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Executives

Dean A. Cantrell - Director of IR

Tim Solso - Chairman and CEO

Pat Ward - VP and CFO

Tom Linebarger - President and COO

Analysts

Jamie Cook - Credit Suisse

Ann Duignan - JPMorgan

Henry Kirn - UBS

Andrew Casey - Wachovia Capital Markets, Llc

Seth Weber - Banc Of America Securities

Charlie Rentschler - Wall Street Access

Cummins, Inc. (CMI) Q3 FY08 Earnings Call October 31, 2008 10:00 AM ET

Operator

Ladies and gentlemen, and welcome to the Third Quarter 2008 Cummins Incorporated Earnings Conference Call. My name is Eric, and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session at the end of the presentation. [Operator Instructions].

I would now like to turn your presentation over to your host, Mr. Dean Cantrell, Director of Investor Relations. You may proceed, sir.

Dean A. Cantrell - Director of Investor Relations

Thank you, Eric. Welcome, everyone, to our teleconference today to discuss Cummins's results for the third quarter of 2008. Participating with me today are Chairman and Chief Executive Officer Tim Solso; our Vice Chairman, Joe Loughrey; our Chief Financial Officer, Pat Ward; and our President and Chief Operating Officer, Tom Linebarger. We will all be available for your questions at the end of the teleconference.

This teleconference will include certain forward-looking information. Any forward-looking statement involves risk and uncertainty. The company's future results maybe affected by changes in general economic conditions and by the actions of customers and competitors.

Actual outcomes may differ materially from what is expressed in any forward-looking statement. A more complete disclosure about forward-looking statements begins on page 3 of our 2007 Form 10-K and it applies to this teleconference.

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.

Before I turn the call over to Tim, I would like to remind you of our upcoming Analyst Day on November 12 in Charleston, South Carolina, There is still time to RSVP, my contact information is included in today's webcast presentation.

Tim Solso - Chairman and Chief Executive Officer

Good morning. I'm very pleased to report that Cummins had the best third quarter in its history. We believe 2008 will be the fifth straight year of record sales and profits. Other highlights from the quarter include the following:

All four of our operating segments had improved revenues with the largest percentage increases coming from Power Generation and Distribution.

Cummins Power Generation experienced significant growth in China, India, Africa, the Middle-East and Latin America compared to the same period in 2007. Cummins improved its market share in the North American heavy duty truck market. It now exceeds 45% year-to-date, nearly 9 points above last year.

The company continued to see strong international demand for its medium-duty truck engines, especially in Latin America. Joint venture income of $66 million was the highest ever for the third quarter.

For the fourth year in a row, Cummins was named to the Dow Jones Sustainability Index which represents the top 10% of the world's largest 2500 companies in corporate sustainability.

We are proud of the outstanding results our business segments are delivering, particularly given the challenges facing many companies in today's economy. One of the primary reasons for our continued run of record sales and profits is our global diversification.

In the last nine months of this year 60% of our sales came from outside the United States, compared to 52% during the same period last year. Geographic diversification has put Cummins in a better position to deal with market down turns then we were in the earlier part of this decade.

This is especially true in the Power Generation and Distribution segments which have done well for us. During the quarter, all four operating segments increased their EBIT versus last year and Power Generation and Components expanded there operating margins.

Power generations EBIT margin was 1.5 percentage points better than the third quarter of last. That performance is even more impressive because the segment had to deal with supply constraints as well as higher commodity costs.

Components also continues to face higher material cost but has made good strides in improving pricing and the manufacturing efficiency of its turbocharger and catalytic exhaust businesses. As a result, Components EBIT margins grew by 3 percentage points over a year ago. Components had an EBIT margin of 7.6% and it is making progress towards its target of 9%.

The Engine business also benefited from diversification in its end markets. It grew operating earnings year-over-year despite the 75% decline in the Dodge ramp pick-up truck market, very low RV and recreational marine sales and increased material cost.

There is not doubt we're entering a much more difficult economic environment. The last time we experienced these conditions was in the 2000 to 2003 timeframe, but I can say that in my 38 years with the company, we have never been in the better position to ride through uncertain times.

From our market perspective we have the advantage of geographic and end market diversification, increasing market share in most of our markets and the adoption of more stringent emission standards around the world. These standards create more growth opportunities for both our Engine and Component businesses which include our emission reduction technologies.

In addition to our markets prospects around world, our company is very strong financially. Our debt is less than 15% of our total capital. We have healthy cash balances, even if certain markets have decline such as our consumer businesses, our global operations continue to generate cash. And for additional liquidity we have $1.1 billion revolving credit line.

Despite these positive advantages and strong balance sheet, we are not complacent. We are well aware of the problems facing us because of the downturn and we've taken steps to deal with the troubled times ahead. For example, we have significantly cut discretionary spending, reducing hiring plans, including the reduction of temporary employees in the plants that have cut production, cut and delayed several major IT initiatives and postponed our capital spending capacity expansion in some areas. We can and we will do more if necessary.

We have been through challenging times before and know how to deal with it. We are very different company then we were as recently eight years ago. We are less cyclical, more diversified, more results oriented and committed to turning a greater share of our sales into profits.

Compared to last downturn, we have a portfolio of profitable joint ventures, a very successful distribution business and substantial market share increases in most markets. It is critical to our shareholders that we demonstrate solid financial performance regardless of economic circumstances and we will do this. This will positively impact our stock more than anything else we do.

Now I will turn the meeting over to Pat who will discuss in more detail the results from each operating segment and will also provide some initial insight into our end-markets for 2009.

Pat Ward - Vice President and Chief Financial Officer

Thank you, Tim. Our third quarter was strong, sales with up 10% and profits grew 24% compared to a year ago. Despite the expected material cost increases and further softening in some markets as economic conditions worsened.

As Tim mentioned our performance is closely tied to diversification in our end-markets and in geographic regions in which we compete. That does include our ability to weather downturns like we are experiencing in the North America consumer markets.

This diversification is evident in the performance of each operating segments. I will start with Power Generation which continues to deliver excellent results. Revenues were up 14% and segment profits increased 30% as price realization, favorable volume leverage... unfavorable volume leverage more than offset higher material costs.

Demand in the commercial, rental and alternative businesses remained strong. International sales were up 29%. However North America was down 15% largely due to the 34% drop in the consumer business. For the full year we expect Power Generation to exceed its target EBIT margin, with sales predicted to be up 15% to 16% and segments earnings above 11% of sales.

Looking at next year, we anticipate Power Generation demand will continue expanding globally. With lead times for units of above one megawatt exceeding12 months, we are well positioned in the following markets; infrastructure development in the Middle East and China, the data centre expansion in Europe and India and distributed generation projects for oil and gas fuels in the CIS and the Middle East and power shortages in South Africa and Latin America.

In our Distribution segments, revenues this quarter were up 47%. The increase is primarily due to organic growth in all product categories and in every geographic region. Acquisitions in North America added $80 million to revenue this quarter.

Distribution segments earnings increased by 33%. Gross margins and operating expenses measured as a percent of sales improved year-over-year. However profitability was negatively impacted as a result of currency translation related to the strengthening of the U.S. dollar during the quarter.

We are forecasting revenue for distribution segment to grow 42% to 43% over last year and the EBIT margin to be close to 11% target for the full year. This projected growth is based on continued strong demand for Power Generation and the industrial engines as well as aftermarket opportunities from the growth in engine population.

The Engine segment reported 6% higher sales and 3% higher profits, despite weakening on highway markets and higher commodity costs as well as investments for future growth.

We continue to benefit from share gains in the heavy duty truck markets in North America. Share now exceeds 45% year-to-date, nearly nine points above last year and is greater than 50% during August. In the medium duty truck and bus business the strength in Brazil and in Turkey and the share gains in the U.S. bus market offset softer truck demand in North America and Europe.

Pickup truck shipments to Chrysler were down 75% from a year ago. However, in September, there was a significant decline in dealer truck inventory to less than a 100 day supply. Overall, industrial revenues were up 19%, despite weaker demand in North America, construction engine sales grew 19%, mainly driven by infrastructure development in the emerging markets of Africa, China, India, Russia and Brazil.

Agricultural engine sales were up 26% with growth in North America and overseas. Commercial marine engine sales to support oil and gas demand in North America and Southeast Asia almost doubled. As a result of the weakening truck and construction markets in North America and Europe, and the strengthening US dollar, we are now projecting revenue growth at 10% to 11% this year and EBIT below the segment target at 7.5% of sales.

Looking into 2009, we continued to see opportunities for growth in the Engine segment despite that term economic environment. We forecast the North American heavy duty truck markets will increase 10% to 15% in 2009 with the opportunity of additional market share gains for us.

The Brazilian medium duty truck and bus markets are projected to deliver modest growth as agriculture demand expands and general economy grows and with lead times for the high horse power engine exceeding 12 months we expect a strong command from mining and commercial marine to continue.

However, construction demand will be flat as weaker demand in North America and Western Europe will be offset by modest growth in the emerging economies and we are not anticipating any recovery in the pickup truck and recreational vehicle markets until late 2009.

The Component segment afforded another quarter of significant year-over-year improvement. Sales were up 8% and profits improved by 79%. Although still below the segment earnings target of 9%, we are very pleased with the profitability improvement from our emission solutions and turbo technology businesses in particular with price realization and increased manufacturing efficiencies.

Increased demand for Cummins diesel engines in North America led to 27% revenue growth in the emission solutions business. Demand in Europe was flat compared to a year ago. Revenues for the turbo technology business increased 9% driven by growth in the truck market in North America and China as well as pricing actions.

Fuel systems experienced 7% higher revenues, truck engine sales into North America and higher aftermarket demand more than offset low demand in Europe. Filtration reported flat sales. However excluding revenues from the exit of the Universal Silencer business last year, sales increased by 8%. All international markets reported growth over last year. Because truck OEM's in North America and Europe have announced recent production cuts, we're now forecasting revenues to be up 10 to 11%, slightly below our previous guidance. We project segment earnings of 7% of sales.

Overall for the company, we now expect revenues to grow 12% this year, below our previous estimates. This expectation reflects a softer truck and construction markets in North America and Europe. We project earnings before interest and tax of 10% of sales, which equates to 20% year-over-year growth.

As we discussed in July, we will be less profitable in the second half of the year for two reasons. First, because we lag the metal market industries by six months we will see higher material input costs. And secondly we anticipate a significant drop in joint venture income from China following the pre buy by in the truck markets. Both will impact our results in fourth quarter.

In addition our volume outlook for truck and construction market has weakened in recent weeks. And currency movements in Europe and Brazil are affecting our foreign operations and putting pressure on our margin through the end of the year.

We are also revising our 2008 full year effective tax rate downward to 32%. Congress retroactively extended the US federal research tax credit during October, meaning the tax rate adjustment from 33% to 32% will be booked in our fourth quarter results.

Before we open the teleconference to your questions, let me remind you how we are prioritizing our use of cash. One, we will maintain a strong balance sheet. We have reduced our debt to a much healthier level and our comfortable with our current capital structure in this uncertain economy. We still have opportunities to improve working capital.

Two, we will continue to invest in profitable growth opportunities. And three, we remain focused on returning value to our shareholders through both the share repurchase program and sustainable growth in our dividend.

As detailed on slide 16, we generated positive operating cash flow, actively purchased 1.4 million and increased our dividend by 40% during the quarter. At the beginning of the third quarter we increased the credit revolver to $1.1 billion, which now gives us total liquidity of nearly $2 billion.

As Tim mentioned earlier we have never been at better position to manage through the uncertainties ahead. We will now take your questions.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from the line of Jamie Cook with Credit Suisse. Please proceed.

Jamie Cook - Credit Suisse

Hi, good morning. My first question is just a clarification. I... on the slides, if you look at slide 17 and 18 when you're talking about guidance. You're saying revenues here are down. In your presentation you said up, 12 on the slide it says, down 12. And then I think the segment results, you also you're saying different things versus what's on the slide, can you just review what is right?

Tim Solso - Chairman and Chief Executive Officer

I am not following you here Jamie, I think

Jamie Cook - Credit Suisse

If you look at slide 18.

Tim Solso - Chairman and Chief Executive Officer

We tried to make sure, we vetted each of that, so that the slide was consistent with what we were saying publicly.

Jamie Cook - Credit Suisse

ell Slide 18, it says engine sales are going to be down... then too, I'm sorry I'm no it's...that's my fault, I apologize. All right let me get to my real question, your slides are right.

Tim, can you just address, if you look at your fourth quarter guidance that implies, based on what you are saying a 10% decline in EPS year-over-year for the fourth quarter and that's at a point where still the emerging markets and the commodity markets are holding together. Can you give us a sense on how we should, is there any...can you help us with how we should think about truck margins or truck EPS and what your expectations at the emerging and commodity markets are, as we look at over the next 12 to 18 months?

Tim Solso - Chairman and Chief Executive Officer

You are talking... the first question was a bridge for our earnings from Q3 to Q4.

Jamie Cook - Credit Suisse

Well, no I guess my point is in Q4 your earnings it looks like, you are going to be down 10% year-over-year and that's at a point where the emerging markets and commodity markets probably don't decline, they are still strong. So I'm trying a take if Q4 is only down 10% in terms of earnings, how I look longer-term at your business in terms of margins by segments because I'm assuming in '09 your sales are going to be... those markets aren't going to hold together which means earnings have to come down more dramatically for the full year versus the fourth quarter.

Tim Solso - Chairman and Chief Executive Officer

Well I mean we are not giving guidance for '09 so I can talk in generalities. We'll give more specific information in the teleconference for our fourth quarter results. I can just say that I think in the last month, the volumes have... particularly in certain markets have really changed significantly. And this is a very volatile time, so it's very hard to predict specific margins by business segment.

I can tell you that the Power Generation business is doing very well right now and as we look out for next year, we think that will continue to grow and we have order boards in certain segments that are basically filled for 2009. And Power Generation still remains very strong in the emerging markets for there is Brazil, China or India.

Our Distribution business will continue to do very well. The Components business that is tied to automotive markets, I think will have some decline although they are gaining market share. And then if you look at the automotive markets, both in North America and Europe, clearly they are in the state of flux. And we adjusted our heavy duty truck volumes from about 240 down to 200 and I understand yesterday ACT came out with a 175,000. So that kind of gives you an idea of just how much change is going on.

Jamie Cook - Credit Suisse

But is there any way you can help us, I mean we can make our own sort of assumptions on what the markets will do or what you said, your top-line will be by segment. Is there any way you can help us with how we should think about decremental margins by segment. Given, I mean you are a much better one run company this time versus pervious cycle. And I think we need to give you credit for that. But I'm just trying to figure out, how I should think out decremental margins based on my own volume assumptions?

Tom Linebarger - President and Chief Operating Officer

Jamie, it's a great question, this is Tom. I think again I just repeat what Tim said that we're really not, we're not done with our plan, we're not prepared to give guidance. And I think it would be mistake to just say, well we've reached this place in fourth quarter so there is only places there is only ways to go down. We still have in mind that our operating margin target is 10%. And we're going to do our best to come up with the plan and hit that. Again the environments really difficult. It's is not clear what we are going to be able to do.

But we have some things against us in Q4, like commodity costs and like the deterioration in joint venture income which may not repeat in same way through next year. So we are diverse company with a lot of market. So even as some are going to be weaker and some things are going against this, we expect some things that will be either improved on next year. So give us the chance to put that together and we will be able to talk more about where... how close we can get to our target and how we do in '09.

Jamie Cook - Credit Suisse

Okay and I will get back in queue. Thank you

Operator

The next question comes from the line of Ann Duignan with JPMorgan. Please proceed.

Ann Duignan - JPMorgan

Hi good morning, it's Ann Duignan.

Tim Solso - Chairman and Chief Executive Officer

Good morning Ann

Ann Duignan - JPMorgan

Good morning, how are you guys. I just wanted to clarify you outlook and your implied EBIT for Q4. I think there maybe some misinterpretation at that. You reiterated EBIT for the year at 10% and if we back into Q4, given what you've done year-to-date, it would imply that your EBIT is going to fall to something closed about 7.4%. Is that what you implied in your guidance or were you really trying to say that, you can still continue to deliver 10% EBIT despite the headwinds in Q4? Could you just clarify that first so we get it right?

Pat Ward - Vice President and Chief Financial Officer

Yeah, and this is Pat, let me try and clarify that. We don't expect our EBIT in Q4 to decline to 7.4%. That will decline from what you've seen in Q3 and will decline fully by over 2%. And let me walk through the four reasons why it will decline.

First of all as Tom just mentioned we will continue to see metal market pressure on the fourth quarter. We lagged the headline cost increases by around six months. So as we indicated in July, we expected that the second half of the year to see more of those costs and that will come through mostly in fourth quarter then in the third quarter.

Joint venture income will be done, and now will be down around at a half a percentage point. When you look as a percentage of sales and again that's consistent with what we said back in July too. Following, prebuy the Euro III implementation in China in July.

The two new areas I would describe this impacting the fourth quarter are the recent drop in volumes that we are seeing in truck and construction market in Europe and North America and some foreign exchange pressure that were seeing in Brazil and Europe.

So, combined those four areas, will amount to under 2% drop third quarter to fourth quarter. So you should expect somewhat in the 8% range, not the 7% range.

Ann Duignan - JPMorgan

Okay, that's great. That's wonderful. And that's exactly what we are looking forward. And then a follow up, can you talk a little bit about working capital. It looks to us like days on hand, day sales outstanding and days payables all deteriorated somewhat. Could you just walk us through what's happening there and whether that's just ones off or FX related or part of the acquisition of distribution businesses? Could you just help us understand what's going on in working capital?

Pat Ward - Vice President and Chief Financial Officer

Yeah this is Pat again. It got a little bit worse in Q4. We were disappointed with it in Q3 rather. I wouldn't say that it was much related to foreign exchange. I would say in most of that the growth we seen came through inventory. We've seen some growth in account receivable, but past years did not grow up significantly. They didn't grew up from around 7.5% to 8.5 and 9 % of sales. But at the end of the third quarter we had not seen a significantly lengthening in our receivable totals.

There was nothing significantly going on with accounts payable. So we will continue to look at our working capital as we have been trying to do over the past couple of years. But you are right, it remains an area that we have not yet met our target and we've got more work to do there.

Ann Duignan - JPMorgan

And just real quick if you could just clarify where you were disappointed on the inventory front, that would be helpful, which specific businesses?

Pat Ward - Vice President and Chief Financial Officer

I think it's pretty across the board, I think we seen inventory growth in that engine business. We have some supply issues impacted our ability to ship high horse power engines there to the end of the fourth quarter. We had some issues in our Components business and the Power Generation business. So, it was across the board, I wouldn't kind of point the finger at one particular segment.

Ann Duignan - JPMorgan

Okay. Thank you very much. I'll get back in line.

Operator

Your next comes from Henry Kirn with UBS. Please proceed.

Henry Kirn - UBS

Good morning, guys.

Tim Solso - Chairman and Chief Executive Officer

Hey, Henry.

Pat Ward - Vice President and Chief Financial Officer

Morning.

Henry Kirn - UBS

How much of the delta in your guidance is from currency changes, can you discuss a little bit what you would expect the impact of the strengthening dollar to be on your result going forward?

Pat Ward - Vice President and Chief Financial Officer

Going forward we are looking at the fourth quarter versus the third quarter of some what around 0.5% or 50 basis points, 40 or 50 basis points of deterioration and on margins. As couple of the currencies the Brazilian Real and the euro remain as weak as for they currently are against the dollar. Although that's moving again even in the last few days. In third quarter the currency year-over-year I think accounted for 2% of our sales growth and about $2 million or $3 million negative on the bottom line.

So if you look over the last couple of years currency has not been a significant issue at the bottom line and as I think we said to you before that has impacted favorably, some of the growth there at 3% or 4%, although this quarter was a little bit less than that.

Henry Kirn - UBS

How much of the reduction in sales came from currency changes?

Pat Ward - Vice President and Chief Financial Officer

Very little, I don't think it was much. If, you are talking--

Henry Kirn - UBS

In the guidance going forward?

Pat Ward - Vice President and Chief Financial Officer

Going forward? I think, we need to come back to you to give you specific answer. I don't have that number on hand just now.

Henry Kirn - UBS

Okay, and could you talk about the market respond so far to your decision to go with SCR for heavy duty engines?

Tom Linebarger - President and Chief Operating Officer

I think, this is Tom, the market response has been generally positive. The discussion that we've had with our OEMs about the advantages of the SCR technology, combined with EGR, I think has done well, our programs going well in terms of preparing ourselves, getting ready for launch, getting testing done, fuel test done and as a general matter, I think there is the potential for high reliable... reliability launch and good fuel economy has got the market excited. So as the general matter good response.

Tim Solso - Chairman and Chief Executive Officer

I would add that several of the large fleets that we have long standing relationships are also having a positive reaction. And some other concerns about the infrastructure round delivering urea seem to be going away. And so I think that generally speaking as Tom said we're ready and I think that the markets is going to respond positively to that.

Henry Kirn - UBS

Okay, thanks a lot.

Operator

Next question comes from the line of Andy Casey with Wachovia Securities. Please proceed.

Andrew Casey - Wachovia Capital Markets, Llc

Thanks, good morning everybody.

Tim Solso - Chairman and Chief Executive Officer

Good morning, Andy.

Andrew Casey - Wachovia Capital Markets, Llc

First question if we could go back to the near-term guidance, the foreign currency assumptions are they, as of the end of Q3?

Pat Ward - Vice President and Chief Financial Officer

Yes.

Andrew Casey - Wachovia Capital Markets, Llc

So, the impact might be a little bit more severe if they stay at current levels, is that right?

Pat Ward - Vice President and Chief Financial Officer

We would actually roll the forecast together Andy around the first week in October. So if they stay as high as they were last week possibly but again if you look at what's happening this week with the two currencies I talked about they are strengthening against the U.S. dollar.

Andrew Casey - Wachovia Capital Markets, Llc

Okay, thank you. And then on Brazil and Europe. What are you truck customers telling you to expect for truck volumes. It seems like it's moving on all over the place?

Tim Solso - Chairman and Chief Executive Officer

Brazil could be up somewhere around 20% this year and our plan is right now is that would not go up as much next year but somewhere around half that amount maybe 10%. That market remains very strong, and Brazilian economy is strong. It's driven by not only commodities but the agriculture boom that's going there. So and also in Brazil, we think there will be some energy shortages next year, so the power generation market will be available.

The European market construction is down on the automotive side, it's really been hit very hard. We have our medium duty engines go into the DAF truck as well as the Nissan truck in Spain. And we've gained some market, so we haven't seen the same kinds of declines that the overall market has, but we think that's going to pretty soft.

Power Generations still remains good particularly in the Eastern Europe. So the power generation market and our Distribution businesses are growing over there. So Brazil is going to be strong, Europe is mixed with probably more down than up.

Andrew Casey - Wachovia Capital Markets, Llc

Okay thanks and just to drill into the European truck piece for a second, without getting into the customers specific if you can just look at the market is it, are you looking for something a little bit worse than normal as you go into '09 instead of that normal kind of tenish for a couple of years down and then things get a little better?

Tim Solso - Chairman and Chief Executive Officer

Yes, I think we have to, what we are hearing from European managers is that we should expect the commercial vehicle volumes in the European union to be down 15% to 20% in 2009.

Andrew Casey - Wachovia Capital Markets, Llc

Okay thanks, Tim. And then if we could look at, I know this isn't really relevant to the quarter, per se but that there is lot of buzz around ownership structure of something like vehicle area and does the fluidity in that meaning Chrysler, GM and all, does that affected to our CapEx plans for the 2010 and beyond timeframe?

Tim Solso - Chairman and Chief Executive Officer

No.

Andrew Casey - Wachovia Capital Markets, Llc

Okay thank you.

Operator

Your next question comes from the line of Joe Otis [ph] with Buckingham. Please proceed.

Unidentified Analyst

Good morning, how is it going?

Tim Solso - Chairman and Chief Executive Officer

Hey, Joe.

Unidentified Analyst

Just two things one can you talk a little bit about the pricing discussions that you are having with customers around 2009, you are seeing a lot of reluctance on their side to expect some more raw material increases or they are going along with it just a characterization?

Tom Linebarger - President and Chief Operating Officer

Hi, Joe, it's Tom, as you know that there if there is a wide variety of markets and it's very difficult to answer in general. But much of our stuff in the truck markets, our pricing with OEMs is under agreement. So, the agreements allow for some price increases and we have those, but those are fixed and those that don't allow, don't allow. And then with regard to some of the other stronger markets like in the high horsepower, industrial and power gen markets, we intend to increase prices again next year and we think we will able to get them.

So it does range by market. But as a general matter we are continuing to push price across markets where we don't have agreements that prevent us from doing so. but there are quite a few of our market customers that are under agreement.

Unidentified Analyst

Okay.

Tim Solso - Chairman and Chief Executive Officer

Keep in mind Joe, as Pat indicated in his remarks we do see a lag from when the commodity industry moves to when did it actually flows through on our businesses and so we're feeling that increase in the material cost right now and that's part of the reason we're out there talking to our customers about price increases.

Tom Linebarger - President and Chief Operating Officer

Right and that just seems like there could be a little bit of squeeze that will holds on a little bit longer than just the fourth quarter.

Tim Solso - Chairman and Chief Executive Officer

I think, I mean pricing discussions, Joe are always difficult in particular big OEM's, it's never an easy discussion and it won't be easy in this environment and it wasn't easy in any other environment. But that's just the environment we live in and we work it all the time.

Unidentified Analyst

Right, got you. And you got some good backlogs too. Can we zero in on China, do you sense any structural changes there? Or is that more just a post Olympic hangover, just a sense there?

Tim Solso - Chairman and Chief Executive Officer

Well, again you can see different numbers, but our assumptions are that the China market is going to continue to grow around 8% and there will be continued investment in infrastructure which plays in our hand. So, we are going to grow our China market. Right now, we're thinking we'll grow in another 20% next year. As Tom said, the truck market, I think may be was passive, the truck market is soft right now because of the EURO III, the change to EURO III but we think that will recover.

Power Generation still remains good. Our components businesses are growing over there. And our distribution business is growing over there and then we have our fulltime joint venture which will be producing engines at the end of 2009. So, that will be a new business that we are going into. So, again I think China and India and I was on the road few weeks ago, there were a lot of questions about that. But, we're seeing really strong business in both countries, both now and looking forward.

Tom Linebarger - President and Chief Operating Officer

Joe, we have regular reports as I am sure you have it. There are some sectors in China which are feeling there... in the South where the lot of export oriented companies are. There is no question that their business is dropping. There is a lot of articles about that, about if you even heard about playoffs and things like that in some of those industries. So, there is no question that some industries are going to do worse and that may affect regions of the country, and Joe Loughrey and I are going next week to China and we will get a much better on the ground feel for where things are but Tim's high level comments about how we are thinking about it. Its growth rate is going to slow but still high relative to other economies is kind of where we are planning today.

Unidentified Analyst

Great. And I'm just sorry for the last one. On free cash flow in 2009 can you just talk about some of the leverage you have to keep that growing, or reducing inventories and other sorts of things? Thank you.

Tim Solso - Chairman and Chief Executive Officer

Well, we are as you guess doing a lot of work on our '09 plan to make sure that we can both capture the strong markets that appear to still be there but be very prudent in environment wins both in terms of our spending and our growth and hiring and things like that we are doing significant reductions in those. We're also though looking at our cash flow and thinking about what kind of opportunities we have to reduce capital or postpone capital.

We do still the growth prospects for the company to be strong over the long run, so we're wanting to make sure that we make needed capital investments that represents platforms for growth, but places where capacity may might not be needed. I assume we'll definitely be delaying investments and we're going through line by line to figure out how we can reduce capital and Pat and I've been going through that now for several weeks and we'll going through for several weeks more. I'm pretty confident we will be able to reduce capital spending.

Working capital as Pat mentioned is a really big opportunity for us. We're definitely not where we want to be in terms of our inventory turns and some of those other kind of operating issues. But also as if volumes do start come down in some of our markets that is typically where our company can begin to rein in working capital. So we have both expectations with regard to just a normal operating as well is to improve performance in working capital that we think we'll reduce our cash use in '09.

Unidentified Analyst

Okay. Thank you very much, that's great.

Operator

Next question comes from the line of Seth Weber with Banc Of America. Please proceed.

Seth Weber - Banc Of America Securities

Hi thanks. Good morning everybody.

Tim Solso - Chairman and Chief Executive Officer

Hi Seth.

Seth Weber - Banc Of America Securities

On the power gen business, can you give us a sense on how... how secure is that order book. Some of the drivers that you said in prepared comments talked about strength in the Middle East or oil and gas markets, is that a market where you typically take deposits or do you ever do you see cancellations in that space, can you just flush that out little bit?

Tom Linebarger - President and Chief Operating Officer

Seth, it's Tom, it is a good question, the order boards are so long and they are not secured by deposits, they are basically secured by the fact that because the markets been sold out for so long people are low to give up slots, they are low to delay or cancel for fear that it will take them a long time to get their generators. I'm talking about large ones in particular here.

So that has kept people staying in line and not delaying even if you know other parts of their project might be delayed. But there is always the possibility that as market softens that order board shortens up because there is no payment that they have to make for cancellation.

So we keep a really close eye on that. We, as most of our products are sold through our distribution system and it's very close to the market and understands when things might be getting softer. So we regularly look at that and we'll be watching it really closely. The other thing I'd say is that, well Pat and I put together our plans for 2009 which do show still good growth in Power Generation and Distribution. We're having each of our business units put together a continuity plan as well. So that if indeed, volumes do start to soften we know exactly what we are going do to reduce cost accordingly so we can still put together a good profit performance for the year. So we've done that before, we know how to do it, we're going to do it again and we're going to have those plans ready even before we enter '09.

So, I don't anticipate that our gen volumes will soften but they could and if they do we will be ready.

Tom Linebarger - President and Chief Operating Officer

And Seth, in such an addition on the opposite end of the spectrum in the low KVA product that we've been selling... a new product offering that we've been manufacturing out of India and selling into a lot of the telecom markets. We've had very strong success with that product launch and in fact that size of Genset is in high demand and another area where we are trying to manage through long lead times to respond as the market opportunity that we see in the lot of the telecom markets outside of the U.S. as well.

Seth Weber - Banc Of America Securities

Okay, thank you. And if I could ask you a follow up to Pat, can you may be just walk us through the pricing versus input costs you know, parity versus... by segment are we... is it possible to talk about each segment you know where you are at parity where you are below?

Pat Ward - Vice President and Chief Financial Officer

Let me talk first of all from an overall Cummins prospect and then we can dive into a couple of individual segments. I think that the guidance that we gave back in July we are still pretty consistent with, that from a net basis I think we said a 150 basis point, 1.5% of sales is going to be the year-over-year impact on commodity cost.

Going through by segment, I think the engine business and components in particular are the two segments that are seeing most of that impact in 2008. Power generation has managed do a pretty good job in pricing; I don't think there will be an over lay stretch by the fuel cost as much as the other two.

So the Engine segment currently and the Component segment currently are the two there because they don't have the ability to up price as quickly as their colleagues in Power Gen are probably suffering more at this time than the other. And as we go into 2009 we'll have an opportunity to recover some of that with pricing.

Seth Weber - Banc Of America Securities

Okay thank you very much.

Operator

Your next question comes from the line of Charlie Rentschler with Wall Street Access. Please proceed.

Charlie Rentschler - Wall Street Access

I want to go back to Chrysler, can you comment on the status of the light duty engine program in Columbus, Indiana? Is that continuing as planned?

Tim Solso - Chairman and Chief Executive Officer

Yes.

Tom Linebarger - President and Chief Operating Officer

Yes.

Charlie Rentschler - Wall Street Access

Okay, and secondly, could you comment about where you see your share of the U.S. heavy duty engine market going over the next 14, 15 months?

Tim Solso - Chairman and Chief Executive Officer

As you know Charlie we've been running low 40's to mid 40's recently now and we do think we have some opportunity to grow that across 2009 not a whole bunch more, not at the same rate we've been, but we do think we can grow it based on just engineering our engines into a few places left in heavy duty market, where there were still some Caterpillar engines been sold.

But as a general matter we expect to get our share up in that same... little about 45 through the year and maybe little bit beyond that. And then mid range truck a little bit more opportunity, although our share grown a lot, this are more applications where with agreements we already have in place would be out engineering our engine into more applications within those OEMs and grow our market share.

So, we expect both to grow in '09 but more in mid range than in heavy duty in terms sheer market share numbers.

Charlie Rentschler - Wall Street Access

Can I skip back to your answer to the question which seem to come up pretty quick, but that those engines were supposed to be coming off the line end of next year, early 2010?

Tim Solso - Chairman and Chief Executive Officer

2010 that's right.

Charlie Rentschler - Wall Street Access

2010, but everything seems green so far?

Tim Solso - Chairman and Chief Executive Officer

Yes.

Charlie Rentschler - Wall Street Access

Okay.

Operator

And your next question comes from the line of Eli Lustgarten with Longbow [ph]. Please proceed.

Unidentified Analyst

Good morning.

Tim Solso - Chairman and Chief Executive Officer

Good morning.

Unidentified Analyst

There are lot of things you never go through. Couple of clarification, one, what is the actual shares outstanding at the end of the quarter, is was roughly 195ish?

Tim Solso - Chairman and Chief Executive Officer

196 I think is the number.

Unidentified Analyst

196. And your tax rate because the 32% implied the 29, 30% tax rate in the fourth quarter. Are we assuming 32% for next year too?

Pat Ward - Vice President and Chief Financial Officer

We give that guidance in the fourth quarter earnings call.

Unidentified Analyst

Okay, and in the guidance you said in the Engine, the guidance for the year is actually the margins will be less than 7.5%? I think as what you said in the quarter, I'm not quite sure, that 7.5, it was less than 7.5% target.

Tim Solso - Chairman and Chief Executive Officer

Yeah, the engine business 7.5% is what I though I said, really I missed it--

Unidentified Analyst

Will be 7.5% or less than 7.5 equivalent?

Pat Ward - Vice President and Chief Financial Officer

Yeah, 7.5%, slide 18 is pretty full clear 7.5.

Unidentified Analyst

Will be 7.5, okay. And the implication was that Power Gen will have a reasonable chance of getting a double-digit gain in '09. Can you talk about [ph] what your comments were, you didn't talk about it?

Tim Solso - Chairman and Chief Executive Officer

Yeah, that's right.

Unidentified Analyst

Okay. And you talked a little bit about your SCR engines, I mean, you made some public comments you get at least 4% ten days ago, better fuel economy are you expecting to be better fuel economy kind of versus the current engine from SCR?

Tom Linebarger - President and Chief Operating Officer

Yes, we said up to 5% over the current engine.

Unidentified Analyst

Okay. And I guess during the comment you talked about you expect your heavy-duty truck to be up kind of 15% next year. And if this has to do ... you have a recession, you don't move freight, fuel economy is going up in '10, why would anybody buy, why would it need to be a prebuy role? Why wouldn't the 175 number for ACT which is down from I guess the 203 at this point, why wouldn't the market be down up to 10%, it's not going to be Mexico, and it is not going to exports to the same degree?

Tim Solso - Chairman and Chief Executive Officer

It's a good question, what ends up in the prebuys is very difficult to predict as you know, it's something that's... it's not a science. So, we don't exactly know what's going on the prebuy. We've been using the 200 as the planning number now for a couple of months. And we may adjust that planning number down, now that we're looking what the ACT has.

All we were saying in there is where we've been working with this 200 that's been kind of where, everyone's been for the while, the new number is out there and we'll take a look at it and see if we think that in fact if less of it's prebuy in fact the better it is for our industry participants. So, we'll be okay with that if is not a big prebuy to and we'll adjust our production and et cetera as we need to.

Unidentified Analyst

One final question, you keep talking you are going to get hit with costs at least for a while because you lag six months. We've had a... a premise [ph] of course it is unbelievable in the last couple of weeks. That would have come through at some points into your numbers also.

Can you talk about how you are looking out over the next year because why would you go... why would anybody give you a price increase if the cost is going to come down you have to give it back in a couple of months? I guess I am trouble in saying why it's surprising when the cost pressures are disappearing completely?

Tim Solso - Chairman and Chief Executive Officer

Again, it is important thing to think about there is again the market by market issue. From the point of view of cost you are correct. We are hoping to capitalize on the fact that some of the metal market prices are coming down. And some as you said pretty dramatically, so we hope to be able to roll that into lower input cost next year and there is bunch of volatility and then we'll see where we getting them. But we're hoping that, that's one of the good things that comes through in terms of our plan for next year.

And in terms of pricing we will be looking for price increases on the basis of the fact that we think we can sell value in whole bunch of markets. So some of that's linked to markets but a lot of it isn't. And then within our agreements your places that are purely on based on pricing agreements linked to metals, then some of those lag and that they would be adjusted to currency and some as you say wouldn't be if material comes down and then we lower the price there.

So its kind of a whole range of things, but what Pat noted to you was that in components and engines there is a lag and the input cost were mostly negative relative to price. If input cost come down the reverse should be true.

Unidentified Analyst

All right, thank you very much.

Operator

Ladies and gentlemen this concludes the Q and A session. Now I will like to turn the call over for closing remarks.

Dean A. Cantrell - Director of Investor Relations

Okay thank you. Once again if year-end is any question that you have I'll be in throughout the day. And once again I would also encourage you to RSVP for the upcoming Analyst Day, that's less than two weeks in Charleston, South Carolina where we will talk about the component segment in more detail.

Thank you once again.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day. .

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Source: Cummins Inc. Q3 2008 Earnings Conference Call Transcript
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