康明斯 (CMI) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2013 Cummins Inc. earnings conference call. My name is Ian. I'll be your operator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference.

(Operator Instructions)

As a reminder this call is being recorded for replay purposes. I would like to turn the call over to Mr. Mark Smith, Executive Director of Investor Relations. Please proceed, Sir.

Thank you, Ian. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the first quarter of 2013. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; President of our Engine business, Rich Freeland. We will all be available for your questions at the end of our prepared remarks.

Before we start please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Security Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement and the slide deck in our filings with the Securities and Exchange Commission, particularly the risk factors section of our most recently filed annual report on Form 10-K and any subsequently filed quarterly reports on Form 10-Q.

During the course of this call we will be discussing certain non-GAAP financial measures and we refer you to our website for the reconciliation of those measures to GAAP financial measures. Our press release, with a copy of the financial statements and a copy of today's webcast presentation, are available on the website at www.cummins.com under the heading of investor and media. With that out of the way, we will begin with our Chairman and CEO, Tom Linebarger.

Think you, Mark. Good morning. I will start with a summary of our first quarter, including comments on performance of our businesses. Then I will talk about our outlook for the full year. Pat will then take you through more details of our first quarter financial performance and our full-year forecast.

As anticipated, we experienced weak demand in a number of our end markets and geographies in the first quarter. Revenues were $3.9 billion, a decline of 12% year-over-year. EBIT for the quarter was 11.1% of sales compared to 14.7% a year ago. Excluding the impact of acquisitions, all four businesses delivered reductions in SG&A costs for both year-over-year and sequentially due in part to the restructuring actions we implemented last quarter.

The Components segment delivered very strong results this quarter, delivering record gross margins despite revenues being down 7% year-over-year. EBIT was 11.7%, down from 13% a year ago due to lower volumes and higher research and development spending to support future growth. However, EBIT percent improved 280 basis points from the fourth quarter due to higher volumes and overall cost improvement. We expect that the Components segment will continue it's strong performance this year, as demand in on-highway markets in North America improve from first quarter levels. We have raised our full-year EBIT guidance for the Components segment, as Pat will cover in more detail.

First quarter revenues for the Distribution business were flat year-over-year. EBIT margins at 12.2% increased 10 basis points compared to a year ago and improved 140 basis points sequentially, due to a strong mix of aftermarket revenues. Our full-year EBIT guidance for Distribution is unchanged.

The Engine business experienced the most significant decline in demand, with unit volumes down 18% year-over-year and revenues lower by 19%. Unit shipments of high horsepower engines declined by 24% due to weakness in mining, oil and gas, and Power Generation markets. EBIT margin for the quarter was 8.5% compared to 13.3% a year ago. Engine business margins were negatively impacted by the lower volumes, especially the sharp decline in shipments of high horsepower units, as well as higher warranty costs.

Performance in our Power Generation business fell short of our expectations the first quarter. EBIT margin was 6.8%, down from 9.7% a year ago and the lowest level since the first quarter of 2010. As a result of the weak performance in the first quarter we have lowered our guidance for Power Generation for the full-year. However, we have not changed our expectations for the business for the rest of the year, as we believe Q1 was a low point.

In total, while we have adjusted our guidance up for Components and down for Power Generation, we are not changing our overall guidance for the Company. We still expect revenues to be flat to down 5% for the year and we still expect to deliver EBIT in the range of 13% to 14% of sales. Now I want to talk in more detail about our sales and our key markets.

As I said, overall Company revenues declined by 12% in the first quarter, with revenues in North America declining 15%, international revenues declining 10%. In North America our revenues were most heavily influenced by a decline in on-highway markets. Our shipment of engines for North American heavy-duty trucks were 19,000 units in the quarter, a decrease of 37%. Demand declined as our industry continued to run at lower production levels following a period of overproduction in the first half of 2012. Retail sales for the industry have exceeded industry production for the last six months and OEM backlogs are increasing. We do expect to see sequential improvement through the year, driven largely by replacement demand. For the full-year we are adjusting our forecast for the market size to 233,000 units, down from our previous forecast of 240,000. Our market share for the quarter was 41.6% through February and we are maintaining our full-year market share forecast of 40%.

We shipped 11,000 units to the US medium duty truck market this quarter, a decrease of 23% year-over-year. Demand is expected to increase in Q2 and beyond, as OEMs continue to ramp up their production of 2013 models. We continue to expect a full-year market size of approximately 109,000 units in 2013, an increase of 2%, and our market share to be approximately 52%. Demand from Chrysler decreased in the first quarter by 17% due to the planned model year changeover that started in January. For the full-year we expect shipments to decline by 10%, in line with our previous forecast.

Our international revenues decreased by 10% in the first quarter of 2013, with the most significant declines in Europe and China and relatively flat markets in Brazil and India. In the Brazilian truck market our unit shipments increased by 20% compared to very weak levels last year. We're raising our estimate of 2013 industry sales to increase 19% compared to our previous forecast of an increase of 15%. We continue to be cautiously optimistic about improvement in the Brazilian economy, although truck industry sales declined 8% in Quarter 1 and industry inventory increased by approximately 12% from fourth quarter levels. Continued growth in the economy and the availability of credit will be important factors determining full-year truck demand in Brazil. In total our revenues in Brazil declined 8%, with the improvement in the truck demand more than offset by the impact of depreciation of the real against the US dollar.

Moving to China, our first quarter revenues in China included joint venture -- including joint ventures decreased 11% year-over-year with the decrease due to lower demand in most end markets. Demand for excavators remained weak in the first quarter, with industry sales down 26%. We did observe a modest reduction in inventory levels at OEMs in the first quarter, but we continue to believe that it will take most of the year to normalize industry inventory levels. Our forecast for our own revenues in the construction market has not changed significantly in the last three months, with no growth expected in engine shipments this year. The truck market in China for medium and heavy-duty trucks combined declined by 12% in the first quarter, as uncertainty over the strength of the economy continued to impact the industry. The revenues of our Dongfeng Cummins joint venture were down 11%, in line with the market.

We expect a modest increase in orders for the second quarter. At this time we are maintaining our full-year forecast for industry sales to be flat year-over-year. Having said that, actual industry behavior is going to be heavily influenced by the final implementation rules for the new NS IV emission standard scheduled for July of this year. Just last week there was a meeting of the largest eight domestic truck manufacturers, the so-called C-Eight. And out of that meeting came a set of recommendations to the government on how to proceed with the implementation of NS IV regulations. We are still evaluating these recommendations. However, on first review it appears that the truck manufacturers are seeking a phased approach to NS IV implementation, which would likely defer widespread adoption of fully compliant solutions, including after treatment, to 2014. It is not clear at this stage what impact, if any, these recommendations will have on the government's approach to implementation of NS IV or even when the government will respond to these recommendations. As a reminder, our current forecast assumes slow adoption of after treatment in 2013.

Volume and revenues at our light-duty joint venture with Foton continue to grow in the first quarter, with revenues for the domestic market up 90% off a low starting point. We continue to have high expectations for the growth of our light-duty engines, both in China and in other markets. The joint venture is now consistently operating above breakeven. Power Generation revenues, including joint ventures, declined 13% year-over-year with the pace of industrial activity in China still relatively weak. Orders for the second quarter currently indicate a modest improvement with the -- from the first quarter and we expect the full year to be a least flat with 2012 levels. For the full-year we still expect total revenues in China to be up 5% with growth in light-duty engines driving the increase. First quarter revenues were in line with expectations and our current full-year forecast is unchanged. In addition to the market-specific factors I have discussed, uncertainty remains about the rate of improvement of the Chinese economy as a whole and we continue to monitor conditions in China very closely.

Business conditions in India have weakened further and we are lowering our outlook for the truck market. In prior calls I have discussed measures taken by the government to address the fiscal deficit that have not been helpful to truck demand. Road building has also slowed in India and overall confidence for capital purchases has weakened. Industry sales for the medium and heavy commercial vehicle market declined 33% in the first quarter. We are lowering our full-year view of the market and now expect a full-year decline of 14% compared to our previous expectation of a decline of 5%. In the Power Generation business we experienced an 11% growth in revenues in the first quarter driven by continued power shortages in the country. As a result, our full-year forecast is that revenues will grow by 10% despite weaker economic conditions, though clearly the outlook is more uncertain.

In Europe we experienced a 12% decline in revenues year-over-year with the Power Generation business most negatively affected. Power Generation revenues in Europe were down 45% with demand in Russia notably weaker in the first quarter. We do not expect revenue growth for our Components -- we do expect revenue growth for our Components business next year with the introduction of Euro 6 emissions regulations, but for this year Europe will remain challenging across all of our businesses.

I will conclude my market comments with an update on our mining business. Three months ago we predicted that our full-year revenues, including aftermarket, would decline by 25% for the full year. Actual first quarter revenues declined by 28%. Overall customer sentiment has been a little more negative over the last three months and our revised mining revenue guidance is for a decline of 27%. Not a significant change, but certainly we do not see any signs of improvement in the near-term.

Aftermarket revenues were down year-over-year, but in line with the fourth quarter levels. Although uncertainty exists in a number of markets, we do expect the first quarter marks a low point for revenues this year. And we expect to see sequential improvement in revenues driven most significantly by on-highway markets in North America, in which we have strong market share for Engines and Components, and by the construction market in North America. Power Generation demand should also improve from first quarter levels, driven mostly by seasonality and increasing demand in North America.

I've covered a lot of ground on markets, but before I turn it over to Pat, I would like to share some of the recent Company news that highlights the strength of our partnerships and our ongoing focus on bringing new products to market. At the Mid America truck show in March, we revealed the new integrated engine and transmission combination of a Cummins ISX15 engine and Eaton transmission that will deliver both improved performance and 3% to 6% better fuel economy for truck customers. Also at MATS we highlighted the new Cummins Westport ISX12 G natural gas engine that is now in limited production and is generating a lot of interest among end users.

At the recent BAUMA show in Munich we displayed three all-new off-highway engines. The new QSM 12-liter engine, the QSF 3.8-liter engine and the L 9.3 made at our Guangxi Cummins Engine joint venture. These engines are designed to offer leading performance and emissions at world-class cost levels for off-highway equipment. They're also the most recent examples of a strong pipeline of new products that will help drive strong profitable growth as our global markets improve. Thank you for your interest today and now I'll turn it over to Pat.

Thank you, Tom, good morning everyone. First quarter revenues were $3.9 billion, a decrease of 12% from a year ago, reflecting expected weakness across many markets and regions. As I said during the fourth quarter earnings call, we expected a tough first quarter and it came out pretty close to what we were thinking back then. North America sales, which represented 50% of our first quarter revenues, were down 15% from a year ago, primarily as a result of lower demand from on-highway markets and also continuing weakness in the oil and gas market. International sales decreased by 10%, driven by weak demand in both Power Generation and in mining markets. Compared to the fourth quarter of 2012, sales were down 9%. The decrease was driven by weakness in the North American bus market following the emissions change and in the Chrysler business due to the planned model year changeover, which occurred in January of this year. Mining revenues also declined sequentially as we had projected and we experienced normal seasonality in the Distribution and Power Generation businesses.

Gross margins were 24.4% of sales, down from 26.8% last year. The decrease was driven by the impact of the reduced volumes, unfavorable mix and higher warranty costs, partially offset by the benefit of improved pricing and lower material costs. Margins also decreased compared to the fourth quarter of 2012 due to reduced volumes and an expected increase in our warranty costs. Selling, admin and research and development spending was down $30 million from last year and down $7 million from the previous quarter. Both a sequential and year-over-year reduction in spending was concentrated in administration expenses.

Joint venture income of $82 million was down 21% compared to a year ago and was flat compared to the prior quarter. The year-over-year decline was driven by a lower contribution from our joint ventures in China and in India, where truck demand was lower compared to the first quarter of 2012. Earnings before interest and tax were $437 million or 11.1% of sales. This compares to 14.7% of sales last year and 12.4% in the previous quarter, excluding special items. And as Tom said, we expect this to be the low point of our performance this year. Earnings per share in the first quarter were $1.49 compared to $2.38 a year ago, with a tax rate of 27.6% in the quarter.

Now let's move on to the operating segments and further discuss first quarter performance and the outlook for the full year. All the numbers and comparisons exclude the $52 million pre-tax or $35 million after-tax restructuring charge that we took in the fourth quarter of 2012. In the Engine segment revenues were $2.3 billion, a decrease of 19% over last year. The decrease was driven by weak demand in on-highway and oil and gas markets in North America. And by a 28% decrease in global mining revenues. This weakness was partially offset by improving demand in the Brazilian truck market, where revenues were up 26% and across global agricultural markets. Compared to the prior quarter sales were down 8%. Sequentially, we experienced weaker demand for Chrysler and North America bus engines, along with weakness in mining and oil and gas markets. Segment EBIT of $195 million, or 8.5% of sales, was down from 13.3% last year, as a result of weaker volumes, unfavorable product mix, higher product coverage costs and a lower joint venture contribution. This was partially offset by improved pricing and lower material costs. Sequentially, the decline in volume, a more unfavorable product mix, the higher product coverage costs and increases in research spending resulted in lower margins. For the full year we continue to forecast that revenue for the Engine segment will be down 5%, driven by weakness in industrial markets, particularly in mining, partially offset by improved demand in the Brazilian truck market. EBIT projections for the full-year remain unchanged at 10% to 11% of sales.

In the Component segment first quarter revenue was $1 billion, down 7% from last year and up 8% from the prior quarter. Compared to the prior year, the lower revenues were primarily driven by reduced demand in the North American heavy-duty truck market and lower demand in Europe, partially offset by increased demand in Brazil. Sequentially, sales increases were driven by strengthening North American and Brazil truck markets. Segment EBIT was $119 million or 11.7% of sales, down from 13% last year. Continued technical investment on lower sales and higher coverage costs resulted in lower margins compared to a year ago. Compared to last quarter, EBIT margins increased almost 300 basis points on an 8% increase in sales. The sequential increase in margins was driven by higher volumes, improved pricing, and lower material costs. We continue to expect revenue growth around 2% this year, primarily as a result of increased penetration of after treatment systems in the North American heavy-duty truck market and growth in the Brazil truck market being offset by weaker demand in both Indian and European truck markets. We are raising EBIT projections for the full-year from 10.5% to 11.5% of sales to 11% to 12% due to strong gross margin performance. This compares to a full year 2012 margin of 10.8% of sales.

In the Power Generation segment first quarter sales were $746 million, down 4% from last year and down 2% from last quarter. Year-over-year we saw weakness in Europe and Russia, partially offset by increases in India and in our North American military business. Sequentially, we saw deterioration in Europe and Russia, partially offset by continued strength in India. EBIT margins were 6.8% of sales in the quarter, down from 9.7% last year. [Forward] volumes and unfavorable mix contributed to this drop in profitability, we also had some unplanned cost that negatively impacted margins, including warranty costs in our alternator business and some gas project costs that were higher than we expected. We expect to see improvement in the second quarter as these costs don't repeat and volumes improve sequentially. EBIT margins were slightly lower than those reported in the fourth quarter as a result of higher product coverage costs, partially offset by reduced administration expenses and increased pricing. For 2013 we continue to expect sales to be down 3% compared to last year, primarily due to weakness in Europe and in Russia. We are lowering our EBIT projections for the full year from a range of 9% to 10% to a range now of 8.5% to 9.5% of sales.

For our Distribution segment, first quarter revenues were $778 million, an increase of less than 1% compared to the prior year and a 14% reduction compared to the prior quarter. During the quarter the Distribution segment acquired a North American distributor, which added revenue of $21 million. Excluding acquisitions, first quarter revenue decreased 11% compared to the prior year and 17% sequentially. In both comparisons organic growth was lower due to weaker demand in Power Generation markets in Europe and in Russia, North American oil and gas markets and global mining markets. EBIT margins for the quarter were 12.2%, flat with margins a year ago, with positive mix being offset by reduced joint venture contribution and higher selling and administration expense, which were both impacted by acquisitions. Compared to last quarter, EBIT margins improved by 140 basis points, driven by positive mix and higher joint venture contribution. For 2013 we continue to forecast 10% growth in revenue over the prior year, including the impact of acquisitions, and expect EBIT margins in the range of 11.5% to 12.5% of sales.

As Tom mentioned, we continue to project total Cummins revenues to be flat to down 5% in 2013, with sequential improvement throughout the year driven mostly by recovery in the North American on-highway markets, with modest improvement in a number of international Engine and Power Generation markets also contributing to higher revenues starting in the second quarter. We continue to project EBIT margins for the Company will be in a range of 13% to 14% of sales compared to 13.6% last year. And as we discussed on the prior quarter's call, for the full-year we expect pricing to add 50 to 100 basis points of margin and lower material cost to also benefit margin by 50 to 100 basis points. These will help offset the headwinds from lower volumes and unfavorable mix, as well as some higher product coverage costs. We are now projecting a tax rate for the year to be around 29.5%, excluding any discrete items. The increase in the rate over last year and over previous guidance is due to changes in the geographic mix of forecasted earnings.

Finally, with regards to cash flow. We produced $428 million in cash flow from operations in the first quarter. We did increase inventory levels in the quarter. In the fourth quarter of last year we knew that some parts of the business would have very low volumes at the start of the year. For example, in our manufacturing plant that supplies Chrysler. We knew that with the model year changeover, volumes would be very light at the start of the year, so inventory levels were cut by at the end of the fourth quarter. Also in some parts of our business we expect the second quarter demand will be higher than first quarter. For example, parts of the Engine and Components businesses that supply on-highway markets in North America. Inventory has increased in those locations. In the parts of the business with the weakest outlook for the year, for example in our high horsepower engine business, we have made good progress in reducing inventory and continue to reduce inventory levels throughout the first quarter. There are always opportunities to improve inventory management. And we are not suggesting it was perfect globally and we do expect inventory and working capital metrics to improve as the year progresses. Overall, we did reasonably well in managing cash flow in the first quarter.

The Company's financial strength is reflected by a Single A credit rating from both Fitch and from Standard & Poor's. In addition Moody's recently upgraded our unsecured debt rating to Single A3 status. The strength of our balance sheet allows us the flexibility to continue to invest back into the Company and also return value to our shareholders, even during periods of volatility. As we discussed on our last call, we expect to invest $850 million in capital expenditure projects this year. We announced a new $1 billion share repurchase program last year and have started to repurchase stock in April and we will continue to do more in the second quarter. Over the last three years we have almost tripled our dividend and remain committed to further increases in a stable and sustainable manner. We are well positioned to continue to return cash to our shareholders in addition to funding our organic growth plans.

The first quarter results represent an expected trough in both sales and profitability for the Company in 2013 based on our current view of global markets. Although revenues were down across most major markets, there are signs of improving demand from these low levels, particularly in on-highway markets in North America, where we continue to have a very strong market share. Now let me turn it back over to Mark.

Thank you, Pat. We're now ready for questions. Please limit yourselves to one initial question and one related follow-up and then rejoin the queue. Operator, we are now ready for questions.

(Operator Instructions)

David Leiker of Baird.

One item first and then to follow-up on that. It sounds like this first quarter results were as you expected to fall in the quarter. Is that accurate?

Yes.

And then if we look through the balance of the year, it looks like most of your end market assumptions really don't assume any sequential improvement in demand. Year-over-year you have comps, but sequentially it seems like you're expecting something pretty similar to what we saw here in the first quarter? Maybe North America truck better, just given where the build rates ended up there.

I think if you look to the guidance we have given for the full-year, David, that we do expect sequential improvement in revenues beginning in the second quarter. And we think that will help provide a platform for improved margin performance for the Company throughout the remaining three quarters of the year.

The first quarter, as you mentioned, was expected to be low and as we want through the quarter it was encouraging to see that that performance, both at gross margin level and an EBIT margin level improved month after month. We started off at close to 10%. We finished off the quarter close to 13%. So, that made me feel good that we've got momentum going into the second quarter that can carry us forward towards this guidance.

Maybe it's more accurate to say given the current level of demand that you are seeing here in April. Things generally are sequentially at the current pace, is that fair?

Yes, that's generally fair. The only thing I guess I would add is that, as I mentioned in my remarks, power gen was lower in margin than we expected., That was the one that -- I get a discipline onto a number of items that occurred in the first quarter we did not expect. But overall revenue levels for them, even for them, we thought were right. The second thing that happened, as Pat was mentioning, our January was weaker than we expected. We had a lot of bus orders and other pre-buy orders at the end of last year.

I will let Rich give you more details on that. It just slowed down our first quarter and, as I talked about in my remarks, mining weakened even a little bit further. So, things were weaker in January, but again as Pat said, we really started to strengthen through the quarter and began to look more like we expected in total for the quarter with the right trajectory.

Now we are expecting sales to improve Q2 through Q4, as we had planned and again it's not major market recoveries.

I guess what I was trying to get at --.

Yes, it's not. It's North America, as we said, people were basically producing below demand and now they are going to step up and go just a little above demand. We have seasonality in power gen. So, there is nothing dramatic, but the results across all those markets is a reasonably decent step up in sales, as expected, and without this major adjustment in January that we had to fight through.

Those things combined lead to better results. We also, of course, finished all of our restructuring actions. Those are all through. We're seeing benefits of those in our expense line. So, we feel pretty good about the margin step up we have laid out through the quarter.

What I was trying to get at is that when you look at some of these end markets for other industrial companies, there's expectations that the second half is significantly better than the first half. Look at Eaton's estimate for Q4 North America truck production at 78,000. You are not baking those types of assumptions into your numbers it sounds like.

I will let Rich -- that's a good question, so let me let Rich comment on North America truck.

Let me just add one more bit of Technicolor around the mid-range side, where we got a little surprised, quite frankly, was in the mid-range side around bus, RV, fire truck. We saw OE's increase their orders in Q4 and basically bought most of their Q1 demand in Q4. And so we got a little positive surprise in Q4 on that and a bit of a negative surprise on Q1 on that.

And that was part of the -- we have seen that come through and we have seen orders get back to a normal rate at the end of March, early April. On the heavy-duty side, we have taken our overall forecast down from 240,000 to 233,000. That does imply an increase sequentially through the year, if you do the math on that. We don't give quarterly guidance, we are seeing that increase in production rates has started here in Q2, where we forecast it to be to get to that 233,000 rate.

There is no magic surprise in Q4. We are already seeing build rates come up now, I guess, is the main point there.

Perfect, thank you very much.

Jerry Revich of Goldman Sachs.

I am wondering if you gentlemen can flesh out a couple of assumptions behind your guidance. On the Navistar aftertreatment business, specifically, what kind of sales contribution are you assuming and what is your heavy-duty truck market share assumption? And, Tom, did I hear you right, you are assuming 52% market share in medium duty where I think you are running a couple points ahead of that in the first quarter. Would you mind just fleshing those points out a little bit?

I think I will let Rich add if he wants to. I think heavy-duty, medium duty we are thinking 40% heavy-duty, 52% in medium duty and both of those were a little ahead in the first quarter and basically our general view is those things fluctuate based on the market shares of the end use truck manufacturers and other variations.

That is why we do it. We look across the year and take an estimate based on those fluctuations. So, we don't see major changes happening. It is the same progressions we have seen across all the markets, but so far we have seen good strength for people using our products, goods feedback on our products, so that all remains good.

With regard to after treatment systems, as you know we did get our system on the 13 liter engine Navistar approved by the EPA, that was good news.

We don't give any specific forecast by customer on sales, because obviously that is confidential to them and those things vary quarter to quarter, but I would just say that we're pleased to see that, it was a lot of hard work by both companies to get them approved and those will start -- sales will start -- they are starting now. They are a Q2 we are going. We are off and running on those things, which is a good sign.

And Mark, you laid out pretty significant components content increase coming up on tier 4 final and one of the appendix slides here that you have used in the past. Can you just frame for us the Cummins opportunity on non-Cummins engines and help us understand the pace of the transition that you expect in 2014 versus 2015.

So, to comment on the pace, Jerry, I don't want to talk about so much on the new wins at this point in time, but on the pace, you've got the between 175-horsepower and 750-horsepower engine sizes going to tier 4-5 on next year. And then, quite frankly, the bigger dollar content per engine opportunity for components, both are important, but also comes 2015, 2016 on the high horsepower engines above the 750 horsepower. So, those are going to come in two waves, if you like.

And then we've also got, Jerry, remember as I mentioned in my remarks, Euro six starting in 2014. While we can't comment on individual wins until the customer does, because they still reserve the right to talk about their products, what I would say is that we feel very good about our position with regard to Euro six and Tier four final, both for our own products but also for winning business with our components Company on other people's engines.

At Bauma, for example, in Munich, Rich and I were both there and if you looked around the construction business there, there were Cummins engines in just about every booth except one or two obvious ones. We were all over the show and the reason is because we have a very good Tier four final solution and people see us as an opportunity to grow business both in their home market, but also as they spread their business internationally.

I think our off-highway engine business -- everything we said about people wanting to partner with us to be able to get the technology and to grow globally was showing up there in that show.

Thank you.

Jamie Cook, Credit Suisse.

This is actually Linda Yan in for Jamie Cook. Could you go into a little more detail on your end market outlooks? I know you guys already went into mining, but those other segments like oil and gas, ag, construction.

Yes, sure.

Construction for the full-year, I think, we're fairly flat across our markets. We do expect -- we had a fairly low-key one in North America following on from our weakish second half, but we do see improvement going forward. But in aggregate for construction across the globe flat full-year. Oil and gas is very weak, so we are going to be down heavy double digits still year-over-year.

Natural gas prices have improved, but we still need to work through the excess equipment in the market in North America. We are seeing increased orders in China for oil and gas fracking engines, but the volumes there are still relatively low.

And in mining -- ag. Ag is a relatively small part of our business, very low single digits but up, was up quite -- is one of the few segments that was actually up significantly in the first quarter and will be probably at double digits for the full year driven by North America and Latin America.

That is one of the questions we get is why are we still seeing oil and gas business down with natural gas prices adjusting upwards? I think our view is that natural gas prices being up will certainly positively impact the industry. It just hasn't really that much yet. There is still a relatively high number of unused frac rigs out in the market and pretty well production has gone up, it has not gone up very much.

And so those -- we still need gas companies to feel like the price is right that they want to produce, put it more out of the ground and then they need to use up the frac rigs they have. So, that's why we still have got a relatively conservative view. We do think the higher prices will help. It just isn't going to do it yet and it's going to still take a few more quarters, we think, before there is a move in our demand.

And then moving over to engines, you guys saw a little bit of unfavorable mix this quarter. Going through the rest of the year how should we expect that mix to trend through the rest of the year?

I don't think the mix is going to change very much as we go through the rest of the year. You have Tom's comments in the mining business. If anything it is a little bit more pessimistic than what we said three months ago. I wouldn't anticipate much change there.

The one business that might be a little bit better, but only marginally, is power generation. The might pick up a little bit from a mix perspective, more in the second half of the year, I would guess, than the first half of the year. But overall I don't think we're going to see much change in the mix profile.

Great, thanks guys.

Thank you.

Andy Kaplowitz a Barclays Capital.

Tom, I like the color you guys gave on sequential margins in the quarter, but if you just take the quarter overall, if I am doing the math right it looks like almost 40% decrementals. It is not like you guys to some extent. Maybe, Pat, were there extra warranty costs that really threw the quarter off? I know R&D was up.

What do you expect for that going forward? But is it just -- I can't believe that you expected that result on the margin side. I know you talked about power gen being a little weaker than you expected, but on the engine business that is what I am focused on.

I think, Andy, it's exactly what we expected for the Company overall. If I go back to -- you, obviously, don't see the plan we share with the board, but if I look at our first quarter plan where we came in both on revenue and profits, it was within a very small range of number of a difference. Engine business came in exactly where we thought. We knew the margin was going to be [up] because of the unfavorable mix with mining.

They were taking a much higher warranty cost with the higher accrual base in the 2013 engines. And for the engine segment, that warranty cost probably was a headwind of 1% relative to what they seen in the fourth quarter. It was not a small number. Distribution came in exactly where we thought it would be. Components, as Tom said, did a little bit better and then the one negative relative to what we anticipating is power gen. But overall, when you look at it for the Company it was pretty much in line for what was expected.

That said, Andy, there's no question that your point about decrementals is right, that it is not what we are aiming for. I think Pat's talked a lot about what our goals with regard to decrement and incremental margins are and this is definitely higher. This is not the kind of quarter where we are aiming for and while we knew it going in, it was a difficult quarter.

Some of the things that we saw that we didn't expect until the very end were this as much activity on pre-buy in the mid-range segment and then the mining segment, while we knew it by the fourth quarter, as Pat said, it dropped really -- it dropped really significantly in our high horsepower business, so we had to adjust very quickly.

So, I think if once you take the trend over a couple of quarters, I think you'll see the decrementals in line with the way that we think about it. Just in terms of averaging the numbers, Q1 was not great on decrementals.

Not where we want to be. But if you take it over a couple quarters our view is that you will look back and say, yes, that's the decrementals that they are looking for and then you'll see the same thing on the incrementals. But just in terms of timing, seasonality, pre-buys, a whole bunch of stuff hit this quarter that made it sting more than we would expect normally.

And, Tom, is it fair to say that by March a lot of these things that were stinging stop stinging? Whereas that they were really bad in January, is that what you are trying to say?

Yes, I will have to carry the insect now. Is it too far, yes, I would say that they were stinging less. You're definitely right. The reason we have confidence in our forward estimates is that we saw improvement month over month, whereas we began to pick up orders some. Again, they were not gigantic increases, but they were enough.

We were starting -- the negative adjustments got through the system. We started to see improvements as we went January, February, March. And by the time we left March and now as we look into April, we are already seeing improvements that make us confident that we will get the kind of incrementals that we are looking for as volumes increase.

There are uncertainties out there, I don't mean to overstate the position. I talked about in my markets, there are uncertainties in markets. But assuming we get the sales that we've got in here, our view is that we can make the margins based on what we have already seen this year.

Tom, a related question comes up then. How is this really different from last year? Last year we had a strong North America that dissolved as the year went on and we were expecting an improvement in emerging markets that didn't happen. This year we are starting out weak again and you are expecting the whole business to rebound over time. I appreciate your comments very much on January through April. Is that what gives you more confidence in the rest of the year or something else?

There is some pretty different, big differences. For one thing, the first half of last year, remember, North America was good. And what we saw was the fault. This first quarter of North America was not good and what we are seeing that is different is that after several quarters of producing at less than demand, we are now seeing them begin to increase order rates. We have already, as Rich mentioned, we have already seen increases in order rates. It's a little bit different. We are not --.

And the second thing I guess I would highlight as a major difference is we were expecting improvements in the emerging markets and we didn't see them. This year we are not expecting improvements in the emerging market, so there is really none of that built into the forecast.

What we've got built into the forecast from a sales point of view is seasonal improvements, this thing I talked about with North America, the basic things that just because Q1 they did a pre-buy and now they are just going to go back to regular order rates. So, no heroic improvements in demand and then just getting back to our normal orders and shipment rates that fit that demand, that is all we are really expecting to do here.

There is really nothing -- no heroic assumptions anywhere and I would say that, again, if something drops off dramatically, like happened in the second half of the year last year, then that would make things worse. We just don't expect that. We just don't see, given our conservative forecast and markets, that there is something that is going to drop off a bunch more. You heard Rich's forecast for North America, it is not aggressive.

Thanks, appreciate it.

David Raso at ISI Group.

Not to belabor the margin issue, but I think by far it is the major issue here with the release, so, we are just trying to better understand it. The rest of the year guidance implies basically 100% incremental margin. $117 million of sales gain year-over-year, you need $128 million of EBIT gain year-over-year. We have to see a big reversal on how the margins just played out.

For this first quarter, the revenue decline year-over-year is not much different than we saw in the fourth quarter and the third quarter. And since then we have laid off 2% to 3% of the headcount.

I assume some other cost actions and maybe with a warranty maybe was bigger. And I appreciate the mix comment, but I'm still trying to appreciate why are the decrementals this much worse after some cost actions and then the next three quarters I have to look at a incremental margin, which I know it's a low number, 1% revenue growth, so it's possible in a revenue growth that low. But, obviously, 100% incremental is not a walk in the park. Can you help us better understand what happened and why the incrementals would be so positive the rest of the year?

David, let me take a shot at that. When we look at the incremental margins going forward and if you look at it from the first quarter baseline, the numbers that take us to the midpoint of our guidance of closer to a 35% to 40%. You can talk to Mark afterwards about the calculation. But we have delivered that type of incremental margin improvement before.

And as I see the engine business picking up as we go through the first quarter, I'm pretty confident that that trajectory is going to continue to play out. The fact the decrementals in Q1 were as steep as what they were, I apologize, because we're repeating ourselves here, but it really that the negative mix, in fact, that the engine business in particular suffered from the lower high horse per volumes was a very significant headwind.

In addition, we had the higher warranty costs that we tried to talk about in our last call and explained the impact of those. So, there wasn't half an (inaudible) in there. There was a couple of one offs in the power generation business to help them in the first quarter. But the key drivers for that decremental was the low volumes, the unfavorable mix and the higher warranty costs, all of which we expected as we came into the quarter.

I would just add, David, we did see the improvements in SG&A from the reductions we made in Q4. On the other hand, we did stay the course on our R&D spending. That was something we decided strategically to do was to continue to invest in our new products and make sure that we were ready. While other people may be hesitating, we are going to continue to release new products, so that as markets improve we positioned ourselves for growth.

That was, obviously, a decision we made that we could've made differently, but we decided that was the thing to do and as a result we have a lot of new products coming out and we will have again next year. And that, I think, positions us well for growth. So, those are decisions we made that, of course, impact quarterly results, but I think they were the right ones for the Company long run.

Is there a price cost change? Because, Pat, you can talk sequentially, but I'm looking at it properly year-over-year first quarter down 40%. The mix in the fourth quarter we already had mining down, oil and gas down, and then since then we have taken some cost out. At lease that was the way it was presented in October about 1,000 to 1,500 heads coming out.

So, again, I am just trying to gain comfort. Is there something about heavy -- high horse power that you already have an order book that is notably improving on the high horsepower to make it clear the mix snaps back? Again, it is 100% incremental year-over-year in the math for the rest of the year. I am just trying to understand, with, obviously, the revenues were generally in line what people thought. It was similar to declines the last two quarters. It's all about the margin.

Right. We're not expecting a snapback in the mix, David. The mining drop was much more significant in the fourth quarter year -- at first quarter year-over-year than it was in the first quarter, significantly. More in the first than the fourth. We're not really -- other than we expect seasonal improvement in high horsepower demand from the power gen business to the engine business going forward.

That is really the only improvement in high horsepower going forward and again, as Pat said, if you start from a Q1 base and look what we need to deliver from that base, which we except has got some costs in there that we would not expect to see on a run rate basis, we're talking in the 30% to 40% of incrementals going forwards from where we are. And we feel comfortable with that.

And just one clarification. The tax rate before was 26%. Do you remember correctly, that did not include the tax benefit in the first quarter.

That is correct. The 26% did not include the discrete item, the R&D tax credit that relates to 2012 that we did book in the first quarter.

And the 29.5% also does not include the tax help, correct?

29.5% is the operational rate for the full year, excluding discrete tax items.

That is helpful. I appreciate it, thank you.

Ann Duignan, JPMorgan.

Can we take a step back and talk a little bit about your [at luck] for market share for the heavy-duty business? It was very obvious at Mid-Market truck show and the Duong Eaton joining forces to deliver new products as more of a defensive move to react to the price liner and Volvo offerings of their own drive train. Should we think about the 40% market share as being the ultimate potential for this business. Should we expect market share to decline somewhat as we move forward?

Obviously, it's going to be our goal for it not to decline. So we -- the dynamics of the heavy-duty truck business and engine sourcing really haven't changed in quite a while.

We are now the only independent engine Company, at least in the developed country markets, and what we are trying to do is make sure that we offer technologies and systems that make customers think that partnering with us, in addition to making their own, makes more sense for them and gives them more technology they can use to sell value to their customers. That remains our strategy and our customers remain focused on ensuring that they have technology that they need and that they don't depend just on one supplier. That hasn't changed either. All of our customers are thinking about what technologies they want to own and what technologies they want to buy, so we have very open and frank discussions with them about that.

What that means as far as final market share, I think, depends on which players make which decisions on there. We have talked about this before. Our market -- market share is not our number one measure of success. We want to made sure we are profitable and profitable growth in the heavy-duty business and that's what we're aiming for.

We think our market share reflects the fact that today we can still offer technologies that even though our customers make their own engines, they think, though, that our technologies help them sell more trucks to customers. And again, I don't mean to get overly philosophical on you, I just mean it's really hard to say that there's a peak or a valley or whatever in market share. It just depends on how well we continue to do that.

Yes, that's a fair point and it's good to hear that market share is not the ultimate goal. Switching gears a little bit on to natural gas, could you give us an update on the 12 liter engine and where we are with that? Are you taking orders for that already or is that for later in the year?

Let me let Rich update you, because obviously there's been quite a bit going on in that this year.

So, no, we are taking orders beginning in April. We have [halt] some ratings and then we will continue -- we will offer some higher horsepower ratings later in the year, in the August, September, October range. We're right on on track with what we said with the April introduction.

That's a big deal, because of course as more customers want to explore options of using natural gas, we really were limited to a nine liter and that engine just isn't big enough for some of the applications people want to try it on. So, the 12-liter really gives customers a chance to try it in a broader range of applications. And since there's so much interest in natural gas, it is just the right product at the right time, in our opinion.

And final question, just a quick follow-up on that. If the 112 liter and the 15 liter are highly successful, what is the impact on the aftertreatment business? For spark ignition you do not need aftertreatment.

It would obviously push aftertreatment demand down. From our point of view this is, of course -- we have a range of technologies and the palette of technologies we're looking at and using all over the world. And the impact of using one over another, there is cross impact on the Companies. There is no question that if we -- if natural gas grows, then the need for SCR on those engines is not there.

That demand would go down for those products. Now again, the good news for us is we sell a lot of -- we're pretty high market share in natural gas engines. The trade-off looks okay to us so far. But, we're always looking at technologies that are going to add value to engine systems and components systems. We do a bunch of work on component systems in natural gas, too, just not SCR.

Okay, thanks guys. I've got my time up.

Tim Denoyer at Wolfe Trahan.

Not to beat the engine segment margin too much, but a couple of other components, if you could just give us a little bit more color on how they go through the year. Did you see the full impact of the price increases in the first quarter? And you've talked about warranty costs coming down through the quarter.

I think you said there was a 1 percentage point increase in warranty cost in 1Q from 4Q. Can you give us a sense of how that might ramp down through the year? And same question on raw materials. Are you expecting a bigger benefit through the year?

I will take a shot at that. A few things going on. We do see the volumes going up. To hit our mid-point we need to be in that 35% to 40% incremental margins, which is a place we have been before and feel very confident we can get there. There is a few pieces of it. One is if the volumes come up, January was a pretty bad month for us. We saw some really low demand at many of our plants. So, we will get the incremental there.

We are going to see warranty going down in the range of half a point. As you know, we set warranty on our new products at a higher rate and then as we demonstrate that the products are doing well we take our rates down. We will see warranty coming down through the year sequentially. We are seeing and driving increased supply chain improvements, which is a key piece or action, which is logistics costs but also on material costs.

We are having success on driving material cost down. It is the combination of normal incremental margins, warranty down, some material cost down, and then not continuation of some of the really the January issues that we had, which is a place we have been before in that 35% to 40%.

And just as a follow-up, on Brazil you've got a few -- there are a few truck OEMs building plants down there at the moment you have good relationships with. Can you give any sense of R&D activity and is there any market share pickup in Brazil baked in your guidance for this year? I think they are potentially opening these plants the three of them later this year.

We don't expect a big impact this year, Tim. We have a lot of activity going on in this. I think this is just an extension of our strategy that said, if we can use our global position and partnerships around the world to help our customers grow in the markets they want to grow into, I think Brazil is a perfect example of that.

There is a number of OEMs going into Brazil who are trying to be part of the growth of that market and who can use Cummins engines, both because we have leadership position in that market, we have a strong brand name and we have service operations there to help support them. We are very active doing application work and other kinds of work with customers and potential customers in Brazil.

But I think although some will open, there aren't going to be significant volumes this year and some of them, I think, it will take them even after they theoretically open, production won't begin for some time. I think there may be some impact next year, but it's probably a year or two before we see significant volumes from most of those new players coming in.

Great, thank you for much.

Probably got time for one last quick question, thank you.

Rob Wertheimer at Vertical Research.

One quick question on R&D. Was it any heavier than expected in the quarter or different seasonality this year? And this just generally power gen's been in a multi-decade uptrend. I am just curious if you can explain any more than you did on geography whether its credit related, the general weakness, the prime power versus backup. Is there anymore color on the market? Thanks.

Nothing really unusual in R&D. The only thing that influences quarter to quarter swings are if we are buying significant prototypes in major programs and there is a little movement each quarter and we had less of it in Q4 and more of it in Q1 and that's -- but that's just normal and what we expected.

With regard to power gen, the geography I give you is that generally speaking our developing country markets, which have been growing infrastructure at a pretty high rate, have clearly slowed down in the last couple of years. Places like China and India, infrastructure development have slowed down.

India we still see power shortages, which have held up the market, but the rate of growth has definitely slowed as infrastructure slowed and I think as those markets begin to pick up again, we will see demand increase. And those are -- think of that product primarily as prime power or at least part-time usage, it is not standby.

And then generally weak economies across the world have driven down non-res capital spending now in most markets. Of course, that is significantly true in Europe, but it's also been true in the US now for several years and low non-res capital means low standby markets. So, really the only places where we have seen improvements in power generation have been data centers, where we continue to see activity there, and then spot issues.

Power shortages and other kinds of things where there is just these chronic shortfalls in power, we have seen, continued to see strong markets. The basic trends on both developing country infrastructure, which require more grid support or companies needing generators to back -- to run their factories when the grid browns out, or just basic standby markets have been down now in a slump for a couple of years. And that's what you have seen in revenues in power gen.

Thanks much.

Thank you very much, everyone. I will be available for calls shortly.

Thank you, ladies and gentlemen, that concludes your conference and presentation. You may now disconnect. Have a very good day.