Cummins Inc.
Q3 2014 Earnings Call Transcript

Published: 28 Oct 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the Third Quarter 2014 Cummins Incorporated Earnings Conference Call. My name is Denise, and I’ll be the operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now turn the conference over to Mr. Mark Smith, Investor Relations. Please proceed, sir.

[Mark Smith:]

Thank you, Denise and good morning everyone and welcome to our teleconference today to discuss Cummins results for the third quarter 2014. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; and our President and Chief Operating Officer, Rich Freeland. We’ll all be available for your questions at the end of the 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 the slide deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed Annual Report on Form 10-K and subsequently filed quarterly reports on Forms 10-Q. During the course of this call, we will be discussing certain non-GAAP financial measures and we refer you to our presentation for the reconciliation of those measures to GAAP, financial measures. Our press release with a copy of the financial statements and a copy of today's webcast presentation are available on our website at www.cummins.com under the heading of Investors and Media. Now I’ll turn it over to our Chairman and CEO, Tom Linebarger.

[Thomas Linebarger:]

Thank you, Mark. Before I start, I just wanted to tell you how much I really enjoyed those disclaimers section, thank you for doing that. Good morning everybody, I’ll start with the 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 $4.9 billion, an increase of 15% compared to the third quarter of 2013. Third quarter EBIT was $684 million or 14% of sales compared to $536 million or 12.6% in the same quarter last year. We delivered incremental EBIT margins of 24%, due primarily to strong demand in North America and improved operational performance in all four businesses. Engine business revenues increased by 13% year-over-year and EBIT margins were 11.7% of sales, up from 10.9% a year ago. We have increased our outlook for the engine business and now expect sales to increase between 7% and 9%, up 1% at the mid-point. We expect EBIT to be in the range of 11% to 11.5% of sales, 25 basis points higher than our previous forecast due to improved productivity in our manufacturing operations. Revenues for the Components business increased 20% year-over-year and EBIT percent improved by a 110 basis points to 13.4%. We have increased our full year outlook for the component’s business and now expect revenue growth of 15% to 17%, 1.5% higher than our previous forecast at the midpoint. We expect EBIT to be in the range of 13.5% to 14%, up 25 basis points, due mainly to higher volumes. Power generation revenues increased by 6% compared to a year ago, an even increase from 6.3% a year ago to 8% this quarter. While this is a good improvement from a year ago, the level of water intake in power generation has remained weak for some time and is not yet showing signs of a significant turnaround. As a result, we are considering taking further actions to align our cost structure with demand starting in the fourth quarter. We have lowered our revenue forecast for 2014 and now expect revenues to decline between 3% and 5%, down from our previous guidance of flat at the midpoint. We now expect EBIT to be in the range of 6.8% to 7.2%, down 50 basis points at the midpoint. This forecast excludes any one-time costs associated with the cost reduction activities currently under consideration. We will provide details of our cost reduction plans during our fourth quarter earnings call. Revenues and the distribution segment increased 37% in the third quarter with organic growth of 8% and acquisitions adding 29%. EBIT for the quarter was 10.1% and EBIT dollars were a record $131 million, up 52% year-over-year. We continue to make good progress with our North American acquisition strategy. Through the first nine months of this year, we completed four acquisitions and another three will close by the end of the year. The acquisitions are expected to deliver incremental revenues for the full year of $500 million for this company and generate earnings per share of at least $0.35. We are forecasting revenue growth of 30% to 35% in the distribution segment for 2014, unchanged from three months ago and have tightened the range for EBIT percent to 9.25% to 9.75%, unchanged at the midpoint. Now, I will comment on some of our key markets, starting with North America. Our revenues in North America grew 19% in the third quarter due to strong demand in on-highway markets. Shipments for the North American heavy-duty truck market exceeded 26,000 units in the third quarter, an increase of 32% from 2013 levels. We now expect the full-year market size to increase by 22%, up from our previous forecast of a 15% increase. We expect our full-year market share to be 37%, consistent with year-to-date performance though August. In the medium-duty truck market, we delivered almost 18,400 engines in the third quarter, up 15% compared to a year ago. We expect the market to grow by 9% for the year, unchanged from our prior forecast. Our market share is 73% year-to-date, and we expect to maintain this market share for the full year, which would be 10 points higher than 2013. Shipments to Chrysler increased by 6% in the third quarter year-over-year. For the full year, we expect that shipments will increase 6% as well. Power generation revenues declined in North America by 1% year-over-year, due primarily to lower sales to the U.S. Military. Excluding the Military business, power generation revenues increased 8% due in part to stronger orders from data center customers. Also in North America, we are experiencing improvement in some of our high horsepower engine markets. Oil and gas revenues more than tripled in the third quarter as the market recovers from very weak levels, and for the full year, volumes are expected to be up by 70% to 80%. We are also experiencing very strong demand in the commercial Marine market, supporting the offshore oil and gas industry. Demand for mining engines remains very weak both in the U.S. and international markets with unit shipments expected to decline 20% for the full year. The combination of a strong commercial Marine market, improving orders from oil and gas customers and data center demand in the U.S. for our power generation business resulted in a 11% growth in global high horsepower engine shipments in the third quarter, following almost two years of declining demand. In 2015, a number of high horsepower markets who adopts Tier 4 Final emissions regulations in the U.S. We have already achieved certification for high horsepower generator sets and for our engines for rail and oil and gas applications, so we feel well-positioned to meet customer demand. We will actually start delivering some Tier 4 Final systems in the fourth quarter of this year and are excited about the opportunities looking at the next year. Our international revenues increased by 10% year-over-year in the third quarter with growth in China and Western Europe offsetting declines in Mexico and Brazil. As I will discuss our full-year forecast for revenues in our largest international markets remain unchanged from our prior forecast. Third-quarter revenues in China, including joint ventures were $824 million, an increase of 16% year-over-year. Secular growth in light-duty engines and components more than offset weak end-market demand. Industry sales for heavy and medium duty trucks in China declined 10% for the third quarter. Sales in third quarter of 2013 were unusually strong due to pre-buying activity ahead of the anticipated an NS4 emissions regulations. NS4 compliant trucks represent 40% of the total industry production in the third quarter and should exceed 50% in the fourth quarter. Year-to-date, total industry sales are down 3%, and we currently expect the full-year market size to decline by approximately 5% consistent with our prior forecast. Our shipments of light duty engines in China increased 94% year-over-year, even as overall market demand declined by 28% as our partner Foton increased the proportion of its trucks powered by the 2.8 and 3.8 liter engines manufactured in our joint venture. Production of our new ISG heavy-duty engine, also part of our joint venture with Foton, are increasing and should contribute to growth in our market share in the fourth quarter. Demand for construction equipment continues to decline as property construction has contracted, and the pace of government investment in infrastructure has slowed. Industry sales of excavators declined 30% in the third quarter and are down 15% year-to-date compared to weak levels last year. We expect full-year industry demand for excavators to decline 17%, down from our previous forecast of a decline of 15%. Revenues for our power generation business were up 4% year-to-date and are expected to be flat for the full year. Full year revenues in China, including joint ventures are expected to increase 10% for the year, unchanged from our previous guidance with new products and higher emissions related content driving our growth. We do expect to see further growth in engine and component sales with broader adoption of the new NS4 regulations. Third quarter revenues in India, including joint ventures, were $283 million, up 17% compared to a very weak third quarter last year. Industry production in the truck market increased 20% in the third quarter compared to third quarter last year and is 1% higher for the first nine months of the year. We now expect truck production for the industry to increase 9% for full year, up from our previous forecast that production would be flat year-over-year. Power generation revenues in India increased 5% in the third quarter, higher pricing for new products introduced to meet the recently adopted CPCB II emissions regulations offset lower unit demand. Year-to-date revenues, however, are down 25% after a very weak first half. The new government in India has placed a strong emphasis on improving infrastructure, which should be positive for our business in the future, the near-term demand remains weak. We expected full-year revenues for the power generation business would decline by 19% compared to our previous forecast of a 15% drop. In total, we continue to expect revenues in India to decline by 8% for the year, unchanged from our prior forecast with improving truck production offsetting weaker power generation demand. Third quarter revenues in Brazil were $189 million, down 14% from the third quarter last year. Industry production of trucks declined 33% in the third quarter as the weak economy continues to impact demand for capital goods. Industry truck production is down 25% year-to-date and we expect a full-year decline of 25% to 30%. We expect our full-year revenues in Brazil to decline by 15% to 20% consistent with our prior forecast with power generation sales and modest (inaudible) in this difficult economic climate. In summary, we currently expect global company revenues to increase between 10% to 12% for the full year, up slightly from our previous forecast of growth between 8% and 11%. The main driver of the increase in our revenue outlook is stronger demand in the North American heavy duty truck market. We expect EBIT to be in the range of 13% to 13.5% up 25 basis points to the mid-point. I'm pleased with the company's strong earnings and cash-flow performance in the third quarter despite weak market conditions in nearly all of our international markets. The strong results underscores the (inaudible) growth opportunities that we have generated with new products, new partnerships and expansion of our distribution business. The results also showed that Cummins can continually invest for long-term leadership and growth while effectively managing our costs. 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.

[Pat Ward:]

Thank you, Tom and good morning everyone. Third quarter revenues were $4.9 billion, an increase of [50]% from a year ago and included a record revenues for both components and distribution segments. Acquisitions accounted for 3% growth year-over-year. North American sales which represented 56% of our third quarter revenues were up 19% from a year ago due to continued strength in on-highway markets along with the impact of acquisitions in our distribution segments on record revenues in our parts business. International sales increased by 10% with growth in China and Europe partially offsetting weaker sales in Brazil. Compared to the prior quarters, sales were up 1%, stronger demand in North American heavy-duty truck market and the impact of acquisitions and the distribution business were partially offset by weaker demand in Brazilian and Chinese truck markets. And discussing performance in the different lanes of our income statement, I want to point out the change that we have made this quarter. Certain activities of a previously classified in selling and general and administrative expenses were mainly measured as cost of sales which allows for consistent treatment across the distribution channel. The revision had no impact on earnings before interest and taxes and cash flows or on the balance sheet and all composites I will discuss today include the adjusted gross margin and selling, general and administrative expenses. Gross margin was a record $1.3 billion in the quarter or 26.3% to sales, an increase of 140 basis points compared to the prior quarter and 100 basis point improvement compared to the prior year. Compared to last year’s stronger volumes, positive mix and more material costs were partially offset by higher warranty costs and unfavorable currency movements, compared to last quarter margins improved due to higher volume and lower warranty expense. Selling, admin and research and development costs increased by $90 million compared to the prior year. Acquisitions and our distribution segment accounted for $22 million of this increase. Compared to the prior quarter, selling, admin and research and development costs increased by $35 million, of which the acquisitions added $6 million. Joint venture income of $99million was up $8 million compared to a year ago, primarily due to increased earnings in China. Sequentially, the joint venture income decreased by $6 million primarily due to lower admin in the China joint ventures. Earnings before interest and tax were $684 million, 14% of sales for the quarter was compared to 12.6% of sales last year and 14.6% in the prior quarter. The third quarter margins represented 24% incremental EBIT margin compared to the prior year. Net earnings were $423 million, an increase of 19% from $355 million we reported a year ago, an earnings per share of $2.32 compared to $1.90 last year. The tax rate was 34.4% for the quarter and included a discrete tax expense of $19 million or $0.10 per share and the change in our projected full year operating rate from 28% to 29.5% related to the geographic mix of our earnings. Let’s move on now to the operating segments and discuss third quarter performance and the outlook for the full year. In the Engine segment, revenues were $2.8 billion, an increase of 13% from last year. North American on-highway revenues were up 22% driven by strong demand in truck and in bus markets. Industrial revenues were up 11% with growth driven by record sales in a commercial marine business. Mining engine revenues were down 10% compared to last year. Compared to the prior quarter, sales were up 3% sequentially we experienced stronger demand in the North American heavy duty truck market and the European construction markets which is partly related to Tier 4 final emission regulations. Segment EBIT was $340 million or 11.7% of sales, up from 10.9% last year. The EBIT margins improved as a result of stronger volumes, more material costs and higher joint venture income partially offset by an increase in the warranty expense. Sequentially EBIT margins increased by 40 basis points. For the full year, we are increasing our revenue under EBIT guidance for the engine segment. We now forecast that revenues will be up 7% to 9% driven by higher demand in the North American heavy-duty truck market. We continue to see weakness in most global off-highway markets and in the Brazilian truck market. We now expect the Brazilian truck market will be there in 25% to 30% for the full year. We are raising our EBIT projections for the full year to 11% to 11.5% of sales which compares to 10.4% that we reported last year. The component segment delivered record sales of $1.3 billion in the quarter, revenues were up 20% from last year and up 1% from last quarter. Compared to the prior year, the higher revenues were primarily driven by increased truck demand in North America along with increased revenues for our after-treatment systems in Europe and China related to the new Emission regulations in both regions. Sequentially, higher revenues were primarily driven by increased demand in the North American heavy duty truck market, partially offset by lower demand in European and Chinese truck markets. Segment EBIT was $173 million, 13.4% of sales, which is up 110 basis points from last year, primarily as a result of the stronger volumes and lower material costs. Compared to last quarter, EBIT margins decreased by 110 basis points due to increased research and development expense which we expect to decline sequentially in the fourth quarter. We are increasing our revenue and EBIT guidance for the component segment and now expect full year revenue growth of 15% to 17% as a result of the stronger demand in the North American heavy duty truck market. We are raising our EBIT projections for the full year to 13.5% to 14% which compares to our full year 2013 margin of 12.1%. In the power generation segment, third quarter sales were $754 million, up 6% from last year and essentially flat from the prior quarter. Year-over-year revenues declined in North America by 1% due to reduced military demand but increase in international markets, primarily China, Africa and in the Middle-East. Our international sales were up compared to the prior year, we remain more than 30% below the 2011 peak. EBIT margins were 8% in the quarter, up from 6.3% last year and flat with the second quarter. The positive impact of higher volumes and ongoing cross management led to the higher margins. Foreign currency negatively impacted power gen's EBIT margins by 90 basis points when compared to the third quarter of the last year. For 2014, we now expect sales to decline 3% to 5% compared to the prior year. The reduction in revenue guidance is primarily driven by continued weakness in international markets. As a result of the weaker demand, we are lowering EBIT projections for the full year to be between 6.8% and 7.2% of sales. As Tom discussed earlier, given the continued weakness in power generation markets, we are considering certain actions to reduce cost structure starting in the fourth quarter. The course of the action being considered could range from $15 million to $40 million. Both power generation and company EBIT guidance exclude any cost associated with these actions. We expect to realize the benefits of these actions beginning in 2015. For the Distribution segment, third quarter revenues were a record $1.3 billion, an increase of 47% compared to the prior year. Acquisitions accounted for 29% of the growth year-over-year. Organic growth of 8% was driven by stronger parts demand in North America oil and gas markets and pre-buy related to tier four final standards in Europe and in United States, EBIT was a record $141 million in the quarter as margins increased from 9.1% last year to 10.1% with improved operational performance and gains from acquisitions partially offset by lower joint venture income. EBIT dollars increased by 53% when compared to last year. For 2014, we continue to forecast revenue growth between 40% and 45% with 3% organic growth and the balance coming from acquisitions. We expect EBIT margins to be in the range of 9.25% to 9.75% of sales. Acquisitions remain on track to add $500 million of revenue to the Cummins in 2014 and earnings of at least $0.35 per share. As Tom mentioned, we may project total company revenues to be up 10% to 12% in 2014, driven primarily by strong on-highway demand in North America and from the impact of the distributor acquisitions. While we are increasing our expectations for revenue growth in North American on-highway markets, we continue to see weakness in power generation, mining and in some top markets, particularly in Brazil. As we mentioned in the last quarter, demand stabilized in India during second quarter but revenues were flat sequentially and we do not anticipate significant improvement in our end-markets this year. We are increasing EBIT guidance to 14% to 14.5% of sales as a result of the stronger performance in North American market which compares to 12.5% last year and represents a 20% incremental EBIT margin at the mid-point of the guidance. We are now projecting a tax rate to be 29.5% in 2014 excluding any discreet items, higher than our previous projection due to a change in geographic mix of earnings. And finally, with regard to cash flow, we produced $687 million of cash from operations in the third quarter. Year-to-date, cash flow from operations has totaled $1.4 billion of 10% of sales. We continue to expect operating cash flow to be in the range of 10% to 15% of sales for the full year. We will invest between $650 million and $750 million in capital expenditure for the full year which is below our previous projection and expect to spend between $475 million and $525 million on distributed acquisitions. During the third quarter, we increased our dividend by 25% and repurchased just over 1.2 million shares, leaving our total share repurchases to the end of September to over 4 million shares. The company has returned $975 million of cash to shareholders so far this year and we are well on track to return 50% of operating cash flow to shareholders as we have previously discussed. And as is a practice, we will provide guidance for 2015 during our fourth quarter earnings release. And now let me turn it back over to Mark.

[Mark Smith:]

Thanks, Pat. Okay, Denise, I think we are ready now to move to the Q&A section.

[Operator:]

[Operator Instructions] our first question comes from Andrew Kaplowitz with Barclays. Please proceed, sir.

[Andrew Kaplowitz:]

Good morning, guys. Nice quarter.

[Mark Smith:]

Hi Andy, thanks.

[Andrew Kaplowitz:]

Tom, you can give us a little more color on how to think about China as we go into 2015 for you guys? You have continued to build out your light duty engines, but you also potentially have a significant build-out here with your new ISG engine with your JV partner in China. So can you talk about what your initial experience has been with your new heavy duty engine, and how should we think about Cummins’ growth relative to the market as we go into ’15 in China?

[Tom Linebarger:]

Broadly speaking, I think we’ll still see secular growth. We see light-duty products continuing to expand, emissions related content continue to expand as we move adoption rates up. They have moved up pretty steadily this year, and I think they will continue to move up next year, and then as you mentioned our heavy-duty engine is really just getting off the ground with our launch. The engine has been successful, we have got good feedback on it so far. We launched it, it’s a first new platform for Cummins, so we definitely were measured in our launch. We were careful with it, we kept production levels at moderate pace, we've been tracking all the engines, so we do have a good feel for how it's going and we are happy with where we are and we will be able to ramp up production and market position next year, so all should contributed to secular demand. What we don't know, Andy, is how good the market is going to be. I think there's a lot of uncertainty still about China. I mentioned in our earlier calls that the truck market has been kind of fits and starts. It actually was strong than we expected in the first half, and then a little bit weaker than we expected in second half. Although we knew second was going to be worse than first, there was more up and down than we expected and we just don't know what to expect next year in that regard. So, we are feeling good about growth next year given the secular growth, but what we don't know is how much headwind or tailwind we are going to get from the market.

[Andrew Kaplowitz:]

Okay, Tom, that's helpful and then I know you get this question a lot because I get it a lot, too. But it has been pretty topical lately, and that's the vertical integration threat. Many investors seem to think that your customers are being more aggressive here regarding vertical integration. You mentioned the 37% share here for the year here in heavy duty, and obviously very strong share in medium duty. So maybe you can talk about that as we go forward here, because this has been something that has been out there for a very long time and you've been able to maintain share. But how should we think about it from here?

[Tom Linebarger:]

I will say a few things, and I’ll let Rich to add because he is pretty actively involved with discussions. First of all, it’s the first time I have ever heard that question about integration. It’s definitely not as you know. It’s an ongoing part of our business, and I think really it has been since the beginning, certainly since we left the shores of the U.S. back in the 70s, in a serious way, this has been part of our business. We regularly take vertically integrated manufacturers and add our engines to their mix, so we kind of whatever you want to say, reverse disintegration or disintegrate them, and that's what we’re, that’s our business. Everyone has an engine already, and every vehicle that they're doing. We are oftentimes replacing their engine with ours and then vice versa. These are integrated manufacturers, most of them and so they have the opportunity at times to integrate themselves. And I think that's an ongoing process. The good news for us is that we have our full engine range, we have a global engine range, and we have good relationships with the best truck manufacturers in the world, which means if they are thinking about using an engine anywhere in the world, we are on the page for them to talk to, and as long as we continue to provide capable products, products that they think will help them sell more trucks, we will be able to keep sharing in these big manufacturers somewhere in the world and big markets. If we are not that competitive from a product performance point of view or cost point of view, then of course we will be unable to the same competitive dynamics that have been true for ever. Rich talks to all these guys as do I, he has been talking to them more recently. Rich, you should talk may be about what conversations you are having with people.

[Rich Freeland:]

Yes, just a couple of things in North America, I think was part of your question, but just to follow up what Tom said, fortunately every customer we sell to produces their own engines, and that's not new that has been the case for the last twenty years. So if you look just at the heavy duty truck market and just an example to what Tom said, if you go back three years ago, we weren’t selling to Navistar, we are now, so things move both ways in this space. We still see ourselves kind of we have said in that 35% to 40% range, we remain there, I think we’re at 37% for the year and projecting that to go-forward. In our penetration with all of the vertically integrated, we are about right what we thought it would be, and it hasn’t changed a lot through the year. I’d say, if anything, we’re a little higher than Navistar than we thought, so that peace is not new. I think the question in the medium duty space, probably just to address that, because I am sure some of you have the question with the recent Daimler announcement. So just a couple reminders on the medium duty-truck market, it's an important one to us, the market is up 9% we are up 15% this year, and that's been with our share gains, we have gone from 63 to 73, and that’s really been on the heels of – we have got a terrific engine in that space and people are moving to that engine. As you know Daimler has announced, they will be introducing a mid-range engine beginning in 2016 with the family of engines in 2016, Daimler is a terrific customer and partner globally, not just in North America, but globally, and of course we prefer they have not done that if we’re honest. What they have done, and I think the impact will be, I think short-term pretty moderate, and it will begin to be introduced in 2016 with an imported engine, so not much impact 2015 and 2016. The question is longer term the impact is naturally determined by the engine. This is a truly and remarkable we have is that the customers will decide which engine they call and this is kind of how we do. We have got a terrific engines in this space and that's why we have the 73% market share, so with the durable engine really a bulk of engine that we have had, the customers thought it’s a most reliable (inaudible) and it has been designed and optimize for this North American market, so it is in the space. So time will tell, I think for the next couple of years, not much impact, we are going to continue to improve that engine and we will be working with Daimler in that pace.

[Andrew Kaplowitz:]

Thanks guys, I appreciate it.

[Operator:]

Our next question comes from Jamie Cook with Credit Suisse. Please proceed.

[Unidentified Analyst:]

It’s Andrew on for Jamie.

[Rich Freeland:]

Hi, Jamie is on the other call, ah? That's how I noticed, okay?

[Unidentified Analyst:]

A little busy today but I am filling in for her so I have got some good questions for you. So I wanted if you could expand more on we have said on PowerGen and I think you have mentioned international market increase, which is pretty encouraging given your market share there, can you provide some more color and going forward what you are expecting for order book and any one country stand out in particular, and then I am surprised – I don’t know if you mentioned India, but more or less do you think you will see specifically were those restructuring efforts are going to take place?

[Rich Freeland:]

Let me start off here, Tom you can jump in here. So PowerGen revenues have stabilized in fact if you look back year over year, we’re seeing some improvement for the first time and you have seen profits stabilized, the start-up with rough Q1 and then we have been pretty stable through the back half of the year but what we haven’t seen is any growth yet and I will talk little bit about what is going on in the market in a second. The action we are taking is, though the revenues are not increasing we are going to take further actions to reduce the cost structure and so we were permitted improving the profitability at these levels with the scene is stabilized. So we will position well when we do, come back. I think globally, world markets are good and bad, we have talked about India being down, being down pretty significantly, North America market is up to take out the impact of the military business and Africa is one we have talked about, in fact actually the business is a fairly well in Africa up about 20%. Now, we are tied a little bit just kind of, the global economy (inaudible) and so we’re now projecting not a rapid growth in any one area, I think strongest would be the North America.

[Tom Linebarger:]

Just market wise, we had a couple of places up a little, Middle-East was up and that had been depressed and now it seems to be showing some strength, China was up little although again I don’t think there is sustained strength there. Latin America on the other hand what we have seen from the strength earlier is down, again it’s pretty anaemic around the world with regard to market. And again as Rich said we don’t know exactly which action we are going to take but what we have said in the earlier in the year is that we anticipate given how low power generation business was, we thought some of the markets would improve to some degree by this time or we start to see signs of improvement, we just haven’t seen that and so as we discussed then we said if revenues don’t improve will take further action and that’s what we’re considering that. We would have of course announced the actions we knew exactly what they were, we just don’t know yet. We are going to figure out ways to reduce the cost and we have been studying that all year. So we have got a good list of items that we’re looking at and we will finalize those this quarter and then we will let you guys know next quarter. So, the way I would read this is that we knew if things didn’t get better way to do something and things didn’t get better and we don’t see a sign right now or things are getting a lot better, so we are following to what we have said.

[Unidentified Analyst:]

Okay and then with those restructuring, with those efforts you are going to do in Q4, how do you see that, I know it is difficult to say at this one but do you see that trickling through and benefiting early next year, how quickly do you think the things will turn around there, given your efforts?

[Tom Linebarger:]

As you know, we had to go through the actions specifically to say that our anticipation of course in all of these things we would like to get costs down as quickly as possible and again all of these kind of actions, we have the first decide what we’re going to do and how we are going to do it and we have not done that, we have not decided what we are going to do and how we are going to do it. So when we to we will have a better set of plans. But from us in the past, we don’t mess it out. When it is time to reduce the cost, we will make good decisions, we will make the right ones for the business but we will make sure we will get the cost and we will get the benefits quickly.

[Unidentified Analyst:]

Alright, thanks guys.

[Operator:]

Our next question comes from Jerry Revich from Goldman Sachs. Please proceed.

[Jerry Revich:]

Gellman, your light-duty engine in the U.S. has made announcement with new sign a just a little while ago, can you just give us an update on when you expect additional new platform announcements to come out and also can you just touch on up highway side you alluded to in your prepared remarks that that's an area of opportunity with Tier 4 next year, I am wondering if you could flush that out on what additional platforms you are on heading into the next year and what sort of tailwind we should be thinking about if you can talk about it at least directionally?

[Rich Freeland:]

Okay, I will go ahead and jump and start with the light duty. So the one who is public now is, is in the pick up space which is Nissan and that will go into production mid-year, next year so that hasn’t changed what we told you last quarter. We do have several other light commercial vehicle customers that will go into production early next year who have not, elected not to make those announcements yet. So there will be further announcements late this year, early next year and we will begun to see some ramp up in light commercial vehicle space early 2015.

[Tom Linebarger:]

And working (inaudible) that we can’t, our policy base let our customer announce when they want to put their engine in and that's the right thing to do but it is frustrating to us obviously that we can’t give you more visibility when we would like to do that. So I reckon that is frustrating. Mark, why don’t talk a little bit about that, that Tier 4.

[Mark Smith:]

In the U.S., Jerry, Tier 4 final regulations are going to impact oil and gas business, rail has particularly you have seen orders in passenger rail business and also (inaudible) high horsepower genset all certified and I know we were the first to be certified in those markets, I don’t know the current status, orders at this time but we feel really well positioned. It is not just about being certified of course but having those final solutions in the hands of the customers, so they can trial and just feel comfortable with them, so we see some momentum going into next year. We can’t say exactly what those end market conditions are going to be but we will definitely deal with some systems here in the fourth quarter and you should expect, we will be talking all three of those segments in the next year.

[Tom Linebarger:]

And to the Mark’s point, Jerry we have problems with quantifying the impact for next year, in the market, they are not that consistent they are pretty volatile. As we talked about oil and gas, we saw some good movement this year and then now oil prices are weakening so we don’t know what impact that is going to have. On the rail side, we have seen a lot of positive increase we have got some business and passenger rail and that is kind of new to us and we got the Hedhog engine coming out. That’s another benefits to the rail side. We really haven’t had an engine big enough really in the main part of the rail business. We have a lot of good stuff coming our way, we are still pretty small though, I mean just to call like it is we are still small and growing, so what the overall impact is going to be, we will see, the biggest positive impact will be in the Genset side if we see market improvement in North America, that will be the biggest one, because that is the biggest volume but we just don’t know whether it is going to.

[Mark Smith:]

Jerry, I just had one thing, in the Tier 4 space we feel really good about technology we have got there. We have been—this is technology we have had in place in automotive markets for multiple years, so we are – we feel good. We are ready, we are on time there will be no delays and we have tested this technology and we know it’s durable and reliable. When we go through this technology changes there is winners and losers and we feel really good about where we stand in the technology.

[Jerry Revich:]

Okay and lastly I know in PowerGen you are still working through the restructuring fees, so I am wondering if you just talk about the existing actions you have in place which is just the production transition of low horsepower units to India where are you now process, what is the margin tailwind as you complete that transition and any other cost saving measures which you should be thinking about outside of the restructuring program?

[Mark Smith:]

There are couple of things Jerry. Generally we provide an initiative to grow our how our business and so we have been naturally ramping production up low horsepower using the (inaudible) from anywhere else, would just be growing in (inaudible) and they are going into multiple markets, we are seeing good growth this quarter and after occurrence some of the other emerging economies. So it wasn’t really a restructuring our low horsepower more of a leveraging our India base and growing where we did take actions and we completed those actions (inaudible) particularly around alternating business so we were moving some production out of Germany and we did that and we completed everything that we said we would do basically at the end of the second quarter and so that’s why you saw through a combination of cost reduction activity that what we have been able to get margins without much revenue growth, we have seen basically every quarter this year, our gross margin essentially been higher to year to date sales are down. So we did all that, but the problem is of course we are still lacking that momentum and revenue we are still not entirely comfortable at 8% margins.

[Tom Linebarger:]

Jerry just a few some numbers that Mark just said. If you look at PowerGen margin, on a year-to-date basis, they have improved 18.1% to 18.7% and that's on the lower sales and that's almost with 1% headwinds from the British pound from currency. So it’s not just that the things we have been working incredibly hard and we see it coming through those margins, we just need the volumes that can (inaudible) much more obviously as you go into the future.

[Jerry Revich:]

Thank you very much.

[Operator:]

Our next question comes from Rob Wertheimer with Vertical Research. Please proceed.

[Rob Wertheimer:]

Good morning everybody.

[Tom Linebarger:]

Hi, Rob.

[Rob Wertheimer:]

Two quick questions, one just out of curiosity on marine and commercial in oil and gas, it didn’t seeing the strength I mean there is obviously a lot of structural trends there but obviously it has been a little weak lately and I think related party called out (inaudible) weakness to offshore rigs, is that strength continuing if you add any cancellation to there and fracking or is there a some sort of I don't really know the cycle there whether there is a big catch up in these to happen regardless of overall for CapEx.

[Thomas Linebarger:]

To this point, just a couple of numbers just to illustrate how we look at the market. But inflationary market in fact will be up 20% throughout this year. So it's been a nice steady growing marketing that we have had here and we are tied to some of the offshore work that's going on so that's a headwind to see what's going on potentially in the short term going on price. Our oil and gas are tracking business is up pretty significantly almost 70% from some pretty low numbers quite frankly. So we had not seen any I don't have any details to give you on what's going on with oil price and some of the stuff you read on tracking. That's held in there for us so far but it's just up, we are paying attention to right now.

[Patrick Ward:]

And one of the things that we have been seeing, we had a big ramp in tracking engines. We have the right engine for the right size and they are huge built out and then it kind of completely dead when people kind of done with that build out and things slowed down. Now what we are mostly seeing is replacements. When we talk to customers and ask them what they are doing, they are not really adding a bunch of tracking units. What they are doing is replacing engine that they have used. And again that’s not only it but in the conversations with customers that's what we are hearing from them. They are moving them around and they are using up the engine and they want to replace the engines and their tracking unit. So I don't think there is a lot of growth in tracking sites. I think they are just using them and then they need replacement engines. And so what's going to happen is as a result of any changes in oil price is not just clear to me there. But I do think there is a steady demand for replacement because though the patter we’re using up.

[Thomas Linebarger:]

The other thing I would add, the commercial learning is much more of a broad base story we’ve seen growth in China, in West Africa not just the offshore piece and it has in fact come out a largest fewer engine end market that’s outside of the power generation business. Very strong, we don't see any kind of big change in demand looking forward oil and gas obviously for rules, it's relatively small and bearing to the U.S. at this point in time.

[Patrick Ward:]

Thinking about the company overall, the market that we are biggest in mining and power gen are still very weak. And the markets are not improving marine, we talked about oil and gas and rail are relatively small and growing. So definitely our high horse power business step back and look at the company it's still way lower than it was previously so we have a lot of opportunities for growth here when markets turn around.

[Unidentified Analyst:]

That's all very, very helpful. Thank you. One quick one I don’t know if you all answered or not obviously the class 8 North America share bounces up and down and maybe you lose some of the OEM in gain and maybe there is underlying poll for your brand one way or the other, a little bit curious as to those as you lose little bit share structuring one OEM are you able to see into 2015 at this point I think you are kind of probably booked out for 2014, are you able to see into 2015 if you are holding share and probably want the answer and I am just curious if they raise production this year, if you can sort of see if that 37 hold or whether you start a little lower run rate. Thanks.

[Patrick Ward:]

So we will wait till December to give that guidance but there is nothing fundamentally changing as we look forward on the next standpoint. So one thing that we have – it's minor but one we counted on was on the natural gas business. So we have 100% in natural gas and we actually we thought that would be a big play by now but it's not. We are more conservative than most. We thought that it would be 2% to 3% share by now and it's going to be closer to 1% share. So that is low kind of appeal when we have is win that happens which we don't see a big change in 2015. But when that market comes which will be the will, that will be some upside for us on the market share.

[Unidentified Analyst:]

Thank you.

[Operator:]

Our next question comes from Steven Fisher from UBS. Please proceed.

[Steven Fisher:]

Hi good morning. I know it's too soon for 2015 guidance but based on the trends you are seeing now, if you had to rank the pace of maybe your international businesses over the next year or so from strongest to weakness, would it still be China growing the best and then India, Europe, Mexico and South America, how would you think about that ranking?

[Thomas Linebarger:]

It's really difficult to say I mean I am not trying to be coy at all, it's really difficult to say. You heard some of our remarks about the different regions. In India you got a new government coming and a lot of positive sentiments going around. Some numbers are moving too. We are seeing some improvements in some numbers. We are not seeing yet it that translating the demand in our markets yet but there is a very positive story there, you just don't know what's that’s going to result in. China I think it's very uncertain also. We just don't know whether what trends are going to do. We don't think China is going to boom. Nobody thinks that. But whether or not number of – our market is still significantly down from where they were even all the way back to 2011. So you could see even among relatively moderate Chinese market, if the infrastructure start to grow at all we could see significant improvement and of course there has been elections in Brazil. I just think there is just great too much uncertainty to rank in terms of upside or opportunity though I would love the market to settle down, I just don't think we have the visibility to do it.

[Steven Fisher:]

Okay. That's fair. And I think you said warranty costs are down sequentially is that right and I think last quarter you said the elevated accrual would kind of remain at that level for some time. Just curious what's developed there?

[Rich Freeland:]

Yes. We are really right where we thought we would be. So we what you do get is some quarter to quarter variation – if there is a big population out there, things get adjusted. So we took the rates up in Q3 and we were kind of saying in the full year the second half will look a little closer to Q2. Longer terms those rates are coming down. And so the effects are in place and we just demonstrate that overtime but we look back the back half of 2015, those rates are coming down. Pat you want to.

[Pat Ward:]

So yes, as you said in the last call, we expect it to be somewhat in the range of 2.6% of sales. We have not changed from that. It look into prospects to last year 2.3%. The biggest headwind is obviously the engine business. If you look at engine business, the fourth quarter of this year to the fourth quarter of last year as a percentage of sales increased by just 1.2%. And the EBIT margins also improved by 80 basis points. So we are doing a terrific job of overcoming that headwind and as Rich said, everyone is working very hard, I think we are pleased with some of the progress we are seeing and we enter next year, specially second half of next year, I think we really start to see some improvements in these warranty rates from the coming levels.

[Steven Fisher:]

Great. Thank you.

[Operator:]

Our next question comes from Ann Duignan from JPMorgan. Please proceed.

[Ann Duignan:]

Hi good morning guys.

[Tom Linebarger:]

Hi Ann.

[Ann Duignan:]

Most of my questions have been answered. But on the distribution side you kept your incremental revenues from the acquisitions as they were, but you raised the EPS guidance can you just talk a little bit about what's happening there and what you are seeing and what's better than you had anticipated?

[Pat Ward:]

Yes. Basically it's down to the gains on acquisition so the purchase account, the businesses that we are acquiring in the value of the 50% that we already yield is getting actually written up a little more than we had anticipated.

[Tom Linebarger:]

I mean the large story as you know Ann is, we are at a little bit ahead. So we have got seven acquisitions planned for this year and our original plan was six. And so with that we have just got ahead a little bit and that's great. In addition to that, we – the integration has gone a little better than we expected in U.S. market been a little bit better than we expected. So that's kind of if you want to say the economic and execution side and then there is little bit annoys around the purchase accounting and what gets written off, what kind of cost we have on the other side, those numbers have been fluctuating up and down but as I mentioned before those will get flushed through and then we will be left with the revenues and the profit dollars or the acquisition which again are ahead of what we anticipated and then we will do it really well.

[Pat Ward:]

I think if Ann if you step back and look at the performance of the segment without acquisition and look at same store business, same store margins have improved by 1% compared to last year and again that's North American market, some oil and gas markets relative to where we’ve been so it's not just an acquisition story, I think the performance of the underlying business is also a little bit better from what we have anticipated maybe three months ago.

[Ann Duignan:]

Okay. That's great. Thank you for the color and I just wanted to follow-up on the diner question earlier. I know 2016 and beyond but I think (inaudible) engines in Q3, could you just remind us what percent of those were?

[Pat Ward:]

I don't know the number on top of my head. I know Mark can get it for you. It's a good question but we don't have the number in front of us, but Mark will have it and again one of the other thing Ann which was getting at it not only will start right away but it will – there will be a transition period of some time because it's going to have the engines one-by-one and what's more is that we will of course continue to compete for the business with them. One of the nice things about working with them are is they are very capable company that wants to sell trucks and systems and I think that's one of the reasons they like to work with Cummins and so they are – we still have opportunity to grow with them in north America in mid range and we will see how that plays out but we – and they are working closely with us. The thing I really appreciate about that is even as they made an announcement that of course we had preferred they would not make, made the decision they talked to us the whole time about it that they were open with us, they talked about what they are trying to do and why they were trying to do it and so I think the relationship remains good and open for us to grow with them. So now and later and we will take transition time to get there and we have a good opportunity to find ways to grow with them even in mid range.

[Tom Linebarger:]

And moving back to the number but it's roughly about half, maybe little less than half of that.

[Ann Duignan:]

Okay great. I appreciate that. I will take the rest offline. Okay.

[Tom Linebarger:]

Thanks.

[Operator:]

Our next question comes from Adam Uhlman with Cleveland Research. Please proceed.

[Adam Uhlman:]

Hi guys good morning.

[Tom Linebarger:]

Morning Adam.

[Adam Uhlman:]

I was wondering if you could talk a little bit more about what you are hearing from your heavy truck customers here in North America about their buying appetite for next year. There is a lot of cross currents out there in the market that fundamental aren’t pretty good but there is driver sort of seems to be holding things up. So maybe can you just talk about what you are hearing from your customers about their buying plans for next year?

[Tom Linebarger:]

Yes, I’ll give Adam but it remains pretty positive. Okay. So all the things we looked at and you looked at, used truck prices are high, I think the one thing we are worried about a little bit is the driver shortage and as it happened in other cycles that appears to be taken care of itself to the extent that folks have ways of addressing quite frankly we see the pay for drivers going up through the cycles one of the ways that's done. Folks are liking the fuel economy they are getting with the trucks they are getting now as they are replacing and looking at the maintenance cost. And where we are right now even though the numbers are up higher, we are really at the replacement level. So folks are not expanding fleet at this standpoint for the most part. If you think of 260 market, that’s pretty close to a long term replacement. So we have got old population out there and people are replacing but we don't have a – it doesn't appear we have kind of overheated, where it's growing here. So the sentiment we just had ATA sentiment is very positive. I mean rates are going up, they are making money. The truck fleets are making money. They are trying to replace their fleets get a newer fleet. And so it's generally positive and I would say the one thing it was seemed to be a little bit of drag on the shortage, the more people I talked to are finding ways to get pass that.

[Adam Uhlman:]

Got you. Thank you. And then Pat just a couple of detailed question. Would you expect the tax rate next year to go up above this 29.5% we’re going to do this year because of the distributor acquisition and then was there any impact to earnings from currency?

[Pat Ward:]

On the tax rate, I will tell you in general, we don't have – we are still looking for plan in the next year. So it's very premature for me to give you a number at this point. On the currency, currency actually helps save much more when we look at Q2 to Q3 it's like 20 million benefit in the top line. However given the strength of the pound, bottom line ended up maybe being $6 million or $8 million negative year-over-year and that really had more than anybody else. But as significant as what you would see in previous quarter.

[Adam Uhlman:]

Great. Thank you.

[Operator:]

At this time we have no further time for questions. I will now send the call back over to management for closing remarks. Please proceed.

[Tom Linebarger:]

Okay. Thank you very much for your time today and I will be available for questions later. Thank you.

[Operator:]

This concludes today's conference. You may now disconnect. Have a great day everyone.