship as a variable interest entity ($7 million), higher pensionincreased outside consulting services primarily due to Sarbanes-Oxley project costs ($25 million) and a reduction in bad debt expense from a customer emerging from bankruptcy ($2 million), and other volume variable spending, none of which individually were significant.  The increase in research and development expenses resulted from higher incentive compensation ($52 million) and development costs for midrange, heavy-duty and high-horsepower engines ($4 million).  Other income and expense increased primarily from lower foreign currency losses in 2004 compared to 2003 ($4 million).  

                For the first halfnine months of 2004, Segment EBIT for Engine was $131$227 million, compared to $2$38 million in the first half of 2003.same period last year.  The overall increase in earnings year-over-year was largely driven by the economic recovery, in the North American truck market resulting inwith higher engine volumes across all markets and the accompanying gross margin benefits of higher absorption of fixed manufacturing costs at our manufacturing plants andas well as higher earnings from our joint ventures. 

A summary and discussion of net sales for the Engine Business by market application follows:

The Engine Business shipped 106,500 engines in the third quarter of 2004, an increase of 24,400units, or 30 percent compared to the same period last year.  Unit shipments to automotive related markets increased 32 percent, shipments to industrial markets were up 24 percent and shipments to power generation markets increased 11 percent.  For the first nine months of 2004, shipments for the Engine Business increased 31 percent compared to the same period last year with automotive shipments up 32 percent, industrial shipments up 30 percent and shipments to power generation markets up 17 percent.

A summary of shipments by engine classification (excluding unit shipments to Power Generation in 2004) is shown in the table below:

Heavy-duty Truck

Sales to the heavy-duty truck market increased $188 million, or 68 percent, in the third quarter of 2004 compared to sales in the same period last year.  The increase was primarily attributable to a strong recovery in the North American truck market with increased third quarter demand and higher market share.  Total global shipments of heavy-duty truck engines increased 97 percent in the third quarter of 2004 compared to the same period last year.  The variance between the sales percentage increase and the volume percentage increase was attributable to the mix of engine sales versus service part sales.  Sales of service part sales increased 28 percent compared to third quarter 2003, but were a lower percent of total sales in the current quarter.  Unit shipments to the North American OEMs were up 119 percent compared to the same period last year driven by higher demand and higher market share while unit shipments of heavy-duty engines to international locations were up 15 percent, with higher sales to OEMs in Mexico, Australia and Asia, more than offsetting sales declines in Europe.    

Sales to the heavy-duty truck market in the first nine months of 2004 increased $472 million, or 61 percent compared to the same period last year.  Total shipments of heavy-duty truck engines increased 88 percent in the first nine months of 2004 compared to the same period last year with unit shipments to the North American heavy-duty truck market up 101 percent and shipments to international markets up 28 percent.  The sales increase was primarily driven by improved market share and the recovery in the North American truck market as OEMs raised build rates to meet the growing demand from truck fleets replacing aging equipment and adding capacity.

 We now have 70,000 EPA-certified, heavy-duty engines compliant to the 2002 2.5g/bhp-hr NOx (2.5 grams of oxides of nitrogen per brake horsepower) standard in service with an accumulation of 5.1 billion miles of experience.  These new engines continue to perform well for our customers and our share of the North American heavy-duty truck market increased from 21.5 percent in 2003 to 27 percent through August 2004, based upon data published by an independent market research firm. 

Medium-duty Truck and Bus

Medium-duty truck and bus revenues increased $55 million, or 39 percent, in the third quarter of 2004 compared to the same period last year, reflecting strong demand from OEMs.  Unit shipments to the North American medium-duty truck market were up 74 percent above the same period last year, while shipments to international markets increased 47 percent, primarily to OEMs in Latin America and Europe.  Bus engine shipments rebounded in the third quarter of 2004 and were up 35 percent worldwide compared to the same period last year, with a 45 percent increase in shipments to North American OEMs, and a 31 percent increase in international shipments, with higher demand in most of Asia partially offset by lower shipments to India and Europe.

Medium-duty truck and bus revenues in the first nine months of 2004 were up $149 million, or 37 percent, compared with the same period last year, driven primarily from increased demand in the North American truck market.  Shipments of medium-duty truck engines were up 92 percent to North American OEMs and up 27 percent to international OEMs during the same period while shipments of bus engines were down 1 percent in North America and down 3 percent to international locations.     

Light-duty Automotive

Sales of light-duty automotive engines increased $35 million, or 13 percent, in the third quarter of 2004 compared to the same period last year.  Total shipments increased 15 percent compared to the same period last year.  Unit shipments to Daimler Chrysler for the Dodge Ram truck were 38,200 engines, up 11 percent compared to the same period last year, driven by strong demand and market share improvement in diesel powered truck sales.  Sales to recreational vehicle OEMs decreased 35 percent in the third quarter of 2004 compared to the same period last year with shipments down 36 percent due primarily to unusually high sales in 2003 in advance of new product introductions.  

 Sales of light-duty automotive engines increased $163 million, or 23 percent in the first nine months of 2004 compared to the same period last year.  Most of the increase was driven by strong demand for Dodge Ram truck engines with shipments up 20 percent in the first nine months compared to the same period last year.  Engine shipments to recreational vehicle (RV) OEMs decreased 8 percent in the first nine months of 2004 compared to the same period last year partially as a result of higher shipments in 2003 in advance of new product introductions and slightly lower market share in 2004.        

Industrial and Power Generation

Engine sales to the construction, mining, marine, agricultural, oil and gas, government and rail markets and Power Generation were up $218 million, or 84 percent, in the third quarter of 2004 compared to the same period last year (includes $140 million attributable to the change in transfer pricing in 2004) .  Approximately 43 percent of total industrial engine shipments were to North American markets and 57 percent to international markets compared to 37 percent and 63 percent, respectively, a year ago.  Sales to the construction equipment market increased 12 percent year-over-year with engine shipments to North American OEMs up 36 percent and shipments to international OEMs up 13 percent, primarily in Korea and Latin America.  Sales to the agricultural equipment market increased 69 percent in the third quarter of 2004 compared to the same period last year, with a 73 percent increase in shipments to North American OEMs and an 11 percent increase in shipments to international OEMs.  Sales of our high-horsepower series engines to mining OEMs increased 51 percent in the third quarter of 2004 compared to the same period last year, primarily due to higher metal and coal prices, with shipments in North America up 89 percent and international shipments up 46 percent, primarily to Russia and CIS (Commonwealth of Independent States).  Sales to the commercial marine market increased 22 percent in the third quarter of 2004 compared to the same period last year, while unit shipments were also up 22 percent.  Engine shipments to the oil and gas market increased significantly in the third quarter of 2004 compared to a low base in the same period last year, primarily due to market share penetration in North America with our QSK series engine.  Sales to government markets, primarily military applications, increased 78 percent in the third quarter of 2004 compared to the same period last year, with strong demand for service parts sales to domestic locations.  Sales to the rail equipment market, primarily international railcar builders, increased 44 percent in the third quarter of 2004 compared to the same period last year, indicating strong demand in this sector.

For the first nine months of 2004, Industrial and Power Generation sales were up 72 percent compared to the same period last year, (includes $357 million for the change in transfer pricing) primarily due to strong demand across most market segments as the capital goods sector of the economy recovers.  The sales increase, excluding the impact of the change to transfer pricing, was split between domestic and international locations with sales to domestic OEMs up 38 percent and sales to international OEMs up 28 percent, with strong sales to construction OEMs in both markets, up 14 percent globally compared to the same period last year.      

Power Generation

            Net sales and Segment EBIT for Power Generation were as follows:       

Sales in the Company's Power Generation Business increased $161$139 million, or 5238 percent, in the secondthird quarter of 2004 compared to the second quartersame period last year (excludes $14 million attributable to the change in intersegment transfer pricing).  Approximately $51 million of 2003,the sales increase resulted from consolidating entities under the provisions of FIN 46R and the remainder was primarily driven by improved economic conditions in the majority of power generationcommercial, consumer and alternator product markets.  Unit sales of generator drives, generator sets, alternators and sales to the consumer and mobile/RV markets increased significantly in the secondthird quarter of 2004 compared to the same period alast year ago as a result of increased demand.

                Segment EBIT for Power Generation was $17 million in the third quarter of 2004, compared to break-even results in the same period last year.  A majority of the improvement was attributable to higher gross margin from increased sales volume and absorption benefits ($32 million), earnings from joint ventures ($1 million), and lower research and engineering expenses ($1 million) partially offset by increased selling and administrative expenses ($15 million), primarily a result of the consolidation of AVK and SEG and higher variable compensation costs.  In the third quarter, we consolidated the results of two Newage operations, our AVK subsidiary and our SEG joint venture that were accounted for under the equity method in 2003.  The consolidation increased Power Generation's sales $51 million but did not impact segment EBIT since both entities are currently performing at break-even.      

          For the first nine months of 2004, Power Generation Segment EBIT was $42 million compared to a loss of $29 million in the same period last year.  Segment EBIT increased primarily from higher sales volume and related absorption benefits ($91 million), higher earnings from joint ventures ($5 million), lower research and development expenses ($6 million), partially offset by increased selling and administrative expenses ($26 million) and other items that individually were not significant.  

A summary of engine shipments for Power Generation by engine category follows: