康明斯 (CMI) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second quarter 2009 Cummins earnings conference call. My name is Fab and I will be your coordinator for today. At this time, all participants are in a listen only mode. We will conduct a question and answer session toward the end of this conference. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call, Mr. Dean Cantrell, Director, Investor Relations. Please proceed.

Thank you, Fab. Welcome, everyone, to our teleconference today to discuss Cummins' results for the second quarter 2009. Participating with me today are Chairman and Chief Executive Officer, Tim Solso; our President and Chief Operating Officer, Tom Linebarger; and our Chief Financial Officer, Pat Ward. We will all be available for your questions at the end of the teleconference.

This teleconference will include certain forward looking information. Any forward looking statement involves risk and uncertainty. The company's future results may be affected by changes in general economic conditions and by the actions of customers and competitors. Actual outcomes may differ materially from what is expressed in any forward-looking statements. A more complete disclosure about forward-looking statements begins on Page 3 of our 2008 Form 10-K and it applies to this teleconference.

During the course of this call, we will be discussing certain non GAAP financial measures, and we refer you to our website for the reconciliation of those measures to GAAP financial measures. Our press release with a copy of the financial statements and a copy of today's webcast presentation is available on our website at www.Cummins.com under the heading of Investors and Media.

Before we review our second quarter performances, I would like Tim to say a few words.

Good morning. Given the challenging economic conditions under which we are operating today, I was pleased with our performance in the second quarter. The actions we have been taking to keep the company strong during the recession have made a difference, which you can see in the improved profitability and cash flow from the first to second quarter. Tom Linebarger will provide more detail on our actions in the second quarter, but I wanted to begin by highlighting a number of positives from the quarter.

Excluding restructuring charges, our EBIT performance has improved each of the last two quarters. In the fourth quarter of 2008, EBIT was 2.8% of sales. In the first quarter, it was 3.9% of sales, and in the second quarter, it increased to 4.8% of sales. This improvement is the result of the aggressive action we have taken to control costs during the downturn. We generated nearly $240 million of cash during the quarter as a result of inventory reduction. Our cash position improved significantly during the quarter and we've not borrowed from our $1.1 billion credit revolver established last year. We increased market share in several markets, including the North American heavy duty truck engine market, where our year to date share is now above 46%, which was 50% in May. And our distribution business has an extremely strong quarter given the current economic situation.

Looking to the second half of this year, our goals remain the same as they have been for the past several months. We will continue to focus on generating cash so we can invest in critical technologies and products for 2010 and beyond. And we will keep a tight rein on costs and closely monitor manufacturing capacity to align with the real demand for our products.

As I have said before, we remain confident that the company is well positioned to take advantage of a number of long term market trends and will resume its growth once the recession ends. We are performing far better in this recession versus past downturns, even though this is the worst economic climate since World War II, and we continue to explore profitable growth opportunities so we can build on our fundamental strengths when our markets recover.

Having said that, I want to remind everyone that the global economy remains weak. While we have seen modest improvement in some markets, such as China and India, we are continuing to manage the business under the assumption that we will not see a meaningful recovery in our markets until at least late 2010. Given our outlook on the economy and end markets for the remainder of the year, we are maintaining the sales and EBIT guidance for 2009 that we shared with you at the end of the first quarter. We expect sales to be slightly more than 30% lower than 2008 and EBIT of 5% of sales excluding restructuring charges.

Finally, I would like to say a few words about our preparation for the 2010 product launch. We remain on track for the largest product launch in our history in 2010. So far, our field test results have exceeded expectations. As a reminder, we are introducing four new engine platforms and several new components in the next 12 months. We have tested our 2010 heavy duty truck engines with approximately 50 major customers. And just as we have in the last several years, we have run the engines in all weather conditions and across all duty cycles. We have tested the engine in minus 40 degree temperatures in Yellowknife, Canada and in the 120 degree heat of Death Valley, California, and the results have shown great performance, solid reliability, and improved fuel economy.

By the beginning of the fourth quarter, we expect to have received EPA certifications on all our engines. And by the time we go into production in January 2010, our new heavy duty and mid range engines will have logged approximately 5 million test miles. Just as we did in 2002 and in 2007, Cummins will live up to its commitment to produce the cleanest diesel engines in the world, on time, and with the reliability, fuel economy, and performance our customers have come to expect.

Now, Tom will share some additional details on the second quarter and why we think the company continues to be well positioned for the future.

Thank you, Tim. I would like to start by quickly echoing two of Tim's themes -- our expectations for the economy, and our markets for the rest of this year and 2010 remain the same. We are seeing modest improvement in our business in China, India, and Brazil, and signs that the recession has bottomed out in these parts of the world, but it is far too early to say the global recovery is underway. We feel good about our position, not only as it relates to our abilities to remain profitable and generate cash through the downturn, but also to our ability to emerge from the recession stronger than ever. In terms of our major geographic markets, we have seen no improvement in North America and Europe, where the latest economic forecasts call for no real growth for the rest of this year.

The situation is somewhat better in our key emerging markets of China, India, and Brazil. In China, domestic demand is relatively strong and improving, while the export market remains very weak. Gross domestic product for the first half of the year was forecast to be 7%, while the second quarter growth accelerated to nearly 8%. We are seeing increased order rates in China in line with the strengthening economy. In India, the situation is similar, with domestic demand expected to grow and exports to remain relatively weak. The Indian government is projecting 7% GDP growth for its current fiscal year, which ends in March 2010, with the recovery expected in the second half.

From an end market perspective, the biggest change from the first quarter came in the rapid volume decline in the late cycle markets, such as mining, oil and gas, and Power Generation. Our Power Generation sales, for example, were down 35% from a year ago and are now expected to be down 30% to 35% for the year. We began implementing cost reduction actions immediately as the downturn started. As Tim mentioned, our performance improved from the fourth quarter of 2008 as our cost reduction efforts began to take hold. For example, our selling, administrative, and research expenses fell $19 million from the first quarter and are down $108 million from the same period in 2008. We also continued to reduce or reorganize manufacturing capacity in response to volume declines. Our actions since the fourth quarter of 2008 to scale back the company's manufacturing operations resulted in $13 million in reduced spending compared to the first quarter and $43 million since the second quarter of 2008.

Capital spending in the second quarter was $75 million, 32% lower than the same period in 2008. And for the first half of the year, we have spent $139 million on capital projects or 31% less than during the six months of 2008. While we are working hard to lower our costs during the downturn, we are still finding ways to make the company stronger for the long run. We are continuing to fund critical and time sensitive projects, such as those linked to 2010 product launches and research and development on fuel economy improvement. Even with the reductions we've made, capital spending in 2009 will represent the third largest total in our history.

We also launched the first of our four new engine platforms in June. The ISF 3.8 engine went into production in our Foton Cummins joint venture in China. The next platform, the ISF 2.8, is expected to start production at the end of this year.

We continue to provide world class service and support to our customers across all four business segments and are investing in new ways to demonstrate that we care about our customers' success, even in the toughest times. We have taken advantage of the volume slowdown to improve processes and synchronized flows at a number of our plants and distribution centers, so that when demand does return, we will be ready to ramp up as quickly as possible. We have moved swiftly, both within individual businesses and working across our business units to solve inventory and supply chain problems. These efforts have led to a significant improvement in our inventory position.

As you know, we have reduced our work force significantly in the past several months. Our employees have responded to this challenge by working together more effectively than ever. The increased productivity we are seeing is one of the primary reasons we have responded to this recession more effectively than in previous downturns.

Pat will talk about our business segments in a moment, but I want to close with a few words on our relationship with Chrysler. As you know, Chrysler emerged from bankruptcy protection in June. As part of its plan, the contracts for the Dodge Ram heavy duty pickup truck were assigned to the new Chrysler. While those associated with our light duty diesel program were not, both of these results were as we expected. Production of the 6.7 liter turbo diesel engine for the Ram has resumed temporarily at our Columbus mid range engine plant to fulfill the remaining demand for 2009. We expect to return to work on a more permanent basis when Chrysler begins production of the 2010 model year trucks this fall.

We are actively seeking additional customers for our light duty engine even as we continue to discuss a new arrangement prior to Chrysler. Although the recession has delayed our plans to begin light duty engine production in the US, we remain convinced that this market has significant potential for Cummins. We have a lot of work ahead of us, but I am confident that we have the plans and the people in place to manage through the global recession and emerge an even stronger company. Now I will turn it over to Pat to provide more details about in second quarter.

Thank you. Cummins delivered a solid financial performance this quarter, considering the challenging market conditions we continued to face. We remain on track to meet our 2009 guidance of achieving 5% EBIT margins before restructuring, and generating positive cash flow. Second quarter sales were down 37%, a drop of almost $1.5 billion from a year ago, which contributed to a decrease in gross margin of $431 million. This was partially offset by spending reductions in selling, administration, and research and development of $108 million. EBIT margins dropped from 12.1% last year to 4.8% in this quarter, excluding the $7 million restructuring charge. Compared to the first quarter, sales were slightly down. However, EBIT margins excluding the restructuring charges improved from 3.9% to 4.8% as a result of the cost reduction actions and stronger joint venture income in the emerging markets. Earnings per share were $0.30 this quarter excluding the restructuring charges.

Let me provide more detail on the performance of each of our segments, as well as affiliate expectations. In order to make the comparisons more meaningful at similar volumes, I will also highlight the sequential variance analysis.

Distribution revenues, highlighted in Slide 7, were down 20% from a year ago, with 9% of the drop due to currency, but were up 12% versus the first quarter. Profitability remains strong at 11.9% of sales, which is above the segment's target profitability levels. For the year, we are maintaining our previous revenue guidance of down 15% to 20% for distribution, implying that the second half will be slightly up from the first half of the year in sales, mainly due to seasonality. Given the year to date performance of this segment, we are increasing our EBIT margin expectations to 12% of sales in 2009. We are pleased with the performance of the distribution segment in this downturn, which shows our diversification efforts are paying off.

In the engine segment, revenues dropped 45% versus the same quarter a year ago, driving segment profitability to nearly breakeven. Compared to the first quarter of 2009, revenues dropped a further 12%, almost $200 million, due to the Chrysler shutdown and a sharp reduction in demand for high horsepower engines. However, despite the lower revenues, segment profitability improved sequentially over the first quarter, as a result of continued cost reduction and stronger joint venture earnings in the emerging markets. We are maintaining our previous full year guidance for revenues down 30% to 35% and EBIT margins between 1% to 1.5% of sales for the engine segments.

You can find more details of our outlook for the engine markets on Slide 11 of our presentation. We are forecasting NAFTA Class 8 heavy duty truck production of 98,000 units in 2009 and our market share for the year of 47%, or 2 percentage points up from 2008. For medium duty truck, we expect our shipments to drop over 20% in Brazil, more than 30% in North America, and close to 60% in Europe. We are forecasting revenues to be up 20% for bus due to stimulus packages, especially in North America and in India. And for industrial engines, revenues will be down more than 40%, with all markets affected by the global slowdown and channel inventory corrections.

Our guidance implies a slight increase in revenues from the first half to the second half of the year for engines, mainly due to the higher demand from truck and bus applications in North America, and some stabilization and global construction markets following inventory corrections. We also expect profitability to improve sequentially in the second half of the year from slightly higher volumes, stronger joint venture income in the emerging markets, lower commodity cost, as well as the impact of the restructuring actions we have taken over the past six months.

For the component segment, revenues in the second quarter also declined significantly by 41% from a year ago and were 5% lower than the previous quarter. The sharp fall-off in demand caused profitability to drop to a negative 2% of sales, which is well below the rate of 9% that we reported last year and was in the previous quarter results. For the full year, we are maintaining our previous guidance of revenue down 30% to 35% and EBIT in the range of 1% to 2% of sales. We expect to see a slight improvement in revenue from the first to the second half of the year, mainly from North America and Chinese on [highway] demand. Profitability for the segment will improve sequentially in the second half of the year as a result of the higher volumes and cost reduction initiatives.

And finally, our Power Generation segment was effected by the global reduction of commercial construction projects and channel inventory corrections, particularly in Europe and in the Middle East. Sales declined 35% in this quarter versus a year ago and 7% from the first quarter, which is normally our weakest quarter of the year. This sharp decline in sales resulted in an EBIT margin of 6.7% of sales in the quarter compared to the [rate of] 12.3% in the second quarter of 2008. For the full year, we are reducing revenue guidance for this segment to a decline of 30% to 35% as the outlook for the second half of the year shows further softening. We are also reducing EBIT guidance to the range of 7% to 8% of sales for the full year, as a result of the sharp [fall] in volumes and the pricing pressure we discussed on our last call. For the total company in 2009, as Tim mentioned, we are maintaining our guidance of revenues down slightly more than 30% and EBIT margins of 5% of sales excluding the restructuring charges.

Now, moving to the cash flow statement, we were pleased with our cash management performance during the second quarter. We generated $238 million of cash from the reduction of inventory, which contributed to a net inflow of cash for the quarter of $181 million. All four segments reduced inventory, but more notably in late cycle businesses of high horsepower engines, Power Generation, and distribution. As a result, we were able to fund operations from internal cash flow throughout the quarter without having to access our available credit facilities.

Our debt to capital ratio at the end of the quarter was 15.9%. Cash management will continue to be a top priority for the company. For the remainder of the year, we believe we have opportunities to reduce inventory further, as we expect the late cycle markets will continue to burn off inventory. We continue to prioritize our capital investments and still anticipate spending $300 million to $350 million this year, including capital for flood-related damage.

In summary, we remain committed to generating positive cash flow in 2009, which will allow us to continue to invest in critical technologies and in profitable growth opportunities. We will now take your questions.

(Operator Instructions). And our first question will come from the line of Meredith Taylor from Barclays Capital. Please proceed.

Hi, good morning. I'm hoping you can talk a little bit more about what you saw in the UK and the Middle East in the Power Gen business. If you could talk about how that evolved over the course of a quarter on a month to month basis, and then if you could give us a little bit more color on where you think that the channel is right now in the way of reducing inventory and how much there still is to go?

Okay. In the Middle East and Europe -- Middle East was the biggest one, and there was a very large growth in Power Gen over the last several years there. And the market was one where there was quite of bit of stocking in the channel, because not only does the -- did they want their -- there was there a lot of growth, but they wanted it on short lead time. So we ended up with a significant stocking position in the Middle East and our business demand was justified in that for some time.

Then over the course of the first and second quarter, demand fell off. What we said in our remarks was that demand fell off significantly in the second quarter, even over the first, which is right. And then our distribution channel began to react. We did some cancellations and reductions in demand in the first quarter. We did quite a bit more in the second quarter. As a result, our inventory positions in both places are down to much more normal levels.

I would say to you, though, that still our view is we have more inventory in the channel than demand would suggest today and particularly in the Middle East. But we will have that corrected within this quarter, is our view. By the time we get done with this quarter, we will be at normal inventory levels, is what we expect. But, again, it's -- our view now is we're in much more -- while there is a little bit left to go, we're in a much more normalized position and feeling much more comfortable with where we are. We took most of the reductions in the second quarter that we needed to take.

Can you talk a little bit about what kind of price action you saw in the inventory that you reduced? Clearly you did a great job in terms of working inventory through the system.

We didn't actually do many price reductions on the inventory. As we said in the last call, we were forecasting price reductions of somewhere on a net basis, somewhere around 1%. So we had some increases at the beginning of the year. Our expectation is we would lose some of those price increases over the course of the year, and the net would maybe be 1% down. So we are not taking significant price actions on a systematic basis.

What we're seeing is in fact in the market, is price is not being a big lever in most markets. There are a few places where dealers have extra inventory and they are taking some action on a deal by deal basis. But so far price is actually doing okay in the market as a general matter and we are being very, very conservative on price. We -- it didn't serve us that well to be aggressive on price in the last downturn. What we did is lower price, and demand didn't go up and our view is that's still likely to be the case here. So really in terms of price, what you can think of is if there is an individual project that looks like we -- lowering price a little bit would make a difference, we might. But as a general matter, we are not lowering price.

Okay. And then just one last quick question and I'll pass it along. Can you just update us on where you are with respect to backlog in that business?

Backlog, we're at about a quarter's worth of backlog. We entered the year at something like nine months of backlog. I'm talking about the commercial Gen-set business now, not all ancillaries, but commercial Gen-set business, which is where backlog mostly exists. We entered the business year with about nine months. We are operating now with about three months. And that kind of lead time, three months lead time is actually pretty typical when you're not sold out of units. That's not -- that's pretty average. So that's okay.

The issue is what will demand go to going forward. That's really the question ahead of us. I think backlog is an okay level now. We just need to make sure we're continuing to see sales flatten out as opposed to drop, which as you heard from Pat, one of our concerns is that sales will drop a little further in the second half.

That's great. Thanks so much.

And our next question will come from the line of Chip Miller from JPMorgan.

Hey, guys. It's Chip Miller for Ann at JPMorgan. Can you provide a little bit more color on some of the other later cycle markets as well, maybe even on just a relative basis, comparing mining, oil and gas, ag to power gen, and then also any color there on how much backlog you have?

In terms of this, in this quarter, Chip, we saw some continued deterioration in some of the other late cycle markets. Mining and oil and gas were two that we definitely saw a sequential deterioration. As you saw in our outlook and in the presentation, we're still expecting very low levels of demand coming from those late cycle markets for the rest of the year. Commercial marine is another one where we've seen, especially from a year-over-year perspective, some very weak levels of demand, as concerns around credit availability and just the fact that freight tonnage for marine purposes is at low levels, as well as commodity prices. So I think the cancellations that started to accelerate at the end of the first quarter, we've clearly seen run through our high horsepower engine facilities in the UK and the US and in India, and utilization rates are at significantly lower levels than what we saw coming into the year.

Chip, this is Pat. I would add to what Dean just said is we would expect mining markets now to be down around 40% for the full year and that second half could be half of what the first half revenues were. So no sign of any improvement in mining through 2009, and we'll see what 2010 comes in the future. Likewise, in oil and gas, we are looking at 50% drop in revenues in 2009 and most of that's already been recognized. Most of the revenues have already been booked in the first half of the year, so both oil and gas and in mining, second half is going to be tougher than the first half.

That's very helpful. Thanks. If I could ask, on the eliminations line, if I look at the operating profit, it was a positive $34 million. Usually it's a negative. Can you just say what drove that?

Yes. I'll be happy to. As total inventory came down in the quarter, the amount of intercompany source inventory also came down quite significantly in the quarter. And let me walk through a simple, hopefully a simple example that can illustrate this to you, Chip. So when the engine business sells an engine to Power Generation, the engine business will record that margin at the time of sale. But in [businesses] if power Gen has not been sold, the engine of Gen-set to an end customer, from a consolidation perspective, it's still in my inventory and I have to back out the margin that the inventory business reported. When the Power Gen does come to sell the Gen-set, including the engine, at that point, both Power Gen will recognize their margin and I can reverse the intercompany margin that I had to eliminate in the previous quarter. So, again, it's a little bit complicated, but basic factors, we've taken inventory down. We've taken intercompany sourced inventory down, and the margins that were tied up in the intercompany inventory -- have also come down quite significantly in the quarter.

Okay. That's helpful. Thank you. Okay. I'll get back in line.

Your next question will come from the line of Steve Volkmann from Jefferies.

Hi, good morning.

Good morning, Steve.

A quick follow-up maybe to start with on that one. Where are we in the process of inventory reduction? Should we expect that corporate eliminations line to be similar in the second half, or do we get back to normal in the fourth quarter maybe?

Well, Steve, we don't give specific guidance on eliminations. It is included in our 5% guidance and has always been. I think through the first half of the year, we've reduced inventory by around $280 million. On the last call, Tom mentioned that our goal for the year was to reduce inventory by over $200 million. In fact, we've been pleasantly surprised at just how much we got off of that in the second quarter. And we do anticipate, as I said in my remarks, further opportunity in the second half of the year to reduce inventory, but it will not be -- you should not expect another $200 million. If I'm looking at a range, I would say a range of between $50 million and $100 million in the second half of the year. So the impact on the eliminations would be much lower than what you see in the second quarter just past.

Okay. That's helpful. Then just back with respect to the Power Gen business, is it all Middle East that got a little bit worse than you expected -- does that really explain the change in the forecast, or are there other parts of the business that we should be thinking about?

No, it's not just the Middle East. That's a good question. The Middle East, we were talking about supply chain corrections and I was just talking about where there was a concentration of the, where we had to bring orders back, cancel orders and we had to get rid of inventory. But in fact, Power Generation markets globally are down. And so what has happened is since the beginning of the year, our expectations for the sales in the Power Generation market have decreased and they -- we decreased them some in the first quarter, and then we decreased them more in the second quarter as we got better views of where we thought the market would be for the year. So both the fact that we had to do some inventory and supply chain corrections, which reduced sales and absorptions in the second quarter happened, but also our view of the sales for the year also declined during -- across all the markets frankly.

Okay, so it's broad based. That's great. Thanks for your help.

Your next question will come from the line of Jamie Cook from Credit Suisse.

Hi, good morning. It's actually Chase Becker in for Jamie. How are you?

Hey, Chase.

Quick question. You guys have done a nice job on the distribution side. I know you touched on the last quarter, there were some mix issues. But specifically, was anything really driving that besides the mix and some of the cost actions that you've had?

Yes, the other thing that we talked about, about the distribution business for the last couple of calls is that we have -- if the business that we've been growing and expanding into over the last several years, a relatively new business for Cummins as an owner. And as a result, we've been able to improve the performance and cost structure of the businesses as we've grown them. So we now have larger distributors with more territory. They have better economies of scale and operation, and we're -- as an owner, we're able to find best practices in each distribution location and then move them across. So we are just having better same-store performance if you want to think of it that way across the board, as well as being able to make sure we can focus on good markets in various territories, and we can bring whatever capability we need to bear in that territory to capture the market. So I think just better performance in the business, as we have grown and become more capable ourselves, in addition to things you mentioned, have improved performance.

Okay, great. And a follow-up. In terms of your expectations for the fourth quarter with heavy duty engines, what are you assuming for stockpiling?

Not to mince words, but stockpiling is not allowed as a general matter. But we don't exactly know how much our customers intend to use in production versus what they need for transition to their new models in 2010. The fact is given the volatility of the market that they are facing, I think it's tough balance for them as it stands. So they are all trying to figure that out themselves.

What we're responding to is orders. So we're responding to orders from our OEMs and trying to be as nimble as we can, because markets, as you know, very low. It's down a lot, and we're trying to make sure that we're ready to capture whatever order comes our way in order to help our customers both serve current needs, as well as transition their models into 2010. And there's a lot of transition. They have not only the engine, but many of them have new truck models they are trying to transition to, and the systems are complicated. So there is definitely transition work in there. But each OEM manages -- they manage what they are going to do there, and we're just trying to make sure we're there to support them.

But as far as prebuy of the new engines goes, or the trucks before the regulation takes place, I don't think it's going to be at the same levels that we've seen in previous years. It doesn't appear to be that way. And we start to see these orders about this time. So we don't expect to have the same experiences that we've had where you maximize capacity in the fourth quarter.

Sure. Makes sense. I appreciate the color.

Our next question will come from the line of Jerry Revich from Goldman Sachs.

Good morning.

Good morning, Jerry.

Pat, can you please give us some more detail on the drivers of the 450 basis points sequential margin improvement you're targeting for components? What portion of that do you expect to come from greater JV income versus cost initiatives that you mentioned, and any other pieces?

There wouldn't be much coming from JV income. Most of the improvement in components from the first half to the second half is going to come through recovery in volumes that we talked about earlier on, but more so from cost reductions and improvement in operation efficiency -- and encouraged by the signs we saw in the second quarter and very confident in the third quarter and the fourth quarter when we announce these results, you'll see the evidence of that.

And, Pat, what parts of the business is that? Is that the turbo charger piece, or is it emissions control? Can you give us some more color on the cost reductions?

My expectation is most of the businesses within the segment will continue as they have been doing to focus on taking costs down, and that will be certainly turbo technology and certainly emission solutions and filtration. Our fuel system business is more linked to the heavy duty demand in the engine segment. So that's a little bit disconnected, but certainly in three of the four segments, you should expect to see -- I would expect to see improvements in cost reductions significantly in the third and fourth quarter.

And, Pat, what was warranty expense in the quarter and what does your guidance assume for the year?

Warranty in the second quarter was 4.4% of sales, very similar to what it was in Q1, and I would not expect much change in that run rate through the rest of the year.

Thank you. And, Tom, based on the joint venture results, looks like you're seeing some improved Power Gen demand in China. Can you talk about if you're seeing signs of order recovery in other parts of Asia in recent months, maybe June, July?

Most of what we're seeing so far in China is actually automotive improvement in China. We're seeing our DCEC joint venture. It's starting to see some uptick in demand. Really already have seen some uptick in demand, which will be for trucks. We've also had bus demand, and there's the beginning to see signs of construction as well because there is the stimulus work in China started earlier, and they have got more of the dollars out. So there is actually stimulus stuff going that's driving, again, bus and construction. But automotive is the biggest single lever for us in China, both because that's the market that's improving the quickest and that's where we have the largest piece of our business in China today.

And, Tom, what about for the Power Gen outlook for China? What are you seeing there? Have you seen orders start their comeback?

Not yet. I mean it's not that -- they didn't fall as far and so there was less negative impact. There isn't the same sign, at least that we've seen, that the Power Gen markets are recovering in a significant way in China. Though I would not be surprised to see them in a couple of quarters later start to also see some recovery, because essentially in China, we're just seeing the recovery starting and Power Gen will be a little later cycle likely than the automotive. So I would not be surprised to see it, but we haven't seen it yet.

Thank you.

Your next question will come from the line of Andy Casey from Wells Fargo Securities.

Good morning, everyone.

Good morning, Andy.

First question, I guess if we can go back to the Power Gen, are you seeing any inventory liquidation at this point from the rental companies?

Andy, nothing that I can speak to. It's not, it's not a subject I'm as up to date as I should be on. There's nothing that I know about in that regard.

Okay, thanks. And then on the -- it was better than expected, but on the heavy duty truck line, I'm trying to understand the revenue performance in the quarter. Did you realize any pricing or improvement in part sales, or a gain in market share relative to what you had in the first quarter?

No, not really.

Okay.

Tell me more. Tell me what numbers you're looking at that seem unusually good to you.

Well, if I tie it to what I assume in the breakdown of that, North American unit production went down sequentially, but your revenues stayed basically flat.

Yes, and I think that the one, one item that could cause some of that would be market share. Market share at the end of May, we were close to 50% and I think at end of June, we were also very close to 50%. So it's up definitely a couple of points from the first quarter. But there's been no pricing and I don't think there's been any parts mix change regards to that segment.

There's probably, Andy, there's probably maybe 500 units more Q2 to Q1 in North American heavy duty trucks, so I think it is more of a reflection, as we indicated, it's not pricing. It's market share. It's penetration.

Okay. Thank you very much.

Sure.

Our next question will come from the line of Charlie Rentschler from Wall Street Access. Please proceed.

I got confused by the four new engine platforms that Tim said would be launched next year, and then, Tim, you went on to talk about heavy duty and I think then Tom pitched in the 3.8 and the 2.8, but I didn't hear what the fourth engine was, or maybe I wasn't paying attention.

The 2.8, the 3.8, and 11.9, and the 13-liter.

Okay. There we go. And Tim, can you update us on your thoughts Navistar's plan to launch heavy duty EGR engines next year?

We still have a fundamental difference of opinion on which technology is the best. We have a long-standing close relationship with Navistar and we continue to have that both at management levels, as well as between our distributors and their dealers. We're about 85% of their build right now, and we continue to discuss future opportunities. But the disagreement between SCR and EGR remains.

Okay, and just as a final question, if you look at the world, would you -- how would you rank the best behaving markets? Would you have China and India at the top and then going on down, or what's your latest -- ?

I would think that in terms of -- as Tom said, and I want to be really careful about this, is that we're seeing a heartbeat in China and India, okay? It's not a full-fledged recovery. And we're also seeing some good activity in Brazil. So when we talk to you 90 days from now, we'll be able to say more about those markets. But clearly in India -- well, in all three countries -- the stimulus activities by their governments has been at least reasonably effective so far. And we'll see those markets -- I think at least in our plans right now, that would be followed by North America and Europe would be last.

Thank you very much.

Our next question will come from the line of Joel Tiss from Buckingham Research.

Good morning, how's it going? Good morning. On the components business, do you think -- do you expect to see a little bit of a ramp in the second half of 2009 and into early 2010 just from having higher content on the new emissions engines?

Yes, mostly 2010, but for 2009. But yes, in 2010, we will have higher content and that will help our revenue, especially in the emissions solutions business, though some degree in turbos too -- the question will be the volume. And right now, we haven't done our 2010 plan now, but the expectation is that volumes will drop in the automotive, the heavy duty truck and mid range truck markets after the first of the year, at least in the -- at least in the first half, it will drop some. And then our hope is to recover after that. We don't know for sure yet, because as Tim says, the prebuy is unclear and not likely to be huge. But that's the part we don't know is the overall volume. But we do expect higher content on the engines that we ship in 2010.

And that's all margin accretive? All those mix pieces you're giving us together?

It's margin accretive, right. If what you're asking is are we selling those emissions products for more than it costs us to make them, yes, we are. That's our intent.

All right.

Is that what you're asking?

No, just you gave us like three different pieces. This will be stronger, this will be weaker. When you put all of those together, do you think we'll start to see more respectable margins out of the components -- ?

I understand your question better now, Joel. The answer is I don't know yet. I mean the answer is I have to put together my 2010 plan, because the volume impact versus the price and cost impact is just not clear till I get a better handle on the volume. Because the volume -- all three will be relevant to whether it ends up being margin accretive or not in total, and I just don't know the answer yet.

Okay.

Long-term it definitely will be. The question is I think for 2010, first half of 2010 is what I don't know yet.

In the engine business -- Andy was asking about this before, but the market share is up only 2 points and it seems like your percentage point gain has been running a lot higher than that since Cat got out of the business. Is there some change going on there, or is it just, I don't know, seasonality or something else?

It was 2% over the second quarter over the first quarter. If you go back last year, the market share's up 5 points.

So still pretty consistent.

Yes.

And you're still sticking with the 35% plus or minus as we round into 2010?

Yes.

Okay. Thank you.

Your next question will come from the line of Henry Kirn from UBS.

Good morning, guys.

Good morning, Henry.

Wondering if you can talk a little bit about the health of the end user balance sheets across your business, given that we're a little further now into the downturn.

Yes, are you thinking trucking company specifically, or wider look, Henry?

Trucking companies, but then also the Power Gen end user set as well.

Okay. So let me start with trucking companies and both Tim and I have visited a number of customers, and they are definitely hurting. There's of course a range. You've got small trucking companies, which are suffering quite badly. Then you've got bigger fleets who have more financial strength, but all are having a really rough go. And a lot of what Tim talked about was with regard to how big the prebuy is partially affected by confidence in our engine, is why they don't need to prebuy, but a lot is also they just don't have money. Buying is a really tough trade cycle right now because people don't have much money to buy.

So balance sheets are definitely -- I mean it's a tough time. Buying capital equipment is difficult and that's what -- that's why you're seeing such low truck purchasing activity. And the other added part of it is used trucks market's weak, so they can't trade old ones away. So for the truck companies, that's what they are trying to deal with, both that their customers can't trade out their old ones and they don't have much money to buy new ones. I think that's probably a straightforward point, given where the economy is. But their balance sheets are generally weak.

In the Power Gen market, it's a very different dynamic that you're looking at, because end users of Power Gen equipment are typically somebody building a building or constructing a sewage treatment plant. And so now there's really no general statements you can make. You're talking about serving really all sectors of the economy and it's really building markets. The question is who is building new buildings or upgrading new buildings or et cetera. And that's why you see such a tide in non-res construction. So it's when people are active and that's why it's a late cycle fall and it's also going to be a late cycle recovery because it's tied to non-res spending mostly.

And I would add that both in construction and in automotive truck, some of the dealers have gone under and there's been some consolidation there. If you go to some of the consumer markets, boat companies can't get credit. They are basically out of production right now and I would say there's several there. Also, the marine dealers are hurting right now. Same thing with the RVs. We've seen some bankruptcies there. Again, the dealers have some issues. So across the board, there's some fallout, and I would say generally credit is either not available or available on a very limited basis.

Henry, you didn't ask it, but just because it's related, you probably know that we're also working very closely with our supply base, and particularly that part of the supply base, also supplies the car industry, and their financial health is a really important focus for us. We've got a very in-depth effort on that. We've been working on that for more than a year now. We have people very closely focused on making sure our supply base, the critical parts of it remain healthy and on a long-standing basis. But that's also concern of ours with regard to financial health.

That actually addressed my follow-up. So one other thing, globally as you look at your competition, are there any opportunities from competitors who may be teetering a little bit?

The answer is we are definitely on the lookout for any such opportunities. While I think it's unhealthy and unwise to predict the failure of any competitor, I do think that we are of the view, as we said and during our remarks, that we think we're well positioned. We think we are financially well positioned. We think we're managing really well. And our opportunity here is to demonstrate that we care about our customers, even when things are tough, so that when things get better, we build customer loyalty and we're there to serve them. And we're going to do that irrespective of who is around to compete with us. But we will be looking for opportunities as they arise.

I would, I would just add that you should not underestimate the fact that we are bringing out more product in 2010 and the various tiers and components associated with that, more than we've ever done as a company. And assuming we perform well in those launches and the products perform well, I think we will have a significant opportunity versus our competition and a significant opportunity for growth. And we've talked about that, and we're now entering into getting very close to launching these products and Tom and the operating people have -- are paying a lot of attention to that. And the results that we're seeing from our prototypes, our tests and so forth, are very positive right now. So I think in looking at CUmmins clearly into 2010 and 2011, our product launches and the amount that we're doing is a significant opportunity.

That's helpful. Thanks a lot.

Your next question will come from the line of Ben Elias from Sterne Agee.

Thank you, good morning.

Good morning, Ben.

How are you guys?

Good.

I have a question -- historically you've given us great detail on the EBIT bridge and I haven't seen that. And if I just compare what we saw in February and then the change in April, especially with FX, where FX went from being a headwind to a tailwind, and since then we've seen the dollar weaken further. I was wondering what the sensitivity was on that and if anything else has changed on that EBIT bridge, especially. The other thing was the high material input costs that, again, swung in your favor, so I was just wondering about that.

And also on the engine side, if the competitor doesn't have an engine ready, how long is that transition period? And people have mentioned a special agreement with a supplier. I was just wondering about your production rates and your contingency planning for additional manufacturing going into the back half of the year.

Well, I'll take the first part of the question and maybe Tom will jump into the second part. On the EBIT bridge year-over-year, it's no different from what we talked about on the last call. We're going to be down close to 4 percentage points from 2008. Volume's clearly the largest driver of that. We are seeing negative joint venture income, 0.7 point year-over-year, which is consistent with what we said before. And they will be offset by pricing and cost reductions. So the bridge I talked about back in April is exactly the same bridge, at the high level, that we're looking at today. If you've got specific questions on Q2 to Q2, I'm happy to take them as a follow-up, but that's the year to year picture.

With regard to foreign exchange, in the second quarter, it cost us about $150 million of revenue, which was about 4% of the total, 4%, but had very little impact at the bottom line. So FX is not really a major factor from a profitability perspective quarter over quarter or year-over-year. And then on material costs, the question you asked on material costs -- it's moving around a little bit, but I think our story remains the same, that the first half of 2009 will be better. It has been better than the second half of 2008, but it's still higher than what the first half of 2008 was. We do expect to see for the company further improvement in the second half of 2009. So we have seen four consecutive quarters last year of a headwind on material costs and commodity costs, and we're starting to see in the first three quarters of this year that coming back and we expect to see more improvement in the second half of the year. I don't think we're going to get all the way back to where we started off at the beginning of 2008, but we'll have significant progress in getting back towards that point.

Then, sorry, just -- Pat talked so long, could you remind me what your question was again, was it about transition?

Sure. I was just wondering about competitors coming out with their own engine, Navistar, and if that engine is delayed, what are the contingency plans if they require more engines? How long is that transition period and what does it do to your production and manufacturing rates?

First of all, with regard to their engine, we're not really privy to what their plans on delays or on time are. There's, as you say, there's some speculation about it, but I think it's speculation. I certainly can't comment on it. They are best to comment on that.

And with regard to transitions, if our customers aren't ready with their engine or their truck, as I mentioned, each of them is going to manage that in their way. They need to be the ones who figure out which trucks are ready and which engines they are going to use and they place orders on us for engines that they need both in current production today and further transition period. And we will respond to engines and respond to orders as such and comply.

There is -- one significant complication is we will be providing engines in 2010 with SCR. Whoever we are selling engines to will need to be able to integrate an SCR engine into their truck. That's what we've spent most of this year making sure that works flawlessly and customers get good reliability and performance. And that's what's providing the fuel advantage economy for our customers in 2010. So that's one complication that every truck maker will have to deal with, which they have to engineer SCR -- and as you know, in Navistar's case, they are not planning to offer SCR in 2010. So that's just one thing to deal with. But I really think in terms of what their backup plans are, that kind of stuff, you better ask them.

Thank you.

Your next question is a follow-up from the line of Steve Volkmann from Jefferies.

Hi. I just wanted to follow up on a couple things quickly. First of all, do you guys -- are you seeing an order book building at all for your fourth quarter truck engine business in the US?

The answer is order book, no. Indications that people may want to increase orders in the fourth quarter somewhat, again, with Tim's caveat that it's not going to be a big prebuy that there will be some increase, yes. Hence our forecast.

Okay. So you still have, I'm assuming, plenty of delivery slots for the fourth quarter available?

That would be correct.

And then just on this whole Navistar thing, I guess just to be clear here, is your understanding of the regulations that Navistar will not be able to purchase a meaningful number of your current 15-liter engine in the fourth quarter to tide them over in 2010?

My understanding of the regulation, again, as you guessed, with any regulation is complicated and it would be -- you would have to read it. But let me just say this simply. What the regulation provides for is that manufacturers still have a reasonable opportunity to transition between one year and the other. That's basically what's allowed for. And that's what all these OEMs are responding to, is reasonable transitions. The rest, I think, is at a level of detail, interpretation that really you ought to take a look yourself. It would be risky and dumb of me to summarize in any way that I interpret it.

What I would say is each of them has a transition plan, and that has been the case for every single emissions change there's been, 2007, 2002, et cetera, and that's what everybody's doing. And so, again, back to the previous question, I think the best way to figure out what Navistar's plan is in terms of transition is ask them. Because it's just not our -- we're not in charge of figuring it out and it would -- we just can't figure it out because they are pretty -- they are managing it as they go. It's not -- they are not all set in stone. They are not all trying to figure out what to do, given market conditions that are out there.

Fair enough, okay. Just trying to make sure. I'm sure you guys understand the regs better than I do, so that's what I was looking for.

No, it's a fair question, Steve. It is fraught with difficulty with any regulation. You have to read it to understand --

It's not precise is what Tom's saying. There's ambiguity there, so people can use judgment.

I guess the definition of the transition period probably sounds like the key issue. Can I just switch for a second? My understanding on your components business is that you guys had been working through some changes in your supply agreements with other people, your contracts and so forth, that would hopefully help you a little bit on the margin front as we move into 2010 and beyond. Am I right about that? Can you give us a quick update there on how that's going?

I think what you should take away, Steve, is I think we've got some design-related work and programs that we've got some design-related work and programs that we think we can get material cost improvements. So I wouldn't -- when Pat was giving you the bridge earlier about components, the ability to deliver 400 or so basis points more in the second half, it has a lot to do obviously with the volume pickup that we expect in the second half in some of those businesses, and the other part being on commodity costs -- not from beating up suppliers, but really some really good work that we're doing to manage the material commodity cost content in our own products.

Okay, and I guess I'm sorry. I wasn't clear about that. I was thinking more about 2010, as you sell components to other manufacturers, I assume you'll have new agreements and new contracts with them. And my understanding was that the pricing, the base pricing would be a little more favorable in 2010 as you did that transition.

Steve, you have that right. That's exactly what we said last time, and that's right. We are definitely -- we renegotiated with 2010, we have more content as one of the previous callers asked, and we've done this cost reduction that both Pat and Dean talked about. And those are all elements to how we drive towards our target profitability as volumes improve, is that we have good contracts with our customers, good costs, and then we begin to get volumes back. That's exactly what will take us to our target profitability levels. You're right that that's a significant element.

Both emissions solutions and turbo chargers have moved towards long-term agreements with the OEMs effective in 2010 and going beyond. That's where the pricing would come in.

And I guess the point is you're getting that pricing as those contracts are renewed, that there hasn't been pushback or anything like that?

Well, there's pushback, plenty of pushback. But they are resolved.

Great, thanks so much.

Thank you.

I think that's all the time we have for questions today. I appreciate everyone's attendance and look forward to talking with you again in the next quarter earnings call. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.