康明斯 (CMI) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2012 Cummins Inc. earnings conference call. My name is Jasmine and I will be your coordinator for today.

At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to our host for today's conference, Mr. Mark A. Smith, Executive Director, Investor Relations. You may begin.

Thank you, Jasmine. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the second quarter of 2012.

Participating with me today are Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; and President of our Engine business, Rich Freeland. 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 be given today will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934. Such statements express our forecast expectations, hopes, beliefs, and intentions on strategies regarding the future.

Our actual future 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 recently filed annual report and on Form 10-K and any subsequently filed quarterly reports on Form 10-Q.

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 are available on our website at www.Cummins.com under the heading of Investors and Media. With that out of the way we will begin with our Chairman and CEO, Tom Linebarger.

Thank you, Mark. Good morning, everyone. I will summarize our second-quarter results and talk about our key markets. Pat will then take you through more details of our second-quarter performance and provide an update on our full-year guidance.

We delivered strong profitability in the second quarter despite the challenging economic environment and continued investment in new products and growth initiatives. Revenues for the second quarter were $4.45 billion, a decrease of 4% from the second quarter of 2011. Excluding the impact of currency movements and divestitures, revenues were flat year over year.

Second-quarter EBIT was $663 million, a decrease of $44 million, or 6%, compared to the second quarter of 2011, excluding gains related to business divestitures. EBIT percent for the quarter was 14.9%, the second highest in the Company's history. Gross margin at 27.2% set a new record for the Company, reflecting continued progress in driving productivity and lowering product coverage costs.

For the second half of 2012 revenues increased by 5% -- sorry, for the first half of 2012 revenues increased by 5% over last year and our EBIT percent increase from 14.6% to 14.8%. We delivered incremental EBIT margins of 19.4%, very close to our long-term targets despite the lower than anticipated revenue growth.

As previously announced, we now expect full-year revenues to be flat with 2011, a reduction from our previous guidance of 10% growth in revenues. Continued weakness in some international markets, particularly in Brazil and China, coupled with slowing orders in US truck, oil and gas, and power generation have caused us to lower our outlook. I will talk further about our outlook for a number of these markets, and we have included a supplementary slide in today's earnings release presentation that quantifies the change in revenue guidance by business segment and by market.

We expect to deliver EBIT margins in the range of 14.25% to 14.75% for 2012, a decrease in our full-year guidance of 0.25 points, but continuing our trend of increasing profitability year over year.

In the second quarter we continued to experience year-over-year growth in North America offset by weakness in a number of international markets. Although our revenues in North America increased, the rate of growth has slowed recently. Our second-quarter revenues grew in North America by 12%, significantly lower than the 40% growth we experienced in the first quarter.

In the North American heavy-duty truck market our engine shipments increased by 13% compared to the second quarter last year. Order rates have slowed recently and we are now lowering our full-year market size expectation to 260,000 units. Growth of 14% compared to 2011, but down from our previous forecast of 278,000 units. We expect to achieve full-year market share of 40%, unchanged from our previous guidance.

Orders in the North American medium-duty truck market have also softened, and we are lowering our market size estimate to 104,000 units from 117,000 units. We continue to expect our market share to exceed 50% for the full year in this market.

Our North American on-highway products continue to perform very well in the market. We are very pleased with the reliability of these products as evidenced by our product coverage costs, which declined again this year, and by the performance and fuel economy demonstrated by our engines in operation.

We have now shipped more than 300,000 engines equipped with our SCR technology and the market feedback has been overwhelmingly positive. Our market share has grown in both heavy- and medium-duty truck and bus markets in the last 12 months.

Also in North America, demand from Chrysler for the Dodge Ram truck remains strong. Our shipments increased 23% in the second quarter and we still expect full-year shipments to increase by 30%.

In the North American construction market we experienced strong demand in the second quarter where engine shipments increased 23% year over year. On the other hand, demand in the oil and gas market in North America has continued to decline as natural gas prices have remained low. Unit shipments declined by 32% in the quarter and we now expect full-year demand to decline by 41% compared to 2011, a change from our previous guidance of a decline of just under 20%.

In mining, our unit shipments declined 6% year over year in North America due to lower orders from the coal industry. Globally strong aftermarket revenues contributed to revenue growth in the mining market year over year.

In our Power Generation business we recorded growth of 23% year over year in North America. Unfortunately, we saw the rate of new orders decrease starting in April. Although we have seen some signs of improvement in orders in July, we lowered our expectation for full-year growth to 15% from our previous guidance of 20%. Approximately two-thirds of our Power Generation growth in North America this year is coming from new products rather than underlying market growth.

In the international markets our consolidated revenues declined by 16% year over year, with the most significant declines experienced in China and Brazil. In China, our domestic revenues across all end-markets, including the revenues of our joint ventures, declined 25% year over year in the second quarter. The most significant decline was in the construction market with our revenues down 55%.

The second quarter of 2011 was an extremely strong quarter for this market and this represents the toughest quarterly comparison for the year. Having said that, demand across the industry remains weak as the rate of GDP growth has slowed causing a reduction in investment, both in infrastructure and private residential construction. We have now lowered our full-year expectation for industry wide excavator sales to down 35% from our previous forecast of down 15%.

Our production will run below industry sales as OEMs lower their existing inventory levels. Although the Chinese government has taken steps to stimulate growth, the steps taken so far have been less significant than previous programs and have not been targeted specifically at improving short-term demand in the markets that we serve. As a result, we no longer expect any improvement in demand in the second half of the year.

The outlook for the truck market in China has also weakened as overall growth in the economy has slowed. We now expect the market, heavy- and medium-duty combined, to decline by 17% compared to our previous forecast of a decline of 10%. Second-quarter engine revenues were down 29% year over year with volumes marginally higher than the first quarter.

Truck volumes will be lower in the second half of the year than the first with the third quarter expected to be the weakest quarter of the year.

In the Power Generation market we are also lowering our expectations for 2012 in China. In aggregate, the Chinese economy experienced zero growth in electricity consumption in the second quarter due to the slowdown in industrial activity.

Second-quarter revenues, including joint ventures, declined by 17% from a very strong quarter in 2011. We now expect full-year revenues to decline 5% compared to our previous expectation that revenues would be flat. We expect our domestic revenues in China across all end-markets and including joint ventures to decline by 13% compared to our previous expectation of a decline of 5%. Decreased demand for construction and truck engines will be partially offset by stronger aftermarket sales and increased sales of light-duty truck engines.

In India the economy has also slowed. First-quarter GDP was 5.3%. It was the lowest recorded in nine years. Revenues, including joint ventures, declined by 4% compared to the second quarter of 2011.

In the truck market industry wide sales declined sharply in June with Tata and other OEMs taking shutdowns as they lowered their build rates. Second-quarter production volumes at our Tata Cummins joint venture declined by 35% year over year. We now expect industry sales in the Indian truck market to decline by 8% compared to our previous assumption of 7% growth. Declining confidence in the economy, coupled with the addition of a new excise tax on commercial vehicles, is driving our lower outlook.

In the Power Generation market demand continues to be driven by power shortages in India despite weaker economic growth. Shortages have been experienced in a number of regions in the country, increasing demand for our lower horsepower products. Demand for high horsepower products, typically more linked to general infrastructure and economic growth, weakened in the quarter.

In total we expect revenues in rupees to increase 16% year over year, but revenues reported in US dollars are now expected to decline by 1% due to the devaluation of the rupee. Previously we had expected our revenues in dollar terms to increase by 10%.

In Latin America our revenues this year continue to be impacted by the difficult transition to the Euro 5 emission standard in the Brazilian truck market. Unfortunately, the economy in Brazil has also slowed. For the full year we now expect our total revenues in Latin America to be $1.5 billion, a decline of 17% year over year compared to our previous expectation of a decline of 6%.

A lower outlook in the Brazilian truck market coupled with lower demand for power generation in a number of markets in the region, including Brazil and Argentina, is driving the lower outlook. We now expect industry sales in the truck market to decline by 33% compared to our previous expectation of a decline of 19%. Truck prices increased approximately 15% with the implementation of Euro 5 at a time when the Brazilian economy faltered, consequently demand for new trucks has been very weak.

Through the first five months of this year less than 6,000 Euro 5 trucks have been sold to end-users industry wide. Despite truck OEMs lowering build rates, Euro 5 truck inventory across the industry built up to approximately 39,000 units at the end of May due to the weak level of retail sales. We expect that it will take some time for sales to recover enough to reduce inventories and justify a significant increase in industry build rates.

Although we anticipate a difficult start to the year, retail sales of Euro 5 trucks have been much weaker than most participants expected.

In Europe, on-highway demand has largely trended as we expected with full-year forecast lowered modestly. Power Generation sales were down 22% year over year as demand clearly weakened in the second quarter across most major countries.

As I discussed during the first-quarter call, our power generation business got off to a slow start in Africa and the Middle East. Importantly, our business improved in the second quarter in both regions. In Africa second-quarter revenues increased 72% year over year and revenues in the Middle East increased 24%.

Clearly, we are experiencing challenging conditions in a number of markets. We are confident that in time demand in Brazil, China, and India will improve and these markets will continue to offer higher growth opportunities than in developed markets. Higher rates of GDP, rising income levels, increasing investment in infrastructure, and societal demands to improve air quality will all improve our business.

Despite the weaker economic outlook, we are pleased with our performance in expanding gross margins and continuing to deliver strong profitability. We've taken actions to manage our costs. We remain confident in our long-term prospects as evidenced by the recent announced increase in our dividend.

Our future growth will continue to be driven by the four key macroeconomic trends driving our industry -- increasingly the global emissions standards, the price and availability of energy, globalization, and increased investment in infrastructure, particularly in the developing economies. We will continue to invest in our growth programs to ensure that we benefit from these trends.

Thank you for your interest today and now I'll turn it over to Pat.

Thank you, Tom, and good morning, everyone. Second-quarter revenues were $4.45 billion, a decrease of 4% from a year ago. Sales in North America were up 12% over the prior year driven by strong demand from on-highway and construction markets, while outside of North America sales were down 16% as a result of weaker demand in several markets, most notably China, Brazil, and Europe.

Compared to the first quarter sales were flat. We experienced lower demand in the heavy- and medium-duty truck markets in North America and Brazil and the construction markets in China offset by higher revenues in Power Generation with the first quarter typically a seasonal low point.

Gross margins were a record 27.2% of sales, up from 25.9% last year despite the lower sales revenues. The improvement over the prior year was driven by manufacturing productivity improvements, price realization, lower warranty and material costs, along with a more favorable product mix. Gross margins also improved compared to the first quarter despite flat revenue as a result of productivity improvements, more warranty costs, and product mix.

Selling, admin, and research and development costs were up $54 million from last year and were $18 million higher than the previous quarter. The growth in spending was driven primarily by research and development from new products, and we have also been investing in our distribution network and IT infrastructure.

Joint venture income of $104 million was 11% lower than a year ago and on par with the previous quarter. Year over year more contributions from joint ventures in China and in India were partially offset by an improvement in North American distributors. Sequentially joint venture contribution was relatively flat.

Second-quarter EBIT was $663 million, or 14.9% of sales compared to the 15.2% we reported last year excluding gains related to business divestitures. Compared to the first quarter, EBIT margins improved 20 basis points despite the flat sales revenue. As Tom just mentioned, for the first half of 2012 EBIT margins improved to 14.8%, up from 14.6% for the same period last year. And they are also a full 1% better compared to the second half of 2011 despite 7% lower revenues.

Earnings per share in the second quarter were $2.45 compared to $2.41 in the second quarter of 2011, excluding gains from business divestitures, and the tax rate was 25% in the quarter.

Let's now move on to the operating segments and discuss second-quarter performance and the outlook for the remainder of the year.

In the Engine segment revenues were $2.8 billion, a decrease of 2% over last year. In North America we experienced stronger demand across on-highway markets and in construction. That was partially offset by weaker demand in the oil and gas market as a result of lower natural gas prices.

Demand in international markets was lower with on-highway markets and Brazil and construction markets in China showing the more significant declines year over year. Foreign currency movements had a negative 2% impact on segment revenues in the quarter.

Compared to the prior quarter, sales were down 1%. Demand from heavy- and medium-duty truck markets in North America were lower than the first quarter, but this was partially offset by stronger demand from Chrysler. Outside of North America truck markets in Brazil and construction markets in China both were sequentially weaker.

Despite lower engine shipments segment EBIT was $376 million, or 13.2% of sales, up from 13% last year as a result of more favorable product mix, better pricing for parts and industrial engines, and lower warranty costs. This is partially offset by weaker contribution from joint ventures in China and India along with increased spending on growth initiatives.

Compared to the first quarter EBIT margins decreased 10 basis points due to higher warranty costs and research and development spending. For the full year we now expect revenue for the Engine segment to be flat with 2011 levels. This is a decrease from our previous guidance of an increase of 10% due to lower-than-expected demand in the on-highway markets in North America and Brazil as well as in the China construction and the US oil and gas markets.

Demand for engines for power generation has also slowed. Segment EBIT projections for the full year remain unchanged at 12% to 13% of sales.

In the Components segment second-quarter revenue was $1 billion. Compared to the prior year revenues were flat with growth in North American on-highway markets offset by lower demand from international on-highway markets, foreign currency movements, and the impact of divestitures completed last year.

Compared to last quarter, revenues were down 6% as a result of lower demand in on-highway markets in North America, Brazil, China, and India. This was partially offset by higher aftermarket demand, primarily for filtration products.

Segment EBIT was $116 million, or 11.2% of sales, down from 11.6% last year. Despite flat revenue gross margins did improve. However, this is more than offset by increased research and development costs and currency movements which had a negative 50 basis point impact on EBIT.

Compared to last quarter, EBIT margins declined 1.8% due primarily to lower volumes and increased selling, admin, and research and development costs, some of which were attributable to the Hilite acquisition. We are now forecasting revenue growth of 5% this year. This is a decrease from our previous guidance of up 10% due to weaker demand in on-highway markets in North America, Brazil, and China, and the impact of a stronger US dollar.

Segment margins are now expected to be in the range of 11% to 12% of sales, which is below our previous guidance. The reduction is the result of lower volumes and additional spending associated with the acquisition of Hilite.

In the Power Generation segment, second-quarter sales were $909 million, flat with the prior year and 17% higher sequentially. Growth in North America was offset by lower demand in Europe, China, and Latin America, and from the impact of the stronger US dollar. Sequentially, revenues improved from a seasonally weak first quarter with the Middle East, North America, UK, and China showing the largest improvements. Demand in Africa also improved significantly after a weak first quarter.

Segment EBIT margins were 10.3% in the quarter, down from 11.6% last year. Gross margins remained stable; however, increased spending on growth initiatives and lower joint venture income resulted in a decrease in EBIT margins. EBIT margins did improve 60 basis points from the first quarter as a result of the stronger volumes, and spending on selling, admin, and engineering increasing at a lower rate than revenue growth.

For 2012 we now expect segment revenues to be flat with 2011. This is a decrease from our previous guidance of up 5% to 10%.

In North America, we now expect growth of 15% compared to a previous expectation of 20% growth. The growth in North America will be offset by lower demand in China, Latin America, and Europe. Segment EBITDA margins are expected to be in the range of 10% to 11% of sales.

For the Distribution segment, second quarter revenues were $794 million, an increase of 1% compared to the prior year and 2% compared to the prior quarter. Currency movements reduced revenues by 5% while strong demand for parts and service in most regions offset weaker demand for engines in the oil and gas market in North America and in some segments in Europe. Compared to the first quarter of 2012 the higher parts and service sales offset weaker demand in the oil and gas market in North America and in the industrial markets in Europe.

Segment EBIT margins for the quarter were 11.6%, down from 13.5% a year ago due to the impact of currency and increased spending to build out our distribution network, particularly in Africa and in China. Compared to last quarter, EBIT margins decreased 50 basis points largely due to foreign exchange and increased SAR spending.

For 2012 we are now forecasting 10% growth over the prior year with approximately 6% of this growth coming from acquisitions. This represents a reduction from our previous guidance of an increase of 20% due to declining demand from power generation equipment in a number of markets, more engine demand in the oil and gas market in North America, and the adverse impact of currency movements. We expect segment EBIT margins to be in the range of 12% to 13% of sales for the full year.

As Tom mentioned, we are now projecting total current revenues to be flat with 2011 levels, with growth in North America of being offset by weaker demand in overseas markets. And we estimate that the stronger US dollar will have a $500 million negative impact for the full year. EBIT margins for the Company will be in the range of 14.25% to 14.75% of sales compared to the 14.2% margin we reported last year.

If second-half revenues are expected to be 4%, or $400 million lower than the second half of 2011, the midpoint of the EBIT guidance assumes second-half EBIT margins will be 14.2% of sales, up from the 13.8% we reported last year. And, as is normal, the fourth quarter will be stronger than the third quarter.

Our assumptions on our guidance include the contribution from joint ventures to be down 5% from last year and the full year tax rate is now forecasted to be 26%.

Finally, with regards to cash flow, we now expect to invest between $750 million and $800 million during 2012 on capital projects. While working capital and in particular inventory grew in the second quarter, we expect to reduce this by $200 million in the second half of the year. The balance sheet remains strong and pensions well funded, which gives us the ability to invest for growth and provide additional return to shareholders through stock buybacks and increased dividends.

During the second quarter we repurchased 1.8 million shares and earlier this month we announced a 25% increase in our dividend. Although revenue growth has slowed in the near term, we remain committed to expanding our EBIT margins. We are pleased with our gross margin and EBIT performance in the second quarter despite the decline in revenues, and while we will continue to invest in critical growth initiatives, we have already adjusted spending plans in view of the reduced outlook for the remainder of the year.

Now let me turn it back over to Mark.

Thanks, Pat. We do have plenty of time for questions, so out of consideration to everyone on the call I would ask that you limit yourselves to one question and one follow-up and then get back in the queue.

Operator, we are now ready for our first question.

(Operator Instructions) Jerry Revich, Goldman Sachs.

Good morning. Can you gentlemen say more about the actions you have taken to adjust the cost structure? Are we talking SG&A or production reductions, and which businesses are impacted most?

Let me start with that one, Jerry. We are taking actions across the business, but I think it is really important to point out that the critical growth initiatives that we have talked about for some time now we are not going to cut back on those. So they are really important to the long-term future profitability of the Company and they are kind of sacred.

Where we are cutting back are on areas such as travel. We are looking to reduce the rate of hiring in some areas; we will freeze it in other areas across the company. But it is important we find the right balance of continuing to invest for growth while at the same time managing spending prudently across the Company, across all four business segments and the corporate areas.

I would just add, Jerry, that the leadership team here is pretty experienced with cost reduction activities. All of us have been through it before.

So every one of them in our recent strategy meeting had to come up with a set of reductions that they thought they would implement and still be able to meet the key, strike the balance that Pat talked about -- about investing in the key growth programs and making sure they can still hit their growth targets and revenue commitments. So that is what we are trying to strike here, and I think every member of the team is committed to doing that.

As a follow-up I am wondering, Pat, if you can bridge for us the margins you are targeting in Power Gen and Engines in the back half of the year versus the back half of last year. On flat to down sales you are looking for margins to be flat to up; can you just step us through the major moving pieces there?

Let me try and take it this way, Jerry. I will give you a high-level bridge from the first half of the year to the second half of the year, and the first half of the year was considerably better than the second half of last year.

We do expect revenues to be flat, maybe slightly better in the second half of the year than the first six months that we have just gone through. That being said, there are a number of headwinds coming our way so the product mix is not as favorable in the second half of the year.

We have talked about reduction in oil and gas. We have talked about reduction in power generation, so in the high horsepower engines where we do have some good margins we see a little bit of a negative mix going on there.

Warranty costs are expected to grow a little bit in the second half of the year and joint venture income will certainly be down in China and in India. More so in the third quarter I expect them the fourth quarter, but it is definitely going to soften.

Now, on the other hand, we have seen terrific work so far in the manufacturing plants to improve productivity. We expect that will continue as we go into the second half of the year. The supply chain savings that we have talked about, the 1% margin target for 2015, we are on track to hit 0.02% or maybe even go a little bit better than that this year based on what we have seen in the first six months of the year.

And, finally, material costs are almost certainly going to be better in the second half of the year than what we have seen in the first half of the year. And that is a combination of metal markets being a little bit better than what we thought they were going to be and just ongoing good working cost reduction with our supply base.

Thank you very much.

Jamie Cook, Credit Suisse.

Good morning. Two relatively simple questions. One, if you could just expand within North American and Power Gen. Last quarter you talked about some weakness in orders. You still cited North America as up; I think you said in your prepared remarks that things in July looked a little better. So can you just give a little more color there and comment on the overall competitive environment?

Then my second question, just with regards to, Pat, as you are thinking about your guidance cut for the year, generally the thing I like about Cummins is you make a cut and it is big so there is not generally risk in the back half. I guess what I am concerned about is I still look at your North America truck forecast, which is essentially in line with ACT, so what gives you confidence orders pick up in September? Or could you just speak to where you think the risk is to your guidance in the back half? Thanks.

Okay, Jamie. First, I'll take the first part of a question on Power Gen in North America. So I think the first thing to remember is we are expecting 15% revenue growth in North America on Power Gen, but two-thirds of that is coming from new products rather than the underlying market. And that has remained a stable forecast for the full year.

We have seen orders bounce around, so for the base business originally we were expecting 10% growth for the full year and we have now lowered that to 5%. We did see a really sharp drop in income and orders around middle of March/April time and we talked about that on the Q1 call. Orders stayed down for a while and then have picked up a little bit recently.

So kind of 10% growth underpinned with the new products, 5% from underlying markets. I think markets reasonably competitive at this point in time, but I think based on current trends it's a little hard to exactly forecast. But we feel pretty good about the 5% underlying market growth.

Jamie, I guess the other thing I would just say is the volatility of the market has obviously picked up some. To talk about recent order trends and things is, obviously, a little frustrating even for us, because we would have liked to have had a better view of what our current guidance is back when we gave our first-quarter call. But things fell off quite quickly.

We saw the order rates trending down in April and we just didn't know how lasting or how big a deal that was. They stayed down through all of Q2 and then recently have picked back up a little bit. So it is volatile and we just don't exactly know how to read it other than, generally speaking, as Mark said, we have got some new business in the market that is helping us plus we have got a pretty broad and global business that is helping us.

So all in we feel quite good about the Power Gen forecast, but we are definitely seeing more volatility in order rates in a number of markets and the number in North America that you have highlighted.

I've got Rich here, though, Jamie. Let me ask him to comment a little bit on the ACT forecast in the North America truck market.

Hi, Jamie; this is Rich. As you noted, we have taken our forecast down from 278,000 production build down to 260,000 so that implies we basically build at a 280,000 the first half of the year. Building at a 240,000 rate the second half of the year.

And so a few things we are looking at. One is, as you are aware, net orders have been weaker than that the last few months. And I think that will probably continue through July.

The things we are looking at that give us some confidence is, one, is retail sales have averaged over 24,000 the last four months. So you think at a 240,000 rate they would be building at 20,000 a month; the retail sales are coming in higher than that.

Conversations we have had with lots of customers, again, more geared towards the larger customers, are saying they are sticking with their second-half order rates that they are going to continue with. The backlog remains pretty strong. So here we are in July and there is well over 80,000 in the backlog.

I think, lastly, we will see just the normal seasonality and some elements of increased orders in November/December ahead of the emissions change or the greenhouse gas change in 2014. So I think it is obviously a moving target, but the net of that I think the 240,000 build rate is balanced and right for the second half of the year.

Then, I'm sorry, just last question, Pat. Can you just quickly quantify what is the material cost benefit in the back half of the year?

Well, for the first half of the year, Jamie, we were about 3/10 or 4/10 of a point in benefit. Second half of the year we expect be over 1%.

Okay, cool. Thanks, I will get back in queue.

David Raso, ISI Group.

Good morning. I wanted to delve a little further into the second-half margin guidance. Obviously the margin guidance is pretty impressive and the two businesses that stick out is the Power Gen business -- the margins in the first half of the year were 10.1%, you are implying they go up to 10.9% -- and Distribution was 11.9% in the first half and they go up to 13.1%.

Can you take us through a little bit what you are seeing? I think you mentioned on Power Gen the mix is a bit adverse, so I'm just trying to understand why the margins would go up first half to second half. I mean you are implying the revenues go up a little bit sequentially, so some of it could just be better overhead absorption. But to just try to better understand that part of the margin guidance.

So we will start with Power Gen. Their gross margins have actually been doing quite well over the last few quarters, and some of that has been masked by mark-to-market adjustments we have had to take on forward contracts for copper. So we don't see copper decreasing further view on this point, so we don't expect to see any more of those mark-to-market adjustments that have kind of negatively impacted their margins in the first and more so in the second quarter of the year.

So as volumes pick up in the second half of the year in Power Gen I expect our gross margin to improve, and then that to fall to the bottom line. Tony and his team, I think, are all over the cost management activities in the Power Gen group so I feel pretty good about their ability to expand margins from where they have been in the first half of the year.

Distribution, they suffered a little bit in the first half of the year, as I was talking in the earlier remarks, on higher currency impact than what we had anticipated. We are down almost 2 points from a year ago and half of that is currency and half of that is just increased SAR spending on key initiatives for them in the future.

I think that revenues are going to improve in the second half of the year; there is no question of that in my mind. I think the mix we are starting to see in that business is starting to move more towards aftermarket and away from whole goods, which again will give them a little bit of a bump as we go forward.

All right, that is helpful. The backlog at the end of the second quarter, do you have any color at all you can provide us on where the backlog is at the end of the quarter year over year?

Backlog for what, David?

I don't know if you have a total company number. I'm just trying to get a feel for your down 4% revenue for the second quarter; back half implied down 5%. Just trying to get a little feel for kind of where we are launching from on a backlog going into the second half and a growth rate.

We don't have an overall one because it is just so different by markets. I think Rich talked a little bit about where he sees industry backlog for North America, so we will have different numbers for different -- but some of our businesses operate with no backlog ever, so it's just too wide a variety.

I will just wrap up then. The related one is share repo; what should we think the second half of the year, maybe at a minimum compared to the run rate we have seen in the first half? (inaudible) the second quarter was, whatever, $188 million or so of repo. How should we think about the next couple quarters on share repo?

We are not really going to change any part of our strategy or our planning when it comes to returning value to shareholders. So we have said before we will look to do that by growing the business profitably; we will look to do that by increasing the dividend, which we just did; and we will look to do that by buying back stock.

We go into the year, as you know, with a target to reduce stock by 1%. If the market price is attractive, we may do more than that. We did more of that in the second half of last year.

So we have the flexibility. I am not going to commit to a number just now, but we certainly don't see any change in the way we want to look after shareholders when it comes to dividends and stock buybacks.

All right, that is helpful. I appreciate it, thank you.

Rob Wertheimer, Vertical Research Partners.

Good morning, everybody. I just wanted to drill into the Power Gen segment a little bit. I assume that your outlook and the comments you made today were made in advance of any changes relative to the terrible outage they are having in India. Does that have the potential to affect anything this year?

And then just in general on the 1Q, did you -- I'm trying to think about the gap between the Engine segment, stationary power, and then the Power Gen revenues. Did you overbuild a little bit and then are going to underbuild a little bit this quarter and the rest of the year?

Rob, I will start with the India thing. You are totally right that we did -- that all the comments we made were before we considered that and really I don't exactly know how it is going to play out. It is terrible actually. There is quite a bit of problems going on, even in some of the bigger cities, like Delhi, with mass transit basically unusable. So it is a bad situation for them.

It is, unfortunately, reflective of the stability of the power grid broadly across the country, and that helps our business, of course, because that is a lot of the reason why people buy standby generators. But definitely the grid needs much more stability than it has.

We will definitely see what we can do to help in different parts of the country with trying to stabilize the grid as well as provide emergency services. That is one of the things we do regularly and do best, so we will be active trying to help.

What the impact is it is just way too early to tell, but I think it talks about why we have -- why we are optimistic long run about our participation in the power generation market in India. There just is a lot of grid improvement and other kinds of things to do there, and that is kind of where our products are targeted.

I think the second part of the question on inventory the drop that we see in demand in the latter part of the second quarter kind of took us by surprise and across the business we ended up with more inventory than we anticipated. So as I said in the early remarks, we intend to work that down through the third and fourth quarter and get inventory back into a more novel target range for us.

I should add to that that there is not really any area that has got a lot of extra inventory or where we have seen a lot of cancellations. As Pat said, it is just across several parts of the business the deceleration happened faster than we could adjust and we are now going to adjust that through the next couple quarters.

So there is no area we are particularly concerned about, but there are several areas where we will have to take production rates down below what sales would be. And that is what has affected our guidance for the second half.

That is very helpful, thank you. Could I ask real quick on the oil and gas, which I know is small, but does your outlook assume that new builds kind of -- I know the revenue outlook, but I don't know how much is aftermarket. So I don't know if that assumes new builds go close to zero.

Are you still getting orders for new builds in that market, and do you assume to continue to get orders in the back half of the year? I will stop there, thanks.

This is Rich. Yes, we are continuing to get orders for new builds. We are down over 50% from where we were in the first quarter, but there is a level of that coming in. Then the parts and service business has remained pretty steady, so while there has been some shutdown we have remained slight growth on the parts and service side of that business.

Thanks.

Tim Denoyer, Wolfe Trahan.

Good morning. Couple questions on the components margins. Pat, did you quantify the impact in 2Q of the Hilite acquisition, or was there an impact? Can you also just talk about the revenue and margin profile of that acquisition?

Yes, so in the second quarter we incurred about $5 million of costs relating to the acquisition, so that is about 50 basis points. In the second half of the year, as we look forward in our guidance, we think that the ongoing cost with that technology business that we purchased is going to cost us about 0.5 point at the Components segment level on their margin in both the third and fourth quarter.

With regards to the profile of the business, I mean this is a technology that we went out to purchase, Tim. So it is not really -- it is not one of these big acquisitions you see other companies do. We have always said that where we see attractive opportunities to move faster with technology development that is what we will be interested in. That is exactly what this deal is.

I think the revenue benefit in the second half of the year is going to be fairly modest. It is probably going to be in the range of $40 million to $50 million, but overall with the cost structure, with the technology investments we are seeing there it will have a negative impact at segment level for about 0.5 point.

(multiple speakers) The technology there helps us across our entire aftertreatment business, so we will see the technology impact our aftertreatment business totally. But the big next hurdle for that business is really Euro 6. So Euro 6 is where the volume starts to turn up and the opportunity first shows.

It also affects Tier 4 final and, as I mentioned, it will affect all of our aftertreatment business. But if you want to think so when does this thing start to show some positive benefits, even though it is a technology investment, it is not 100 miles off. Euro 6 and Tier 4 final are relatively close in time.

And is it fair to assume that the liquid-base SCR, the doser, is lower cost than the [ARS] ones that you are using now in North America truck?

What I will say about that now -- because it's new products and, of course, we want to make the proper announcement at the proper time -- our target is to provide customers with better performance at lower cost across these technologies. In an aftertreatment the name of the game is being able to give people the ability to integrate effectively in a very complex system with high reliability, lower costs, and better performance.

That is what we are thinking this technology brings us. Especially across the large engines, the technology is pretty unique and so we think it will give us an advantage with customers.

Andrew Kaplowitz, Barclays.

Good morning, guys. Tom, I wanted to ask you about the mining business. You mentioned that it was a little softer in the US but you have a big international business. What is your visibility like in that business and what are your customers telling you? There is a lot of noise out there, as you know, in the system.

Yes, there is a lot of noise. I have got Rich here; I'm going to let him comment. But I would just say at a high level, our view about the mining business is that we have -- it's one of those markets where we do get reasonably good visibility. We are able to look out pretty far in terms of order rates and backlogs.

There is not one million customers that we are serving there, so we can kind of see what they are doing, and we can watch commodity prices with relative ease. You can kind of see what the numbers are and see what drives what. Obviously, our view of the market changes when we see commodity price changes dramatically, but we do have reasonable lead time on that. And Rich I know has been in conversation with a number of customers, so I will let him comment further about what he is seeing.

So we're still -- we're staying with our guidance about 7% for the year. Coal, obviously, is our biggest concern with commodity prices coming down, so that is the one we are paying the most attention to. Copper, iron ore, gold, those remain strong.

We have not seen a lot of cancellations, small numbers. We have seen some delays and so it's one we will be watching. I think through the balance of the year it looks pretty solid, and just one we'll have to pay attention to going into 2013.

The order boards are still strong, as you know, our orders, and there is a delay. We have a lag effect on our side, so folks are still building out equipment and we are still shipping engines. So I feel pretty confident through the balance of 2012 that we will see not a lot of changes.

I do think it is one of these things where if copper, iron ore prices fall off a lot again, we would then change our outlook probably for 2013. Again, it is unlikely to have a big effect in the second half of this year, but changes in commodity prices down would affect prospects for next year and vice versa.

Of course, if they strengthen or get some underpinning for where they are, we think that will help next year. So we are keeping our eyes really closely on this and everybody knows the things to watch here in terms of commodity prices. But right now, the good mines still are keeping their equipment running and ordering new equipment. The good mines, I mean the ones that are low-cost operation and effective and large, they are still doing it.

New mines, we have seen a bunch of announcements about people saying they are going to postpone activity on new mines. I think you have probably read some of those, but existing mines are still going.

Tom, that is helpful. So kind of similar, but maybe a little different place where we have -- it's more difficult to get visibility is China. I know you have talked about China.

Your OEMs sometimes tell you one thing and then something else happens. The confidence level that you have from the OEMs now as we go forward, given that China at least is sort of making more noise about infrastructure investment and sort of doing the right thing, how comfortable are you that we won't need to change our Chinese forecast again when we go forward.

I think you have characterized it well, that it is difficult to get good numbers. I think the OEMs, in their defense, suffer from the same lack of information that we do to some degree. The published numbers are not often timely or not often complete, and there is even some game playing by the OEMs in terms of how they put the numbers, how they feed the numbers into the market research work. So I think there is some uncertainty around the numbers.

And I think there is also debate within the Chinese government about what they want to do with this stimulus program. I have met with members of the government while I was there last. There is clearly -- the number one priority is to make sure it is a soft landing not a hard landing, but there is also priorities within the government about shifting the economy a little bit away from only internal infrastructure and into consumer-based economy, which you have probably read some about that.

And there is also a sense that the last stimulus program kind of over stimulated. There ended up being quite a bit of waste in some of the programs and they ended up with a big bump that they had to recover from with inflation overrun. So I think there is just different parts of the government and different builds they are trying to manage here.

So I have high confidence that they will stimulate and they will continue to work on the economy to ensure it is not a hard landing. In other words, it doesn't get a lot worse than it is now. But I do think it is hard to say how quickly it is going to improve, especially in this infrastructure side.

We were feeling reasonably confident that they would stimulate enough to clear the excavator inventory and to get construction going by the fourth quarter. As you know from our remarks, we have now -- our view has dimmed on that and we think it will not do enough to clear the inventory and begin to increase build rates this year at all. We think it will be into next year before that happens now; when and how we are just not sure.

So I think it is uncertain. I would be very careful about anyone who says they are certain about what is going to happen there because I think it is hard to know. And certainly any one OEM would not be a reliable estimator.

That is helpful, Tom. Thank you.

Stephen Volkmann, Jefferies.

Good morning, guys. Curious about sort of the cadence of the quarter. It seemed like, and please correct me if I'm wrong, but it seems like things sort of changed fairly rapidly through the quarter.

I am wondering -- you made a couple of comments, Tom, I think that you thought things had sort of stabilized. I wonder if you could just sort of take us through the key markets where things really did deteriorate and whether they have stabilized, and if you even have any kind of quick look into July.

Steve, it is a good question because, again, we left the first-quarter call with a couple of troubling signs but not a clear view really of where the rest of the year was going to go. So we were unable to change our guidance in a way that was any more accurate than what we already had. That was unfortunate, because, as you said, it changed pretty quickly.

April was a very good month for us and then May and June were weaker, and that was the cadence basically. I think what made it worse is that our view was that as we saw those numbers weakening we didn't see instigators that were going to make them improve quickly and turn around.

Examples we have talked about today, North America truck. While we do see some improvement in the back half of the year, we didn't see a way we were going to get back to 278,000 units. We saw the order rates dropping, and you saw them too, but we were all debating in April was that just a one-off, were there special causes. Then as we went through the rest of the quarter we said, no, it looks like it is going to stay.

In China, we saw a bunch of new data come out. A bunch of information about how inventory had changed in the first quarter, or in this case had not changed very much, in excavators was disturbing news for a whole bunch of people and made us rethink where we were. Truck markets in China, same kind of thing.

India economic results were much worse. Excise taxes got implemented; there was some debate about whether they were. And then I mentioned Brazil where what we saw -- we saw Euro 5 transition struggling, that was evident, but the combination of the worsening economy and how badly retail sales were going was just -- kind of came to light during the quarter. So we saw a lot of negative news about how things were progressing.

In all those things you hear about stuff but then when OEMs actually take build rates down, which they do over -- they do that for a few months, you know now you're going to have to lower your realistic expectations. That is an example of what happened in Brazil.

So, anyway, lot of those things happened in the quarter. They made us change not only our view of the quarter, but our view of the year. We just felt like, given what we saw in May and June, we wanted to get out and tell you guys that things had changed in just two months.

With regard to change now, it is not that there has been significant improvements anywhere. It just looks like we have kind of now captured this new environment as best we can. I did mention that there is volatility and hard to know it in some places like China. And the Power Gen orders have been bouncing around.

But, broadly speaking, we feel like we have reflected the environment that we are experiencing now and so that is why we feel good about the guidance. But I would say it is a much more volatile economy than we were looking at in the first quarter of the year and it is much harder to predict.

So just to be clear, can I say the last few weeks have sort of stabilized or they remain volatile and you just think this captures it?

I think the second thing is more accurate -- they remain volatile and we think we have captured it. We think we have better characterized what we think is going to happen, because when we are out in the first-quarter call is when everything was starting to get a little bit squirrelly. We have now had three months to look at it and say, indeed, it is worse.

Okay, great. Then just a follow up, just to broaden that out a little more. It feels like a lot of companies this quarter have sort of taken the tack that things have certainly slowed here, but we are still in a growth market; 2013 and 2014 are probably still up years. We don't want to cut a lot of muscle here so we are willing to build a little inventory; we are willing to keep our R&D spending going, etc.

Would you put yourself in that camp? Are we still in a growth market as kind of a longer-term backdrop, or are you kind of more nervous? And what would you have to see to really start to batten down the hatches?

Definitely we would put ourselves in that category of seeing our long-term growth prospects remain the same. The basic characteristics of our industries that I mentioned in my remarks have not changed. Our view still is developing countries will be growing faster than developed countries, and investing in infrastructure and our position there remains strong.

We will still be investing in new products and technology. The Components business, for example, we have got a lot of promising technologies there that will require investment. We will still be spending money there.

Having said that, we do know how to reduce costs and we're starting to reduce costs, so we are striking a balance now is the way I would characterize it. Obviously we can change that balance pretty rapidly. There is a whole bunch of us here that have a set of programs that we know what to do when we need to do it. We will be monitoring -- in a volatile economy like this watching closely all the time and making adjustments on the fly is exactly what we need to do.

Having said that, I feel, like those others do, that the characteristics of our industry are still ones that will give profitable growth over a sustained period as the economy is returned. The question for us, and I think probably for a lot of people, is when do the economies return. What is the instigator that gets things back? And I think that is where there is a fair bit of uncertainty and, frankly, right now a fair bit of negative yield.

Great, thank you very much.

Ann Duignan, JPMorgan.

That is a new one. I think I should just translate it to Irish (inaudible). Most of my questions have been answered, but I say with somewhat tongue in cheek we have gone almost an hour and nobody has asked about natural gas, which I think is a big change from a quarter ago or two quarters ago.

Maybe you could just update us in terms of your outlook for naphtha heavy duty. Have you seen any change in demand for CNG equipment or CNG-related engines?

Certainly demand on our natural gas engines has increased significantly. Versus a year ago volumes in the second quarter were double, so we are definitely seeing more demand. We are seeing a lot of inquiries. So it is an active market for sure and we expect that to grow.

It is still, if you look at the overall mix of business, relatively low compared to the total, but it is growing and we are active in the market. Rich, I don't know if you want to comment at all about anything else.

That is fine.

We are seeing it active, we are seeing growth, and we are seeing a lot of inquiries about it. And with gas prices where they are, I just don't expect those are going to slow down. I think there is going to be a lot of people that are going to try to get natural gas into their on-highway truck engines, among other applications, and see if they can get the overall cost to work out when they look at where they can fuel and how they maintain and all that kind of thing, because prices are really attractive today.

It remains, as you know, somewhat infrastructure constrained so places where that is not a constraint, like refuse market, where you can go out and refuel, we have seen high market share and business move there. So I think it is going to be mostly driven by infrastructure buildout and you can take advantage of these lower prices.

Sure, I appreciate that. The as my final quick follow-up, we know that Navistar is going through a supplier selection process for its SCR components. Is that something you are prepared to talk about?

Are you bidding on that business? Have you been invited to bid? Is it something that you would be interested in, or is it an engine plus aftertreatment or nothing?

Ann, this is Rich again. As you said, lots of speculation rumors out there. Couple things we do know is the technology now settled out, EGR versus SCR, and with their announcement moving to the SCR.

Another thing we know is Navistar remains -- is a large customer of Cummins. 25% market share we still have in their naphtha business, again, outside of the US.

So we know where the technology is, we know -- we have been partners or customers for a long time and maintained discussions and relationships even despite the competition we have had the last couple of years in the US. How this technology change impacts their product plan we don't know, and so it wouldn't be appropriate for me to add to that speculation of how that might turn out. And so I would really need to direct you back to Navistar on what their product plan would be and who their sources will be to meet that product plan.

Okay. I will leave it there and take it off-line given the time. Thanks, I appreciate it.

Okay, I think that is the end of the hour. Appreciate your interest and your questions, and I will be available for follow-up.

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