康明斯 (CMI) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Cummins Incorporated earnings conference call. My name is Ann, and I will be your coordinator for today's call. As a reminder this conference is being recorded. At this time all participants are in listen only mode. (Operator Instructions) We will be facilitating a question and answer session following the presentation.

I would now like to turn the presentation over to Mr. Dean Cantrell, Director of Investor Relations. Please proceed, sir.

Thank you, Ann. Welcome everyone to our teleconference today to discuss Cummins' results for the third quarter of 2010. 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 statement. A more complete disclosure about forward-looking statements begins on page 3 of our 2009 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.

With those formalities out of the way we'll begin our remarks with our President and Chief Operating Officer, Tom Linebarger.

Good morning. I will start today by sharing some thoughts on our performance in the third quarter. Pat will then provide greater detail on the quarter and our updated 2010 outlook, and Tim will talk about our longer term priorities.

The third quarter was a continuation of our strong performance throughout 2010. Sales and profits rose sharply from the same period last year led by strength in our international markets and the significant improvements we have made in manufacturing productivity during the downturn.

Sales of $3.4 billion were 34% higher than the same period in 2009. All four business segments reported significantly higher sales led by our Engine and Power Generation segments which increased by 44% each.

Earnings before interest and taxes also increased from the third quarter of 2009 to $449 million or 13.2% of sales. That compares to 7% of sales excluding restructuring charges during the same period in 2009.

To further illustrate our improved profitability, consider that in the second and third quarters of this year we produced the same EBIT as we did during the second and third quarters of 2008, at the height of our business before the recession, on $1 billion lower in sales.

Our Engine business reported record quarterly EBIT of 10.8% of sales despite continued weakness in the North American truck market. The Power Generation business has rebounded strongly from its low point of the downturn during the third quarter last year and matched its best ever quarterly EBIT percentage at 12.3%. Our Distribution businesses set a quarterly record by earning EBIT of $74 million and our Components group continued to perform well during the quarter as EBIT doubled from the same period in 2009.

As has been the case all year, strong markets in China, India and Brazil continued to drive large sales increases in the third quarter. Consolidated sales in China rose 72% from the third quarter of last year while sales in Brazil increased 90% and sales in India were up 49%. Overall, sales outside the US increased 56% from the same period last year accounting for 63% of our total consolidated revenues in the quarter.

For example, international sales of engines to the industrial markets increased 96% compared to the same quarter last year led by sharply higher demand for construction engines in emerging markets. Sales to the mining market doubled in the third quarter due to stronger demand for coal and other commodities. And Power Generation sales to international markets increased 65% compared to last year.

Many of our US markets remain weak as a result of the slow recovery in the US economy. We are well positioned for the recovery in these markets but don't expect to see any meaningful improvement until 2011.

While we're on the topic of our US business, I want to provide an update on our 2010 engine launch which continues to go extremely well. Through the end of September we had shipped nearly 37,000 medium and heavy duty engines to North American truck and bus customers equipped with selective catalytic reduction after-treatment devices. The feedback we have received from our customers has been very positive and confirms that the new engines are performing as expected in term of both reliability and fuel economy.

Many of our heavy duty customers say they are experiencing a 5% to 6% improvement in fuel economy compared to our EPA 2007 engines, with some reporting even greater improvement. More than ever, we are confident that SCR is the right choice to meet current and future emissions standards in this market while helping us to achieve the fuel economy our customers demand.

In addition to our leadership positions in several growing international markets we continued to benefit from our efforts to become low cost producer around the world. We have talked in recent quarters about productivity improvements in our manufacturing operations which have allowed us to respond quickly to demand fluctuations, to gain market share and to improve our profitability.

Today I wanted to share a few thoughts about a broad effort we have launched to strengthen our global supply chain. The growth we have seen in recent years has made us a stronger company but has also significantly increased the complexity of our global supply chain. Our ability to become the low cost producer in our industry will depend to a great degree on the competitiveness of our supply chain. We have been studying ways to manage our global supply chain so that it better meets our customers' needs for responsiveness at a lower cost.

As an important next step in that process, we have created a new senior leadership role to direct our global supply chain work, reporting directly to me. Lisa Yoder, a long time operations and supply chain leader at Cummins, will lead a multi-year initiative that will focus on improving the performance of all elements of our supply chain including cost, lead time, reliability, responsiveness and optimizing flows from different supply points.

Part of the answer to achieving these improvements is integration and alignment between our businesses, increasing our investment in supply chain capability and tailoring our supply chains to meet customer needs. As one small example of the type of change we're talking about, we have recently started work to reduce the number of our parts distribution centers around the world from 61 to 35 over the next five years, while improving the availability of parts for our customers.

Before I turn it over to Pat to discuss details of the third quarter, I want to say a few words about our long term financial targets and our planning for 2011, both of which I know are of interest to all of you. Our performance this year has clearly been better than we had anticipated.

Our business especially in the emerging markets has come back much faster than we had forecasted. We are also seeing stronger margins on the increased sales as a result of improved productivity in our manufacturing operations. As a result, we are ahead of where we expected to be at this point relative to the targets we communicated in March.

We will be revisiting those targets in the near future, but first we are focused on finishing 2010 as strongly as possible and preparing our 2011 plan. We will provide our 2011 outlook including details by business segment and end markets when we report fourth quarter earnings next February, but I can offer you a few thoughts on some market trends that will be influencing our planning.

In North America, we expect significant growth in engine shipments and components to the truck market for two reasons. First, we expect the NAFTA Class A truck market to grow nearly 60% next year to near replacement levels; and second, our shipments will grow faster than the overall market. As you know, we under produced relative to the truck OEMs during the first half of 2010 as they consumed transition engines; and this phenomenon will not repeat of course in 2011.

We expect continued growth in our markets in China, India and Brazil in 2011 though we will not see nearly same year-over-year growth rates we have seen this year. Still we expect our sales growth to exceed the GDP's growth rate in all three countries.

Once we have completed our 2011 plan, we will then revisit our long term targets, this time looking out to 2016. When that work is complete we will share our new long term targets with the investment community.

Let me close by saying that we are very optimistic about our future prospects in both the short term and the long term. As I've said, the first three quarters of this year have exceeded our initial expectations, and the longer term growth trends that we have discussed on several occasions continue to look extremely promising.

I'll now turn it over to Pat who will give you additional details about the third quarter as well as our updated guidance for 2010.

Thank you, Tom, and good morning, everyone. As Tom said, demand for our products continued to improve in the third quarter with revenues reaching $3.4 billion. Compared to the same quarter of last year, revenues were up $871 million or 34% with significant growth from all regions outside of the US.

Revenue in both China and Latin America grew in excess of 70% while sales in India and Europe were up 49% and 45% respectively. Compared to the second quarter, revenues were up $193 million or 6% led by stronger demand in India, Latin America, and some recovery in North America.

Earnings before interest and taxes were $449 million, 13.2% of sales, significantly better than the 7% reported a year ago excluding restructuring charges. The third quarter results included a $32 million pre-tax benefit in the gross margin from a favorable legal ruling in Brazil on the tax treatment of imports during the period 2004 through to 2008. Excluding this one-time benefit, EBIT was 12.3% of sales, which was in line with the guidance we gave for the second half of the year on our previous call in July.

Joint venture income of $88 million was up significantly from last year mainly driven by the strength of the Chinese and Indian truck markets but down 9% from the prior quarter, as a result of slightly lower volumes in China and India following our record second quarter. Our profitability improvements from the third quarter of last year are driven from our ability to leverage higher sales volumes, the productivity improvements in our manufacturing plants, strong joint venture income, lower warranty costs and favorable pricing.

Net income almost tripled from $95 million a year ago to $283 million in the third quarter of 2010, while earnings per share improved to $1.44 in the quarter compared to $0.48 per share a year ago.

Now let me give you some details for each operating segment. The Engine segment delivered $2.1 billion in revenues, up 44% from last year, despite a 54% drop in shipments to the North American heavy duty truck market. Shipments to the construction, mining and power generation markets as well as to truck markets outside of North America drove significant revenue growth year-over-year.

Compared to the second quarter Engine segment revenues were up 9% as we begin to see higher shipments to the North American on-highway markets as well as continued growth in mining, oil and gas and construction markets.

EBIT of $223 million or 10.8% of sales was a record for the Engine segment and significantly better than the $61 million or 4.2% of sales reported last year. Compared to last year, this improved performance came from increased volumes and productivity improvements in our manufacturing plants, stronger joint venture income, benefits from pricing in certain markets and lower warranty costs. Compared to the performance in the second quarter, EBIT margins improved as a result of higher sales volume and strong operating leverage.

The sequential revenue improvement will continue for the Engine business next quarter, led by strength in global industrial markets, particularly construction, mining, and oil and gas and also recovering engine demand for heavy duty trucks in North America. We now expect full-year revenues to be close to $7.8 billion, up 21% in 2010, which is slightly below our previous guidance due to the slower recovery of the US heavy duty truck market than we had previously anticipated.

Engine joint ventures will continue to deliver strong results on a record year for shipments in China and in India. We continue to forecast the Engine segment EBIT margins at 10% of sales for the full year which is significantly better than the 3.9% we reported last year.

The Power Generation segment also delivered a very strong quarter. Revenues were up 44% compared to the prior year with strong recovery in all markets outside of North America. Compared to the second quarter, revenues were up 12% led by commercial product sales in India, Latin America, UK, and in the Middle East. Power Generation profits of $97 million sharply increased from the $23 million we reported in the third quarter of 2009.

EBIT margins were 12.3% of sales in the quarter compared to 4.2% last year, a performance that is comparable to the record level achieved at the peak of the last cycle in the second quarter of 2008. Most of the improvement came from strong operating leverage off the higher sales volume.

We expect demand to remain strong in emerging markets and slowly recover in North America and Europe. For the full year we are now forecasting 18% revenue growth to over $2.8 billion and segment EBIT margins of 10.5% of sales compared to 6.9% last year.

In our Components segment, revenues were up 30% from the same period last year driven by higher technology content on EPA '10 engines, production recovery from European truck OEMs, improved global aftermarket demand, and strength in emerging markets. Revenues were up 5% when compared to the second quarter with almost all of the growth coming in first-fit OEM sales as a result of the increased shipments of EPA '10 products in North America.

Components segment profitability of $63 million was more than double the profit from a year ago. EBIT came in at 8.2% of sales compared to 5.2% of sales in the third quarter of 2009 as a result of volume leverage from higher sales and operational improvements. Compared to the second quarter, EBIT margins were down 2 percentage points due to some warranty adjustments on legacy products, higher investment spending in research and development, and some increased expense related to manufacturing operations in our filtration and turbocharger businesses.

For 2010, we now expect full year revenues of just below $3 billion, an increase of 26% over 2009 which is slightly lower than our previous guidance due to the slow recovery of the US truck market. We are forecasting the Components segment EBIT margin to finish the year at 9% of sales compared to 4% last year and remain very confident that we will continue to see further margin improvement in our Components segment as we move into 2011.

In the Distribution segment, revenues were up 36% from a year ago. The western Canada consolidation accounted for 16% of the growth while the remaining 20% organic growth came from higher engine shipments in Europe, power generation recovery in the Middle East and improved service revenues in the South Pacific region. Revenues were essentially flat with the second quarter.

Segment EBIT of $74 million was a record for Distribution. The EBIT margin of 12.9% of sales was essentially flat from last year as a result of the dilutive impact of the consolidation of the western Canada distributer in early 2010.

Compared to the second quarter, favorable product mix and currency movements as well as higher joint venture income helped to improve the segment EBIT margin by almost 1 percentage point. We are now forecasting Distribution revenues to be up 28% in 2010 to almost $2.3 billion and deliver segment EBIT margins of 13% which is essentially at the same level as 2009, despite the dilutive impact of the western Canada consolidation.

As a result of the stronger performance in the Power Generation and Distribution segments, we are now raising the full year financial guidance for the Company to an EBIT of 12.5% on revenues of $13 billion. This represents a 20% growth in revenues and over 100% growth in profits compared to 2009.

Finally, we now project the effective tax rate for the year to be 30%, slightly lower than our previous guidance.

Looking at the balance sheet and cash flow statement, we continue to perform well. Our balance sheet has probably never been stronger and in the third quarter our credit rating was upgraded by both Moody's and Standard & Poor's.

In the first nine months of the year, we have invested $385 million in working capital to support the increase in demand for our products. While working capital dollars have increased, compared to the third quarter of last year, our inventory turns are higher, our receivable Days Sales Outstanding and past dues are lower, and in total working capital is lower as a percent of sales.

We have invested $170 million in capital expenditure so far this year and expect an outflow of between $375 million and $400 million for the full year. We have several capacity expansion and new product introduction projects to be completed in the fourth quarter.

In addition to increasing the dividend in the third quarter by 50%, we have repurchased over 1 million shares this quarter bringing our total this year to 3.5 million shares at a cost of $241 million. We will continue to return value to our shareholders in the form of sustainable dividend growth and share repurchases.

Let me turn it over now to Tim for his remarks before we take your questions.

I want to start by repeating just a few thoughts on our outstanding third quarter results. Our performance in the quarter is further confirmation that we are on a path towards sustained long term profitable growth. As Tom said, we are ahead of the growth pace we shared with you during our Analyst Day in March.

Our EBIT margin has improved steadily over the past seven quarters and all of our businesses are operating at or near all-time highs in terms of EBIT margins. We continue to see strong margins as our volumes grow as a result of the improvements we made across our manufacturing operations over the past two years. As you heard Tom discuss, our 2010 product launch is going extremely well and we are more convinced than ever that our choice of SCR as the technology to meet new emission standards was the correct one for now and in the future.

As we look ahead to 2011 and beyond, the picture is probably even brighter than what we thought at the beginning of the year. In addition to a number of favorable long term trends that we have discussed over the past year, we are preparing for growth in many of our markets outside the United States next year both in our consolidated businesses and at our joint ventures. We plan to invest significantly across all business segments in 2011.

Much of that investment will go to increased capacity or to launch new products in international markets where we already hold leadership positions. For example, in India, we are opening a second facility for our midrange engines at our Tata-Cummins joint venture to expand capacity by 50% by the end of this year and are investing more to further increase capacity in 2012.

Work also continues on our mega site location in Phaltan, India, which will house a number of operations across all our business segments in a single location when it's complete. A remanufacturing operation is scheduled to be completed there by the end of this year and a parts distribution center will open in the first quarter of 2011. The mega site investment will strengthen our ability to serve the Indian market and also provide a base for exporting even more products such as generators out of India.

In China, we plan to expand midrange engine capacity by 25% at our Dongfeng Cummins joint venture and invest in capacity expansion and new products at our high horsepower engine joint venture in Chongqing.

We also have capacity expansion projects planned across all of our component businesses in China. In Brazil, we will significantly increase our capital spending in order to prepare for the Euro 5 product launch in 2012. We will also make investments to improve processes and facilities across all our operations in the country.

And here in the US, we are investing heavily in our high horsepower engine business to meet expected demand both in this country and in international markets. Work has begun on the $100 million expansion in our high horsepower plant in Seymour, Indiana, that will allow us to produce larger displacement engines to take advantage of long term opportunities in markets such as power generation, oil and gas, mining, and commercial marine.

In addition to the capital investment in the plant, we expect to spend $200 million to develop the new engine platform over the next few years. These new larger displacement engines will use both diesel and natural gas fuels.

I want to remind you our success this year has come despite continued economic weakness in the US and Western Europe. While much of our future growth will continue to come from emerging markets we do expect to see a return to meaningful growth in our developed markets starting next year. Our market share in North American medium duty truck engine markets is over 50% and we currently have more than 40% of the heavy duty truck engine market. Because of that, we are well positioned to take advantage of the industry growth expected in 2011 and beyond.

This benefits our Engine businesses as well as our Components businesses which are producing significantly greater content for the EPA 2010 engines than for previous engine models. We expect additional growth for our Components segment in Europe as Europe and other parts of the world adopt tougher emission standards for both on-highway and off-highway markets both over the next several years.

While I'm speaking of growth opportunities I wanted to talk a little bit about Mexico.

I along with the rest of Cummins' Board of Directors and several senior Cummins leaders visited our operations in Mexico last week and return excited about our operations and leadership position in Mexico. We have been in San Luis Potosi and Juarez, Mexico, for more than 25 years and have developed a strong manufacturing base for Engines and Components products.

We are the leading producer of heavy duty truck engines in the country with an 85% market share. Cummins' total sales in Mexico through the first three quarters of this year are up 60% compared to the same period last year.

We currently employ about 3600 people in Mexico and our presence will continue to grow. For example, our low cost filtration plant in San Luis Potosi is in the final stages of an expansion that will allow us to serve the majority of our North American market from a single location, allowing us to remain competitive in an extremely price sensitive market.

Let me close by saying that our people have done an outstanding job over the past two years. First by taking quick and decisive actions in the early days of the recession to keep the Company strong and then in managing the business very conservatively through the downturn. The results have been a quick return to growth and a very bright future for Cummins.

We are well positioned to capture growth opportunities for next year and beyond and continue to make investments in people, facilities and technologies around the world in order to capture those opportunities. In fact I've never been more optimistic about our future than I am right now. Thank you and we'll take your questions.

Thank you, Tim. Out of consideration to others on the call I would ask that you limit yourself to one question and a related follow-up. If you have additional questions you are free to rejoin the queue. Ann, we are now ready for our first question.

Thank you. (Operator Instructions) Our first question comes from the line of Adam Uhlman with Cleveland Research. Please proceed.

Hi guys good morning. Just a clarification on the earnings guidance for the year, first of all the $0.11 gain is included in the numbers; correct?

Yes, that's correct.

And then within the margin forecast it would appear that the corporate expense line is going to be turning to a gain in the fourth quarter, about a $100 million swing or so relative to the last quarter. Is that correct? Pat, could you talk through what's happening there?

Yes, I think what you're looking at is the elimination column. We did have a sizeable profit inventory increase in the third quarter as intercompany inventory increased over our second quarter levels.

We do not expect the inventory levels to increase in the fourth quarter; our current thinking is it could come down. So I would not expect to see any sizeable increase in that column, in that charge in Q4 and my guess is it's going to be pretty close to zero.

Okay. Great, thanks. I'll get back in queue.

And our next question comes from the line of Henry Kirn with UBS.

Hi, good morning guys. Could you talk a little bit about what your order book is telling you about the cadence of the North American Class A rebound? Not maybe this magnitude for guidance but the timing?

Henry, we are starting to see the order board pick up. It definitely started later than we originally planned and so third quarter was not as good as we originally planned. It's not a huge difference but it didn't come up quite as quickly, and we were getting a little worried about that for next year even.

But it has started to pick up now in the fourth quarter. So we are seeing forward orders, not as far out as that would tell you it's going to get to replacement demand yet, so the order board isn't that full up. But we are definitely seeing increases in the fourth quarter.

So what we are projecting is a step by step increase. It's not going from flat to way up again. It's sort of step by step Q4 will be better than Q3 and then Q1 again more improvement.

And what are you seeing in terms of price discipline in the market?

On the truck side I can't comment so well, but on the engine side we're in long term agreements there, so there's very high discipline. We don't change them because we have long term agreements with our OEM customers on how we're going to deal with engines. But for the truck side, you'd be better off to talk to our customers about that and they could give you I think quite detailed comments about that point.

Great. Thank you very much.

And our next question comes from the line of Jerry Revich with Goldman Sachs. Please proceed.

Good morning. Tim, can you give us an update on Foton Cummins production rates and profitability in that quarter and rough order of magnitude what kind of contribution do you think we could expect from that business in 2011?

In terms of the production rates by quarter, you'll recall that we started off very slowly this year. We were doing about 1,000 engines in the first quarter. We did 4000 in the third quarter and I expect we'll be closer to 8000 in the fourth quarter. So for the full year, we're going to be somewhere around 17,000, 18,000 compared to just 1000 last year.

And Pat, the P & L position of that business in the fourth quarter, is that enough of a production run rate to get it into the black?

No, it's not. As we expected we're still in the ramp up phase of the Foton joint venture and we're still losing money on that joint venture, which we expected when we went to it.

We also are stepping up development of more different variants of the engine. So the engineering spend over that period has also continued to increase. So we are spending more money as we go.

And then also to the point that Pat made, the ramp up is not enough yet to cross the breakeven line, the joint venture. So both are happening at the same time.

So prospects for the joint venture look even brighter because we've added more products to the list and we're doing more work together. But it's obviously behind where we had hoped in terms of ramp up.

And that's primarily as a result of the implementation of the Euro 3 standard in China being delayed by some degree and also having different kinds of enforcement by region, which has slowed down Foton's implementation of the engine into their vehicles. So as that implementation continues to happen, then volumes will increase.

We will also plan for a loss for next year.

That's helpful, thanks. And Pat can you say more about the sequential margin performance in Components? What proportion of the margin decline was due to out of period warranty accruals? And what specifically were the drivers of the higher manufacturing expenses you cited? Thanks.

Sure, so of that 2% drop from the second quarter, 1% related to warranty and then the other 1% split fairly evenly between the increased investment in research and development and some of the operation issues we have been having in a couple of our plants. They are mainly in our filtration business and in our turbocharger business.

The filtration issue, we've moved some lines to a plant in Mexico. It's a little bit behind where it should be in the ramp up. So that is going to cost us a little bit more expense than what we had anticipated and what we have seen in the second quarter.

In our turbocharger business we had some system issues -- sorry, we upgraded some systems at the start of the year into the first quarter, we're recovering from that. We're behind in some shipments to customers so that means we now have to incur more premium freight to make sure we deliver product on time to customers.

Thank you.

I just want to add in both those cases -- I mentioned a lot of productivity improvements in our previous calls that we've seen in the plants. And both those changes that Pat talked about -- the filtration, consolidation in the San Luis Potosi plant and the consolidation of the turbocharger plants in Charleston plus the IT upgrade -- both those will lead to the same kind of productivity increases in those two businesses.

In the short run though we're behind where we should be. So our implementation of those two things weren't nearly as good as the other productivity improvements we made, and that's why we're finding ourselves losing some ground in third quarter. But we will get those resolved and we do expect both of those to lead to better productivity and better profitability in those two businesses.

And last follow-up, the timing of when you expect those issues to be resolved roughly?

We will definitely be through them by the end of the year. It doesn't mean there won't be any things we're still resolving, but from a financial impact we will definitely be through them by the end of the year. And I think the biggest impact has already occurred in the third quarter.

Thank you very much.

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

Excuse me, good morning. Just clarification. You talked about lower warranty expenses throughout. What were the warranty -- can you give us the warranty expenses for year-over-year and quarter to quarter?

Warranty expenses for the quarter was 2.9%, I think this time last year we were 3.9%. We do expect warranty to increase in the fourth quarter as we ramp up our EPA '10 product launches. So fourth quarter warranty expense expected up to 3.4% of sales.

Full year we'll be at 2.9% and that's going to about 1 percentage point better than the 2009 level.

Okay. During some of the commentary you talked about more moderate I guess is the word gains in China, India, Brazil next year, more in line or better than GDP or so.

With all the expansion going on do you expect to be able to hold profitability in that part of the world with the more moderate gains? Or are we looking -- or improving? Can you give us some idea of what you'll be able to do given that the growth rate is now probably low double digit, at least as we see preliminary talk about it, and you have huge expansions going on?

We do expect to be able to maintain profitability there, Eli. As you noted, in each different joint venture or different operation as we add capacity or we ramp up engineering spending for investments there are definitely impacts at least in the short run on profitability. But if you kind of look across all of them, while one's a little bit down -- we talked about the Foton joint venture already -- then the other is doing well. So DCEC this year for example had a tremendous year. So Foton was a little bit lower, DCEC was a little bit higher.

So if you look across all of them, even with growth rates coming off their torrential pace this year, there will still be good growth rates. So we are not going to have any absorption issues or anything. We are out of capacity and adding as you know; in Tata Cummins for example we will be adding more capacity and Dongfeng.

So we're still operating at very efficient levels in both China and India, so we still expect to be able to maintain profitability. And our final planning really isn't done for those regions. I tried to give some indication that growth rates will still be decent, because there's a little bit of concern that after these kind of growth rates are you expecting it to be down or something, and we don't expect that at all.

How good they will be we still have to figure out. But we said, as I've said to you in my remarks, they will be better than GDP and we think they could be significantly better. We just have to go through all the planning and see country by country and see where we are going to come out.

One final question. The Distribution step up in profitability, can you talk a little bit more? Is this a new permanent level that we should be thinking about? I mean 12.9% you are hanging around and 13% in the fourth quarter also is what you're guiding. So can you talk about the profitability step up and how sustainable this is as we look into next year?

I think I'm trying to recall the long term targets we gave for Distribution, I think it was 12%. So I think what you're seeing just now, Eli, is that aftermarket demand has held up much better than whole goods demand over the last couple of years and aftermarket has much better margins than whole goods. So that's kind of inflated the margin to some extent.

I do expect long term margins to remain pretty much what we said before, at around the 12% level. Just now we're performing slightly better than that.

Yes. All right, thank you.

Our next question comes from the line of Meredith Taylor with Barclays Capital.

Hi, good morning. I'm hoping that we can just dig, I wanted to revisit the Components margins. Maybe if you can, it was very helpful to hear you parse out some of the couple points of headwind that you saw on a sequential basis. I'm hoping that you can talk a little bit about the swing that you mentioned in R & D expenses. Was this a pull forward from Q4, from 2011? Or is this kind of a net increase in how you view R & D over heading into 2011 in that business?

And then can you talk a little bit about -- I know you talked about some of the operational challenges that you saw in the filtration and turbo side of the business. But could you talk about some of the mix impacts that you're seeing and then some of the operational improvements that you're seeing in other pieces of the business and how much more runway you have with those?

Okay. I think in the first part of the question the R&D, we are going to continue to see further investment in research and development as we go forward. In order to stay ahead of the pack that's clearly one area that we've got to continue to make good investments in.

So it's not a significant surprise that R&D investment was up. I think it somewhat was highlighted as a more significant factor than what it could have been because warranty was also up and we had some of the production issues in a couple of those plants.

On the operational issues in turbos and filtration, the other issue in filtration, it was much less of a dollar impact, but you asked if there was any mix issues that have been going on. The growth in the third quarter was really through first-fit OEMs. So the aftermarket business did not really increase much at all in Q3 over Q2.

In turbos it wasn't much of a mix issue at all sequentially. Outside those two businesses I think CES are performing very well, CES being our emissions solutions business. We are seeing very strong margins as we expected in that business as it continues to ramp up, and I would think there's more opportunity for them to grow further as we go into next year.

Meredith, if I could just comment. I appreciate your question about so what's kind of going right there or examples of that. The filtration business is operating now at margins that are up near its historical highs again, so it's operating incredibly well.

Do I wish we had got our consolidation better in Mexico? Sure I do; but their plants across the world are doing very well. Our business is improving. We're adding new technology to our field filtration and other filtration businesses which is driving up premiums on our products.

On CES, emission solutions, we've had this delay in the 2010 truck market; but despite that, we've ramped up both volumes and margins very, very well in that business. And it's now meeting target margins and as the 2010 ramp up continues we'll see further improvement in that business.

The turbocharger business is now doing very well globally. We just launched a new light duty turbocharger that will be manufactured first in China and that will go on these Foton Cummins engines as well as a number of other people's engines. So all those businesses are performing incredibly well.

What you've seen of course, because we have come off two years where we had the two of them not doing so well, is I think there's questions about what the potential is of those companies. But we inside the Company see the Components business as both our fastest growing segment and one which we're highly confident will meet target margins and will be a significant engine for growth in the Company.

So we're very optimistic about it. I recognize that when we have these blips it's hard for people to be sure, but we feel very confident about it. And each of those businesses has seen improvement in productivity, in quality, and in margin over the period, so I think you can look forward to continued improvement there.

Okay, that's helpful and just as a follow-up. I noted that your heavy duty build outlook, the 130,000 actually hasn't changed from 2Q. I mean, can you bridge the fact that this build outlook for the industry hasn't changed with the change to your heavy duty outlook?

You're right, Meredith, this is Dean. That outlook of 130,000 Class 8 NAFTA Group 2 or those engines that are bigger than 10-liters has not changed. I think what we have seen is the number of transition engines in the marketplace that are still being consumed by the truck OEMs is the difference between what you've seen in our revenue forecast versus the market outlook of the 130,000.

Okay, great. Thank you.

Our next question comes from the line of Andrew Casey with Wells Fargo. Please proceed.

Good morning, everyone. If I could, a question on the Engine JVs. Could you clarify if you continue to expect the second half to be approximately what you benefited from in the first half, or is it a little down given the increased R & D going into some of them?

I think in the Engine joint ventures we do anticipate second half to be a little bit softer than the first half. So for example, in the largest joint venture we have with Dongfeng Cummins in China, we built 120,000 engines in the first half of the year and we're going to be somewhere around 110,000 in the second half of the year. So second half Engine joint venture earnings will be a little bit softer than the first half but still significantly better than the second half of last year.

Remember, Andy, we had thought in China early on that what we were going to see was a much stronger first half than second half because the government was planning to try to put a handle on growth, they took control of the money supply and do other things to reign in growth a little bit which they did do. The stimulus package ended to a large degree and the government did try to reduce money supply, and we have seen some impact on the economy.

But really the joint ventures that we're involved with, with Dongfeng, Foton and Chongqing, all have seen their demand tail off much less than we originally planned, which just I think in part demonstrates the fact there was more demand than there was capacity. So while the economy may have come off its torrential growth rate to just growing really fast, in fact there was some pent-up demand and so the second half is not much weaker. It is weaker as Pat said but not much.

In India on the other hand, we're kind of capacity paced in TCL, so we don't expect the second half to be weaker than the first half from a production or a revenue point of view. In fact we're really anxious to get our second TCL joint venture on stream at the end of the first quarter so that we can begin to ramp up production and revenue.

And Andy, just to be clear I was talking about the Engine joint ventures. When you look at the total business of the rest of the business in the second half of the year Power Generation joint ventures will do better than what they did in the first half of the year; and our Distribution joint ventures will do better than what they did in the first half of the year.

Okay, thank you very much for that and then lastly, on the Tier 4 implementation, how are you looking at that? As I know it's next year and you don't want to give guidance; but qualitatively, is that progressive through the year as getting better, or is that more lumped into the second half and really see benefit in the following year?

Well, I think as we talked about with Tier 4, because in both the European implementation and the US implementation they have phase-in processes. They are different processes and the phase-in process is a little bit more, has more flexibility in the US than it does in Europe. But in both cases the phase-in process is likely to make demand for Tier 4 things stretch out and be less of a cliff event than we might see in an automotive market. So that affects timing to a large degree.

But having said that, we will be implementing on time and we do expect, just like with automotive, it will drive up the content of our components in our engines. It positions us well competitively compared to other folks as we have good solutions for those Tier 4 products. And we have seen some wins with OEMs as a result of the fact that we're ready and have the right technologies ready to go for those.

So I guess overall we're seeing it as continued positive messages because, again, we're prepared for those and the OEMs like that. But I think it will be more of a phase-in and we won't see the dramatic impact in one single quarter. Dean, anything you'd add to that?

Yes. Just as we've talked about before with the fourth quarter of this year in Europe, we are still seeing pre-buy orders for engines in the European market but not so in the US market. So there will be a little bit of a change much like we've seen in the US truck markets following an implementation. We will see that in Europe where the volume that was pulled forward into the fourth quarter of 2010 will be weaker in the first quarter of 2011.

But other than that, to Tom's point, in the US market it is just going to be a gradual phase-in. We'll get another size band of engines moving at the beginning of 2012, the below 174-horsepower so a little bit 6 B, 4 B, 3 B, or 3.3-liter engines that will move to the next emission change in 2012. So it's going to be an ongoing phase-in for the industrial markets.

Okay, thanks. Look forward to hearing about the new long term targets next year. Take care.

Our next question comes from the line of Robert Werthheimer had with Morgan Stanley.

Thanks, good morning everybody. Just a quick one because you've been pretty clear on the JVs, but there was another manufacturer out there who saw some weak orders in Brazil and China. Have you seen any market change in the order outlook whether in response to the China tightening or otherwise?

Not that I'm familiar with Robert. We're still seeing Brazil as being very strong. So it doesn't mean that it won't turn down at some point, but as we said in my remarks we're still looking at Brazil and 2011 as being further growth over 2010.

Perfect and then I wanted to ask another Tier 4 question if I may. The kind of wins you're seeing, I just wanted to ask about the timing of it, whether you're getting more and more activity as people have had a chance to try out the trial engines of other manufacturers and they are not working out as they thought, there's also other waves of implementation. So would you say that you've gotten most of the wins you expect to get on platforms out of Tier 4 Interim or is that just starting?

First of all remember with Tier 4 Interim, then is goes to Tier 4 Final. So as Dean was saying there's kind of going to be a steady stream of activity between now and 2014 of implementations of Tier 4, so we do not think we've won all the wins that we're going to win. We hope to see many, many more wins.

So we're still fighting a bunch of battles trying to make sure that people see what we can bring to their equipment and again, we expect to continue to do well in that competitive arena. So we don't think we've won them all.

And as you maybe were hinting at there, in the off-highway markets, definitely there's the cost of transitions relative to the volume of sales is more difficult for them. What they're talking about is lots of variety of equipment, lots of changes to make and maybe not nearly as much volume as a highway manufacturer might have. So for them these transitions are complicated and difficult and they take them time to figure out how to manage it most effectively. So again there's still a lot of decisions being made I guess is what I'm getting on with that.

Are you still in competition for anything that's Jan 1, 2011, do you think or not?

Oh, no, Jan 1, 2011, we would already be --

That's all done for everybody?

Way too late to change there.

Perfect. Thank you.

Our next question comes from the line of Jamie Cook with Credit Suisse. Please proceed.

Hi. Good morning. Two quick questions. One, you talked about growing the heavy duty truck market in North America, being up 60% next year; you'll be able to outgrow the market. Could you just give us your updated thoughts on market share shift from 15 to 13 or what your assumptions are so we can -- what your assumptions are for 2011?

And then my second question is I'm just looking at your implied earnings for the fourth quarter which is about $1.70. That gets you to a run rate of earnings next year of at least $6.80 in EPS which is pretty impressive. I know you don't want to give guidance but are there any big headwinds we should be aware of, whether it's R & D, warranty costs, whatever it may be as we are thinking about the year ahead?

Okay, Jamie, just on the truck side first, so market share, we have not seen a big shift from 15 to 13 by the way. It's early days and there's a lot of transition this year, so I think there's a lot of stuff left to happen. But we haven't seen it and we're not really seeing it in a significant way, so we're --

It doesn't sound like you're expecting it.

No, not per se. Again there are more 13-liter engines out there, as you know, with Paccar putting their MX engine. So they will definitely be promoting their engine and they expect to see a certain amount of share with that.

We've talked before about what we think is going to happen. We're expecting to end this year around 40% market share. And we think over time as International stops using our engines and Paccar introduces their engine that we'll sort of settle in this 35% to high 30%s kind of market share. That's kind of what we're targeting to do and we think that will be a good and profitable place for us to operate.

So that's where we're headed and you can do your own kind of calculations on what you think that means on mix versus 15 versus 13 on that, to see how that works out. But that's where we're headed for 2011 and beyond.

With regard to the guidance, the only thing I'm lothe to respond to in your question is it looks like I'm getting shoved into guidance one way or the other, but let me see if I can --

I would never do that.

Let me see if I can avoid that dance by saying that we don't see a whole bunch of big headwinds. There's obviously a bunch of uncertainty about US markets and European markets and you read about as much about that as I do.

But the developing economies look strong as I mentioned in my comments. There are some sectors that look like they are poised to recover. We talked about the heavy duty truck.

We do think commodity costs are likely to continue to increase. That's a headwind on the one front. On the other hand we sell a lot of equipment into commodity generating markets; so on balance I think that's a good thing, not a bad thing. But it will be a headwind to some degree in costs.

But there's really nothing big that I would highlight to you as saying this really has a big offsetting push to what we're trying to do. But we're still rolling together all the growth rates and making sure we've got a good balance between investing for long term and generating returns in the short run. That's a big part of how we're going to generate the new long term growth targets that you're waiting for us to produce for you.

Great.

This is Tim. Let me add a couple more comments on the 15 versus the 13-liter engine. First of all, the large bore engines have represented about 60% of the market for some period of time. These debates periodically appear but there really hasn't been any change.

If you consider over the road a 15-liter is better than a 13-liter in fuel economy, the resale value is better, it's more durable and reliable, so I know there's a lot of discussion out there but we really don't see a mix change here.

Okay, that's encouraging, thanks.

And our next question comes from the line of Ann Duignan with JP Morgan. Please proceed.

Hi, good morning guys. I wanted to take a step back and wonder if you could comment a little bit on yesterday's joint announcement from the DOT and the EPA in terms of fuel efficiency and greenhouse gas emissions for the truck industry for 2014. I spoke to some industry folks yesterday at the defense convention in Washington DC and the impression I got was that the industry was very much involved with this decision and therefore not a huge negative reaction to the press release yesterday.

However there were some people at the show who thought that it might lead to a significant pre-buy in 2012 and 2013. Could you just comment on each of those perspectives that we got, both not a big surprise and then might we see a pre-buy on the back of this announcement?

Ann, with regard to the industry involvement I think that is accurate. At least that is our experience, that we were involved for a significant period of time.

The EPA made a really big effort to try to get input from a wide range of people in the industry repeated times. So there were several different forums by which they did that and that includes all of our industry, trucks, engines, etc. as well as truckers, the American Truck Associations, etc., were all asked for input over the writing of the rule, not just now that they are in the comment period. So I think there was a lot of industry involvement and to-ing and fro-ing before they got to the rule.

Another positive about the rule is that what we've got is several agencies who each could have taken a separate path actually working together on one rule. And that's the principle for if you're going to have regulation having one rule enforced one way is a huge benefit.

Second thing they did well is they have lead time between the time they are introducing the rule and the time it actually hits.

And third is that they are trying to get technology introduced that can both meet the standard and perform well for customers at reasonable cost. And so they are drawing in technology and they've got a couple of funding mechanisms through the DOE like the Super Truck program we talked about to push technology forward.

So those three elements I think make it on balance a relatively good regulation in terms of as regulations go. Now, we still have to read the details of the rule. They are just out for public comment. Reviewing those is a really important thing to do so we're going to do that in some detail and give comments as we see necessary. But in general, I would say that the process was relatively robust.

I would just add a couple of comments that this is one time where the end-user will benefit because they will get better fuel economy as opposed to earlier regulations. And Cummins has been really in the lead with the EPA in working this and we've supported this for the reasons that Tom talked about.

We were at the White House when the Memo of Understanding was signed between CARB, the DOT, and EPA, as were Navistar, Freightliner and Volvo, so the industry is supportive of it. But Tom's correct when he says that we need to see the details and we'll be working again closely with both EPA and CARB on it.

With regarding pre-buy, for the first level anyway I don't expect a significant pre-buy. I don't see significant technology changes involved. Again we need to read the rule in some detail; but based on the initial look I don't think that the first 2014 targets are likely to have a significant technology effect. So I don't see those necessarily driving a big pre-buy.

And I think for future levels, pre-buys are driven by either increases in cost or people being concerned about technology. So again the better the industry is at introducing proven technologies that are well field tested at reasonable cost, the better we'll do on reducing pre-buy.

And would this ruling benefit any of your businesses more than the other? Is there any competitive advantage whether it's SCR, EGR, or maybe even natural gas as we look past 2014?

What I'd say is that it's our view that Cummins is well positioned in the fuel efficiency technology market just as we were in the emissions technology. The kind of technologies that are relevant for our customers have huge overlap because you're really trading fuel efficiency against emissions. And so we do believe that our Components business, our Engine business are very well positioned to benefit when customers are looking for fuel economy leadership, so we do think that's a plus for Cummins.

Okay, I'll in the interest of time take the rest off line. Thanks.

I think that's all the time we have for questions today. I appreciate everyone dialing in and engaging us in our Q3 earnings call and look forward to talking to you out in the market during the fourth quarter. Thank you, everyone.

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a great day.