康明斯 (CMI) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Quarter 3 2013 Cummins, Inc. earnings conference call. My name is Sheena. I will be your operator today. (Operator Instructions)

As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Mark Smith, Executive Director for Investor Relations. Please proceed, sir.

Thank you, Sheena. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the third 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 will all be available for your questions at the end of the prepared remarks.

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 and strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of the 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 Factor 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 will refer you to our website presentation 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 are available on our website at www.cummins.com under the heading of Investor Media. Now I'll turn it over to our Chairman and CEO, Tom Linebarger.

Thank you, Mark. Good morning, everyone. I'll start with a summary of our third quarter, including some brief comments on each of our business segments, and then I will talk about our outlook for the full year. Pat will then take you through more details of our third quarter financial performance and our full-year forecast. Revenues for the third quarter were $4.3 billion, an increase of 4% year-over-year. EBIT for the quarter was 12.6% of sales compared to 12% a year ago.

The improvement in EBIT percent this quarter was a result of gross margin expansion with material cost savings for activity improvements and lower warranty expenses, all contributing to stronger performance year-over-year. Revenues for the Engine Business declined by 1% compared to the third quarter a year ago, with weakness in global mining and Power Generation demand offsetting higher revenues in truck markets in North America and Brazil.

EBIT for this segment was 10.9% compared to 9.5% last year, with higher parts sales, lower material costs, improvements in warranty expenses and stronger joint venture earnings in China offsetting the impact of a 24% decline in high horsepower unit shipments. Revenues in our Components business increased 14% due to higher demand in on-highway markets in the US, China and Europe. EBIT of 12.3% improved 280 basis points year-over-year due to the benefits of higher volumes and good cost control. Distribution revenues increased by 18% year-over-year, with acquisitions accounting for 16% of the improvement and organic growth adding 6%, while currency negatively impacted revenues by 4%.

EBIT in the Distribution business for the third quarter was 9.1% compared to 12.4% a year ago. The decline in EBIT percent was due to the dilutive effect of acquisitions and the negative impact of currency, which offset improvements in underlying operations. Power Generation revenues declined 13% year-over-year, as continued weakness in most international markets offset higher demand in North America. Third quarter revenues and new order intake were well below expectations, as demand fell sharply in India due to the declining business confidence, weaker manufacturing activity, and an easing of power deficits, as economic activity has slowed there.

Orders have also been weak for large [gen] sets in Australia, Indonesia and other parts of Asia as a result of the cutbacks in resource industries. Demand in the Middle East has also been below expectations. Power Generation EBIT of 6.3% was down from 9% a year ago. The benefits of higher pricing and lower engineering costs were more than offset by lower volumes and adverse mix, exacerbated by one-time costs for product coverage in legal settlements this quarter.

We continue to execute our restructuring actions in Europe and reduce costs throughout the business to combat lower the levels of demand. Pat will take you through the details of our guidance for the rest of 2013, but in summary, we now expect full-year revenues for the Company to be down by 4% from 2012. This is a reduction from our previous forecast that revenues will be in line with 2012. Power Generation revenues are now expected to decline 10% compared to our previous expectation of a 3% decrease. Engine Business revenues are projected to be 8% lower than last year.

This is lower than our previous expectation of a reduction of 5% due to lower demand from Power Generation and a lower outlook for the heavy-duty truck market in North America. We now expect to deliver EBIT in the range of 12.5% to 13% of sales for the year, with the biggest change in our EBIT guidance coming from Power Generation. I want to add more details about our sales in key markets around the world. As I said, Company revenues increased 4% in the third quarter, with revenues in North America up 11% and international revenues down 4%.

Our shipments of engines for North America heavy-duty trucks were 20,000 in the third quarter, slightly above last year, but a decrease of 6% from the second quarter and below our forecast three months ago. For the full year, we are adjusting our forecast for the market size to 223,000 units, down from our previous forecast of 229,000 units. Demand for new trucks has not grown as much in second half as we expected. Our market share, though, is 40% year-to-date, consistent with our plan and our full-year guidance.

We shipped 16,000 units to the North American medium-duty truck market this quarter, an increase of 38% year-over-year. We expect a full-year market size of approximately 110,000 units in 2013, up 3% from 2012. Our market share increased again in the third quarter and currently stands at 62% year-to-date, ahead of our previous guidance of 60%. As Navistar starts to ship trucks powered by our ISB engine we should see further market share gains going into 2014. Demand from Chrysler decreased by 23%.

Shipments in the third quarter of 2012 were very strong, as dealers orders increased ahead of the 2013 model year change. Full-year volumes are expected to decline 10%, consistent with our prior guidance. Power Generation revenues increased by 17% in North America, boosted by sales to the US military. Excluding the military business, sales to our traditional markets increased 3%, reflecting the general trend of moderate growth in a number of our end markets in North America. Our international revenues decreased by 4% in the third quarter, with declines in India, Australia, and Europe offsetting growth in China and Brazil.

Our revenues in Brazil increased 14% with improvements in Engines and Components driven by stronger on-highway demand as the truck market recovers after a challenging year in 2012. Our Power Generation and construction business also grew in the third quarter. For the full year, truck production for the industry is expected to grow by 38%. However, production for the fourth quarter will be lower than the third, as some OEMs take shutdown days to lower inventory.

Third quarter revenues in China, including joint ventures, increased 23% year-over-year, due mainly to higher demand in on-highway markets. Demand in our Power Generation and construction markets remains relatively weak, consistent with a slower pace of infrastructure investment and weak manufacturing activity. In the medium- and heavy-duty truck market, industry demand increased by 26% in the third quarter, driven largely by pre-buy ahead of the anticipated implementation of NS4 emission regulations. Year-to-date, industry sales are up 14% and we now expect full-year demand to increase by 15% over 2012 compared to our previous forecast that the market would increase 5% year-over-year.

The truck industry is still awaiting communication from the Chinese government regarding a specific transition plan and timetable for the new emissions regulations. Although a number of cities and regions that have announced the implementation of the new regulations is growing, very few NS4-compliant products are currently being produced. We have received some orders for after-treatment systems to be delivered in the fourth quarter, which is encouraging, but we continue to believe that the transition to NS4-compliant technology will be gradual. Volumes and revenues at our light-duty joint venture with Foton grew in the third quarter, with revenues for the domestic market up 36%.

For the full year, we expect revenue growth of 66%, as Foton continues to produce more vehicles equipped with our joint venture engines. Demand for excavators in the third quarter increased slightly, with industry sales up 10% against extremely weak comparisons. Year-to-date industry sales are down 7% and we expect the full year to be down 4%, consistent with our expectation that 2013 would be a year characterized by weak end user demand and destocking. Cummins' third quarter revenues in construction increased 10% year-over-year but still remain at very depressed levels.

Power Generation revenues for the third quarter in China, including joint ventures, increased 21% compared to a year ago when orders were quite weak and dealers were reducing inventory. Revenues for the year are expected to be flat, consistent with our prior year forecast. For the full year, we now expect our total revenues in China, including joint ventures, to be up 10% compared to our previous forecast of an increase of 5%, with growth in on-highway markets more than offsetting weakness in off-highway markets.

Of all of our markets, India is currently the most challenging. Revenues, including joint ventures, declined by 25% in the third quarter, as demand dropped sharply in most end markets. Customers cut orders to lower working capital and preserve cash as business confidence declined in the face of weak industrial activity and rising inflation. Truck production for the medium and heavy commercial vehicle market declined 33% in the third quarter,, and we now expect a full-year decline of 25%, down from our previous projection of a decline of 12%. Industry truck sales in September represent the lowest monthly total since 2003.

Power Generation revenues declined by 34% in India, excluding the impact of currency movements, as demand for power weakened with a slowing economy and an easing of the power crisis in the south of the country. We now expect full-year revenues to decline by 12% compared to our prior expectation that revenues would grow 8%. We now expect full-year Company revenues in India, including joint ventures, to decline by 19% compared to our previous forecast of a decline of 11%. In Europe, we experienced a 3% decline in revenues year-over-year.

Revenues in the UK declined by 37% caused by weak demand for Power Generation equipment for rental and power projects. Weak sales to UK-based customers were partially offset by increased sales to Russia. Sales in other European countries increased modestly. Revenues in Australia declined by 24%, with the depreciation of Australian dollar causing 10% of the reduction. Weaker demand from mining companies has affected our Engine, Power Generation and Distribution businesses there.

Although demand remains weak in a number of our major markets, we are encouraged by the strong interest from OEMs to partner with Cummins, as they execute their global product plans. In the third quarter, a number of OEMs announced plans to increase the use of Cummins engines, including Nissan and Navistar, and this month there have been further announcements. Scania announced the ISB engine in bus applications in Europe for Euro 6, the first time a Scania vehicle has been powered by an externally sourced engine. Just this week at Fenatran, the Brazilian truck show, MAN exhibited a Constellation truck powered for the first time by the Cummins ISL engine. At the same show, Ford exhibited a new vehicle that will also be Cummins powered.

Our leadership is focused on driving strong financial results, despite the weak global markets, all while continuing to invest in our key programs that position us for profitable growth in the future. We continue to launch leading new products in the major markets around the world and help our customers and partners achieve competitive advantage. At the same time, we improved gross margins year-over-year and our operating cash flow has increased 69% through September. There is no question that it's a challenging period, but we will continue to perform well and build for the long term. Thank you for your interest today, and now I'll turn it over to Pat.

Thank you, Tom, and good morning, everyone. Third quarter revenues were $4.3 billion, an increase of 4% from the third quarter of last year. North American sales, which represented 54% of our third quarter revenues, were up 11% from a year ago, with increases in each of our four operating segments. The increase in revenue was driven by stronger demand and market share gains in the North American truck markets, along with the impact of acquisitions in our Distribution segment and increased military sales in our Power Generation business.

Growth in our North American on-highway business was partially offset by continued weakness in industrial markets, in particular mining. International sales decreased by 4% as a result of continued weakness in global industrial and power generation markets, particularly in India, where we experienced a 28% decline in revenue compared to the previous year due to the slowdown in the economy and the devaluation of the rupee against the US dollar. In total, the stronger US dollar negatively impacted international sales by $65 million, mainly in India, Brazil and in Australia.

On a more positive note, China sales improved by 20% from the third quarter of last year. Despite a 28% drop in high horsepower engine sales, gross margins improved to 26% of sales in the quarter, up from 25.3% last year. This increase was the result of improved pricing, lower material costs and productivity improvements, partially offset by an unfavorable product mix. Selling, admin and research and development costs increased by $23 million compared to last year, but remained unchanged as a percent of sales. The acquisitions in our Distribution segment accounted for $15 million of this increase.

Joint venture income of $91 million was down 3% compared to year ago and negatively impacted our EBIT margin by 20 basis points. Compared to last year, lower earnings from our North American distributors as a result of the acquisitions was partially offset by increased earnings in China. Earnings before interest and tax improved to $536 million, or 12.6% of sales for the quarter, compared to 12% of sales last year, which represents a 27% incremental EBIT margin. Earnings per share were $1.90 compared to $1.86 a year ago and the tax rate was 29.2% in the quarter. Compared to the second quarter of 2013, sales were down by 6%. The Engine and Component segments were impacted by decreased demand in North American truck markets and we experienced reduced demand in international Power Generation markets.

Despite the lower revenues, gross margins increased by 50 basis points when compared to last quarter. Selling, admin and research and development costs were essentially flat for the second quarter, but increased as a percent of sales as a result of the lower revenues in the third quarter. Joint venture income of $91 million was down $17 million compared to the prior quarter, as a result of lower earnings from joint ventures in both China and in India. Other income was $20 million lower as one-time favorable items in the second quarter did not repeat in the third quarter. As a result of the lower sales and joint venture income and one-time benefits in other income recognized last quarter, earnings before interest and tax declined from $621 million, or 13.7% of sales, to $536 million, or 12.6% of sales in the third quarter.

Let's move on to the operating segments and discuss third quarter performance and the outlook for the remainder of the year. In the Engine segment, revenues were $2.5 billion, a decrease of 1% from last year. Increases in North American, Brazilian and European truck markets were more than offset by a 30% reduction in sales to our Power Generation segment and a 33% reduction in sales to global mining markets. Compared to the prior quarter, sales were down by 6%. Sequentially, we experienced weaker demand across most end markets, including North American truck markets and global industrial markets.

Segment EBIT was $272 million, or 10.9% of sales, up from 9.5% last year, with the improvement all coming in gross margins, with lower material and warranty costs and improved pricing more than offsetting the headwinds from lower high horsepower engine demand in mining, oil and gas and to power generation. Sequentially, the decrease in volume and lower joint venture income resulted in EBIT margins decreasing by 190 basis points. For the full year, we are adjusting our forecast and now project that revenue for the Engine segment will be down 8% compared to our previous guidance of down 5%. The reduced guidance results from lower demand in the North American heavy-duty truck market and international power generation markets, coupled with general weakness in India.

Compared to 2012, revenue decreases are driven by weakness in industrial markets, in particular mining, and lower demand in the North American heavy-duty truck market. This is partially offset by improved demand in the Brazilian truck market and market share gains in the North American medium-duty truck markets. We now project EBIT for the full year to be between 10.5% and 11% of sales. In the Component segment, third quarter revenue was $1.1 billion, up 14% from last year, and down 4% from the prior quarter. Compared to last year, higher revenues were driven by stronger demand in global truck markets, excluding India, combined with market share gains in our emissions solutions business.

Compared to last quarter, reduced demand in the North American heavy-duty market was partially offset by increased demand for after-treatment systems in international markets. Segment EBIT was $132 million, or 12.3% of sales, up from 9.5% last year. Higher volumes, along with lower material costs, resulted in improved margins compared to a year ago. Compared to last quarter, EBIT margins improved by 10 basis points, with lower warranty costs partially offset by the lower volumes. We continue to expect full-year revenue growth of 7% for the segment, and compared to our previous guidance, we now expect slightly weaker demand in North America to be offset by stronger demand in the China truck market.

Compared to 2012, revenue increases are primarily due to increased after-treatment market share in the North American truck markets. We now project EBIT for the full year to be between 12% and 12.5% of sales. In the Power Generation segment, third quarter sales were $712 million, down 13% from both the prior year and the prior quarter. Compared to the third quarter of 2012, weakness in international markets, especially India, was partially offset by higher sales in our North American business. Sequentially, we saw weakness in both North American and international markets, including India, which saw sales decline by 30%. EBIT margins were 6.3% in the quarter, down from 9% last year and 9.3% last quarter.

The lower EBIT margins were the result of the sharp decline in volume and from a legal settlement. For 2013, we now expect sales to decline 10% compared to last year, primarily due to the weakness in international markets. The reduction in revenue guidance is primarily driven by deteriorating conditions in India and China, along with weaker demand across most international markets. As a result of the weaker demand, we are lowering EBIT projections for the full year to between 7.25% and 7.75% of sales. For the Distribution segment, fourth quarter revenues were $944 million, an increase of 18% compared to last year, and a reduction of 1% compared to the prior quarter.

Excluding the impact of acquisitions, third quarter revenue increased 2% compared to last year, and decreased 5% sequentially. Compared to the prior year, growth in parts and service revenue in North America was partially offset by weakness in North American oil and gas markets, global mining markets, and international power generation markets. Currency negatively impacted revenues for the segment by 4% compared to last year. EBIT margins as a percent of sales were down 3.3% from a year ago and were down 1.4% from last quarter.

While the acquisitions completed during this time were accretive in EBIT dollar terms, they were dilutive as a percent of sales as we have previously explained. Currency movements negatively impacted both EBIT dollars and EBIT percent compared to last year and also last quarter. For 2013, we continue to forecast 10% revenue growth. However, we are reducing EBIT projections for the full year to between 10.25% and 10.75% of sales due to the expected impact of the unfavorable currency movements. Overall, our third quarter results represent an improvement over the previous year, and incremental EBIT margins for the Company were slightly better than our long-term target that we communicated at our investor day last month.

However, where we expected third quarter revenue to be lower than the second quarter, the decline was more than we anticipated due to weakness in international power generation markets, along with a significant deterioration in Indian markets and the reduction in the North American heavy-duty truck market size. As a result of this, we have adjusted revenue guidance to reflect these conditions and we now project total Company revenues to be down 3% in 2013 and we are forecasting EBIT margins for the Company will be in the range of 12.5% to 13% of sales, down from our previous guidance of 13% to 14%. The change in EBIT guidance is driven by the lower volumes in Engine and Power Generation segments, along with negative impacts of currency, which primarily impacts the Distribution segment.

We are now projecting a tax rate to be 28.5% in 2013 excluding any discrete items. During the quarter, we completed a $1 billion debt offering, which we will primarily utilize to fund our acquisition of the North American Distribution channel. Our debt to capital ratio has now increased to 19% and all rating agencies reiterated A and AAA credit ratings for the Company. You should expect interest expense for the Company to rise from the current run rate of approximately $8 million a quarter to $20 million beginning in the fourth quarter of this year. We've produced $1.3 billion of cash from operations year-to-date, which equates to just over 10% of sales.

Year to date, we have reinvested almost $600 million back into the business and returned $600 million to shareholders in the form of stock buybacks and dividends. During the third quarter, we did increase our dividends to shareholders by 25%, marking a 257% increase over the last four years. We will invest approximately $700 million in capital expenditures for the full year, which is below our previous projection. Inventory levels of $2.5 billion are down $60 million from this time last year. Excluding the impact of the acquisitions, inventory is down $178 million from a year ago. We do expect to lower inventory levels further in the fourth quarter. And as is our practice, we will provide guidance for 2014 during our fourth quarter earnings release. Now let me turn it back over to Mark.

Thanks, Pat. We are now ready for questions. I would ask that you limit yourself to one question each and an associated follow-up and then get back in queue. Operator, we're now ready for questions. Thank you.

Thank you, sir. (Operator Instructions) Andrew Kaplowitz from Barclays, please proceed.

Hello, Andrew? Our next question comes from Jerry Revich, Goldman Sachs. Please proceed.

Good morning.

Hi, Jerry.

Tom, can you talk about how we should think about the margin structure in Power Gen with your highest margin business obviously declining from here, can you keep that at a 20% or so margin business in India, and can you get the segment back to double-digit margins? And within that, what was the exact legal settlement costs in the quarter?

Well, let me just talk first of all about what is happening in Power Gen and how I think that's affecting margins, and I'll hopefully get to your question about what I think the opportunity is. Clearly, we're operating now at significantly below capacity. So we are, especially in our high horsepower side, which is impacting mix. So we're seeing worse gross margins because of mix and we are also well below capacity, so we're having absorption challenges in our plants.

Having said that, we've put in place a number of cost reduction efforts. I've mentioned those last time. We've been doing a lot of work in Europe, where we've had very, very low demand for our large alternators. We've also done work across the whole business in terms of reducing costs, improving supply chain costs, and as you heard from Mark (multiple speakers) -- and pricing has been a net positive despite the challenging environment.

We've been managing in a tough environment to try to hold our margins best we can, but there's no question that we are disappointed with where we are. The biggest negative impact in this quarter was India, where we were -- it was not doing well up till now, but it really fell off a lot in Q3, much more than we expected, as it seemed like the economy just hit a tipping point. All of a sudden, people started to say we have to reduce orders and we have to preserve cash now, and that was, frankly, a surprise to us, how quickly that happened. And so a whole bunch of orders were cut or pushed out towards the second half of the quarter and it looks like will extend into Q4. So that also impacted us.

I do feel, I still believe, Jerry, that our opportunity in Power Gen to get back to double-digit margins is clear. Our path is clear. Tony laid it out in our analyst day and we still see it as more than doable. Basically, we've got to get our volumes and growth up. That's clear. So we can utilize some of our capacity.

We've got to get our high horsepower business up, which will definitely happen, as markets return. And then we'll benefit from the cost reduction actions we're taking now and that will drive us up to double-digit margins. I have complete confidence that that's going to occur. We do need some markets to turn back for it to happen.

And, Jerry, on the legal settlement, that relates to a case in Brazil that goes back to 2002, 2003 that we settled this quarter and that was for about $8 million.

Our next question is from Andrew Kaplowitz, Barclays. Please proceed.

Hi, guys. Can you hear me now?

Yes, welcome back, Andy.

Thank you. Tom, maybe -- I know you don't want to give 2014 guidance now, but can you frame some of the puts and takes as we go into 2014? What could be better in 2014? We know about Navistar. We know about you are buying your Distribution businesses. But to bridge the gap to 2015, we need a pretty strong growth here off of these levels in the second half of the year. So where do you think that comes from? What's the visibility you have today on the 2014 growth?

Right, it's a great question, Andy. And, again, without providing guidance, let me just talk to you about some of the big things that are happening. Obviously, economic conditions are uncertain. I won't be able to give you much view about that because we just don't have a good view of it. That would be something that hopefully as we get to the closer to the time we give guidance we'll be able to give you a better view of it, but right now, we don't see a big wind behind us on economic conditions.

There's a few places getting a little bit better, like the US, but most places, it's not clear. But there's a whole bunch of stuff going on for Cummins which is not related to the economy that we think drives some level of growth next year. For example, Euro 6 and Tier 4 final, both emissions regulations hit next year. That will have a positive impact on our Components business, significantly positive. You talked about Distribution acquisitions. We'll start to see more and more of those come in, which drive earnings dollar growth throughout the year.

We launched a whole new range of low-horsepower Gen sets and those will be in the US, which is, again, one of the markets that's doing a little bit better. It's a market where our share is not very large today and we have an opportunity to grow and it also helps our Distribution business. We've got the ISF business, which has been growing, but pretty slowly. It's now starting to see some critical mass. Foton is now taking more engines and putting them in their vehicles.

They are a very large vehicle supplier in China. But also we have off-highway applications now coming for the ISF. So that business is likely to improve. And that's, again, new market share that we're not in today. The 10- and 12-liter, we talked about the ISG before. It will be a slow start because it's a new launch. Our sales will grow.

Our profitability will be below what we'll achieve at maturity, but it will grow through the year and improve through the year and that will be a nice add. Then, of course, we've been doing cost improvements all year. When we stay flat and we have cost improvements, we begin to absorb those, we see better margins at the same sales. But also, we'll be continuing, of course, to do more next year. But I think the effect of the cost reductions we're taking this year also helps us next year. So those are just wins that are coming our way, I think, separate from what happens in the economy.

Okay. That's helpful, Tom. If we look at 3Q over the last several years, it's been kind of weak versus 4Q. And your implied guidance talks -- it seems like it talks more about flat in EPS and down actually in sales. So is this just India being extremely weak at the end of the quarter that makes you guide like this? And is it also, as you mentioned, I think you mentioned Brazil is down quarter-over-quarter, sequentially also?

Yes, this is Pat. I think India is a big factor in us taking a more prudent position in the fourth quarter than what we may have done in the past. The drop-off really in the last couple of months in the third quarter did catch us by surprise and there's no signs that those markets will recover any time soon. The other area I would throw into the mix would be the North America truck market, heavy-duty truck market, in which we're seeing weaker demand than what we envisioned three months ago.

You may remember, we kind of envisioned the truck market kind of getting better each quarter. There's a pretty big improvement from Q1 to Q2 and then steady improvement, and in fact, that started out that way and then started to level out and head down again, and so that's just worse across our Components and Engine business for North American heavy-duty truck.

Okay, guys. Appreciate it.

Thanks, Andy.

Steve Volkmann, Jefferies. Please proceed.

Hi, good morning.

Good morning.

I'm wondering if I can just expand this maybe a little bit further. It sounds like things sort of -- obviously, you gave the preliminary view that things were a little bit weaker than you expected when you were at the analyst day, and it sounds like maybe -- I don't want to put words in your mouth -- but they actually sort of deteriorated further from that point. I guess I'm just trying to put this in the big picture. Do you still believe that the 2015 targets you put out there are achievable given what you are seeing now, especially with the India weakness, or should we be reevaluating that a little bit?

No, you may remember, Steve, as we set targets, we're always looking at trying to understand targets in the face of market conditions we are in -- vary by market conditions. But as we stand now, we still believe we can hit our 2015 targets. And when we don't think so, we'll tell you that. Right now, it's too early to tell what economic conditions we're going to have for 2014 and 2015, and as we understand it, we'll definitely share with you, but right now, we're still headed for those targets. There's no question, as you said, that Q3, which is one quarter, was weaker than we expected.

And as Pat highlighted, the big, the parts that were weaker were India, which really -- it was already bad. So we already had a weak forecast in, but it was a lot weaker than we thought. Then as we said, North American kind of crept down some. On the high horsepower side, the reason we saw things weaker when we talked before is that the high horsepower markets have been kind of, have been to the bottom end of our ranges in nearly every market. So mining's at the bottom end of the range.

High horsepower, Power Gen is now below the bottom end of the range. So a whole bunch of those. They are not really way out, but they are -- everything's as bad as it could be. Then you added these other two things in and we just had no room in Q3 really to make it up. So that's what happened in Q3. But we're -- we've still got a lot of favorable things happening in 2014 despite the market, so we're still shooting for our 2015 targets.

Okay, great. That's helpful. Then I guess, I know we ask you this every quarter, so I'll try again and see what happens. Seems like Navistar is the biggest swing factor ex- market growth next year. And it's going to be a big deal, I guess, as to where these numbers settle out for 2014. Can you give us any help yet in sort of putting parameters around what you think that opportunity is specifically?

No. I appreciate you asking again, though. Thanks. (laughter) You probably understand the sensitivity of that in terms of market planning for them and for us and all that kind of thing. But it is a good opportunity. But, again, it's one of many. I talked about them before, but the Euro 6 and Tier 4 (final) will be significant opportunities for our Components business. Those will be big ones.

And the Distributor acquisitions will continue to contribute. So there's a number of good new product launches. One of the things you could say about us is that over the two years, or year and a half, while growth has been relatively modest, given the markets, we have continued to invest to make sure we've got new products available. Those will help us in 2014, and as markets return, they will help us even more, which is why I remain confident about our 2015 targets. So I think those give us some tailwind, even in flat markets.

I appreciate it.

I would just add one more comment on Navistar. We are on track, if you look at the heavy-duty for what our share would be at Navistar. We're approaching 60%, which is actually higher than we had simulated. And our medium-duty share with the beginnings of Navistar, we're now up to 62%. So recall, we talked, we -- as recent as five years ago, we were at 38%. So we see more upside to growing the medium-duty share as we move forward in 2014.

I appreciate it.

Next, our question is from Jamie Cook, Credit Suisse. Please proceed.

Hi. Good morning.

Hi, Jamie.

I guess a couple questions. One thing, you had pretty good margin performance on the gross margin line, which was impressive, but I guess as I look at your SG&A levels as a percent of sales, or on a dollar basis, just given where revenues are going, I'm just wondering if there's more opportunity there versus what we're seeing today? And if you could talk about some of the actions that you're taking there. And then I guess my next question, on the Engine side, you cited material costs and warranty costs, I think, helped you.

How much was that versus mix, which was a headwind? And then just my last question on Power Gen, in some of the other industrial companies I cover, we're starting to hear about pricing deterioration in ag and construction equipment. I'm wondering on Power Gen, is pricing taking a turn for the worst? Thanks.

Jamie, why don't I address SAR and Power Gen. Pat, maybe you can talk a little bit about the mix of numbers, or Mark can.

Sure.

On the SAR side, that's something, as you would guess, we take a pretty good look at. The balance that we're striking on the SAR side is we definitely see relatively weak economic conditions today, so we need to keep our costs down, we need to keep finding ways to reduce costs. On the other hand, we need to invest to make sure that we've got future growth. So we're balancing those two.

And we've talked about that before, but my leadership team spends a lot of time going through project-by-project to figure out where we can reduce, where we can delay, where do we want to carry on and we're doing that even more. It's just getting, with growth, again, not really coming in the last few quarters, it's getting tougher and tougher. So we're having some pretty tough conversations about that. I think you will continue to see us keep a very tight squeeze on SAR. One thing I just wanted to highlight to you is versus a year ago, acquisitions was half of the increase in SAR.

So if you just look at SAR year-over-year, we're about the same in dollar terms. And so we're not really growing very much, and sales aren't growing very much, so that's about what we can afford to do. So I think we're, we are keeping a tight lid on it. We're definitely looking for opportunities to reduce everywhere. In Power Gen, remind me, our question about Power Gen?

Well, my question was, on Power Gen, just are you seeing -- you talked about mix, you talked about India. I'm just wondering if pricing is becoming a factor,, or discount?

Yes, and so far, Jamie, we have not seen deterioration in pricing. Obviously, it's something we take a good look at, and it's not that we don't see competition here and there where something gets more aggressive, it does happen. But generally speaking, I would say pricing has held up pretty well. In fact, we put in a pricing initiative to improve pricing this year and we'll get some pricing benefit year-over-year in Power Gen. We'll see how it goes, but so far, that's not been a major impact, again, other than individual deals, we, obviously, see competition now. But our expectation is that it will be up a percent or something in pricing.

And, then, Jamie --

And then -- sorry. Go ahead.

That's okay. The question on the--

Engine.

The Engine.

What was the material cost warranty versus mix?

Yes. If you look year-over-year for the Engine segment, despite sales being down (inaudible) business actually improved their gross margins from 20.5% to 22%. So that was terrific. Pricing was about 1.5 to 2 percentage points of that. Material costs was about 1% of that. And then the volume mix went the other way, was about 1.5 percentage points. Warranty was a little bit better. We're talking tenths of a point now.

Okay, great. I'll get back in queue. Thanks.

Thanks, Jamie.

Ann Duignan, JPMorgan, please proceed.

Hi, good morning, guys. How are you?

Hi, Ann, good.

Can you talk a little bit just philosophically, I guess, what do you think is going on in the North America heavy-duty truck market? We hear a lot anecdotally about hours of service, we hear about GPS, the lack of drivers. What's your sense of what's going on out there? And to that question, why do you think there's such a big disparity between what we're seeing in heavy-duty versus medium-duty? Just be interested in getting your color.

Well, let me take a first shot at this. Having said that, we've been wrong most of the last few times we've talked about heavy-duty truck. But right now, it appears, and we talked to the same people you do -- the fleets -- the bigger fleets are kind of in a replacement mode, and generally folks are not expanding fleets, despite some pretty positive things that you look macro at the market. Used truck prices look good.

The ages of fleets, freight's up. But we kind of -- we see it going sideways right now quite frankly with, despite there appears to be some positive things that we would expect. On the medium-duty side, we've gotten some help from -- the housing market is a piece that's helped us in North America. That's a piece that's helped us and then plus we've gained share through the year on that. Again, it's -- we have seen the impact of the natural gas has come in too, it's filled in some of that gap as we've introduced ISX 12.

Ann, the only thing I would add, broadly speaking in the truck market, I think we're seeing the same thing we're seeing in most business-to-business environments in the US. Conditions are okay and they are growing slowly, but business confidence is not very high for major investments. Basically, people are making small investments, and conservative investments, they are not hiring that much, so they are not doing anything, but it's pretty conservative and pretty slow versus, as you know, we see in the consumer economy, is a little bit more robust. But business-to-business is not.

We just had ATA, a lot of our folks were interacting with a lot of fleets. And nobody thought it was a disaster, but nobody was getting ahead of themselves. They are all kind of just staying within their -- within the fairway here about what they think they can afford, they will buy trucks when they have a new route, they will replace trucks that look like they are past, and that's what they are going to do.

Okay, that's helpful, and just to touch on the 12-liter natural gas, can you give us an update there? There was a lot of excitement earlier in the year from the OEMs. How is the launch of that engine going? Is it in line with your expectations, better or just slower or ramping up given the macro, just an update there, please? Thank you.

Sure. We rolled out the full line in August, with the higher ratings, and, in fact, the acceptance has been good. Again, we're now engineered in with all the OEs in North America. In fact, our sales are running a bit higher than our internal projections.

Okay. I'll leave it there and I'll get back in line. Thanks, guys.

Andrew Casey, Wells Fargo, please proceed.

Thanks. Good morning, everyone.

Good morning, Andy.

Just a little bit back to Ann's question on the NAFTA truck market. The end use customer is, obviously, seeing some challenges. I'm wondering if you're seeing any industry order activity acceleration during October?

No, we haven't, Andy. We'll be delayed from the truck guys, obviously, Andy, so you'll -- obviously, you'll talk to them, I assume, and see. But right now, if you look at build rates or whatever, we're not seeing anything accelerating in build rates.

Okay, and then same sort of question on the oil and gas markets, Tom. Are you seeing any movement in drawdown on the excess inventory that you talked about over the last couple calls?

Yes, it appears that we're, we're seeing the bottom of that. And in fact, they are from very low comparables that we're seeing a bit of an uptick in the order rate in oil and gas. We talked to folks that have, much of the equipment has been moved from the shale gas, into the oil side, and so equipment appears to be -- utilization rates are pretty good right now. And so that's one we see, we've shaken out most the inventory, and I've seen at least real short signs of some improvement there.

In order rates to us.

That's good. And then one last one, we've heard some kind of mixed commentary about the Brazilian truck market. Are you guys seeing any change in trajectory down there? Or is it still pretty positive?

Well, as I mentioned in my remarks, Andy, the only thing I would say is that the Q4 looks like build rates will drop a little bit because people will take some shutdowns, which, again, they are saying they are managing inventory and things. That gives you some cause for concern. I think, the other thing I hear about is that [fenamy] rates might increase. There's a lot of discussion about how the government's trying to manage costs and they have got their own budget challenges and things like that, so they are talking about pushing [fenamy] rates up, which, again, could drive down volumes.

So there's a couple of headwinds, I would say, in the market. But as I mentioned, things are significantly improved from last year. Truck market's generally pretty good, especially at the heavy end. The part that's help supporting the ag markets, which are pretty robust, that part of the truck market looks quite good. The rest of the truck market looks like the rest of the economy, which is some level of growth, but not awesome.

Thank you very much.

David Leiker from Baird. Please proceed.

Hi, just two things I want to talk about a little bit. I know we talked about pricing a little bit earlier. In your mining end markets and your Power Gen end markets, both pretty weak, and in those types of environments, usually see discounting or incentives or things like that. You don't seem to indicate that any of that's happening?

Yes, again, as I mentioned, it doesn't mean that in an individual deal, individual market there isn't some work on that. But generally speaking, I would say in those markets because there are, there's relatively few players, all those players are in for the long run. The products are pretty highly engineered. The customers are generally not looking for a 3% off. They either have the money to do the project or they don't, right, or they want to get the mine running or they don't. So there's a little bit less of this mentality, well, I would do it for 5% less, but I wouldn't do it for that price, a little bit less in those segments of the market.

Again, it's not that it doesn't happen, but it has not been an overwhelming trend. We did see it a decade or so ago when there was a lot of overhang in the rental business. And one of the things I mentioned in my remarks, several comments were, rental demand is down a lot. And rental demand tends to be the one that's sort of swings more to adjust the capacity when they start to see downturn, they got to bring down capital purchases a lot to make sure they don't get too much equipment.

That has happened. So some of our big customers, like a Graco, have cut orders dramatically. Bunch of Middle East rental players also cut dramatically and what that will do is help prices. It's really bad for demand, but it helps prices because the rental inventory overhang doesn't drive down prices.

Okay, great, thanks. And then, one additional item. Nice wins at Scania and MAN. Can you talk a little bit and provide some color, are those new engines in terms of those placements? Are those replacing internal engines or are they a new range of engines within those OEMs? Just a little color there, please.

Yes. Those are both new ranges for those guys. So think -- in the Constellation truck example, that's MAN. And they are basically the power requirements of customers in those midrange or small, heavy trucks is going up. So people are asking for more power to do more things. It's just a typical evolution of the truck market, and the Constellation, which is an incredibly popular truck, has been for years, is just pushing up the power.

We've been working on that with them for years, and it's going to be -- it's a terrific launch. It's a great vehicle. It will be really well accepted, given the demand. So that's that one. On the Scania side, they don't offer much in this lower range of products. So they have had generally heavy trucks and heavy buses.

This midrange engine that we're providing for them gives them a little bit smaller, shorter bus to compete in more markets. So for them, it's an opportunity to expand their product range.

And if you look across the market and your customers, how many more opportunities are there for share gains of product extensions at your customers?

Yes, I appreciate the question. This is the, this is the bright spot I was trying to cover. It's a tough economy and you got to figure out where you think the opportunities are. But we are getting more positions at more OEMs than ever. Why is that? Because you we've got global scale, especially in our midrange business. We make more midrange engines than anybody by 10 times.

We are so much larger and we're in every market with every technology. Plus, because we're launching all these new emissions products, that means when you buy one of our engines in any size range, you can launch it in Brazil, you can launch an earlier version of it in China, you can launch an even earlier version in Africa, and you can even eventually take it to the US if you want to. So you partner with us, you get a lot of choices in terms of international expansion. So every OEM, OEMs who have never talked to us before, Scania has never had an outside engine, said, okay, we'll try it. It's the only way they can compete in that size engine.

So I see us getting win after win. In off-highway, that's even more. The volume numbers are lower in off-highway applications, but it's even more wins. So I see us having lots of opportunities there, and if we see an economic upturn, if we actually see markets grow, all this stuff will turn into significant revenue and profit opportunity for Cummins.

No, that sounds great. Thank you for the time.

Next question is from Alex Potter with Piper Jaffray. Please proceed.

Hi, guys.

Hi.

First, when you were kind of running through the list of incremental opportunities that you have in 2014, I noticed that you left NS4 in China out. Is that because it's tough to predict, or I'd just appreciate it, I guess, a little color there?

It's a great question. I know you pay close attention to this. The view is the transition is going to be gradual and because you're launching new products, we'll see gradual increase in volume and relatively modest margins to start with that will get better over time. I was just looking at the opportunity so say, yes, it's there, but there's not a bunch of dollars to count to the bottom line, unless the transition goes faster than we anticipate. So it's a great opportunity for Cummins.

I didn't mean to say that. Just to say, like, if I think through how much is that going to contribute to growth in profit and based on our assumptions for how gradual it's going to be, it doesn't look terrific until towards the end of the year. But as you said, there's a lot of uncertainty about that. The fact the government hasn't given guidance is remarkable. Companies are acting like they have guidance because they have no choice.

They are definitely buying some, a few vehicles and a few engines and after-treatment systems and figuring how they can set them up and be ready, but there's just very little volume today and very little clarity about when there will be volume.

Okay. Fair enough. Was wondering then also, I guess, on, again, on Power Gen this time in Europe, how much longer do you think it will take before restructuring is complete there?

We'll be done with it for sure by the end of the year. And that assumes, again, that we kind of reached the bottom of our volume curve. Of course, we always re-look. If things got worse, we would have to take more action and that's kind of where we are. We're quite a bit below full capacity in our Power Gen business, especially in our European plant. So we would take another look. But for the program we're running now, we'll be done at the end of the year.

Okay, great. Thanks, guys.

Thank you.

Our next question is from Jeff (inaudible) of Buckingham Research. Please proceed.

Thank you very much. You clarified the currency impact on the revenue line, mostly Distribution. Could you clarify the currency impact on an operating profit line?

Yes, for the Company, Jeff, if I compare Q2 to Q3, the currency impact on sales was $65 million. The currency impact on the EBIT line was $6 million. So for the Company overall, it wasn't such a big deal. For the Distribution segment, they are always more exposed given their profile to currency movements than any of the other three segments.

Okay, and if I just kind of hear all the commentary, talking about the end markets, at the end of the day, is this more a function, and let's take India and put that in its own special bucket, is this more a function of weak markets, just not improving as much as we thought in terms of the disappointing guidance? Or is this a function of your view on global growth changing?

I think it's really three things, Jeff, to summarize. Again, there's a lot of changes but just let's give three big ones. Number one is that the high horsepower market trends, so the mining, power generation, the big project kind of work, all that stuff is at the bottom of its range. It's not really a different thing. It's just worse.

Right, right. So that's bucket one, where it was weak and we didn't see it get better?

We didn't think it would get better, but it just got worse, exactly.

Okay, all right.

Second one was -- I would put in the second bucket, which is we thought North American truck would get steadily better through the year, and it actually turned back and started to get flat or worse.

And do you view that more as a shorter-term concern given where the market is and maybe some weaker profits at the truckers, because we do have a lot of new product coming in the market next year, or do you view that as a change in the market?

I think it's just a weaker situation. I think basically we are in the same condition, North American truck, we have been for a long time which is that, as Rich was saying, there are people that are replacing trucks, that's fine, but they are not really growing any fleet. And if you look at -- so when the truck companies kind of build their stock and anticipate what people -- they overcall it by a little bit and now they had to cut build rates, so, and order rates are not really growing, so we ended up with a little weaker Q3 and Q4 than we thought.

It's not a big change, but it's big enough in this low market to pinch us, but it's not a gigantic change, shift in market. What we really need is we need confidence in the US economy to grow so business-to-business investment goes up and then we'll see a real bounce back. And the third bucket really is India. And India, I would just say to you, I think we should have seen it better than we did. The market was already bad.

And it just turned a lot worse in Q3 than we anticipated. I'm disappointed that we didn't see that earlier on. One thing you step back from these things and say, wow, how come we didn't know it was going to fall so much? But it really took a turn for the worse in Q3 and we just didn't see it. We knew it was bad but it got a lot worse.

If I am understanding your commentary properly, in your view, yes, it got worse, but it's really being exacerbated by an inventory drawdown?

Yes.

Okay.

That's people trying to preserve cash because they have lost confidence.

All right. Thank you.

Yes.

Our next question is from Robert Wertheimer, Vertical Research. Please proceed.

Hi, good morning.

Hi, Rob.

Actually, just to follow up on that inventory drawdown -- Komatsu kind of caught their numbers both on mining, OE and after market during the quarter. Is there an abnormally bad swing this quarter just as they caught up the market? Maybe you were already there. Can you just talk about whether that was an incremental negative?

Yes, it wasn't -- the inventory drawdown was really in Power Gen in India. Mining's kind of tracking exactly where we said pretty much all year, Rob. So year-to-date, we're down 42% in mining and engine revenues, and for the full year, we'll be towards that upper end of the down 40% to 45%. So nothing dramatic to mine this quarter, it's Power Gen in India.

I think that the comments you're hearing from Komatsu and other people are them catching up. Each mining company had a slightly more positive, slightly less positive outlook, and they are all just trying to get back to where the outlook's really going to come out. It's going to be at-- we gave a pretty lousy forecast for the year and it's going to be at the bottom end of our lousy forecast. So it's bad. There's no question that mining is bad. But different companies are just catching up to where the market is versus what they are, how optimistic or pessimistic their market outlook was.

Perfect. Can you update the mining after-market for the quarter and the year? And then is there anything to say on Power Gen in the Middle East, which I think you said it was soft and I didn't expect that. Thanks.

I'll do the Middle East first and then I'll let Mark talk a little bit about after-market. In the Middle East, things are improving in the Middle East. I was just there. I just spent a week there. And definitely, like in Dubai and Saudi, you see projects starting to ramp up, buildings going again in Dubai, and again, Saudis, the oil price is high enough that they are definitely building. So projects are going versus over the last 12 months projects were basically on stop. They are going again.

But the rental business, which is the guys who go out and do projects around the region, they have sort of cut orders in order to make sure they don't end up with too much equipment since projects have been so weak for the last 12 months or so. So my own view is that Middle East will eventually come back up and start going again, but right now it's just a question of settling, letting some of the inventory draw down as orders improve, which they are. Q3, even Q3, orders improved. And Q4, orders will improve again, I expect. But they will draw down inventory and then we'll start to see equipment shipments into the Middle East.

And then on your mining -- last comment, Rob -- on your mining after-market, we said the full year we expected to be flat. We've picked up from that weak point Q4 last year, year-to-date we're down about 1%. So maybe just a touch below our forecast, the comps get easier on after-market in Q4 because we saw a pretty big drawdown. So not a lot of variation.

Perfect. Thank you.

Thanks.

Thank you very much, everybody.

Thank you very much.

Thank you, ladies and gentlemen. I would now like to turn the call back over to Mark Smith for closing remarks. Thank you, Mark. Ladies and gentlemen, thank you for joining today's conference. This concludes the presentation. You may now disconnect. Good day.