PART I

Item 1. Business

BUSINESS STRATEGY

The five key principles upon which we drive our business strategies are as follows:

• Being a Low Cost Producer in as Many of our Markets as Possible. In many of our markets, product or system cost is a critical performance parameter for our customers. To achieve cost leadership, we will continue to leverage our innovative technology, economies of scale, global presence and customer partnerships. We have focused on reducing costs and lowering our breakeven point to maintain a competitive advantage and to deliver quality products to our customers. The following key initiatives are integral to this strategy:
  
• Six Sigma. Since the program’s inception in 2000, we have applied Six Sigma to manufacturing processes and in the initial design of new products, and also expanded the program to include processes with customers, suppliers and distributors. Six Sigma yields significant cost savings and improved quality as well as strengthening our relationships with these important stakeholders and contributing to the development of long-term relationships.
  
• Global Sourcing. Our cost reduction efforts in supply chain management include global procurement from lower cost countries such as China, India and Brazil, where we manufacture engines, generators and components for the local market, and have developed excellent local suppliers. Our efforts have resulted in significantly reducing the cost of purchased materials and services during the last six years.
  
• Technical Productivity. Cummins operates 17 technical centers around the world. We have managed our research and development costs through a number of initiatives including a) using analysis-led design to eliminate capital-intensive prototypes through virtual computer modeling; b) performing significant analysis work at our technical center in India; c) applying engineering standards globally; and d) negotiating cost-sharing arrangements with OEM customers and joint venture partnerships. These initiatives have helped us to continue to be a technology leader, while maintaining our research and engineering expense at approximately 3 percent of consolidated net sales for 2007.
  
• Expanding into Related Markets. We will continue to focus growth initiatives in related businesses where we can use our existing investments in products or technology, leading brand names or market presence to establish a competitive advantage. We focus particularly on ventures that complement our existing businesses by being less capital-intensive and less cyclical or counter-cyclical to our core businesses. For example, we will produce light-duty diesel engines in an existing Cummins facility that will introduce us to a new consumer customer base. Furthermore, we will target related markets that offer higher rates of growth, attractive returns and more stable cash flows through product and end market diversity. Specific growth opportunities are outlined below.
  
• Our Engine segment strategy includes the development of light-duty diesel engines for the SUV/light duty pick-up truck and industrial markets both in the U.S. and in China. In addition, our strategy includes the development of high horsepower engines for the growing oil and gas and marine markets.
  
• Our Power Generation strategy is focused on attaining leadership positions in all major commercial generator set markets globally, including growth in market share in European, Middle Eastern and African markets and penetration gains in power electronics and controls, such as automatic transfer switches and switchgear. The business is also pursuing growth opportunities in adjacent markets for consumer generator sets, including towable trailers, portable generator sets, auxiliary power units and residential generator sets.
  
• Our Components segment will leverage our filtration, exhaust, fuel systems, turbocharger and engine technologies to provide integrated solutions for its customers that meet increasingly stringent emissions requirements.
  
• Our Distribution segment is growing through the expansion of the aftermarket parts and service business by capitalizing on its global customer base and fast growth markets in China, India and Russia as well as the Middle East. Our strategy also includes increasing our ownership interest in key portions of the distribution channel.
  
• Creating Greater Shareholder Value. We use return on equity as a measure of our consolidated financial performance. We report the performance of our operating segments based on segment EBIT which is our primary measure of financial performance. Segment EBIT is earnings before interest expense, taxes and minority interests.
  
• Leveraging Complementary Businesses. Strong synergies and relationships exist between our operating segments in the following areas:
  
• Shared Technology. In addition to common platforms of base product technology, our operating segments have technical capabilities which can be applied commercially to provide integrated solutions for our customers. The operating segments also realize synergies in the development and application of broader technology tools (such as information technology).
  
• Common Channels and Distribution. All operating segments utilize a common distribution channel, which provides access to a full range of our products and also provides economies of scale.
  
• Shared Customers and Partners. There is substantial commonality in customers and partners between operating segments, which allows us to build strong customer relationships and provides opportunity for expanded product offerings.
  
• Corporate Brand and Image. All operating segments benefit from the established and respected corporate brand.
  
• Creating the Right Environment for Success. We believe that creating the right environment for success means creating an inclusive learning environment, while reinforcing a performance ethic that attracts, develops and retains high-quality talent. We measure our success through skill and competency assessment, leadership development outcomes and participation in tailored individual development and training programs.
  

OUR OPERATING SEGMENTS

   We operate four complementary operating segments that share technology, customers, strategic partners, brands and our distribution network to gain a competitive advantage in their respective markets. With our size and global presence, we provide world-class products, service and support to our customers in a cost-effective manner. In each of our operating segments, we compete worldwide with a number of other manufacturers and distributors that produce and sell similar products. Our products primarily compete on the basis of price, performance, fuel economy, speed of delivery, quality and customer support.

Engine Segment

   Our Engine segment manufactures and markets a broad range of diesel and natural gas-powered engines under the Cummins brand name for the heavy- and medium-duty truck, bus, recreational vehicle (RV), light-duty automotive, agricultural, construction, mining, marine, oil and gas, rail and governmental equipment markets. We offer a wide variety of engine products with displacement from 1.4 to 91 liters and horsepower ranging from 31 to 3,500. In addition, we provide a full range of new parts and service, as well as remanufactured parts and engines, through our extensive distribution network. The Engine segment is our largest operating segment, accounting for approximately 52 percent of total sales before intersegment eliminations in 2007.

   The principal customers of our heavy- and medium-duty truck engines include truck manufacturers, such as PACCAR, International Truck and Engine Corporation (Navistar International Corporation), Daimler Trucks North America and Volvo Trucks North America. CNH Komatsu, Hitachi, Ingersoll Rand, Brunswick and Terex represent manufacturers of construction, agricultural and marine equipment to whom we sell our industrial engines. The principal customers of our light-duty on-highway engines are Chrysler and manufacturers of RVs.

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

   Our Engine segment organizes its engine, parts and service businesses around the following end-user markets:

Heavy-Duty Truck

   We manufacture a complete line of diesel engines that range from 310 horsepower to 600 horsepower serving the worldwide heavy-duty truck market. We offer the ISM and ISX engines and in Australia, the Signature 620 series engines, which we believe comprise the most capable engine line in our industry. Most major heavy-duty truck manufacturers in North America offer our diesel engines as standard or optional power. In 2007, we held a 38 percent share of the Group II engine market for NAFTA Class 8 heavy-duty trucks. We are also the market leader in Mexico and South Africa. Our largest customer for heavy-duty truck engines in 2007 was PACCAR with sales representing almost 5 percent of consolidated net sales.

   We have long-term supply agreements with three key customers to improve the ease of doing business and increase market share. We have a long-term agreement with Volvo Trucks North America, Inc. under which we act as its sole external engine supplier. We also have long-term supply agreements with PACCAR and International Truck and Engine Corporation (Navistar International Corporation) covering our heavy-duty engine product line. These supply agreements provide long-term, stable pricing for engines and eliminate certain dealer and end-user discounts, in order to provide our customers with full responsibility for total vehicle cost and pricing. In addition, these agreements enable Cummins to work more closely with them in joint engineering efforts earlier, delivering seamlessly integrated, dependable vehicles to the market. The joint sales and service efforts also provide better customer support at reduced cost to the partners.

Medium-Duty Truck and Bus

   We manufacture a product line of medium-duty diesel engines ranging from 200 horsepower to 400 horsepower serving medium-duty and inter-city delivery truck customers worldwide. We believe that our ISB, ISC and ISL series diesel engines comprise the most advanced and capable product line in the industry. We sell our ISB and ISC series engines and engine components to medium-duty truck manufacturers in North America, Asia, Europe and South America. For the year ended 2007 our market share for diesel powered medium-duty trucks in the North American Class 7 medium-duty truck market had grown to above 37 percent. We are the exclusive medium-duty engine provider for PACCAR world wide and Ford in Brazil. We are the largest manufacturer of natural gas and hybrid bus engines in the U.S. as well as a significant global provider of natural gas engines. Daimler Trucks North America (formerly Freightliner LLC), PACCAR, Ford and Volkswagen AG are our major customers in this worldwide market.

   We also offer our ISB, ISC and ISL diesel engines and their alternative fueled counterparts, for school buses, transit buses and shuttle buses worldwide. Key markets include North America, Latin America, Europe and Asia. The demand for alternative-fuel products continues to grow both domestically and internationally. Cummins Westport Inc. (CWI), a joint venture formed in 2001 with Westport Innovations, Inc., markets low-emission, propane and natural gas engines in bus markets worldwide. Significant fleets are located in cities ranging from Los Angeles, Boston, Salt Lake City, Vancouver, Canada and Beijing, China. We are the largest provider of diesel engines for hybrid bus applications in the United States.

Light-Duty Automotive and RV

   We are the exclusive provider of diesel engines used by Chrysler in its Dodge Ram trucks. Our relationship with Chrysler extends nearly 20 years and in 2007 we shipped over 142,000 engines for use in Dodge Ram trucks. The 6.7-liter Dodge Ram Turbo Diesel engine offers best in class 650 lb-ft of torque and 350 horsepower and this popular engine continues to result in strong sales volumes with the availability of our engine in the 2007 Dodge Ram Chassis Cab model and the Sterling Bullet.

   We are the leading manufacturer of diesel engines for use in the Class A motorhome market, with a market share above 70 percent of the diesel engines in retail Class A motorhome sales. The diesel segment of the Class A motorhome market has grown to approximately 50 percent in 2007, indicating a growing preference for diesel power for this application.

Industrial

   Our mid-range, heavy-duty and high-horsepower engines power a wide variety of equipment in the construction, agricultural, mining, rail, government, oil and gas, power generation, commercial and recreational marine applications throughout the world. The engine range extends from the A-series to the QSK78 allowing Cummins to penetrate the light utility market with smaller engines up to the largest mining machines with the QSK60 and QSK78. Our major construction OEM customers are in North America, Europe, South Korea, Japan and China. These OEMs manufacture approximately one million pieces of equipment per year for a diverse set of applications and use engines from our complete product range. Agricultural OEM customers are primarily in North America, South America and Europe, serving end-use markets that span the globe. Our engines are sold to both recreational and commercial boat builders, primarily in North America, Europe and Asia. In the recreational marine markets, our joint venture, Cummins MerCruiser Diesel Marine, is the market share leader in the North American and South Pacific recreational boat segments for power ranges in which we participate. We offer a full product line of high-horsepower engines for mining applications that compete in all segments from small underground mining equipment to 400-ton haul trucks. We occupy a strong number two position in the mining market, where we offer the broadest engine line-up in the industry. In this market, we continue to be the exclusive or preferred supplier of engines to large construction and mining equipment OEM’s such as Komatsu, Hitachi and Belaz. Our sales to the rail market are primarily to railcar builders in Europe and Asia and we are a leader in the worldwide railcar market. With our QSK60 and QSK78 engines, we expect to move into a larger proportion of the locomotive and railcar markets outside North America and commercial marine markets worldwide. Government sales represent a small portion of the high-horsepower market and are primarily to defense contractors in North America and Europe. Our full line of diesel and natural gas engines, power generation products and global distribution and customer support capabilities have enabled us to achieve significant growth and penetration with oil and gas customers in North America and moderate growth internationally.