康明斯 (CMI) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2012 Cummins earnings conference call. My name is Darcel and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). I would now like to turn the conference over to your host for today, Mr. Mark Smith, Executive Director of Investor Relations. Please proceed.

Thank you and good morning, everyone. Welcome to our teleconference today to discuss Cummins's results for the fourth quarter of 2012. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; and President of our Engine Business, Rich Freeland. We will be available for your questions at the end of the conference.

Before we start, please note that some of the information that 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 forecasted expectations, hopes, beliefs and intentions on strategies regarding the future. Our actual results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed Annual Report 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 a 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. Now I would like to turn it over to our Chairman and CEO, Tom Linebarger.

Thank you, Mark. Good morning, everyone. I will start with a summary of our fourth-quarter and full-year results and then I will also talk about our outlook for 2013. Pat will then take you through more details of our fourth-quarter financial performance and our forecast for this year.

In the fourth quarter, we made good progress in reducing inventory throughout the supply chain and largely completed our restructuring actions. During our second-quarter earnings call, we targeted $200 million in inventory reductions in the second half of the year. As demand continued to weaken, we made more cuts to production in the fourth quarter. Excluding the impact of acquisition and currency movements, we reduced inventory by $355 million in the fourth quarter for a total reduction of $428 million in the second half of the year. We expect to make further improvements in working capital efficiency this year.

Revenues for the fourth quarter were $4.3 billion, a decrease of 13% compared to the fourth quarter of 2011. Fourth-quarter EBIT, excluding one-time items, was $552 million compared to $677 million in the same quarter last year, resulting in a decremental EBIT margin of just under 20%.

Revenues in the Engine business, Components and Power Generation all declined year-over-year as we experienced weak demand in most major markets. Revenues in the Distribution business were essentially flat year-over-year, excluding acquisitions.

Reviewing 2012 overall, demand in the US started out strong, but weakened as the year progressed. In Brazil and China, we expected a difficult start to the year, but the anticipated improvement in the second half did not materialize with the economies of both countries continuing to slow. After a solid first quarter of 2012, the Indian economy also faltered with the third-quarter GDP the lowest in a decade. Europe remained weak all year as expected and markets in the Middle East and North Africa were negatively impacted by events surrounding the Arab spring.

For the full year, Cummins' sales were $17.3 billion, a decrease of 4% year-over-year. Despite lower revenues, we were able to deliver record gross margins in 2012 due to lower product coverage costs, lower material costs and supply chain improvements. Full-year EBIT margin, excluding special items, reached 13.7% in 2012, a decrease from 14.2% in 2011. EBIT decreased as a percent of sales due to lower joint venture earnings and continued investments in selling, admin and research activity to support the future growth of the Company, which offset improvement in gross margins.

Before I turn to our outlook, I would like to make a few comments about some of our key markets in 2012. Our revenues in North America grew 9%, but this simple statistic doesn't reflect the changes we experienced as the year progressed. After seeing year-over-year growth of 40% in the first quarter, growth slowed to 12% in the second quarter, 2% in the third and in the fourth quarter, revenues actually dropped by 8% as a slowing US economy and decline in business confidence impacted demand across multiple end markets.

The North American heavy-duty truck market reached approximately 250,000 units in 2012, an increase of 9% over 2011 levels. Our full-year marketshare was 39%, up from 38% the year before and we delivered a record number of ISX15 liter engines in 2012. The US medium-duty truck market reached approximately 107,000 units in 2012, an increase of 9%. We continue to be the market leader in medium-duty truck engines with a marketshare of 52%.

We enjoyed very strong demand from Chrysler for the Dodge Ram with engine shipments increasing by 37% year-over-year. In December, we delivered our 2 millionth engine to Chrysler reflecting the successful partnership between our two companies and the strong customer demand for the Ram truck combined with the Cummins engine.

In our Power Generation business, demand in our traditional market segments, including nonresidential construction, softened in the second half of the year. Fourth-quarter sales were actually down 19% year-over-year as the US economy slowed. The weakness in our traditional markets was offset by growth in sales of generator sets to the US military.

Our international revenues decreased by 15% in 2012 with the most significant declines in Brazil, China and Europe. In Brazil, our revenues declined 38% driven by the weaker truck market. Industry truck production declined by 37% as a result of the weakened economy and the impact of the transition to Euro 5 emission standards.

Full-year revenues in China, including joint ventures, were $2.6 billion in 2012, a decrease of 20% year-over-year. The Chinese construction industry continued to experience weak demand for new excavators through the end of 2012 with fourth-quarter sales of excavators down 25% year-over-year. Full-year industry sales declined 35%, in line with our previous guidance. There is still a significant overhang of inventory both in distribution channels and at OEMs that will dampen new equipment production in 2013 even after the end markets begin to recover.

The truck market in China for medium and heavy-duty trucks combined declined by 21% for the full year as the slowing economy impacted the utilization of existing truck fleets and depressed demand for new trucks. Demand for trucks stabilized in the fourth quarter. Demand for Power Generation equipment declined sharply in the second half of 2012 as the Chinese economy slowed. Full-year revenues declined 15% year-over-year. As a reminder, revenues in 2011 were boosted by widespread power shortages in the country.

Full-year revenues in China, including joint ventures -- sorry -- in India -- full-year revenues in India, including joint ventures, were $1.5 billion, down 10% due to weaker truck market and the impact of the depreciation of the rupee against the US dollar.

The truck market in India weakened significantly during the second half of the year with full-year industry production declining by 14% to 318,000 units. A slowing economy, coupled with the government's decision to eliminate fuel subsidies, negatively impacted truck demand. Talking the economic trends, Power Generation sales remained strong all year due to widespread power shortages with full-year unit growth of 18%.

In Africa, our revenues for the full year, excluding currency impacts, were flat year-over-year, which was disappointing. We made good progress in Ghana, almost doubling sales year-over-year. In Angola, we also generated growth. However, it took longer than anticipated to get our new Angolan distribution business operational. So we fell short of our targets for the year. We also fell short of plans in Nigeria.

It is early days for us in our strategic efforts to build capability in Africa, but I'm confident that with the additional investments we have made in people and training that we will deliver better performance in 2013.

We also experienced weak demand both in Europe with total revenues down 13% and in the Middle East where revenues declined 11%. In both regions, our Power Generation business was the most negatively impacted. Now I would like to provide our overall outlook for 2013 and then comment on individual regions and end markets.

Due to continued weakness in developing economies and continued uncertainty in the US, we are currently forecasting total company revenues to be flat to down 5% in 2013. We expect EBIT to be in the range of 13% to 14% of sales. In North America, we expect our on-highway business in the aggregate to be relatively flat to 2012. Shipments to Chrysler are projected to decline 10% following a very strong year in 2012 as Chrysler manages a new model changeover beginning in the first quarter. We forecast the 2013 market size for heavy-duty trucks to be 240,000 units, a decrease of 4% year-over-year with our marketshare projected to be approximately 40%.

In the medium-duty truck market, we expect the market size to increase slightly to 109,000 units and we expect to maintain our marketshare at 52%. In China, we expect domestic revenues, including joint ventures, to increase 5% in 2013. We do not expect growth in sales of our engines to excavator OEMs as the industry needs to work through high levels of equipment inventory. If there is a strong spring selling season and construction equipment, industry equipment levels will fall -- excuse me -- industry equipment inventory levels will fall, but demand for new production will still lag until inventory levels throughout the supply chain are reduced and market confidence increases.

We expect the market size for heavy and medium-duty trucks in China in 2013 to be similar to 2012 levels. As you are aware, there is an emissions change scheduled for July 1, 2013 with the planned introduction of National Standard 4 or NS4, which is roughly equivalent to the Euro 4 standard. Based on our discussions with Chinese regulatory bodies and industry participants, we remain confident that NS4 will be introduced on July 1.

Encouragingly, the only engines to receive certification of the NS4 standard so far are electronic engines, which contrast with the Euro 3 when both mechanical and electronic engines were approved, which contributed to a difficult and lengthy transition to Euro 3. In major cities in China, you can now find urea tanks and pumps at some fueling stations, but these are not yet widespread.

Despite these encouraging signs, it is not clear how broadly and how quickly the new regulations will be adopted. The current order board for the first quarter and OEM forecast for the first half of 2013 do not suggest a pre-buy prior to the introduction of NS4 providing strong indication that the market anticipates inconsistent enforcement at least initially.

In India, we expect total revenues, including joint ventures, to be flat year-over-year. Demand for Power Generation equipment remains strong due to ongoing power shortages and we currently project unit growth of 12% and revenue growth of 9% in 2013. In the commercial vehicle market though, we are now anticipating industry sales of 303,000 units.

In 2012, the Indian government increased excise taxes on commercial vehicles and last September announced the removal of fuel subsidies that effectively increased the price of diesel by 14%. Only this month, the government announced further declines in fuel subsidies that will increase consumer fuel prices by a further 15% over time. We expect these further actions will negatively impact truck sales, especially given the sluggishness of the overall economy.

(technical difficulty) very challenging 2012. Although truck production has been slow to recover in 2012, we did see industry retail sales exceed industry production in the fourth quarter for the first time in more than a year. The industry ended 2012 with a truck inventory of 66,000 trucks, down significantly from 114,000 at the end of 2011 and consistent with the levels experienced in 2008 through 2010.

The Brazilian economy appears to be improving slowly and we expect demand for engines and aftertreatment systems to improve steadily through the year. In Power Generation, we expect demand to increase by 9%, driven by infrastructure spending and ongoing grid reliability issues.

In Europe, it's hard to see a catalyst for growth in the near term given the weak euro zone economy and austerity measures planned in multiple countries. Our business with the largest exposure to Europe is Power Generation and our largest individual customer in Europe has already announced significant cuts in capital expenditures.

I think it is also important to comment on our global mining business. Typically, during a down cycle in mining activity, we observe three successive phases of adjustment to mining operations by industry participants. First, the mining companies announced cuts to future capital expenditure plans, which has little or no effect on current orders. This happened, of course, during the first half of 2012.

Second, we experienced cancellations of existing orders for mining equipment OEMs. Third, depending on the depth of the downcycle, we see a decline in aftermarket revenues as equipment is used less and service work is deferred. During the second half of 2012, we observed all three phases of adjustments to mining activity.

In the fourth quarter of 2012, our shipment of engines for mining equipment declined by 30%, driven primarily by weaker demand from international markets. Our aftermarket revenues decreased by more than 10% in the fourth quarter with lower demand for parts and engine rebuilds.

We currently have a very weak order board heading into the first quarter of 2013 and we anticipate that our total mining revenues, including aftermarket, could decline by as much as 25% for the full year. We do know that when confidence improves, the business can come back very rapidly and we will be ready to meet increased demand when it returns. But at this time, the outlook for our mining business is the weakest of any major end market that we serve.

2012 proved to be a challenging year with marked change in business conditions in the second half of the year, but we have a very experienced leadership team at Cummins that is well-versed in managing through periods of volatility. We start 2013 with a high degree of uncertainty about business conditions in several markets, but the work we have undertaken to reduce costs and lower inventory should benefit the Company when the global economy improves.

I would like to acknowledge the contribution of all of our employees around the world for their hard work in 2012, for their support and agility reacting to the changing market conditions and for their efforts to reduce costs and still meet our commitments to customers and shareholders.

Finally, I would like to thank our customers for their continued confidence in Cummins. Thanks for your interest today and now I will turn it over to Pat who will cover our 2012 performance and 2013 guidance in more detail.

Thank you, Tom and good morning, everyone. As Tom described, we faced challenging conditions in many of our markets in 2012 with demand reaching across a number of geographies and end markets in the second half of the year. We responded to the changing market conditions with a number of actions that were intended to reduce costs and positioned the Company to deliver a stronger financial performance when market conditions improve.

Specifically, we reduced discretionary expenses as evidenced by the reduction in operating costs in the fourth quarter. We largely completed our restructuring actions by the end of 2012. We aggressively lowered build rates at the manufacturing plants, which allowed us to reduce inventory by more than $400 million in the second half of the year, excluding the impact of acquisitions and we maintained our investments in product development and critical growth initiatives.

Full-year revenues for the Company were $17.3 billion, a decrease of 4% over the prior year. Despite the lower revenues, we were able to deliver record full-year gross margins of 26.2%, an increase of 80 basis points over 2011 as a result of lower material and supply chain costs, improved pricing and ongoing cost-reduction initiatives in our manufacturing plants.

Selling, administration and research and develop costs increased by $139 million in the year with over two-thirds of the increase relating to research and development investments. And joint venture income was down $32 million compared to last year, reflecting the weaker markets in China.

In total, earnings before interest and tax, or EBIT, excluding the restructuring charge in the fourth quarter, was 13.7% of sales in 2012, down from 14.2% of sales, excluding the gains from the divestiture of two businesses and from the flood insurance settlement in the previous year.

Net income was $1.66 billion, or $8.74 per share. Excluding restructuring charges and gains from divestitures, net earnings were $1.7 billion, or $8.90 a share. This compares to $1.75 billion, or $9.07 a share in the previous year, excluding the gains from the divestiture of two businesses and from the flood insurance settlement. The operating tax rate for the full year was 26% with one-time items reducing this to an [all-in] rate of 23.6%.

Now let me comment specifically on the fourth quarter and provide some more details on our performance. All the numbers and comparisons exclude the $52 million pretax or $35 million after-tax restructuring charge that we took in the fourth quarter of 2012 and the gains from the divestiture of two businesses and from the flood insurance settlement in 2011.

Revenue of $4.3 billion was 13% lower than the previous year, but increased 4% from third-quarter levels. Compared to the prior year, North American revenues were down 8% as a result of a decline in the heavy-duty truck market and the oil and gas market, partially offset by increased shipments to Chrysler and in the North American bus markets.

International revenues were down 18% due to weaker demand in the Brazilian truck market and lower demand for Power Generation, construction and mining equipment. Quarter-over-quarter growth was driven by increased revenues in the Distribution business primarily from the impact of acquisitions and from some improvement in North America, Europe and in Africa.

Despite the drop in volumes, gross margins for the quarter were slightly higher than a year ago at 25.3% of sales with improved pricing and lower material costs offsetting the impact of lower volumes and higher product coverage costs. Sequentially, gross margins were unchanged from the prior quarter with cost reductions, both material and operating costs, offsetting increased product coverage costs and an unfavorable product mix.

Selling, admin and research and development costs decreased compared to both the prior year and the prior quarter as we saw the benefits of reduced discretionary expenses and other cost adoption actions. Costs decreased by $42 million, or 6%, compared to the fourth quarter of last year and declined $9 million or 1% sequentially.

Joint venture income was $82 million, 19% lower than the prior year and 13% lower than the prior quarter. The year-over-year decline was driven primarily by lower volumes at our Engine joint ventures in both China and in India. The sequential decline was driven by lower earnings in North and Latin America distributors.

Earnings before interest and taxes were $552 million, or 12.9% of sales, down from 13.8% a year ago, but up from the 12% we reported in the third quarter. The significant drop in volume, along with weaker joint venture earnings and higher warranty costs as a percent of sales, were the most significant drivers of the lower EBIT margin. Sequentially, EBIT margins improved due to both lower material and operating costs. Net earnings for the quarter, excluding restructuring, were $416 million, or $2.21 per diluted share, which includes a one-time tax benefit of $0.21 per share.

Moving on to the operating segments, let me highlight their performance in the fourth quarter and conclude with the revenue and profitability expectations for 2013. In the Engine segment, fourth-quarter revenues were $2.5 billion, down 18% compared to last year and a decline of 1% compared to the fourth quarter. Compared to the prior year, stronger demand for bus and light-duty engines in North America was more than offset by reduced demand in the Brazilian truck market, heavy-duty truck (technical difficulty) markets in North America, global construction and in international mining markets.

Segment EBIT margins were 10.9% in the quarter compared to 12% last year and 9.5% in the prior quarter. Compared to the prior year, lower volumes and weaker joint venture earnings negatively impacted the EBIT margins, partially offset by improved pricing and lower material cost. Compared to the third quarter, improvements in material and manufacturing costs and lower spending contributed to the improvement in EBIT margins.

In 2013, we expect revenues to be down 5% and EBIT margins are forecasted to be in the range of 10% to 11%, down from 11.8% for the full year of 2012, but an improvement over second-half 2012 results. Lower volumes with a less favorable product mix, along with higher warranty rates and lower joint venture income, are the key contributors to the year-over-year margin growth. These will be partially offset by material cost, pricing and supply chain benefits.

In the Components segment, fourth-quarter sales were $939 million, down 14% over the prior year, primarily driven by reduced demand in the North American heavy-duty truck market and lower demand in Europe, partially offset by increased demand for aftertreatment systems in Brazil following implementation of the Euro 5 emission standard.

Sales were flat compared to the third quarter with no significant changes in any individual markets. EBIT margins for the quarter were 8.9% of sales compared to 12.1% in the prior year and 9.5% in the third quarter. The decrease in margins over the prior year was driven by lower volumes and increased investment in the technical spending to support future growth. Compared to last quarter, increased spending on research and development on flat sales negatively impacted margins.

We expect revenues to be up 2% in 2013 with increased penetration of aftertreatment systems in the North American heavy-duty truck market and growth in the Brazilian medium-duty truck market being offset by weaker demand in the truck markets in both India and in Europe. EBIT margins are expected to be in the range of 10.5% to 11.5% of sales with lower material costs and supply chain savings being partially offset by increased technical spending and product coverage costs. This compares to 10.8% for full-year 2012 and just over 9% in the second half of the year.

In the Power Generation segment, fourth-quarter sales were $765 million, down 17% from last year due to lower demand in Europe, the Middle East, Latin America and China, partially offset by better demand in North America. Sequentially, revenues declined by 6% due to weaker demand in China, Europe, the Middle East and in Africa.

EBIT margins were 7.1% of sales in the quarter compared to 9.5% in the prior year and 9% last quarter. Compared to last year, margins declined due to lower volume and increased technical spending focused on new products. Sequentially, margins declined due to lower volume and lower joint venture income.

For 2013, we expect Power Generation sales to be down 3% primarily due to continued weakness in Europe and in the Middle East with EBIT margins in the range of 9% to 10% of sales. This compares to 9.1% for full year of 2012 and just over 8% in the second half of last year. Positive pricing impacts, as well as productivity improvements and targeted actions to reduce overcapacity in some parts of the business, will drive the majority of the margin improvements.

And for the Distribution segment, fourth-quarter revenues were $907 million, an increase of 9% over the fourth quarter of 2011, which is mainly driven by acquisitions. Revenues increased 13% over the prior quarter due to acquisitions and some growth in [whole good] sales in North America, Europe and in Africa.

EBIT margins for the quarter were 10.8% of sales compared to 10.4% a year ago and 12.4% in the third quarter. Compared to the prior year, margins improved due to lower spending, partially offset by weaker joint venture income. And compared to the third quarter, margins were impacted by lower joint venture income and a mix shift away from aftermarket towards whole goods.

For 2013, we are forecasting 10% growth in revenue over the prior year, including the impact of acquisitions and expect EBIT margins in the range of 11.5% to 12.5% of sales. As Tom mentioned, we are now projecting total Company revenues to be in the range of flat to down 5% in 2013. We expect a challenging first quarter; however, based on improving economic data points in some regions, we do expect demand to start to improve in the second quarter and be up year-over-year in the second half of 2013.

Tom has already covered the assumptions for a number of key markets in 2013 and you can also refer to our earnings presentation for additional information.

We expect EBIT margins of between 13% and 14% for 2013 and this compares to 13.7% for full-year 2012 and 12.5% for the last six months of the year. We remain focused on driving improvements in the gross margin in 2013 despite the relatively weak revenue outlook. Gross margins are expected to benefit from price realization of between 0.5% to 1% from lower material costs of approximately 0.5% based on current assessments and 0.2% from our supply chain initiatives. Offsetting these items will be higher warranty costs and an adverse product mix within the Engine business. We are currently projecting our tax rate to be approximately 26% in 2013, excluding any discrete items.

Finally, let me turn to the balance sheet and cash flow. We generated $1.5 billion in cash from operating activities in 2012 and continue to use that cash to reinvest back into the Company and return value to our shareholders. We have raised our dividend by 25% in 2012 and the Board recently authorized an additional $1 billion share repurchase plan. Our pension plans remain very well-funded and our debt-to-capital position at the end of the year was 10%.

Our strong balance sheet allows us to continue to invest in the business and return value to shareholders. We invested $690 million in capital expenditure projects in 2012 and expect investments of approximately $850 million in 2013. Key projects include continuing the development of new high horsepower engines, on-highway natural gas engines and investing in our global technical centers, which will allow us to maintain our position as a leader in emissions compliance and in fuel efficiency.

Finally, I wanted to share with you that we will hold our Analyst Day on September 17 at the New York Stock Exchange. Now let me turn it back over to Mark.

Thanks, Pat and operator, we are now ready for questions. If you can please ask one question and keep it to one related follow-up, we are fine with one related follow-up. Thank you very much.

(Operator Instructions). Stephen Volkmann.

Hi, good morning, guys. I am wondering, Tom, if we could ask you to go a little deeper on some of your end-market outlooks here. You talked about mining; very helpful. What about things like oil and gas, ag, construction? Just maybe go around the horn a little bit and tell us kind of what you are seeing and thinking here.

Yes, so oil and gas, we continue to see weakness in the US. That hasn't changed really. We are still at gas prices, which are -- slow down the fracking business significantly. It has improved a little recently, but not enough to move the number. So we are still seeing weakness -- as a matter of fact, we will see it weaker year-over-year. I think it is about 10% down year-over-year.

In China, we are seeing a little bit better. That is a small number for us in relative terms. The US is still our largest market, so it doesn't -- in no way -- goes to offset it. But we are seeing outside the US some increased activity, but overall it is down year-over-year for us in oil and gas.

Construction is basically flat. We did see some improvements in construction markets in the second half of the year, in the US anyway. China, you got to hear all my China remarks. A pretty rough year in China and there is a lot of talk now about a strong spring selling season in China and that would be awesome. It is not going to do enough, we don't think, to change engine demand because you have got to get rid of inventory in the field, you have got equipment inventory and engine inventory and by the time you get rid of all that, it is going to be a real monster spring selling season to really get demand for engines moving in the near term. So our view is it is going to be pretty weak.

You asked about ag, which is a pretty small market for us, but, Mark, do you have any comments on ag?

It is improving a little bit in Latin America. It's a relatively modest piece of the business.

Anything else, any other markets, Steve?

That's probably good. Thanks. Maybe I will just ask my related follow-up. Pat sort of mentioned 1Q would be the weakest. I think we all kind of expect that, but any more color you would like to give us or are we on our own there?

I will give a little bit more color. I think as we looked at the year, clearly, it is going to be the opposite of what we experienced in 2012 where the first half of the year was very strong and then as you heard from Tom, second half was relatively weak. As I look into 2013, and if you go to the midpoint of our guidance, it would not be unreasonable to think first-half sales could be down in the range of 10% year-over-year and obviously first quarter will be more challenging than that, but then we would expect some recovery in the second half. So second half would be up somewhat, maybe 5%, compared to the second half of last year.

Thank you very much.

Tim Denoyer, Wolfe Trahan.

Good morning. I guess a couple of questions around North America Class 8, if I could. Are you expecting marketshare for 2013 to be roughly flat and did you see, in the fourth quarter, any customer inventory build ahead of the new ISX that launched in 2013?

Yes, this is Rich. Didn't see much of a pre-buy at all, [so] much customer build, so don't see any overhang there. As Tom said, we are projecting 40% and you ought to think of that as relatively flat, but probably a little better second half of the year than first half of the year. We ended the year at about 37% this year, so we were 38% a year ago or two years ago. We were at 39% last year and now we are projecting 40% this year.

Okay, and that 40% includes -- can you give a sense of what it includes for Navistar?

No, we won't comment on the specifics there.

One way to think about all this, we have talked about this before, but what we have got, of course, is different shares at different OEMs. And so part of our goal is to be available in more OEMs. And of course, our business with Navistar helps with that and the other thing we are trying to do is help those truck suppliers who are selling more of our stuff win more in the market. So a lot of it has to do with how they do in the marketplace.

And so we are, of course, trying to drive more PACCAR trucks with Cummins engines in it and more Freightliner trucks with mid-range engines and so we are trying to drive those sales and help those customers using our engines sell more trucks and that mix also affects how you see our marketshare. So that is why, even though we gave you the number for the full year, in fact, as Rich said, our fourth-quarter marketshare was 36% or 37% and the full year was 39%. That is just the mix of what gets sold changes quarter-to-quarter.

Thanks very much. I will get back in line.

Jamie Cook.

Hi, good morning. Two questions. I appreciate the top-line (technical difficulty) who knows what is going to happen in the macro, but I guess if I were to push, which markets do you feel like have the potential for more upside relative to sort of what you are guiding today? Just based on anecdotally what you're hearing from customers and just your sort of own view of the market?

And then I guess my second question relates to the margin guidance and just margins longer term, Pat, I was impressed with the margins you put up in the quarter given the environment that you are in. And as I think about the inventory issues going away and I think about some of the restructuring that you did and potentially volumes getting better, I don't know, the low end of the margin guidance doesn't seem realistic to me. So can you sort of help me through that and then just sort of help me thing through how I should think about incrementals assuming markets do improve? Thanks.

So I can make a few comments on the markets and Mark might have a few to add. Obviously, from our point of view, we tried to cull the markets in the middle and not to be overly negative or overly positive. So I guess my broad view, not to be glib, is that all of them have a chance to overachieve and many have a chance to underachieve. And the reason I -- we don't have very good visibility is the truth. If we look out today, we expected second half of last year to see improvements in most developing economies and we did not see them.

As you know, in our previous calls, we were consistently disappointed, especially by China. We thought, as the new government got seated in, we would see some improvement and we did not see that. We saw a stabilization in the truck market by the end of the year, but it was a pretty rough year for every one of our major markets in China.

Brazil we already talked about. Things seem to be going the right way and they could go the right way a little faster; that would be awesome. We would benefit from that. And of course, the big economies that can really make a difference in our business are the US and China. If the US -- if we get our act together on budget issues and confidence builds -- I mean it is not just about the budget, but it is about general confidence in the US and if China kind of gets its economy back going again, I think that not only helps us in those markets, but I think it drags a whole bunch of these other markets with them, including Brazil.

So there is some really good upside if we get the two biggest economies going and I think the reverse is also true. If we stay stagnant and figure out ways to decrease confidence in the US, which we have been very good at over the last 12 or 18 months, we could see worse results. And so we are just trying to say, hey, we think it is going to be about like it was because we don't really have a better picture. I realize that is not a terrific look at it, but there you have it.

That was still helpful. That was helpful. And then just on the margins?

Margin, yes.

So let me spend a couple more seconds in the margin and then maybe let (technical difficulty) EBU, our Engine business. So if you look at the total margin outlook for the Company in 2013 versus the second half of 2012, we improved from 12.5% to between 13% and 14%. And given the midpoint of our sales guidance based on what we are seeing is that second half is going to continue all the way through 2013. Now it will be definite in the first half/second half, but, for the full year, that is the rate we're running out.

So on flat sales, we are seeing improved margins not just for the Company, but in each of the four operating segments too. The one segment that is probably under more margin pressure in 2013 is the Engine segment and I talked through some of reasons in my (inaudible) comments, but we are seeing lower volumes and we are seeing an unfavorable mix as we see a drop in higher horsepower engines in mining, oil and gas, and Power Gen markets. We are expecting warranty rates to be higher in 2013 and that is due to the launch of the new 2013 engines.

We always tend to take a more considered or conservative view when we launch new engines and the warranty rates will definitely be higher and we are expecting lower joint venture income with the startup of some new joint ventures in China and in South Korea. So all those factors can play into the Engine segment being a little bit lower than what you were maybe thinking. Rich, is there anything you wanted to add there?

I think you covered it all.

So again, Jamie, we are not really taking a conservative view there either. I mean we have done the math and said we think -- as you know, we think deriving margins on flat sales and certainly on up sales is our job as management. So we have worked very hard on that in our guidance to say we expect to drive better margins on flat sales or even slightly down sales, but there are a couple of trends there that Pat highlighted to you that are real that we are going to have to manage and you know the formula we drive on warranty.

When we launch a new product, we just push up the rates. We don't have any experience, we just push them up. That is what we do and then as we deliver the product and we get better results than our projected rates, we'd bring them back down. Again, we do that every time and our last set of launches in heavy-duty, we had great results there because we had good launches and we expect the same in 2013, but we have to let the numbers play out and we have to let the process play out. That is just the thing we do.

The other part of your question, Jamie, when you were asking for some comments on long-term incremental margins, I don't think we have changed our position on that at all. Over the long term, 20% incremental EBIT margins is still the target for the Company.

Okay, thanks.

Just one last thing. We are, Pat alluded to it, but we are continuing our investment and in fact, it ramps up on flat to lower sales on some of the big growth initiatives. So like the high horsepower engine, for the fuel economy improvements, or additional Tier 4 for fit-for-market. So we are continuing the investment on the [R] side, in fact, increasing it in 2013.

That's not just unique to Engines, it is also true for Components as well.

Rob Wertheimer, Vertical Research Partners.

Hey, good morning, everybody. One just sort of, I guess, structural question on how you approach the restructuring that you did. Did you worry that you might just be adding back people in 6 or 12 months and there is a frictional cost to both the actual termination expense and the training and retraining? Were you thinking about a two-year issue when you did this or how do you approach it?

Rob, I always worry about that. I think it is always a risk in any cyclical business that you take costs bringing people on and then when you reduce them you pay again and have to bring them back on. And we experienced some of that in the '08/'09 downturn. The issue is, in each time these things come, you don't really know how long they are going to last. So there is a part of our business where we have quite flexible arrangements in our plants that allow us to bring people on relatively quickly and with very low frictional cost and those are -- those we manage well and we have no issues.

With professional, especially engineering, people and things, that sort of issue is much more complicated. The way that we try to think of it is we always make sure that we deal with the part of our workforce where we think there is performance issues or they are not doing as well as we had hoped they do or they are not a good fit, we do those first and that way, we don't -- while there may be frictional costs, we feel like we are always trading up.

And then the second thing we do is look and say how long do we expect the downturn to last and based on that, how much action should we take and it is always a judgment call. We have made as best a judgment we could in this last reduction, set of reductions. Again, that was kind of related to my comment that many of us have been through this four or five times over our career. It is not that it is fun anytime, but you just get a little better at making the judgments the more times you have to do it.

Okay, that was helpful. And this is my second question. To the extent you can, are you able to comment on Dongfeng and the developments there with the JV partner? Do you see any medium-term risk of engines being switched out?

Yes, so that announcement -- Dongfeng announced a partnership they are doing with Volvo and I think you probably know this, but we have been partners with Dongfeng for more than 25 years now. Matter of fact, the year before last, I went out to their 25th anniversary and a whole bunch of our leaders celebrated with a bunch of theirs and we realized that, over the course of that time, they have had multiple partners, they have continued to buy engines, make engines themselves during that entire 25 years and bought engines from others over that 25 years. Unfortunately, despite my best intentions, I can't -- most of my customers decided they are going to buy from some other people and make their own as well; that is not different for them.

So really there is not a big strategic shift here. I mean it is -- we would (technical difficulty) strategy in any of those 25 years and what is more, they have global intentions for their truck business and they need partners to help them with that. So they are thinking about their truck business and how they want to grow that and so they think Volvo is a good partner for them.

In the near term, here is a couple things -- and medium term -- here's a couple things to think about. We now have roughly 60%, a little under 60% share at Dongfeng. So we are very successful in getting our engines into their vehicles. We sell to nine different divisions of Dongfeng, so we sell all over and in fact, we launched four new -- into four new vehicles last year. So we added more vehicles last year and every year, we add more vehicles among those multiple divisions. And we are continuing in engineer in new trucks now.

So not only is it going to take a while for that joint venture to even have products that may be competitive; in the meantime, we will not sit still because we think the way we win with all of our partners no matter they make their own or partner with other people is that we have a better product. They win more by working with us than by other means. We never get all the exclusive, we are the only one choice. So we are always looking to say we are going to beat them on results.

So yes -- so, I guess, always those partnerships have a potential for threat, but, in our view, this is not a significant change and we are continuing on with our strategy and still see pretty good results in the future with Dongfeng.

That's great. Thank you very much.

David Raso, ISI Group.

Hi, good morning. It's regarding the use of the balance sheet. The last couple quarters combined, the share repo was only a total of $70 million. I know the authorization was getting a bit low, but it was still, I would have though, able to be more than that and obviously, now, you have the $1 billion new authorization. So I am just trying to think of the use of the balance sheet because you are roughly looking at a Company free cash flow of $1 billion. You can pay your increased dividend and the JV investments and still have $500 million a year to invest or pay back to shareholders on top of the starting point here as your net cash is already $900 million.

And we can't describe it as, well, you are leaving money on the table maybe for big CapEx expenditures in the future because you have already been spending a lot on CapEx. The last couple years, CapEx has been almost 200% of D&A. The guidance for '13 looks like CapEx again 200% of D&A. So you're definitely putting money to work there. The use of the balance sheet, can you explain, now that we are starting a new year, how are you thinking about that, Pat? It just seems like the authorization of even $1 billion should be something you should be able to utilize this year and raise the dividend and still be underleveraged.

Yes, thanks, David. I don't think there is any change in our look how we think about using the balance sheet, using the cash we generate from what we've talked about over the last few years now. So you'll recall that we've talked about reinvesting between 60% and 70% of the cash we generate back into the business when we see profitable, good profitable growth opportunities. We are clearly doing that.

Our pension plans are very well-funded and as we look forward, we will only have to put 5% to 10% of the cash we generate into those plans to keep them well-funded and that allows us then to return around 30% of the cash we generate back to shareholders. And we do that through increasing the dividend and over the last three years, we have effectively tripled the dividend. So we are pleased with the progress we are making there. Not done, but we are pleased with the progress.

And on stock buybacks, we go into each year with a nominal target to reduce our outstanding shares by 1%. If you look at just the average number of shares we had in 2011 and compare that to the average number shares we have in 2012, we actually came down by 2% over the full year. So I think we are doing exactly what we said we would do with regards to using our cash and using our balance sheet. I know the balance sheet is strong -- we are determined to keep it strong. I mean we have to be able to move fast when opportunities arise and we see promising growth opportunities. But, at the same time, when market conditions turn and economies turn as they have, we have got to be able to continue to fund those most important investments the Company is making.

I guess, at the end of the day, everything you described just kind of asks the question why, why the balance sheet that strong? What opportunities are you thinking about? Just because you don't want somebody else thinking should we be leveraging this balance sheet for you. I'm trying to understand why the balance sheet (multiple speakers) this level.

It is a super question, David. Again, what we are trying to do is develop a use of cash that we think serves shareholders over time the best. And again, Pat laid out the formula, I won't lay it for you again, but that formula we think adds up to the best answer. And again, we decrease cash year-over-year, so it is not like we are trying to build up a -- we are not -- we don't have a targeted amount we want on the balance sheet; we just want to have enough to operate. And then as we -- if we exceed our expectations, then we, as Pat said, we have more than to put into that formula and return to shareholders.

So whenever we have more cash, we will look at exactly that formula to say how do we return it to shareholders and our view -- we are not waiting up for anything, we are not storing up for anything, we are not planning any big acquisitions. Nothing has changed there. All we are trying to do is make sure that we have a good conservative structure on our balance sheet so we can go up and down. And by the way, with regard to even the leverage point, if we had a good use of proceeds to borrow and lever more, we would be happy to do so. We do not feel like our leverage position is stuck where it is. It doesn't have to be debt-to-capital of 10%; it could be higher.

And we have a view on that -- of what it could go up to. It is just that we don't have a good use of proceeds to borrow today, so we think we are where we need to be on the balance sheet. It is a good set of questions by the way and one we ask ourselves all the time should we be doing something different and right now, we think we are in a good spot.

Okay. Thank you very much.

Jerry Revich, Goldman Sachs.

Good morning. Tom or Mark, on National 4 standards in China, I guess, in the past, you have spoken about providing engine customers several aftertreatment product options for those standards. And I'm wondering if you can give us an update on how that is going and how optimistic are you on your ability to get your aftertreatment product on non-Cummins engines in China.

Those developments are going well. We feel very optimistic that we will have our aftertreatment on other engines. I think you know we have started doing work with Dongfeng. That is one of the new platforms we got going with them where we will provide their engines with some aftertreatment. I mean I think our big, as I mentioned in my remarks, our big concern in the short run is what is the implementation rate of NS4. We feel very good about the engineering and where our products are and our customers' interest in the product. The question is to what degree will adoption occur, especially in the early quarters, in Q3 and Q4, how much is there going to be.

I mentioned the approval of electronic engines is really good. That means at least the products are ready to take on aftertreatment and that was a real mixed bag back in the NS3 period. But how fast they will put them on, what will enforcement look like, that is still a lot in the air. And again, I don't mean to say I know the answer, but the early signs of pre-buy and other things aren't particularly good that adoption rates will be high in the early period.

Sure, thank you. And in a similar vein, can you talk about your capacity utilization in your US aftertreatment facilities? You've continually picked up share since 2010 and I am wondering do you have enough roofline capacity in place if you were to pick up meaningful additional share in medium-duty engine platforms?

Yes, we will be fine. We feel good about capacity. As you know, we have a very strong partnership with Faurecia, who does the stamp parts. We have good assembly capacity with them. We also have been building up our capacities to engineer and develop more products and that has really been the bottleneck as opposed to production capacity is making sure we can get enough folks on the development side with knowledge and capability to run the different programs we have. And again, so far, we are managing that, but that is our tightest spot.

Thank you very much.

Ann Duignan, JPMorgan.

Hi, there. It's Mike Shlisky filling in for Ann today. Hey, just wanted to touch quickly on your natural gas engines, your CNG and LNG engines. Can you update us perhaps on the development of your 15 liter spark-ignited engine that you guys have been talking about, as well as how it is going with the 12 liter that was going to be launching with Cummins Westport at sometime in 2013, as well as your maybe you overall view of how the natural gas truck market is kind of shaping up in like the US and Canada?

Hey, Mike, this is Rich Freeland. I'll start with the 12G, so we will go into production as planned in April and through the year, we will add more ratings. And so we will start with the 350 horsepower. By August, we will have the full line of ISX 12G through the Cummins Westport joint venture in place.

For the 15 liter, as we have announced, we started work on that. So that is one of the places where we are increasing investment. And so what we are really sorting out is when that comes to market. So as you know, there needs to be an infrastructure put in place that is not there yet to support the long haul. So customers, we are talking to them, we are doing work on it. The infrastructure does need to be there. We think the 12G introduction, which again rolls out this year and then expands in 2014, will be a piece of creating demand for that infrastructure, which will help build it out.

So we don't have an exact date on the 15. I would say it will -- when we introduce the ISX15, I would say it will not be -- at this point, we wouldn't see that there would be a market for that through 2014. So we would be looking out into 2015 for the introduction of that. But again lots of moving pieces, as you know. So what we are doing is doing the investment and getting ourselves in position that we can introduce.

The only thing I would add to Rich's comments is we feel very good about customers' response, which again started off pretty slow, but now it is unusual to meet a fleet that either doesn't want to buy one or two and try them or wants to buy a bunch. People are very interested in trying it and I think, as the infrastructure develops, this will be -- I think it could be a significant part of the market and when I say significant, I don't mean it will be the whole market. I just mean it could be a real part of the market and it has been a very marginal part of the market for all of its history now.

So there is growing interest and as Rich said, the infrastructure I think gets built when people want to fuel up trucks. So the 12G working more in the regional markets I think has the potential to help build that infrastructure more than just people writing essays about how great the market is going to be one day in the future. Actual demand for fuel will be a much better driver of infrastructure.

Okay, thanks so much, everyone.

Andrew Kaplowitz.

Good morning, guys. Maybe for Tom or Rich, if we could go back to US heavy-duty truck, I mean it looks like orders have been pretty good four months in a row. I am just wondering if this is an area where you're actually getting some better visibility. Some freight customers out there, actually most of them are making good money now and we are passed the fiscal cliff. Although there is lots of other cliffs out there. So have things improved over the last few months in that business from what you are seeing?

Marginally, yes. We are seeing right now the well-capitalized fleets are saying they are replacing their fleet. We don't have a lot of evidence of people expanding still at this point. And so we have had three or four months in a row of over 20,000 on the net order board, which is good. The production rates are currently lower than that 240,000 we are projecting for the year. So it requires an improvement in the second half of the year. So I would say our confidence in that happening, that improvement in the second half of the year, has grown with the order board having three or four strong months. But there is not strong evidence of fleets wanting to expand their fleets at this time.

Okay, that's helpful, Rich. Frankly, I am a bit confused about the Power Gen business globally. Like maybe I could even just take the US and you have got cost (inaudible) there, like everybody has nonresidential improvement and then, of course, (inaudible) to the extent that there were any. How do you really think about the Power Gen business and these puts and takes as we enter 2013?

Yes, you are right though that there are some countervailing things going on. I mean the basic trend though I would say is that the general economy is weak, nonres construction spending is not great around the world. Again, there are exceptions to that, as you noted. There is a few segments, which are doing okay, but broadly speaking that is a problem and then some of these infrastructure projects in Africa and other places have also been slowed down.

[Greco] is a big customer of ours. That is the one I mentioned in Europe, and they have cut their capital purchases for rental equipment quite a bit. They do a lot of that infrastructure work. Those were also down I think in part because general economic weakness and some of that sort of political and other things going on in North Africa and the Middle East. All that together says we are thinking Power Gen is down in that flat to down 5% kind of range again with, as you said, a lot of puts and takes up and down. And it is a little complicated, but, all in, it doesn't look great.

Thanks, Tom. I appreciate it.

Okay, I think our time is up. Thank you very much for your interest today.

Thanks, everybody.

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