Cummins Inc.
Q3 2015 Earnings Call Transcript

Published: 28 Oct 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the Cummins Inc. Q3 2015 earnings release. 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, today's conference is being recorded. I would now like to introduce your host for today's conference, Mr. Mark Smith, Vice President of Investor Relations. Sir, please begin.

[Mark Smith:]

Thank you. Good morning, everyone and welcome to our teleconference today to discuss Cummins' results for the third quarter of 2015. 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 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 any subsequently filed quarterly reports on Form 10-Q. During the course of this call, we will be discussing certain non-GAAP financial measures and we refer you to our website for the reconciliation of those measures to GAAP financials. Our press release with a copy of the financial statements and a copy of today's webcast presentation are available at our website at cummins.com under the heading of Investors and Media. Now, I will turn it over to our Chairman and CEO, Tom Linebarger.

[Tom Linebarger:]

Thank you, Mark. Good morning. I will start with a summary of our third quarter results and the actions we are taking to respond to very weak demand in a number of important markets. I will also provide an update on our outlook for the full year. Pat will then take you through more details of our third quarter financial performance and our forecast for the rest of the year. Revenues and earnings in the third quarter declined from a year ago as a result of very weak demand in global off-highway and power generation markets and a continued slowdown in Brazil and China. Although we anticipate lower demand in these markets, orders have fallen further than expected, causing disappointing results for the company in the third quarter and a lower outlook for the full year. We have already taken a number of actions to reduce cost across the company, especially in the power generation business. However with further weakening in most of our end markets and no clear signs of improvement in the near-term, we are now implementing additional restructuring and cost reduction actions. First, we will reduce our professional headcount by approximately 2,000 people, with the majority of these reductions to be completed by the end of year. We expect these reductions will reduce cost by between $160 million and $200 million on an annual basis. In the fourth quarter of this year, we will record costs of between $70 million and 90 million associated with this action. Second, we are reviewing our manufacturing capacity in each business and region on a -by-facility basis and we will evaluate if restructuring actions are required in any of our plants. We expect to complete this evaluation by the end of the fourth quarter and will take actions as needed. Revenues for the third quarter were $4.6 billion, a decrease of 6% compared to the third quarter of 2014 with currency negatively impacting sales by 4%. Third quarter EBIT was $577 million or 12.5% of sales, compared to $684 million or 14% in the same quarter last year. Margins in the quarter were negatively impacted by reduced volumes, a lower mix of high horsepower engines, currency and pricing. Theses impacts were partially offset by improvements in material cost and supplier pricing, reductions in warranty costs and distributor acquisitions. Engine business revenues decreased by 10% year-over-year with very weak demand in global off-highway and power generation markets resulting in the lowest quarterly shipments of high horsepower engines since the third quarter of 2009. Production in the truck market of Brazil is the lowest since 2004 and the industry sales in most end markets in China are at multiyear lows. Demand in these markets will inevitably recover, but in the near-term conditions remain very challenging. EBIT of 10% of sales was down from 11.7% a year ago due to lower volumes and weaker mix which offset the benefit from material cost and improved warranty costs. As a result of a lot of focused work across the company, warranty cost in the third quarter were well below the levels in the first half of this year and lower than third quarter last year. This was true both for the engine business and for the company as a whole. Warranty cost for the company were 2% in the third quarter, down from 2.6% in the second quarter and 2.4% last year. Revenues in our components segment decreased 4% year-over-year with a negative impact of currency, pricing and very weak demand in Brazil offsetting volume growth in North America and China. Revenues in China grew 19% despite a 24% decline in the truck market in the third quarter as we continue to capitalize on the new NS4 emission regulations. EBIT of $156 million or 12.6% declined from 13.4% last year as a result of lower volumes in our turbo business and the negative impact of currency and results in our filtration business. Distribution revenues increased 20% compared to the second quarter of 2014 with acquisitions adding 27% and currency negatively impacting sales by 8%. EBIT for the quarter was 7.9%, down from 10.1% a year ago. EBIT percent declined due to currency, primarily the appreciation of the U.S. dollar against the Australian and Canadian dollars and the dilutive effect of acquiring businesses previously held as joint ventures. Excluding the impact of currency and acquisitions, operating margins in our distribution business improved year-over-year. We completed three distributor acquisitions in North America in the third quarter as planned. Our forecast for the positive impact of acquisitions is unchanged from three months ago. We expect to add approximately $600 million to company revenues this year in addition to the more than $460 million added in 2014, exceeding the $1 billion in revenues we projected for 2015 at our last Analyst Day. We currently expect to add $0.20 to our earnings per share this year on top of the $0.43 added in 2014 for a total of $0.63, also ahead of our 2013 projections of $0.50 per share. In the power generation business, revenues decreased 13% year-over-year with lower sales in most major markets except the Middle East and India. The decline reflects very challenging conditions in our markets as a result of weaker investment in infrastructure in emerging markets and declining capital spending by data center operators in North America. EBIT declined from 8% last year to 6.4%. The negative impact of lower volumes and pricing more than offset 100 basis point improvement from cost reduction actions. Now I will comment some of our key markets, starting with North America. Our revenues in North America grew 4% in the third quarter due in part to the positive impact of the distributor acquisitions. Shipments to the North American heavy-duty truck market exceeded 24,000 units in the third quarter, a decrease of 9% from the third quarter last year. Our market share to-date is approximately 34%. Based on current projections from our OEM customers, we expect our full-year market share to be in the range of 33% to 34%, below our prior projection of 34% to 35%. We expect the full-year market size to be approximately 286,000 units, up 7% from 2014, but down 4,000 units from our prior forecast. In the medium duty truck market, we delivered more than 22,000 engines in the third quarter, up 10% from last year. We currently project that market will be flat for the year, lower than our previous forecast of growth of 3%. Our forecast for market share is now 78% for the year, up from 72% last year and higher than our previous forecast of 76%. Shipments to Chrysler increased by 6% in the third quarter and we forecast full-year shipments to increase 3% compared to 2014, up slightly from our previous forecast of up 2%. Our engine shipments to the North American construction market decreased by 35% compared to the third quarter last year. This decline is partly explained by the pre-buy in 2014, ahead of the Tier 4 final emissions regulations and partly by weaker demand due to economic conditions. Power generation revenues declined by 12% in North America in the third quarter, due primarily to lower sales to data center customers. We are winning new orders from data center customers in Europe and Asia, but the rate of investment in North America has slowed. Cummins International revenues declined by 18% year-over-year due to very challenging market conditions and the negative impact of an appreciating U.S. dollar. Third quarter revenues in China including joint ventures were $775 million, a decrease of 6% year-over-year. Very weak demand across our key end markets more than offset market share gains and growth from new products. Industry demand for heavy and medium duty trucks in China declined by 24% in the third quarter and is down 29% year-to-date as the industrial economy continues to slow. We are maintaining our full-year forecast for the truck market to decline 30%. Our third quarter engine shipments were flat year-over-year. In very challenging market conditions, we increased our market share by 550 basis points year-over-year to more than 16% as shipments of our new heavy duty ISG engine to Foton increased and our market share with Dongfeng improved. We expect our market share to increase again in the fourth quarter to 17%. Shipments of our light-duty engines in China grew 2% in the third quarter and are up 21% year-to-date in a market that's down 9%. We gained penetration to Foton and other Chinese OEMs displacing local competitor engines. Our light-duty market share has increased 160 basis points to over 6% so far this year. Our power generation revenues declined by 32% compared to a strong quarter last year and are down 3% year-to-date due to lower infrastructure investment and a low rate of growth in electricity consumption, consistent with a weaker economy. Demand for construction equipment remains very depressed in China due to the slowdown in real estate development and infrastructure spending. Industry demand for excavators in China declined 31% in the third quarter compared to very weak numbers last year and is down 40% year-to-date with no clear sign of improvement. Our construction revenues declined by 21% in the third quarter. Full year revenues in China across all segments including joint ventures are now expected to be flat for the year, down from our previous projection of 6% growth due to weaker market demand in power generation, light-duty truck and construction markets. We continue to gain market share in the world's largest truck market, despite increasing competition and a weak market. And with more emission changes ahead, we are well-positioned to continue to outperform our end markets here. Third quarter revenues in India including joint ventures were $378 million, up 7% year-over-year due to growth in our truck and power generation businesses, partially offset by depreciation of the Rupee against the U.S. dollar. We now expect industry truck production to increase 27% for the full year, up from our prior forecast of 22% growth. Bharat Stage IV emission standards went into effect in the North of India in October and countrywide adoption is expected in April 2017 which should present opportunities for further growth for Cummins, particularly in our components business. Power generation revenues in India increased 12% in the third quarter as demand slowly improves from very weak levels last year. Government plans for further investment in infrastructure should stimulate stronger demand going forward. In India, we project total revenues including joint ventures to increase 12% for the full year, consistent with our previous forecast. Third quarter revenues in Brazil were $78 million, down 43% from the second quarter as the economy is in recession and the Real has depreciated by almost 60% against the U.S. dollar. Industry truck production declined 53% year-over-year in the third quarter and is down 47% year-to-date. Our engine shipments are down 43%. We are maintaining our full year projection for industry production of trucks to be 70,000 units, the lowest level since 2004 and decline of 50% from 2014. Revenues in our power generation and distribution businesses have declined less than the truck business but demand is down significantly in all markets. Global shipments of our high horsepower engines in the third quarter declined by 18% compared to a year ago and were the lowest since the third quarter of 2009, reflecting a severe and prolonged impact of slower growth in emerging economies and weaker commodity prices. Demand in our mining, oil and gas and commercial marine business are all impacted, with full year volumes in these markets expected to decline by between 20% and 40%. All this is exacerbated by lower demand in power generation markets. Given the weaker markets we are facing, we are lowering our forecast for company revenues and EBIT. We now expect full year sales to be flat to down 2% compared to our previous guidance of growth between 2% and 4%. Earnings before income tax is now expected to be in the range of 12.75% to 13%, also down from our previous projection of 13.5% to 14%. I want to close by saying that while this is no doubt a difficult time in our markets, we have been here before. We have a management team at Cummins that has proven capable of effectively managing through periods of weak demand. We will take the right actions to ensure the company emerges with higher profitability and stronger leadership positions in our major markets just as we have in the last three cycles. We look forward to our Analyst Day in November 10 in New York where we will share how we will deliver profitable growth even in this environment and generate strong returns for our shareholders. Thank you for your interest today and now I will 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. Fourth quarter revenues were $4.6 billion, a decrease of 6% from a year ago. The acquisitions of the North American distributors added 3% to revenues, but were more than offset by a 5% decline in organic sales in addition to a 4% reduction from unfavorable foreign currency movements. Sales in North America which represent 62% of our third quarter revenues increased by 4% from a year ago, primarily due to distributor acquisitions. International sales decreased by 18% compared to the prior year as a result of weak demand in global off-highway markets, more sales across all markets in Brazil and from the negative impact of foreign currency movements against the U.S. dollar. Gross margins were 26.1% of sales, down 20 basis points from a year ago. The benefits of lower material and warranty costs were offset by a combination of weaker volumes and unfavorable mix and more heavy-duty and high horsepower engine sales, negative foreign currency impacts and from pricing. Selling, admin and research and development costs of $727 million or 15.7% of sales were flat with the previous year in dollar terms, but increased by 80 basis points as a percent of sales. The increased cost associated with the distributor acquisitions were offset by the benefits from a stronger U.S. dollar. Joint venture income of $78 million decreased by $21 million compared to a year ago, primarily due to the acquisitions of North American distributors, previously held as joint ventures. Earnings from our joint ventures in China increased 12% year-over-year due to the market share gains made in on-highway markets. Earnings before interest and tax were $577 million or 12.5% of sales for the quarter compared to $684 million or 14% of sales last year. Earnings per share were $2.14, a decrease of 8% from the $2.32 reported in the same quarter last year and the tax rate was 30.1% for the quarter. This is a disappointing set of results after coming off a strong second quarter. In fact, July margins continued to improve over the second-quarter levels. However, demand weakened in August and has continued further into September. Let's now move on to the operating segments and further discuss third-quarter performance and the revised outlook for the full year. In the engine segment, revenues were $2.5 billion, a decrease of 10% from the same quarter last year. Off-highway revenues declined by 20%, primarily due to weak demand in global construction and marine markets. On-highway revenues declined by 5% as a result of weaker demand in Brazil and more global demand for heavy-duty trucks, partially offset by an increase in North American medium-duty truck and global bus revenues. Segment EBIT was $252 million or 10% of sales, down from 11.7% last year. Gross margins dropped as a result of the lower volumes and a less favorable product mix. Shipments of high horsepower engines declined 18% from the prior year and were the lowest volume since 2009, has contributed to the unfavorable product mix. Both selling, admin and research and development costs were lower than last year. They increased 100 basis points as a percent of sales due to the lower sales revenues. For the full year, we now expect revenue for the engine segment to decline 5%, as demand in off-highway markets continues to weaken and industry production in North America truck market slows. The reduction in volumes has also caused us to lower our outlook for segment profitability. Full year EBIT margins are now expected to be 10.75%, compared with 11.2% in 2014. For the distribution segment, third-quarter revenues were $1.6 billion, an increase of 20% compared to the prior year. Acquisitions completed in the last 12 months added 27% to segment revenues year over year, but were partially offset by foreign currency movements that negatively impacted sales by 8%. EBIT margins for the quarter declined in both dollars and as a percent of sales, from 10.1% a year ago to 7.9%, primarily due to the negative impacts of foreign currency movements, which lowered the EBIT margins by 220 basis points. An improvement in the margin of existing businesses increased segment margins by 100 basis points, but this was offset by the dilutive impact of acquisitions. For the full year of 2015, distribution revenue is now forecasted to grow 20% at the midpoint. This reduction reflects a larger-than-expected impact from foreign currency compared to the forecast from last quarter. We now expect EBIT margins to be in the range of 7%, compared to our previous guidance of 7% to 8% of sales. The components segment recorded revenues of $1.2 billion, a decline of 4% compared to the third quarter last year. Increased sales in North America and sales from the new NS4 compliant products in China were more than offset by negative impacts from foreign currency and to a lesser extent from pricing. Segment EBIT was $156 million or 12.6% of sales, a decline of 80 basis points from a year ago. Gross margins were relatively flat to last year, with improvements in material cost more than offsetting lower pricing, unfavorable mix and the negative impact of foreign currency. While selling, admin and research and development spending was flat in dollar terms year over year, they increased 60 basis points due to the lower revenues in the quarter. We now expect full-year revenues in 2015 to be up 1%, which is lower than our previous estimate of 4% to 8% growth. We have also lowered our EBIT projections for the full year to be in the range of 14.25%. This compares to a full-year 2014 margin of 13.4%. In the power generation segment, third-quarter revenues were $659 million, a decrease of 13%. Year-over-year, international revenues declined 14%, primarily in Europe, China and Russia, which were partially offset by growth in the Middle East, India and in Africa. Currency movements reduced sales by 3%. In North America, revenue declined 11%, due to lower demand for the large standby generators used in data centers, along with reduced military sales. EBIT margins were 6.4% in the quarter, down from 8% last year. Weak demand, the negative impact of currency, primarily the depreciation of the Euro against the U.S. dollar and lower pricing in the alternator business more than offset the benefit of cost reduction actions. For the full year, we now expect power gen revenues to be 5% lower than last year and for the EBIT margins to be 6.75% of sales. We are now projecting total company revenues to be flat to down 2% in 2015, due to the weakness in off-highway and power generation markets, along with a slowdown in demand in some markets in North America. We are maintaining our forecast for joint venture income to decline 15% from 2014, primarily due to the acquisition of distributors in North America previously held with joint ventures. We still expect joint venture revenues in China to grow this year as a result of the market share gains and new product sales in on-highway markets, which will partially offset the declines from the distributor acquisitions. We have now forecasted EBIT margins for the company to be in the range of 12.75% to 13% of sales, excluding costs associated with the restructuring and other cost-reduction actions. Compared to the second half of 2014, we now expect sales to be down around 7% and decremental margins to be around 25% for that period. The full-year tax rate of 29.5%, excluding discrete items, remains unchanged. And finally, cash flow generated from operations through the first nine months of the year was $1.1 billion. We continue to expect our operating cash flow to be in the range of 10% to 15% of sales for the full year, with stronger cash flow generation in the second half of the year than the first, as is typical for our business. Capital expenditures will now be between $650 million and $700 million, down from our previous guidance of $700 million to $800 million. During the third quarter, we announced 25% increase in our quarterly dividend and year-to-date we have returned $1.1 billion to shareholders, including the repurchase of five million shares. Our cash balance has declined by over $600 million so far this year, due to reinvestment in the business and higher returns to shareholders due to increased dividend payments and share repurchases. Despite strong results from our cost reduction efforts and material costs, supply chain and quality and the success of a number of new product launches, we are disappointed that the results were weaker than expected in the third quarter as demand in a number of important markets weakened further. We are addressing our cost structure in light of the weaker demand, as Tom highlighted and we are confident that we will announce some stronger performance as demand improves, just as we have done in prior cycles. Finally, I want to remind you of the upcoming Analyst Day on November 10 in New York. Now let me turn it back over to Mark.

[Mark Smith:]

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

[Operator:]

[Operator Instructions]. Our first question comes from the line of Steve Volkmann with Jefferies. Your line is now open. Please go ahead.

[Steve Volkmann:]

Hi. Good morning, guys.

[Tom Linebarger:]

Good morning, Steve.

[Pat Ward:]

Good morning, Steve.

[Steve Volkmann:]

So yes, I guess obviously the focus is kind of shifting quickly to 2016 and I am guessing you probably don't want to say too much about that yet, but I am wondering if you can give us your thinking about the various programs you may have that could continue to get traction above whatever we think the market is doing in 2016? And I guess I am thinking about the China NS4 stuff and are there other areas where you think there is a penetration story that can help us in 2016? Thanks.

[Tom Linebarger:]

Steve, as you mentioned, China is a good one and that, we think, is both an engine and components opportunity for the company. Hedgehog, our large-engine program, is another one. We were really just getting started with that, but it's another opportunity for us to grow both in large gen sets and in engines. India is an opportunity, as I mentioned, where emissions hurdles, the Bharat Stage IV hurdles are just the place where now you will start to see some aftertreatment and electronic engines go into the market. So that again gives us a chance. That's mostly a content and components opportunity because we already have quite a share in terms of the engines. Rich, anything I left out there that you would highlight?

[Rich Freeland:]

The only one I would add is, we will introduce the Nissan engine. That goes into production here in Q4 and it will begin ramping up in Q1 next year.

[Tom Linebarger:]

I guess the other more big story, I think, for Cummins is, we are really focused in the distribution segment on acquiring and really integrating the back office of the distributors. We really haven't done anything on sales or cost synergies in a significant way in the distributors. We will really be more active on those elements in 2016, which we think again provides both sales opportunities as we begin to focus our attention on national accounts and put more engineering attention on some of the more technical intensive projects and then also on cost synergies from consolidations and other opportunities inside the distribution system. So that, I think, also gives us an opportunity above the market.

[Steve Volkmann:]

Great, I appreciate that. And maybe, could I just get you to comment quickly on pricing? You called it out a couple of times in your prepared remarks, I think in components and alternators. But can you just give us a sense of your view of what's happening in pricing?

[Tom Linebarger:]

Yes. As we highlighted last time, in the power gen segment we have now seen some pricing competition come in, primarily as a result of low Euro. So there is just a number of competitors in the European area that are Euro based costs and so areas where Eurozone exporters can compete with us, we are seeing some price competition in the gen set. There is not a lot of excess capacity and those kind of things that may generate a more broad scale, but we are seeing competition there, which is why you saw the negative impact on pricing. And again, power gen because it is basically a retail sale, that's often an area where we can increase price, instead we are seeing backward prices on that. We are seeing pricing, as always, in our components areas. We have contractual kind of arrangements there which is normal, but we are more than offsetting those with material costs. So as you heard, material cost opportunities, we have been taking advantage of those all year. We think it's another big opportunity next year. So we are very focused on material costs to more than offset any kind of pricing.

[Steve Volkmann:]

I appreciate it. I will pass it on. Thanks.

[Tom Linebarger:]

Okay.

[Operator:]

Our next question comes from the line of Andy Casey with Wells Fargo Securities. Your line is now open.

[Andy Casey:]

Thanks a lot. Good morning, everybody.

[Tom Linebarger:]

Good morning, Andy.

[Andy Casey:]

I was wondering, a couple questions. First on the benefit from the restructuring headcount. I think that's the $160 million to $200 million you called out. Is that all to be realized in 2016? Or does some of that carry over into subsequent years?

[Tom Linebarger:]

It's an annualized figure that we are generating an annualized estimate and we are really, as you heard from our remarks, we are trying to get all of our work done this year. It won't all get done because in some jurisdictions, there is just some legal requirements and other things, so that won't work perfectly and so that will make it not perfect for our 2016 number. And as you guessed, there's a lot of other moving parts which will impact it, but think of it as an annualized figure based on an estimate of reducing all those people and we will have a very, very hard focus on doing those things as quickly as we can and getting them all done in the fourth quarter.

[Andy Casey:]

Okay. Thanks. And then I wanted to go back to Pat's comment about more of the short-term stuff that you saw during the quarter. I think the comment was faster demand drops as the quarter progressed. Could you give a little more color as to in what region and/or segments you saw that?

[Pat Ward:]

Yes. Andy, so as I said we had a really very good second quarter and we followed that off with an even better July. We did start to see a bit of a slowdown in August, mainly in the components and engine segments. That's not unusual. So having that slowdown in August is not the first time that's happened. What was surprising and disappointing was the slowdown continued into September, again primarily in those two segments. Power gen came off a little bit as we went through the quarter, but most of it was in those two that I just mentioned.

[Andy Casey:]

Okay. And then, Pat, just within the power gen side, it seems like that changed a little bit from your prior guidance. Is that another area where you just don't see any short-term reversal in the trend?

[Pat Ward:]

It's hard to see any immediate pickup in many of these industrial off-highway markets. Power gen has been down for a period of time just now across many regions and I would not anticipate any recovery in the short term in power gen.

[Tom Linebarger:]

Okay. The only part we are seeing a little bit of improvement in India, a little bit of improvement in Middle East, but we are not counting on any improvement going forward and a lot of the restructuring that we are talking about will again be aimed at the power gen area.

[Andy Casey:]

Okay. Thanks a lot, Pat and Rich.

[Tom Linebarger:]

Thanks, Andy.

[Operator:]

Our next question comes from the line of Ross Gilardi with Bank of America Merrill Lynch. Your line is now open.

[Ross Gilardi:]

Good morning. Thank you.

[Tom Linebarger:]

Hi. Ross.

[Ross Gilardi:]

Hi. Yes. I am just trying to understand the shortfall in components a little bit more and the cut to guidance. The revenue weakness seems to be more specifically in turbo and filtration, as opposed to emissions and what is driving that? And where specifically is the weakness geographically? And then, I had a follow-up to that.

[Tom Linebarger:]

Again, just going back to Andy's question. So we had a fall-off in the third quarter and we saw segments where we normally have some down days. They just took more down days. So construction in particular and truck, we just saw more down days than we had anticipated, unplanned down days. Those impacted components, for sure. And as you mentioned, the turbocharger and filtration business was hurt harder, more than the rest. Filtration was really a currency story. So they have more global aftermarket, which just turns into lower U.S. dollars because it's all over the world and we get lower U.S. dollars because of the currency. Turbochargers had the same impact as everybody else, plus China truck, where I mentioned the truck market is down. We are offsetting that with market share gains with our engines and components, but turbocharger already has a big market share across all engine suppliers. So while they got the benefit with Cummins engines, they got the decrease from the other engines. So they have had an offset compared to everybody else who just gained with Cummins' market-share gains.

[Ross Gilardi:]

Got it. Thank you. And then just on components like longer term, how should we think about just the resilience of profitability? Clearly, it's been one of your strongest businesses even through a lot of the softness we had seen in emerging markets perhaps until this quarter. But eventually, should we look for demand to just follow truck build lower with a lag over the next couple years? Or do you think this business can continue to grow and why?

[Tom Linebarger:]

Again, at a high level, the opportunity remains for the components business to get above market growth in those areas where emissions requirements are increasing. So we just talked about China, for example, where we are gaining market share and gaining more content because emissions hurdles are being implemented. India, we just mentioned as well. And then off-highway, we are still working through the globe on Tier 4. So we are a small way along. I think in markets like the U.S. market, where you are seeing both the emissions hurdles have largely been done, then you will see components business largely track with the end markets that we are supplying them to. So it's a mix story, but we definitely feel like there are significant secular opportunities in the components business to continue to grow above the market levels and to grow profitability. And again, in the components segment, like most of Cummins' businesses, the opportunity to stay ahead is that we have the lead in technology. If we lead in technology, we can sell our products for good margins and continue to grow them. If we fall behind in technology, that becomes more challenging and then we compete more on price. So that remains the same strategic formula for us in components as it does in engines and most of our end markets.

[Ross Gilardi:]

Got it. Thank you.

[Operator:]

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

[Jamie Cook:]

Hi. Good morning. I guess two questions. One, the weakness that you have seen, Tom, has been primarily in the emerging markets, off-highway, high horsepower type markets. But the concern from the market is, the market that's still doing pretty well for you that's driving components and engine, which is North America truck, is ready to roll. You have seen used truck prices weaken. We have heard about production cuts. We heard some of the customers drawing in their CapEx. So relative to where you were last quarter, how do you think about North America truck into 2016? And is that one of the reasons why you are contemplating additional restructuring relative to what you have already announced this quarter? And then, my second question sort of relates to capital allocation. In a lower growth environment, how do you think about buying back stock versus just building cash? Or the other side of it is, Tom, you have been a little more aggressive on the M&A front, I would say, relative to your predecessor. So given the success that you have had with North American distribution acquisitions, would you be more willing to look at acquisitions in a downturn? Thanks.

[Tom Linebarger:]

Okay. Jamie, that's some big ones. I am going to let Rich talk about North American truck because he is very close to it.

[Rich Freeland:]

Okay. So hi, Jamie. As you know, we took our guidance down by 4,000 units, so down just a bit. And like we said last quarter, production has been running higher than orders and that we needed a pretty healthy order board through Q3 and Q4 where eventually the production had to look closer to orders. And while the orders were solid and good, we are not at the rate, still didn't keep pace with production. So the backlog now is down to 137,000 units, which is from the peak of 190,000. So it's down a bit. It's not a weak backlog. In fact, it's higher than it was a year ago at this time, but the sentiment has clearly changed, some of the things you talked about. So, the way that plays out for Cummins is that when the backlog gets lower, not all the build slots are full in a given week or month or quarter. And so, we see some pretty near term reductions in requirements for engines. And we saw that in Q3 and, frankly, we see that continuing into Q4 and into 2016. And so it's evident now that retail sales and production will be down going forward. We are not calling out exactly what that is at this point. The freight actually is pretty good, but some of the indications we talked about, like truck prices, dealer inventories are up, cancellations are up a bit, there is a lot of moving pieces there. So that's exactly why we took the actions now that were taken, in anticipation of that, not declaring exactly where that will end up. What you will see is our plants are very flexible at adjusting to this. They were designed to flex quickly. So in weeks and months, not over quarters. So as production goes up or down, our whole system is set to flex and so we are already doing that in our production plants.

[Tom Linebarger:]

Thanks, Rich. And then, Pat, do you want to talk a little bit about stock buyback?

[Jamie Cook:]

Capital allocation

[Pat Ward:]

So you will recall, Jamie, that at the last Analyst Day we committed to return 50% of cash from operations to shareholders and we did that in 2014 and we feel we are going to exceed that in 2015. Now we have repurchased five million shares so far this year. As soon as the blackout ends this week, we will be back in the market to buy more stock at this price in Q4. So clearly in a environment that we have got, lower growth outlook at least in the short term, we have been looking to do some more there. On the mergers, acquisition type question, I think it's probably best to hold our remarks until we get to Analyst Day. We will have more to say on that subject, as well as the whole point about capital allocation over the next two or three years when we get to that point in the year.

[Tom Linebarger:]

If I can just add, Jamie, I think we increased our dividend after last quarter and we are in a tough period and we want to make sure our shareholders knew that we feel strong and sustainable through this period and we do. And we will increase stock buybacks, as Pat said. So just as we talked about before, 50% is our guideline, but we think today our cash flow remains strong and our opportunity to repurchase shares looks stronger. So we will be active and more active than we would have been in a different circumstance. And as Pat said, we have a lot to say about how we are going to grow in this environment and we will talk a lot about that and we will include capital allocation and M&A and all that in our discussion in November. So thanks for the question, though.

[Jamie Cook:]

Okay. Great. I will reserve the rest for November 10. Thanks.

[Operator:]

Our next question comes from the line of Ann Duignan with JPMorgan. Your line is now open.

[Ann Duignan:]

Well that was a fancy pronunciation.

[Tom Linebarger:]

You are French now, Ann.

[Ann Duignan:]

It's almost, Gaelic, Pat. Let's take a step back to components, if we can. I know you said that pressure on pricing was contractual and normal, but can you help us think about pricing going forward, then? Is this once you reach a certain volume with a customer, you give them X percent back? Or is it giving up lower input cost? If you could just give us a little bit more color there, because it was a little bit of a surprise that pricing was negative in components.

[Tom Linebarger:]

Yes. Ann, it's all those things and it's actually not a surprise in the sense that we always have done these contractual things. Again, the big difference in pricing now is we normally have offsets that make pricing for the company look neutral or positive and that's because you normally got markets, off-highway markets and power gen markets and parts that push up and then you have got your normal contractual things that push down and the whole thing adds up too fine. And in this case, you have got power gen dropped the other way, the off-highway markets are very challenged, so then just pricing shows up. But the answer to your question specifically about components is, some of the agreements are just contractual on time. Some are related to metal markets or other kinds of agreements related to back door prices. Some are related to introduction of cost reductions that we made and then we offer some to customers. So, it's a range of those things. It's not as standard as you would guess in our negotiations with customers. We like zero of those. So we are always negotiating for less or none and they are negotiating for more and we end up with some compromise in those agreements that we think adds up to good returns and profitability for us and that's how they are set up. So the reason though, you are seeing them in our variance analysis today is because they don't have the same offsets they would normally have.

[Ann Duignan:]

Okay. And would you expect that to persist going forward on the components side specifically?

[Tom Linebarger:]

It's going to be challenging in this environment because, as I mentioned, the markets that we are normally relying on to push prices through look like they are mostly not. We are not able to push prices through and again, power gen, they look challenging the other way. Again, the thing I would just say is that we are more than offsetting those with material costs. So the same environment exists for our suppliers and we are taking full advantage of that. And so, the margin enhancements that we are getting for material cost is more than offsetting the pricing hit. So volumes is what we are challenged by, as opposed to pricing versus cost.

[Ann Duignan:]

Okay. I appreciate the color. I think most of my other questions were answered. Thank you.

[Tom Linebarger:]

Thanks, Ann.

[Operator:]

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

[Joe O'Dea:]

Hi. Good morning. With the announced restructuring and outlook across power gen and some of the components challenges in emerging markets, could you just talk about and these markets have now been down for a while and so how you address that over the course of the quarter to come to the conclusion that is it going to go further down from here? Is it more an expectation of stabilization around a bottom, but not getting better for a while? Just how your view has developed there?

[Tom Linebarger:]

Yes. Joe, it's a complicated answer because each market is a little different, but let me just try to hit it at 10,000 feet. The answer is that we have set our plan not expecting a whole bunch of improvements in those markets, but they were starting to bottom, just as you suggest and if anything would be level or coming up. And in fact, what's happened is they have gone down further. And that's, I think, what maybe is the thing that says we haven't clearly bottomed in most of those markets. We thought we had and we have not and where the bottom is, we are not exactly sure, but it doesn't look like we have reached it. And there still looks like to be a general weakness in off-highway markets across the world and not a lot of instigators for improvements in those economies that would suggest infrastructure spending or commodity prices would start to come up. And then on the truck side, as we have also already said, we have seen further down days and other things that make us more concerned about next year than we were, say, three months ago or six months ago. So all those things combined together, they are not the same trend or whatever, but all of them came together to say to us, hey we are at a different business level globally than we anticipated being at this time and on a different trend.

[Joe O'Dea:]

Okay. And then on North America truck and as you see build coming down into the fourth quarter, could you just talk about any incremental pricing risk you see there, either related to the contractual side of things or whether it's additional pricing pressure that you are feeling, but how much risk we could see on the margin side moving into lower build rates?

[Rich Freeland:]

Joe, this is Rich. Nothing on the pricing side on the engine side. Again, we have long term contracts and those won't change going forward. But nothing on the engine side on pricing.

[Joe O'Dea:]

Okay, great. Thank you.

[Operator:]

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

[Jerry Revich:]

Hi. Good morning.

[Tom Linebarger:]

Hi, Jerry.

[Jerry Revich:]

You folks have focused on structurally improving margins with your restructuring actions in prior downturns. Can you just talk about how the biggest opportunities you see for Cummins on the other side of the manufacturing footprint adjustment? And just maybe touch on the broader high level framework that you folks are thinking about in sizing the business plan and the structural changes that we should look for.

[Tom Linebarger:]

Yes. It's a good question, Jerry. So as you said, just like the last downturns, we will take action that we think will put us in a position to emerge from this weakness stronger than competition and to be able to grow faster and raise profits, just as we have done the last three times. And so, we do have a framework on that. Our first step, as you see here, really is trying to bring our professional workforce down to what we think the business level and business trends look like for right now. The second thing you saw in our announcement is to look through our facilities to see if there are opportunities to do some kind of structuring that we think leads us to a better cost position over time. And as Rich was saying, we adjust our plants pretty quickly to demand, but at some point, opportunities get created, where you say I am now at a low enough level of supply here that I can potentially put these together or move this to another place where I can be in a better position cost wise and we will look for those opportunities, for sure. As I mentioned in our announcement, we are going to spend the next quarter looking at those because we want to make sure we understand them really well and we make the right structural calls from a long term performance point of view. So we will do that and those decisions will be made over this quarter. We are, as you would guess, very active on that project already and so there will be things along the way. But we will be done with that this quarter. And then, the last thing is that as we look through our new product introductions and programs, we have been for the last couple of years making sure that we are keeping our costs under control, but positioning ourselves in the key markets for when they return to gain share and gain margin in those markets. And so you see what we are doing in China today. So increasing, we are launching in markets which we think, when they return, will be large and profitable for Cummins. We will continue to push on our product portfolio in those areas so that we can indeed emerge stronger. So think of it in terms of products, facilities and cost structure and then overall overhead and the workforce for business levels. Those are the broad framework of what we will be looking at, just as we have before.

[Jerry Revich:]

Okay. And then from a shorter term standpoint, the guidance looks for 100 basis point improvement in engine and components margins 4Q versus 3Q. Can you just bridge for us the major building blocks? How much of it is adjusting the plants? It sounds like your lead times were low in 3Q. I guess how much of that margin expansion target do you feel like you already accomplished to start the quarter? Any color there would be helpful.

[Pat Ward:]

Yes. I think we have the Q4 derived guidance, if you back into the number, failed a bit in defense in both the components and the engine segments, which were the ones that fell off most in August and September. So we have been taking actions in the manufacturing plants to get their cost structure in line with demand for the fourth quarter. So I would expect their margins to improve, based on the actions we have taken so far and are taking right here as we speak. We also expect warranty average as being a good improvement as we have seen in the third quarter as they continue at these levels and probably got a little bit better, actually, in the energy segment with what we have seen in Q.

[Jerry Revich:]

Thank you.

[Operator:]

Our next question comes from the line of Nicole DeBlase with Morgan Stanley. Your line is now open.

[Nicole DeBlase:]

Yes. Good morning, guys. Thanks for taking my question.

[Tom Linebarger:]

Good morning, Nicole.

[Nicole DeBlase:]

So my question is around China market share and I guess it's more of a medium term question. So you guys have made a lot of progress there, I think you gained more share than we had expected. So I am curious, once we get to 2016 and even beyond that, how much market share do you think you can gain on a sustainable basis in China in the future?

[Tom Linebarger:]

On our last analyst conference, Nicole, we talked about this and we had hoped to be about where we are by the end of the period. So 2017 or 2018, we had hoped to be here. And I had said at that time, much to my leader in China's chagrin, that what I was really targeting long run was 25% share. So to me, that's Cummins' entitlement. If we could be at 25% share, I feel like that's being fully deployed with our two biggest partners and then also playing a role, albeit smaller, in the broader market and that's where I would like to get. Whether we can get there or not, we will see. We will talk a little bit about our plans in November, longer run, but clearly we are ahead of our plans in terms of market share so far and I think we do have more opportunity to grow with our partners. Remember, we are now in our light duty side 6% market share, in the light duty market, 6%. So we have room to grow and we are partnered with the largest light duty truck maker in China. And on the heavy duty side, we have made good progress, but we are still on the ramp up phase. We still have more to go there. We have introduced a new telematics system in there. We just started that work and with this telematics system now, Chinese customers for the first time can track fuel economy and performance of their drivers, as well as the reliability of their truck. And we visited a few of them. Rich and I visited a few of those end customers and needless to say, those trucking companies are very interested in keeping track of fuel economy, just like everybody else. And so, I think we have a lot of opportunity still there to grow.

[Nicole DeBlase:]

Okay. That's really helpful. Thanks, Tom. And then for my follow up, on Brazil. Brazil has been weak for some time and the volumes are getting pretty ridiculously low there. So I am just curious, do you think that it's possible that the Brazilian truck market is bottoming? Or do you see the potential for even more downside in 2016?

[Tom Linebarger:]

Boy, I wish I knew the answer to that. Rich, do you know the answer to that?

[Rich Freeland:]

Right now, we are assuming bottoming. So we are assuming no improvement at this point. And so we are down to pretty low numbers where we are right now. So it seems like not a lot of downside risk. But we are not counting on any improvement in 2016.

[Nicole DeBlase:]

Okay. That's helpful. Thanks. I will pass it on.

[Operator:]

Our next question comes from the line of Alex Potter with Piper Jaffray. Your line is now open.

[Alex Potter:]

Hi guys. I was wondering if you could comment a bit on market share trends in North America on-highway market. Obviously, you guys are inclined to hope for share gains, I guess, amongst certain OEMs. I am just wondering if you have any commentary there regarding, I guess, through the end of this year and then into next.

[Rich Freeland:]

Alex, this is Rich. It looks like we have fairly settled in at this 33%, 34% range. We have been there between and 33% and 35%, each of the last four quarters. And that's what we are projecting going forward. We get a little bit of some quarter-to-quarter things where sometimes the OEs build a little more of their own product in Q4 and so we have seen some historical, a little dip down in Q4 and then a bounce back in Q1. So we have assumed a little bit of that. But, again, it's a couple points lower than where we started the year forecast and so our share is a bit lower with PACCAR right now and our share is, in fact, higher than we planned at Navistar, but their overall share is down a bit. But again, with all those puts and takes, it seems like we have settled right at that 34% range.

[Tom Linebarger:]

And then medium duty, I think, Alex, you probably saw the numbers there, but medium duty, we have gained a little more share than we anticipated. Ford is not really back in the market yet. SO our market is stronger there and I think our view is our market share opportunity in medium duty is mostly about trying to hold share and, again, it's looking good so far. We will have more competition as the years move on, but we feel like we have got a pretty good say on advantage in the medium duty truck engine. So we are pushing hard to maintain share there and again, it's a very, very good position to start from.

[Mark Smith:]

We have probably got time for one last question.

[Operator:]

Our next question comes from the line of Ted Grace with Susquehanna. Your line is now open. Please go ahead.

[Ted Grace:]

Good morning, gentlemen. Thanks for squeezing me in.

[Tom Linebarger:]

Hi Ted.

[Ted Grace:]

Hi. I was just wondering, maybe to follow up on Jerry and Joe's line of questioning on the restructuring, could you maybe just walk through how to think about it, COGS versus SG&A? I know you talked about 2,000 professional jobs, but just trying to dimensionalize where those savings will accrue on the P&L? And then maybe to the degree you could walk through segments? It seems like maybe power gen and engines are the two that have maybe the most overcapacity. But can you just dimensionalize how we should think about where those savings will accrue?

[Pat Ward:]

Yes. Ted, this is Pat. Let me take a shot at that. It's a little bit early to give you too many specific details, but you are right. Most of it's going to be in power gen, back to the remarks that Rich touched upon earlier on. We have to do more work. So we are clearly well ahead with our planning. And the engine business is also deep into this. We talk about where those are going to land in terms of the P&L. We will be taking actions in our manufacturing plants to flex our operations there. So that was dropping costs of goods sold and help nudge, But most of what we are talking about here, when Tom was talking about the 2,000 professionals, they will primarily be in the SG&A side of the business.

[Ted Grace:]

But would it be more corporate or would it be more at the divisional level?

[Pat Ward:]

It's going to be across the board. So we are looking at corporate. Obviously, we are looking at power gen and the engine business. We are going everywhere on this. We are looking where we have got excess cost today and we are trying to deal with that, given the environment where we find ourselves in.

[Ted Grace:]

Okay. And then the last thing I will ask is, just as we think about today's news on the restructuring, would it be appropriate to think about this as Phase 1 of a multistep plan? Will that be dependent on the outcome? I am guessing the answer is yes, with what happens in 2016 and 2017, but in terms of today's announcement and the $160 million to $200 million of savings, would you say you expect that, at this point, to be the extent of the restructuring? Or just how would you frame that dynamic?

[Tom Linebarger:]

So here's the thing. As I mentioned it, we are trying to do these actions quickly because we think that's the best way to get our cost structure right and also the best way to manage our people to keep going and move forward and emerge stronger as we go. But as we mentioned, there really are two steps to this. The first step is this professional workforce reduction and the second thing is we will be looking through our facilities to say, are there structural opportunities for us in the manufacturing plants that we can take and things will come out of that. I don't exactly know how many things, but we have already identified a couple of things that look like big opportunities for us. So we just want to make sure we handle those right. Those are more complicated things to do. So we want to make sure we understand exactly what the biggest strategic opportunities for the company are to position us well. So we are going to take a little more time with that. But again, not that much more time. It will be really this quarter that we will be working on that. So again, rather than think of it as two or three or four, the professional action we are taking, we are going to do that very quickly. As quickly as we can get it done. And then the manufacturing thing will depend on which opportunities we see there. But again, expect us to get through that work this quarter and not stretch beyond that.

[Ted Grace:]

Okay. That was really helpful. Good luck this quarter and we look forward to the Analyst Day.

[Tom Linebarger:]

Thank you.

[Mark Smith:]

Thank you. Thank you, everybody. We will be available for your questions later. Thank you.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.