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Edited Transcript of CMI earnings conference call or presentation 6-Feb-19 3:00pm GMT

Q4 2018 Cummins Inc Earnings Call

COLUMBUS Feb 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Cummins Inc earnings conference call or presentation Wednesday, February 6, 2019 at 3:00:00pm 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. - VP of Financial Operations

* N. Thomas Linebarger

Cummins Inc. - Chairman & CEO

* Patrick J. Ward

Cummins Inc. - VP & CFO

* Richard J. Freeland

Cummins Inc. - President, COO & Director

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Conference Call Participants

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* Alexander Eugene Potter

Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst

* Andrew Millard Casey

Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst

* 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

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Q4 2018 Cummins Inc. Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded. I would now like to turn the call over to 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, Chelsea. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the fourth quarter of 2018. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; President and Chief Operating Officer, Rich Freeland; and Vice President of Financial Operations, Mark Smith. 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 the 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 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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Very compelling. Thank you, James. Good morning, everybody. I'll start with a summary of our fourth quarter and full year results and finish with the discussion of our outlook for 2019. Pat will then take you through more details about our fourth quarter financial performance and forecast for the year.

Revenues for the fourth quarter of 2018 were $6.1 billion, an increase of 12% compared to the fourth quarter of 2017, with growth in all of our operations segments and major geographic markets. EBITDA was $896 million or 14.6% compared to $769 million or 14% a year ago. EBITDA increased as a percent of sales due to the benefit of higher volumes, improved pricing, lower warranty costs and the absence of tax reform impact on JV earnings in the fourth quarter last year. These positive factors more than offset an increase in research and engineering to support new product development and the negative impact of tariffs.

For the full year, Cummins sales were a record $23.8 billion, up 16% year-over-year. Our EBITDA margins were 14.6% compared to 14.8% in 2017, with the impact of higher sales, improved pricing and the benefit of cost reduction programs offset by product campaign charges in the first half of the year and an increase in research and engineering. EBITDA dollars were a record $3.5 billion.

Engine business sales increased by 18% in 2018 due to stronger production of heavy and medium-duty trucks in North America and higher demand for construction equipment globally. EBITDA was 13.7% compared to 12.8% in 2017 due to the positive impact of higher revenues and improved pricing, partially offset by product campaign charges.

Sales for our Distribution business grew by 11%, driven by increased demand in North America and Europe. Full year EBITDA was 7.2% compared to 7.1% in 2017, with the benefits of improved pricing offset by the impact of strong U.S. dollar and currency volatility in Africa.

Full year revenues for the Components segment increased by 22% due to higher truck production in North America, Europe, India and Brazil. The automated transmission business contributed 6% to segment growth. For the full year EBITDA was 14.4% compared to 15.6% in 2017 as the benefits of higher sales and material cost reduction programs were more than offset by product campaign costs and the dilutive effect of the new automated transmission business.

The automated transmission business delivered revenues of $543 million in 2018, driven by stronger demand in North American heavy-duty truck market as well as higher-than-expected penetration rates of automatic manual transmissions which reached 73% of new heavy-duty trucks in 2018. Customer feedback on the new Endurant transmission has been very positive and joint venture profitability is benefiting from transitioning to selling the new and improved products.

Power Systems sales increased by 14% in 2018, driven by higher demand for power generation equipment and an increase in sales to oil and gas and mining customers. EBITDA was 13.3% compared to 10.1% in 2017, driven by the positive impact of higher sales, lower warranty costs and improved pricing. While EBITDA margins improved significantly for the full year, they were well below -- they were below, excuse me, our expectations in the fourth quarter. Due to stronger-than-anticipated demand for power generation equipment, our alternator business, which is still in the restructuring process, incurred additional production costs and premium freight to meet delivery commitments. EBITDA percent in the fourth quarter was also negatively impacted by lower joint venture earnings in Africa, the impact of tariffs and a lower mix of parts sales. We do though expect to grow earnings in 2019 as a result of stronger power generation sales, improved pricing and sustained improvement in our alternator operations, all of which will offset weaker demand from oil and gas customers.

In our Electrified Power business, full year EBITDA was a loss of $90 million, in line with our forecast. We continue our targeted investments in areas which we expect to see broad market adoption, primarily in urban and shorter-range applications.

Included in the fourth quarter results were 2 nonrecurring items with combined negative impact of $58 million of EBITDA. These items were costs related to closing a start-up electronic logging device business and the impact of marking to market assets to underpin our nonqualified benefit plans. The mark to market loss was driven by volatility in debt and equity markets in the fourth quarter. The ELD business was part of our strategy effort to increase digital services to customers and included the design of the smartphone-based app that help truckers meet electronic logging requirements in the U.S. While this specific market didn't materialize as we expected, we continue to launch new digital products that serve our end customers' needs.

Now I will comment on some of our key markets in 2018, starting with North America, and then I'll comment on some of our largest international markets.

Our revenues in North America increased 19% in 2018, primarily due to higher levels of truck production. We also experienced growth in sales of engines and parts to customers in oil and gas, construction and mining markets as well as the full year impact of the automated transmission business. Industry production of heavy-duty trucks increased to 286,000 units, an increase of 29% from 2017 levels, supported by strong freight rates and improved fuel economy in new trucks. Our market share was 34% for the full year, up from 33% in 2017.

The market size for medium-duty trucks was 132,000 units in 2018, an increase of 9% from 2017 and the highest level of production in over a decade. We maintained our clear leadership in the market with full year market share of 80%, up from 78% a year ago.

2018 marked another strong year for pickup truck sales in North America. We shipped 150,000 engines to pickup customers in 2018 and recently unveiled the next-generation 6.7-liter turbo diesel engine, boasting a first-in-class 1,000 foot-pound of torque in a Ram truck at the Detroit Auto Show. 2019 marks the 30th anniversary of Cummins availability in Ram trucks.

Engine sales to construction customers in North America increased by 31%, driven by record levels of nonresidential construction and the strongest year of residential construction spending since 2006. Engine shipments to high-horsepower markets in North America increased by 18% from last year, driven by demand from oil and gas and mining customers. While power generation revenues increased by 10% year-over-year, with particular strength in demand from data center customers.

Our international revenues increased 12% in 2018. Full year revenues in China, including joint ventures, were $4.8 billion, down 2% compared with 2017 with lower sales in on-highway markets, partially offset by strong construction markets. Industry demand for medium- and heavy-duty trucks in China decreased by 2% from the record level experienced in 2017.

Within the truck market, construction-related dump truck and specialty vehicle sales were up 45% in 2018, while tractor and flatbed sales, utilized primarily for linehaul applications, were down 10%. Our market share in 2018 was 12.7%, down from 14.8% in 2017 due to lower market share at our OEM partners, mostly driven by the change in market mix towards construction-related vehicles. The light-duty market in China grew 10% in 2018 and our share ended the year at 7%, in line with our guidance.

Industry demand for excavators set a new record of 203,000 units in 2018, an increase of 45% from 2017 levels. Our market share ended the year at 15%, 1.5% higher than in 2017 due to market share gains made by several of our key domestic OEM partners.

Revenues for our Power Systems business in China increased by 29% due to increased demand for power generation equipment and growth in industrial engine shipments to mining customers.

Full year revenues in India, including joint ventures, were $2.2 billion, a 23% increase over 2017. Industry truck production was a record in 2018 and increased 22% from the year previous.

Our truck market share ended at 40%, which was flat when compared to last year.

Sales in our Components segment increased more than 14% due to increased content associated with the transition to BS IV emission standards in the truck market beginning in April last year. Strong economic growth and infrastructure investment also led to a 10% increase in power generation sales during the year. In Brazil, our revenues increased by 27%, mainly driven by a 27% increase in truck production.

Now let me provide our overall outlook for 2019 and then comment on some individual regions and end markets. We are forecasting total company revenues for 2019 to be flat to up 4% from 2018, driven by an increase in heavy- and medium-duty truck production in North America and Brazil as well as increased demand in power generation markets. We exposed -- expect most of our end markets in China to decline in 2019, while European and Indian end markets are expected to remain relatively flat.

Industry production for heavy-duty trucks in North America is projected to be 292,000 units in 2019, a 2% increase year-over-year. The industry enters 2019 with a record backlog and high visibility of production levels in the first half of the year. We expect our market share to be in the range of 32% to 34%.

In the medium-duty truck market, we expect market size to be 134,000 units, a 2% increase from 2018, with our market share projected to be in the range of 74% to 76%.

Our Engine shipments for pickup trucks in North America are expected to be flat compared to a very strong 2018.

In China, we project domestic revenues, including joint ventures, to be flat in 2019. We are currently projecting a 10% reduction in heavy- and medium-duty truck demand and a 7% reduction in light-duty truck demand. We expect our market share in the medium- and heavy-duty truck market to be in the range of 13% to 14% in 2018 -- excuse me, in 2019, up from 2018. Our share in the light-duty market will be 8% to 9%, up from 7%, with growth coming from our new joint venture in -- with JAC, which became operational in December.

There continues to be uncertainty around the adoption of national standard 6 in China this year. Our projection for industry truck sales to decline by 10% in 2019 assumes low industry demand for NS VI-compliant products, with adoption concentrated in urban-use vehicles for Tier 1 cities. In the event that the enforcement of NS VI standard accelerates adoption, we anticipate that overall truck sales could decline additional 10% below our current forecast, but our content per engine would increase.

Industry sales of excavators in China are expected to decline 25% from record levels in 2018. While 2019 demand will be down, it will still represent the third highest year of sales on record.

In India, we 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. Demand will be muted in the first half of 2019 as elections take place, but we expect strong growth in the second half of 2019, ahead of the planned implementation of Bharat Stage VI standard in April of 2020. We also expect 5% to 10% growth in construction and power generation markets as continued infrastructure investment drives incremental demand.

We expect to see growth in all of our businesses in Brazil this year due to improved economic conditions. We expect truck production to be up 13% in 2019 and power generation demand to increase 15%.

We project our global high-horsepower engine shipments to be flat in 2019, with a 5% improvement in new engine orders from mining customers as they replace aging equipment.

Demand for new oil and gas engines are expected to decline by 40%, with sales continuing at levels experienced in the second half of 2018, following robust fleet replacement in the first half of last year.

In summary, we expect full year sales to be flat to up 4% and EBITDA to be in the range of 15.75% to 16.25% of sales. The improvement in EBITDA this year will be driven by positive pricing, material cost reduction, lower warranty and variable compensation costs, partially offset by metal markets and tariffs.

We returned a record $1.9 billion in cash to shareholders in 2018 in the form of dividend and share repurchases and currently plan to return 75% of operating cash flow to shareholders in 2019 as well.

Before moving on to Pat, who will discuss our financial results in more detail, I'd like to take a few minutes to share some of the progress that's been made in our Electrified Power business unit this year.

2018 marked the full -- first full year of operations of our Electrified Power business unit. In 2018, we announced partnerships with on- and off-highway OEMs that are working on electrification solutions in products ranging from bus to medium-duty trucks, light commercial vehicles, excavators and drayage trucks.

Vehicles with Cummins electrification content were on display at several industry events. And to date, we have over 11 million miles of testing and development on vehicles with our Electrified Power technology. We have begun selling battery electric power train systems to Blue Bird for use in school bus market in the United States and are progressing toward launches with additional customers, including GILLIG, for transit buses later this year.

We are continually assessing and innovating across a broad portfolio of power solution, from diesel to natural gas, fuel cells, hybrid and fully electric options. We plan to provide our customers with the right technical solutions for their application at the right time and to continue to be the leader in power for commercial and industrial equipment.

As we begin 2019 and the 100th anniversary of our company, we continue to see the benefit of our leadership in diesel technology as well. The next generation 6.7-liter turbo diesel engine in Dodge Ram pickup trucks, boasts a first-in-Class 1000 foot-pound of torque and was announced at the Detroit Auto Show in January. The new lightweight Cummins X12 Engine will be available in a number of chassis in 2019, including several with Daimler Trucks North America.

Customer demand for our industry-leading ISX15 liter engine remains strong and we are producing at all-time record levels.

Finally, Amtrak announced on December 21 that it would be purchasing 75 charger locomotives for delivery starting in 2021, equipped with our QSK95 engine.

I want to close with a brief salute to our CFO, Pat Ward. Pat's outserved our company with distinction for more than 30 years, including the last 10 as CFO. Throughout his career, he's demonstrated a remarkable ability to identify the key areas to focus on, to drive improvement in the business and then to partner with our business leaders to deliver outstanding results. I'll miss Pat for lots of reasons, but most of all, because he's a committed servant, a trusted adviser and a great friend. Pat leaves behind a very strong finance function and has been working closely with Mark Smith to ensure a smooth transition. Congratulations, Pat, on your well-earned retirement. And also to Mark, as our new CFO.

Now let me turn it over to Pat for the last time.

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Patrick J. Ward, Cummins Inc. - VP & CFO [4]

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Thank you, Tom. Good morning, everyone. I will start with a review of our fourth quarter results before moving on to the full year 2018 performance and then finishing up with our outlook for 2019.

Fourth quarter revenues were $6.1 billion, an increase of 12% from a year ago and a record fourth quarter for the company.

Sales in North America increased 17% as a result of higher commercial truck production and improved demand for construction and power generation equipment.

International sales grew by 6%, mainly driven by stronger demand in Europe and the Asia Pacific from power generation and construction customers. A stronger U.S. dollar negatively impacted international sales by 4%.

Gross margins were 25.2% of sales, 10 basis points higher than a year ago. The positive impact of higher volumes, favorable pricing and lower warranty expense were offset by industry supply chain and operational costs along with a less favorable mix of sales in our Power Systems segment.

While selling, admin and research and development cost of $887 million increased by $36 million, with all the increase coming in research and development, they were 100 basis points lower as a percentage of sales.

Joint venture income of $79 million was $23 million higher than last year due to the absence of a $39 million tax charge related to the Tax Cuts and Jobs Act passed in December of 2017. Excluding that tax charge, earnings declined mainly due to weaker sales at our on-highway joint ventures in China.

Earnings before interest and tax, depreciation and amortization were $896 million or 14.6% of sales for the quarter compared to $769 million or 14% of sales last year.

As Tom just mentioned, included in the fourth quarter EBITDA results were a $24 million write-off of an investment in our very own electronic data logging company and a $44 million adjustment of mark-to-market losses incurred in company-owned life insurance investments which we used to fund our nonqualified benefit plans, reflecting the volatility experienced in markets -- in the financial markets in the fourth quarter.

Net earnings for the quarter were $579 million or $3.63 per diluted share and included a $0.43 negative impact from the 2 investment losses I just mentioned, partially offset by a $0.15 benefit related to the 2017 tax legislation and other discrete tax items. This compares to net earnings last year of $503 million or $3.03 per diluted share, excluding the $777 million in onetime charges related to tax legislation.

Our tax rate in the quarter was 14.1%, which included $51 million or $0.32 per share of favorable discrete tax items. Excluding the discrete items, the operational rate was 21.3% in the quarter.

Now let me comment on our full year results and provide some more details on our performance. Full year revenues for the company were a record $23.8 billion, an increase of 16% compared to the prior year. Sales improved in each of our operating segments, driven by higher commercial truck production in North America, strong demand in global construction and power generation markets as well as improved demand in oil, gas and in mining markets.

North America revenues increased by 19% in 2018 and represented 51% of our total revenues. International revenues improved by 12% with higher sales in most regions, including Europe, Brazil, China, India, Japan and Australia.

Gross margins of 24.1% were 90 basis points lower than last year. The $368 million after-treatment campaign built in the first half of 2018 and headwinds from currency and tariffs were partially offset by higher volumes, favorable pricing actions and material cost reductions.

Selling, admin and research and development costs increased by $156 million, with almost all the increase coming from increased investments in research and development, and were 160 basis points lower as a percent of sales.

Joint venture income increased by $37 million compared to last year. The 2017 joint venture income included a $39 million tax charge related to the tax legislation that I discussed earlier. Excluding that tax charge, 2018 joint venture income results were flat year-over-year.

Other income was $97 million lower than 2017 as a result of the mark to market losses incurred on company-owned life insurance investments, gains recorded on the sale of assets in 2017 and some foreign currency losses.

In total, EBITDA was a record $3.5 billion or 14.6% of sales compared to $3 billion or 14.8% a year ago.

Net revenues were $2.1 billion or $13.15 per diluted share, both full year records for the company. This compares to $1.8 billion or $10.62 per share in 2017, excluding the $777 million in onetime charges related to tax legislation.

The operating tax rate for the full year excluding $14 million of discrete benefits was 21.1% compared to 58% last year or 24.5% adjusted for the tax legislation.

Moving on to operating segments, let me summarize performance in the quarter and for the full year of 2018 and then provide a forecast for 2019. I'll then review the full year cash flow and conclude with the company's revenue and profitability expectations for the upcoming year.

In the Engine segment, revenues were $2.7 billion in the quarter, an increase of 18% from last year. On-highway revenues grew by 17% from higher heavy- and medium-duty truck engine sales primarily in North America.

Off-highway revenues increased by 21% as a result of stronger demand for construction equipment in China, North America and in Europe. Segment EBITDA in the quarter was $393 million or 14.6% of sales. This compares to $271 million or 11.8% of sales a year ago. The improvement in EBITDA percent was driven by benefits from the higher volumes and from favorable pricing actions. So for the full year, revenues increased 18% from a year ago and EBITDA increased from 12.8% to 13.7% of sales.

For 2019, we expect revenues to be flat to up 4%, with growth in North American truck markets and improving demand in Brazil, partially offset by a lower construction demand in China. EBITDA is projected to be in the range of 14.5% to 15.5% compared to 13.7% of sales in 2018, driven primarily by lower warranty expense.

For our Distribution segment, fourth quarter revenues were a record $2.1 billion, increasing 6% compared to last year. The growth in sales was primarily driven by stronger demand for power generation equipment and parts and service in North America, partially offset by reduced demand for engines in oil and gas markets. EBITDA for the fourth quarter was $140 million or 6.8% of sales. Compared to last year, the fourth quarter EBITDA margin increased by 50 basis points as a result of higher sales and favorable pricing actions, partially offset by the negative impact of a stronger U.S. dollar. For 2018, the Distribution segment delivered both record sales and EBITDA. Sales grew by 11% compared to last year and EBITDA increased by 13% to $563 million or 7.2% of sales.

We expect 2019 revenues in the segment to be flat to up 4%, primarily due to increased demand for parts and service in power generation in North America, along with favorable pricing, partially offset by the impact of a stronger U.S. dollar. EBITDA margins are projected to be in the range of 7% to 8% of sales compared to 7.3% in 2018.

For the Components segment, revenues were $1.8 billion in the fourth quarter, an increase of 14% from a year ago. Sales in North America increased by 23% due to higher heavy- and medium-duty truck production and the impact of the automated transmission business. International sales grew by 3% with lower demand in China being more than offset by stronger sales in Europe and in India. Segment EBITDA was $278 million or 15.7% of sales compared to $214 million or 13.7% of sales a year ago. EBITDA improved driven by the benefits from the higher sales, lower warranty expense and material cost reductions. For 2018, our Components segment delivered record revenue, which grew by 22% due to strong on-highway demand in North America, Europe and India, in addition to the impact of revenues from the automated transmission business. EBITDA as a percent of sales decreased from 15.6% last year to 14.4% in 2018, primarily driven by higher warranty costs recorded in the first half of the year. For 2019, we expect Components revenue to increase 1% to 5% as a result of growth in North American and Brazilian on-highway truck markets, partially offset by weaker demand in China. EBITDA margin is projected to be in the range of 15% to 16% of sales, up from 14.4% in 2018. Lower warranty expense will be partially offset by increased investment in preparation for the upcoming India Bharat Stage VI and China national standard 6 emission regulations.

In the Power Systems segment. Fourth quarter revenues were $1.2 billion, up 9% from a year ago. Power generation sales grew by 13%, driven by increased demand for power generation equipment in North America, Asia Pacific and in India. Industrial sales were unchanged compared to last year. EBITDA margins was 10.3% in the quarter, down from 11.3% last year. The EBITDA margin decline year-over-year is primarily due to the increased supply chain and operational costs that Tom referred to earlier along with a less favorable mix of sales and lower joint venture earnings.

2018 was a record year for our Power Systems segment in terms of revenues, which grew by 14%, primarily driven by increased demand for power generation equipment and stronger demand in mining and oil and gas markets. EBITDA increased by 49% to $614 million with margins expanding from 10.1% to 13.3% of sales, driven by the higher volumes, lower warranty expense and favorable pricing.

For 2019, revenues are expected to increase 3% to 7% with growth in data center markets, increased military revenue and higher demand for mining engines, partially offset by lower demand in oil and gas markets. EBITDA is projected to be in the range of 14% to 15% of sales, up from 13.3% in 2018, primarily due to the positive impact of stronger returns, stronger revenues and the benefits of actions taken in 2018 to rationalize the manufacturing footprint of our alternator business.

In the Electrified Power segment, EBITDA losses were $29 million in the fourth quarter and $90 million for the full year, in line with our guidance. For 2019, we expect the net expense of $120 million to $150 million as we continue to make targeted investments in this space.

And as Tom mentioned, we now project the total company revenues to be flat to up 4% in 2019. Increased demand in global for power generation equipment primarily at data centers and improvements in truck production in North America and Latin America drives the majority of the growth in revenue.

Foreign currency headwinds are expected to negatively impact revenues by approximately $300 million.

Income from our joint ventures is expected to decline approximately 5% as a result of lower demand for heavy and medium-duty trucks in China and in India.

EBITDA margins are projected to be between 15.75% and 16.25% of sales for 2019, up from the 14.6% recorded in 2018. We expect EBITDA margins in the first quarter will be at the low end for the year due to seasonally weak demand in our Power Systems and Distribution businesses. With reduced warranty and variable compensation expense along with pricing and material cost improvement will positively impact margins, partially offset by tariffs and investments in the automated transmission business, the Electrified Power segment and in Components, primarily related to China national standard VI and India Bharat Stage VI emissions.

We are currently projecting our effective tax rate to be 21.5% in 2019, excluding any discrete items.

Turning to cash flow. Cash generated from operations was $980 million in the fourth quarter and a record $2.4 billion for the full year. We anticipate operating cash flow in 2019 will be within our long-term guidance range of 10% to 15% of sales.

Capital expenditure for the full year was $709 million and we expect that our 2019 capital investments will be in the range of $650 million to $700 million.

In 2019, we returned a record $1.9 billion to our shareholders or 78% of operating cash flow. We repurchased almost 8 million shares and increased our dividend by 5.6%. Our capital allocation plans remain consistent with what we've told you previously. We will maintain a strong financial position to sustain us across cycles and variation in our business levels. We will focus on growth, targeting higher-return investments, both organic and inorganic. And for 2019, we plan to return 75% of operating cash flow to shareholders.

We are pleased with the record sales, EBITDA, earnings per share and operating cash flow in 2018 and the returns on invested capital were top quartile. That being said, there are clearly areas where we could've done better, and you can see from our guidance that we expect improvements in operating margins in 2019.

And just before I finish, I do want to thank you all for your interest in Cummins throughout my tenure as CFO. The company is in a very strong position, and I look forward to following Cummins' continued success as a shareholder.

Now let me turn it back over to James.

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James Hopkins, Cummins Inc. - Executive Director of IR [5]

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Thanks, Pat. (Operator Instructions) And if you have additional questions, please rejoin the queue. Chelsea, 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) And our first question comes from the line of Alex Potter with Piper Jaffray.

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Alexander Eugene Potter, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [2]

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I guess, first of all, it sounds like pricing had been a tailwind in 2018 across a number of your segments. You called it out, I guess, multiple times. Just wondering the extent to which you expect that to be a tailwind again in 2019. And which areas do you think the biggest opportunities are?

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Richard J. Freeland, Cummins Inc. - President, COO & Director [3]

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Alex, this is Rich. Yes, it was a tailwind in 2018. In fact, it will be a little bigger tailwind in 2019. And the primary areas where we'll be able to get some pricing is in the parts business and in some of our power generation markets. Again, some of that will be needed to offset the impact of tariffs that we have also coming in 2019.

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Alexander Eugene Potter, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [4]

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Okay. Also, I was wondering if you could comment on Nissan. You mentioned the big, that monster diesel engine you're putting in the Ram pickup. If you can comment, I guess, on both of those platforms, both Ram and Nissan, how those have, I guess, developed relative to your initial expectations and what the outlook is there over -- not just in 2019 but over the next couple of years, diesel penetration for that type of vehicle as well as Cummins' market share.

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Richard J. Freeland, Cummins Inc. - President, COO & Director [5]

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Okay. Thanks. Yes, let me start with the Chrysler. So yes, we're really excited about this. We're going to be in the lead in the torque that's with this Engine. And that market remains strong, it's going to -- it was 150,000 last year, and we see that continuing. I mean, we're -- basically, it's the supply chain trying to keep up to produce them. We will see that in Q1. It'll be the low point though, so it'll be lower than that run rate in Q1 as we go through the model year change and transition there and some issues, kind of, on working that up. But no -- we're excited and we're -- basically, the whole industry is trying to add capacity to meet the demand. On the Nissan front, that one still remains kind of below our expectations of what would be our projections. I'll just have someone correct me here, but we're in the 15,000- to 20,000-engine range for that, which has been relatively flat. So that one continues to -- has not gotten the traction that we wanted on the 5-liter V8. And so I'd say from a Chrysler standpoint, we see only upside in '19 and continuing as we continue to grow share. And in Nissan, relatively flat at the low levels.

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Operator [6]

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Our next question comes from the line of Jerry Revich with Goldman Sachs.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [7]

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And Pat and Mark, congratulations. Pat, we'll miss working with you. I'm wondering, Tom, if you can talk about the major electrification product milestones that you expect over the next year. You mentioned some of the highlights on a trailing basis. Can you just talk about the number of new platforms that you folks are going to be participating on over the next 12 months? What your win rate has been to get on additional platforms? And then any updated thoughts on when the revenue contributions here will accelerate? Obviously, you provided guidance for '19. But I'm wondering if your longer-term thoughts have evolved at all.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [8]

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Yes. Thanks a lot, Jerry. So big milestones this year, of course, are the transit bus launch with GILLIG. That's something we've been working to really since the beginning of the business. We see the transit bus market as kind of the -- maybe the most obvious adopter, the one where there are significant incentives in the cities to drive towards electrification. The application lends itself towards electrification, either pure BEVs or potentially with a small engine to get you back to base. So we think it's a good application for electric vehicles. So that's where we're targeting. The GILLIG launch is a big one. We've got a good order for that. So we're pretty excited about that and pretty focused on that.

I mentioned drayage trucks, and frankly drayage trucks have a very similar application in terms of they're relatively short range, pretty easy to charge, loads are pretty predictable. So we think that's another area that's going to go. We've got a launch partner there, I don't want to announce ahead of them. So I think those are really our 2 major platform milestones. And I've mentioned that we're already working with Blue Bird, and we are trying to get some more launch partners on the school bus side. All those just reflect the ones that we think will early adopt. And kind of, one level lower, Jerry, there's a pretty big milestone for us to have our battery pack that we're developing meet the performance standards at least for our first-generation that we're looking for. That's a pretty big deal too, so we've got a milestone related to our battery pack and then related to the entire electrical system launch.

Further out, there is a number of applications we're looking at. I would say that we are pretty strongly focused on these near-term milestones. There's a lot of development work going on. It's a big effort for us to get right. And then we'll look forward. And with regard to revenues, I would say we're still in, kind of, the market development phase. I would -- I'd be remiss to give you a good view on revenues. I think market adoption in the markets that I mentioned is likely to move with some steadiness. But still, I've heard people project that the transit buses, which again I mentioned is one of the best markets, might be 50% electric in 10 or more years. That's a long time, and that's for new buses, which means there's -- you've got all the diesel buses still selling. So I still loathe to call the transitions. I think what we're thinking about is trying to get our products ready to convert in these markets that are moving fast and then see what kind of adoption rates we get and then we'll start being able to call more of the financial side about what we think ramp or revenues. I know that's a little dissatisfying, it is to me anyway, but we're still trying to manage these launches and making sure that we're available and then we'll be able to figure out, kind of, where the launches go.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [9]

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Okay. Really appreciate the color. And on the X12, I am wondering if you can update us on any traction with additional OEMs. Nice to hear the data point on Daimler, how close are you to rolling out with the others? And do I remember correctly, you had spoken about that platform potentially adding 2 to 4 points of market share? Is that still the way to think about it when it's rolled out?

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Richard J. Freeland, Cummins Inc. - President, COO & Director [10]

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So, to date we've -- hi, Jerry, this is Rich. We've added Daimler. Of course, we'll let OEMs make their own announcements on that. But currently it is Daimler and some, kind of, smaller distributor OEMs that we've signed up.

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

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And Autocar, Rich. I think Autocar was also -- Autocar is the refuse specialty vehicle. And they are, kind of, using the ISX12 as the big launch vehicle for them and they're -- launch engine for them on some new platforms. And they're pretty excited about it, too. So I think that -- and it kind of fits -- the ISX12 fits their applications really well. So I think that will be another important launch for us.

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Richard J. Freeland, Cummins Inc. - President, COO & Director [12]

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Yes. So we're looking at close to 5,000 this year, Jerry. And so I think for the market share gain of the -- a couple of points, I still think that's out there. I think it's, kind of, a couple of years out there though where we need to add some more.

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Operator [13]

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Our next question comes from the line of 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 [14]

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Congrats to both Pat and Mark. Regarding the comment about North America. Tom, not to nitpick on the choice of words, but I thought it was interesting you said visibility to the first half of '19. Some of your key customers are saying visibility with the backlog, as large as it is, kind of late 2019. So I'm just trying to clarify how are you viewing the current backlog, how long it can carry us? What do you think of orders? And any thoughts around North American truck production in the back half of the year?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [15]

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I'll let Rich talk about that.

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Richard J. Freeland, Cummins Inc. - President, COO & Director [16]

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So I'll start and maybe you can chime in here, Tom. Yes, the backlog is big, right, it's close to 300,000 units. And we're projecting a 290,000 market with our projections. And so I think it's just -- our -- we might be being a bit conservative because it's -- it is strong through the whole year. We're just going to pay attention to what's going on with cancellations and, kind of, what's going on with freight rates. But I would say, we don't have any insight beyond that. It actually looks pretty strong, and I'd say there is growing confidence. We had projected a bit of a reduction in the second half of the year, a slight one. There is more and more confidence that could fill in though, Jerry. So we're just paying attention to it. So you know what our assumptions are, and that's what we try to do here.

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

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Yes. David, again, I just -- I think your question about the words is a good one. I -- we weren't trying to call a difference between us and the truck makers. It's just that we are always -- we've seen a lot of these cycles before, and we've seen sometimes when order board cancellations start, they can happen fast. We don't have any reason to think that's going to happen here and we're watching the truck orders, just like you guys are. And we've got 2 months of not such great orders, and we just want to keep our eyes on it. But we are planning that this -- as we said, that the year is going to be a good year. And definitely, the order board is full enough, if we don't see cancellations, that we'll have a terrific year.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [18]

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Okay. I appreciate the clarification. And also on truck in China, I mean, we all know you're not that exposed to the dump truck market, you're more about freight, flatbed. So within that industry baseline view you have of down 10%, where are you more exposed? the freight haul, kind of, flatbed market? Can you help us with the mix? Like how do you view that market, which is obviously a little more relative?

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

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We're not forecasting a big mix shift year-over-year. I mean, again one of the things that happened is in China, they're clearly stimulating construction growth. And there were also some changes in regs on -- inside the truck market which drove more of these construction trucks. So you've got stimulus and this change in regs, which drove this mix shift. It's pretty dramatic. I mean, normally the mix shift is just not something that we would call out. But frankly, these 2 things combined shifted a bunch. And as you said, our engines are more for these longer-range things. So we got negatively surprised on market share. I mean, that's what happened. And so we were disappointed with the market and market share. So we're thinking to ourselves that we're -- that there may be a little mix shift back because we won't have these special factors anymore. But we're not thinking that there's a big -- there's certainly not any negative trend. If anything, the market share trends should be -- I mean, the mix trends should be slightly positive for us. The big news in China really is how does NS VI get enforced? So what's going to happen with the standard? How tightly do they enforce it on the first day? We were thinking we were heading into a time where now all these enforcement -- they would be launched, they would all be enforced aggressively across the country. But because of the economic situation in China, it looks like that's not going to happen. And we're going to move back to some of those old enforcement plans where the cities will go first and things will move slower, which means we're going to be in a fair bit of uncertainty in the market, we think, for 12 or 18 months while the NS VI stuff gets enforced over time. So that I kind of -- I think that's driving most of the uncertainty as opposed to the mix.

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Mark A. Smith, Cummins Inc. - VP of Financial Operations [20]

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And freight is pretty flat.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [21]

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Yes, freight is flat. Mark was just adding that freight is flat. So again, we're not calling for a disaster. We think things are going to continue to move along fine. But mix is slightly favorable maybe, is what we hope. Again, we didn't call it that well last year, but we think it's favorable this year. And we think that this NS VI thing is what we're really having to manage.

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David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [22]

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I'll pass the baton here, but just so we're level set here on if there is downside risk to the volume due to NS VI, how much is the offset of your content?

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

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Yes, that just totally depends on how it goes. But I guess our feeling is that to the extent we're exposed at all on revenue related to the market, that'll be to our benefit in the long run. We think we gain share in NS VI, we think we gain content and margin in NS VI. So it's -- we think it's a win for Cummins the faster it moves. That said, to project does it mean we'd be down x points, it's really hard to say given the ways it could go. But let's just say that we would -- we're ready for it to be enforced as fast as it can go. That would be the best thing for us financially.

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Mark A. Smith, Cummins Inc. - VP of Financial Operations [24]

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And the content would be consolidated, 100% owned.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [25]

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Yes, where, as you know, the Engine sales, the JV versus the Components is 100%.

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Operator [26]

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And our next question comes from the line of 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 [27]

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I guess first question just on the guide. I know you've talked bigger picture headwinds, tailwinds in terms of price, cost, tariffs, warranty, incentive comp. Is there any way you can quantify on a basis point level, just so we can understand what your assumptions are there? I think your top line assumptions are reasonable. I just want to know what the other puts and takes are.

And then my second question, Tom or maybe to the whole team, as we think about the -- as we think about previous downturns, I think Cummins has always done a very good job supporting higher trough earnings through a number of different diversification initiatives or share repo or whatever. As we think about 2020 and if the downturn does come, what are the puts and takes we should be thinking about? Because as I think about this next downturn, I am more concerned investment costs are going to be higher and you're really only levered to help support EPS would be repurchase. And by the way, congrats, Pat and Mark. Sorry.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [28]

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Great. Great questions, Jamie. Thank you. And as you said, we are having a pretty forward stance on cash flow and repurchases, as we've had in previous times like this, where we think if we start to see a financial downturn ahead, we will be aggressive on making sure we support our stock and we're in a good position to do that and our cash flow will be strong. But I think just let me break the 2 questions. I'll have Mark kind of go through the detail that you asked about. I think he can do a good job of supporting that. And then maybe I'll have Rich talk a little bit about how we're posturing the company to approach a time when business is strong, but maybe over the horizon looks like a downturn. So Mark, I'll turn it over to you.

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Mark A. Smith, Cummins Inc. - VP of Financial Operations [29]

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Okay. So pricing is going to be about 80 basis points plus. Variable compensation, 40. Warranty, 140. Then we get to the less exiting part of the list, tariffs, takes away about 50 basis points; metal markets, 40. If you combine the pricing metal markets and tariffs, Jamie, that leaves you about neutral in all of those. And then slight tick up in research and a slight tick down in year-over-year earnings is the balance as China markets we model currently will be able a little bit lower. Those are the moving parts.

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Richard J. Freeland, Cummins Inc. - President, COO & Director [30]

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Okay. And just a little comment on how we think about the cycles, Jamie. Just internally, we talk about -- the mantra is you embrace the cycles, okay? You win the upturn, you win the downturn, which means that you have improved earnings at the trough and you have improved earnings at the peak. So we're committed to that. So you can imagine, given that we've had a good run in a lot of our markets, many of them are above replacement cycle, we have plans ready for a downturn. So we'll do what we always do which we'll flex down quickly when we see that's coming. And we already have plans in place to do that. We'll also look to structurally change the company through the downturn. So things you can't do when things are going fast on how we just change the way we structurally do business. So we have those things that we're thinking about. And then we will continue to invest in growth areas through the downturn when others don't. So we got a strong balance sheet. So we try to do these 3 combinations. When we come out of this thing, we come out stronger each time. So we're committed to continually improving. We commit to 25% decremental margins through the downturn, and we'll do that again. And then maybe I'll turn it to Tom just a little bit from a balance sheet and share repurchase, how we think about that.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [31]

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Yes. And again, we will continue to generate strong cash flow throughout the period. And so that -- we'll manage that through of course making sure that we don't spend more capital than we need to. And you saw we're watching that now as we see things leveling out and maybe heading down. And we'll continue to step up share repurchases where we think we don't need as much cash flow to invest. So those things are the things you've heard from us before. And I think what we're trying to do is make sure that each time we approach this, we capture the things that worked well on the previous downturn, improve the things that didn't work as well as we'd like. And the leadership team is already having significant discussions about that as we enter 2019. So our plan this year has steps -- has already taken steps anticipating this thing turning back down at some point. Again, we don't know when, as my conversation with David outlined, but we know it's coming.

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [32]

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Okay. Congrats again, Pat and Mark. And Pat, I'm sure you will miss these earnings calls. Thanks.

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Patrick J. Ward, Cummins Inc. - VP & CFO [33]

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Thanks, Jamie.

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Mark A. Smith, Cummins Inc. - VP of Financial Operations [34]

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Thanks, Jamie.

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Operator [35]

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Our next question comes from the line of Andy Casey with Wells Fargo Securities.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [36]

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Congrats, Pat and Mark. Tough act to follow there after Jamie's comment.

First, a clarification on the segment reporting basis. Were the $58 million write-down in mark to market recorded in eliminations?

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Patrick J. Ward, Cummins Inc. - VP & CFO [37]

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$24 million in eliminations, Andy; $16 million in the Engine business; and then the balance evenly distributed across Distribution, Power Systems and Components.

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

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And the reason, Andy -- a reason that some get distributed is because they just -- we take it -- we took the electronic logging device write-off as a corporate cost. And then we allocate across the businesses, right? That's why it ends up that way, spread across. It wasn't that the -- those businesses had anything to do with it. It just got allocated as part of corporate expense.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [39]

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Okay. That's helpful. And then just on China truck. You answered a lot of it in -- with respect to David's question. But are you looking for the full year drop to be driven mostly by the first half, with flattish performance in the second half?

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Patrick J. Ward, Cummins Inc. - VP & CFO [40]

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Say that again, Andy?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [41]

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On China truck, are we -- do we have a view about -- this, kind of, quarter-to-quarter seasonality view?

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Patrick J. Ward, Cummins Inc. - VP & CFO [42]

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Yes, still the same seasonality, weaker second half.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [43]

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Yes, the second half weakness really is driven by this NS VI anticipation, Andy. That's just a part that we're -- frankly, just -- it's not -- our visibility isn't so great. I mean, as I've tried to highlight. I mean, we have a view and it's as reasoned a view as you can get. But it's just going to come down to, do people think -- are people's adoption rates going to be faster or slower? And I think what we're saying now is we're saying that we think they're going to hit the Tier 1 cities, which will mean that there'll be very little volume effect. People -- there's just not that many trucks purchased for that, it's mostly buses and things, maybe refuse vehicles. So most of the trucks will remain to the old standard which means it will kind of truck along that steady freight rates with a small decrease. Where we see a significant move potentially downward is if people thought, hey, I -- the NS VI standard comes in, the price goes up a lot -- a fair bit and I think I'll just wait now. And of course, if people thought that's going to happen 1 month from now, they might buy more, coming in front. So these are the things that are acting against each other, plus a relatively weak economy. All those coming together are just making it difficult to predict. But right now, what we've got is steady first half, drop a little in the second half. And that's about as best we can do sitting where we sit down.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [44]

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Okay. Tom, and then one last one. Electrified power, the expected losses in 2019 are stepping up a little bit. I just want to make sure. Are we still looking for that same $500 million investment that you outlined in the '17 Investor Day?

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [45]

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Yes. No change in the overall investment plan. The run -- the expense run rate you're seeing is really -- so we have a fourth quarter run rate that we're, kind of, running across the year. So we have our teams staffed up now for those milestones I talked about. They are staffed, they are working towards delivery. We're not changing very much. We're just, kind of, sticking to it. As I mentioned, these milestones are big deals. We want to get those right, we're not trying to get distracted by a lot of other things. And so we still see that $500 million number to be okay. I mean, it's -- again, there's -- you can't predict it perfectly, but it feels like the right place for us still. And not too much change in what we're focused on and what we're doing. A lot of people are working hard though. I -- I'm giving it a pretty steady picture. But there is a lot of work going on to make sure that we get that battery pack where we want it and the overall electric vehicle system where we want it. And so I would -- they would -- those people would be sad if I said it was all smooth. They're working hard. But again, I think from an investment point of view, you should think on the same plan, on the same run rate, no change.

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Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [46]

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Great. And good luck again, Pat.

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Patrick J. Ward, Cummins Inc. - VP & CFO [47]

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Thank you.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [48]

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Thanks, Andy.

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James Hopkins, Cummins Inc. - Executive Director of IR [49]

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All right. Thank you, everybody. I appreciate your interest in Cummins today. And we'll be ready to take phone calls later this afternoon with everybody.

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N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [50]

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Thank you, everybody.

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Operator [51]

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