康明斯 (CMI) 2013 Q2 法說會逐字稿

A very good day to you, ladies and gentlemen. Welcome to the second-quarter 2013 Cummins Inc earnings conference call. My name is Nancy and I will be your operator for today. At this time all participants are in listen only mode. We will conduct a question and answer session towards the end.

(Operator Instructions)

I would now like to turn the call over to Mark Smith, Executive Director Investor Relations. Please proceed.

Thank you, Nancy. Good morning, everyone, and welcome to our teleconference today to discuss Cummins results for the second quarter of 2013. 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'll all be available for your questions at the end of the teleconference.

Before we start, please note that some of the information you will hear or will be given today will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs, and intentions on strategies regarding the future. Our actual 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 we will be discussing certain non-GAAP financial measures and we refer you to our website for the reconciliation of those measures to GAAP financial measures.

Our Press Release with a copy of the financial statements and a copy of today's webcast presentation are available on our website at www.Cummins.com under the heading of Investor Media. Now, I'd like to begin the call with our Chairman and CEO, Tom Linebarger.

Thank you, Mark. Good morning. I will start with a summary of our second quarter, including some brief comments on individual business performance, and then I will talk about our outlook for the full year. Pat will then take you through more details of our second-quarter financial performance and our full year forecast. Revenues for the second quarter were $4.5 billion, an increase of 2% year over year. EBIT for the quarter was 13.7% of sales compared to 14.9% a year ago. Revenues improved by 15% from first-quarter levels driven by higher revenues in North America.

Profitability also improved from first quarter levels with incremental EBIT margins of 31%, sequentially. Revenues for the Engine business declined by 7% compared to the second quarter last year, due to lower demand in the North American heavy duty truck market. We saw 38% decline in shipments of high horsepower units driven by global weakness in mining and other off-highway markets. EBIT for this segment was 12.8% and held up well compared to 13.2% last year considering the decline in high horsepower markets. Performance rebounded strongly from first-quarter levels due to higher demand across a number of on-highway markets in North America and higher joint venture earnings in China.

The Components business benefited from increased demand in on-highway markets in several regions, achieving a record revenues in the second quarter of $1.1 billion and delivering strong earnings. EBIT of 12.2% was up 50 basis points sequentially and 100 basis points year over year. Performance for the Power Generation business has been below our expectations in recent quarters. Second-quarter revenues declined 10% year over year as weakness in most international markets offset higher demand North America. EBIT of 9.3% was down from 10.3% a year ago, mainly due to lower volumes. We did though see encouraging improvements in operational performance from first quarter levels with EBIT margins improving 250 basis points due to higher volumes, lower warranty costs, and improved productivity. We expect to maintain the improvements delivered in the Second quarter and see opportunities to drive further improvements in gross margin.

Acquisitions in North America contributed strongly to revenues in the Distribution business this quarter. In fact, nearly all of the revenue growth in the quarter from the DBU came from acquisitions of North American distributors completed in the last 12 months. We expect to pursue further acquisition of distributors in North America in the future, though we do not expect any additional transactions to have a significant impact on 2013 revenues or earnings. We will discuss our long term plans for the North American distribution system, along with other important regions of the world, at our upcoming analyst day in September. EBIT in the Distribution business for the second quarter was 10.5%, compared to 11.6% a year ago and 12.2% in the first quarter. In both comparisons, acquisitions added to EBIT dollars but were dilutive to EBIT percent because we were acquiring 50/50 joint ventures, where the sales are not consolidated but 50% of the earnings are already included in our EBIT.

Pat will take you through the details of our guidance for the rest of 2013 but, in summary, we now expect full-year revenues to be approximately even with 2012. This compares to our previous guidance of flat to down 5%, with Components revenues now expected to increase 7% compared to our previous expectation of an increase of 2%. We still expect to deliver EBIT in the range of 13% to 14% of sales for the year, with some changes in guidance for individual segments which Pat will discuss. Before I close, I want to provide some more color about our sales for the quarter and our key markets.

As I said, Company revenues increased by 2% from the first quarter, with revenues up 7% in North America and international revenues down 4%. Our shipments of engines for North America heavy duty trucks were 21,000 in the second quarter, a decrease of 19% from last year but an increase of 12% from the first quarter. Demand continues to recover moderately after a period of very weak industry orders in the second half of 2012, but OEMs remain cautious in raising build rates. For the full year, we are adjusting our forecast for the market size to 229,000 units, down from our previous forecast of 233,000 units, with third-quarter production likely to be close to second-quarter levels. Our year-to-date market share is 40%, in line with our full year guidance.

We shipped 15,000 units to the US medium duty truck market this quarter, an increase of 18% year over year. We continue to expect a full-year market size of approximately 109,000 units in 2013, an increase of 2%. Our products are performing extremely well in terms of reliability and fuel economy, leading to market share gains. We now project our full-year market share will be 60%, up from our previous guidance of 52% and up from 38% just five years ago. Demand from Chrysler increased in the second quarter by 10%. Due to a weak first quarter, though, caused by Chrysler's model year changeover and tough comparisons in the second half of 2013, we expect unit shipments to decline by 10% for the full year, in line with our previous forecast.

Our international revenues decreased by 4% in the second quarter with the most significant declines in India and Europe offsetting growth in Brazil and China. Our revenues in Brazil increased 22% with improvements in Engines and Components driven by stronger on-highway demand. We are maintaining our forecast for industry growth in truck production of 19% this year. Second-quarter revenues in China including joint ventures increased 8% year over year, with the increase due mainly to higher demand in truck and bus markets. In the medium and heavy duty truck market, demand increased by 35% in the second quarter driven largely by uncertainty regarding the implementation of NS4 emissions regulations that were scheduled to be in effect on July 1, 2013. Year-to-date industry sales were up 10%, and we now expect full year demand to increase by 5% over 2012 compared to our previous forecast the market would be flat year over year.

NS4 was supposed to be implemented nationally in China on July 1. Implementation has not started nor has there been an official delay of the standard. There's a lot of activity by industry participants to try to assist the government in forming an implementation plan which achieves a transition to NS4 technology, but deals with the incomplete availability of low sulfur fuel especially in the center and the west of the country. In the meantime, approximately 40 cities or regions have announced the implementation of NS4 that was unclear if they have begun issuing new certifications in any of these jurisdictions. There's a lot of uncertainty among end-users and industry participants at this point as to what is going to happen, though most expect the government to announce a transition plan of some kind in the near future. We do not expect a rapid transition to full NS4 compliant technology and expect very modest volumes of these products to be sold during 2013.

Demand for excavators remained weak in the second quarter, with industry sales up 5% against weak comparison but down 12% year-to-date. We continue to expect no growth in this market in 2013 as OEMs continue to reduce inventory. Volumes and revenues at our light duty joint venture with Foton grew in the second quarter with revenues in the domestic market up 66%. For the full year we expect revenue growth of 70%, as Foton continues to produce more vehicles equipped with our joint venture engines. Power Generation revenues in China including joint ventures were flat year over year in the second quarter, consistent with the overall weak economy. Revenues for the year are expected to be in line with 2012 consistent with our prior forecast. For the full year, we still expect that our total revenues in China will be up 5%, with strong growth in light duty engine and modest growth in medium and heavy duty trucks offsetting weakness in off-highway markets.

Moving to India. Business conditions remain weak and our second-quarter revenues including joint ventures declined 12% year over year, due to the weak truck market and the impact of the depreciation of the rupee against the dollar. Industry production for the medium and heavy commercial vehicle market declined 6% in the second quarter, and we expect full year decline of 12% consistent with our previous guidance. In our Power Generation business in India we now expect full year unit growth of 8%, down slightly from our prior forecast of growth of 10%. We expect a full year revenues from all businesses in India including joint ventures to decline by 11%.

In Europe we experienced a 3% decline in revenues year over year. Revenue in the Components business increased by 17%, due mainly to the acquisition of the Urea Doser business completed in the third quarter of 2012. This increase was offset by continued weakness in the Power Generation business.

Overall, I was pleased with our performance in the second quarter, and particularly with the improvement in profitability from first-quarter levels. I remain very confident about our ability to execute both in strong and weak markets, as well as our prospects for sustained profitable growth when global markets recover. I look forward to sharing our plans with you in more detail at our upcoming analyst day in September. Thank you for your interest today and now I will turn it over to Pat.

Thank you, Tom, and good morning, everyone. Second-quarter revenues were $4.5 billion, an increase of 2% from a year ago and included record revenues for both the Components and Distribution segments. Sales in North America, which represented 52% of our second-quarter revenues, were up 7% from a year ago due to stronger demand in the light duty and medium duty truck markets, growth in our Power Generation business, and from acquisitions in the Distribution business completed in the last 12 months. International sales decreased by 4%, as a result of weaker demand in Power Generation and in mining markets. Gross margins were 25.5% of sales, down from 27.2% last year. This decrease was driven by the impact of unfavorable mix and higher warranty costs, partially offset by the benefit of improved pricing and from lower material costs.

Selling, admin, and research and development costs were down $13 million from last year and positively impacted our EBIT margin by 50 basis points. Joint venture income of $108 million was up 4% compared to a year ago. Compared to last year, higher earnings in China offset lower earnings in North America. The reduction in JV earnings in North America was partly driven by the impact of acquisitions. Earnings before interest and tax were $621 million, or 13.7% of sales for the quarter, though earnings per share was $2.20. This compares to 14.9% of sales last year and earnings per share of $2.45, excluding special items. The tax rate was 28.1% for the quarter.

Compared to the first quarter of 2013, sales were up 15%. The Engine and Component businesses benefited from increasing demand in on-highway markets. We also saw revenue increases in Power Generation markets and from the impact of the acquisition in the Distribution business. Gross margins increased 110 basis points when compared to the first quarter, due to the increase in volumes across all four business segments and from lower warranty and material costs. Selling, admin, and research and development costs were $35 million higher, but 140 basis points lower as a percent of sales compared to last quarter as we successfully leveraged spending on higher revenue.

Joint venture income of $108 million was up 32% compared to the prior quarter. The sequential increase was driven by higher contribution from joint ventures in China, where truck and power generation demand was stronger compared to the first quarter of 2013. And the earnings before interest and tax of $621 million, or 13.7% of sales, compares to the 11.1% we looked forward to last quarter, which represents an incremental EBIT margin of 31%.

Let's move on to the Operating segments and further discuss second-quarter performance and outlook for the full year. In the Engine segment, revenues were $2.7 billion, a decrease of 7% from last year. The decrease was driven by lower demand in heavy duty truck and oil and gas markets in North America, and by a 38% decrease in global mining revenues. This weakness was partially offset by improving demand in the Brazilian, North American, and European medium duty truck markets, and from stronger demand in North America and Latin America for engines for agricultural applications. Compared to the prior quarter, sales were up 15%. Sequentially, we experienced stronger demand in North America truck and bus markets, and saw modest improvements in most industrial markets, except mining which declined by 11%.

Segment EBIT was $339 million, or 12.8% of sales, down from 13.2% last year as a result of unfavorable product mix. This was partially offset by improved pricing, lower material costs, and higher joint venture income. Sequentially, the increase in volume and higher joint venture income resulted in EBIT margins increasing by 430 basis points. Overall, the Engine business delivered very strong EBIT margins, considering the shipments of high horsepower engines declined by 38% year over year and 14% sequentially.

For the full year, we continue to forecast that revenue for the Engine segment will be down 5% driven by weakness in industrial markets, particularly mining, and from lower full year demand in the North American heavy duty truck market. This will be partially offset by improved demand in the Brazilian truck market and market share gains in the North American medium duty truck market. We are raising EBIT projections for the full year to 10.5% to 11.5% of sales. This compares to our full year 2012 margin, excluding restructuring, of 11.8%.

In the Components segment, second-quarter revenue was $1.1 billion, a record for the segment, and up 8% from last year and 10% from the prior quarter. Compared to the prior year, higher revenues were primarily driven by stronger international demand for aqua treatment systems and the impact of the Doser business acquired last year. Compared to last quarter, sales increases in all four businesses within the segment were driven by growth in on-highway markets in North America, China, Brazil, and in Europe. Segment EBIT was $136 million, or 12.2% of sales, up from 11.2% last year. Higher volumes along with lower material costs resulted in improvement in margins compared to a year ago. Compared to last quarter, EBIT margins increased by 50 basis points primarily due to the stronger volumes.

We now expect full year revenue growth of 7%, compared to prior forecast of 2%, primarily due to increased market share in the North American medium duty truck market. And we are raising EBIT projections for the full year to between 11.5% and 12.5% of sales, largely due to the increased volumes. This compares to full year 2012 margin of 10.8%. In the Power Generation segment, second-quarter sales were $814 million, down 10% from the prior year and an increase of 9% sequentially. Year over year, weakness in most industrial and international markets was partially offset by stronger demand in our North American business.

Sequentially, we saw improving demand in North America, China, and Brazil, partially offset by weaker demand in India. EBIT margins were 9.3% of sales in the quarter, down from 10.3% last year. The negative impact of lower volumes was partially offset by pricing actions. EBIT margins improved compared to last quarter going from 6.8% of sales to 9.3%. Increased volumes and joint venture income, combined with lower warranty expense and improved operational execution, all contributed to the margin improvements.

For 2013, we continue to expect sales to be down 3% compared to last year, primarily due to weakness in Europe and in Russia. We are maintaining EBIT projections for the full year of between 8.5% and 9.5% of sales. And for the Distribution segment, second-quarter revenues were $954 million, an increase of 20% compared to the prior year and 23% compared to the prior quarter. Excluding the impact of acquisitions, second-quarter revenues increased 1% from the prior year and 13% sequentially. Compared to the prior year, stronger North American power generation demand was partially offset by weakness in North American oil and gas markets and in global mining markets.

So, EBIT increased in dollar terms both year over year and from last quarter, EBIT margins as a percent of sales declined down 1.1% from a year ago and down 1.7% from the previous quarter. And both comparisons acquisitions added to EBIT dollars, but were the biggest driver of the lower EBIT percent. Sequentially, we also experienced the mix shift away from aftermarket to whole goods which also contributed to the reduced EBIT percent. For 2013, we continue to forecast 10% growth in revenue over the prior year, however, we now expect that a greater proportion of the growth will come from acquisitions and less from organic growth than we previously expected. We are reducing EBIT projections for the year to between 10.5% and 11.5% of sales, due to lower organic growth, the dilutive impact on the EBIT percent from acquisitions, and the expected negative impact of currency in the second half of the year assuming that exchange rates at the end of the second quarter prevail for the remainder of the year.

As Tom mentioned, for the Company we have adjusted revenue guidance to the top of our previously announced range. We now project total Cummins revenues to be flat in 2013 when compared with 2012 levels. We continue to project EBIT margins for the Company will be in the range of 13% to 14% of sales. And as is typical for our business, we currently expect that earnings for the fourth quarter will be stronger than the third quarter, as the impact of OEMs from our shut downs and seasonal declines in joint venture volumes, particularly in China, impact third-quarter results. We are now projecting a tax rate to be 29.1% in 2013, excluding any discrete items.

Finally, with regards to cash flow, we produced $532 million in cash flow from operations in the second quarter. And through the first half of the year, we've produced almost $1 billion in cash flow from operations, more than double the amount during the same period in 2012. Our financial strength allows us to continue to invest in our business. We will invest between $750 million and $800 million in capital expenditure, slightly below our previous projection, and we will continue to return cash to our shareholders.

Earlier this month, we declared a 25% increase in our dividend. With this announcement, we have increased the dividend by a total of 257% over the last four years. We also repurchased 2.6 million shares in the second quarter, and in doing so, we completed the $1 billion share repurchase program authorized by the Board in 2011, and we began repurchases under the new $1 billion program authorized at the end of 2012. We have now repurchased 15 million shares over the past four years. Our second-quarter results represent solid improvement from the first quarter and we demonstrated that with increased volumes, we can deliver good incremental margins and generate strong positive cash flow. Now, let me turn it back over to Mark.

Okay. Thanks, Pat. Operator, we are now ready to move to questions and answers. I would ask that you limit your first question to one question plus a related follow up and then get back into the queue. Thank you very much.

Thank you very much, Mark.

(Operator Instructions)

The first question is from the line of Andrew Casey from Wells Fargo.

Good morning, everybody.

Good morning, Andy.

Couple questions, first on Components margin was quite a bit higher than I expected. Could you run through what the material cost impact was on margins?

You're talking year-over-year or quarter-over-quarter, Andy?

Year-over-year. Thanks, Pat.

Yes, so for year-over-year, there was about 1.5 percentage improvement in material costs for the Components margin through material costs.

Okay, thanks, and then on the engine side on the joint ventures, the Beijing Foton Cummins had quite a sequential improvement. It increased to $9 million in the quarter from $1 million in the first quarter. Is there anything special behind that or is that all, it's hard to see the volume improvement from the retail sales data that we have?

Andy, this is Rich. Couple things. About half of that is volume, and so leveraging the volume going forward. The other, there is a one-time, or not a one-time but a warranty improvement that we've seen there, so that product is performing very well. And so, we've been able to adjust the accrual rate down in Q2. So about half of that gain was warranty and about half of it's incrementals from the volumes.

Okay, would that warranty level be a catch up or would it continue into --?

It's a catch up and we'll also adjust the rates down going forward.

Okay.

Remember how those work, Andy? So, we set a rate and then we have actual experience, and then if our actual experience is different enough then we adjust the liability and that's the point when you say catch up, what you're doing is adjusting liability, but then you also lower the rates going forward which means you're lowering ongoing expense. So, we do both things at once and, of course, if the reverse is true and warranty goes up you have to do the other thing. You have to figure out how to add your liability and then increase, too. But in Foton, we've had good experience on the engine quality, which has allowed us to lower the liability and lower the ongoing rate going forward, which is good news.

Okay, great, thank you.

Thank you very much for your question, Andrew. We have the next question from the line of Jerry Revich from Goldman Sachs.

Good morning.

Good morning, Jerry.

Tom, as we think about your business once the China national floor standards are ultimately implemented whenever that is, can you just give us a sense for how your discussions with other engine manufacturers are tracking? Can you get your after treatment market share to similar levels as you have in your turbocharger business? And can you give us your latest sense on concept per unit at after treatment based on the latest sets of configurations that you've seen?

Yes, the after treatment business is still, I would say, it's unclear what the competitive landscape is going to be because there's just been such uncertainty about the NS4 standards. I mean, obviously, we're coming to market with a set of competitive products, not just one. We'll have a set of competitive products and the after treatment business with our full intention of gaining significant market share with our JV engines, as well as with other peoples engines. But I would just say, right now, the landscape is unclear because the enforcement of the standard's unclear, how fast it's going to move. One thing is clear, at least to me, is that it's not going to go fast this year. Other than that, it's not so clear how fast it's going to go. I think the stronger the enforcement of the reg, the higher our market share will be. And the weaker the enforcement, the more competitive other products might be, so we just don't know.

We're ready to compete in whatever thing turns up, but I just would say how high a market share we can reach relative to turbos is uncertain, but that's certainly our target, that's where we're headed. Our view is that we're competing in China like it's our home market, so we compete on the terms of competition there and we're going to win.

And in the US components business, pretty massive win on the Navistar medium duty after treatment. Can you just flush out for us your production plan to support the additional business? Is it as simple as adding a shift? Do you have capacity to do that just so we can get a sense for operating leverage next year?

Yes, I think we have capacity. We've had to do some significant planning as you guess for that, especially on the supply side. So, we've had to do a bunch of work with suppliers to make sure that we have adequate capacity. You remember in the past, when things peaked out we had capacity limitations on the insides of the after treatment system, both coatings as well as bricks. And so, we've done a lot of planning on that to make sure we have adequate capacity, not just for the start but for when things get stronger and I think we've got a good position on that. I'm not worried about our ability to ramp with them. They are a mid range business that they've transferred to us, it's not all ramping at the same time so we have plenty of ability to ramp up with them. But, as I said, the important thing is making sure we're planning to have adequate capacity for all customers at the peak of the market not just at the start, so we feel good about that is the net answer.

Jerry go ahead, your line is now open. I do apologize, thank you.

Thank you for the answer, Tom.

Sort of shut you down there, Jerry. I'm not sure how we did that, but sorry about that. (laughter) Okay, so did you get what you needed out of that though? The capacity looks fine.

That's perfect, thank you.

Okay, thank you, Jerry.

We have the next question from the line of Ann Duignan from JPMorgan.

Yes, good morning.

Hello, Ann.

My first question, could you talk a little bit about what drove the Power Gen demand in North America? What specific segments? What size of product you're interested in? Concerning that will be helpful.

Strongest business growth we've had, as you know we had to do a lot of different business. But the growth has mostly come from the military business. You remember this contract that we won some time ago to supply the forward operating base generator instead of the one that they send to every base. And that business has been ramping up over most of last year and we are now sending them at reasonably large volumes and we've got the line quite productive now. It's a good piece of business for us. And in the midst of a market which is pretty weak across-the-board, that's been a really good win for us. So that's been most of the growth.

And that will wind down when?

Not any time soon.

Okay.

So it's still, it's really over time it's a replacement of all of the generators out there, so at what rate it increases is really the question as opposed to whether it's going away. There's obviously with sequestration and things like that, there's always a question of what military priorities are, but so far, we've been able to keep demand rates up pretty high from the military.

Good, thank you that's good color. And then two real quick follow-ups. On the Chinese demand, can you talk about when the joint venture with LiuGong would become material to the business?

Yes, so we'll go into production next year and begin ramping up. We've got capacity for 50,000 units there, Ann, and so it will begin to become material next year and then full production in 2015.

Okay, and real quick follow-up, same sort of question on the 12-liter natural gas engine with Westport, we heard a lot of pent-up demand at the alternative fuels conference a couple of weeks ago, and when would you expect that business to start to become material?

Well, as you know, we introduced in April with some of the ratings and we said we would bring out the full ratings in August, and so we're on track with that. In fact, we're about three weeks ahead of schedule and so there's lots of interest as you know. The products are really just now getting into the market, the feedback on them is terrific and so there's a lot of excitement for it. I think, just put it in perspective, we still see it over the next couple of years that's 2% to 3% of the total truck market and longer term, we're thinking 5% to 10% over a 5 to 10 year period.

And I think that, Ann, this is where the disagreement starts among different people with different interest in the truck market. Nobody really knows what final percent natural gas will be of a truck market, some of it will depend on fuel prices and some of it will depend on other factors about buildout of availability and things like that, but this is where it gets, people lose track of things. If you're very invested in the natural gas business, you'll be thinking that because there's a lot of interest there will be hundreds of thousands of units in no time. Most of us that have been watching all the units don't really think that's very likely. It doesn't mean there's not of great interest. There are some customers who think this is the answer to their problems.

The fact is, though, if you look at all of the orders and all of the buys in total, most people are buying a few now to try them as opposed to replacing their whole fleet and we'll see what happens after they try them. At what rate people change, but I think Rich has given you the sort of the middle of the road consensus view that maybe it gets to 10% or 5% or something like that over some period of time. But we're prepared for all of those eventual outcomes, that's just what we see right now and we are working very actively to get that 12-liter in as many people's hands who want to try it as we can, while still making sure we're doing our normal quality launch. So, we're performing -- with every launch of a new product, we make sure we have good infant care, we know every customer whose got it, we're tracking everything really closely, and that's really important in this market just like every other so we're doing that as we go.

I obviously agree with you on the outlook for the natural gas side of things, so I'll leave it there and get back in line, thanks.

Thank you, Ann.

We have the next question from the line of Jamie Cook from Credit Suisse.

Hello.

Hello, Jamie.

Good morning. A couple questions, just one, could you give a little color on what you saw in mining in the quarter in terms of OE and aftermarket, how much that was down? And then my other question is a longer term in terms of that. As I think about your implied margins in the back half of the year, I think the midpoint implies like 14.5% which is pretty healthy. So Pat, I'm just wondering, I can make my own assumptions about 2014, but is there any reason to believe going forward that assuming some volume growth, we still can't get the 20% incremental because the margins are looking pretty robust as we exit the year? Thanks.

Okay, Jamie, I'll start with mining and then Pat can chip in on the profitability. So in Q2, our engine shipments were down 40% in mining year-over-year which is kind of in line with what we said for the full year 40% to 45%. Our aftermarket revenues were down slightly, although they have increased from fourth-quarter levels both in Q1 and Q2. For the full year, we've said total revenues down 27% including parts, but we're kind of tracking along that range plus or minus a little.

And on the market question, Jamie, I think we're obviously very pleased with the incrementals that we've seen in the second quarter. And while I'm not going to talk too much detail about 2014 just now, we're still targeting that 20% incremental EBIT margin over the long term, so there has been no deviation on that particular target.

Sorry, are there any particular cost savings that are hitting the back half of the year that you could quantify or no? Because if you look at the back half of the year, I think your top line, if we look at the back half versus first half, it implies 5.5%, 6% growth and 25% EBIT growth. So, I'm just trying to get comfort with the back half and also then of course what it implies for going forward?

Yes, I think the one segment that we are looking for continued improvement in the second half of the year is Power Gen. So, Engines picked up really nicely in Q2, we expect Rich and his team will continue at those levels as we go forward. I think Components are having a terrific year and are on track to deliver their guidance.

Power Gen are 8%, just over 8% for the first half of the year, so they are going to have to pick up about a 1 point to 1.5 point to hit the midpoint of their guidance, that's where the biggest stretch is going to come from. But I'm really pleased with the progress that Tony and his team has made in the second quarter around their business. The other factor to keep in mind here, and this is getting a bit technical, but in the first half of the year we built up about $200 million in inventory.

Okay.

That's a the negative headwind on profit inventory that takes our, you see that in the eliminations call going second at least.

Got you.

But we are not expecting to build up $200 million of inventory in the second half of the year, so that should help us.

Okay, that's great color, thank you.

Next question is from the line of Eric Crawford from UBS.

Hello, good morning, everyone.

Good morning, Eric.

On the CapEx, could you speak to some of the factors leading to the 9% lower guidance? Is that a function of the competitive dynamic easing as competitors dial back their own CapEx? Or more a shift in your growth outlook for certain markets? Any color would be helpful?

Yes, we took it down a little bit. There's been a couple of projects overseas, facility projects, where getting approvals from the local authorities took longer than what we anticipated, so construction is about three months behind what we intended to be so that's going to carry into next year. That's really the biggest driver. The rest is really just tweaking around the edges. There hasn't been anything significant that we've cut back in the capital. It's more of a timing issue.

Okay, that's helpful. And just on the distribution guidance, and sorry if I may have missed it, but I'm looking at the biggest uptick in your EBIT guidance, in your EBIT margin guidance, is in that segment but you haven't touched the revenue. So, just wondering if you can reconcile what the drivers are for the better margin performance there?

We actually lowered that one, Eric.

Did you?

From prior guidance, we dropped it a full percentage point because we're getting more of the revenue from acquisitions which is dilutive.

Engines the one, and Components, they went up and then Distribution went down. And the Distribution, remember, what's going on with Distribution that the profitability of the businesses are still doing about the same. The area that we highlighted in the business was that the aftermarket related mining in oil and gas has been weaker in the last couple quarters than we've seen in prior years, and that's just related to those markets. But broadly speaking, the business is still doing about the same and then we have the situation whereas you buy a joint venture distributer, you now consolidate the sales which you're 100% of them and you bring in 50% of the earnings. So, that's had a little bit of effect on the EBIT margins, so other than that, though, not a lot of changes in the Distribution business.

Okay, that's perfect. My mistake, thank you very much, helpful.

Thank you.

We have the next question from the line of Alex Potter from Piper Jaffray.

Yes. Hello, guys.

Hello.

Just coming back a little bit to the question on margins in the back half. Last quarter, you had given us a little bit of color on how margins trended through the quarter. Was wondering if you could do the same this time? If you're calling for say Power Gen to have a little bit better margin contribution in the second half, were things looking better toward the end of Q2?

Yes, things were fine all the way through the quarter, Alex. There wasn't the same kind of behavior that we talked about back in January and February.

Okay, fair enough. And then switching over to North America heavy truck, you brought down your full year market expectation. Are you in the camp, I know you're probably not going to talk too much about 2014, but just generally speaking from a market wide standpoint, are you in the camp that would believe that anything that we're cutting in 2013 in terms of heavy duty truck volume we're just going to get back in 2014?

I think our cut was so small we took 4000 units out of the 250,000 markets, so I really wouldn't look at it that way. I think longer term, we think all of the fundamentals are pretty good that you look at, yet no one is expanding their fleet size. So, we're kind of in a replacement mode right now so we've seen a little bit of timing, so maybe a little bit of timing, but I wouldn't declare that a one-for-one.

The one thing that you hear, Alex, is that because we've been below replacement value numbers for so many years, and at best what we're doing here is replacing, doesn't at one point don't you have to catch back up again? Even if you've taken out, you've stretched out the amount of time someone will hold the truck, doesn't there need to be some production over retail demand for some period of time? There's a lot of discussion about that and we do believe that that has to be the case. How much and for how long we don't know, but we just don't know when. And so that's why I think it's hard to say, well this 4000 goes next year. But we do believe, based on talking to customers and things, that there is, there will be a point when people will buy more trucks than they're retiring for some period of time in order to restock to some level. We just don't know when it's going to be and we think most of it has to do with confidence in the US economy, so when the people believe that do whatever sort of budget and debt deal or whatever set of combination of things people get confidence again about the US economy, we think that's when it will happen.

Okay, thank you very much.

We have the next question from the line of Steve Volkmann from Jeffries & Company.

Hello, good morning, guys.

Hello, Steve.

Sort of along that same line, Tom, I'm wondering how the Navistar project is going in terms of ramp and so forth? And I guess what I'm trying to think about is if things remain flattish as they seem to be for the overall industry, that would still seem like you might have some opportunity for growth with that new project?

Rich is really close to that. I'll let Rich talk to that.

So a couple things, first we're on track with introducing the 15-liter where we thought we would be, so we're engineered in. Where the market share between the 13% and 15% is right about 15%, which is where we projected. And as you stated, the thing that's behind a bit is Navistar's share in the market. And so, I do know and they publicly stated their plans and they've got solid plans to increase that, but it's a tough business and tough competitors out there and we know them well and we supply them. And so, we will, I think, we will see improvement in the Navistar share. I think for us we still view the net of all of that is about the 40% range, and that's where we are year-to-date. You'll see some month-to-month variation around that, but I think the 40% is solid when you put all of the variables together that we're looking at.

But as you said, we do, that is up from our, some before we were working with Navistar, so we do think that helps a little bit. We also think the mid range business, as we talked about, after treatment is going to help our Components business. So there is incremental business for us relative to where we were before we started working with Navistar, even in a flat market. But because it is a competitive market and because we supply some other really terrific partners, PACCAR, (inaudible) who are going to fight for their share, too, it's not going to be a dramatic move month-to-month. There's a lot of people fighting in a flat market.

Okay, great. That's helpful. And then just maybe more broadly, if you would, Tom, I appreciate the outlook on the markets by end market and geography and so forth, but everything sounds fairly sort of flattish to me as we look going forward. And I'm just wondering as you have these conversations with your customers, do you get a sense that things are sort of bottoming in any of these end markets? Is there a reason to be optimistic in certain areas or end markets?

You noticed that too, did you? (laughter)

The flattish tone?

It is pretty flattish. That really is how it is. Latin America is a notable exception. When I go to Latin America, I was there not too long ago, things are definitely moving in a positive direction. Brazil we had talked about, but it's true, really, in Spanish speaking Latin America, too. Mexico is pretty good. This quarter we saw generally speaking it has been pretty good.

But I would say in India, the trend is not good. Not only is it not bottoming, it's hard to say when it's going to bottom, but I don't think it's bottomed yet. I don't think it's going to get a lot weaker, but it's not strong.

China is the most perplexing. It really is flattish. It's not getting a lot worse, but it's not getting a lot better, either. There's clearly a lot of pent-up demand. When you visit there, you'll definitely hear all of the reasons why next week it's going to be taking off and doing great. It just turns out that that's not been true for some time. So my own view is that China is the one where if it got going, a lot of other things that get going, but right now I just don't see that in the near term.

The one with the most positive potential short-term is the US. I think if we could get some confidence in the US, we would see turn, at least in our businesses, in the US pretty quickly. We talked about the truck but it would be true in Power Gen and other things as well, and that would be a pretty good boost to demand for a whole bunch of companies like us and we would be ready to respond with capacity. Again, whether that's going to happen or not is another question, but right now I think the flattish view is about right. It doesn't seem like it would take a whole bunch to change the fortunes of the US and China in the market to at least get a little bit better and that would make a big difference. I don't think India is going to turn so quickly, but I think China and the US could, but when, I don't know.

Okay, waiting.

We're just planning for that flattish -- what you see from us in our estimation for this year is sort of that flattish view.

Mining bottoming or no?

Yes, it looks like it. I mean, it's not very good though. It's not very good, but it's bottoming. It's hard to say for sure. Rich, you've been talking to mining customers more. What are you hearing?

I mean, I think we're close to the bottom but I think there's still some pressures to take that down. I mean all the mining houses have balance sheet problems now, they turned over their leadership, they are driving to take capital down. And so, I think we're close to the bottom but there could be another small step there down.

Thanks, guys.

And then the only thing I guess I would add is that there are some emissions changes coming up which we think stimulate some demand for us even in flat markets. So, obviously, we're hoping for some good recovery in 2014, that would be terrific, but we also have some sort of non-cyclical things going on. We've got tier 4, we've got Euro 6 coming, each of which are going to increase content and increase demand in some of our businesses irrespective of volumes going up.

Great, I appreciate it.

We have the next question from the line of Tim Thein from Citigroup.

All right, thanks, good morning. I just want to dig in a little bit to the guidance for the overall joint ventures and just, specifically, how you're thinking about the interplay between the manufacturing businesses and North American distribution? Given what you discussed earlier in terms of as you're consolidating more of those North American partners, obviously, it will be a drag on that JV line. But, I guess, I'm just trying to get at has your underlying view in terms of the profitability to the manufacturing businesses changed over the last, say, quarter or so?

No, I think strategically, I can let Pat or Mark talk a little more about the accounting if you want to, but strategically our view is our growth prospects, as I've mentioned in my remarks, remain equally favorable from the manufacturing business. What we've been doing over the years, and we have really been doing across the world, is acquiring more of our Distribution business so that we can get some of the system benefits of having a consistently coordinated distribution system. A lot of the product we sell is highly technical, we talked about mining as an example, and our customers are looking for very technically capable support. And they want support whether or not they bought a lot of engines this month or last month or two years ago and they want consistent support region to region.

Marine business, Power Gen business, these customers are now spanning geographic regions. So, our old network idea of most customers operated within one geographic region has over years just come under more and more pressure. So, as we operate as an overall system, we're able to say to a customer, if you do business with us you'll experience the same technical support, same service, same quality at all parts of our network that service you and we can make the investments necessary to do it. It's one thing to say you're going to do it. It's another to have the investments in place, technical, people, tools, et cetera, and we need to make sure we make those investments in a coordinated and on time way, so that's what's driving the changes in strategy as opposed to any lack of confidence in the growth and manufacturing business.

And one thing, Tom. So, I think we've got a couple pretty mature joint ventures in the manufacturing space, the DCEC, CCEC, and those are going to move with the market, but we've got a few others coming through in the investment period that we see some really nice growth opportunity. We talked about Foton, but we also --- we have the new joint venture in LiuGong with Hyundai that are both coming through an investment period that then move into profitable businesses and growth businesses. And then we talked about even in Westport with the 12-liter gas becoming a part of that portfolio, so several pretty positive ones where we're coming through an investment period over the last two or three years.

It's a good point. We are adding more new joint ventures and faster than we are taking them out by acquisitions for sure. So, I think Rich is right that there's a big potential growth still in the joint venture line coming from the non-distribution side.

Okay great, and then, Pat, any update on the outlook in terms of the full year expectations for in terms of the gross margin impact from pricing and raw material cost? Or is that the same?

No, I don't think that has changed very much, Tim, since the last time we talked. But we're still thinking close to 1% from pricing and close to 1% from material costs and we've experienced that really through the first half of the year and expect that to continue as we go through the next six months.

Okay, great, thanks a lot.

Thank you.

Our next question is from the line of David Raso from ISI Group.

Hello, good morning. I was wondering if you wanted to touch at all on the September 17th analyst meeting that's coming up? Maybe just set some expectations and how we should be thinking about what we should hear at that meeting?

Well, I'll let Pat add some detail, but in our typical fashion, what we're going to try to do is update people on the strategy of the Company, what if anything has changed from the point of view of strategy and our look at the environment over the next three to five years. We'll layout a new model for what we think financially we're going doing over that time. And as we've done before, we'll look at different economic scenarios and see how the Company will perform over those times and try to demonstrate that we're setting targets that are on financials that are appropriate for shareholders in all kinds of markets, be them weak or strong, we'll make sure that we talk about that.

We'll also highlight, we'll have our business leaders there, we'll have our big international leaders there who can talk about what are some of the key things going on both from a view of market, but also what are the key strategic initiatives we're running to make sure we capture growth in those regions and businesses, so pretty typical for us. Again a lot of interaction with our leadership and a lot of opportunity to hear color on how we think we're going to achieve the financial targets we're setting out, as well as whether those financial targets are appropriate given shareholder expectations. Pat, I don't know if you have anything to add?

I think you covered it, Tom. We'll talk about 2015 and what's definite from what we indicated to two years ago, and then we'll talk beyond what we think for the next three or four years we think we can do.

Yes.

I think I'm trying to figure out is obviously goals from a couple years ago, understandably the revenues have to come down and maybe the margins as well, but at the same time, maybe less growth also frees up some use of the balance sheet in a more aggressive fashion. And if I recall correctly, I don't think last time you really incorporated a ton of use of the balance sheet getting some more, I would call, appropriate leverage financially in your outlook. Could we see with maybe a slower top line baked into the longer term targets a more aggressive use of your balance sheet? Because as I've asked in the past, I'm still surprised you're running at such a heavy net cash position?

Well, the one thing we did cover last time and we expect to cover again is how do we intend to use the cash that we generate? Because, of course, the cash we've generated is not a surprise. It's pretty much in line with what we expected. We talked about what percentage of the cash we think we'll invest in the business, which has been tracking pretty closely to what we said. And then what are we going to do with the rest? So, we think it's, again, from our point of view as we talked to analysts and shareholders about this kind of thing, we think it's basically shareholders money, not ours. So, what we're talking to them about is here is our intention to use it to grow the Company and, therefore, grow the value of their Company.

And then, secondly, the things we don't think we can use to grow the business how we're going to make sure that they get it returned to them and they can use it somewhere else. Broadly speaking, we will give that guidance. Again, we will, of course, get questions and discuss whether or not our balance sheet is too conservative or not conservative enough and all those kind of things, we got those questions last time and we'll get them again this time. And as you guessed, there's a difference of opinion between shareholders as to how to deal with that and we're, of course, talking to all of our shareholders about exactly that question. We really feel obligated to them to use their resources in the way they think is appropriate, and so we talk to them regularly about that question and we're still doing that. And I think the one thing you can say, whether you agree with our strategy or not, is that we are living our strategy. So, as you look at the share repurchases we've done, you look at the dividend repurchases we've done, you look at the investments we've made in the business, they are very consistent with what we said we would do and we are continuing to do it as we look forward.

I could tell, tell me about what you just said there was again how to use the cash we're going to generate as if the current financial leverage is okay to maintain? Because I still look at, you can write a check for $2 billion, buyback 9%, 10% of the Company right now, and still have net debt-to-cap below 15%. But it just sounds like, again, even September 17th, whatever guidance we're going to get, even though it's a slower growth environment from two years ago, it's only about spending the cash you're going to generate, not changing the current financial leverage, is that correct?

I think you should wait for the day. It will be a good encouragement for you to come I hope to hear whether we'll address that directly. And by the way, the question that you're asking has been asked by others. It's not new to us, so it's not that we don't have a keen ear, we got it, we heard the question. We are looking at that among a whole bunch of other strategies, and I'd love to be able to address your question at that meeting with more detail and more financial, so please come and ask it. It's a good one.

All right, thank you.

Thank you. We have one more question from the line of Andy Kaplowitz from Barclays.

Good morning, guys.

Hello, Andy.

So, industrial overall revenue, engine revenue, was up sequentially for the first time since 2011. You'd mentioned a 20% sequential increase in shipments. This is despite mining being down 11%, you said. So, are we seeing a modest inflection in this business? And can you talk about your confidence level of overall high horsepower engines bottoming here in terms of shipments?

It's, firstly, the volume trajectory in industrial is on the construction side, Andy. So, it's not the high horsepower units are down sequentially on year-over-year and Rich can talk a bit more about that. So, we did see, and as we anticipated in our first-quarter call, sequentially industrial volumes improve primarily in North America in one or two international markets.

Maybe highlight those markets, Rich.

So, we are seeing all around the construction, with housing up, is helping us. We're seeing that. We're seeing agriculture business up good. And then we're seeing some modest improvements across-the-board, once you back the mining out and once you back the oil and gas out which are both, as we talked about, down.

I guess, Rich, were these anticipated improvements or maybe a little better than you thought in Q2? Or just in line with what you would have expected?

A little better, a little better than what we expected on those sides and mining might have been a little bit worse than we expected.

Yes, so we did tweak the industrial guidance for the year slightly less negative for the full year. Ag is the one, it's a small unit for us, but it's up 83% year-over-year, so that's one area where there's been, probably, exceeded our expectations.

Got you. And then, Tom, if I could ask you about Brazil a little bit more. You don't change, if I'm not mistaking, you didn't change your Brazil truck shipment forecast? But you started the year pretty strong and, obviously, there's been some recent political issues down there. So, is it conservatism around that or is it something else? Because I would have expected maybe a slight tweak higher in that?

Yes, I totally get it. Me too, by the way, but yes, GDP is not doing that well. Overall, Brazil, it's definitely showing signs of slowing again. The government lowered their forecast for GDP. Orders have weakened for trucks, so the signs are that despite a pretty strong start, it doesn't look like it's going to holdup. Again, it's not plummeting or anything, but it's not doing as well as it was. So, that's why we didn't grab the first quarter and say, okay, now we're going to see this big upturn is because things are not quite as strong as maybe we were hoping. And certainly it hasn't gone from, building hasn't gone from strength to strength and we'll see what happens. But, overall, I think the economic growth, while it's there, is not nearly as good as the government was originally hoping for.

Okay, that's helpful, Tom, thanks.

Okay. Thank you very much.

Thank you, everybody. I'll be available to your call shortly.

Ladies and gentlemen, that's all the time we have for questions today. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day, thank you.