康明斯 (CMI) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the third quarter 2009 Cummins Inc earnings conference call. My name is Jasmine and I'll be your operator. At this time all participants are in a listen-only mode. Later we'll conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host of today's call, Mr Dean Cantrell, Director of Investor Relations. You may proceed.

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

This teleconference will include certain forward-looking information, any forward-looking statements involves risks and uncertainties. The Company's future results may be affected by changes in general economic conditions, and by the actions of customers and competitors. Actual out comes may differ materially from what is expressed in any forward-looking statements. A more complete disclosure about forward-looking statements begins on page three of our 2008 Form 10-K as it applied to this teleconference. During the course of this call, we'll 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. With those formalities out of the way, I'd like Tom to open with a few remarks.

Good morning. I would like to start today by sharing some thoughts about our performance during the third quarter and then spend a few moments talking about our expectations for the first half of 2010. Given the economic challenges we continue to face in most of our markets, the Company performed extremely well in the third quarter. As you know, we began to take decisive actions late in 2008 to lower spending and to adjust our manufacturing capacity to meet lower demand for our products. Those efforts have resulted in improved profitability and cash generation despite continued weak demand in many of our end markets. Sales rose only 4% from a very low base in the second quarter, but profitability improved significantly. Earnings before interest and tax, excluding restructuring and other charges, was 7% of sales. That compares to 4.8% of sales in the previous quarter and 3.9% of sales in the first quarter. Our cash position improved by $152 million in the quarter as a result of significantly improved working capital. Most of our end markets and channel have completed their inventory burnoff and in some cases we have started to restock.

The Engine and Components businesses returned to profitability in the third quarter, led by increased demand in advance of the 2010 emissions changes in the US, recovery in China, India and Brazil and our focus on reducing costs throughout the year. Our Distribution business continues to perform very well. Improving segment EBIT from the second quarter despite a softening of sales. As expected, our Power Generation sales declined as retail channels in the market continue to burn off inventory. Sales fell by $61 million from the second quarter, and segment EBIT declined to 4.2% of sales in the quarter.

In broad terms the global economic situation that have developed over the last few months as we expected. Economic conditions remain very weak around much of the world with some notable bright spots in the key emerging spots. For example China and India have rebounded relatively quickly and have resumed our growth mostly for domestic demand. The Brazil economy has expected to return to stronger growth in 2010. Cummins sales are respective of the economic trends around the world. Given our strong positions in India, China and Brazil, we are seeing increased demand in these markets as they start to recover. As importantly, our sales have stabilized in places such as the US and Europe, although demand remains at very low levels, it has stopped falling which has allowed us to plan better and operate more officially. Additionally, our share in key markets continues to grow as a result of our industry leading technology and strong partnerships. One example is in North American truck market where we have continued to meet challenging emissions regulations with products that use less fuel and provide drivers with excellent performance. In addition, we continue to strengthen our important partnership with PACCAR, an excellent company. PACCAR has a long history of leadership in the truck market and our strong relationship with them has helped Cummins gain market share that has improved PACCAR's product offering and support network.

Based on our improved sales and profit performance we are adjusting our financial guidance from 2009 upward from what we shared last quarter. We now expect sales to be down slightly less than 30% from last year and EBIT to be approximately 6% of sales excluding restructuring and other charges. Despite the improvements we have seen in some some of our markets we still face considerable challenges over the next year. In particular we expect the first half of 2010 to be extremely difficult, especially in North America where the US on highway markets will be very weak as an emissions cycle takes place in conjunction with the prolonged economic downturn. Much of the recent growth in demand for engines and components in the US is a result of OEM orders being placed in advance of the new EPA standards, as is typical in an emissions change here.

We're still working through our planning process for the next year and will provide more comprehensive guidance on our Q4 earnings call but I can provide thoughts on 2010. As we said, we can expect continued weaknesses in the US and European economies but China and Brazil will be stronger. As a result of the weak economic situation, we expect our revenues to be relatively flat next year in most markets with two exceptions. Domestic sales in China, India and Brazil will grow, second, our shipments to North American on highway markets will be lower next year due to the emissions standard change and the transition from old model trucks and engines to new model trucks and engines. What is more, first half shipments to the truck market will be significantly lower than those in the second half. We are currently projecting North American truck and bus shipments to drop 75% in the second half of 2009 to the first half of 2010. We do expect North American end user demand for trucks to start recovering late in 2010 with freight demand in the release of OEM vehicles. With regard to late cycle markets, while we are not expecting significant recovery for the next several quarters in power generation and marine markets, we are seeing positive trends in both mining and oil and gas markets. One last comment about power generation, we expect flat revenue in total for the year, but by geography we expect North America and Europe to be down and emerging markets to be up.

We will continue to manage the business very conservatively in the coming quarters and do the things that we have allowed us to be successful during the worst of the recessions. As a reminder, our current priorities include maintaining a realistic estimate of demand and then aligning our cost structure and manufacturing capacity with that demand. Generating positive cash flow-throughout the downturn, continuing to invest in the new products, business process and technology projects that are critical to our business in both the short and long-run and lastly demonstrating that we care about our customers more than anyone else, especially now when they need us most. The decisive actions we have take then line with these priorities have allowed us to remain profitable and generate significant cash during the worse recession in decades. We still have a lot of work ahead of us in 2010, but we have the people and the plans in place to position Cummins for significant profitable growth once we emerge from the recession. We are very excited about the Company's prospects, for once the recovery begins if earnest and Tim will share some of his vision for our future in a few moments. First though, I'll turn it over to pat to provide more details about the third quarter.

Thank you, Tom. And good morning, everyone. As Tom said, we continue to face a challenging environment in all end markets as evidenced by the year-over-year decline of 31% in our revenues but we are seeing signs of improvement in the emerging markets as well as the on highway market in North America which is reflected in the 4% increase in consolidated revenues over the second quarter of 2009. Our EBIT margins dropped from 10.3% last year, to 7% of sales for the quarter, excluding restructuring and other charges. With the severe drop in revenue being the key driver in this decrease. Compare with the second quarter of 2009, sales of 4% higher but EBIT, excluding restructuring and other charges, increased 53%, to $177 million. This was our third consecutive quarter of margin improvement. Sequentially gross margins improved from 18.4% in the second quarter to 19.9% in the front quarter as a result of higher volumes and of Engine and Component segments, the benefit of cost reduction actions and more material costs. We remain very focused on managing selling, admin, and research and development expenditures as evidenced by the $107 million reduction compared to a year ago. Compared to the second quarter, we did see an increase in the third quarter in part due to higher research and development costs, and the impact of Cummins improvements.

Earnings per share, excluding restructuring and other charges were $0.56 in the quarter. We have lowered a projected three year tax rate from 30% to 27%, which contributed $0.04 to EPS in the third quarter. We also recorded $22 million for restructuring and other charges in the quarter, which included severance costs associated with actions taken in our Power Generation and Components segments as well as a curtailment charge related to a cumulative affect of the actions taken to date.

Here are some details of the performance and future expectations for each of our four segments. For the Engine segment, year-over-year revenues were sharply down, but we did see sequential improvement in demand driven by a combination of strengthening market share and an uptick in vehicle production in North America, a stabilization of the Mexican truck market, following a free buy in 2008 and signs of stabilization in the construction market, at least in China and in Brazil. The sequential improvement in EBIT to 4.2% of sale this is quarter was a solid performance for the Engine segment and was driven by higher volumes, price realization, favorable material costs and more managed expenses, much like we expected and discussed during our last quarter call. For the full year, we now expect revenues for the segment to drop 30% and EBIT margins to finish between 2.5% to 3% of sales.

In the Component segment, revenues were down 26% from a year-ago, but up 18% sequentially, driven by the truck market demand in North America and in Asia. Segment EBIT of 5.2% of sales was down from a year-ago, affected by the steep volume decline but was a significant improvement from the loss in the second quarter. As we anticipated, this segment benefited from higher volumes and cost reduction actions. For the full year we now expect Components revenues to drop 30% year-over-year and EBIT to finish between 2% and 3% of sales.

The Power Generation segment continued to be affected by the global slow down in nonresidential construction, the lack of financing for power plants and connections in channel inventory. Sales declined 38% from a year ago, and 10% from the second quarter. This further reduction in volumes and an unfavorable revenue mix were the main reasons for the drop if EBIT margins to 4.2% of sale this is quarter. Revenues dropped sequentially in Europe, the Middle East and Africa as well as in North America and the south Pacific region but were slightly up in the brit countries of Brazil, Russia, India and China.

The Consumer segment recorded a small uptick for the second consecutive quarter albeit from a relatively low base. Although we do not expect the significant recovery in third generation demand for the next several quarters, we do believe the third quarter was likely the low point for the segment as most of the inventory corrections in China are complete. Full year guidance for Power Generation revenues remains unchanged, down 30% to 35% compared to the prior year. However, EBIT was adjusted down to 7% of sales, which is at the lower end of the range of our previous guidance.

Revenues for the Distribution segment were down 27% from a year ago, and down 9% versus the second quarter. The sequential drop in revenues was mainly driven by further market softness in the late cycle markets of industrial engines and power generation. Particularly in south Pacific, Europe and the Middle East. Profitability improved both from prior year and prior quarter to 13% of sales, driven by a stronger mix of after-market revenues, better joint venture performance and favorable currency movements, more than offset in the impact of lower sales volumes. For the full year we are maintaining our previous revenue guidance of down 15% to 20% for this segment, but are raising EBIT market segments to between 12.5% and 13% of sales in 2009.

In the last topic I would like to cover is cash flow management performance. We generated more than $400 million in cash from operating activities in the quarter. And more than $700 million year-to-date. Our inventory reductions contributed $7 million to $8 million to cash flow this quarter, in line with our projection of $50 million to $100 million benefit for the second half of the year as we discussed in the last call. More so of the reduction was from the Power Generation and Distribution segments. Although we started improvement opportunities, we believe most of the excess inventory has now been washed out of the system. At the end of September, we had a cash balance of just under $700 million, up from $426 million at the start of the year and the debt-to-capital ratio is now 15.2%. We are expecting higher revenues in the fourth quarter, which may require more working capital, but we remain on track to meet our objective of generating positive net cash flow for the Company in 2009. We will continue to take a conservative approach in managing our balance sheet and use of cash. As Tom just said, we're planning for a very difficult environment for the Company in the first half of next year, and we want to make sure we have the resources for the business once the demand in our market starts to improve again. That being said, we are lifting the temporary suspension of our stock repurchase program that we have had in place during this year but will use judgment to determine when we will reenter the market. Before we take your questions, Tim would now like to say a few words.

Thanks Pat. I would like to start by underscoring two of Tom's main points. First, I'm extremely proud of our performance in the third quarter and throughout all of 2009. In many ways, we have performed better during the recession than during the days of our record profits. That can be seen in our steadily improved profitability and cash management throughout the year under difficult circumstances. Second, I also want to make it clear that we have not worked our way through the current economic downturn. As Tom pointed out, we expect next year, especially the first six months, to be even more challenging than this year. Having said that, however, I am very excited about the long-range prospects for the Company for many reasons. As you know, we entered the recession in the best financial position in the Company's history, as a result of five years of very strong performance. As you may recall, our priorities during that period were to reduce debt, reward our shareholders, and invest in the business. Our performance over that time, during which we generated more than $4 billion cash from operations, allowed us to do all of those things.

By the end of last year, we had reduced our debt to less than 20% of total capital. We raised our dividend three times for a total increase of 133%, from 2006 to 2008, and split our stock twice during that period. We also bought back more than $600 million worth of our stock from 2005 through 2008. Even with the significant stock market correction late in 2008, our average annual return to shareholders from 2003 to 2008 was 23%, well above our peer group. And we also came into the recession with access to more than $1 billion at credit at good interest rates. Our strong balance sheet, along with our swift actions in the early months of the recession, has helped us perform well during the worse recession in decades. Not only have earned a a solid profit throughout the year which has increased each quarter, we've continued to invest in our business. We're in the final stages of work on our 2010 product launches and I'm confident they will play an important role as we work to leverage our technical advantage in the future. In fact, we are in the midst of the largest new product introduction in our history. We are introducing four new engine platforms ranging in size from 2.8 liters to 13 liters, two of which began production in China this year.

For our North America on highway markets next year, we're introducing a new 11.9-liter engine along with key component products such as the XPI fuel system, variable geometry turbochargers and exhaust after treatment systems. We have tested our 2010 heavy-duty truck engines with approximately 50 customers and we have run the engines in all weather conditions and across all duty cycles. By the time we go into production in January 2010, our new heavy-duty and mid range engines will have logged proximately 5 million miles. Our fuel tests have exceeded the Company's expectations and customers are telling us how much they like the fuel economy and the performance on the new engine. Our testing has also confirmed that our heavy-duty truck engine customers can expect up to 5% improvement over Cummins current industry leading fuel economy while mid range customers can expect to see up to 3% improvement. Our technological leadership is just one of a number of long range trends working in favor as we look beyond the current economic cycle. In addition to the new emission requirements in the US beginning next year, major Cummins markets around the world will be moving to at least Euro 4 and tier 4 emissions standards by 2014 for both on and off highway applications. As emission requirements get more stringent, it creates a significant barrier for entry for competition in our integrated OEM customers that have lower engine volumes, therefore, it also creates a considerably opportunity for Cummins in both Engines and Components businesses. Not only does Cummins expect to increase its Engine market share around the world, but we expect other engine manufactures to increasingly turn to our Components group for critical technologies to help their engines meet emissions regulations. As a result we're very well positioned to sell more engines worldwide and to create more Cummins own content provisions sold, whether they are ours or our competitive OEM customers.

As we look across our businesses we see significant opportunities in a number of other area as well. Here is just a few examples. The expected global shortage of electricity, especially in developing regions such as the Middle East, India, Latin America and Africa will benefit our Power Generation business which is poised to capture many of these opportunities. In many of these areas a lack of investment in central utilities has made the electricity grid unreliable or inaccessible and we expect this to remain an issue for years to come. At the same time, we have seen that central utilities in these emerging markets have difficulty keeping up with the demand during strong economic times. This will create an additional opportunity for Cummins during the recovery in both distributed generation and stand-by power. Increased infrastructure spending as a result of government stimulus efforts around the world, especially in large markets such as China, India and Brazil, should increase demand for our products in both short and long-term. Our positions in large growing markets such as China, India and Brazil will serve us well as they return to significant GDP growth in coming years. Nearly 45% of our engines are produced in the emerging markets with China and India our second and third largest engine markets respectively. We have never been in a better position to take full advantage of the tremendous long-term opportunities in front of us. We will focus on performance and execution during the remainder of this recession, especially in the first half of 2010. We will manage our costs, matching capacity to real demand, generate positive cash flow and invest in and introduce new products reliably. We are now happy to take your questions.

(Operator Instructions) Your first question comes from the line of Meredith Taylor of Barclays Capital. Please proceed.

Hi. Good morning and congratulations. First, how are you thinking about production planning heading into the fourth quarter? Given your expectations for the soft first half of 2010, how are you thinking about ramping up capacity utilization in the fourth quarter to meet the demand for transitional stock of engines since your guidance suggested 20% top line sequential growth, and can you talk about how much you have to add back to the cost structure to do so and how we should think about the implications would be for the first half of 2010.

It's an excellent question. Obviously we've been doing a lot of planning on exactly that point. And because of the fact we've had some time to think about how this is going to go, given the expected demand increase at the end of this year, we've been thinking about it all year. And we are managing that process in my opinion extremely well. The Engine business and Components businesses have both managed to add costs as flexibly as possible. So we have what we call rings of defense in each of our plants that allow us to add people back, add over time, bring in temporary workers, work down days and on days which give us ability to be up at very high levels of production in the -- in Q3 and Q4 and then down at very low levels of production in Q1 and Q2 with very little fixed cost addition. There is no question that it's difficult to manage and we're trying to figure out how to minimize the fixed cost addition, but I think we're doing an excellent job and I think we will not add fixed cost structure in any significant degree in Q3 and Q4. A little bit here and there, but not a significant amount anywhere.

What we're also trying to do, though, is make sure that our overhead levels, which is what Tim and I were talking about, making sure our overhead levels stay low even as we have more and more investments to make and new products and growth areas, we need to keep our overhead costs down so that as we carry through the first half of next year, our financial performance remains good.

Okay. That's great. And then you certainly have noted the first half head wins on highway truck and bus. Can you give us a little -- calibrate a little more specifically how you're thinking about the second half of the year.

Yes. Our view is that just by the nature of the transition, there will be improvements in the second half of the year. So even without significant improvements in freight, et cetera, there will be improvements because the OEMs will be launching new truck models and as they launch them, there is just a transition period. So as they get launched, they get their engines in, there will be more new product in the market and as customers become more comfortable with new trucks and new engines, that just drives increased demand. We also hope that there is some improvement in freight and other drivers of demand, but as we said in our remarks, we're really not planning for that. We hope there is, but we're planning pretty conservatively that not much economic improvement in the US in 2010 and so most of the increase in demand will just come from the transition that happens in every emissions hurdle year.

Okay. I guess I was just trying to get to a more specific range in terms of how you're looking at second half of the year versus first half of the year since you were pretty specific around how much you think first half could be down.

Right. And we'll definitely provide that in Q4 earnings call, so you can anticipate we'll be able to give you much better view of quarter by quarter performance and I'm sorry, we do not have more details yet. But this is kind of our planning period. We're going through all of the markets and all of the territories to make sure we have a good handle on numbers both production and sales. So again, by the Q4 earnings call we'll have more details for you on that.

Understood. Thank you so much.

Your next question comes from the line of David Raso of the ISI group. You may proceed.

Hi. Thank you very much. Sorry for the raspy voice this morning. Regarding the announcement from the courts recently, the EPA about Navistar and the EPA may reconsider their 2009 guidance for the industry for the 2010 emissions, an order of stay for the proceedings for about 60 days, can you take us through your thoughts on that and what the implications could be.

David, as you get, since it's not our case, we're not experts in what is intended by the parties, but I can tell you what our take on it is. Essentially, what Navistar is seeking is a delay in the 2010 regulations and to quote our general counsel, they're grasping at straws and looking for ways to slow it down and the -- us and the rest of the industry is ready to go. And so they put a suit in as a way to do it. The EPA has -- is holding all of the cards. This is just a guidance document so it has no legal affect one way or the other whether the guidance document is in place or not in place or whatever. The way I interpret the stay is just that the EPA wants more time to form its case, it's in the middle of doing all of its work to get ready for 2010 among other things and so they're just taking more time to finish the case. But it's our view that the case has no merits and will not succeed in any way and by the time the case is even heard we'll be making engines and customers will be selling trucks.

Let me add to that. Is that we've submitted all certification for all of our engines for 2010 and are waiting momentarily for those to be approved by both the EPA and subsequently the carbon in California. And you can look at the complications in the legal case, but the bottom line is it will have zero impact on Cummins.

And the idea of the truckers, having something else to think about for buying trucks next year, obviously Navistar feels how the truck is handled when they are noncompliant and the tank is empty how quickly the truck derates, or however the EPA might address tightening those regulations. Your take, net-net, no impact on how you'll approach 2010 at this stage and you do not think the trucker has an incremental worry of what could change around it's SCR trucks for 2010.

Right.

Real quick on these second half 2009 to first half of 2010 truck engine volumes, you said down 75% and that's just taking the implied fourth quarter engine revenue for heavy truck and doing the math, you're saying about $138 million revenue each of the first two quarters in heavy truck, which is the lowest you've ever printed in -- since the data has been coming out. What kind of market share are you assuming for yourself in -- not even just of the first half but thinking through 2010 and what kind of industry builds are you assuming in your business case?

Well let me first talk about market share. As you would guess, the transition period is going to be a difficult time to think about market share because each of the truck manufacturers will be dealing with this transition period while they'll have engines they had before and engines that they are making in the new market. But our view is Cummins market share will remain strong during 2010. We expect, as international does not offer our engines over the course of 2010, that our market share will drop some. But our view is that it won't drop very much because our feeling is that our customers will strengthen their truck market position. So when we do the Q4 earnings call we'll be able to give you a much better detailed view of how that market share will transition over the year but our view is our market share will stay very, very strong during 2010. And I think you know this, because you've been involved with us for a while, David, but from our point of view, we feel great about our truck market share but we built the business, the truck market business, on assuming we could be at market share levels way down near 20% if we needed to and still be profitable and really what we're measuring the performance of our truck business on is what is our profitability, and what is the quality and capability of our engines and how they serve customers and we feel very good about that in 2010 and onwards. But as you say, the drop that we're going to see in Q1 and Q2 is really putting us to the test to the earlier question we got about how to flexibly cycle down in capacity and then ramp back up and then obviously coming off a very high production level in Q4. So that's the challenge we're all talking about and it's definitely the challenge we're up to.

All right. I appreciate it. Thank you very much.

Your next question comes from the line of Jerry Revich of Goldman Sachs. You may proceed.

Good morning.

Good morning, Jerry.

Tim, can you elaborate on the opportunities you see for your Components business on tier 4 interim, perhaps discuss any engine platforms where you have already reached supply agreements.

Let me step in for Tim. The off highway tier 4 side again presents significant opportunities for our Components business because tier 4 is what is driving now the off highway markets to have to do after-treatment, much more sophisticated air handling, both of which play to our strengths from a Components point of view. So we not only have Components business that goes with Cummins engines but we are also -- have Components business with outside customers, partners of Cummins on off highway engines in tier 4. There is no question if you look at the order of things, we've been working most aggressively in the Components business on meeting on highway 2010 customers first, but now our focus will quickly switch to figuring out how to meet tier 4 needs as we finish launching 2010.

I would just add or back up where you've heard me talk about it before is that, if you take the four Components business that we have and each of their subsystems, when we integrated with the engines we tend to get an advantage as far as cleaner air as well as better fuel economy. And so we're now operating after probably four years where our Components companies are working very close together with the same customer so that we're offering that advantage in -- whether it's tier 4 or other emission requirements, those opportunities seem to be expanding even in developing markets. I think the one Company in our business Components business that particularly has some opportunity is the emissions solutions business because all of these engines to meet requirements in the future are going to need exhaust after-treatment devices and they're one of the best in the market today.

And Jerry, this is Dean, we're obviously very excited about the opportunity tier 4 will provide for the Component segment but it's a little premature to announce what contracts we have. We do not want to get ahead of our customers. So I think you can anticipate in the upcoming trade shows in the spring you'll see a number of announcements from the OEMs about what their lineup is for tier 4 and we'll be there to help point out where our components are on their engines or our engines and their equipment.

Thank you very much. And Tom, I'm wondering if you could give us an update on the timing of the Foton Cummins production plan. It looks like you incurred some startup costs this quarter and I wonder if you could step up the timing of the ramp there.

We did hit our launch dates on the the 3.8 and the 2.8 is also launching the first rating this quarter and second rating is next year. So we're okay on the launch times but you're right about the volumes, the volume ramp up is slower. What that reflects mostly is that in China, the transition to Euro 3 and Euro 4 emission levels have gone slower than the market anticipated when we put the joint venture together. But the engine's working great, it's on its cost target, it's on it's performance target, we're engineering into the Foton vehicles and we are also exploring with customers outside of China to use the engine. So we feel great about where the engine is and the position we feel disappointed with the ramp up in China as a result of the application of the emission standards, but that will write itself but it will take longer time than we thought.

Thank you. And lastly, Tom, you can talk about the drivers or your expectations on improved power gen markets in the third quarter versus the fourth quarter on pretty similar sales volumes.

As I mentioned, again, as the market has cycled down, we've had both -- we've had to clear out the inventory in the channel and we've had uncertain levels of demand. So we haven't had our cost structure matched to the actual demand and as you know power gen fell later so a number of our cost reduction actions were done in the power generation in second and third quarters. As a matter of fact, Pat talked about the restructuring charge in the third quarter of a big chunk of that was related to power gen cost reduction. So they're just later to the cycle in terms of taking the cost out related to lower manufacturing levels. They've now stabilized. The demand has stabilized, inventory has cleared our and so what we have is a much more stable environment for them to work from and a lower cost base now that we've taken the action. So it's the same kind of things we saw in the other businesses it's just two quarters later.

And just to add some technical to that, power gen did reduce their salaried workforce by 10% in the third quarter. So as Tom said, our later cycle business Engine and Components were after us in the first half of the year and (Inaudible). So I think that gives us confidence for Q4 and the quality in margins.

Thank you very much.

Your next question comes from the line of Henry Kirn of UBS.

I wonder if you could talk about how currency may have impacted this quarter's earning and then, going forward, what's baked into your guidance.

Let me take the first part of that. On the third quarter compared to the second quarter with the dollar weakening, it somewhat helped our sales by about just under 2% so of that 4% growth you see quarter over quarter, less than half of that was sales, on the bottom line it impacted about $50 million positive. Now there is a fairly significant (inaudible) factor in that $50 million, which is a fairly large number, if you recall back in Q2 we did report some negative losses on the measurement and unrealized -- realized former (inaudible) transactions and that was about $9 million by Q2. We had $0 in Q3. So we were operating performance of the FX in the third quarter was much closer to $6 million net benefit in the bottom line than the $50 million I just gave you. But it was certainly helpful to -- pretty much all of our businesses in particular the Engine business and the Distribution business in third quarter versus second quarter. I think we'd expect to see for the fourth quarter some continued benefit given the way the currencies are moving. It should not be as significant in the bottom line fourth quarter versus third quarter though.

That's helpful. And within the power gen segment, could you talk a little bit about the global competitive dynamics there and how pricing is holding up, maybe region by region or product type by product type?

I can talk a little bit about that. Clearly in the developed markets in Europe and the US, sales have fallen significantly and as I said in my earlier remarks, I expect sales to be down in 2010 in those regions versus 2009. On the other hand, in the developing markets, China and India specifically, things have dropped but they have already started back up and we expect them to recover and be stronger in 2010 even versus 2009. So competitive dynamics are as you guessed different by market. The thing I noticed about this downturn versus the previous Power Generation downturn though is that the major competitors in the market are behaving more sensibly with regard to price. It doesn't mean there aren't individual dealers who are discounting if they have inventory or something like that, but there was a significant negative impacts on price in the last downturn, not so much of that now. The trend in price is reasonably good. As I say, there are spots where price is more competitive than others but we did not lower prices here across the board and we are not expecting to and we're not expecting to next year either. There is a -- some here and there, but not a major trend downward and that's a big improvement over less downturn.

And just to add on to that, if you go back to the last phone call, between the fourth quarter of 2002 and the second quarter of 2003, power gen were losing between 5% and 7% EBIT across that period. We think we are at the trough of the power gen business in the cycle just now we're down at 4% and about part of that improvement is because we've been much more disciplined on pricing than we were at six or seven years ago as Tom just said.

Thanks a lot. Good quarter, guys.

Thank you.

Your next question comes from the line of Eli Lustgarten of Longbow Securities. Please proceed.

Thank you, good morning.

Good morning.

Just one quick question. Did you say the engine business would be down 40% for the year or 30%? I couldn't exactly --

30%.

I'm sorry. 3-0?

Yes.

Can we talk a little bit about the components business in the first half of 2010. There's a big drop in engine, when you talk about a 75% drop from second half of 2009 to 2010, is the Component business facing the same kind of issue or is it somewhat less because of the new engines are drawn and give us some idea how that will play out.

First, I just want to make sure that I clarify one thing. The 75% drop is on the on-highway North America truck markets not the engine business. You got that right? Right. Okay. With regard to how the Component business is affected, so they will be affected in a volume way on their applications in North America and truck and bus in a similar way. But remember that they will add content, so we are -- we do have new component things like SCR on to heavy-duty truck engines for example so the Components business will have more contact which will mute the affect. And secondly if you think about their mix of business, they also have a broader mix. Some of our components business for example, filtration, has a significant after-market component, the turbocharger business has a broad mix of customers outside of North America, so you can expect a more muted affect on the Components business than you would on the Engine business, both because of content changes and because of a broader spread of demand.

And that's to cut it in half or better than that or is that the magnitude we should look at because it's going to be a material number. Just trying to gauge.

Well again because the number I gave was only the truck and bus number, and so you need to think about that as compared to the whole. I think the best way for you to kind of get to what you're after is get your numbers after the Q4 call where we can go through market by market. Because I think to give you the answer that you need, I need to understand much more about all of the other markets that I do not have yet figured out. So I think -- the point is that it will be muted, exactly what percentage, I think we just don't know yet.

And even within the Engine business, like the auto and RV business, that tends -- exactly what the demand is in that sector, even though RV I guess has picked up slightly. Do you have any feelings as to what is going on in the fourth quarter and how you would look at 2010 as you go into that part of the business?

I just want to clarify your question, Eli. You're asking what will happen with the RV business in Q4?

Yes. The RV and what is left of the auto.

In the auto.

Light-duty auto.

Let me first talk about Chrysler and then we'll add the RV. In Chrysler, as you know, we only recently started back with Chrysler as they've opened up their truck plants and are ordering diesel engines again which we're quite happy about. And so they're in kind of a recovery and restocking mode. So we are seeing some increases in demand. I don't think there is -- they're not reflecting big increases and user demand yet. What they're reflecting is them kind of getting back up and running again. So we expect our Q4 to be strong, but I don't think -- we're not expecting to be back anywhere near levels where we were before or anything like that. So we're pleased to be back in business, but I think we need to remain relatively conservative about how things are going to go forward from here. With regard to the RV business, that business was, as you know, so low that it was hard to come up with numbers small enough to predict where it was going and it has bottomed out which is good and we have seen some small increases in demand and I do not -- Pat, you have the numbers.

Yes. I think in Q4 we would expect the RV business to be up maybe 50% over Q3 volumes.

50?

50. 5-0.

But that's from an incredibly low rate.

And I was clarifying for goodness. Do not mix up your 40s and 30s and 50s. Watch out for that.

I want to go back to Chrysler too for a minute. Again, reminding everyone that their share of the heavy-duty pickup truck market remains about a third and we're over 80% dieselization in that. So the product has been -- is doing as well as it was in the marketplace. And because we shut down -- they shut down plants, so we shut down the engine plant here, the volumes have been very low this year coming back in the fourth quarter, but we would expect off of that low base to have the volumes increase about 50% next year.

And one final question. You talked about the Distribution side of the fourth quarter particularly next year and with the expanded components and product change and that ramp up opportunity in both revenue and profits and distribution as we look out.

No, not so much. I think the Distribution business opportunities remain similar to what we've been getting, which is that we are as a business increasing our scope, meaning we are going to more and more markets around the world as we support our customers and as we add markets, then we bring our full range of services to those markets and second we are consolidating and improving the performance of distribution dealers that we have and distributors that we have by putting bigger -- making them bigger, adding capability and reducing cost. Those are still the two primary drivers of improvement year-over-year. I think because we see the economic situation of 2010 largely being not that good. I think we're seeing Distribution business opportunities with regard to big sales increases as not that -- not so much so. But I think we'll continue to improve performance in the distribution and in the two ways that I mentioned.

Remember the distributors sell whole engines into smaller OEMs like construction markets and that type of thing and those markets aren't coming back as well as into selling generator sets in the Power Generation markets so to the degree that one of our distributors see that as a significant portion of their business, it won't be coming back. Not at least in 2010.

All right. Thank you.

Your next question comes from the line of Andrew Casey of Wells Fargo Securities. You may proceed.

Good morning, everybody.

Good morning Andy.

Congratulations, Tom, on doing the leadoff.

It's a big movement.

Yes. Clarification point. Assuming flat volumes, specifically a question on this NAFTA truck stuff, if the truck share decreases in the second half of 2010, your mission content still goes up in class eight and medium duties, so total Cummins revenue for that regional truck market likely goes up, is that about right?

So I think the math you're doing, you're question is if our share decreases but our content goes up, do they offset each other?

Yes. If it's a modest share. I just want to clarify.

Yes. What I would say is I can't give you the answer for 2010 in the second half because there is too many details to figure out and too many confounding effects like what happens to the truck share of our customers, what is the total volume, one quarter versus next, so I can't say. But the general point is still right. We do not expect a significant share loss. There will be some. We do think we're going to add more content and we do think that our customers are using our engines are going to do better than the folks that aren't using our engines and so those things are all true. Whether it exactly offsets, I think we need to get more of the details before we know that.

Okay. And then before I get to the meat of the questions, the 75% sequential drop you discussed earlier, does that include medium-duty or is that just class eight?

That does include medium-duty also.

It includes our medium-duty truck and bus as well as the class eight. It does not include LDA.

Yes, not Chrysler.

Okay. Now moving on to a bigger part of the business, power gen, the comment about Q3 being the low point due to the end of inventory destocking, other than the regions, can you talk about the trends you're seeing in commercial products within power gen? Is that uniformally down or more mixed like some of the regional comments you made earlier, Tom?

Yes, the comments I mentioned apply to commercial in the sense that we are seeing commercial generator set business stronger in China and India specifically, we are seeing growth in demand there. And the second thing is that from a trough point of view, we are seeing -- we have seen a pick up in order rates this quarter for forward orders. So it's not -- we're not ready to count our chickens or anything, but the point is the trough comment comes from the fact that we are seeing is the fact that we are seeing order rates pick up in China and India and we did see order rates pick up for Ford orders a little bit. Those are both good signs. But as I also said, I don't think it's going to -- not going to be great. We don't think Q1 and Q2 are going to be terrific orders for power gen. We still think there will be a slow recovery because the US and Europe will be down year-over-year.

And if we look directly at the US, obviously we're seeing the RV market come up from extremely low levels and typically that tends to be your early cycle indicator in that power gen segment. What is your normal lag time between the improvement there and what you typically would see in the commercial products?

I actually, when I was in power gen, Andy, we did some analysis on that and the problem is that the lag time moved every cycle far enough that it was difficult to use as a predictor. The two things that affect it are nonres capital spending and so when nonres capital spending comes back then commercial starts to go. But you know the relationship between GEP and other cycle markets and nonres market spending isn't stable. There is a lag but it's not a stable lag. So we just do not really know on that point. And the second thing is that the international segments compounded also. So for example India here is booming and nonres construction spending trends are terrible in the US but India is going, so it's difficult to say. I understand what you're asking and I wish I had a good lag set of quarters to give you, but I just do not.

Okay. And then skipping down, on the eliminations profit contribution that has been positive for the last couple of quarters, is that eventually going to reverse, and, if so, would it be as quick as Q4?

Well it will eventually reverse, yes, as we start to see the business grow again and build up inventory, you'll see what happened over the last two or three years repeat itself. I don't think it will happen to any significant extent in the fourth quarter.

Okay. Thank you very much.

Thank you, Andy.

Your next question comes from the line of Jamie Cook with Credit Suisse. You may proceed.

Hi, good morning. It's actually Chase Becker in for Jamie. Just had a quick question regarding the Components. Specifically in the quarter, was the price -- did price have a positive impact or are we going to start seeing that more with some of the contracts in 2010.

The latter, chase. It will be more in 2010. I think what we talked about with Components in the last call was that we would see a good contribution coming from the volume uptick they would see in some of the markets as well as the improvements and some of the restructuring actions and material costs projects that they were working on that we alluded to in the Q2 call, that they would really start to benefit their bottom line in the second half of 2009 and I think that has clearly played out in their results here in the third quarter.

Okay. That's helpful. And then switching back to some of the commentary you made on the mining and oil and gas side. I know that was down sequentially in the quarter but at the beginning of the call you mentioned you had some positive trends and I was wondering if you could get more granule on what you are seeing in the market.

We are forecasting higher shipments in Q1 for mining and for oil and gas. And it's really just because we're beginning to see some pick up in orders from OEMs who are ordering equipment. The drilling market, not really. But in all of the other elements of the oil and gas market, we are seeing increased engine orders and same with mining equipment, coal of course has still been going consistently. But even the copper mining mines and others are starting to see some orders. Now again it's not what we were at. It's not returning to the original levels. But it's an improvement off the low levels we were seeing now and we'll begin to see that in Q1. I don't think it will affect Q4 numbers very much but in Q1 we'll see the improvement.

Okay. Thank you.

Say hi to Jamie.

Will do.

Your next question comes from the line of Joel Tiss with Buckingham Research Group. You may proceed.

Hi. How is it going?

Good morning.

And just on that power gen, that last question, do you think you're gaining share there or is that just the market getting better?

Was that power gen you're asking about?

Yes. Oil and gas and mining.

Oil gas and mining. I don't have a good view on share gain, Joel. I don't think there is significant share gain billed to that. I think that's market. Over the long run, I think we're definitely gaining share in both. I don't -- I just think in this period, though, there is not a significant share gain view on that.

Okay. Just because I know you guys are trying to inch in on Caterpillar on that oil and gas business.

We are inching away.

And maybe this would help everybody, can you -- you think you can hold your -- the margins that we saw in the third quarter for the full year of 2010 in the Components and in the Engine business? Because there is -- obviously we're going to have whatever first half, second half, are going to be different volumes but then we get price increases, more components in there, should be higher margins. Can you just try to balance that all together and help us frame it.

Yes, Joel. As Tom said, we're walking through all of that stuff just now so it would be very premature for any of us to give you a 2010 outlook at this stage. We'll give you that on the call at the end of January. And what is very clear, and one should figure out by now. Is that the first quarter in particular and through to the second quarter, when you talk about decremental margins they're probably going to be higher than what we normally see just because of the significant falloff that Tom described on the North American on highway markets in particular. If you look at some of some of the results we've seen the third quarter, bot in engines and components, both those segments produced incremental margins at around 30%, higher than average, so that illustrated where the volumes come back and when we'll see a significant falloff in the first half of the year, I'm expecting to figure out when the declines done, but it's going to be a higher decremental margin that normal, over the course it will come back and second half will be better. But we'll give you a lot more technical than that (inaudible).

And just last one. You sound a little more confident than your -- than your statements in the last year about holding on to a 35% market share in the on highway engine business. Is that the right perception?

Well, let's be clear, Joel, the 35% number that has been used in past calls was always a worst case scenario in terms of class eight market share. But I think what we're thinking about market share, what we're thinking to ourselves is our business is built on profitability at relatively low market share we are focused on the quality and performance of the product and driving partnerships that lead to performance for our customers. There is a whole bunch of variables playing out there. As you know there is mix between 15 liter and 13-liter engines and there is new engines being produced, so there is a whole bunch of water under the bridge to go. Our view is if we continue to launch really good products, launch them well, support our customers we'll do very well and some of the market share I think misses the point really because it's not just math, it's actually how well you do with the products that you have, that's really what drives it not just math between what -- what percentage of this and what percentage of that. So we have a lot of work ahead of us with our partners to make sure that our market share stays good. So that's what we're trying it do.

Okay. Beautiful. Thank you.

That's all of the time we have for today. I appreciate everyone's attendance on the call today and obviously [Claudia, Mare] and I we'll be available for your questions throughout the day. Thank you, everyone.

Ladies and gentlemen, that concludes today's conference. Thank you for attending. You may now disconnect. Have a great day.