康明斯 (CMI) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cummins second-quarter 2015 earnings release conference call.

(Operator Instructions)

As a reminder this conference is being recorded. I will now turn the call over to your host Mark Smith, Vice President of Investor Relations. Please go ahead.

Thank you Stephanie, and good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the second quarter of 2015. Participating with me today are Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; and our President and Chief Operating Officer, Rich Freeland.

Before we start please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934. Such statements express our forecast expectations, hopes, beliefs, and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement on the slide deck in 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 subsequently filed quarterly reports on Form 10-Q.

During this call, for this call, we will be discussing certain non-GAAP financial measures. I will refer you to our website for the reconciliation of those measures to GAAP financials. Our press release with a copy of the financial statements and a copy of today's webcast presentation are available at our website www.cummins.com under the heading of Investors and Media. Now I'll turn it over to our Chairman and CEO, Tom Linebarger.

Thank you Mark. I will start with a summary of our second quarter results and provide an update on our outlook for the full year. Pat will then take you through more details of both our second quarter financial performance and our forecast for the rest of the year. Revenues for the second quarter were $5 billion, an increase of 4% compared to the second quarter of 2014. Second-quarter EBIT was $721 million, or 14.4% of sales, compared to $657 million, or 13.6% in the same quarter last year. This represents an incremental EBIT margin of 36%. Key to these strong results was an improvement in gross margin of 170 basis points year-over-year. Good performance from our manufacturing and supply chain organizations and solid execution on material cost reduction initiatives improved gross margin. Moreover the Company was able to expand gross margin while launching new products and adjusting to weak demand in a number of important markets.

Engine business revenues increased by 2% year-over-year with strength in North American truck and bus markets offsetting lower demand for trucks in Brazil and in global off-highway markets. EBIT of 12.2% of sales improved from 11.3% a year ago due to strong operational performance, lower material costs, and higher joint venture earnings in China. Revenues in our Components segment increased 9% year-over-year with strong demand in North America and sales of new products in China more than offsetting weakness in Brazil and Europe. Revenues in China grew 29% despite a 28% decline in the truck market in the second quarter. As our investments in new NS4 compliant products yielded strong results.

EBIT of $223 million or 16% of sales was a record both in dollars and in margin percent, reflecting strong performance in all four Components businesses. Distribution revenues increased 21% compared to the second quarter of 2014 with acquisitions adding 20% -- 6%, excuse me, and currency negatively impacting sales by 6%. EBIT for the quarter was 7.6% down from 10.2% a year ago. EBIT percent declined due to currency, primarily the appreciation of the US dollar against the Australian and Canadian dollars, and the dilutive effect of acquiring businesses previously held as joint ventures. Excluding the impact of currency and acquisitions, operating margins in existing businesses improved year-over-year. Moreover, EBIT percent improved 160 basis points from first quarter levels due to strong incremental margins on organic sales growth.

We remain on track to complete three further Distribution acquisitions in North America in the third quarter. Our forecast for the positive impact of acquisitions is unchanged from three months ago. We expect to add approximately $600 million in Company revenues this year. In addition to the more than $460 million added in 2014, exceeding the $1 billion in revenues we projected for 2015 at our 2013 analyst date. We currently expect to add $0.20 to earnings per share this year on top of the $0.43 added in 2014 for a total of $0.63. Also ahead of our 2013 projections of $0.50 a share.

In the Power Generation business, revenues increased just 1% year-over-year. This low growth reflects a slow pace of global infrastructure investment. EBIT declined from 8.2% last year to 7.6%. The negative impact of currency, primarily the appreciation of the US dollar against the euro, and lower pricing in the alternator business offset an 80 basis point improvement from cost reduction action. EBIT did improve 40 basis points from first quarter levels. We completed the exit of our German alternator operations in the second quarter as planned, and this will yield additional cost savings in the second half of the year. However, with weak demand projected for the remainder of the year, a competitive market, and continuing challenges from currency, EBIT for the Power Generation for the full year is expected to be in the range of 7% to 8%, up from 2014 but below our original projections of 8% to 9% for this year.

Now I will comment on some of our key markets starting with North America. Our revenues in North America grew 12% in the second quarter due primarily to strength in on-highway markets and Distribution acquisitions completed in 2014. Shipments to the North American heavy-duty truck market exceeded 28,000 units in the second quarter, a increase of 18% from the second quarter last year. Our market share year-to-date is approximately 34.5%, up from 33% in the first quarter. Based on current projections from our OEM customers, we expect our full-year market share to remain in the range of 34% to 35%, below our original projection of 36%. We expect full-year market size to increase by 8%, unchanged from our previous guidance.

In the medium-duty truck market we delivered 26,000 engines in the second quarter, up 18% from last year. We currently project the market -- that the market will grow by 4% for the year, 3% stronger than our previous forecast. We are also raising our market share forecast with our full-year market share now expected to be 76%, up from 72% last year, and higher than our previous forecast at 74%. Shipments to Chrysler increased by 5% in the second quarter, and we forecast full-year shipments to increase 2% compared to 2014, up from our previous forecast of flat. Our Engine revenues from the North American construction market decreased by 7% compared to the second quarter last year. Our revenues will be lower in each quarter of this year compared to last year, as OEM demand for engines was elevated in 2014 ahead of the Tier 4 final emissions regulation, which went into effect on January 1 of this year.

Power Generation revenues declined by 12% in North America in the second quarter due to lower sales to [data center] and rental customers. Our global data center customers are expanding in Europe and Asia-Pacific, but the rate of investment in North America has definitely slowed. After several quarters of growth, rental customers reduced their purchases as they focused on increasing utilization of their existing equipment, with some reports of lower rental activity in oil and gas markets.

Cummins international revenues declined by 6% year-over-year, mainly due to the negative impact of appreciating US dollar and weakness in all end-markets in Brazil. Second-quarter revenues in China, including joint ventures, were $916 million, an increase of 6% year-over-year. The growth was driven primarily by stronger sales of new engines and components in our highway markets which more than offset very weak market conditions.

Industry demand for heavy and medium-duty trucks in China declined by 28% in the second quarter and is down by 30% year-to-date as the industrial economy continues to soften. We have lowered our full-year forecast for the truck market to decline 30%, down from our previous forecast of down 15%, as confidence in the economy has weakened and freight is barely growing. The good news in this challenging environment is that our market share has increased, and the Chinese government continues to plan for the adoption of more stringent emissions regulations, which will be positive for our business longer-term.

Our Engine market share is 15.5% year-to-date, up from 10% a year ago, as shipments of our new ISG heavy duty engines to Foton increased. We have also increased share in the medium-duty market with Dongfeng Motors. We currently project our full-year market share to exceed 17%. Shipments of our light-duty engines in China grew 21% in the second quarter, in a market that declined 5%, as we gained penetration at Foton and some additional customers, displacing local competitor engines. Our market share increased to 6% from 4% a year ago.

Our Power Generation revenues declined by 2% year-over-year in a weak market due to lower infrastructure investment and a low rate of growth in electricity consumption, consistent with a weaker economy. Demand for construction equipment remains depressed in China due to the slowdown in real estate development and infrastructure spending. Industry demand for excavators in China declined 34% in the second quarter and is down 42% year-to-date with no visible sign of near-term improvement.

Our construction revenues declined by 25% in the second quarter, though the impact is small due to the low level of business at this point. Full-year revenues in China across all segments, including joint ventures, are now expected to grow 6% for the year, down from our previous projection of 15% growth, due to very weak demand in most of our end markets. We continue to gain market share and grow our joint venture earnings in challenging conditions, and with more emission changes ahead we are well positioned to outperform our end markets and build a sustainable leadership position in the largest truck market in the world.

Second-quarter revenues in India, including joint ventures, were $309 million, up 6% year-over-year due to growth in our truck and Power Generation businesses. Industry demand in the truck market increased 20% compared to the second quarter a year ago, as the economy continues to show signs of improvement. We now expect industry truck production to increase 22% for the year, up from our previous -- prior forecast of 15% growth. Currently the truck industry is planning for the introduction of broad Stage 4 emissions standards in the north of India in October this year, and country-wide adoption is expected in April of 2017, which should present opportunities for further growth for Cummins.

Power Generation revenues in India increased 8% in the second quarter as orders improved following two years of weak demand. We are maintaining our full-year forecast for growth of 5% for this year. We remain optimistic that government plans for further investment infrastructure should stimulate stronger demand going forward. In India we project total revenues including joint ventures to increase 12%, up from our previous forecast of 8% due primarily to stronger truck demand.

Second-quarter revenues in Brazil were $110 million, down 43% from the second quarter last year due to the severe slowdown in the economy and a near 40% depreciation of the real against the US dollar. Industry truck production declined by 40% year-over-year and our shipments declined 38%. We have lowered our full-year projection for industry production and now expect a decline of as much as 50%, worse than our previous guidance of down 27%, due to deteriorating business and consumer confidence. We expect our engine shipments to decline by 45%.

Revenues in Power Generation and Distribution in Brazil have held up much better than in the truck business, but conditions are very tough across all end markets. In summary, we currently expect Company revenues to increase between 2% and 4% for the full year, unchanged from our previous forecast. We are also maintaining our forecast for EBIT to be in the range of 13.5% to 14%. In this challenging environment we delivered strong financial results in the second quarter. We gained market share in some important markets with the successful launch of new products, and we increased cash return to shareholders through dividend growth and share repurchases. Thank you for your interest today, and I now will turn it over to Pat, who will cover our first-quarter results -- excuse me, our second-quarter results, and full-year guidance in more detail.

Thank you, Tom, and good morning everyone. Second-quarter revenues were $5 billion, an increase of 4% from a year ago. Organic revenue growth is 5% with distributor acquisitions completed last year added 3% to revenues while currency movements reduced our sales by 4%. Sales in North America, which represented 60% of our second-quarter revenues, were up 12% from a year ago. Due primarily to stronger demand in on-highway markets and from distributor acquisitions. International sales decreased by 6% compared to the prior year as a result of negative foreign currency movement against the US dollar, weak demand in global off highway markets, and extremely weak truck production in Brazil. Gross margins were 26.6% of sales, up 170 basis points from a year ago.

Strong operating leverage on higher volumes and lower material costs were the primary drivers of the strong performance, more than offsetting a negative impact from currency. Selling, Admin, and Research and Development costs of $703 million, or 14% of sales, increased $11 million from a year ago, and were 30 basis points lower as a percent of sales due to good cost control and the impact of currency movements. Joint venture income of $94 million decreased by $11 million compared to last year. The acquisition last year of our North American distributors that were previously held as joint ventures reduced the joint venture income, more than offsetting earnings growth in China. Earnings before interest and tax were $721 million, or 14.4% of sales for the quarter, compared to $657 million or 13.6% of sales last year. The incremental EBIT margin was 36%, a [slightly strong] operating performance. Earnings per share were $2.62, an increase of 8% from the $2.43 reported in the same quarter of 2014. The tax rate was 29.5% for the quarter.

Now let's move on to the operating segment and further discuss second quarter performance and the outlook for the full year. In the Engine segment revenues were $2.8 billion, an increase of 2% over last year. On-highway revenues were up 8%, driven by strong demand in North American truck and bus markets, partially offset by weaker demand in global industrial markets compared to a year ago. Segment EBIT was $341 million, or 12.2% of sales, up from 11.3% last year. Reduced Selling, Admin and Research expenses along with increased joint venture income provided the majority of the margin improvements. For the full year we continue to forecast that revenue for the Engine segment will be flat to up 2%, primarily driven by North American on-highway demand. Compared to three months ago we now expect weaker truck production in Brazil and China as Tom just described. We are maintaining our EBIT projections for the full year at 11% to 12% of sales which compares to the 11.3% reported last year.

For the Distribution segments, second quarter revenues were $1.5 billion, an increase of 21% compared to the prior year. Acquisitions in 2014 added 26% to segment revenues year-over-year. Organic growth is more than offset by foreign currency movements that negatively impacted sales by 6%. EBIT margins for the quarter declined from 10.2% last year and 7.6% due to the dilutive impact on EBIT percentage from acquisitions of businesses previously held as joint ventures and due to the negative impact of currency movements. Strong operating performance in existing businesses added 60 basis points to EBIT margins. For the full year, Distribution revenue is now forecasted to grow by 20% to 24%. A lower previous guidance of 23% to 27% growth due to a more negative impact from currency than anticipated at the start of the year. We are maintaining our EBIT margin percent gains in the range of 7% to 8% of sales.

The Component segment delivered record sales of $1.4 billion compared to the second quarter last year, the higher revenues were primarily driven by increased truck production in North America and Europe and increased sales in China of the new national standard for compliant products, all of which offset the negative impact of currency and the weak truck production in Brazil and in China. Segment EBIT was a record $223 million, or 16% of sales, up 150 basis points from last year as a result of excellent operational performance across all four businesses. Strong operating leverage on higher sales and good execution on the material cost reduction initiatives helped drive the EBIT margin improvement. We still expect full-year revenue growth of between 4% and 8% in 2015, and we are raising our EBIT projections for the full year to 14.5% to 15.5% of sales despite being a strong performance and this compares to full-year 2014 margin of 13.4%.

In the Power Generation segment, second-quarter sales were $747 million, up less than 1% with likely continued weakness in a number of important markets. Year-over-year international sales increased, offsetting more sales in North America and the 4% reduction in revenues resulting from currency movements. In international markets, stronger demand in the Middle East and in India more than offset lower revenue from Russia and from Latin America. EBIT margins were 7.6% in the quarter, down from 8.2% last year. The negative impact of currency, primarily depreciation of the euro against the US dollar, and more pricing in the alternator business, more than offset the benefit of cost reduction actions.

For the full year our guidance for the power gen segment, revenue remains unchanged with revenues expected to be flat to down 4%. Although revenues are up 3% year-to-date, weak recent order trends indicate that revenues in the second half of the year will be lower than second half of 2014. EBIT is expected to be in the range of 7% to 8% of sales, down from a prior range of 8% to 9%, despite being a continued headwind from currency and a more competitive pricing environment in some international markets. Our guidance for total Cummins revenues to be up 2% to 4% in 2015 remains unchanged. Strong North American on-highway demand, increased revenue from distributor acquisitions, and growth from new products will more than offset the negative impact of currency and the weakness in global off-highway markets.

Joint venture income is now expected to decline 15% from 2014 compared to our previous guidance of down 10%. The driver of the lower earnings is our acquisition of distributors in North America previously held as joint ventures. Joint venture earnings will grow in China this year as a result of market share gains and new product sales, but not at the same rate we anticipated at the start of the year due to a weakened economy which has negatively impacted demand in our end markets. We continue to project EBIT margins for the Company will be in the range of 13.5% to 14% of sales, and the projected full-year tax rate of 29.5% excluding the discrete items, remains unchanged.

Finally, cash flow generated from Operations through the first half of the year was $569 million. We continue to expect that operating cash flow to be in the range of 10% to 15% of sales for the full year, with stronger cash flow generation in the second half of the year than the first, as is typical in our business. Capital expenditures will be between $700 million and $800 million for the year. Earlier this month, we announced a 25% increase in our quarterly dividend, and we have now raised that quarterly dividend by 457% since the beginning of 2010. The Company returned $794 million of cash to shareholders in the first half of the year through dividends and share repurchase, consistent with our plans to return 50% of operating cash flow. Year-to-date, the cash balance has declined by $541 million due to reinvestment back into the business and from higher returns to shareholders through increased dividend payments and share repurchases.

Finally, I wanted to advise that we have moved the date of our analyst day to November the 10 in New York. Invitations to the event will be sent out this week. Now let me turn it back over to Mark.

Thank you, Pat. We're now ready for the question and answer session. You can please limit yourselves to one question and one related follow-up and then get back in the queue. Thank you, Stephanie we're ready to proceed.

(Operator Instructions)

Our first question comes from Ted Grace with Susquehanna. Your line is open.

Hey, gentlemen, congratulations on the good quarter.

Thanks Ted.

I was just wondering if you could talk a little more granularly about what you're seeing in China; I know you talked about gaining share and I know you talked about the market being tougher than expected. Maybe if you could give us your most current read on kind of where you think the market is and kind of what the back half looks like and really what that implies about the exit rate and how we should think about 2016, admittedly as you haven't given guidance on 2016.

Yes, Ted, this is Rich. Let me start out here and Tom can jump in; but obviously, we don't know. It's moved a little bit, but we've taken it down, and there's some -- there's a little growing confidence that the adjustment we made down 30% is solid for the rest of the year. Again, we're on a march to increase share despite what happens there. So you've seen we've grown from 5% up to 15.5% and we plan to end the year at 17% on the heavy-duty side, and so the product we've got out there looks really good. We believe we're changing the market, okay? So we've got this low-cost product, so competing with the China competitors step function improvement in fuel economy, reliability, putting telematics on it.

So while there continues to be uncertainty in the market, our big picture, what we're demonstrating, showing, is we're growing share. Same thing on the light duty on the ISF. With the market down 5% our ISF volumes will be up 21%. Coming from a macro market which was more your question you see the uncertainty there, the freight numbers are actually up a little bit, so the freight numbers aren't down to the level that demonstrated 30%, so our view is there's still some kind of shakeout to be going on here. We're a bit optimistic -- or the positive sign we see is in the freight numbers.

I guess I would just add two things, Ted. First, that as I mentioned, emission standards, if anything, are tightening. They've got a date now for Euro 5 implementation. They've got cities like Beijing, Shanghai talking about implementing Euro 6. There is a lot of support from local and federal government about pushing ahead with emission standards, and all that just drives people towards better technology, more focus on fuel efficiency, and the quality of emissions equipment, which we think is good for us. It just builds on the points that Rich was making that we've lowered our costs and are offering products that are competitive to local market folks, but we're able to apply technologies in a way that some of them are having a tougher time.

So we feel very good about market share, and I guess the second thing I would add is it's obvious I think that the Chinese economy is going through a change and the government's very serious about making this change. So I don't -- I'm not optimistic that we're going to see a big bump-up in any of our end markets in a hurry because I think the Chinese government's going to try to keep going on this change of their focus in the government, not so much in infrastructure, not so much on building export, a little more on consumer and a little more discipline in the provinces, how they're going to succeed and at what rate I don't know. I also think there is some stabilization going on in the markets. They're pretty low now. They definitely seem to be bottoming up and stabilizing as Rich was indicating, so we don't see a further fall than we've indicated but we also don't see necessarily a major turnaround in the near term.

Tom, to that point on taking share and the advantages Cummins has, when we think about a path looking up three, five years, are there any structural considerations we should think about as maybe inhibiting you from getting to North America-like market share? Is that a realistic goal? Is that the way people should think about the potential? Any hand holding there?

As we discussed, our goal for 2018 that we set out was to get to 17% market share, and of course we expect to achieve that this year, so that feels pretty good, especially in the backdrop of some of the markets we're facing. But we also said, hey, we'd like to get ourselves up to a 25% share, and that was kind of our stretch goal and we still have that in mind. I do think the Chinese government pays attention to the role that foreign companies play in industries relative to the domestic companies. In part, we've addressed that by joint venturing most of our major engine operation there are in joint ventures, and we therefore are supporting local competitors and the industry in general. That's the posture we take, so I think that helps us some on that. But there's no question that the government pays attention to it. I really don't know what that means with regard to market share. I think it means you have to pay attention to where you are and make sure the government sees you as a positive force for the industry and not something else.

Okay, very helpful. Best of luck this quarter, guys.

Our next question comes from Jamie Cook with Credit Suisse. Your line is open.

Hi, good morning, and congrats a good quarter. I guess just two questions. One, I think within the power gen business you alluded a couple times to slightly more competitive behavior. I was just wondering if you could give a little more color. Has this been ongoing, is this sort of a big change this quarter? And I think you also mentioned oil and gas slowing due to rental or something like that, so any color you could provide there on the power gen business, and then I guess my second question, Tom, is just a bigger picture question. Obviously what's weighing on Cummins' stock while you're very diversified as concerns US truck, is it peak in 2015, Volvo came out on their last earnings call and said they think 2015 is peakish and 2016 is likely down though not materially. Can you talk about sort of your view and how you're managing your business in that environment? Thanks.

Okay. Jamie, thank you. So on power gen, a couple of things to give color on that I started on but I could give more. Competitive market, a couple things that are going on. I mentioned alternators. In the alternator business our business sells a lot in Europe and the Middle East and companies that export from there to other parts of the world, and we are competing with many companies that are based in Euros and so the price competition I talked about or the competitiveness is partly a function of the fact that the Euro is so weak that some of the competitors, especially given how low the demand's been, have begun to take some of the cost advantages and turn them into price. It's not consistent. It's not global, but it is happening.

The second thing is, in the alternator business, is that copper prices have dropped a lot, and of course alternators are made of a lot of copper and so some of our competitors have done the same thing. Turned some of the copper price decreases into price decreases. In our case we hedge a lot of that copper so we're protected when it goes up and we're unfortunately protected when it goes down a little bit. Which means our cost decreases don't fall exactly in line with the market. Some of that price competitiveness has hurt both our margins and our demand at the alternator business. And there's a little bit of it in the gen set business too. But as I said, it's really not global, it's not consistent, and it really has got going pretty recently. We just haven't seen it very much, and I would still say that it's not consistent.

The thing I mentioned about oil and gas markets. We've had pretty good results selling gen sets to rental businesses. That's been going pretty well. It's been one of the parts of the US market -- is where my comments were coming from, where it's going pretty well. And it has just recently turned down a little bit, and some of our customers have said that oil and gas demand is a little lower. It's the first time we've heard it. It's not surprising given what's going on in the market. First time we heard it and we don't know if the rental guys are going to stop for a little while or what's going to happen. It's just that we heard this quarter. So as you know, power generation business generally speaking is pretty low everywhere. You're getting the highlights of -- which may not even have made the news when our business was much larger, but it's pretty small now so small variations in these markets are having a pretty negative impact.

And then --

Let me just let Rich talk a little bit about the truck markets just because he's been talking to customers more recently.

Okay. Great. Thank you.

Jamie, so there continues to be lots of positives in place. The backlog is still of 158,000 units, so that's up from 120,000 a year ago. We're paying attention to retail sales. In fact they were up in Q2. As I talk to fleets, I don't -- I'm not sensing a big change in sentiment. Folks are still generally positive and one kind of common comment we get is the new trucks are significantly better in fuel economy and some of the safety systems put on board, so folks want to continue on their place of replacing the older fleet. Used truck prices are pretty strong. Lower oil prices tend to be a net positive. There's lots of kind of positive things, you know?

Where the nervousness comes from is now we've had, after I think 14 months in a row where production was less than orders and the backlog was increasing, we've now had four straight months of production being higher than orders. And so while the backlog is at a very healthy level, almost 160,000 units it's down for -- it was approaching 190,000 units four months ago. It's kind of balancing these two things. Our anticipation is we will see orders kind of come in Q4, Q1. If that doesn't happen obviously production will have to come down and better match what the orders are. It doesn't feel like -- we all track these cycles. It doesn't feel like some of these past cycles where when production was greater than backlog we had a bunch of fundamentals in the market that looked pretty bad. You saw these major drops. The fundamental market looks pretty good. There hasn't been the big run up that we've had in other cycles. So I think the jury's still out whether the market fundamentals turn into orders kind of in Q4 or Q1. That's the nervousness you're sensing.

Okay. All right. Thanks. I'll get back in queue.

Thanks Jamie.

Our next question comes from Jerry Revich with Goldman Sachs. Your line is open.

Good morning.

Hi Jerry.

Pat, I'm wondering if you can just say more about the capital deployment priorities longer term. You mentioned in your prepared remarks you drew down on the cash balance so far this year. Any update how you're thinking about capital deployment in a slower growth macro environment? Any update there would be helpful.

Yes, so we'll talk a little bit more on long-term capital deployment plans when we get to our analyst day in November. For now Jerry you should not assume any major change from what we've said before. We want to reinvest back into the business where we see really good opportunity for profitable growth and we're trying to do that as best as we can in this environment. We're also very conscious about delivering on our commitment to return 50% of cash to shareholders, which we did last year and we're on track to do that again this year, so at this point in time there's nothing new to add to what we said before on how we deploy capital.

Okay. And then on the new product side, Tom can you please give us an update how you're thinking about the Class 4 to 5 opportunity in the US. There have been a couple of product announcements, and I'm just wondering if you could just give us an update for the Cummins opportunity longer term and any update on how the high horsepower Hedgehog program is tracking?

Okay. On the class 4 and 5, as you know, we're kind of more in the 6, 7 market and that's where we compete in North America. Some of the recent announcements on folks entering the 4 and 5 are less of a direct impact on us. And I guess just maybe another comment, just what's in the mid range market it continues pretty strong in North America and, in fact, we're taking our share guidance up. We started the year and said, potentially going down with the announcement of Ford introducing their own engine, and what we've found in that market quite frankly is we've got a terrific engine that's low-cost, leading fuel economy and folks that use our engine have gained share and those who have moved away have lost share at times, so that's proved out in this case also.

Before we leave that, Rich, the two areas that you know about, the V8, which will be launching with Nissan imminently, so they'll plan to start selling those in the fourth quarter, or at least produce them in the fourth quarter. So that will get us in to -- that's not really a class 4, 5, that's a consumer vehicle, but size of engine's probably in that, and of course we're offering in a few other vehicles as you know, RVs, buses and things like that which might be classed in that range, and our hope is to gain some position there, and we've got some good start customers.

The other area that we are definitely expanding in as you know is with the 3.8 engine, just not in the US today. We'd love it a chance to do it. Just right now it's not -- we don't have a customer for it, and it doesn't make sense today. We are expanding with that engine around many markets in the world in that same segment. We're definitely in it. As Rich said we're pretty small in it in the US, and over time we hope to change that. We're putting a bunch of markers in place that we can.

Jerry, I'll touch on the 95-liter. So I guess, start out saying we're on track with what we've been saying for some time on the 95-liter, so we've -- we're going into -- we've gone into production on the power gen business. We'll go into production on Q4 in the rail business. We've secured orders in the commercial marine business that we'll begin shipping next year, so we're ramping up production. We'll be producing up at 4 a week by Q1 of next year, and the product's doing really well; in fact, much of the production we're ramping up to we've in fact secured orders for already, for that ramp-up for next year. Generally on schedule. Remember, we're -- with this new product it gives us access to about a $5 billion market globally that we have not had access to in the past. So getting started, and the product doing well out of the chute and securing customers is really important. While it's not big numbers right now it leaves us on track for what we want to do in the 95 product liter line.

Thank you.

Thanks Jerry.

Our next question comes from Tim Thein with Citigroup. Your line is open.

Great thanks. And maybe Rich just continuing on that thought, if you look at the high horsepower volumes, you're running basically flat year-to-date through the first half. In light of the step-down in some of the industrial markets, how should we think about just kind of the back half in terms of the quarterly pace of high horsepower volumes?

Yes, I don't have much positive to say there. Quite frankly. We took our guidance down on mining and we're not projecting recovery through the balance of the year there. the oil and gas, which started out pretty good at the end of the year, that well until, again, no step-up in oil and gas. Our commercial marine, we think will be flat for the year, but, there's a little bit of headwinds there. It's about 30% of our commercial marine business is tied to oil and gas. We're on the crew boats that do the offshore work, so we're getting a little bit of headwind there. The Hedgehog or the 95-liter is new business that we didn't have before. We talked about power gen markets which remain pretty flat, so as we look, we've kind of settled in at this number. Nothing really positive for the second half of the year in the high horsepower range.

I would just say incremental changes is the summary versus, Tim, versus even at the start of the year. Incrementally a little bit negative I would say in most of them but not dramatic changes to our overall guidance.

Okay. And then switching gears to components, just in the implied step-down in margins in the back half, what are some of the headwinds that we should be thinking about there? And I guess somewhat related, and I know you have some hedges in place, but what, if any, impact should we expect just in light of the recent sharp declines in some of the PGM markets?

You're not accusing me of hedging, there, Tim, are you? I think what we are seeing on components-- and normally in the third quarter of the year we see a softness in the [nines and our OEM] being shot down, and so that's been a gateway into the second half guidance. Other than that I think we're looking for components to finish off the year. Products go on. We've lost a lot of [rev] in an uptick in some research and development spending related to new products compared to the first two quarters of the year, but they're on track to deliver a [raft of g] of both top line and bottom line.

Great. Thanks a lot.

Our next question comes from Ross Gilardi with Bank of America Merrill Lynch, your line is open.

Good morning, thank you. Tom, I mean I realize you're not gunning for 2016 yet but wondering if you could just comment more broadly on what you think Cummins' ability to grow earnings over the medium term if indeed the North American heavy duty truck is peaking and we remain in this lousy emerging market environment.

Yes, obviously that's something we've been thinking a fair bit about. Given what we're seeing as far as opportunities for near-term improvement. Again, like we've seen this year, there's -- we're in a lot of markets in a lot of places around the world, so inevitably something's doing a little bit better which helps us. But as you said, generically there's a lot of weak markets and there's not an obvious turnaround in very many of them. India obviously is a notable exception. And the US market isn't too bad generally.

In that environment our expectation is that we will continue to launch products and enhance our products through telematics and other value added that helps us gain share and sort of have a different trajectory than the market on its own. We can't do that in every place in every market around the world, but our general view is we're looking for opportunities like we've had in China. This year we think we'll be able to do some of that in India as broad Stage 4 comes in. We'll continue to look for opportunities to sort of cut a different curve than the market's cutting.

The second thing which you've heard from us many times is that we'll be figuring out ways to earn higher margins on the same sales. So driving cost out of our business, to material cost, it's been a huge driver for us for improvement this year, supply chain improvements we'll complete our program this year that we set out in our 2011 analyst day to try to drive 1% gross margins in supply chain. I think we will be able to report in November analyst day that we'll be able to do that.

So again, we'll be continuing to drive costs out of our business everywhere we can, while still delivering better value and better technology in our products. That's kind of our schtick now. That doesn't add up to a whole bunch of revenue growth if markets don't improve. Again, we think we can continue to drive some earnings growth. Again, that's painting a pretty bad scenario for the markets but we need to be prepared for that. We don't know if that will be the case but we need to be prepared if it is.

Great, thank you, and maybe just my follow-on just on a similar question just on components specifically. I guess you are implying a softer second half. You did see acceleration of the top line, margins continue to improve off a pretty high base. Can that business continue to grow on a multi-year basis, and could you comment on how China ties into components and the contribution from China?

Yes, our view is the components business has benefited from trends related to emission standards and fuel efficiency adding to engine technology over last decade. That was -- those, when we set about to launch the components business and launch our emissions standards business and enhance our filtration business, this was the trend we were banking on, and sure enough that's what's playing out. As you asked about China, a lot of our growth in the components business, in the last couple quarters anyway, we've got some good growth in China. We've got great growth in North America. Truck market's been strong. We have a lot of emissions and other components content on engines here. Even in Brazil which has been a really rough market, if it weren't for Euro 5 coming in there and then us being able to apply emissions equipment it would be much worse for us. The components business has been one of the key areas for us to buck this trend where we can have a different trend than just the general market does. And so our ability to keep growing in there will depend on our ability to capitalize on trends related to emissions, fuel economy, and other technology trends in our end markets, truck markets and off-highway markets. So we're looking to grow in that market both on our existing platform and our new platforms. As you know a couple of years ago we acquired a doser business which is a key part of the emissions equipment and that has a pretty high growth rate and so we'll be continuing to evaluate other trends and other ways to add platforms in our components business.

Got it. Thank you very much.

Okay.

Our next question comes from Joel Tiss with BMO. Your line is open.

Hey, thanks a lot guys. I just -- almost everything I was going to ask has been asked, but can we drill down a little bit into the distribution business and just over the next couple of years whatever time frame you want to give us, what -- what's left to do on restructuring and what kind of margins do you think this business should normalize at after you've been able to run it for a couple of years?

Yes. Maybe I can comment a little bit on the strategy side and then Rich and Pat can add a little bit on some of the underlying financial trends and things like that. At the strategy end, as we talked about in our 2013 analyst day, we've got a couple of things to do in the distribution business. Start with North America. We've now -- by the end of this year we'll have made the vast majority of the acquisitions. There will be two small businesses left that we'll acquire over the next couple of years. That means we will have by the end of this year -- to be fair, maybe middle of next year -- we will have done the vast majority of integration. We've got integration left to do on HR systems and things like that, which take a little bit longer time, and that's why I think it will probably take us the middle of next year to do all those things. We'll then have back office integrated, we'll have all the businesses in, and that will be great. I mean that's pretty good for us to do it. We haven't lost key people. We haven't lost key customers. Instead what we've seen is a lot of efficiencies already and a very excited and loyal work force, which doesn't happen that often. So we feel pretty great about that from an acquisition point of view. Also, we've had great accrual of earnings against -- relative to the cost of acquiring.

The next step, though, which is really the even larger opportunity for the Company, is now to look at this geographically-based distribution system and say how can we serve our customers more effectively? So we have a bunch of end customers that are still kind of geographically based. You can think of truck fleets that are running across the US and things like that, they need a lot of stops. They need a lot of places that they want to be serviced. We also have some ones that are pretty focused in their geographies by things like mines and marine customers. We don't really need to have locations in every single state that service that. We also have parts depots and warehouses in nearly every single branch, so a lot of different opportunities for us to build efficiencies in our distribution system, which we think can drive up average margins. Just on a strategic level that's the opportunity, and that we still have ahead of us. I think we'll continue to improve margins. Rich and Pat I don't know if you want to add anything to that.

Not a lot to add on that. I think, again, what we consciously put the focus on making the acquisitions and generally leaving distributors as they were, so not chasing a lot of synergies in step one. As Tom said we're generally through that. We do think the synergies are significant, and Tom outlined several of them. Redundant PDCs, call centers, our whole purchasing, which you've seen we're pretty good at as a Company, we'll be able to centralize the purchasing and take advantage of that. We have yet to quantify that, but the numbers will be significant kind of in our next step, and we've consciously delayed some of that other than the back office work.

I think for further acquisitions -- so we'll complete most of that next year we have one more to do, North America -- and then I'd say that we have some more to do strategically outside the US. But from a material dollar standpoint, not so significant. More of getting at what Tom talked about better taking care of customers and serving customers better across geographies.

And one thing I would add on to what Tom and Rich have added there. Organic performance from a same-store sales perspective has been really good. I think we're up 60 basis points compared to the second quarter last year. So really pleased with that. Unfortunately the whole currency headwind is masking all that, and we talked to our 6% revenue headwind in the second quarter. I think for the full year is probably close to $250 million of a currency headwind in top line and not far away from $100 million in the bottom line. If you struck out currency, this segment is doing really well from an organic same-store performance, and Tom took you through -- some of the acquisition numbers are ahead of what we thought they would be when we launched this two years ago, so the segment has actually been performing very well.

Okay. Thank you very much.

Thanks Joel.

Our next question comes from David Raso with Evercore ISI.

Question for Tom and Pat. When I think about the stock, it's less than 13 times this year's earnings, less than 8 times this year's EBITDA, you hear the questions around can you grow earnings next year. You have this analyst meeting every two years. Four years ago at the meeting you had EM strong, two years ago you lost some EM, but you had North America strong. This meeting is more of a debate of what do we really have the next couple of years. We can have market outgrowth, but people are concerned about the growth beyond this year, you see in the multiple. This is going to be the ninth year out of ten that you're net cash, so we've discussed this before, but given you don't have one of the two major blocks you've had the last two meetings, what is keeping you from cashing what I would refer to as a rainy day check? I mean you're net cash. You can write a check for $3 billion, buy back 13% of the company and still have net debt to EBITDA at 1 times, so I'm just trying to understand the philosophy of how you're managing the balance sheet, especially given some of the growth drivers that we've had in the past, maybe aren't quite as dynamic looking out going to this analyst meeting.

Let me just say two things in that David. First is what you're asking will be the primary topic at the investors conference. I mean, so I'm conscious about not jumping ahead from just an SD point of view and all that kind of thing, and I feel strongly that we have to address the point you're talking about. It's not lost on us at all that the growth that we were expecting organically has not really happened in the last several years given the market outlook. We've had some very good wins as we talked about in China, and as you called it outgrowth where we outperformed the market and we think there's more. But given we're kind of running up a down escalator from a market growth point of view, our growth rates are not double digit as we had hoped and therefore we don't need the same amount of capital to fund it, and we need to figure out a way to drive more shareholder value than we're doing. We agree with that. And so the question is what's the right formula to drive either higher growth or higher return. That's exactly what we'll be addressing, and we will be addressing it in full and to our best ability because we agree with that. Right now, though, I think we kind of, as Pat said, we're on the same strategy until we change the strategy, and so we're carrying on as we are, and again, trying to make sure that our business is the best performing business in our industry, and that we manage our cash well, conservatively, effectively, et cetera. But there's no question that the things on your mind are on our mind in a big way.

And Tom with the analyst meeting pushed back it's probably even more helpful if you can at least just give us just some philosophical parameters on how you think of running a business like this when it comes to financial leverage? Because we could say we'll address it in November but your stock's going to trade for the next three or four months thinking about this. So if you could just give us some idea just philosophically, would 1 times leverage be something that you're uncomfortable with? I mean people are going to run their numbers no matter what you say about waiting until November. So can you just help us a little bit in how you think about it? Because nine out of ten years being net cash definitely has at least folks like me wondering how do you think about the leverage that's appropriate for this business model?

And as you said the stock will be trading for a number of months between now and then, and frankly it's been trading on this issue for some time. So I am conscious of that and it concerns me. Having said that, I think talking philosophically about it is the same as talking about it, so it seems like not a smart thing to do. We have talked about leverage before, though, David, and we have said that we are comfortable with a much higher leverage ratio than we have now and that we don't need to be A or A plus. We're okay being investment-grade through the cycle and carrying leverage appropriate for that. So that's -- it's in our thinking and will be in our thinking when we talk about it. I'm sorry that I can't be more disclosive at this point. It just feels like, given that a limited number of our investors are on this call and it's not what the call is about that I should wait until the investor conference.

I do appreciate it. Thank you for the comments.

Our final question comes from David Leiker with Baird. Your line is open.

Good morning everyone. I just want to circle back on China a little bit and talk about what your pipeline looks there in terms of launching new engines, new products, new vehicles, new customers. If you can give us a little bit of perspective about where you are, you in that line sequence, and what we might be able to expect.

From a new -- David, from a new engine standpoint I'd say we're just starting. We're in the infancy of the new product. Kind of a clean sheet of paper on 2.8, 3.8, the 10- and 12-liter, a new product that we've introduced in the rear loader market, with Lugong, the 9.3-liter. And so I think the next big thing is the emissions are going to continue to change, and so Tom mentioned that, but NS5, as early as 2016 in the east and continue to grow. So really investing in our components technologies to be able to meet emissions and I think what we found is there's a learning curve on this starting out ahead, we sae it in North America, but picking the right technology. These are only going to get tougher. I think a lot of what we're going to be doing is doubling down on the investments we've made in those areas as the emissions continue to improve. And it's a big opportunity, really a big opportunity. Someone asked earlier on components, also. As emissions continue to grow and change, you've seen it already. We're not done with that playing out in China.

And you know as you move from Euro 4 to Euro 6, you might think 5 point is the same, it's not that big a change, but that's exactly what happened between -- in the US between 2002 and 2010, and of course the engine changed dramatically over that time. None of those were platform changes. Same block, same head, just a lot of system changes. And as you know big winners and losers across those years in the US, and the same transition is now going to happen in China. They're now going to finalize the Euro 6 date pretty soon and it's not going to be 2025, it's going to be around 2020, maybe earlier depending on kind of how they get around. There's some people tossing around 2018.

That's really fast, and that's a big change in technology, so I mean, this -- the drive to get from where we are to Euro 6 will be a major, major technical development for China, for Cummins of course, and for a lot of others, and as Rich said that will be shaken out for a lot of people, and that should help us. And I guess the only other thing I'd mention about China is we are also bringing new large engine technologies into the market. We have a very -- we don't talk about them much, but we have a very good market share in large engines there, 19-liter and above, and we'll be bringing in some updated technologies in through our joint venture there too. Which again will be representing new launches to the market. There's a pretty big pipeline there, and I think there will be still quite a bit of change ahead which should position Cummins further ahead, I guess.

Okay. Great. Thank you very much.

Thank you very much, everybody. I'll be available for calls later. Thank you.

Thank you, ladies and gentlemen, that does conclude today's conference.