U.S. Distributor Guarantees

Since 1997 we have had 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.  The 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. 

Under the amended and restated terms, our guarantee of any particular distributor financing is limited to the amount of the financing in excess of the distributor's "borrowing base." The "borrowing base" is equal to the amount that the distributor could borrow from the financial institution without our guarantee. Furthermore, if any distributor defaults under its financing arrangement with the financial institution, and the maturity of amounts owed under the agreement is accelerated, then we are required to purchase from the financial institution at amounts approximating fair market value certain property, inventory and rental generator sets manufactured by Cummins that are secured by the distributor's financing agreement. 

                The operating agreement will continue in effect until February 7, 2007, and may be renewed for additional one-year terms. As of June 26,September 25, 2005, we had $7$3 million of guarantees outstanding under the operating agreement relating to distributor borrowings of $131$130 million.

Residual Value Guarantees

                We have various residual value guarantees on equipment leased under operating leases.  The total amount of these residual value guarantees at June 26,September 25, 2005, was $10 million.

Other Guarantees

                In addition to the guarantees discussed above, from time to time we enter into other guarantee arrangements, including guarantees of non-U.S. distributor financing and other miscellaneous guarantees of third party obligations. The maximum potential loss related to these other guarantees was $20$24 million at June 26,September 25, 2005.

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 June 26,September 25, 2005, if we were to stop purchasing from each of these suppliers, the amount of the penalty would be approximately $38$15 million.  However, based on current forecasts, we do not anticipate paying any penalties under these contracts.

Indemnifications

                Periodically, we enter into various contractual arrangements where we agree to indemnify a third party against certain types of losses. Common types of indemnifications include:

• product liability and license, patent or trademark indemnifications,

• asset sale agreements where we agree to indemnify the purchaser against future environmental exposures related to the asset sold and

• anyAny contractual agreement where we agree to indemnify the counter‑toer‑party for losses suffered as a result of a misrepresentation in the contract.

            We regularly evaluate the probability of having to incur costs associated with these indemnifications and accrue for expected losses that are probable.  Because the indemnifications are not related to specified known liabilities and due to their uncertain nature, we are unable to estimate the maximum amount of the potential loss associated with these indemnifications.

NOTE 9.  COMPREHENSIVE EARNINGS

A reconciliation of our net earnings to comprehensive earnings, net of tax, was as follows:

NOTE 10.  EARNINGS PER SHARE

We calculate basic earnings per share (EPS) of common stock by dividing net earnings 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 debt 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.  The following is a reconciliation of net earnings and weighted-average common shares outstanding for purposes of calculating basic and diluted net earnings per share:

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The weighted-average diluted common shares outstanding for the three and sixnine months ended June 27,September 26, 2004, exclude the effect of approximately 0.1 million and 0.60.4 million common stock options respectively, since such options had an exercise price in excess of the average market value of our common stock.

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NOTE 11.  OTHER (INCOME) EXPENSE, NET

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

NOTE 12.  OPERATING SEGMENTS

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.  We use segment EBIT (defined as earnings before interest expense, taxes and minority interests) 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.

Our reportable operating segments consist of the following: Engine, Power Generation, Components and Distribution. 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.  

As previously announced, effective May 2, 2005, we made certain leadership changes within our management team.  In connection with these changes, certain modifications were made to our internal reporting.  These modifications are summarized below:

• The Filtration and Other Segment was renamed the Components Segment and now includes operating results of the Fuel Systems business which were previously included in the Engine Segment.  Historically, the Fuel Systems business primarily transferred product within the Engine Segment at cost and beginning in the third quarter those costs were eliminated from segment results.transfers use a cost-plus based transfer price.  As a result of this change, does not materiallySegment EBIT increased for the Components Segment and decreased for the Engine Segment but there was no impact Engine segment revenues or EBIT.to consolidated earnings.  Revenues of the Components Segment were also increased to reflect transfers to the Engine Segment and eliminations were increased by a corresponding amount.  

• The North American Distribution business was combined with the International Distribution Segment and renamed the Distribution Segment.  Previously, the North American business was reported in the Engine and Power Generation Segments as equity from investees and also includes the results of a partially owned distributor we are required to consolidate.  As a result, revenues of the Engine Segment were increased to reflect sales to the consolidated distributor that were previously eliminated and decreased for the revenues of the consolidated distributor which are now included in the Distribution Segment.  In addition, earnings from equity investees in the Engine and Power Generation Segments decreased while equity in earnings from investees in the Distribution Segment increased by a corresponding amount. 

              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 segmentSegment EBIT may not be consistent with measures used by other companies.   

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Due to the extent of intersegment sales activity and certain seasonality in inventory levels during the year, we have presented the elimination of intercompany profit in inventory resulting from intersegment transactions in the eliminations column of our segment reporting.  This presentation better aligns segment revenues with segment costs and presents segmentSegment EBIT as if each segment were an independent entity. 

                A summary of operating results and net assets by segment for the three and sixnine month periods is shown below:

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

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is management’s discussion of 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.   This section should be read in conjunction with our Consolidated Financial Statements and related Notes to Consolidated Financial Statements in the "Financial Statements" section of our 2004 Annual Report on Form 10-K.  Certain prior year amounts included in this section have been reclassified to conform to the current year presentation.  All references to earnings per share amounts are diluted per share amounts.  Our discussion contains forward looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions.  Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “RISK“ RISK FACTORS RELATING TO OUR BUSINESS” included in Part I of our 2004 Annual Report on Form 10-K and “Disclosure“ Disclosure Regarding Forward-Looking Statements” presented at the end of this section.

COMPANY PROFILE

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

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

We maintain an internet web site at www.cummins.com.  Investors can obtain copies of our filings with the Securities and Exchange Commission (SEC) from this web site free of charge, as well as from the SEC Webweb site at www.sec.gov.

FINANCIAL OVERVIEW 

Current Quarter Compared to Prior Year’s Quarter

                We experienced veryanother strong performance in the secondthird quarter of 2005 with net earnings of $141$145 million, or $2.83$2.90 per share, on net sales of $2.5 billion, compared to secondthird quarter 2004 net earnings of $82$116 million, or $1.76$2.40 per share, on net sales of $2.1$2.2 billion.  Net earnings and sales were a third quarter record for Cummins as we continue to benefit from improved economic conditions resulting in high levels of demand across our business.businesses.  All of our segments reported increased sales increases in the secondthird quarter compared to a year ago, with particularly strong demand in the North American heavy-duty truck market where engine sales increased 2515 percent and our market share continues to strengthen compared to the second quarter a year ago.strengthen.  Our joint ventures contributed $35$28 million, or 2519 percent, of net earnings in the secondthird quarter of 2005 compared to $29$26 million, or 3522 percent of net earnings in 2004, with the largest increase from DCEC.2004.

The table below provides an analysis of changes in the Consolidated Statements of Earnings for the secondthird quarter of 2005 compared to the secondthird quarter of 2004.

Current Year-to-Date Compared to Prior Year-to-DateYear

The                Earnings performance for the first halfnine months of 2005 was equally as strong  as the second quarter with net earnings of $238$383 million, or $4.80$7.70 per share, on net sales of $4.7$7.2 billion, compared to the first half of 2004 with net earnings of $115$231 million, or $2.53$4.95 per share, on net sales of $3.9 billion.$6.1 billion for the first nine months of 2004.  The earnings improvement in 2005 compared to 2004 was primarily driven by a 21higher sales, up 18 percent, increase in net sales and a 29 percentcorresponding increase in gross margin, compared to the first half of 2004up 30 percent, as weour businesses continue to benefit from high levels of demand, pricing actions and our focus on cost improvements across our businesses.improvements.  All of our businesses reported increased sales increases in the first halfnine months of 2005, with particularly strong demand in the North American heavy-duty truck market where engine sales increased 4428 percent and total automotive related sales accounted for 47 percent of the increase in sales as our market share has continuedcontinues to strengthen compared to the same period a year ago.  Our joint ventures contributed $66$94 million in earnings in the first halfnine months of 2005 compared to $47$73 million in the same period a year ago, with the largest increase from DCEC.

The table below provides an analysis of changes in the Consolidated Statements of Earnings for the first halfnine months of 2005 compared to the first halfnine months of 2004.

BUSINESS OUTLOOK

Our Engine Segment experienced much stronger than expected volumes in virtually all of its markets in 2004 and most economic indicators point toward continued improvement at a moderate pacethrough the first nine months of 2005 our financial performance for this segment indicates we will deliver record results in 2005.  We currently expect North American heavy-duty truck production levels to increase approximately 2426 percent, from an estimated 245,000246,000 units in 2004 to approximately 305,000310,000 units in 2005.  While 2004 demand was driven partially from fleets adding capacity as freight volume increased, the majority of the increase resulted from the replacement of aging vehicles.  In 2005, we expectnew truck demand will bewas again driven primarily bypartially from fleets adding capacity as freight volume increased, but the economy as manufacturing and consumer spending levels increase and trucking fleets expand their capacity through equipment purchases.  We also expect salescontinues to reflect strong demand for replacement of aging vehicles.  Sales of midrange engines to the medium-duty markets to increasehave increased in 2005, as economic indicators for this market historically correlate with those of the heavy-duty market.  Sales of our 5.9 liter turbo diesel engine to Daimler Chrysler for the Dodge Ram truck reached record levels in 2004 and we expect significantly higher annual volumes in the second half of 2005 with the launch of the new model year Dodge Ram truck.  Although we expect a flatthe worldwide bus market we expecthas been relatively flat, our market share with bus OEMs to increasehas increased in North AmericanAmerica and Latin America.  Our industrial markets also experienced a strong recovery in 2004 and our 2005 performance indicates continued growth is expected through 2005,in this market, with particularly with higher demand for engines from OEMs in the construction and mining OEMs. industries.

                In 2004, profitability returned to our Power Generation Segment driven by strong demand for commercial products in China and the Middle East, a significant increase in alternator sales to generator set OEMs, record sales of Onan branded generator sets to RV manufacturers, our continued focus on cost reduction initiatives, restructuring benefits and new product introductions.  InThrough the first three quarters of 2005, we expectexperienced continued growth in international markets for commercial power generation and alternators and stronger growthstrong demand for commercial generator sets in North American markets.America and the Middle East.  In the consumer markets, we expectour revenues to increaseincreased from new product launches but expect essentially flatand higher volumes in the towables RV generator setmarket, thus offsetting lower volumes in the Class A RV market where industry-wide motor home production has exceeded market demand.  Overall, Power Generation revenues are expected to increaseon pace for a record high in 2005 with improved profitability for this segment from pricing actions, capacity utilization and benefits from cost reduction initiatives.    

                In our Components segment, we expectSegment, revenues to increaseare up in 2005 from market growth and share penetration.  Revenues from our Emission Solutions business are expected to be slightly higherup 9 percent through the first nine months as we continue to gain market share in the domestic retrofit business while revenuesbusiness.  Revenues from our Holset turbocharger business are expected to increasehave also increased with strong demand in North America and from OEMs in Europe and China.  Overall, profitability is down slightly but expected to improve as a result of cost reduction initiatives, the impact of pricing actions to offset steel cost increases and manufacturing and logistic efficiency improvements.   Sales of fuel systems products to the Engine Segment, which historically were transferred at cost will now use a market-basedcost-plus based transfer price.  This change will increaseincreased segment EBIT for the Components Segment and decreasedecreased segment EBIT for the Engine Segment but willdid not impact consolidated earnings.

                In 2004, revenues of our Distributor segmentSegment improved in every geographic region and profitability increased significantly.  As the worldwide economy improves and our engine population increases, we expectour 2005 sales growth in engines, parts, service and power generation equipment to continuecontinues in this segment as we capitalize on a growing global customer base.  In 2005, weWe also expect revenuesearnings to continue to increase from sales growth in existing markets, distributor acquisitions, and branch expansions with increased earnings from the higher sales volume, controlled expenses and planned consolidations.expansions.

                Earnings from our joint ventures are expected to bewere strong again induring the first three quarters of 2005, particularly in Asia, through our partnership,partnerships, DCEC which is a supplier to the second largest truck manufacturerand CCEC in China and in North America through our distributorship joint ventures.  Recent regulatory changes in China limiting truck size, may adversely affectrelaxed enforcement of the overload policy/law and higher fuel prices have softened demand for DCEC product volumesproducts in the short-term as OEMs and end users assess the impact of thethese changes.  However, we continue to expect long-term growth in the China automotive truck market, particularly for our higher horsepower engines. 

                We had a very strong performance inthrough the first halfnine months of 2005 and benefited from growinga strong global rebound in demand across a number of our markets.  Our outlook for the remainder of the yearfourth quarter indicates continuing robust demand for our products and services.  Our current estimate of 2005 revenue growth is approximately 15 percent and we expect to deliver another record year with improved margins from cost reduction initiatives, and price realization and higher earnings from joint ventures, we nowventures.  We currently expect demand in our full year earningsbusinesses to range from $10.10 to $10.30 per share.  For the third quarter of 2005, we expect per share earnings to range from $2.40 to $2.50 per share.remain strong through 2006.   

                We expect our businesses to generate sufficient cash from operations in 2005 to fund capital expenditures, research and development, pension funding, debt service costs and dividend payments.payments in 2005.  In addition, we expect cash outflows for 2005 capital expenditures in 2005 to range frombe less than our previous second quarter estimate of $220 million to $240 million and funding of new investments in our joint ventures will approximate $15$6 million to $20 million.$10 million in 2005.  We also have available various short and long-term credit arrangements, which are discussed below and disclosed in Note 11 to the Consolidated Financial Statements in our 2004 Annual Report on Form 10-K. These credit arrangements and other programs, such as our accounts receivable program, provide the financial flexibility, when needed, to satisfy projected working capital requirements.