康明斯 (CMI) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2016 Cummins Incorporated earnings conference call.

(Operator Instructions)

I would now like to introduce your host for today's conference, Mr. Mark Smith, Vice President of Financial Operations. Mr. Smith, you may begin.

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins results for the third quarter of 2016. Participating with me today are Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; and President and Chief Operating Officer, Rich Freeland. We will all be available for your questions after our prepared remarks. 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, thoughts, 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 the number of risks and uncertainties.

More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in our slide deck today 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 our subsequently filed quarterly reports on form 10-Q. During the course of this call we will be discussing certain non-GAAP financial measures and we refer you to our website for the reconciliation of those measures to GAAP financial measures. Our press release today with a copy of the financial statement are in today's webcast presentation or available on our website at Cummins.com under the headings of investors and media. Now I'll turn it over to our Chairman and CEO, Tom Linebarger.

Thank you, Mark. Good morning. I will start with a summary of our third quarter results and provide an update on our outlook for the full year. Pat will then take you through more details of both our third quarter financial performance and our forecast for the year. Revenues for the third quarter were $4.2 billion, a decrease of 9% compared to the third quarter of 2015. Third quarter EBIT was $398 million, or 9.5% of sales compared to $577 million, or 12.5% in the same quarter last year. Our results this quarter include a $99 million increase in accrual for a loss contingency. As we have disclosed in prior quarters, the loss contingency relates to the cost of the campaign to remedy quality issues with after-treatment systems sourced by one of our OEM customers from a third-party and paired with our engines in the OEM vehicles. The combination of a Cummins engine with a third-party after-treatment system is unique to this particular OEM.

We increased our accrual in the third quarter to reflect recent testing results that indicate that similar quality issues are impacting a second population of vehicles manufactured by the same OEM. We have accrued the expected cost of the campaign but final resolution of cost sharing with our OEM customer has not been finalized. All parties are committed to supporting the vehicle owners and the agreed plan to replace the after-treatment systems is currently being executed. Excluding the loss contingency, we delivered decremental EBIT margins of 23% in the third quarter, better than our target of 25%, reflecting strong operational performance in the face a very weak markets. Benefits from the restructuring actions we initiated in the fourth quarter of 2015, strong execution on material cost reduction initiatives and [for] activity gains all helped to mitigate the impact of lower volumes in the third quarter.

Engine business revenues decreased by 12% year-over-year, primarily due to lower industry production of heavy and medium duty trucks in North America. Earnings before interest and tax was 4.8% of sales, down from 10.3% a year ago. Excluding the loss contingency, EBIT was 10.1% compared to 10.3% a year ago. Restructuring benefits, material cost reduction and lower warranty cost all contributed to the strong operating results. Revenues in our components segment decreased 8% from year ago with lower demand in North America more than offsetting growth in China. Sales in China increased by 37% as demand for our products continues to outpace end-market growth. Despite lower sales, [EBIT] percent improved from 12.6% to 12.9% as strong execution of our cost-reduction programs more than offset the impact of weaker volumes.

Distribution revenues decreased 3% compared to the third quarter 2015. The positive impact of acquisitions made in the second half of 2015 were more than offset by the negative impact of currency in weaker sales to off-highway markets. The distribution businesses EBIT for the quarter was 6.4%, down from 7.9% a year ago with results last year benefiting from gains on the acquisition of three distributor joint ventures. The positive impact of operational improvements and increase pricing were offset by the negative impact of currency. Revenues for the power systems business declined by 13% year-over-year with lower sales in most regions due to weaker demand in power generation, commercial marine and oil and gas markets. EBIT decline from 7.5% to 6.9% with decremental EBIT margins just 12% due in part to a 15% reduction in operating expenses in the business.

Now I will comment on some of our key markets starting with North America. Our revenues in North America declined by 13% in the third quarter due to weaker demand in on-highway markets, especially heavy-duty truck. We shipped 16,400 engines to the North American heavy-duty truck market in the third quarter, a decrease of 33% from a year ago. Our market share improved from the second quarter this year and stands at 31% year-to-date. We are forecasting full-year industry production to be 200,000 units and our market share to be in the range of 27% to 30%, unchanged from our projections three months ago. Frost and Sullivan recently recognized Cummins as the leading supplier of heavy-duty engines to the US heavy-duty truck market, reflecting the results of its extensive survey of both truck fleet and owner operators.

In the medium-duty truck market we delivered approximately 18,000 engines in the third order, down 20% from last year. Our market share through the end of August was 73%, within the range of our full-year guidance of between 72% to 75%. Industry production dipped sharply in the third quarter. It is not expected to improve in the fourth quarter. And as a result, we have lowered our full-year forecast of market size to 108,000 units from 117,000 units three months ago. Our engine shipments to North American pickup truck customers increased by 2% in the third quarter. Shipments to Chrysler declined by 11% due to plan production changes at Chrysler plant but will more than offset by shipments of our V8 engine to Nissan, which we launched in the fourth quarter of last year. We currently expect our revenues in the pickup segment to increase by 10% in 2016, down a little from our prior forecast of 12% growth.

Our engine revenues in North American construction market decreased by 21% compared to the third quarter last year. While housing and commercial construction activity remains positive, weaker demand in the oil and gas market has led to an excess supply of used equipment. Power systems revenues declined 8% in North America in the third quarter due primarily to lower engine orders from oil and gas and mining customers. Our international revenues declined by 3% year-over-year driven by lower sales in the Middle East and Africa, which more than offset growth in China. Weak commodity prices and slowing economic activity negatively impacted demand for power generation equipment in the Middle East and Africa.

Third quarter revenues in China, including joint ventures, were $826 million, an increase of 6% due to growth in on-highway and construction revenues. Industry demand for heavy and medium-duty trucks in China increased by 30% in the third order. Our market share in the third quarter was 16.5%, up from the second quarter but down from 17.9% a year ago. Some OEMs have been aggressively discounting trucks this year to gain share in the near term while our partner Dongfeng has experienced a decline in market share. We expect our full-year engines market share to be 16% compared to 16.4% in 2015. We now project full-year industry sales to increase 16% to 870,000 units this year, up from our prior forecast of 820,000 units, or 9% growth. Shipment of our light-duty engines in China grew 23% in the third quarter compared to a 3% increase for the overall market as we increased penetration at Foton, displacing local competitor engines.

Our share of the over market was 7.7%, up 120 basis points year-over-year. We currently project industry sales to decline by 4% for the year, unchanged from three months ago. Industry sales of excavators in China decreased -- increased, excuse me, by 43% in the third quarter and our volumes more than doubled off a very small base due to stronger investment in real estate driving uptick in equipment demand. While this was a nice increase, construction equipment markets in China are still very weak in historical terms. Revenues for our power systems business in China declined by 11% in the third quarter reflecting weak demand in marine, mining and power generation markets. Full-year revenues in China across all segments, including joint ventures, are expected to grow 4% for the year, up from our prior forecast of 3% due to stronger demand in the heavy and medium duty truck market.

Third-quarter revenues in India, including joint ventures, were $376 million and flat year-over-year with lower on-highway volumes offsetting growth in power generation construction and aftermarket revenues. Industry truck production dropped by 17% compared to a year ago after a very strong first half of the year. Truck OEMs lowered build rates to reduce inventories as sales slowed in the third quarter. For the full-year, we now forecast industry truck production to be 340,000 units, up 6% year-over-year but down from our prior forecast of 370,000 units. We currently project our market share to be 41%, up from 40% in 2015. We currently project full-year revenues across all segments in India and including joint ventures to increase 5%, consistent with our prior forecast. Strong demand in construction and improving demand in power generation are expected to offset the weaker outlook for trucks.

Third-quarter revenues in Brazil were $85 million, up 9% from the third quarter last year reflecting a modest improvement in sales to on-highway markets. Our shipments of engines to truck customers increased 5% while overall industry truck production decline by 14% year-over-year. We project full-year industry truck production to decline by 20%, unchanged from three months ago. Our sales in the Middle East declined by 12% in the third quarter primarily impacting our power systems business and reflecting weakness in infrastructure investment in the region. As a result of the slow pace of growth in the global economy we continue to face of persistently weak demand in a number of our largest markets. Our restructuring and other cost reduction initiatives are helping to maintain EBIT margins well above trough levels from prior cycles.

In addition to reducing cost and improving productivity, we've also continued to invest in our business to improve our competitive position throughout this protected downturn. In the fourth quarter we will acquire our last remaining distributor joint venture in North America, completing the strategic initiative that we announced in 2013 and allowing us to improve the consistency and quality of our service and support to our customers wherever they operate. We've also continued to invest in new products. For example, we are growing sales in market share with our new QSK95 Engine even in extremely challenging markets. We currently expect our full-year sales to decline by 9% consistent with our prior guidance. EBIT percent is now expected to be 11.3%, down from our prior guidance of 11.6% to 12.2% largely as a result of the increased accrual for the loss contingency in the engine business. Our EBIT expectations for the components, distribution and power system businesses are all unchanged from three months ago.

We remain on track to deliver our goal of 25% decremental EBIT margin for the whole year 2016. So far this year we have returned $1.3 billion to shareholders in the form of dividends and share repurchases consistent with our plans to return 75% of operating cash flow to shareholders. Thank you for your interest today. And now I'll turn it over to Pat who will cover our third quarter results and full-year guidance in more detail.

Thank you, Tom, and good morning, everyone. Third quarter revenues were $4.2 billion, a decrease of 9% from a year ago. Sales in North America, which represented 59% of our third quarter revenues, declined 13% from last year due primarily to lower demand in heavy and medium-duty truck markets and declines in power generation in industrial engines sales. International sales declined by 3% from a year ago as increased sales in China helped to offset weaker demand in both the Middle East and in Africa. Despite the 9% decline in revenues, gross margins of 25.8% of sales were only down 30 basis points from last year with material cost savings, productivity improvements and the benefits from the restructuring actions helping offset the negative impact from lower volumes and an unfavorable product mix. Selling, admin and [reception] development costs of $670 million, or 16% of sales, decreased by $57 million year-over-year mainly due to restructuring actions executed in the fourth quarter of 2015 and more spending for research and development projects that did increase as a percent of sales by 30 basis points.

Joint venture income of $74 million decreased $4 million compared to a year ago primarily due to lower earnings in power systems, joint ventures and the acquisition of North American Distributors, previously held as unconsolidated joint ventures. Earnings before interest and tax were $398 million, or 9.5% of sales for the quarter compared to 12.5% a year ago. Included in the quarter was an additional $99 million charge related to the previously disclosed loss contingency, as Tom just discussed. Excluding this charge, our decremental EBIT margin was 23% compared to the same quarter last year, slightly better than the 25% that we previously committed to. We are benefiting from a lower cost structure due to the actions taken in the fourth quarter of 2015 and strong execution on the (inaudible) cost reduction programs and productivity improvements. Net earnings for the quarter were $289 million, or $1.72 per diluted share with the increase accrual for the loss contingency net of compensation reducing diluted earnings per share by $0.30. Net income in the third quarter of 2015 was $380 million, up $2.14 per diluted share. Effective tax rate for the quarter was 21.5% more than a year ago primarily due to changes in the geographic mix of pretax income.

I will now highlight the performance of the individual operating segments during the third quarter and provide updated guidance for the full year. In the engine segment, revenues were $1.9 billion, a decrease of 12% from last year. On-highway revenues declined 13% due to lower levels of heavy and medium-duty truck production in North America. Off-highway revenues declined 6% due to continued weak global demand. Segment EBIT was $89 million, or 4.8% of sales, which included the $99 million charge to increase our estimate to the loss contingency previously disclosed. Excluding this additional provision, the engine segment EBIT was 10.1% of sales compared to 10.3% in the third quarter of last year. Material cost savings, lower warranty expense and benefits from previous restructuring actions partially offset the negative impact of lower volumes and an unfavorable product mix.

For full-year 2016 we now expect engine segment revenues to be down 11% from 2015 levels primarily due to weaker truck production in North America compared to our guidance three months ago for sales have declined between 9% and 12%. EBIT margins for 2016 are now expected to be 8.75% when taken into account the $99 million loss contingency charge, down from our prior guidance of 10% to 11%. For the distribution segment, third quarter revenues were $1.5 billion, down 3% compared to last year. The decrease was driven by a 5% decline in organic sales and a 1% unfavorable impact from a stronger US dollar, which were partially offset by a 3% increase in revenue from acquisitions made a year ago. The EBIT margin for the quarter was $96 million, or 6.4% of sales. A decrease from 7.9% a year ago mainly due to the fair market value gains recorded on distributor acquisitions in the third quarter of 2015 and from the impact of negative foreign currency movements.

At the beginning of October we completed the acquisition of the last remaining unconsolidated North American Distributor, bringing the total acquisitions to 13 since we announced the plan in September of 2013. We now expect full-year revenue to decline 1% compared to last year as additional revenue from acquisitions will help to offset weak demand for industrial engines and power generation equipment as well as the headwinds from foreign currency movements. We expect full-year EBIT margins to be 6% at the midpoint of our previous guidance range. For the component segment, revenues were $1.1 billion, a decline of 8% from a year ago. Sales in North America declined 16% as industry production in on-highway markets declined. International sales increased 7% with a 37% increase in sales in China, more than offset from weaker revenues in Europe.

Despite the lower sales, gross margins improved by 80 basis points as material cost reductions and benefits from restructuring more than offset the negative impact of weaker volumes. Segment EBIT was $148 million, or 12.9% of sales compared to 12.6% of sales a year ago. We expect full-year revenue in 2016 to decline by 8% and EBIT to be 13.25%, consistent with the midpoint of our previous guidance. In the power systems segment, third quarter revenues were $856 million, down 13% from a year ago. Power generation equipment sales declined 12% due to lower demand, especially in the Middle East and in Asia. Sales to industrial high-horsepower engine markets declined by 15% as weak demand continues in oil and gas, marine and mining markets. EBIT margins were 6.9% in the quarter, down from 7.5% last year, which equates to a decremental EBIT margin of 12%.

Material cost reductions, lower cost following the 2015 restructuring actions and the benefits from the weaker British pound helped offset the impacts from lower volumes and joint venture earnings. We now expect full-year revenues for the power systems segment to decline by 14% compared to our previous guidance of down 12% to 14% and full-year EBIT to be 7.5% of sales at the midpoint of our prior guidance. We're now projecting total Company revenues to be down 9% in 2016, consistent with our prior guidance of down 8% to 10% as we face a 31% decline in industry production of heavy-duty trucks in North America and very weak global demand for industrial engines and power generation equipment. We expect EBIT margins to be 11.3% of sales this year, including the charges related to the loss contingency incurred during the year representing full-year decremental EBIT margins of 25%. We now expect our full-year effective tax rate to be 25.5% and to deliver earnings per share of approximately $8 per diluted share this year.

Turning to cash flow, cash generated from operating activities in the quarter was $576 million, $14 million higher than last year. For the first nine months of the year operating cash flow is $1.3 billion, up from $1.1 billion for the same period in 2015. Working capital levels of $482 million are 11% lower than this time last year. And we anticipate operating cash flow in 2016 will be around $2 billion, similar to 2015 levels despite the 9% drop in revenues. Capital expenditures are expected to be in the range of $550 million to $600 million in 2016 and we still plan to return 75% of operating cash flow to shareholders this year through a combination of dividends and share repurchases, having returned $1.3 billion year-to-date. And as you know, we increased the dividend by 5% during the third quarter and year-to-date have repurchased 7 million shares. Now let me turn it back over to Mark.

Okay. Thanks, Pat. And we're ready now to turn it over to the Q&A section. Operator, please go ahead with that part of the call. If you could limit your questions to one question and a related follow-up please and then get back in queue.

(Operator Instructions)

Jerry Revich with Goldman Sachs.

Good morning, everyone.

Good morning Jerry.

Can you talk about the contract structure regarding the warranty costs that impacted you for the past two quarters? Going forward, are you still underwriting the warranty risk of the third-party after-treatment or were you able to get the contract structure modified on new shipments? And can you talk about in terms of the size of the population now with the additional charge, what proportion of the total field population has been provisioned for?

Hi, Jerry. This is Rich. Let me take a shot at those series of questions. As you allude to, it's a unique situation. We've got our engine with a third-party after-treatment. So it's the only one we have kind of in the Company. What we did here in this quarter was we increased the accrual for a second population of vehicles. And so as we did some additional testing, we now found that this second population is going to need to have a recall also. So that was the increase that you saw in Q3. So now we have the population is set. We've estimated the cost of those accruals -- those recalls and that's what's reflected in our numbers.

What we have not concluded is the commercial negotiations with the OEM customer. And so while we don't expect the final outcome to be materially higher, in fact it could be lower. As far as your ongoing, what we've implied in there is there more to come, I guess, is maybe what you were also asking. What we have is there are three populations and we have accrued for two of those. The third population we have not accrued for. And it's a different duty cycle involved in this third population. It has a different emission standard that's in fact higher than this. And third, we have concluded our emissions test and all emission test to date have past. So that third population is similar in size to the other two that we have taken in accrual line. And of course we're adjusting all the agreement going forward so for the ongoing issue. And I guess lastly maybe it's implied but the fix has been put in place for some time. So the production -- the product being shipped today does not have this issue. What we're talking about is a fixed amount that unfortunately we've had to come back to a couple times.

And I guess one last thing the -- just so maybe close this out is -- in fact the products that were talking about is doing terrific. And we are actually gaining sales, gaining share. I was at the plant that produces this engine yesterday. We are in the process of taking up production at the end of the year to meet increased demand. So it's an unfortunate situation. It's disappointing. It's complex. It's unique. But this point we've accrued for kind of all the known issues and then we will kind of move into the commercial negotiations to try to finish that one up to come.

Okay. I appreciate the context. And second question, on the Hedgehog engine -- obviously the end-markets have been tough. Can you talk about how the production plan has been tracking versus your initial product expectations as we head into 2017 and if you are willing to quantify the top-line contribution, if it will be significant enough to call out as we think about 2017 versus 2016? Thanks.

Yes. Thanks, Jerry. This is Rich again. We're actually a little bit ahead of our productions on the Hedgehog despite the weak markets. And so -- and that's been driven primarily due to the data center markets where this has proven to be a terrific product to meet those markets. We're also going in -- have gone into production in marine applications and rail applications. So we started the year building I think three a week. We are up to -- we're right now at five a week as we go into the year. And so, again, I don't have a projection for 2017 but I'll just close and say we are really pleased with how this has gotten -- how we got the good start here and despite these bad markets coming out ahead of plan. The total top-line revenue in the $150 million to $180 million range this year.

Thank you.

Alex Potter with Piper Jaffray.

Thanks, guys. I wanted to ask a couple questions on China. First, it looks like the deadlines for compliance with the new NS5 and NS6 emission standards have been announced. Just hoping you can give an update regarding the incremental content you expect to be capturing from each step along the way as the emission standards get more complex and then as well as your expectations for timing and severity of any pre-buy that we might end up seeing.

Let me take the first shot at the. So for the NS5, Jerry, not a lot of -- sorry, Alex. For the NS5 not a lot of content increase and therefore not a lot of not of price increase. And we don't anticipate a pre-buy on the NS5. So the big step up for the content and then get into those issues will be more in the NS6 range. And I guess given the experience on and NS4, we're more optimistic about enforcement and implementation of both NS5 and NS6.

Okay. And in terms of the timing of a pre-buy associated with NS6 that would be probably something like 2019?

Yes. At least. Yes.

Okay. And then I guess the last one on China, then I'll turn it over, is status update regarding the revolutionary engine coming out of China coming to the US. I guess any sort of progress update you can give their -- any progress you've made negotiating with OEMs in the US as well as on the production side status update. Thanks.

Okay. Great. Thanks for remembering the revolutionary engine. We are on track. We're going to bring that in late 2017. We have multiple OEMs signed up to use that product. It's going to be a terrific product where weight is important. So in the Day Cab area, in the vocational markets and those that have followed Cummins for a long time think back to our M11 product that was a real success there. This is -- so we're on track. We're moving ahead with that.

Okay. Great. Thanks, guys.

Thanks, Alex.

Jamie Cook, Credit Suisse.

Good morning. Two questions. One, I'm just trying to think about sort of broadly 2017 and I know you don't want to give end-market guidance but can you talk to me about what levers you think you can pull in 2017, assuming the markets aren't improving, whether it's restructuring, whether it's market share? And then capital allocation -- whether it be share repo and where we are on the M&A front. And then my follow-up question just -- I think you said the charge in the quarter was offset by compensation. Did you lower your compensation assumptions for the year? I just wanted to clarify that as well. Thanks.

Let me just -- I'll get the first one first. Jamie it's, Tom. We did lower our compensation estimates. And again, they are related to our performance targets for the year. So when our performance target estimates change then we adjust our compensation up or down accordingly. So we did adjust compensation estimates.

And did you quantify -- I'm just trying to figure what -- out how much that was or what the EPS impact is for the --

It's about $20 million in the quarter, I think. Right?

$0.07, Jamie.

Okay. Perfect. Thank you.

So let's get to the 2017 -- as you said, we won't be giving guidance. Let me just tell you how we're thinking about it though. And again, Rich can add of he has some more thoughts on it. But we're going to go into the 2017 conservative on markets. As we talked about before, we don't see obvious turnarounds. We do see some bottoming in some markets but there's not an obvious instigator for turnarounds. So we intend to enter 2017 much as we enter 2016 with a relatively conservative view on markets and then trying make sure how we get our cost appropriate set appropriately for those markets and how we continue to fund the critical new products and new capabilities we need to succeed and grow in the market. Yes, we will be targeting market share and you probably know some of the places we're doing that. Our very large engine, for example -- we talked about that earlier. We're gaining share.

We are expanding share in China, that's both with components and engines. We had several new launches there that are going well. So we will be targeting to gain share in different markets where we think that opportunity exists. We will be investing to do so. But at a high level, what you will see is relatively conservative planning on market outcomes and pretty aggressive on how we get costs in line to make sure that we keep our decremental margins at 25% or below.

Any update on the M&A front, Tom? I know this has been a focus of yours but just trying to get a sense of if there's -- if we've made any progress, I guess.

Yes, we've made tons of progress. We've done lots of good work. Again, unfortunately the way that you will hear about it is when we have an announcement and not in one of these calls. Because we can't really say anything until we say things. But, yes, things are -- the thing I would say that's probably important for shareholders is we haven't changed our focus areas. We remain focused on the areas I discussed with you. We are continuing to progress in those. We remain focused on how to expand our businesses in areas that we think we have the capabilities that will make the returns meet our targets and that we can invest a sum that we think we can earn a return on.

So that same conservatism about how to invest, how to make sure there are things that we belong in -- that has stayed the same, which as you guessed, takes a little bit more to find the right thing. But we feel optimistic and I just say for myself that I'm very committed to the areas that we set out and doing it in the way we set out in our strategy session with investors.

Okay thanks. I'll get back in queue.

David Raso with Evercore ISI.

Thank you. Tom, just following up on the idea of your talk going into 2017 now. Obviously folks are looking at you as maybe a way to play stronger emerging markets in the 2017. But your comment right there seemed to be a little more on the cautious side. Can you give us a little more detail around how you are really thinking about the Chinese and Brazilian markets and just around the horn?

Again, I don't mean to imply that there won't be recovery in some markets. We've seen decent recovery in the Chinese truck market this year. I just mean to say that in broadly speaking, our view is that markets are -- across Cummins markets broadly that they continue to be weak. And while we may see some bottoming, we don't have an instigator for significant growth directly in front of us. So our view is, given that we been doing this for a couple years now, the right posture for the Company to take is to assume relatively weak markets, set our cost structures accordingly, find opportunities for cost savings productivity gains and then continue to invest in those opportunities where we think markets could improve and we'll be able to gain share and gain business accordingly.

So for example in China you've seen us have a pretty aggressive posture, a new product launch and on share gain. And so if and when China starts to improve next year, if it did we would be positioned well to take advantage of it. Of course in Brazil we'd love to hear it. It's a very, very weak market. We have a very strong position in Brazil where we are ready to ramp up when the market is ready. Whether it's going to ramp up in 2017, I just don't know. So again, we're still doing work on it, Dave, so we will have a much better view in a couple months about if we see some of those markets actually starting to turn back. We will definitely forecast those. I wanted to give you a sense of how we are approaching our planning rather than specifics in this one emerging market or another.

Again, I'm not trying to push you but obviously your stock is at a valuation gap versus other names that would suggest, yes, we understand some of the develop market weakness in truck or power gen. But the reason the multiple even is what it is is that maybe Cummins gives me more of that EM ramp in 2017. Right? It's not baking in a ramp in both developed and emerging markets, otherwise your valuation would be higher. But there's still some base case of EMs should be up notably next year. Are you not yet seeing the order book or at least commentary from your customers to suggest that we can think about the Brazils, the Indias, the Chinas is up double-digit for you next year -- off a low basis, I appreciate it, but are you just not seeing that yet? Or are you seeing a little bit and just not willing to state it?

In the China truck market we've seen improvements already this year. We gave our forecast for the China truck market. What that means for 2017, we just don't know yet. We have not seen much of an uptick in Brazil yet. Whether or not it will be better next year, I just don't know. I just don't -- my view is that valuation of Cummins stock is really a good deal, really inexpensive. So I think it would be a goodbye for anybody for any of those reasons.

But again, my view is that we will have a better view in February about what the individual markets are. I don't know what individual investors have built in about assumptions for next year. But I will they that we are capacity wise, new product wise, market leadership wise -- if markets go up, we will benefit more than anybody. We are positioning incredibly well for that. But we're also prepared if it doesn't turn out to do better than anybody else. And that's really as a management team all we can do is be ready for both because we just don't know really what's going to turn around and when. But as you know, our order lead time is very short. So it's very difficult to see from just an order book point of view what's going to happen in the middle of next year. But again, we will have a much better view in February and I suggest we take up this conversation again then.

I appreciate the thoughts. Thank you very much.

You bet.

Joel Tiss with BMO.

Again, not trying to get too much but if we are trying to handicap the medium duty market share for 2017, just like some of the moving parts -- can you help us understand the timing of competitive product coming in the market versus your 12 leader coming in as well?

Yes. Sorry, this is Rich again. Sore throat here. We don't see a lot of move in next year in the medium-duty market share. There's a couple moving pieces that you know about. So the -- we will see a four-cylinder [m-deg] engine being introduced at low volumes, which will be a negative. And we also, though, will see our share continue to grow in that. In fact we introduced the ISL nine liter engine here in Q3, which is a positive. So we -- again we will give further guidance but you ought to think of kind of more of the same in 2017 at this time as far as market share.

Okay. And then, Tom --

Joel, you mentioned the ISG, which is in -- we put in heavy-duty markets. That's a mid-four but heavy duty market. That's why -- so I just want to make sure because I heard you mention that. That was not included in whatever Rich just talked about.

And that will come at the end of 2017.

Okay. Yes, I was just trying to get the timing of the different pieces. And then on power gen, you seem to keep cutting costs, repositioning the business and the volumes keep dropping on you, is there anything else that can be done structurally to kind of put a floor underneath those margins? And I appreciate it. It's kind of a terrible end-market. Like the whole industry is struggling. But is there anything else? It feels like you are kind of chasing the decline a little bit. And I don't know if there's anything else to do their. Thank you.

Joel, it's a good comment. As you've heard me express frustration about that in the past that I think while we've done a really good job on reducing cost in a lot of our segments, I do believe over the last several years we have chased the power gen market down as opposed to getting in front of it and I'm disappointed in that for that reason. But I believe that we made a step early this year that is really helping us get ahead of that and find new ways to establish productivity and further reduce cost. And that was by combining our large engine business with our gen set business.

What that's brought to us is some new opportunities for both how we do production, how we consolidate production and therefore take steps out of production, reduce supply chain, reduce inventory. Which, again, means as markets vary we end up holding less stuff, we end up holding less stuff that we can sell, et cetera. And then also our new product development process we are able to streamline that to make sure that we are ready with the products that we want. Because the engine produces the one that the gen set wants and we don't produce stuff that we don't need. We don't generate new products that we're not going to use. So I feel like both of those, both in terms of efficiency, cost an asset utilization will continue to improve.

We got one of our best leaders leading the group. So I think over the next year or two, not only do I feel like we are starting to reach some bottoms in some of the markets, I feel like we've got some renewed opportunities for cost reduction to further improve margins in that area. Now again, I thought that before so it's really great to talk about. What we've got to do to is deliver it. And no one here is confused about that.

And just to jump in for a second here, Joel. If you keep in mind the power systems revenue dropped by 13% in the quarter and we managed to keep decremental EBIT margin at 12%, I think that just validates everything you just heard from Tom. And I think we'll see mor of that as we go into the fourth quarter.

That's great. Thank you.

Thanks, Joel.

Joe O'Dea with Vertical Research Partners.

Good morning. Similar theme and just thinking about cycles in some of your comments around markets that are bottoming and if you could just talk about power gen broadly. How you are thinking about it from a cycle perspective and really how much more downside is there I think as we are sort of five years into declines? And then similarly, just to address some of the high-horsepower key markets and whether or not there is much downside left really in say oil, mining, some of the marine markets and how confident you are in a bottom in 2016 there.

Great. I'm going to let you know, I'll share this one. But has it only been five years because it feels like a decade. (laughter) It does seem like we've been in the down cycle for a while, to your point, and frankly longer than we've seen in the past, which is frustrating. So obviously we're kind of the discussion earlier from David -- we'd like to see some of the things turn back. We just haven't seen yet signs that they are turning back. And of course power generation reflects a couple things. One, in emerging markets it reflects infrastructure building and general economic growth where reserve margins start to get under threat and things like that. And then it reflects non-res capital spending in some of the more mature markets where we are selling standby.

And again, while non-res capital spending isn't a disaster in the US and our business isn't a disaster, both those statistics broadly across the world are still [fighting]. So our view is that where we start to see turnaround in power gen is when we start to see infrastructure spending starting to come back in some of these emerging markets across the world. And then we see non-res capital spending coming back and more aggressively in some of the more advanced countries. And we just -- right now that's just not obvious when that happens. So as we were talking about, we are prepared to be at levels like we're now or a little better or a little worse. And we are finding ways to get more money out of our business at those levels.

We are completely ready for when it turns around to gain a lot of growth but also gain profitability improvements. So there's no question about that. But right now I would just say we are approaching it conservatively. We will see what happens. And, Rich, I will let you talk about some of the other large engine markets.

On the mining and oil and gas no one is calling a turnaround, certainly we're not, on production orders. There are -- I'd say there's a couple positives -- signs out there, anyway. Commodity prices up is one. But what we are seeing is more inquiries and some our business both on rebuilds of products and aftermarket parts, which is generally the precursor to actual orders going up. So it's a faint [green shoot] but you -- we've seen just a little bit of that to give some optimism there. We're down 7% in mining this year and, again, no one's really calling for that to turnaround at this time other than the aftermarket piece.

And then in marine?

Marine -- I would think maybe has a little longer delay to it. I'd probably be a little more pessimistic there. We're down a little heavier. Most of our marine -- a lot of our marine is tied to oil and gas. So maybe 30%, 40% of our marine business tied there so until you see some turnaround in oil and gas, and then there will be a lag effect there, I would say I'm more pessimistic on the marine side.

Okay. That's really helpful. And then maybe it's a little early but just thinking about a lot of the initiatives underway this year and what it means for the carryover tailwind into next year and any ability to talk to what some of the productivity and material and restructuring benefits mean just as a carryover benefit into next year.

Right now we will have a hard time seeing those because we are just putting together our plan. You can bet that our intention is to find ways to carry those over and add to those with new initiatives. That's what you've seen from us every year. You will see that again. We will be trying to capture the benefits of things we put in place, put in some new things to help drive more and then deal with whatever variations that we are seeing in the markets. Again, that's kind of our broad approach to the plan. We will be able to quantify those things for you though much better in February.

Great. Thanks a lot.

Adam Uhlman with Cleveland Research.

Good morning.

Good morning, Adam.

A quick clarification -- Pat, what would be the material cost benefit that is expected to be seen for the full-year this year?

We are tracking towards 1.5% this year, which is consistent with what we delivered last year too, Adam.

Okay. That's pretty good. And then broadly stated, could you just maybe share your thoughts on where you think the North American on-highway markets are tracking going into 2017? The medium-duty forecast got cut for the second quarter in a row and I'm wondering if you've got anymore color on what exactly you're seeing there. And then there seems to be a pretty wide range of forecast from your OEMs on heavy-duty does. Do you think you are leaning more on the optimistic side of a flattish market or more on the pessimistic side of more declines to come? Thanks.

Okay. I think we've probably been a little more pessimistic than most on this as we started the year, which is why we took a pretty good reduction in cost at the end of last year anticipating this. There's no sign of a pickup out there right now. I think what you have a situation is for many, many months we're still producing more than the orders are coming in. And that hasn't changed. So the backlog is down -- that 85,000 which is kind of the [forward] order board. And you're hearing from lots of lots of fleets that while businesses -- they're a little nervous on business, they are delaying purchases. So how do I stretch the assets out a little bit?

And we are in that -- that's the mode we are in right now. I don't have quite the miles that I need to make a trade out and the truck engines are really good out there so you can stretch a little more out of it. And the lead time is really low. So if I need one I can get it quickly. As we look at it, I see the fundamental business is not bad. And so we're maybe moving towards were retail orders are getting close to trough. I still think, though, from a production standpoint there's a step down still in their, which is what we've assumed. If you run our numbers it says it steps down in Q4 and, quite frankly, I think we'd continue into Q1 on the production side.

So retail orders getting close to trough, production there's always a bit of a life there and that's what we've seen -- again, that's what we've seen other cycles. Especially towards year-end the folks take a bit of a shutdown as they end year and they start the year up. We're planning for that kind of step down in production. Now whether it actually happens or not -- or when it happens, what quarter? But that's how we're thinking about it right now.

Great. Thank you.

Robert Wertheimer with Barclays.

Good morning. I had a couple product questions if I may. Your Class 8 after-treatment system -- I think you went to a cylinder for your own engines and for an OEM customers. It seems like it gives a lot of weight savings and it seems beneficial in that way. Is there any headwind to revenue or dollar margin on the components because you are becoming more efficient and how you provide after-treatment solutions to customers?

First, you are accurate. It's one of the big advantages -- well one of a couple advantages of the new single module, which is the weight savings on it. I can't quote the exact number but over 100 pounds that will be taken out. And then in second what we're doing is changing the cycle to do repair on it. So we take it out well beyond the first owner so that you never have to touch the after-treatment if you buy this. So those are some of the big advantages we've got with it.

Our normal approach is what we sign up with customers is to continually take cost out of product and pass that cost -- pass on those savings to customers. And the after-treatment is in the same mode that we -- Pat talked about material cost savings, we're after taking cost out and working with customers to share in that with them.

Is that a big enough to impact the growth curve on components or not?

It really depends I think on -- this is Tom speaking -- it depends on what else we've got going. Rich painted our business model pretty closely which is that in the components business we're constantly trying to find ways to do the same thing for less money or do more for the same money. And without it -- that's essentially what new products mean -- and with out it we don't get to be the supplier. And then what we have to do is come up with new things or new capabilities, new features, new something in order to make sure that we have revenue growth.

And we've been able to do that for the last 15 years in the components business by finding new markets to go to, new products to add, new systems to go. So if everything was status quo, it would have an impact on our revenue. Of course everything isn't status quo. For example, we just grew our business in China by 37%. So this is the kind of thing we are trying to do is to offset sales revenue declines driven by cost savings, which don't necessarily translate into margin dollar decline but they do mean sales goes down, into other things that we can do for those customers to drive sales up.

If I could just add one more example on that would be next year we look at India as we go BF4. So we will be adding content there in both the after-treatment and the fuel system. We will be replacing the existing supplier. That's an example of where you'd be if the step function changes when you have emissions changes.

Perfect. Thank you. If I can ask a quick follow up -- the comments on ISG sounded pretty positive really. For clarification, do you have multiple OEMs who are sort of exploring it or with the engineering path you can see who have already committed to putting in trucks?

We have multiples who are doing the engineering work to put it in trucks.

Great. All right. Thanks very much.

Steven Fisher with UBS.

Thanks. Good morning.

Good morning, Steve.

Can you just talk about your market share in heavy-duty truck in North America? It picked up sequentially but you didn't change your full-year expectation. Can you just give a little more color on what was happening there in the quarter? Was it just sort of a lumpy order? And then how are you expecting that share to trend in 2017?

Okay. Yes, Steve. Our share is the production share. So it's the share of the trucks built in a given quarter. And our share is high with a couple OEs and not so high with a couple others where they use their own engine. And so in Q3 we saw a couple the ones who are low users of Cummins took their production down, which took our percent up. So that was the reason for the step function. I think we were close to 35% in Q3.

Having said that, we're gaining share in the market in a lot of places. With virtually every mix fleet customer I talk -- so using multiple engines -- they are increasing their share with Cummins now, which we couldn't say two years ago. So I think there's some base improvement going on. But I think the big step-up you saw in Q3 was more of production cycles changing and which OEs are taking down weeks versus expanding production.

Okay. That's very helpful. And then can you remind us what the posturing is of that OEM involved in this loss contingency situation as you head into the commercial discussion?

Let's see if I can answer the question and you can do a follow-up if I miss it. We are in a dispute on who pays for this. Okay? So that's where the disagreement is. Quite frankly, on everything else -- and we've separated that and said we are going to resolve this separately, we know what the amount is, both companies have accrued for that, and we will run through a process to resolve with that final amount is. Everything else we are moving ahead with and how we grow the business and move ahead. So the posturing is let's separate that. And we've agreed to disagree and we're going to resolve. In everything else, let's go win in the marketplace.

Okay. So they have agreed to disagree. It's not that they said we will just work it out later and you'll get some recovery? It's more of -- it needs to be adjudicated some way?

That's accurate, yes.

Okay. Thank you.

Yes.

Ross Gilardi with BofA Merrill Lynch.

Good morning. Thank you.

Hey, Ross.

I just want to ask about the China market share. It sounds like you're going to be down slightly this year. What's going on? I mean is [Wayshi] getting more aggressive on pricing? Are you actually relinquishing any share specifically at Foton or is this just a pure customer mix issue of certain Chinese OEMs growing faster than others and it's causing your share to move around?

It's the last thing. It's just that there's just different customers gaining share. Again, there's been discounting in the market. Share was lost by some and they went to gain some back. With our customers, with Foton we are gaining share. I talked about some of the numbers there. We're gaining share. Our ISG is doing well in the market. With Dongfeng we are maintaining share. We're not losing anything there. In fact, despite all of the predictions, we're just as strong as we've ever been with them.

And so I feel very good about our position. I also feel really good about those OEMs. Those two OEMs are building quality product, meeting new emissions targets and I believe that they will restore share they are losing. It's just during this last year, Dongfeng in particular has lost a little bit of share while some of the others have gained some through some improvement in their products too. Not just only discounting but they did take some old product launched some new products. So it's just share things going on. By the way, Wayshi never stopped discounting during any of it so that's never going to stop. But I think still our product is both competitive from a performance end-cost point of view in China.

Thanks a lot, everybody, and I'll be available for calls later on.

Thank you, Ross.

Thank you. This concludes today's Q&A session. I would now like to turn the call back over to Mark Smith for any closing comments. Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.