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Edited Transcript of CMI earnings conference call or presentation 30-Apr-19 2:00pm GMT

Q1 2019 Cummins Inc Earnings Call

COLUMBUS May 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Cummins Inc earnings conference call or presentation Tuesday, April 30, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James Hopkins

Cummins Inc. - Executive Director of IR

* Mark A. Smith

Cummins Inc. - CFO & VP

* N. Thomas Linebarger

Cummins Inc. - Chairman & CEO

* Richard J. Freeland

Cummins Inc. - President, COO & Director

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Conference Call Participants

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* Adam William Uhlman

Cleveland Research Company - Partner & Senior Research Analyst

* Ann P. Duignan

JP Morgan Chase & Co, Research Division - MD

* David Michael Raso

Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team

* Jamie Lyn Cook

Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst

* Jerry David Revich

Goldman Sachs Group Inc., Research Division - VP

* Joseph D. Vruwink

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate

* Robert Cameron Wertheimer

Melius Research LLC - Founding Partner, Director of Research & Research Analyst of Global Machinery

* Ross Paul Gilardi

BofA Merrill Lynch, Research Division - Director

* Steven Fisher

UBS Investment Bank, Research Division - Executive Director and Senior Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Q1 2019 Cummins Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. James Hopkins, Executive Director of Investor Relations. Sir, you may begin.

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James Hopkins, Cummins Inc. - Executive Director of IR [2]

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Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the first quarter of 2019. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Mark Smith; and our President and Chief Operating Officer, Rich Freeland. We will be available for your questions at the end of the teleconference.

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 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 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.

With that out of the way, we'll begin with our Chairman and CEO, Tom Linebarger.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [3]

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James, thank you. The introductions would be more boring without the British accent. Thank you.

Thank you, and good morning, everybody. I'll start with a summary of our first quarter results and finish with a discussion of our outlook for 2019. Mark will then take you through more details of both our first quarter financial performance and our forecast for the year.

Revenues for the first quarter of 2019 were $6 billion, an increase of 8% compared to the first quarter of 2018. EBITDA was a record $1 billion or 17.2% compared to $700 million or 12.6% a year ago. Lower campaign costs, higher volumes and positive pricing more than offset increased material costs and the impact of tariffs.

Engine business revenues improved by 8% in the first quarter compared to a year ago. Increased production and improved market share in North America truck markets, along with strong demand from global construction customers, drove most of the revenue growth. EBITDA margin for the quarter was 16.5% compared to 11.7% for the same period in 2018. Lower campaign costs, higher volumes, improved pricing and efficiencies in our manufacturing plants more than offset lower joint venture income and the negative impact of tariffs.

Sales for our Distribution segment grew by 8% year-over-year, driven by higher demand in North America across all lines of business. First quarter EBITDA was a record $171 million or 8.5% of sales compared to 6.6% in the first quarter of 2018. EBITDA margins benefited from higher volumes, improved operational performance in our North American service business and positive pricing.

First quarter revenues for the Components segment rose by 6%. Sales in North America increased 17%, driven by higher truck build rates, while revenues in international markets declined by 8% as a result of lower truck demand in India and China. EBITDA for the first quarter was a record $325 million or 17.5% compared to 12.9% in the same quarter a year ago. The increase in EBITDA was primarily due to higher volumes and lower campaign costs.

Investments in research and development increased by 21%, in line with our expectation as we prepare to launch NS VI and BS VI products in China and India over the next year. These important product launches will result in increased content in both regions along with opportunities to gain both Engine and Component market share.

Power Systems sales in the first quarter were flat year-over-year. Demand in industrial markets was up 1%, while sales of power generation products declined by 1%. Power generation sales increased 6% in North America, driven by continued strength in data center markets offset by a 7% decline in international markets. Foreign currency movements negatively impacted sales by 2%. EBITDA in the first quarter was 12.8% compared to 13.2% a year ago. Lower joint venture income in China and a higher proportion of [whole group] goods relative to aftermarket parts resulted in lower margins compared to a year ago.

In the Electrified Power business, EBITDA was a loss of $29 million in the first quarter, in line with our expectations as we invested in the development of new products for commercial launch beginning in the fourth quarter of this year.

Now I will comment on the performance in some of our key markets for the first quarter of 2019 starting with North America, and then I will cover some of our largest international markets.

Our first quarter revenues in North America grew 13% to a record $3.7 billion, driven by higher industry build rates of medium- and heavy-duty trucks, continued growth in the sales of construction equipment and sales of power generation equipment to data center customers.

Industry production of heavy-duty trucks grew 22% in the first quarter of 2019 supported by a strong industry backlog, while sales of our heavy-duty engines increased by 31%. Our market share through March was 34% compared to 32% a year ago.

Production of medium-duty trucks increased 18% in the first quarter, while our Engine shipments grew 17% compared to the prior year. Our market share in the medium-duty truck market was 79% through March compared to 81% a year ago.

Total shipments to our North American pickup truck customers decreased 9% compared to a year ago as we launched a new engine for Ram 2500 and 3500 pickup trucks. Volumes will increase from first quarter levels and we expect another year of strong demand in this market.

Engine sales for construction equipment in North America increased 27% in the first quarter due to growth in both nonresidential construction and infrastructure spending.

Revenues for power generation grew by 6% due to higher demand in data center markets, partially offset by lower sales to recreational vehicle OEMs. Demand for engines in oil and gas markets declined by 53% due to a reduction in purchases of new fracking equipment.

Our international revenues increased by 1% in the first quarter of 2019 compared to a year ago. First quarter's revenues in China, including joint ventures, were $1.3 billion, a decrease of 2% due to lower sales in on-highway markets, partially offset by increased sales to construction customers.

Industry demand for medium- and heavy-duty trucks in China decreased by 2% compared to a year ago. Our market share improved to 11.8% this quarter from 11.5% a year ago as we increased our share of engines at Foton. We expect further improvement in our market share in subsequent quarters due to further share expansion at our OEMs and a shift in the market to our over-the-road trucks versus construction-related dump trucks.

Industry sales of light-duty trucks grew by 6% in the first quarter. Our engine market share was 8.8%, 1.8% higher than a year ago. This increase was driven by our new joint venture with JAC, which launched in late 2018.

First quarter demand for excavators in China increased 25% from a year ago. Our market share increased by 1.4% to 14.3%, driven by the strong performance of our domestic customers. Market dynamics remain competitive for OEMs in this market with aggressive pricing, low down payments, flexible payment terms and generous trade-in values for used equipment, all positively impacting short-term demand.

Demand for power generation equipment was flat in the first quarter with lower demand for standby power in most segments, offset by growth in data center markets.

First quarter revenues in India, including joint ventures, were $454 million, a reduction of 12% from the first quarter a year ago due to lower industry truck demand and the impact of a weaker rupee. Industry truck sales decreased 5% year-over-year compared to the record demand a year ago. Our market share in the quarter was 37% compared to 38% last year.

Now let me provide our overall outlook for 2019 and then comment on individual regions and end markets.

We continue to forecast total company revenues for 2019 to be flat to up 4%. We've raised our forecast for industry production of heavy-duty trucks in North America to 300,000 units, up 5% compared to 2018 and above our prior guidance of 292,000 units. While the industry backlog remains at historically high levels, it has declined over the past few months and our guidance projects the truck build rates will moderate in the fourth quarter. We expect our market share to be between 32% and 34%, unchanged from our view last quarter.

In the medium-duty truck market, we are increasing our forecast for industry production to 140,000 units, up 6% year-over-year. And we expect our market share to be in the range of 74% to 76%, unchanged from our prior guidance.

We expect our Engine shipments for pickup trucks in North America to be flat for 2019, compared to a very strong 2018 and unchanged from our expectations 3 months ago.

In China, we continue to expect domestic revenues, including joint ventures, to be flat in 2019.

We are maintaining our outlook for medium- and heavy-duty truck market demand as 1.2 million units, representing a 10% decline from 2018.

In the light-duty truck market, we continue to expect a 7% reduction in demand, in line with our previous guidance. We expect our market share in the medium- and heavy-duty truck market to be in the range of 13% to 14%. And in light-duty, we expect our share to be in the range of 8% to 9%, both in line with our prior guidance.

We now expect industry sales of excavators to decline 10% from the record levels achieved in 2018. This compares to our prior guidance of down 25%, all given the first -- strong first quarter.

In India, we continue to project total revenue, including joint ventures, to be flat in 2019. We anticipate industry demand for trucks to be 5% lower than the record levels experienced in 2018 and power generation in construction to grow 5% to 10% due to continued infrastructure investment. We do anticipate lower demand in the second quarter as elections take place, but we expect strong growth in the second half of 2019. We are forecasting second half growth to be helped by increased truck demand ahead of the planned implementation of Bharat Stage VI standards in April of 2020.

In Brazil, we continue to forecast truck production to increase 13% in 2019. We project our revenues in Brazil will be flat, with increased demand in power generation and construction markets offset by the impact of Ford exiting the Brazil truck market.

We expect our global high-horsepower engine shipments to be down 5% compared to our previous forecast of flat.

We continue to expect demand for new oil and gas engines to decline by 40%. However, we now anticipate sales in North America will decline by 60% compared to our 40% expectation 3 months ago with lower demand for new equipment in the Permian Basin. This deterioration in our outlook for North America is offset by increased sales in China, which is seeing increased investment in developing onshore oil and gas assets.

Demand for mining engines remains stable and we continue to expect volumes to increase 5% in 2019. Demand for power generation equipment was flat in the first quarter and we have seen orders decline in certain geographies and applications. We are now expecting global power generation revenue to be flat compared to our previous forecast of up 5% to 10%. Growth in data center markets and increased military revenue will be offset by lower sales of generator sets in the U.S., RV market, lower demand in backup power applications in China and in large prime power applications in Europe.

In summary, we are maintaining our revenue outlook for the year, with improved truck markets in North America offsetting lower demand in power generation markets, while increasing our EBITDA guidance range by 50 basis points due to lower material costs and strong operational performance.

During the quarter, we returned 68% of operating cash flow or $279 million to shareholders in the form of dividends and share repurchases consistent with our plan to return 75% of operating cash flow to shareholders for the year.

Strong execution in the first quarter resulted in both record EBITDA and the best first quarter operating cash flow performance in 5 years. We converted strong revenues into profit and cash, lowered quality costs and continued to invest in our future to ensure strong performance over time.

Now let me turn it over to Mark.

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Mark A. Smith, Cummins Inc. - CFO & VP [4]

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Thank you, Tom, and good morning, everyone. I'll start with a quick summary of the drivers of our strong financial performance in the first quarter and then comment on our improved outlook for the year.

First quarter revenues were $6 billion, up 8% from a year ago. Sales in North America grew 13% while international revenues rose 1%. Currency movements, primarily as a result of a stronger U.S. dollar, negatively impacted revenues by 2%.

Earnings before interest, tax, depreciation and amortization or EBITDA are a record, exceeding $1 billion and reaching 17.2% of sales for the quarter.

EBITDA increased by $333 million year-over-year. Excluding the charge for an Engine system campaign incurred last year, EBITDA increased by $146 million or 130 basis points, driven by stronger gross margins, operating expense leverage and higher other income, all of which more than offset lower joint venture earnings.

Gross margin of $1.5 billion or 25.5% of sales, improved by $145 million or 60 basis points year-over-year, again excluding the impact of last year's emission engine system campaign. Growth in gross margin dollars outpaced the rate of sales growth due to the benefits of positive pricing, higher volumes and cost-reduction initiatives that more than offset the impact --the negative impact of tariffs and metal market inflation.

Our selling, administrative and research costs of $830 million increased $43 million year-over-year, a decline as a percent of sales to 13.8% from 14.1%. The majority of the increase in dollars was driven by new product development in the Engine, Components and Electrified Power segments.

Joint venture income declined by $23 million due to weaker truck demand in China and India and increased expenses in China associated with the launch of new on-highway products to meet the new National Standard VI emissions regulations.

Other income of $66 million increased by $56 million year-over-year, primarily driven by $37 million of mark-to-market gains on the investments that underpin our nonqualified benefit plans. The mark-to-market gains were recorded in other income in the income statement and within eliminations in our segment reporting.

The effective tax rate in the quarter was 20.8% compared to 37.9% in the first quarter of 2018. Excluding discrete items, the tax rate was 21.5%, down from 22.9% a year ago.

Diluted earnings per share were $4.20 in the first quarter, up from $1.96 last year, resulting from the positive combination of stronger earnings, lower taxes and a reduced share count due to our share repurchase activity over the past 12 months.

Operating cash flow in the quarter was an inflow of $412 million compared to an outflow of $117 million a year ago due to stronger earnings, a slower pace of working capital expansion and a lower payout of variable compensation. The first quarter is typically the weakest of the year for operating cash flow, due to the seasonality of sales and the payment of annual variable compensation earned and accrued in the prior year.

I will now comment on our revised guidance for 2019.

For the Engine segment, we expect full year revenues to be up 1% to 5%, up a little from our prior guidance of flat to 4% growth. We've raised our forecast for EBITDA margins to be in the range of 15.5% to 16% compared to our previous guidance of 14.5% to 15.5%, driven primarily by stronger operating performance in our manufacturing and supply chain operations and lower material costs.

Our outlook for Distribution segment revenues strengthened, and we now expect growth of 2% to 6% compared to our previous guidance of flat to up 4% with a stronger forecast in North America. We are raising our outlook for EBITDA margins in Distribution to be in the range of 7.5% to 8.5% compared to our prior guidance of 7% to 8% as a result of higher revenues and strong cost control.

For 2019, we expect Components revenue to increase 1% to 5%, unchanged from our previous guidance. We have raised our forecast for EBITDA margins to be in the range of 15.5% to 16.25%, up from our prior guidance of 15% to 16%, driven by operational efficiencies and an improved outlook again for material costs.

We now expect Power Systems revenues to be down 2 to up 2% compared to our prior guidance of up to 3% to 7% as a result of our lowered projection for sales of power generation equipment, as Tom has described. EBITDA margins are projected to be in the range of 13.25% to 14% of sales, down from our prior guidance of 14% to 15% due primarily to the weaker sales outlook.

In the Electrified Power segment, we continue to expect a net expense of $120 million to $150 million as we continue to make targeted investments and advance new product development towards commercial launch.

The net impact of these individual segment -- the net impact of the changes to the individual segment projections is that we still forecast total company revenues to be flat to up 4% in 2019, unchanged from our previous guidance.

We are raising our forecast for company EBITDA margins to be between 16.25% and 16.75% for 2019 compared to our previous guidance of 16% at the midpoint. This increase is primarily due to improved manufacturing supply chain performance benefit from our material cost reductions and a little lower tariff than expected in the first quarter, all of which will more than offset higher variable compensation expense in future quarters.

We currently project our effective tax rate to be approximately 21.5% in 2019, excluding any discrete items and unchanged from 3 months ago.

Full year operating cash flow is expected to exceed 10% of sales and our capital expenditures are expected to be in the range of $650 million to $700 million for the year.

As Tom mentioned, we returned $279 million to shareholders through dividends and share repurchase in the first quarter, and expect to return 75% of operating cash flow to shareholders this year as we projected 3 months ago.

To summarize, we delivered a strong first quarter and have raised our earnings outlook for the year. We have a clear focus on improving cycle-over-cycle earnings, increasing operating cash flow, delivering first quartile ROIC and returning cash to our shareholders, all while continuing to invest in new products and services to deliver future profitable growth.

Now let me turn it back over to Tom before we move to Q&A.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [5]

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Before we take questions, I want to highlight the press release we issued last night, which announced that we are reviewing our certification process and compliance with emission standards. This follows ongoing conversations with the U.S. EPA and CARB regarding certification for the engines in the 2019 RAM 2500 and 3500 trucks. This is a voluntary action and we are committed to completing a thorough and independent review and to quickly implementing recommendations to improve our compliance and certification processes.

Cummins strives to be a leader in developing and implementing technologies that provide customers with leading products that lower emissions. We have a long history of working with governments and regulators to achieve these goals. Cummins remains committed to ensuring that its products meet all current and future emission standards and to delivering value to our customers. It is too early in our review to determine what if any actions we might take and if there will be any financial impact.

Now let me turn it back to James.

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James Hopkins, Cummins Inc. - Executive Director of IR [6]

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Thank you, Tom. (Operator Instructions)

Operator, we're now ready for our first question.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Jamie Cook with Crédit Suisse.

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [2]

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I guess just first question, Tom. Understanding you can't comment much on the emission certification process, but is there any way -- obviously, this is going to be -- there is a concern that this would be an overhang on the stock. Is there any way you can frame this relative to issues that we've had in the past or give some color around when you guys will have more -- a better understanding of whether or not this could potentially impact your earnings for 2019? I guess that's my first question.

And then my second question relates to Power Systems. The margins over the past couple of quarters have -- or past 2 quarters or so have disappointed. I understand the end market demand is a little weaker, but just confidence in ability to achieve year-over-year margin improvement in the back half of the year given the tempered top line outlook.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [3]

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Okay. Maybe Rich and I'll tag on this one. Just with regard to your questions about the review we're doing, right now we don't have a way to quantify or put a clear time frame around it. And I don't think it makes sense to compare it to any previous one, just because we are doing the review to find out all those things. Again, it's -- we recognize that not being able to say much about it or quantify it is frustrating and it's frustrating to us too. We will work with urgency to get to the bottom of the questions that we got and to examine our certification and compliance processes, so we will be working with urgency to complete that review. And then we also will be working quickly to implement those changes that we want to as a result of this review. So we'll work as quickly as we can. We'll quantify as quickly as we can and we'll try to help people create a box around it as quickly as we can. We just can't do it today.

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Richard J. Freeland, Cummins Inc. - President, COO & Director [4]

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Okay. Jamie, this is Rich. On the Power Systems, just a quick reminder first. As we look from 2017 to '18, we took -- the sales were up and what we said is we're going to deliver good incrementals on that. And you saw that we had -- took the EBITDA from 10% to up over 13% with that gain. As we look to this year, it now looks that sales will be flat. We kind of guided to minus 2% to plus 2%. But with those flat sales, we -- the guidance implies we'll be taking the EBITDA up again with those flat sales. And to your question, is there confidence in that? Yes. We're going to continue some of the restructuring work. We're still getting the benefits of that today. And so there's confidence in delivering that despite the fact that this part of the business gets hit fairly hard by tariffs and that's built into -- and that impact is built into this guidance. So relatively flat sales, but continue to expand the margins in 2019.

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Operator [5]

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And our next question comes from Ann Duignan with JP Morgan.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [6]

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Just back to the press release again, sorry. Maybe you could just explain what it is in the process that has been questioned. Just a little bit more color and what specifically you're doing and having to review?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [7]

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Well, again, we are -- what we -- our new product introduction for the 2019 engine for the Dodge Ram, we applied for certification. We got a lot of questions from the EPA and questions that we take very seriously. And so what we wanted to do is launch an independent review and see if we have anything we need to change about our compliance and emissions processes, and if so, make those changes quickly. So that's what we're committed to do. We will work cooperatively with those agencies. We have a long history of doing that. We'll continue to do that. That's what we're focused on. And again, as soon as I can say more about what the results of that review are, or other things about our compliance and emissions process, I will. But that's really all I can say about it today.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [8]

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And I just want to make sure I'm interpreting it all correctly. So this is -- you do your own testing in lab and you're basically self-certifying, and this is just going back to make sure that you're doing all the right tests in the right environments. Is that the best way for us from the outside to interpret this?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [9]

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We do, do our own tests and evaluations and we submit that data to the EPA and to CARB, who then do their own independent evaluation. Sometimes they do independent testing. They always review the data we provide and then they provide us with the certification for those engines. And in both the case of the 2019 Ram 2500 and 3500 engines, we have conditional certification from CARB and a similar kind of certification from the EPA. And so both of those are still under review.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [10]

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So there's no risk that you'll have to stop shipping engines, is there?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [11]

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Again, because they are conditional and cert from CARB and revocable, so they have the right to make us stop if we don't meet the conditions of those certifications.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [12]

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Okay. I don't want to take up my whole Q&A on this. But just one other one. I think you said that rest of the world, Power Systems were -- was down 7%. If you could just expand on that a little bit? That will be appreciated.

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Mark A. Smith, Cummins Inc. - CFO & VP [13]

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It's principally Europe and that's the area of weakness. When you look by geography, North America up, Europe down in the first quarter.

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Richard J. Freeland, Cummins Inc. - President, COO & Director [14]

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We got some big prime power projects in Europe last year that did not continue into this year. They were onetime.

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Operator [15]

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And our next question comes from Jerry Revich with Goldman Sachs.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [16]

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Yes. Tom, I'm wondering if you could just give us your updated thoughts on how the next-generation diesel platform discussions are going for you folks, light and medium duty globally. I guess what's the opportunity set as you presumably have some lower investment from some of the vertically integrated players in diesel versus electric? How's that playing out for you folks? What's the incremental opportunity set qualitatively or quantitatively? To the extent you're willing to share that with us, that would be helpful.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [17]

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Good question, Jerry. So obviously from a global point of view, a global OEM point of view, so our customers, all of them are trying to figure out how to rationalize the many investments they need to make. They've got investments to make in autonomous vehicles, in electrification, in other technologies as well as trucks, controls, et cetera. And then, of course, more diesel engine and potentially natural gas platforms. So it's a lot of investment to make. It's -- that's -- and that's sort of been our value proposition to OEMs since we started operating 100 years ago is that we think we can specialize in powertrain platforms, so that if OEMs don't want to make every single investment for every single powertrain, that we can help them and partner with them both to help their own and to provide a full powertrain from us. And we just think that, that proposition is stronger now than ever because of their requirements to make so many investments.

So as I've maybe said on previous calls, so we are having important strategic conversations like that with every major OEM in the world. It at least feels like that. There may be 1 or 2 that we're not, but most if not all. And again, I don't think it's a clear-cut answer for every OEM. Each OEM is going to figure out where their priority sits. And again, because we're providing electrified powertrains now as well as diesel as well as natural gas, I think each will try to figure out where and how do I want to use Cummins? Where geographically? Which vehicle? And which platform? But we will be able to provide them whichever platform that they need in order to make their entire strategy come through as well as subsystems that they need to carry out their own platform. So we think that proposition is stronger and stronger going forward than even it was in the past. And so again, that's what we're investing for and ready for. And that seems to be playing out, although I'm convinced it will take some time to play out all the way.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [18]

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And Tom, I'm wondering if you could expand on that last point. From a timing standpoint, how long before we're talking about firm visibility on platforms or actual top line and higher market share from a common standpoint? Is it 2022 type event? Or can you just give us any additional color there?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [19]

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Yes. Jerry, so there's some big decisions for people to make because these platform decisions are -- for U.S. and Europe are made in this 2024 to 2027 time frame, which I know sounds very far away, but that means investments starting in the next year or 2. So if people don't want to make those investments, they kind of need to make a decision pretty soon. People are already making some decisions in India and China on NS VI. We talked a little bit about that, about the opportunities we think we have to gain share there because not everybody will want to make those investments. And then I think, again, the next platform after that in India and China will be a little ways out. But I think what we'll see is between next year and 2024, a number of OEMs making decisions that will impact their platform choices first in the U.S. and Europe because, again, those choices are coming sooner, and then in India and China, again as they follow suit.

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Operator [20]

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And our next question comes from David Raso with Evercore ISI.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [21]

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Just trying to figure out the setup here sort of exiting the year, the way the guidance is laid out, especially going into the November Analyst Meeting you're having. The rest of the year you're implying sales year-over-year basically flat. And you made the comment about fourth quarter North American truck production. I assume you're implying it's down. So I'm just trying to get the sense of the fourth quarter, the cadence for the sales the rest of the year, is the idea we're up a bit in the next 2 quarters and then fourth quarter, the revenues are down? And if that is the case, maybe just if you could help us a bit, I know it's only end of April. But the meeting in November, what are sort of the issues we should start thinking about that you're going to try to eliminate in more detail about the cycle and how the company could perform in that meeting?

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Richard J. Freeland, Cummins Inc. - President, COO & Director [22]

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David, this is Rich. Let me take the first half of that one, which is kind of the guidance for the full year, and a lot of that's driven by our view of North American truck. So I'll just say what we've assumed, that right now, the backlog is coming down about 45,000, 50,000 a quarter. And we think that will in fact continue in Q2. So from a peak of over 300,000 units, it's down to roughly 250,000 now. The momentum going into Q2 will remain strong though, and there's no letup going from Q1 to Q2. And so all we're -- basically what we're assuming in this financial forecast is if orders don't start to come in heavier towards the fall later in the year, we built in that potentially there could be some reduction in heavy-duty truck and that's most of what drove the reduction here. So we're not calling that yet, but it will require at least, in my opinion, some orders going up above this 15,000 a month that we're seeing in heavy-duty. And I think that's what we'll probably see in December. Through the summer is another -- at pretty low levels. And so this will probably be decided later in the year if it comes back. As always, we're prepared for every scenario. And so we've got our own scenarios that if it goes down -- if it continues, we've clearly got the capacity to continue to run this longer should the orders come in later in the year.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [23]

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I think -- and I think with regard to the investor conference, David, so what we don't know now really is what kind of cycle we're going to be in. Again, we are seeing -- we have increasing visibility in the North American truck market, so we'll kind of understand with that. But what happens to everything else, I think there's still a lot of uncertainty about that. And so again, what we hope to do between now and then is kind of understand a little bit more about where the economic cycle is.

We kind of had a view, I think maybe last year, that we start to see the U.S. economy begin to fall at the end of this year or early next year. And again, I think we'll have better visibility of that as we get closer. But in any case, what you can count on from us is that we will be ensuring that in the cycle, Cummins does better in the downturn than we did last time and that we emerge stronger, so that we have a better upcycle than we had in this upcycle. So that will be our planning process, which we are already engaged in and operating to today.

And then we'll also talk a lot more about some of the questions that Jerry asked, what do we think the opportunities for us to grow are and to grow share, given the changes in technology landscape around the world, and we'll try to update investors on what's happening in electrification and some of these others where we had an early look a couple of years ago, but we'll have some updated views about how fast those transitions are occurring, where they're occurring. So those are some of the things. We're, of course, open if you have input on other topics to cover, but those are some things that we've begun talking about. But we will talk about the cycle, we will talk about where we think we are in it and what we're going to do to emerge stronger. So that will definitely be one of the topics.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [24]

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Yes. I mean, it's just interesting. In a way, the fourth quarter is going to be a microcosm of what the analyst meeting is going to try to discuss, right? You're implying the fourth quarter of this year is the first quarter we deal with a down North America truck and how the earnings hold up other opportunities to offset it is sort of what the meeting, I assume, is going to try to address. So I just want to make sure the baseline here is set. It appears next 2 quarters growth, fourth quarter revenues are down. And I know you don't give quarterly EPS guidance, but that's sort of the idea, we're trying to figure out how much damage that down North America truck do versus the other opportunities you have, so...

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Mark A. Smith, Cummins Inc. - CFO & VP [25]

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Just to put that in context, David, you know that new orders for engines for the heavy-duty truck market are less than 20% of our revenues, to Tom's earlier point. So we've got growing aftermarket business, growing distribution. So I think we just got -- we will not put the Analyst Day just in the context of 1 quarter, but it certainly will address the environment that we see that we're in at that time. And it's just a set of assumptions for now that we'll try to be clear on.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [26]

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Yes. I mean, the last comment, you look at the rest of the year, you're implying your sales are basically flat. But if you exclude the year-over-year drag from the warranty last year -- in the last 9 months of the year, you're basically implying your earnings are flat to down a little bit. So it's just an interesting, again, microcosm of kind of what the whole discussion will be about at that meeting. So I appreciate your comments.

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Mark A. Smith, Cummins Inc. - CFO & VP [27]

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It's reduction, yes, that's good for the margins. Yes.

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Operator [28]

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Our next question comes from David Leiker with Baird.

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Joseph D. Vruwink, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate [29]

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This is Joe Vruwink for David. I wanted to focus on Electrified Power. So the loss rate has been running pretty consistent for several quarters now, $29 million, $30 million a quarter. The guidance seems to contemplate that maybe accelerates a bit into the remainder of the year. Is that kind of front-loaded investment for programs that are set to generate revenue in the near term? Or are you still building up critical mass in engineering behind that number?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [30]

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It's a good question. It's a little of both. I mean we are definitely ramping up to launch commercially in Q4. And the reason by the way it's not a big varying number, it's kind of a flat number is that we are investing to sort of launch a set of commercial products year by year that get us into each application. We could go faster than that, but our feeling is, given the adoption rate of the markets, that the right plan is to invest to kind of launch 1 commercial or 2 commercial applications kind of every year and ramp up adoption. So that's kind of our base plan built into those numbers.

There's a little bit of ramp-up in Q2 and Q3 because we're launching in Q4. So there's -- that's that. We are though still trying to build capability in our engineering department. It's an area where, as you'd guess, Electrified Power development is an area where there's a lot of demand and not as much supply of capabilities. There's no question that both with our acquisitions and some of our hiring that we're trying to build capability there still. Again, we have a lot, but we're trying to build more.

Just as you kind of think through like what does all that mean though, we will commercially launch towards the end of this year. We will begin real commercial sales first quarter. Our expectation is there is significant interest in this. How much that will result in orders that lead to a profitable business is -- remains to be seen. It's going -- our own projections today are the ramp is going to be reasonably slow. Everybody wants 10, 20 or 2 electrified power units. Not that many people want 1,000. And that's just because everyone is kind of learning how to use them, figuring out how the economics work, can I make money doing this, how can I charge and operate? So we definitely feel like we need to be in there, seeding the market, driving the market, but we also recognize that we're going to have a slower ramp-up on this new product than we would a replacement for a diesel engine or something like that. So that's just going to be part of the learning curve and investment curve that we've got in the business.

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Joseph D. Vruwink, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate [31]

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And then on a somewhat related topic, when you think about higher earnings at trough, which presumably we're talking 2020 now, do you think a smaller decline for electrified power in 2020 is part of that equation? Or maybe can you walk through some of the items that are in your control that you have visibility on, that could be drivers of higher trough earnings in 2020?

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Mark A. Smith, Cummins Inc. - CFO & VP [32]

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Yes. We may not be at a trough in 2020, of course, Joe, depending on what happens to the balance of our markets, but -- so yes, we've got a continual focus on cost control, productivity gains, quality improvements. And it's just a balancing act of what items we tend to accelerate when we're in a weaker period of demand, and which goes lower down the list for prioritization. So we got a list of things. We've been through several cycles. And of course, we've got a healthy growing aftermarket business as well, all of which gives us confidence about growing the trough earnings over time on a pretax basis. And hopefully, we're enjoying lower taxes than we did in the last cycle. And of course, we're continuing to buy back shares, all of which should help with the EPS on a trough basis.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [33]

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And I think this is a bit what David was asking about. We will be able to give better visibility in our investor conference about, so what are some of the key cost reduction things that we're working on. Again, most of us in the management team have done this somewhere between 4 and 7x through different cycles to try to figure out where can we find costs that don't hurt our long-term investments that allow us to emerge stronger from the downturn as you get that -- that's a lot of pushing and pulling to figure out how to do that and how to execute it well. As I mentioned to David, we actually started that process with this annual operating plan. So last November, talking about how did we want to hire and cost control this year given that we can begin to foresee the North American truck market will peak out some time this year, what do we want to do now. And then as I also mentioned, since we don't really know what all the other markets are doing, there is a reasonable chance that we could see a downturn across a number of North American markets in 2020. And there seems to me an increasing chance that we won't. Again, I'm not forecasting either. I just don't know. And I think we'll be able to have a better view of that when we do our investor conference and we will be specific about the kind of things that we're seeing opportunities for cost in, as we look at the next year and the cycle itself.

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Operator [34]

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Our next question comes from Steven Fisher with UBS.

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Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [35]

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So the data center market has been pretty strong for a while now, but you did mention data centers a number of times in the prepared remarks. So just curious if there's something different about what you're seeing this quarter? Maybe some market share gains? And what's the visibility you have to ongoing strength there? And maybe where you think we are in that cycle?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [36]

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It's a good question, Steve. I think the reason you hear about it so much is because as you say, it's kind of the one strong segment where a lot of other segments have been either up and down or aren't as strong. We've had a really good run in North American RV markets that is clearly starting to turn the other way. Generally, PowerGen markets internationally, not in every segment but generally speaking, haven't been as strong as we have seen in previous upturns. The data center market has been a notable exception. So that's one of the reasons you hear a lot about that.

Our share, we have really strengthened our product line and our customer relationships in that segment, both in the PowerGen business and also in the Distribution business that Tony runs, where we have been now consolidating a lot of our efforts there to make sure that we can provide data center customers with the kind of support they need. So we like our position in that market. It's been going well for a while and -- where the others have been not as strong.

Where we are in the cycle of that, I really don't know. And -- but we do worry about it. We do worry that it's been strong for a while. And we know that people's data center customers are wondering how long the thing lasts. But so far, we're still seeing growth. And one of the real kind of positives that we see is the growing demand in some countries outside of the U.S. and Europe. So China, for example, we've seen some strong quarters recently with data centers. We expect the same in India down the road. So we are seeing that some of these developing countries are adding data centers. And that means, since we already have a strong position there, we have the opportunity to -- if things do weaken in some of our historical markets to grow our sales there and potentially offset the difference. So we are active, as you'd guess, in both those regions.

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Mark A. Smith, Cummins Inc. - CFO & VP [37]

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The momentum is the same as it was last quarter for this year.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [38]

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Yes. No change in order of patterns. Right. Yes.

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Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [39]

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Got it. And then if you could just give us a little more color on the oil and gas outlook and what you're hearing from your customers there. Is that just the capital discipline we're hearing from customers in the Permian? And then maybe I guess similarly on the mining side, what you've assumed there for kind of the balance for the year and going forward?

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Richard J. Freeland, Cummins Inc. - President, COO & Director [40]

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Yes. On oil and gas, you got it exactly right. Just the capital discipline is strong, so we had a nice run. We got some orders last year. I think we're down 40% is what we're saying. And I don't see any sign of that changing between now for the balance of 2019. An exception I would make on that is in China. And so the China market is developing there and we're getting a nice size of the market share there. So that's one we'll pay attention to. And if there's going to be any movement up, it would be because we said China looks better.

On the mining side, a couple of things. The utilization looks decent, okay? The rebuild activity is going to be up this year compared to last year, the number of rebuilds we do. But the new product, new engines going into new equipment has softened. And I think we're saying up 5%. And I think that one's going to be under a little pressure, especially if you look at what's going on in coal, some recent conversations about Indonesia. So again, we're projecting 5% up, but that one I would say has got a little bit of pressure on it going forward in the short term.

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Operator [41]

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Our next question comes from Rob Wertheimer with Melius Research.

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Robert Cameron Wertheimer, Melius Research LLC - Founding Partner, Director of Research & Research Analyst of Global Machinery [42]

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Rich, a follow-up on China. I mean, could you characterize for us how that market is developing in oil and gas? Whether we're doing testing still on fracking or whether there's a broadening out of the market of successful operations, et cetera, and maybe the potential size of it.

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Richard J. Freeland, Cummins Inc. - President, COO & Director [43]

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Okay. I don't have a quantification for you today. We can follow up with you. But it is all onshore. It is in the fracking. It's utilizing the horizontal fracking capability. And it's a pretty recent phenomenon where we're actually turning this into orders. So I would say, our knowledge of the run on this looking forward is not as good as it needs to be. I would say that I just came back from China. The excitement in the conversation about this and the momentum is positive. And so I'd say we haven't revised our guidance on that, but that's one we're going to be paying attention to and seeing how long are the legs on this.

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Robert Cameron Wertheimer, Melius Research LLC - Founding Partner, Director of Research & Research Analyst of Global Machinery [44]

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Great. And then in PowerGen, are you able to say how much or how important data centers currently are? And then what the rest of the PowerGen market looks like outside RV and data center?

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Mark A. Smith, Cummins Inc. - CFO & VP [45]

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Data center is around about 10% of our business in the PowerGen side. And in RV, it's around about 6% or 7%.

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Robert Cameron Wertheimer, Melius Research LLC - Founding Partner, Director of Research & Research Analyst of Global Machinery [46]

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Exactly. So it's a fairly diverse pie and then really you have -- sorry.

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Richard J. Freeland, Cummins Inc. - President, COO & Director [47]

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You have it right. It's a diverse pie.

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Robert Cameron Wertheimer, Melius Research LLC - Founding Partner, Director of Research & Research Analyst of Global Machinery [48]

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I'm sorry. And then just your feeling on just the rest of the business. So how we are in this cycle? I mean, are we at the end of a strong run-up or just kind of plugging along really in growth?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [49]

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Yes. That's -- it's a great question. And one we're struggling with a little bit. I mean, again, if I look at the growth cycle for PowerGen this time versus the last cycle, it's a lot weaker. It's just not as robust as what we've seen in the past. Part of that we know to be because utility residuals in many, many countries are stronger than they used to be. We also know that economic growth rates were -- while they were positive, they were more moderate than they were in the previous cycle. So we expect that has something to do with the residual ratios that we see.

We also think that countries are doing -- especially developing countries are growing at a rate where they're doing a better job of keeping up with electricity builds, but those are all really interesting statistics, but they don't really explain everything. And so I guess, the way we'd characterize it, and I kind of said this before, is that the data center market is only 10%, but it's been consistently good, consistently growing. We've been growing our position in it. It's been good domestically. It's been good internationally, at least more recently. So we like that part. It tends to have pretty value added because they tend to buy sophisticated products and we usually do a pretty sophisticated installation.

The basic business, though, of just standby power is still a larger percentage of the total and I put that in the plugging along category. But we just don't feel -- it's just not as robust as we would have expected from prior cycles. And we don't really know how much longer it holds up, given some of the conversations we're having about potential downturns and things like that.

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Operator [50]

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And our next question comes from Adam Uhlman with Cleveland Research.

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Adam William Uhlman, Cleveland Research Company - Partner & Senior Research Analyst [51]

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I was wondering if we could go back to NS VI and the BS VI standards in China and India. If you can remind us how much incremental content you think you have and the total opportunity from a Components side and any early look on Engines? And then has the legislation -- the implementation of the standards in China, has that shifted at all? Any update there would be helpful.

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James Hopkins, Cummins Inc. - Executive Director of IR [52]

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Adam, this is James here. So expectations haven't really shifted there. So we're looking at implementation in China in the beginning of 2020 through 2021. And that will start in kind of your major Tier 1 cities on the East coast and then spread to the rest of the country. Then in India, what we're expecting is implementation in April of 2020. And that's kind of a one-shot thing in India there. So those are kind of the 2 big drivers. From a revenue perspective, we've talked about the opportunity there being around $600 million at maturity. And so that would be more in kind of the 2023 time frame when we've kind of done the complete transition in both of those markets. And that revenue primarily within the Components segments on after treatments and then a little bit on turbos as the turbochargers have to get a little bit more complex to meet those new NS VI standards.

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Richard J. Freeland, Cummins Inc. - President, COO & Director [53]

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Maybe just a little more technicolor. So on the China piece, pretty small volumes of NS VI in 2019. I think we're saying as few as 10,000 kind of going in the municipalities. Another step-up midyear of 2020. And then kind of gets to full midyear 2021, which is slower than we thought. We're positioned really well with our Euro 5 product there right now. So that's -- it's a good business for us right there. India is going to be a little different. I think it's going to happen April of next year. In fact, we'll probably see some type of a prebuy yet this year in anticipation of Bharat standard changing in April of next year. And that one looks solid, and that date is going to hold.

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Adam William Uhlman, Cleveland Research Company - Partner & Senior Research Analyst [54]

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Got you. That's helpful. And then switching back to North America. Can you talk about what you're seeing with the medium-duty truck industry? The orders have softened a bit here in recent months. What's kind of the general feedback that you've been collecting from your customers?

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Richard J. Freeland, Cummins Inc. - President, COO & Director [55]

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Yes. It's a pretty diversified customer base, absent kind of the top 3 that we have there. But we -- I was just looking at it. We've got 8 quarters in a row of year-over-year growth in production. And this has just been a very resilient market. It's such a diversified market. So again, we've actually taken our guidance up for this year on the market size. And this one feels just much less cyclical if you look over time just because of that diversity in the market. So I think it's at historic really strong levels, but we got a nice backlog, something like 60,000 units in backlog, which is market we generally don't have big backlogs looking us in their sight. I'm pretty bullish that we'll -- this one looks stable at a good level, remaining pretty stable going forward.

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Operator [56]

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And our next question comes from Ross Gilardi with Bank of America.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [57]

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Yes. Tom, I was just wondering if you could talk a little bit more about electrified powertrain and how the competition is evolving. I mean, where is it going to be the heaviest when you commercialize towards the end of the year? And are you seeing customers doing a lot of in-house work? Where else is the competition coming? And just -- like how is pricing evolving even though it's kind of early to answer that question, I realize, but -- and I have a follow-up to that.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [58]

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Those are good questions, Ross. It's a range of things. So you have some companies that are kind of early start-ups, you know probably names, Proterra in the U.S., for example. There's equivalence to them in a number of other -- in Europe and other jurisdictions where companies that are essentially in the game to do electrified power. And then there are a number of OEMs who because they couldn't get what they wanted early enough started working on their own. A good example would be New Flyer. So New Flyer wanted people to supply them electrified power units, didn't like what they were seeing in the market and just started working on their own.

So there is a pretty diversified base. And so I think as the market begins to operate, then customers -- end customers -- operators will have to decide kind of how -- what they want and how they want it. There are already purchases of Proterra buses, BYD is another big operator, Chinese supplier, who is -- who sells buses and makes batteries. So there is already price competition in the market, most of it coming from Chinese, most of it from BYD.

So most of the other suppliers, the New Flyers that make their own, Proterra, suppliers in Europe are trying to figure out how to recover full cost of their products because they're really -- they're not selling very many. They're spending a lot of money on engineering and not selling very many. BYD is just taking a different strategy. They are just trying to build volume and build market position and so they tend to price very aggressively. And so it depends -- it really depends on whether the buyer -- the bus operator wants to take the risk associated with operating BYD buses, but that's -- so that's what's occurring today.

I believe as more companies like Cummins go into the market, the market will begin to think more about where they want to settle on platforms. So when -- in big companies like Daimler, as they offer their own, I just think you'll start to see more stability enter the market. Price will begin to settle on really what's there. And a lot of it's going to depend on how long batteries live and what you can do with them when they are no longer useful in the bus. So right now, buses normally operate about 12-year cycles -- 12-year life cycles. That's how they operate with diesel engines. And so that's what they'd like to continue, but batteries right now won't last 12 years. So they're -- what we're trying to figure out is how do you change them out mid-cycle? How do you reuse them? How do you recycle them? That's going to drive a lot of the cost and therefore, the price of the final units. Again, all that stuff is really in its early days. So I just -- I would just say that all of us are kind of trying to figure it out at some level.

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Ross Paul Gilardi, BofA Merrill Lynch, Research Division - Director [59]

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Got it. And then just any thoughts on ZF and WABCO combination and implications for Cummins Eaton in the AMT space? And could you tell us where else do you compete with ZF around the world?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [60]

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Yes. So we are -- we cooperate or compete with them pretty much everywhere in the world. They're a global company. We see them in China. We see them in India. We see them everywhere. I mean they are stronger in some places than other. I'd say Europe and China has -- have historically been the 2 places I saw them most and then the other places slightly less, but they are global.

And the combination of the 2, I think, does give them a bigger footprint in autonomous. I'd say that's kind of the biggest part of it. So what they're putting together is steering and brakes and controls and trying to figure out how we -- they can play a role in trucks as they have more autonomous systems. It's not that they won't offer AMTs. It's just that I would say that ZF already had a significant portfolio in AMT and so WABCO is -- has some minor additions to it maybe for developing countries like China, but not a significant addition. I'd say primarily it's an autonomous truck play.

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James Hopkins, Cummins Inc. - Executive Director of IR [61]

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Great. Thank you, everybody. I think with that, we're at the end of our hour. I appreciate your interest in Cummins this morning, and I'll be available for questions this afternoon. Thank you.

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Operator [62]

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