康明斯 (CMI) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2012 Cummins Inc. earnings conference call. My name is Tony 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 this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Mark Smith, Executive Director of Investor Relations. Please proceed, sir.

Thank you, Tony; and good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the third quarter of 2012. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; and the 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 forecasts, 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 on Form 10-K and any subsequently filed quarterly reports on form 10-Q.

During the course of this call, 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'll begin with our Chairman and Chief Executive Officer, Tom Linebarger.

Thank you, Mark. Good morning, everyone. Before I begin my remarks, on behalf of Cummins I would just like to express our condolences to the families and communities who have been impacted by the devastation of Hurricane Sandy. I'm guessing that some of you on the phone have been personally affected, and I hope for a quick recovery for each of you.

Now I'll summarize our third-quarter results and talk about our key markets. Pat will then take you through more details of our third-quarter performance and provide an update on our full-year guidance.

Revenues for the third quarter were $4.1 billion, a decrease of 11% from the third quarter of 2011. Third-quarter EBIT was $496 million, a decrease of $144 million or 23% compared to the third quarter of 2011. EBIT percent for the quarter was 12%, down from 13.8% a year ago, with a negative impact of lower volumes and lower joint venture income, partially offset by lower product coverage costs and material costs.

As previously announced, we now expect full-year revenues to be $17 billion, down from $18 billion last year. Demand has clearly weakened in a number of our markets over the last several months. I will talk about our outlook for many of these markets. And we have included for reference a supplementary slide in today's earnings release presentation that further quantifies the change in revenue guidance by both business segment and by market.

We expect to deliver full-year EBIT margins of 13.5%, down from our previous guidance of between 14.25% and 14.75%. Pat will cover the changes by business in his remarks; but, overall, the reduction in demand across multiple markets and geographies is the main driver of our lower EBIT margin forecast. I will discuss the actions we are taking to reduce costs following my comments on our major markets.

In the third quarter, our revenues in North America increased 2% year-over-year. The rate of growth of our revenues in North America slowed significantly during the third quarter, with the most significant change in the North American heavy-duty truck market. As a reminder, total Company revenues in North America grew 43% in the first quarter, and 12% in the second quarter, compared to the previous year.

In the North American heavy-duty truck market, our engine shipments decreased by 26% compared to the third quarter last year. Although an industry-wide cut in production rates was anticipated in the third quarter, the reduction was larger than expected and the industry is experiencing slower-than-expected new order rates. End users are reluctant to proceed with new purchases, apparently due to uncertainty about the US economy and concerns about possible impacts from the fiscal cliff.

Given lower-than-expected industry order rates, we are now lowering our full-year market size expectations to 245,000 units, down from our previous forecast of 260,000. We expect to achieve full-year market share of 40%, unchanged from our previous guidance.

Our forecast for the North American medium-duty truck market is for a market size of 104,000 units, an increase of 11% over 2011, and unchanged from our previous guidance. We continue to expect our market share to exceed 50% for the full year. Our shipments declined by 9% in the third quarter, but are up 20% year-to-date.

Our North American on-highway products continued to perform well in the field. We have now shipped more than 335,000 engines equipped with our SCR technology, and the market feedback continues to be extremely positive. Our products continue to demonstrate very good reliability, as evidenced by another quarter of low product coverage costs.

Consistent with our track record of being a leader in meeting increasingly stringent global emission standards, Cummins recently became the first engine manufacturer to achieve certification for the EPA 2013 regulations and the new 2014 greenhouse gas rules, with our ISX 15-liter engine.

Also in North America, demand from Chrysler for the Dodge Ram truck remains strong. Our engine shipments increased 81% in the third quarter compared to the third quarter last year, as Chrysler prepares for a model year changeover. Year-to-date, engine shipments to Chrysler are up 42% year over year, and we expect full-year shipments to increase by 30%, consistent with our prior guidance.

In the North American construction market, we continue to experience positive growth in the third quarter, with engine shipments increasing 12% year-over-year, although the rate of growth has decreased from prior quarters. Demand in the oil and gas market in North America has continued to decline as customers have further reduced capital expenditures in natural gas fracking operations, reducing orders for our engines.

Unit shipments in North America declined by 65% in the quarter. And we now expect full-year global demand to decline by 50% compared to 2011, a change from our previous expectation of a decline of 41%.

In mining, our engine shipments declined by 32% year-over-year in North America. It is important to note that a significant proportion of the mining engines we deliver to OEM customers in North America are put into service in international markets; and, therefore, the decline in shipments should not be interpreted as a 32% decline in North American mining activity. Global unit shipments declined 14%, due primarily to reduced orders in coal mining in the US, China, India, Australia and Russia. Mining activity for copper and precious metals remains strong. We have lowered our full-year forecast for mining engine revenues as a result of capital expenditure cuts announced by a number of global mining companies. We now expect engine revenues to decline 1% year-over-year, compared to our forecast of an increase of 7%.

In our Power Generation business, we recorded growth of 14% year-over-year in North America. We are maintaining our full-year forecast for revenue growth of 15%, driven mainly by new products, as we have previously discussed.

In international markets, our consolidated revenues declined by 21% year-over-year. Consistent with prior quarters, revenues were down most significantly in Brazil and China. Demand in Europe, the Middle East and Africa also weakened during the third quarter.

In China, our domestic revenue across all markets, including the revenues over joint ventures, declined by 26% year-over-year in the third quarter. Demand weakened for trucks, excavators, and power generation equipment, consistent with the overall slowing of the economy. We continue to experience declining revenues in the construction market, with our revenues down 50% in the third quarter.

Industry sales for excavators are down 35% year-to-date through September, in line with our full-year expectations of a decline of 35%. Our production of engines will continue to run below industry sales, as OEMs lower their existing inventory levels.

The outlook for the truck market in China has weakened, as overall growth in the economy has slowed. Our joint venture revenues in the heavy- and medium-duty truck market were down 31% in the third quarter. Year-to-date industry sales were down 26% through August; and we now expect full-year industry sales to be down 26%, lower than our previous guidance of a decline of 17%.

In the Power Generation market, we are also lowering expectations for 2012 revenues in China. Our third-quarter revenues, including joint ventures, declined by 29% year-over-year, against a strong third quarter last year that was driven by summer power shortages. We now expect full-year revenues to decline 14% compared to our previous expectations that revenues would be down 5%.

We now expect our full-year domestic revenues in China across all end markets, including joint ventures, to decline by 21% compared to our previous expectation of a decline of 13%. We are yet to see any signs of improving demand in the markets we serve, despite actions announced by the Chinese government to accelerate infrastructure project approvals.

In India, the economy has remained weak, and recent actions by the government to reduce the fiscal deficit have not helped to stimulate growth in the markets that we serve. On top of an increase in excise duties on commercial vehicles earlier in the year, the government also reduced fuel subsidies, effectively raising fuel prices by 12%.

In India, our total revenues, including joint ventures, declined by 19% in the third quarter compared to the same quarter last year. As we had expected, production at our Tata Cummins joint venture declined by 33%, as Tata lowered third-quarter production rates to reduce inventories.

Our full-year forecast for the truck market in India is for a decline of 8%, consistent with our previous forecast. Volumes at our Tata Cummins joint venture are down 15% year-to-date, and are expected to be down 13% for the full year, also unchanged from our previous forecast.

In the Indian Power Generation market, we continue to see strong demand for low-horsepower products, due to ongoing power shortages in the country. We estimate that demand for Power Gen -- power in India exceeds grid capacity by more than 10%. We expect power generation volumes in India to increase 15% this year, unchanged from our previous guidance. As we discussed last quarter, though, the devaluation of the rupee against the US dollar means our full-year expected revenues in dollar terms is a decline of 1%.

Also, for the full year, our revenues in India, including joint ventures, are expected to be $1.5 billion, a decrease of 11% year-over-year and unchanged from the previous guidance.

In Latin America, we expect our revenues, including joint ventures, to be $1.4 billion, a decline of 22% year-over-year compared to our previous expectation of a decline of 17%. We are experiencing lower demand for power generation equipment, and the outlook for the truck market in Brazil has also weakened.

Industry sales in the truck market in Brazil are down 36% year-to-date through August, due to a combination of the impact of the transition to Euro 5 emission standards and a weaker economy. We now forecast a full-year decline of 37% compared to our previous guidance of a decline of 33%.

Industry sales of Euro 5 products increase in the third quarter, reaching approximately 12,000 units per month compared to an average of 2000 units per month in the second quarter.

Industry inventory levels have dropped approximately 10% in the last three months as a result of improving retail sales. The inventory trend is encouraging. However, a further improvement in new order levels is required before the industry build rates increase.

We experienced our weakest quarter of the year in Europe. Total Company revenues were 19%, with lower demand in most end markets; particularly power generation, construction, and on-highway markets. As a reminder, a significant proportion of the power generation products we deliver in Europe are subsequently put into service in other markets outside of Europe.

In the Middle East and Africa, Power Generation represents our largest business. Demand dropped by 17% in the Middle East year-over-year, due to lower orders from rental fleets. And in Africa, revenues dropped 10% year-over-year. Third-quarter revenues in Africa were similar to the second quarter of this year, and well above the weak levels we saw in the first quarter, but still lower than a year ago.

Clearly, we are experiencing significantly weaker demand in many of our largest markets. Unfortunately, there is also a high degree of uncertainty about the direction of the global economy. At this point in time, it is not clear when demand will improve.

In this uncertain environment, the leadership team at Cummins is focused on ensuring that we manage our costs appropriately. We have announced a number of actions over the last three months to adjust to a lower-demand environment. We have frozen professional hiring; cut discretionary expenses; reprioritized, and, in some cases, canceled projects. We have reduced production levels at our manufacturing facilities, and in doing so we have operated some plants at reduced work weeks, and we have taken plant shutdowns.

Given the decline in revenues over the last three months, actions are underway to further reduce our cost structure. And several of our manufacturing plants have reduced global headcount by between 1000 and 1500 people by the end of this year.

This management team has demonstrated the ability to effectively manage through periods of uncertainty. And we will continue to make the right decisions to maintain strong financial performance while ensuring that we deliver the new projects and programs necessary to meet customer commitments and to the drive strong, profitable growth in the future.

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

Thank you, Tom, and good morning, everyone. Third-quarter revenues were $4.1 billion, a decrease of 11% from a year ago. Revenues increased by 2% in North America, but were down 21% internationally compared to the prior year. And currency movement reduced revenues by approximately 4%.

Compared to the second quarter, revenues were down 7%, with lower demand in both North America and in international markets. Gross margins were 25.3% of sales, down from 25.7% last year. This decrease was driven by the impact of the reduction in volumes, partially offset by lower material cost and improved price realization.

Sequentially, gross margins decreased from 27.2% in the prior quarter as a result of the lower volume and a more unfavorable mix, partially offset by the benefit from lower material costs.

Selling, admin, and research and development costs are down by $11 million from last year, and down $32 million from last quarter. Both the sequential and year-over-year reduction in spending has occurred in selling and administration expenses.

Joint venture income of $94 million was 8% lower than a year ago, and 10% lower than the previous quarter. The year-over-year and sequential declines were driven by lower contribution from joint ventures in both China and in India. In both comparisons, Dongfeng Cummins in China accounted for the largest variance due to the weaker demand in the China truck market.

Earnings before interest and tax were $496 million or 12% of sales. This compares to 13.8% of sales last year. Earnings per share in the third quarter were $1.86 compared to $2.35 in the third quarter of 2011. The tax rate for the quarter was 24.1%, which included a $16 million benefit for discrete tax items. $6 million of the discrete items were included within our original guidance for the effective tax rate.

Let's now move on to the operating segments and discuss third-quarter performance and the outlook for the remainder of the year. In the Engine segment, revenues were $2.5 billion, a decrease of 14% over last year. Sales were down in nearly every international region, particularly on-highway markets in Brazil and industrial markets in China and Europe. Revenue in North America declined modestly as strong demand from Chrysler and from construction markets was offset by weaker heavy- and medium-duty truck, oil and gas and mining markets.

Sequentially, segment revenues were down 11% as a result of the decline in North American heavy- and medium-duty truck markets, oil and gas markets, and industrial demand in Europe and global mining markets. Segment EBIT was $239 million or 9.5% of sales, compared to 11.8% in the prior year, and 13.2% in the second quarter.

Compared to the prior year, the benefits from better price realization and lower material costs were more than offset by the drop in volume, lower joint venture contribution, and continued technical investments in growth programs. Sequentially, the decline in volume, a more unfavorable product mix, and weaker joint venture income resulted in lower margins.

For the full year, we now anticipate revenue for the Engine segment to be down 6% compared to 2011. This is down from our previous guidance of revenue being on par with 2011 levels. The decrease is driven primarily by the reduction in the North American heavy-duty truck market; reduction in sales to our Power Generation business, as we focus on reducing inventory levels; and more demand in global mining markets.

As a result of lower volume and weaker contributions from joint ventures in China, we are also lowering our full-year expectations for EBIT as a percent of sales. And we now forecast that EBIT will be in the range of 11% to 11.5% of sales.

In the Components segment, third-quarter revenue was $938 million, down 8% compared to the prior year, and 9% sequentially. Both comparisons were impacted by lower aftertreatment and fuel system demand in North America, along with weaker turbocharger demand in Europe. In addition, aftermarket demand decreased in several regions.

Revenue in Brazil increased year-over-year due to additional content being sold following the implementation of Euro 5 emission standards. Currency movements negatively impacted revenues by almost 4% compared to the third quarter of 2011.

Segment EBIT was $89 million or 9.5% of sales, down from 11.1% last year and down from 11.2% in the prior quarter. Lower volume, unfavorable currency movements, and increased technical investments resulted in lower margins compared to a year ago. Sequentially, the impact of the lower volume was partially offset by reductions in selling and administration expenses.

We are now forecasting the Components segment revenue to be flat for 2011. This is down from our previous guidance of 5% growth, resulting from more on-highway demand in North America and in Europe. Full-year segment EBIT margins have also weakened, and are now expected to be in the range of 10.5% to 11% of sales. The reduction is due primarily to lower volumes.

In the Power Generation segment, third-quarter sales of $814 million were down 7% from the prior year and down 11% sequentially. In both comparisons, international revenue decreased sharply in several regions. The year-over-year revenue decline was primarily driven by lower demand in China and in Europe. And while we experienced volume growth in India, this was more than offset by the devaluation of the rupee against the US dollar.

The sequential decline was driven by lower demand in India, Europe, and in the Middle East.

Revenue in North America grew 14% over the prior year, driven by new products, as we've discussed previously; and sequentially, the revenue in North America was down 5%.

Segment EBIT was $73 million or 9% of sales in the quarter, down from 10.5% last year, and down from 10.3% in the prior quarter.

Compared to last year, benefits from improved pricing were offset by lower volume; increased technical spending, focused on new products; and lower joint venture income. Sequentially, the impact of reduced volume was partially offset by lower material costs.

For 2012, we now expect segment revenue to be down 5% compared with 2011. This is a decrease from our previous guidance of being flat with the prior year. While guidance in North America remains unchanged at 15% growth, international revenue is lower than previously expected.

Power Generation demand in Europe, China, India, Brazil and in the Middle East has weakened over the last three months. The reduction in volumes has also caused us to lower our outlook for segment profitability. And now, full-year segment EBIT margins are expected to be in the range of 9% to 9.5% of sales.

For the Distribution segment, third-quarter revenues were $801 million, an increase of 2% compared to the prior year, and 1% compared to the prior quarter. During the quarter, the Distribution segment acquired a North American distributor, which added revenue of $57 million. Excluding all acquisitions, third-quarter revenue decreased 7% compared to the prior year, and 8% sequentially.

Currency movements negatively impacted revenues by almost 5% compared to the third quarter of 2011.

In both comparisons, organic growth was lowered due to weaker power generation demand in Europe and in Africa; and in mining markets in the United States and Australia. Sequentially, we experienced lower demand in Australia, Europe and in Africa.

Segment EBIT was $99 million or 12.4% of sales, which includes a $7 million gain from the consolidation of a North American distributor. Excluding this gain, margins were 11.5% of sales, down from 13.3% a year ago. This decrease is the result of currency movements, ongoing investment in our distribution capabilities, and the expansion of our distribution footprint, and some variation in geographic mix.

Sequentially, EBIT margins were relatively flat, with a negative volume impact being offset by lower selling and administration expenses.

For 2012, we are now guiding to 5% growth over the prior year. Growth from acquisitions will be offset by a 3% decline in the base business. This reduction from our previous guidance of north of 10% is the result of weaker international demand, particularly for Power Generation and in some mining markets. And we now expect segment EBIT margins to be in the range of 11.5% to 12% of sales for the full year.

As previously announced, we now project total Company revenues to be $17 billion, a reduction of 6% from last year. Growth in North America on-highway, construction, and power generation markets will be offset by lower demand internationally. And we anticipate a negative currency impact of approximately $450 million in the year, compared to 2011.

EBIT margins for the Company will be approximately 13.5% of sales compared to the 14.2% margin, excluding gains and divestitures, that we reported last year. Despite the lower sales, we expect gross margins to improve by 100 basis points; but this is offset by higher expenses in selling, admin, and in research and development. With research and development costs, for example, up 15% this year, as we continue to develop technologies and products focused on future growth.

Other guidance changes include a lower joint venture contribution, where we now expect joint venture income to decline 8% from last year. Growth in contribution from North American distributors will be more than offset by weaker joint venture income in both China and India. And we now expect our tax rate to be 26.5% for the full year, excluding discrete tax items. The division is driven by lower projected earnings in markets where the tax rate is less than in the United States.

I continue to be pleased with our gross margin performance. Despite year-to-date revenue being relatively flat with the prior year, gross margins have improved by 100 basis points. And if we just focus on the second half of the year, revenues will be $1.5 billion, or 15% lower than the second half of 2011. However, gross margins as a percent of sales will be on par with the second half of last year.

As we continue to manage through this period of elevated uncertainty, we are committed to rightsizing our cost structure, as Tom just discussed. We also remain committed to investments in new products and in expanding our distribution footprint that are important for future growth.

The strength of our balance sheet provides us with the flexibility to make these investments for growth and provide additional returns to shareholders, even during periods of uncertainty. For example, in July we increased the dividend by 25%. Also, year-to-date, we have repurchased approximately 2.3 million shares, and our outstanding share count is 2% lower than this time last year.

In recognition of the performance of the Company and their strong balance sheet, Fitch Ratings Services recently upgraded our credit rating to single-A status. We remain committed to maintaining our strong balance sheet. And, specifically, we are taking steps to improve working capital efficiency in this lower-revenue environment.

During our second-quarter earnings call, we committed to reduce inventory by $200 million by the end of the year. We made a start on this in the third quarter where, excluding acquisitions, inventory decreased by $73 million from the previous quarter. But we know we still have much more work to do on this.

We have taken actions to reduce inventory levels further in the fourth quarter, and I expect us to deliver the $200 million of inventory reduction we targeted back in July. In addition, we have adjusted our capital expenditures and now expect to invest between $650 million and $700 million, down from our previous guidance of between $750 million and $800 million.

Cummins is well-positioned to manage through this period of uncertainty and emerge stronger when growth returns, as we have done before. We have taken actions to address spending, and are prepared to do more if required.

Now let me turn it back over to Mark.

Thanks, Pat. It's now time for our question-and-answer section. I would ask that each caller limit themselves to one question and a related follow-up. And if you have additional questions, rejoin the queue.

Tony, we are now ready for our first question.

(Operator Instructions). Andy Kaplowitz, Barclays.

Good morning, guys. Could you talk about the visibility that we have in the US truck market? The OEMs still -- some of them -- have some decent inventory here. Some of them are talking about increases in production. Some of them are talking about decreases in production. How do you get a handle on that? Do you think, now, we are conservative enough in looking ahead in the next quarter or two, around US truck production?

Well, I'll give a couple high-level comments, and then I'll have Rich talk a little bit about how we get -- we have pretty decent visibility. I'll let him talk about that. Broadly speaking, I'd say we are pretty well -- we have a pretty good handle on how conservative we should be. I feel like we're in the right spot.

I think the truck market has latent demand. I think there are people out there who, if they had more confidence in the future of the US economy, would buy more trucks, and buy significant numbers. There's no question in my mind that, when it turns up, it will turn up significantly. And we'll be able to -- and the whole industry will benefit from that.

But as you said, right now there is -- each of the truck makers is trying to figure out how to find a profitable level of production that works for their plants and also feeds the market at the right level. And, given the uncertainty and the frankly, weakening retail sales, they have all kind of moved around trying to do that.

Rich, why don't you comment about how we understand those movements, and plan accordingly?

Okay, maybe just one additional comment on the longer-term. As I think Tom said, the demand is there, and it's pent-up and it's going to release. So part of what we view is, when it comes back, we're going to be really well-positioned for it. We've put in capacity to meet it. The products are doing well. The fuel economy is good.

So I think, longer-term, when it turns is a bit of your question, when do you see that flip? While we don't know exactly when that is, we like where we are positioned when it happens. In the real short-term, Q3 was a bigger decline, frankly, than we anticipated, and so there was some correction. While the industry had been building more than we were selling; and, obviously, we were building more engines, that correction happened in Q3.

We have pretty good view, in the short-term, what things look like. And we're confident that, through the end of the year at least, that Q4 is going to look a lot like Q3, and there's not any further deterioration that we're looking at. And then, we are not giving guidance today on the 2013, but looking at those macros and say, there will be a turn at some point; and we're just not, right now, predicting when that will be.

Jamie Cook, Credit Suisse.

Hi. Actually this is Andrew Buscaglia in for Jamie Cook. Thanks for taking my question. So my question is actually on China. (technical difficulty)

Andrew, are you on a cell phone? We really can't hear you, I'm sorry.

I am a cell phone. Can you hear me now?

Try your question again.

Sure. The question is on China. Can you give me a little more commentary there? It sounds like things (technical difficulty) and things aren't improving, despite the potential for government stimulus. Can you talk about your thoughts on that region?

Sure. There is no question that China has -- this year, has not met our expectations, the ones we put in place at the beginning of the year. The market was not strong when we started the year. And we knew it wouldn't be a fantastic market. But we anticipated some improvement, specifically in the second half, and we have not seen that. In fact, we've seen, as we mentioned in our remarks, further deterioration.

And part of that is a result of the fact that the capital spending sectors of the economy really have not recovered; and part of it is because of the inventory levels that got built up in the construction market. So not only are the -- is capital spending lower, but there is inventory in the field, and in the plants of the equipment makers, and the excavator market, particularly, that they have to get rid of at much lower retail sales rates. So both of those things have caused our production levels to be lower than we anticipated.

Right now, we don't have a good feel for when it's going to turn back the other way. And we know that the government has planned, and has, in fact, announced stimulus measures to try to get some of the capital projects going in the provinces. But we have just not seen a significant impact on our markets from those efforts to date.

When the last time we were involved in the stimulus, which was not that many years ago, we saw those impacts -- they were significant and they happened pretty quickly. So right now, we're not seeing those and we're not sure when and if we will see them. We are definitely -- it's uncertain to us, and we are planning accordingly. We are planning for markets to remain down for some time.

We don't see it worsening further, but we're not clear when it's going to turn back. We're obviously watching very closely to look for signs for that, but right now we're just not sure. As you may know, in the truck market, there is an emissions hurdle coming next -- the middle of next year. So as we enter next year, we'll have to deal a little bit with the uncertainty around that as well.

What that means with regard to whether they will buy more trucks in the first half because of that, or less; or what will happen -- we just don't know today. But what we do know is the recovery has not started in China, at least not in our markets.

Andrew Casey.

Good morning, everybody. Back on China, quickly, can you help us understand the cadence in Q3 versus Q2? It looks like the contribution decline accelerated to 40% from 35% in Dongfeng. What is driving that? Was that higher expenses? Or is that all volume deterioration?

It's both. Volume is probably the most significant factor. Of course there's a normal, seasonal decline from Q2 to Q3, as you are well aware, Andy. But, of course, things have weakened. But then, we have got some expenses within the [GOV] as we prepare for NS4, the new emissions change. So, some increase in expense as well, but volume is the biggest challenge.

Okay, so the expense for NS4 pretty much should continue through mid-year next year?

Yes, yes.

Okay. Then a technical question; then a longer-term question. But first the technical. On the tax rate, does the annual 26.5%, ex- the discrete items -- and I think you had $29 million year to date -- does that imply something like a 33% rate for the fourth quarter? And then, subsequently, are there any remaining discrete items that could affect the rate in Q4?

The rate for the fourth quarter, Andy, won't be as high as 33%. So afterwards Mark and I can take you through the markets, if you're looking at some numbers there, but it will be much lower than that. We continue to work on our tax planning strategies. It could be some more discrete items in the fourth quarter. But as of now, I wouldn't bank on it.

Okay, thanks, Pat. And then, strategically, we're in the midst of these mining company CapEx cutbacks. How are you viewing those? Is that a short-term thing, and we get on with life one or two years from now? Or is that something more prolonged?

Our view is that the long-term outlook for commodities remains really strong, and I think that's what's going to drive mining. We still believe that to be the case. If you just step back and look at the requirements (technical difficulty) and the big economies that have been growing over the last five or 10 years, commodities still look like they're going to be in demand; and, in fact, in a significant way, there is not enough source.

Our view on mining remains strong, long-run. However, in the short run, what we've got is commodity price drops, especially in coal. Needless to say, the first thing that happens is the ones who are looking at big capacity additions say, well, not now. Don't do it now, because it's a lot of money to put in, and we have more uncertainty about when the demand picks up.

And then the second thing that happens is those that are operating marginal mines start to say, well, I'm at the high end of this cost structure; so, at prices for my commodity drops, this doesn't look so good to keep going.

In the coal side, some of those mines have either reduced production or stopped production. And then the ones that are effective on cost and have good quality keep on going through this time, unless things get really low. And, as I mentioned in my remarks, coal is clearly down enough that we have seen both first-rung and second-rung effects; whereas copper and some of the precious metals have not seen that.

We are kind of in the middle there. We're not as big as the drop we saw last time. But we're definitely -- we've definitely reduced our demand forecast as a result of what's already happening. So we are kind of in between those two. It's possible that there is further reductions if things continue to weaken. But I think, again, long-run, we see the same strength in these mining markets over the extended period.

Jerry Revich, Goldman Sachs.

Good morning. Tom, can you talk about which businesses are seeing the most significant staffing reductions? And are there any permanent changes to the manufacturing footprint as a result? I think you have been looking to shift your genset assembly to India to a greater extent. Is that part of what's happening here?

Jerry, without commenting on specifics too much yet-- because, of course, as you would guess, we need to talk -- we need to go through all the efforts and we need to talk to our employees first, and all that kind of thing. But let me just give you a broad view of it.

All parts of our Company are participating in this cost reduction. Because we are, as I mentioned in my remarks, we are seeing weakness in a lot of markets around the world. If we see reductions in one area, we just deal with that area right away. But in this case, we've got pretty broad reductions in demand. So all businesses and all parts of the Company are participating in figuring out how to reduce cost structure.

In the plants, most of what we're going to do is reduce within the plants we have, and keep largely the same plant footprint. It's not that there will be no changes; there will be. Because we constantly are looking to say how can we use the efforts and downturns to position ourselves strategically more where we want to be for the long run.

So as you mentioned, if we are trying to move more capacity to one area of the world or the other, when we reduce headcount, we will use that as an opportunity to move more towards the production areas that we want to. But, far and wide, we have done a lot of that. And so those effects will be relatively small as compared to, say, just reducing capacity in plants that we don't need as much today; and then, of course, taking cuts across the Company in overhead areas.

The last thing I would say is that we are ensuring that we fund the key product programs and other projects that are going to be critical for the future, while reducing some of those that we can afford to delay for some period, or that we think were -- the least attractive ones, we'll cut those. So we are being pretty specific about those areas we reduce and those areas we continue to fund. And that, of course, ensures that when we come out of this downturn, we will emerge stronger than when we went in.

Adam Uhlman, Cleveland Research.

Hi, guys. Good morning. Tom, just to continue on that discussion, I was wondering if you could -- and I know it's still early, and you're not providing guidance yet. But I was wondering if we could build out a framework of how you are thinking about 2013, in terms of cutbacks and hiring plans? Even just on the domestic truck market, whether or not you think the market might be up or down next year, might be helpful.

Well, as you said, we're not going to do too much in guidance today. Because, as you know, some of those -- once we start down that trend, we are kind of all the way in. But let me just give you a broad feel about how we are planning for it, which fits with my remarks, which is that -- our view is, there's a significant amount of uncertainty in these major markets, and so we're planning accordingly.

We're thinking about the market. We're not counting on the markets to improve. And we're just making sure that we are ready for it to go flat, though the same, go up, go down. All those outcomes are possible from what we see. As Rich commented, in the North American heavy-duty truck market specifically, we are thinking that if things do turn back, they could turn back quite dramatically, given the latent demand that's there.

If we see improvement in confidence in the US economy -- so, fiscal cliff goes away, and some sort of budget deal is struck, and people start to think the US is going right direction -- that could be an instigation for improvement in the truck market. And it could come back pretty quickly. In which case, again, the work that Rich and the engine business have done to prepare for it, I think will serve us well.

But we'll be ready if it doesn't come back that fast, too. That's how we're trying to think about it. And, as Pat said, we'll take whatever actions we need to in whatever area of the Company. If things worsen further, we'll take the actions we need to to be in the right cost position for those activities, too.

I'm sorry I'm not giving you more detail, but we are just planning for -- we are going to set a plan that does not assume a great outcome next year. But we'll be ready if things are stronger than that. And we'll be ready if things are weaker than that.

And we're doing that place-by-place, strategically. What's the most important place to have a quick response capability? Where could we have a little bit more delayed response capability -- and then adjust our cost structure and supply-chain accordingly.

Ann Duignan, JPMorgan.

Hi. Good morning, guys. Tom, could you talk a little bit about -- you talked about really looking at CapEx spend and reevaluating projects. Could you give us some examples of projects that you are moving ahead with, regardless? That you have total confidence in, regardless of what you are seeing out there right now; versus maybe a project or two that you have decided to postpone or push back or reevaluate.

In the interest of not revealing too much about our competitive plans, let me just -- I think I can give you a flavor for the kind of thing. We had a number of projects that were going to drive capacity increases, in preparation for next year or the year after. For example, in China, and we have delayed some of those. We have delayed some of those capital projects which increased capacity further.

On the other hand, some of the product programs that are addressing NS4, which is imminent, as well as some of the product programs that we think have major impacts on our long-term profitable growth -- for example, our new high-horsepower program that we announced -- we are continuing to fund those.

So that at least gives you a flavor. Things that have short-term impact, -- Tier 4, fuel economy staff; the ones that have major growth like high horsepower, those we will continue to fund. Those that have short-term capacity additions; things that we can postpone; projects that might improve our productivity down the road, but cost a lot in the short run; we might delay some of those. IT programs, things like that, we might delay. Those are the ways we are thinking about it.

And as you would guess, in a Company of our size, there are a lot of those to think about. We are, of course, reviewing the major ones with my leadership team. But then each of the leadership teams around the world are taking a look at their projects, and seeing where they sit on all of them.

And all those do, by looking at these programs -- it doesn't just impact capital expenditure. It impacts the demand we have for resources, which means when we have lower demand for resources, we can then reduce the number of resources. Because we have already frozen hiring, so you can't bring in new people; and then, we're reducing headcount, so there will be fewer resources to do the work.

Vance Edelson, Morgan Stanley.

Thanks. Given that you believe there is pent-up demand, and you expect a pretty healthy snap back when it does occur, when we do see that turnaround, you've suggested you will be ready. But just how quickly can you bring back the capacity, bring back the headcount, and so forth? Are we talking a number of weeks or months? Could you just provide some color in that regard?

Yes, I'm going to let what Rich talk about that.

Yes, we're actually able to respond really quickly, especially if you think about the heavy-duty truck demand. The long lead time capacity items -- plant assembly, test cells -- we've got in place; and in fact, we are increasing it a bit, to be ready for that. We've been through this a few times before, and so we know the key suppliers and where the bottlenecks are. And we actually tested the system pretty hard earlier in the year, and so we're doing work with those.

We don't have to go out and buy capital equipment, invest in bricks and mortar; we can bounce back and handle different scenarios of a peak demand pretty well. Our workforce flexes pretty well. And the whole supply base we've worked with does that. I think, really, well -- think in weeks, a month; not longer than that to respond.

And we have one -- as Rich said, we have one of the most flexible plants that at least I've ever been in contact with at in Jamestown. And we have demonstrated, just in 2010, you can go look at the production levels that we talked about in 2010 to see the variation that we can deal with at that plant. And it comes because employees are flexible.

We've figured out ways to bring in temporaries, and let go of temporaries, and other kinds of things where we can ramp up and ramp down quite quickly. And it's a remarkable place in that regard. And then some of our other plants like Rocky Mount, North Carolina, where we serve mid-range trucks, have some of the same capabilities. So, again, it's not something that we could have come to just now. It's something that we have been working at for many, many years to be ready to go up and down.

Rich has also got some supply-chain work he's done to put in some strategic inventory. One of the things that we're trying to do is reduce inventory while still maintaining some strategic inventory to allow us to ramp up in those markets that we think might come quickly.

Steve Volkmann, Jefferies & Co.

Hi. Good morning, guys. Hey, Tom, this is a finger-in-the-wind kind of a question, but if your implied revenue guide for the fourth quarter is down about 20%, do you think all your customer production is down that much? Or how much of that might be inventory reduction across the various end markets?

It's both, for sure, Steve. It is definitely both going on. I mentioned, in my remarks, some places where it's pretty clear that there is some inventory that -- adjustments that went on in Q3. And some of those inventory adjustments are definitely not done. We talked about excavator markets in China, which is the most dramatic case of it, where you've got inventory in the system that is going to extend some time into next year. We don't know how long; it depends on retail rates.

But there's a lot of inventory in the chain there. I talked about Brazil; trucks being another place where retail demand has picked up; inventory has started to drop; but there's no question that there is more inventory to make up. And then we even talked about North American trucks where, what Rich said is, we saw the industry producing at a higher rate than demand was happening in Q3. And so they have adjusted build rates in Q4 to try to balance the two things.

Both are going on, for sure. Even in the genset market, where there is -- some of the big project demand dropped off, there will be some inventory in some places in the field where they will have to clear out. And that will reduce production. So it's both. No question, it's both.

But make no mistake, end markets are not -- in the areas that I talked about -- are not strong. So both are going on.

David Raso, ISI Group.

Good morning. My question, just trying to think of the second-half 2012 run rate. And if you can indulge me in taking us through which markets do you think sequentially second-half 2012, the first half 2013. So at least there is some sense of visibility; it's not a full-year type question. Which markets do you think will be better? Which will be worse? Second half 2012, the first half 2013.

I'll give you a high-level, and Pat may have other comments. But, again, I think that is part of what we're not really clear about. In my remarks what I was talking about is we don't have particularly good visibility about where the markets go from here. And, as I mentioned, we are not assuming that things are going to get a lot better really quickly. So we're building our plan and our actions around the fact that things are not going to improve quickly.

Again, some markets will improve, some markets may not. But right now, our view is that visibility is not very good. And so we're going to assume not a bunch of improvement.

Pat, I don't know if you want to make any other --?

Yes, I'll add a couple of things, Tom. I think much of it is dependent on factors out of our control. So in the US, if we get a decent resolution on the fiscal cliff issue early in the new year, I think that could really help a number of markets in North America. If we point out a bit longer, clearly that's a different scenario.

If you look at Brazilian markets, for example, given the major events that they've got coming up, between the World Cup and the Olympic Games, we know they're behind with significant infrastructure investment. Then you would expect that, at some point, they have to kind of get a move on with that and pick up the pace.

Again, we will talk more about it on our call at the end of the year. And hopefully by then we'll have much more -- a much better view of some of these external factors that can drive it one way or the other.

Eli Lustgarten, Longbow Research.

Thank you. Good morning, everyone. Can I have just one clarification? Somebody asked about the tax rate in the fourth quarter. Since you threw up the tax rate in the third quarter, why wouldn't it be 26.5%, unless you come up with a -- some more discrete items?

Let me take you through it. I may have confused a few people (technical difficulty). The tax rate in the third quarter of 24.1%, that I talked to -- that was the all-in tax rate. So that includes discrete items. The year-to-date tax rate, including all discrete items, is 25.5%. So when we look at the full year, I was giving you a full-year ETR without discrete, which is 26.5%. All-in, it's going to be somewhere between 24% and 25%.

So, Q4 is going to look somewhat similar to Q3 when it comes to tax rate. It might be a little bit lower if we get some of the tax planning we're working on completed by the year. So hopefully that's quantified it a little bit for people.

All right, thank you. Because it was somewhat confusing. My main question is, you just signed a major finalized agreement with Navistar. Do you have any feeling with some guidance of what that will mean for the Company; what impact on revenue or parts or something like that? I assume you won't get anything until fiscal 2013. But can you give us some feeling for what it means?

Yes, it's hard to estimate today, as you've guessed, Eli. Because we understand what products we are doing from them. What we don't know is how quickly those products are going to ramp up and go into the market. Because Navistar's truck, with our engine, will have to compete with the other trucks with our engine, and other engines.

We just don't have a good way to quantify it. Our view is that we are working really hard to be ready on Navistar's schedule to have the 15-liter in the pro start truck; and then, in other trucks that they ask us to put it in. And we're working with equal urgency to make sure that we've got components on their 13- and 11-liter engines so that those are available in the market with SCR systems in next year as well, hopefully by the end of the first quarter.

So we're working with urgency on both things. It is just kind of hard sitting where we are right now to say -- so, what's the estimate of sales or profit for next year.

We've probably got time for one more question.

Andrew Casey.

Good morning again. Question on the heavy-duty truck capacity, given what Eli just alluded to, the Navistar business win. On the engine side. If memory serves, you were running up against some constraints in the first half of the year, mainly the first quarter. If the industry goes back up to those rates, and you have the incremental market share, does that imply that you are adding capacity at Jamestown or somewhere else to support that? I know we are a ways away from that right now.

Yes, Andy, this is Rich. Yes, in fact, we have continued to add capacity through the last 12 months. Of course, even then, while we met demand at that peak, it was pretty hectic. And so, we were operating over our capacity. So we have, again, on all but bottleneck operations -- and in some cases we've added hard capacity or inventory to be able to do that.

So, yes, we have added capacity, really, through last year, and then into this year to meet that increased demand or to be able to meet those peak demands.

I guess in summary, Andy, we feel confident we can meet the peak demand even if it comes next year. And, hopefully, it comes soon next year. We'll be ready to meet the peak demand with our customers that we've agreed to supply. That's part of our commitment to them.

Ladies and gentlemen, due to time, I'm turning it over -- back to Mr. Mark Smith for closing remarks. Please proceed.

Thank you, everyone, for your participation and interest today. Obviously, I'll be available for calls later on. Thank you, and that's the end of the call.