Cummins Inc.
Q3 2016 Earnings Call Transcript

Published: 1 Nov 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Third Quarter 2016 Cummins Incorporated Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. 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.

[Mark Smith:]

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins's results for the third quarter of 2016. Participating with me today are our 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 forecasts, expectations, hopes, beliefs and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in our slide deck today and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed Annual Report on Form 10-K, and 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 metrics. Our press release today with a copy of the financial statements and today's webcast presentation are available on our website at cummins.com under the heading of Investors and Media. Now, I'll turn it over to our Chairman and CEO, Tom Linebarger.

[Tom Linebarger:]

Thank you, Mark. Good morning. I'll 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 included $99 million increase in accrual for our 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 engine in the OEM vehicles. The combination of a Cummins engine with the third-party after-treatment system is unique to this particular OEM. We increased our accrual on the third quarter to reflect recent testing results to 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; the 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 system 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 of very weak market. Benefits from the restructuring actions we initiated in the fourth quarter of 2015, strong execution on material cost reduction initiatives and productivity gains all helped to mitigate the impact of lower volume 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 costs all contributed to the strong operating results. Revenues in our components segment decreased 8% from a 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 the 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 of 2015. The positive impact of acquisitions made in the second half of 2015 were more than offset by the negative impact of currency and weaker sales to off-highway markets. The distribution business’ 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 distributed joint ventures. The positive impact of operational improvement and increased 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 decreased from 7.5% to 6.9% with decremental EBIT margin just 12% due in part to 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 off-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 of 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 & 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 quarter, 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 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 pick-up truck customers increased by 2% in the third quarter, shipments to Chrysler declined by 11% due to planned production changes at Chrysler plant but were more than offset by shipments of V8 engine in 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 America 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 quarter. 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 the 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 3% increase to the overall market. As we increase penetration at Foton displacing local competitor engines. Our share of the overall 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 increased 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 up-tick in equipment market. 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 track 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 truck. 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 engine to truck customers increased 5% while overall industry truck production declined 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 continued to face 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 pre-prior cycles. In addition to reducing costs 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 customer wherever they operate. We have also continued to invest in new products, for example, we’ve grown sales in market share with our 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 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 expectation 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 full-year of 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 over to Pat who will cover our third-quarter results and full-year guidance in more detail.

[Pat Ward:]

Thank you Tom and good morning everyone. Third-quarter revenues were $4.2 billion, a decrease of 9% from 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 and industrial engine 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 25.3% of sales were only down 30 basis points from last year with material cost savings, productivity improvement and the benefits from the restructuring actions helping offset the negative impact from lower volumes and an unfavorable product mix. Selling, admin and research and development cost 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. But debt increased as a percent of sales by 40 [ph] basis points. Joint venture income of $74 million decreased $4 million compared to a year ago, primarily due to lower earnings from 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% in year ago. Included in the quarter was an additional $99 million charge related to the previously disclosed last contingency as Tom just discussed. Excluding this charge of 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 material cost reductions programs and productivity improvements. Net earnings for the quarter were $289 million or $1.72 per diluted share. [indiscernible] loss contingency, net of compensation reducing diluted earnings per share by $0.30. Net income in the third quarter of 2015 was $380 million or $2.14 per diluted share. The effective tax rate for the quarter was 21.5% more than a year ago primarily due to changes in the geographical mix of pre-tax 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, up 4.8% of sales, which included $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 will decline 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 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 stronger US dollar, which were partially offset by 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 decreased from 7.9% a year ago, mainly due to the fair market value gains reported on distributed acquisition 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 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 industrial production in on-highway markets declined. International sales increased 7% with a 37% increase in sales from China more than offsetting weaker revenues in Europe. Despite the lower sales, gross margins improved by 18 basis points as material cost reductions and benefits from restructuring more than offset the negative impact of retail 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 margin were 6.9% in the quarter, down from 7.5% last year, which equates to decremental EBIT margin of 12%. Material cost reductions, lower cost following the 2015 restructuring actions and the benefits from a weaker British pound helped offset the impact from lower volumes and joint venture earnings. We now expect full-year revenues for the power system segment to decline by 14% compared to a previous guidance of down to 12% to 14% and full-year EBIT to be 7.5% of sales at the midpoint of our prior guidance. We are now projecting total company revenues to be down 9% in 2016 consistent with our prior guidance of down 8% to 10% as we face 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 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 or 11% lower from this time last year. And we anticipate operating cash flow in 2016 would be around $2 billion, similar to 2015 levels, despite the 9% drop in revenues. Capital expenditures are expected to be in the range of $530 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 dividend 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 I will return it back over to Mark.

[Mark Smith:]

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

[Operator:]

[Operator Instructions] Our first question comes from the line of Jerry Revich with Goldman Sachs. Your line is open.

[Jerry Revich:]

Can you talk about the contract structure regarding the warranty cost that impacted you for the past few quarters? Going forward, are you still underwriting the warranty risk for 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 additional charge, what proportion of the total field population has been provisioned for?

[Rich Freeland:]

Hey Jerry, this Rich, let me take a shot at those series of question. So as you alluded to it, it’s a unique situation, we’ve got our engine with a third-party after-treatment, so the only one we had kind of in the company. What we didn't hear 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 the 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 estimated the cost of those accruals - of those recalls and that’s what’s reflected in our numbers. What we have not included 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 you’re ongoing kind of what we implied in there is there more to come I guess is may be what you were also asking. What we have is there are three populations and we have accrued two of those. The third population we have not accrued and it’s a different duty cycle that’s involved in this third population, it has a different emission stranded, it has in fact higher than this. And third we have concluded our emissions tests and all emission test to-date have passed. And so the third population is similar in size to the other two that we have taken an accrual on. And of course we are adjusting all the agreements going forward 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, we are talking about is a fixed amount that unfortunately we've had to come back to a couple of times. And I guess one last thing to just maybe close this out is, in fact the product that we are talking about is doing terrific and we are actually gaining sales, gaining shares, 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, its unique but at this point, we have accrued for kind of all the known issues and then we’ll kind of move into the commercial negotiations to try to finish that one up to come.

[Jerry Revich:]

I appreciate the context. And the 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 ‘17 and if you're willing to quantify the topline contribution it will be significant enough to call out as we think about ‘17 versus ‘16? Thanks.

[Rich Freeland:]

This is Rich again. So we’re actually a little bit ahead above projection on the Hedgehog despite the weak markets. And so - and that's been driven primarily due to data center markets where this is - its proven to be a terrific product to meet those markets. We are also going - 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 are right now at five a week as we go into the year. And so we have - I don't have a projection for 2017 but I’ll just close and say, we’re really pleased with how this has gotten - how we got a good start here and despite these bad markets coming out ahead of plan. And the total topline revenue kind of in the 150 million to 180 million range this year.

[Operator:]

Thank you. Our next question comes from the line of Alexander Potter with Piper Jaffray. Your line is open.

[Alexander Potter:]

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

[Tom Linebarger:]

Let me take a first shot at this. So for the NF V Jerry, not a lot of - oh sorry Alex, sorry Alex. The NS V not a lot of content increase and therefore not a lot of price increase and we don't anticipate a pre-buy on the NS V. So the big step up for the content and then get into those issues will be more in the NS VI range. And I guess given the experience on NS IV, we are more optimistic about enforcement and implementation of both NS V and NS VI.

[Alexander Potter:]

And in terms of the timing of the pre-buy associated with NS VI that would be probably something like 2019?

[Tom Linebarger:]

Yes. Yes. At least, yes.

[Alexander Potter:]

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

[Tom Linebarger:]

Okay, great. Yeah. Thanks for remembering the revolutionary engine. Yes, 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 in kind of -- where weight is important, so in the day cab area, in the vocational markets and those that have follow Cummins for a long time think back to our M11 product that was a real success there. This is -- so we are on track, we’re moving ahead with that.

[Operator:]

Thank you. Our next question comes from the line of Jamie Cook with Credit Suisse. Your line is open.

[Jamie Cook:]

Hi, 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 leverage you think you can pull in ‘17, 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.

[Tom Linebarger:]

Let me just get the first one first, Jamie. It’s Tom. We did lower our compensation estimates and again they are related to, they relate 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.

[Jamie Cook:]

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

[Tom Linebarger:]

Yeah. It's about 20 million in the quarter, I think, right.

[Pat Ward:]

It haven’t changed, Jamie.

[Jamie Cook:]

Okay. All right, perfect. Thank you.

[Tom Linebarger:]

Yeah. Okay. 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 so, and again Rich can add if he has some more thoughts on it. But we are going to go into the 2017 conservative on markets. As we talked about before, we don't see obvious turnaround. We do see some bottoming in some markets, but there is not an obvious instigator for turnaround, so we intend to enter 2017 much as we enter 2016, with a relatively conservative view on markets, and then trying to 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've 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 and we will be investing to do so. But at a high level, what you will see is relatively conservative planning on market outcomes and to be aggressive on how we get costs in line to make sure that we keep our detrimental margins at 25% or below.

[Jamie Cook:]

And 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 is, if we’ve made any progress I guess?

[Tom Linebarger:]

Yeah. We’ve made tons of progress, we've done lots of good work. Again unfortunately, the way that you’ll 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, 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 at some that we think we can earn a return on. So, that same conservatism about how to invest, how to make sure the things that we belong in. That's stayed the same, which, as you guess, 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 in the way we set out in our strategy session with investors.

[Jamie Cook:]

Okay, thanks. I'll get back in queue.

[Operator:]

Thank you. Our next question comes from the line of David Raso with Evercore ISI. Your line is open.

[David Raso:]

Hi, thank you. Tom, just following up on the idea of yours stocks going into ‘17 now, obviously folks are looking at you as maybe a way to play stronger emerging markets in the ‘17, but your comment right there seem to be a little more on the cautious side, can you give us a little more detail around how you're really thinking about the Chinese and Brazilian market and just around the horn?

[Tom Linebarger:]

Yes. 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 a significant growth directly in front of us. So our view is, given that we get in this for a couple of years now, the right posture for the company to take is to assume relatively weak markets, set our cost structure accordingly, find opportunities for cost savings, productivity gains, and then continuing to invest in those opportunities where we think markets could improve and we will be able to gain share and gain business accordingly. So, for example, in China, you've seen us have a pretty aggressive posture with 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're in a very strong position in Brazil, where we're ready to ramp up when the market is ready and 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’ll have a much better view in a couple of months about, if we see some of those markets actually starting to turn back, we will definitely forecast those. I just wanted to give you a sense of how we are approaching our planning rather than specifics on one emerging market or another.

[David Raso:]

Yes. Again, I'm not trying to push through, but I mean, obviously your stocks had a valuation gap versus other names that would suggest. Yes, we understand some of the developed market weakness in truck or power gen, but the reason among, even as what it is, is that, hey, maybe Cummins gives me more that EM ramp in ‘17, right? It's not baking in a ramp in both developed and emerging markets. Otherwise, your valuation would be higher, but there is still some base case should of EMs should be up notably next year. Are you not yet seeing the order book or at least commentary from your customers that suggest that we can think about the Brazils, the Indias, the Chinas, that’s up double-digit for you next year, I mean off a low basis, I appreciate it, but are you just not seeing that yet or are you seeing a little bit and not willing to say anything?

[Tom Linebarger:]

In the China truck market, we've seen improvements already this year, I would give a forecast for the China truck market, what that means for 2017, we just don't know yet. We have not seen much of an uptake in Brazil yet. Whether or not we will be there next year, I just don't know. My view is that evaluation of the Cummins stock is really a good deal, really inexpensive. So I think it would be a good buy for anybody for any of those reasons, but again, my view is that we’ll 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 say that we are, capacity wise, new product wise, market leadership wise, if markets go up, we will benefit more than anybody. We are positioned incredibly well for that, but we are also prepared if it doesn't turn out to do better than anybody else. And, as such, 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.

[David Raso:]

I appreciate the thoughts. Thank you very much.

[Operator:]

Thank you. Our next question comes from the line of Joel Tiss with BMO. Your line is open.

[Joel Tiss:]

And so again, not trying to get too much, but if we're 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 products coming in to market versus your 12 liter coming in as well?

[Rich Freeland:]

Okay, 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 is a couple of moving pieces that you know about, so we’ll see a 4-cylinder engine being introduced at low volumes, which will be a negative and we also though, we will see our share continue to grow in that. In fact, we introduced the ISL 900 engine here in Q3, which is a positive. So again, we’ll give further guidance, but you ought to think of kind of more of the same in ‘17 at this time as far as market share.

[Joel Tiss:]

Okay. And then Tom --

[Tom Linebarger:]

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

[Rich Freeland:]

And that will come at the end of ’17.

[Joel Tiss:]

End of ’17. Okay, yes. That’s what 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's kind of a terrible and market like the whole industry is struggling, but is there anything else that feels like you’re kind of chasing the decline a little bit and I don’t know if there is anything else to do there? Thank you.

[Tom Linebarger:]

Joel, it's a good comment. I mean, you’ve heard me express frustration about that in the past that I think while we've done a really good job on reducing costs in a lot of our segment, 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 earlier 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 market vary, we end up holding less stuff, we end up holding less stuff that we can’t sell, et cetera. And then also our new product development process, we’re able to streamline that to make sure that we’re 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 -- 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 and asset utilization will continue to improve. We’ve 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're 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 got to do is deliver it and no one here is confused about that.

[Pat Ward:]

And just to jump in for a second here, Joel. And if you keep in mind the power systems revenues go up by 13% in a quarter, and you manage to or they manage to keep detrimental EBIT margin [indiscernible] and I think you’ll see more of that as we go into the fourth quarter.

[Joel Tiss:]

That's great. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Joe O'Dea with Vertical Research Partners. Your line is open.

[Joe O'Dea:]

Hi, good morning. For a similar theme and just thinking about cycles in some of your comments around markets that are bottoming and if you could just talk about kind of power-gen. Broadly, how you’re thinking about it from a cycle perspective and really, how much more downside is there I think as we’re 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’re in a bottom in ‘16 there?

[Tom Linebarger:]

Great. I’ll share this one, but ha it only been five years, because it feels like a decade. So it does seem like we’ve been in the downcycle 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 to 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’re turning back and, of course, power generation, reflects a couple of things. One, in emerging markets, it reflects infrastructure building and general economic growth where the 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’re selling standby. And again, while our non-res capital spending is in a disaster in the US and our business is in a disaster, both of those statistic broadly across the world are still quite there. 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 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’re prepared to be at levels like we are now or a little better or a little worse and we’re finding ways to get more money out of our business at those levels. We are completely ready when it turns around to gain a lot of growth, but also profitability improvements. So there is no question about that, but right now, I would just say we’re approaching it conservatively. We will see what happens and Rich, I’ll let you talk about some of the other large engine markets.

[Rich Freeland:]

Yes. I’d come on mining and oil and gas, no one is calling a turnaround. Certainly, we are not and production orders. There are, I’d say there is a couple of positive signs out there anyway. Commodity prices up is one, but what we are seeing is some more enquiries and some more business, both on rebuilds of products and aftermarket parts, which is generally the precursor to actual orders going up. So it's a greenshoot, but we've seen just little bit of that to give some optimism there. We are down 7% in mining this year and again, no one is really calling for that to turn around this time other than the aftermarket at least.

[Joe O'Dea:]

And then in marine?

[Rich Freeland:]

Marine, I would think, maybe has a little longer delay to it. I would probably be a little more pessimistic there. We're down a little heavier, and most of our marine, a lot of our marine is tied to oil and gas, so maybe 30%, 40% of our marine business is 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.

[Joe O'Dea:]

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 kind of 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?

[Tom Linebarger:]

Right now, we’ll have a hard time seeing those, because we’re 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’ll 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’re seeing in the market. Again, that’s kind of our broad approach to the plan. We’ll be able to quantify those things for you though much better in February.

[Joe O'Dea:]

Great. Thanks a lot.

[Operator:]

Thank you. Our next question comes from the line of Adam Uhlman with Cleveland Research. Your line is open.

[Adam Uhlman:]

Hi, good morning. I guess a quick clarification, Pat, what would be the material cost benefit that is expected to be seen for the full year this year?

[Pat Ward:]

We're tracking to launch 1.5% this year, which is consistent with what we delivered last year too, Adam.

[Adam Uhlman:]

Okay, it'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, have you got any more color on what exactly you’re seeing there and then there seems to be a pretty wide range of forecast from your OEMs on what heavy duty does, I guess do you think you’re leaning more on the optimistic side of a flattish market or more on the pessimistic side of more declines to come? Thanks.

[Tom Linebarger:]

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 big reduction in cost at the end of last year, anticipating this. There is 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 orders are coming in, and that hasn't changed. So the backlog is down 85,000, which is kind of the forward order board and we’re hearing from lots and lots of fleets that while businesses, they are little nervous on business, they’re delaying purchases. So they had always stretched the assets out a little bit and we’re in that. That’s the mode we’re in right now. I don't have quite the miles that I need to make a trade out and the trucks and 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 that fundamental business is not bad and so we’re maybe moving towards where retail orders are getting close to trough. I still think though from a production standpoint, there is a step down still in there, which is what we've assumed. If you run our numbers that says, it steps down in Q4 and quite frankly, I think, would continue into Q1 on the production side. And so, retail orders getting close to trough, production is always a bit of a lag there and that's what we've seen there again. That's what we've seen in other cycles, especially towards year-end, folks take a bit of a shut down at the end of the year and they start the year out. We’re planning for that kind of step down in production and whether it actually happens or not, or when it happens, what quarter, but that's how we are thinking about it kind of right now.

[Adam Uhlman:]

Great, thank you.

[Operator:]

Thank you. Our next question comes from the line of Robert Wertheimer with Barclays. Your line is open.

[Robert Wertheimer:]

Good morning. I had a couple of product questions if I may. Your class 8 aftertreatment system, I think you went to a single cylinder for your own engines and for an OEM customer, 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 of the components, because you’re becoming more efficient in how you provide aftertreatment solutions to customers?

[Rich Freeland:]

Well, first you’re accurate. It’s one of the big advantages, one of the couple of advantages of the new single module, which is the weight savings on it, can’t pull the exact number, but over 100 pounds that will be taken out. And then, and second, what we are doing is changing the cycle to do repair on it. So take it out well beyond the first owner, so that you never have to touch the aftertreatment 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 aftertreatment is in the same mode that we -- Pat talked about material cost savings and we are taking costs out and working with customers to sharing that with them.

[Robert Wertheimer:]

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

[Tom Linebarger:]

It really depends I think on, this is Tom speaking, it depends on what else we got going. I mean, I think Rich I think painted our business model pretty closely, which is it is in the components business, we are constantly trying to find ways to do the same things for less money or do more for the same money and without it, that’s essentially what new products mean and without 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 and new products to add, new systems to go. So if everything was status quo, it would have an impact on our revenues. Of course, everything is in status quo. For example, we just grew our business in China about 37%. So this is the kind of thing we're 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 go down into other things that we can do for those customers to drive sales up.

[Rich Freeland:]

If I could add just one more example on that would be next year, we look at India. As we go to BS4, so we will be adding content there in both the aftertreatment and the field system where we will be replacing existing supplier. So that's an example of where you’d be if the step function changes, when you have emissions change.

[Robert Wertheimer:]

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

[Rich Freeland:]

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

[Robert Wertheimer:]

Okay, all right. Thanks very much.

[Operator:]

Thank you. Our next question comes from the line of Steven Fisher with UBS. Your line is open.

[Steven Fisher:]

Thanks, good morning. 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 you’re expecting that share to trend in 2017?

[Tom Linebarger:]

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 of OEs and not so high with a couple of others, so they use their own engine. And so in Q3, we saw a couple of the ones who are low users of Cummins took their production down, which took our percent up. So that was the reason for the kind of 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’ve talked to, and so using multiple engines, they are increasing their share with Cummins now, which we couldn't say two years now. So I think there is some phased improvement going can, but I think the big step up you saw in Q3 was more of production cycles changing and which OEs are taken down versus expanding production.

[Steven Fisher:]

Okay, that's very helpful. And then can you remind us what the posturing is of that OEM involved and this was continuing to be a situation as we head into the commercial discussion?

[Tom Linebarger:]

Well, see if I answer the question. You can do a follow-up if I miss it. So 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, I think both companies have recruited for that and we’ll run through a process to resolve what that final amount is. Everything else we are moving ahead with and how do we grow the business and move ahead. So we kind of -- the posturing is a separate path and we’ve agreed to disagree and we’re going to resolve it and everything else, let's go and win in the marketplace.

[Steven Fisher:]

Okay, so they have agreed to disagree, not said, they said, we’ll just work it out later and you’ll get some recovery, it sort of needs to be adjudicated in some way?

[Tom Linebarger:]

That's accurate, yes.

[Steven Fisher:]

Okay, thank you.

[Operator:]

Thank you. And our next question comes from the line of Ross Gilardi with BoA Merrill Lynch. Your line is open.

[Ross Gilardi:]

Hey, good morning. Thank you. I just wanted 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 we’re trying to 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?

[Rich Freeland:]

It's the last thing. It's just -- there are just different customers gaining share, again, there has been discounting in the market. The 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. So we're not losing anything there. In fact, despite all the predictions, we’re just as strong as we’ve ever been with them. And so I feel really good about our position. I also feel really good about those OEMs, those two OEMs are building quality products, meeting new emission targets and I believe that they will restore or share they are closing. 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 to not just only discounting, but they did take some old product and launched some new products. [indiscernible] So that’s never going to stop, but I think still our product is both competitive from a performance and cost point of view in China.

[Pat Ward:]

Thanks, everybody and I will be available for calls later on.

[Tom Linebarger:]

Thank you, Ross.

[Operator:]

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.