康明斯 (CMI) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2011 Cummins Inc. earnings conference call. My name is Jasmine, and I will be your coordinator for today. (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 for today, Mr. Mark Smith, Executive Director Investor Relations. Please proceed.

Thank you, Jasmine. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the third quarter of 2011. Participating with me today are our 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.

Before we start, please note that some of the information you will hear or will be given today will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs and intentions on strategies regarding the future. Our actual results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recent filed annual report on Form 10-K and any subsequently refiled quarterly reports on Form 10-Q.

During the course of this call, we will be discussing certain non-GAAP financial measures, and we will 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 are available on our website at www.cummins.com under the heading of Investor & Media.

With that out of the way, we will begin with our President and Chief Operating Officer, Tom Linebarger.

Good morning. I will start this morning by sharing some thoughts on our performance in the third quarter and our outlook for the remainder of the year. I will also update you on our long-term profitable growth plans. Pat will then provide greater detail in the quarter and our updated 2011 guidance.

We delivered strong results in the third quarter. We continued to generate good revenue growth and gross margins with incremental gross margins of 30% year over year. All four businesses delivered double-digit operating margins.

Sales for the third quarter of $4.6 billion were 36% higher than the same period in 2010. All four business segments reported higher sales, 11% terms by the Engine and Distribution segments, which increased sales by 43% and 37% respectively. The Components business also delivered very strong growth, up 32% year over year.

We report EBIT for the quarter of $640 million or 13.8% of sales in the third quarter. This represents an EBIT of 43% year over year. Importantly, we continue to grow profits faster than sales.

I would now like to make some comments about trends in our markets, starting with North America and then moving on to our international markets. Sales in North America increased 49% compared to the third quarter of 2010 with the Engine and Components businesses benefiting from the continued recovery in on-highway markets. North American shipments of heavy duty truck engines more than tripled, and engines from medium duty trucks increased by 92% compared to a year ago.

We have now shipped more than 163,000 heavy and medium duty engines with our SCR technology in North America. Our engines continue to perform extremely well in terms of fuel economy and reliability, delivering benefits for our customers and resulting in lower warranty costs.

For the North American heavy-duty truck market, we are still projecting a market size of 228,000 units for 2011, and we are confident, based on customer order trends, that we will achieve full-year market share between 35% and 40%, a little better than we projected last quarter.

We also experienced very strong growth in mining and oil and gas markets. The Engine business set a new record for shipments of mining engines this quarter, reporting a 95% increase in units year over year in North America. Our engine shipments to oil and gas customers increased by more than 170%.

Our Power Generation business experience revenue growth of 25% in North America, but that was against a weak comparison. As we discussed during our recent Analyst Day in New York, demand for our Power Generation products has leveled off in North America. In the third quarter, we saw only 2% growth in revenues compared to the second quarter. Order rates are stable at this time with strength in data centers and telecoms offsetting weakness in nonresidential construction.

Now I will make some comments about our international markets. Total Company revenues outside of North America grew 28% compared to the third quarter of 2010. During our second-quarter earnings call, I provided full-year revenue projections for our business in India, China and Brazil, and I would like to provide a further update today for these key markets.

As you aware, governments in India and China have been trying to manage inflation and have taken a number of measures, including increasing interest rates and tightening credits, to try to get inflation under control. The Reserve Bank of India recently implemented its 12th interest rate rise in the last 18 months, for example. Tightening monetary policy has had an impact on growth in both India and China, and as a result, we have seen some changes in our end markets since the second-quarter earnings call.

At our recent Analyst Day, I commented that we have started to see a slowing rate of growth in India, particularly in our Power Generation business. Typically our aggregate revenues for all businesses in India are seasonally the highest in the second quarter, and that will be the case this year. In Power Generation, however, order rates have clearly slowed the on seasonal patterns as concerns about a slowing growth rate have resulted in lower activity in commercial construction.

We have also had to adjust our revenue outlook due to the appreciation of the US dollar against the Indian rupee. From June to September, the dollar appreciated by more than 9% against the rupee, lowering our reported revenues from India. As a result of lower demand in our Power Generation business and the dollar appreciation against the rupee, we are now projecting total revenues from our Indian operations, including joint ventures to be $2.3 billion, down $100 million from our second-quarter guidance.

In China we now expect our total revenues, including joint ventures, to reach $3.7 billion, an increase of 19% over 2010, but down $100 million from our previous guidance, primarily due to lower demand in construction markets.

In construction markets, our OEM customers have lowered their forecasts for the remainder of the year due to uncertainty about the near-term pace of growth and in light of the recent credit tightening and government actions to cool the housing market.

In our second-quarter earnings call, we projected full-year unit sales for the excavator market would be 20% higher than 2010. We now expect the full year to be 10% higher than last year. We are confident that the market will turn to growth next year as the Chinese government moves forward with its plans to dramatically increase the number of affordable housing units across the country.

As we had predicted during our second-quarter earnings call, we saw a reduction in demand for truck engines at our Dongfeng Cummins joint venture in the third quarter as the Chinese truck market works through an inventory correction. Current customer forecasts indicate an improvement in truck engines sales in the fourth quarter, but slightly lower than we anticipated three months ago.

Power Generation revenues in China remain strong in the third quarter, growing more than 40% over last year. As we discussed last quarter, demand has grown due in large part to power shortages. We do expect demand to ease in the fourth quarter, though a little less than we had projected in our second-quarter call. Despite the revised outlook for India and China, we have enjoyed extremely strong rates of growth in both countries this year, and we remain very confident in the long-term growth prospects for our businesses in both countries.

We continue to have a very strong year in Brazil and other parts of Latin America. Our 2011 revenue projection of $1.8 billion, an increase of 38% year over year, is unchanged from our second-quarter guidance. In Brazil, starting next year, our business with MAN will undergo a long expected transition with MAN introducing its own D8 engine for its Volkswagen branded truck business, replacing our ISB engine for the Brazil market. And MAN will still use our ISB engine for lagging emission markets, for example Argentina.

At the same time, part of the MAN range of trucks and buses will for the first time be powered by our ISF 3.8L engine and our ISL 9L engine. All Cummins power trucks will use our SCR aftertreatment.

Our average annual revenues for the MAN business over the last two years have been approximately $380 million. Although revenues will drop by approximately $170 million next year, based on current projections, we expect to return to the current revenue run rates in 2013.

We continue to have an excellent relationship with MAN, and only last week Cummins was recognized by MAN as its best aftermarket supplier for the third straight year.

Naturally we spend a lot of time discussing our business in Brazil, China and India as these countries are a significant source of revenue today, and we have high expectations for future growth as we discussed in our Analyst Day.

We have also been investing in our capabilities in other emerging markets, which we believe offer long-term growth opportunities. We are gaining traction in several other high-growth regions. We are expanding our footprint and product offerings in Africa, Russia and the CIS and in Asia and Turkey, for example, and we are experiencing good revenue growth in each of these regions.

In Russia and the CIS, our third-quarter revenue grew 54% year over year, and our total sales, including joint ventures, will approach $600 million for 2011, driven in part by sales of the our ISF engine to GAZ, a leading light duty truck OEM in Russia. While we expect strong profitable growth in both developed and developing regions of the world over the next five years, we will no doubt experience periods of volatility in some of our markets. We are well prepared to deal effectively with this volatility. In 2008 and 2009, we clearly demonstrated our ability to take actions to reduce spending without compromising our growth plans. We will continue to monitor our end markets closely, and we will respond quickly and decisively when necessary.

We remain committed to our long-term targets of achieving $30 billion in revenue and an EBIT of 18% in 2015. Our products are performing very well. We are investing to maintain our technology leadership, we have unmatched global distribution network, and we have strong global partners. Moreover, we are investing to strengthen our global leadership position.

Last week we announced the formation of a joint venture with LiuGong, a Chinese construction equipment maker in China, to produce engines for the Chinese off-highway markets. This new venture is consistent with our strategy of establishing and growing partnerships with industry leaders in key growth markets. The joint venture will begin production in 2013, and we expect this business to generate significant future growth.

To summarize, we had a very strong quarter with revenues of 36% year over year and good incremental margins. We continue to invest in our business, to extend our market leadership position and drive future growth. 2011 will be a record year for the Company in terms of revenues, earnings and cash flow, and we remain highly confident in our profitable growth plans through 2015.

Now I will turn it over to Pat who will go through the financials in more detail and discuss our full-year guidance.

Thank you, Tom, and good morning, everyone.

Third-quarter revenues were $4.6 billion, an increase of 36% from a year ago and slightly below the record levels reported in the second quarter. Compared to the third quarter of 2010, the growth was driven by stronger demand for our products in the global mining, construction and oil and gas markets, as well as in the on-highway markets in North America and in Brazil.

Sequentially we continue to see strong demand from on-highway markets in North America and Brazil; however, these increases were offset by lower construction demand in China and lower Power Generation demand in India and in Latin America.

Gross margin for the quarter was 25.7% of sales. This level of gross margin represents strong improvement over the prior year due to better operating leverage from stronger volumes, improved price realization and lower warranty expense, which dropped to 2.1% of sales in the quarter.

Also, keep in mind that the gross margin in the third quarter of 2010 benefited by approximately 1% from a revenue base tax credit in Brazil. Excluding last year's one-time benefit, incremental gross margins were just over 30%. Compared to the second quarter, gross margins as a percent of sales were largely unchanged with benefits from the lower warranty expense being offset by higher commodity costs and increased operational costs, including premium freight, as we overcame some supply-chain issues and ensured all our customers' (inaudible) requirements were met.

Selling, admin and research and development costs were up 37% from the prior year and 5% sequentially. Research and development costs were only 60% higher than a year ago as we develop new products and continue to build on our technology leadership to ensure long-term profitable growth. Projects are underway to expand the product line, including both higher and lower displacement engines, new natural gas offerings, and new components, all of which will improve our competitiveness and open new markets for future growth.

Selling and admin expenses have also increased as we invest in our infrastructure and international distribution network to support future growth, as well as through the annual merit increases to our employees that went into effect in July. Joint venture income of $102 million represents an increase of 16% over the prior year, driven by strong mining and oil and gas markets in North America and industrial and Power Generation demand in China.

Compared to the second quarter, joint venture income decreased by 13% as expected, driven by the lower demand for truck engines in China.

Earnings before interest and tax were $640 million, an increase of 43% from the prior year and 9% lower than the record second-quarter performance. Incremental EBIT margins, excluding the one-time benefit from the revenue-based tax credit in Brazil in the third quarter of last year, were just over 18%. EBIT as a percent of sales reached 13.8% in the quarter compared to 13.2% a year ago and 15.2% in the prior quarter.

Net earnings were $452 million, up 60% from the third quarter of 2010, and earnings per share in the third quarter were $2.35, which includes a $0.15 favorable impact from discrete income tax items. This compares to $1.44 from a year ago.

Now let me provide some additional details on each of our operating segments. In the Engine segment, third-quarter sales were $3 billion, up 43% from the prior year and up 2% sequentially. Compared to the prior year, this increase was driven by stronger demand in the on-highway markets in North America and Latin America and in worldwide mining, oil and gas and construction markets. Sequentially both medium and heavy duty truck demand remains strong in North America, up 10% and 14% respectively.

We have also seen increased demand in global mining markets and in construction markets in North America and Europe, ahead of the Tier 4 off-highway emission change. However, these improvements were partially offset by a lower industrial demand in China and in India. Joint venture income decreased by 5% compared to the prior year and by 29% sequentially. The driver for both the year-over-year and sequential reduction is lower on-highway demand for truck engines in China as we discussed on the second-quarter teleconference.

Segment EBIT was $349 million or 11.8% of sales. This represents a 57% increase over the prior year and is down 7% from the record set in the second quarter. Year-over-year the benefits from better operating leverage and lower warranty expense were partially offset by an increase in commodity costs and higher SCR spending to support future growth initiatives, particularly in research and development.

Compared to the prior quarter, the benefits from reduced warranty were offset by higher commodity costs, increased SCR spending, and a lower contribution from joint ventures in the emerging markets, mainly China.

For the full year, compared to our previous guidance, we now expect a lower outlook for construction demand in China and lower stationary power demand in India. We now expect engine segment revenues will be up 40% over the prior year, and EBIT as a percent of revenue will be between 11.5% and 12.5% compared to last year's EBIT of 10.3%.

Moving on to the Power Gen segment, third-quarter revenues were $874 million, an increase of 10% over the prior year, but a reduction of 4% sequentially. Year-over-year improvement was driven by stronger demand in China, North America and Europe. Sequentially, however, we saw flat to lower demand in most regions. Modest increases in North America and the Middle East were offset by lower demand in India, Latin America and most of Europe.

Segment EBIT was $93 million or 10.5% of sales. This represents a reduction of 5% from the prior year and 12% from the prior quarter. Compared to the prior year, Power Gen benefited from improved volumes and a higher joint venture contribution. These improvements were offset by investments in SAR required to support future growth initiatives through extending the Power Gen product range in gen sets, alternators and other equipment.

Sequentially improvements in joint venture earnings in China were more than offset by lower volumes in other markets and higher SCR spending. Given the lower volumes in India, in particular, and some uncertainty in the developed markets, we are revising a full-year revenue and earnings outlook for the Power Gen segment. We now project revenue to be up 18% over the prior year, and EBIT as a percent of sales will be between 10.5% and 11.5% compared to last year's EBIT of 10.2%.

In the Components segment, third-quarter revenue was $1 billion, representing a 32% increase over the prior year and down 2% from the prior quarter. Compared to the prior year, all businesses experienced strong growth driven by higher demand in the on-highway markets in the US and stronger growth in the emerging markets.

Sequentially improvements driven by increased demand for on-highway markets in North America were offset by lower demand in Europe and China, as well as from the impact of the divestiture of the exhaust business.

Segment EBIT was $113 million or 11.1% of sales, up sharply from 8.2% of sales last year and slightly below the EBIT performance in the prior quarter. The year-over-year improvement was driven by strong operating leverage from increased EPA 10 volumes and operational improvements. Sequentially the reduction is the result of lower volumes, increased product coverage, and higher research and engineering expenses to support future growth.

Due to a revised truck market outlook in China and lower on-highway demand in Europe, we are revising our full-year revenue outlook for the Components segment. We are now forecasting revenue growth of 30% over the prior year, while EBIT as a percent of sales will be between 11% and 12% compared to last year's EBIT of 9.1%.

In the Distribution segment, third-quarter revenue was $783 million, an increase of 37% over the prior year and in line with the prior quarter. Year-over-year growth was driven by mining and oil and gas markets in North America, Power Generation demand in Asia, and industrial demand ahead of the Tier 4 emission change in North America and in Europe.

Sequentially growth in parts and service revenue offset lower demand for August. Segment EBIT margin was $104 million or 13.3% of sales. This compares to 12.9% in the previous year and 13.5% in the prior quarter. Compared to last year, this improved profitability is the result of higher sales and increased joint venture income. Sequentially the benefits from higher aftermarket sales were offset by selling and general expenses as we continue to invest in our distribution network globally, including Africa as we previously discussed.

For the full year, we are projecting revenue growth of 30% over the prior year and EBIT of 13% to 14% of sales compared to last year's EBIT of 12.8%.

So for the Company, as a result of the lower near-term outlook in India and China and the recent appreciation of the US dollar against several currencies, we are now projecting 2011 full-year consolidated sales to be between $17.5 billion and $18 billion. This still represents more than 30% growth over the prior year. EBIT will increase by more than 50% from last year and as a percent of sales will be in the range of 14% to 14.5%, up from 12.5% last year with every business segment growing its profits at a faster rate than sales.

This guidance excludes the impact of the Exhaust business transaction in the second quarter and the light duty filtration transaction which is expected to close in the fourth quarter. Also, in October the Company collected $40 million as the final settlement of a 2008 flood claim. This will be reported in the fourth-quarter results, but it is also excluded from our full-year guidance.

The full-year forecast for the effective tax rate is 29.5%, excluding discrete items. Including discrete items, the rate will be 28%.

Before I turn it over to Tim, let me say a few words about cash flow and the balance sheet. Cash from operations through the first three quarters of the year is just under $1.4 billion, already surpassing our best ever year. Our working capital metrics continue to improve, and working capital as a percent of sales is now below 18% compared to over 20% this time last year.

Our pensions remain well-funded, and year-to-date we have invested $377 million in capital expenditure projects, and we are on track to invest a total of $600 million to $650 million for the full year.

During the third quarter, the Company increased its dividend by 52% and re-purchased an additional 1.9 million shares of our common stock. This brings our year-to-date repurchases to 5.4 million shares at a total cost of $546 million, resulting in a reduction in our outstanding share count of almost 2%. And our debt to capital position at the end of September was 12.6%.

As evidence of the Company's strong balance sheet and improved financial performance, our credit rating was recently increased by Standard & Poor's to single A. This is the highest level we have been since the late 1970s and follows a similar update by Fitch at the end of June.

And with regards to next year, we are in the process of developing a 2012 annual operating plan. As we discussed at our Investor Day back in September, there is uncertainty in macroeconomic conditions, but as you just heard from Tom, we will be prepared to deal with it. 2012 will be a good year, and consistent with prior years, we will provide 2012 guidance during the fourth-quarter earnings teleconference.

Now before we open the call to your questions, let me turn it over to Tim.

Thank you, Pat, and good morning, everyone.

As most of you are aware, this is the last quarterly teleconference before my retirement at the end of the year. I will step down as Chairman and CEO of Cummins on December 31, leaving the Company in the very capable hands of Tom Linebarger and his outstanding team. This leadership transition, only the fifth in the Company's 94-year history, was announced in early June and has been proceeding seamlessly since then.

Succession planning and leadership development are a key part of a CEO's responsibility. Years ago the Board and I recognized in Tom the qualities needed to lead this Company into the future. He is smart and energetic. He has the business know-how needed to help Cummins succeed in today's highly competitive global marketplace. His many and varied experiences at Cummins have contributed to the breadth of his leadership skills. He lives the Company's values and is a man of character and integrity.

Tom has played an integral role in helping shape Cummins into the Company it is today. He was instrumental in creating our key strategies in the early part of last decade. He helped the Company through the downturn at the start of 2000 as the CFO and led the turnaround of the Power Generation business during that same timeframe.

He has significant international experience. At the beginning of the recent recession, Tom, Pat and the team took decisive steps in the face of rapidly declining markets. His quick actions helped us remain profitable during the global decline and led to a record year in 2010.

I am a big fan, not only of Tom but of this leadership group. Tom has built a talented, committed team that is the best I have seen in my 40 years with Cummins. I am confident that they will take the Company to new heights of performance and global leadership.

We have had some remarkable success over the last 10 years. The Company has undergone a transformation becoming less cyclical, more diversified and more focused on results and expanding profits. Today I believe we are better positioned for growth than ever before. Our record results this year, despite all the uncertainty in the world, say a lot about the performance culture at Cummins.

You have heard us talk about macro trends that play to our strengths, including emissions standards around the world, globalization, infrastructure investment and the price and availability of energy. To take advantage of those trends and building on our industry-leading technology, we have many new products in our pipeline. Our position in emerging markets is second to none, and we have a foothold in promising locations such as Southeast Asia and Africa. We are investing in our distribution network to drive further improvements in customer service because we know how critical it is to take care of our customers' needs every time, on time, and in a consistent way around the world.

We are also focused on enhancing our supply-chain capabilities to improve cost, quality and customer responsiveness and there is more. As you can tell, I am very excited about the future of this Company.

I have enjoyed my career at Cummins every day and have had a lot of fun. I am passionate about our success and humbled by the opportunity to serve the Company for more than four decades. I want to thank all of you for your interest in Cummins, and I wish you all the best.

Okay. I think we are ready for Q&A now. If we can limit our questions to one question each and one related follow-up and then rejoin the queue if you have further questions.

(Operator Instructions). Adam Uhlman, Cleveland Research.

Congratulations, again, Tim, on the retirement. First, to start off here, could we dig into the joint venture income for the quarter and the outlook for the year and maybe provide some details on what you saw at DCEC and how that is expected to trend going into the fourth quarter?

Yes, so joint venture income came in pretty much exactly where we expected it to be for the third quarter. On the second-quarter call, you heard Tom and Mark talk about their expectation for a slowdown in the China truck market in the third quarter, and that really impacts our DCEC joint venture. And it played out almost exactly the way they had talked about it.

We ended up building around 46,000 engines at DCEC in the quarter. That was down from over 60,000 in the first and second quarters. We are expecting to see some improvement as we go into the fourth quarter, but I will not get back up to the 60,000 units per quarter this year. So we will see some improvement in Q4, but not back to the levels that we enjoyed in the first half of the year.

Other than that, join venture income is right on guidance that we gave back in July, and it will not change this time around.

Got it. Great. Thanks. And then can you talk about the order booking trends in the Power Gen business, maybe some more specifics on what you are seeing over in China and India? China sounds a little bit better than what you were talking about before.

This is Tom. In China we had some strength in the last couple of quarters because power demand exceeded supply. So the country was short on power. Factories were being asked to get off the power grid for days or parts of days.

And so what we saw was an increase in orders, especially for large generator sets which serve as factory backup in that kind of case. And, indeed, that helped our demand in Q2 and Q3. And we -- everyone had expected as the summer season comes to an end and demands softens and power grid catches up, that Q4 would be not as strong, and indeed, that is what we expect.

The difference I made in my remarks is that the easing has taken more time than expected. So, in other words, more people are still ordering gen sets, and we don't have a clear view as to exactly why that is. It seems as if people are still concerned about power shortages. So we expect easing. It is just that the market is staying a little bit up from what we expected.

In India, on the other hand, the continued struggle the government has had with inflation control has meant that construction markets have really taken a hit, and therefore, Power Generation demand is, indeed, even softer than we anticipated. We expected a hit when we talked in the second quarter in the Analyst Day, but, in fact, that hit has been even more as the construction markets have been hit by the government's tight monetary policy.

Right now the government is still trying to get inflation under control. Weakening commodity prices would serve them well, and I talked about that in the Analyst Day. If we get some softening in commodity prices, that will help India, and that will, of course, help them and let them loosen some of their monetary policy and improve construction markets there.

Andrew Kaplowitz, Barclays Capital.

This is Vlad Bystricky for Andy. You guys talked about strong demand in both Brazil on-highway and industrial engines ahead of the Tier 4 change coming next year. Are you anticipating at this point a large drop-off in those businesses next year?

Well, of course, right now we are not giving specific guidance, but I think certainly for Brazil every on-highway emissions change we do see a period of correction after the emissions change.

What we said on the last call is we felt we were going to see about a prebuy of about 10,000 units this year. That has actually moderated in the second half, and we see maybe a prebuy of about 5000 units. So I think there will be some easing earlier in the year. Of course, we are getting more content with the emissions change, which we benefit from with our emissions solution business and the introduction of SCR as well.

And then the Tier 4, that is particularly on the small end equipment below 174 horsepower. We are seeing a little bit in Europe and a little bit in the US. That's not a huge revenue driver for us. I think we are thinking about 6000 units of prebuy, but pretty low average selling price relative compared to our average business.

Great. Thanks. And then just one quick follow-up. On the emerging markets, in particular China and India, can you talk just a little bit about the cadence through the quarter and whether those markets continue to weaken or whether you are starting to see signs of stabilization, particularly on trucks in China and the India power demand?

Let me start with that, and then Tom can jump in. I think in the top market, as I said when I was answering the question from Adam, we are seeing some small improvement in demand as we go into the fourth quarter, not terribly significant yet, but it is showing better signs. Construction is deteriorating. So, the third quarter was lower than what we had anticipated when we gave second-quarter guidance, and the fourth quarter is turning out to be a softer quarter, again, than what third quarter tended to be.

Power Gen, although it did come down, is coming down in the fourth quarter, it is probably going to end up better than what we anticipated. So they are the three big markets.

Tom, do you want to add anything?

Well, I would just add, Tim and I and Pat were all in China last week, and we got to see a lot of this stuff firsthand and talk to a number of OEMs. Definitely while things have softened some in the second half, optimism is still very high for next year. We have given you guys a lot of detail on how things have come off a little bit, $100 million or so from what we thought in the second quarter.

But what we see still is very, very strong markets. I mean excavator markets, despite a really, really bad year in relative terms, will still be up 10% year over year, and most of the people we talked to expected them to be up next year again as a result of this big move the Chinese government is making to add affordable housing units.

Similarly, with the truck market, there was a pretty significant inventory correction, and most people are projecting the truck market to, again, increase next year.

So, again, we are very optimistic about the market, and it is just a question of at what rate things return, at what rate does the government start to let off some of its tightening policies. So, again, we really don't know the answer to that, but what we expect is that it is a relatively short period, and we will start to see growth again.

And we have experienced terrific growth in demand for our products in China. The revenue this year we include our joint ventures, as Tom said, is going to be around $3.7 billion. That is double what it was two years ago. So we are seeing this kind of near-term, short-term slowdown in some markets. But there is no question at all China is the right place for us to be longer-term.

And our next steps is that we are -- we have just announced this LiuGong joint venture which expands our presence into off-highway and will create growth in 2013, and we are still talking with other partners about expanding existing joint ventures into new areas for further growth. So we have quite a bit of growth left to go even beyond the economic growth forecasted for China.

Stephen Volkmann, Jefferies & Co.

Tom, in your prepared comments, you talked about being more flexible and being able to respond if market conditions were kind of weaker. I guess I wonder if we are at that point. I think you were quoted recently as talking about how the US and Europe might already be in recession, and I just wonder if you guys are doing anything at Cummins to batten down the hatches for a tougher environment going forward?

Yes, Steve, I appreciate you bringing up that article. (multiple speakers) As you guessed, I regretted that interview.

Just for what it is worth, my view in that interview was exactly the same view I gave in the Analyst Day of, we really just don't know where the markets are going. There is a fair bit of volatility, especially in Europe and the US as to what is going to happen, and that is exactly where we remain today, and I feel like things have not changed there. And we are, as a result of that, tightening some spending. So we are reducing some discretionary spending areas to say where we can cut back, we are. We are making sure that we are keeping all our growth plans in place. We are not doing anything dramatic, but we are reducing discretionary spend wherever we can. We have reduced hiring rates, and we will continue to do that for a while until we just understand what the next steps for these markets are. We are kind of in that period of wondering how long the low growth period goes and what happens in China and India with regard to them coming back to growth. So we are acting now, but it is not a huge change. It is just taking a look at every place we can cut back pretty easily.

So, as we model the Company, should I be thinking about SG&A down a little bit or CapEx down a little bit, or is it just going to be more of a rounding below the surface?

Well, I think, again, we don't want to get ahead of ourselves on guidance for next year, so give us time to put together the whole plan, and we will give you a really good view of it. But what you should expect from us is that we will continue to look at markets to say where we think it is time to make significant moves, we will, and we will not hesitate. Right now we're in that mode of saying discretionary spending we are going to slow down, hiring we are going to slow down, but we are going to keep driving on growth.

So I guess what that tells you, we are still expecting to invest in our growth initiatives completely because we still think the most likely case is a slow growth period for a period of time and then returning to growth, and so that is what we are basically planning on.

Let me remind you of -- this is Tim -- the 2008 and 2009. In the fourth quarter of 2008, in October the sales fell off between 25% and 60%. Tom and the team were able to reduce spending and headcount as early as December, and we still earned 2.4% EBIT in that quarter, and each quarter in 2009 sequentially got better. We took a second round in January, and Power Generation acted at the end of the first quarter. So, if we have some kind of issue, and I don't think it will be anywhere near what we saw in the '08 timeframe, I think we have demonstrated that we can act in a very quick period of time when the spending is aside.

But I think to that point, Steve, we do not see this period as like that one yet. I mean it does not mean it can't be, but we just don't see it that way. And we kind of see it the same way we laid out in the Analyst Day, which is that it looks like the most likely case is slow growth and that the inflation and monetary tightening that is going on in China and India will ease over some period of time, and we will see growth in both those economies. That is what we think the most likely case is.

Great. That is helpful. And just final on that one is, does it change your view of capital allocation, uses of cash here? I will leave it there.

No, it does not change at all, Steve.

Jamie Cook, Credit Suisse.

I will refrain from The Financial Times article, but I guess I just wonder why -- I don't know, it seems to me like at some point -- I guess I wonder why we did not pre-announce the quarter or the earnings? Because it does sound like there was a change in tone from the Analyst Day versus The Financial Times article. So, one, if you could address that?

And then my second question is, I'm just thinking about your longer-term targets that you gave at the Analyst Day. I think to achieve your long-term targets, you had to sort of think about get to about a 20% incremental margin, and it sounds like we are going to be about that range in 2011 based on your new guidance. So I'm just trying to think longer-term just given where we are in the cycle how you continue to put up that 20% margin, incremental margin, the puts and takes of how we get there.

Again, just going back to the same point, my tone did not change at all. What the guy chose to write about was what he wanted to right about. So I gave him the same balanced view that I gave the analysts about me not knowing where things were going to go and where things were going, and there is a chance that we were already there, and there is a chance that we are going to have slow growth, and there is a chance that it would snap back quickly, and my most likely case was it was slow growth. And he printed what he printed. So -- I had no new information then about anything that I had when I talked to you guys.

And, by the way, I still don't have a better view of it even today. What we have a better view of, as we talked about, was what happened in the third quarter. That is it. The rest of the economic outlook I don't have any better outlook than I had back in the Analyst Day.

So, and our view on incremental margins, as you know, that is the whole -- I mean, that is exactly what we are building our whole set of strategies and plans around is where can we leverage our partnerships, our distribution network, our technology leadership to drive growth that yields incremental margins in line with our plans. That is the whole point of it. And what we are trying to do is find those places where the technology we bring to bear provides enough value to our partners that we can earn that kind of incremental margins.

The second thing we are doing is we're just trying to make sure that we are always thinking about costs in everything we do. It is how we develop the technology, so how we partner to do it, how we do it ourselves, how we set up our manufacturing plants and drive them for productivity. So all those elements are how we are going to do it. And, again, it is -- that is pretty much what we focus on everyday. I don't know what else to say about it.

But it does not sound like just -- and I know we are in the early stages -- it does not sound like or maybe this question is better addressed to Pat -- there is any big headwinds, structural headwinds we should think about in 2012 that would suggest that incremental margins would be below that level? (multiple speakers) As we -- I don't know what it could be, but I mean there's no big things out there that we should just be aware of without you giving formal guidance for 2012.

So, again, we are not giving formal guidance. You are absolutely right. There are no significant major headwinds coming our way that we can see causing us problems in 2012.

Jerry Revich, Goldman Sachs.

Tom, can you talk about the extent to which you are under-producing on-demand in China construction and truck markets in the third and fourth quarter? I guess the $100 million sequential decline in industrial engine sales next quarter, despite the Tier 4 prebuy, suggests a pretty sharp cut?

Well, I think firstly, of course -- the excavator market, we sell the largest market in China. We are importing those engines as a demand, so those are -- while it is a very important market, they are part of broader manufacturing operations in our developed markets. So I think generally our volumes are quite good in our plants.

I think in China clearly the truck was down. It was in line with our expectations, and we expect some improvement in Q4. So I don't think -- that is not a major concern. We are not changing our capacity investments for the long-term as we have talked about, so not significant.

And just to that point, one of the places that we visited was DCEC, and they have been flat out out of capacity for some time now. And, as you know, we are adding some capacity in the fourth quarter here. In fact, the building is up, and the machines are going in. And we can really use it.

So DCEC, which is not a significant contributor to the excavator market, as Mark said, that is not where we are producing most of the excavator engines. We are importing those. But, from a truck point of view, we still foresee the need for more capacity at DCEC, and it is evident when you go there. It is not that they could not produce more in the third quarter. Obviously they could because they produced in the second quarter. But to get there, they will work in three shifts. The place was running just too tight. And so our view is that the incremental capacity we are adding is needed and will be used up very quickly.

I appreciate that. Where I was going with the question is, typically your customers cut their inventories of engines during adjustment periods like this. So I'm just trying to understand whether shipments coming into their doors are well below truck or excavator shipments that are coming out in 3Q and 4Q?

I think in the truck side that things are balanced out a lot better than they were. So, as you know, in China we had a pretty strong finished goods inventory at dealers for a period. Then the production of trucks backed off, and then that drove back into the engine production. And I think at this point now we are starting to see retail demand pick up, inventories are relatively level, truck production is relatively in line with retail sales, and now engines are getting there, too.

So, on the truck side at least, I think things are getting pretty balanced out after a couple of quarters of supply chain movements back and forth.

On the excavator side, I just don't have as much insight into that. I don't know, Pat, if you have any. I don't have a good answer for your question, so we will have to follow up with you on that.

Appreciate it, Tom. Can you talk about when you expect China to implement National 4 standards and touch on whether you have signed up any engine makers in China or Brazil to use your aftertreatment systems on the new Euro V and National 4 standards respectively?

Yes, addressing the first question, on NS4, there is not a date published yet for when they are going to do it. I mean the only date that exists is the first of the year, which is the one -- the first of 2012, which is the one that they originally sent down. Most market participants do not expect them at least to be implemented and enforced on that date. Most people think it will be sometime in the middle of the year or the end of the year as the most likely case, and to the degree to which it will be phased in across regions of the country, it is all basically supposition at this point. There's lots of rumors and lots of people's opinions about it.

What we are doing as Cummins is we are ready for all those outcomes. So we have got products ready to supply our customers that meet the existing standards, that will meet the new standards, so we are ready to go on whatever happens. So we just don't know, though, exactly how it is going to be implemented, and we, of course, voice our opinion with the regulators whenever we can about the importance of having a firmer introduction schedule and about sooner is better. But we will see what it is going to be.

On CES, Pat, any comments on CES implementation in Brazil? I don't have any on Brazil. In China the NS4 standard is when we would begin to produce aftertreatment devices. So we don't have any sales of aftertreatment devices yet, and we will not until Euro IV starts. But on Brazil I don't have --

Other than we have already said on the MAN and the new vehicles, all Cummins (multiple speakers) we are not able to say a lot -- (multiple speakers)

For non-Cummins engines, we don't have any comment on that.

David Raso, ISI Group.

Obviously the key to your stock is one's view on the emerging markets. I just wanted to get from your qualitative comments before, not trying to get 2012 guidance from you, but the industrial business next quarter will be down year over year and Power Gen as well. I mean principally from the emerging markets being lower.

But, from all of your qualitative comments, I mean if you were looking at 2012 when we were trying to model the quarters out in 2012, it sounds like you are thinking those businesses return to positive growth in the not-too-distant future? Just so I kind of get an idea how you are benchmarking that emerging markets exposure in 2012, when do you see those businesses returning to positive growth year over year? And this is industrial and Power Gen.

David, I thought you would say that the key to our stock was great leadership, so I'm a little disappointed with that.

That is a given, Tom.

But the idea of -- I think the problem with answering your question is I think it just ends up us giving guidance. Again, let me just go back to what I can say about it, which is that in both cases we see the underlying fundamentals of China and India and Brazil to be incredibly strong, and those views have not changed.

What we had in China and India's case is the government acting to reduce inflation and basically restricting money supply or tightening credit policies, and both governments are trying to balance the need for inflation control with economic growth. Our view is that they will manage that back to economic growth when they think they have struck that balance. But, again, the underlying drivers, the underlying fundamentals of both countries are incredibly strong, and we are well positioned in each of the markets to capture the growth. That will underpin our 2012 strategy and beyond that, too. So, again, beyond that, I think anything else I would say is the same as giving guidance.

I guess structurally if I think about the JV exposure to emerging markets, obviously it is huge in engines, huge in Power Gen, pretty big in components as well. You can back into the margins. Obviously you have been making a healthy margin in those markets on the JVs. Can you help us on the consolidated emerging market exposure? All right? It is roughly 30% engines, 50% or so in Power Gen. Are the margins selling in the consolidated business into emerging markets similar to the read we can get from the JV income? Like how would you bogey that versus, say, Company average?

The margins -- first of all, Power Gen is not a big JV business, just to correct your first intro.

No, I mean of what they have --

Very little is in JV. (multiple speakers)

What they have that is heavily [EM].

Right. So, on the consolidated side, the point is margins for those are all basically a function of how much leadership position we have in the markets and how strong our products are relative to competitors. It is not a function of JVs or consolidated. So there is not a good way to answer your question by that split. There is not a good way to answer our margins by size of product or by country. In each case, if we have a leadership position, we have good products that are leading the market. We end up with quite good margins where we are still developing a leadership position or a smaller share than margins are tighter. That is the better way to think of it. And so JVs and consolidated don't help you much in terms of trying to figure out where margins are higher or lower.

Just one other thing I would say, I don't agree that broadly we are going to be down year over year in the fourth quarter in all of our segments. In fact, that is not what is really implied in our numbers.

No. If I did not say it clearly, it is the implied industrial revenues are down 11% year over year in the fourth quarter and down 4% year over year in Power Gen being driven by some of the emerging markets weakness. So I'm just trying to handicap where your head is on 2012 for the emerging markets from the qualitative comments.

All right. I just did not want to leave people with the impression that we are ending Q4 with all of our markets in China down year over year. We can talk some more -- (multiple speakers)

Andrew Casey, Wells Fargo Securities.

Good luck, Tim. It has really been a pleasure working with you.

A couple of questions. First, on the expected 2012 MAN Brazil-related revenue, 54% decrease, should we view that as heavily first-half weighted?

Yes, I -- it is not going to be only first half. Really what is happening there is that they are bringing their own engine to Brazil to put in the VW truck for the one displacement, the one engine. And then we have been working with MAN now for some time to introduce our smaller and larger engine into their trucks.

And the good news for us is that the trend in the market is to move up in horsepower. So that over time will benefit us being in a larger displacement engine. But the substitute rate and what happens with the prebuy and after that, all of that is stuff that we just don't know the answer to. Right? How quickly will people buy the larger displacement? How well will the small engine take off? How well will their launch go on their engine, and then what happens with the prebuy? There is a whole bunch of variables to figure out with regard to the quarter. All we wanted to make sure people knew is it is a transition that we have been working with them for some time. We feel very good about our relationship with them. We feel excited about putting these new engines in there, and so we will be supporting them throughout their truck range still.

And then if we could go back to the European truck comments I believe you made in the monologue, we have been hearing varying things from the OEMs over there. Could you comment on range of magnitude you expect Q4 truck production to be down, and are you seeing that as uniform by customer?

So I think we have seen a modest decline in the second half of our forecast, maybe 3% or 4% really in on-highway volumes. Of course, it is not the largest market for us, but we do have turbo, the components business and some on-highway engines. So it is modest in terms of what our customers are telling us for the second half of the year versus what we saw in July.

Okay. Thanks. And then one last one. Are you seeing any sort of weakness other than some of the truck comments made by adjacent customers to you in the Middle East? Is there anything going on with Power Gen or oil and gas?

Middle East Power Gen has definitely fallen some. So that, in addition to comments you heard, we have definitely seen Power Gen orders in the Middle East tail off. I was there not too long ago, and there still is quite a bit of activity in construction going in the Middle East. So I do think we are still in a lull, but I still think the underlying trends are for significant expansion of infrastructure. So we are seeing Power Gen slow down. I think a whole bunch of construction projects in Dubai went on hold and have stayed on hold ever since, which took a whole bunch of demand out of the market. But if you just go over the adjacent emirates, go over to Abu Dhabi, you see construction projects starting back up again. Saudi Arabia has got significant construction. Qatar has got significant construction. So, again, our view is we are seeing a lull, but we are likely to see growth, again, take off provided oil prices stay relatively high.

Okay. And I think we are out of time now. So I will be available for your calls later. So I look forward to continuing our discussions.

Thank you.

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