康明斯 (CMI) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first-quarter 2014 Cummins Incorporated earnings conference call. My name is Steve and I'll be your operator for today. (Operator Instructions)

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

Thank you, Steve, and good morning, everyone. And welcome to our teleconference today to discuss Cummins' results for the first quarter of 2014.

Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; and President of our Engine Business, Rich Freeland. We'll all be available for your questions at the end of the prepared remarks.

Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities and Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs, and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties.

More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck and our filings with the Securities and Exchange Commission, particularly the risk factors section of our most recently filed annual report on Form 10-K and any subsequently filed quarterly reports on Form 10-Q. During the course of this call, we will be discussing certain non-GAAP financial measures and we refer you to our website for the reconciliation of those measures to GAAP financial metrics.

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 investor and media. Now, we would like to begin with our Chairman and Chief Executive Officer, Tom Linebarger.

Thank you, Mark, and congratulations on being a Vice President. I know it must be those thrilling disclosure statements that got you the promotion. (laughter) Good morning everybody on the call.

I'll start with a summary of our first-quarter results and provide an update on our outlook for the full year. As usual, Pat will then take you through more details of both our first-quarter financial performance and our forecast for the year.

Revenues for the first quarter were $4.4 billion, an increase of 12% compared to the first quarter of 2013. First-quarter EBIT was $528 million, or 12% of sales, compared to $437 million, or 11.1% in the same quarter last year. We delivered incremental EBIT margins of 19%, driven by stronger performance in the components and engine businesses, as well as demand improved in on-highway markets in North America and China.

Engine business revenues increased by 11% year over year, and EBIT improved 200 basis points to 10.5%. The components business delivered record quarterly revenues and earnings, as sales increased 21% and EBIT margins increased by 190 basis points to 13.6%.

Both businesses demonstrated that as end markets improve, we can deliver strong incremental margins. And as Pat will discuss later, we have raised our outlook for both businesses for the year.

Revenues in the distribution segment increased 22% in the first quarter, but earnings declined year over year due to the negative impact of currency movements, costs associated with distributor acquisitions, and IT infrastructure investments. EBIT for the quarter was 8%. We will still see earnings growth in subsequent quarters, as the pace of distributor acquisitions accelerates and acquisition-related costs are spread over a larger revenue base.

End-market demand in North America is improving, which will also contribute to increased earnings. We are on track with our plan to acquire our North American distributors and we expect to deliver incremental revenues of at least $400 million and add earnings per share of between 20% and 25% this year -- $0.25 this year from the acquisitions consistent with our prior forecast. Our guidance for the segment remains unchanged with full-year revenues expected to grow between 22% and 30%, and EBIT to be in the range of 9% to 10%.

In the power generation business, revenues declined by $107 million, or 14%, due to lower revenues in India and North America. Gross margins improved 10 basis points year over year despite the revenue drop, but gross margin dollars declined.

EBIT margin declined from 6.8% to 3.9% due to the reduction in volumes and the negative impact of currency movements, particularly the appreciation of the UK pound against the US dollar. We do expect revenues to increase in the second quarter, with demand improving in North America, China, and the Middle East. For the full year, we still expect revenues to be flat year over year, but we now expect EBIT to be in the range of 7% to 8%, lower than our previous forecast, due mainly to the impact of the stronger pound.

Now, I will comment on some of our key markets, starting with North America. Our revenues in North America grew 25% in the first quarter, and as a result of improving demand, we are raising our full-year outlook for most on-highway markets.

Shipments to the North American heavy-duty truck market exceeded 22,000 units in the first quarter, an increase of 18% from 2013 levels. First-quarter market share was 40%. We now expect the full-year market size to increase by 12%, up from our previous forecast of an 8% increase. We still expect our full-year market share to be at 38%, unchanged from our previous guidance.

In the medium-duty truck market, we delivered more than 19,000 engines in the first quarter, up 74% from a weak quarter last year, following the implementation of the EPA 2013 emissions regulations. We now expect the market to grow by 9% for the year, up from our previous expectations of 7% growth.

Our market share improved to 66% in the first quarter, and we expect to achieve full-year market share of 70%, consistent with our prior forecast, and 7% higher than 2013. Shipments to Chrysler increased by 31% in the first quarter, compared to a very weak quarter a year ago when demand was low due to Chrysler's model year changeover. We expect that for the full year, shipments will increase 5% compared to 2013, up from our previous forecast that shipments would be flat.

Power generation's revenues declined in North America by 11% year over year. In the first quarter of 2013, we experienced very strong orders for data centers, which did not repeat in the first quarter of this year. Power generation order rates increased during the quarter and we expect stronger revenues in North America in the second quarter.

Our international revenues were flat year over year, with growth in China and Europe offset by declines in India, Australia, Mexico, and Brazil. As I will discuss, we are raising our full-year outlook for China and lowering our forecast for India and Brazil.

First-quarter revenues in China including joint ventures were $720 million, an increase of 21% year over year. The growth was driven primarily by stronger demand for engines and components in on-highway markets. Industry demand for heavy- and medium-duty trucks in China increased by 12% for the first quarter, as demand remained strong ahead of the expected transition to the NS4 emission standard.

In the first quarter, OEMs increased the production of NS4-compliant vehicles to between 15% and 40% of total output, depending on the OEM. The variation in build mix between OEMs reflects their specific strategies and target segments, as well as general market uncertainty regarding both the extent of enforcement of the new regulations and the strength of end user demand for the new vehicles.

Some OEMs, including Dongfeng, are actively promoting the transition to NS4 product. However, it appears that the OEMs that have ramped up their production of NS4 vehicles more aggressively have lost some market share.

Last week, the Ministry for Industry and Information Technology, MIIT, published a directive that sales of NS3-compliant vehicles must cease by the end of this year. This is a positive development, but clear plans for strict enforcement of regulations have not been shared.

With the deadline for sales of NS3-compliant vehicles now set, it would be logical to assume the demand for NS3 vehicles will remain strong for the remainder of this year. But with OEMs already having shifted a significant proportion of production to NS4 vehicles, it's not yet clear how overall industry demand and OEM production will play out in the second half of the year.

Overall demand in the first quarter did exceed our original expectations. And our current forecast assumes that industry demand is flat for the year, an improvement from our previous forecast of a decline of 7%.

Our shipments of light-duty engines in China more than doubled year over year, as our partner Foton increased the proportion of its trucks powered by the 2.8- and 3.8-liter engines manufactured in our BFCEC joint venture. Demand for power generation and construction equipment is expected to grow by less than 5% for the year, consistent with slower growth in the economy and unchanged from our view three months ago. First-quarter performance was consistent with our full-year view.

Overall, full-year revenues in China, including joint ventures, are now expected to grow 15% for the year, up from our previous guidance of growth of 11%.

First-quarter revenues in India, including joint ventures, were $385 million, down 25% year over year due to weaker demand across most end markets as the economy remains very weak. Industry demand in the truck market declined 7% in the first quarter compared to the first quarter last year, but did rebound from very low levels in the fourth quarter of 2013. We expect the truck market to be flat for the full year, unchanged from our view three months ago, with much easier comparisons to come in the second half of the year.

Power generation revenues in India declined 46% in the first quarter. Demand in the first half of 2013 remained strong due to power shortages, but weakened significantly in the second half of 2013 as the economy slowed. Demand remained weak in the first quarter of this year.

The implementation of new emissions regulations in the power generation market, called CPCB2, were delayed from April 1 to July 1, pushing back sales of higher value products for Cummins. For the full year, we now expect power generation revenues to decline by 15%, down from our previous expectations that revenues would be flat. In total, we now expect revenues in India to decline by 8% for the year, compared to our previous forecast that revenue would be flat.

First-quarter revenues in Brazil were $183 million, down 11% from the first quarter last year. Business and consumer confidence in Brazil has weakened as the economy has slowed, hurting demand for capital goods.

Industry production of trucks declined 9% in March, as orders slowed and OEM inventory levels increased. In order to reduce inventory, a number of OEMs are planning shutdowns in the second quarter that will lead to a sharp reduction in industry production.

We now expect that the full-year truck market could decline by as much as 20% compared to our previous forecast that industry production would be flat compared to 2013. We now expect our full-year revenues in Brazil to decline by 15% due to the weaker truck demand.

In summary, we currently expect Company revenues to increase between 6% and 10% for the full year, up from our previous forecast of between 4% and 8%. The increased forecast reflects stronger demand in North America and to some degree, China. Within international markets, our improved outlook for China should offset weaker demand in India and Brazil.

We expect EBIT to be in the range of 12.75% to 13.25%, consistent with our prior forecast. We have said in previous quarters that as end markets improve, we expect to deliver strong incremental margins. I'm pleased that in the engine and components businesses, we clearly demonstrated our ability to grow margins as demand increased in the first quarter.

We are on track to deliver the benefits associated with the distributor acquisitions in North America, and we expect that as demand in power generation improves and we complete our restructuring actions, we will demonstrate clear improvement in profitability. Thank you for your interest today. And now, I'll turn it over to Pat who will cover our first-quarter results and full-year guidance in more detail.

Thank you, Tom, and good morning, everyone. First-quarter revenues were $4.4 billion, an increase of 12% from a year ago, and were stronger than we anticipated three months ago. Improving demand in on-highway markets in North America and in China, and the better than expected start to the year in Europe, resulted in higher than expected revenues in both the engine and component segments.

North America sales, which represented 56% of our first-quarter revenues, were up 25% from a year ago, primarily as a result of higher demand in on-highway markets along with the impact of acquisitions in our distribution segment. International sales were flat, with continued weakness in international power generation markets and negative foreign currency movements, offset by growth in our components segment.

Compared to the fourth quarter of 2013, sales were down 4%. The decrease was driven by lower demand in global power generation markets, which impacted both our power gen and distribution segments, as well as expected weakness in European and North America construction demand after the transition to Tier 4 final emission standards on the 1st of January.

Gross margins were 25.3% of sales, up almost 1% from last year. The improvement was driven by stronger volume and lower warranty and material costs, partially offset by unfavorable foreign currency movements primarily related to the British pound, the Brazilian real, and the Australian dollar. Compared to the previous quarter, despite the lower revenues, gross margins as a percent of sales remained relatively flat.

Selling, admin, and research and development costs were up $66 million from the prior year, but were lower as a percent of sales. The acquisitions in our distribution segment accounted for $18 million of this increase. Compared to last quarter, selling, admin, and research and development costs increased by $11 million.

Joint venture income of $90 million was up $8 million compared to year ago, and up $10 million compared to the prior quarter. The year-over-year increase was driven by contributions from joint ventures in China, where truck demand was higher compared to the first quarter of 2013.

Earnings before interest and tax were $528 million, or 12% of sales. This compares to 11.1% of sales last year, reflecting a 19% incremental EBIT margin. Foreign currency movements negatively impacted EBIT margins by 30 basis points compared to the first quarter of last year. Compared to the fourth quarter, EBIT margins decreased by 30 basis points on the lower revenues.

Earnings per share in the quarter were $1.83 compared to $1.49 a year ago, an increase of 23%, with a tax rate of 29.9% in the quarter including discrete items. Let's move on now to the operating segments and further discuss the first-quarter performance and the outlook for the full year.

In the engine segment, revenues were $2.6 billion, an increase of 11% over last year. The increase was driven by strong demand in North American on-highway markets, partially offset by a 15% decrease in high horsepower revenues, primarily related to weak mining and power generation markets.

On-highway revenues were up 24% compared to the prior year, as a result of the increased demand in North America. Compared to the prior quarter, sales were flat. Sequentially, we experienced stronger demand in North American on-highway markets, offset by lower demand for construction and agriculture engines in North America and in Europe, as the industry transitioned to Tier 4 final standards.

Segment EBIT was $269 million or 10.5% of sales, up from 8.5% last year, as a result of the higher volumes and lower material and lower product coverage costs. Sequentially, margins improved by 140 basis points.

For the full year, we now expect revenues to be up 6% to 8%, higher than our original guidance of 4% to 6%. Increased demand in North American on-highway markets will more than offset the weakness that we are seeing in Brazil.

We continue to expect industrial revenues to be flat in 2014, and high horsepower volumes will be flat to down 10%. EBIT projections for the full year remained unchanged at 10.5% to 11.5% of sales.

The components segment recorded record sales of $1.2 billion, and a record EBIT margin of 13.6% in the quarter. Revenues were up 21% from last year and up 8% from last quarter.

Compared to the prior year and the prior quarter, the higher revenues were primarily driven by increased demand in North American and Chinese on-highway markets, along with increased demand for after-treatment systems in Europe, post transition to Euro VI standards on the January 1 this year.

Segment EBIT was $167 million, or 13.6% of sales, up from 11.7% last year as a result of the stronger volumes and lower material costs, which offset the negative impact to margins from foreign currency movements. Selling, admin, and research and development costs grew at a slower rate than sales, positively impacting margins by 150 basis points.

Compared to last quarter, EBIT margins increased 130 basis points, or an 8% increase on sales. The sequential increase in margins was driven by higher volumes and lower product coverage costs.

We now expect revenue growth of 10% to 15% this year, higher than our previous guidance of 8% to 12%. The increase is the result of stronger demand for all four businesses in North American truck markets, and in China, where we expect truck production to be flat in 2014 compared to our previous projection of down 7%. We are raising our EBIT projections for the full year to 12.75% to 13.75%, and this compares to our full-year 2013 margin of 12.1%.

In the power generation segment, first-quarter sales were $639 million, growing 14% from last year and 16% lower than last quarter. Year over year, we saw weakness in North America and international markets, particularly in India, which was down 46%.

Sequentially, we saw lower demand in most markets with North America down 21% and international revenues down 13%. EBIT margins were 3.9% in the quarter, down from 6.8% last year. The lower volumes had a significant impact in margin performance; and foreign currency movements, primarily a stronger British pound negatively impacted margins by 110 basis points.

EBIT margins were lower than those reported in the fourth quarter by 220 basis points, as a result of the lower volumes and the negative currency movements. For 2013, we continue to expect sales to be in the range of minus 3% to plus 3%. And we are lowering EBIT projections for the full year to a range of 7% to 8%, mainly due to the impact of the unfavorable foreign currency movements.

For the distribution segment, first-quarter revenues were $950 million, an increase of 22% compared to the prior year. Acquisitions accounted for 21% of the growth year over year. Organic growth was 6%. However, unfavorable foreign currency movements lowered segment sales by 5%.

The organic growth was driven by strong service demand, especially in North America. Compared to last quarter, revenues declined by 11%, or 15% excluding the acquisitions. Stronger North American service demand was more than offset by weakness in global power generation markets.

EBIT margins for the quarter declined from 12.2% last year to 8% due to the negative impact of foreign currency movements, which impacted margins by 200 basis points, and also from the cost associated with distributor acquisitions and IT infrastructure investments. Compared to last quarter, margins declined by 250 basis points, as a result of the foreign currency movements and the dilutive impact of acquisitions on the EBIT percent.

For 2014, we continue to forecast revenue growth of between 22% and 30% over last year, with 3% organic growth and the balance from acquisitions. And we expect EBIT margins to be in the range of 9% to 10%. Our North American acquisitions remain on track to add $400 million of revenue to Cummins in 2014, and earnings of between $0.20 to $0.25 per share.

As Tom mentioned, we now project total Cummins revenues to be up 6% to 10% in 2014, driven primarily by improving North American on-highway demand and the impact of distribution acquisitions. We continue to expect high horsepower markets to be flat to down 10% this year and total industrial markets to be flat, which is consistent with what we saw in the first quarter.

While we are increasing our expectations for revenue growth in North American on-highway markets, we continue to see weakness in a number of international markets. We have lowered our expectations for truck production in Brazil for 2014, and see more signs of demand improving this year in India.

We now expect our joint venture income will be flat when compared to 2013. This is an increase from our previous guidance of down 10%, and is driven by increased expectations for truck production in China, which Tom discussed earlier, along with strong performance in our North American distributor channel.

We continue to project EBIT margins for the Company will be in the range of 12.75% to 13.25% of sales, compared to 12.5% last year. We remain focused on driving improvements in our gross margin in 2014, particularly from lower material costs and from our supply chain initiatives.

The full-year tax rate is projected to be 28.5%, excluding any discrete items. And our tax rate guidance does not assume that the research and development tax credit is extended into 2014.

Finally, with regards to cash flow, we produced $263 million in cash from operations in the first quarter, lower than the amount we produced last year, as a result of an increase in working capital associated with the higher revenues and an increase in our pension contributions in the quarter. We continue to expect our operating cash flow to be in the range of 10% to 15% of sales for the full year.

As expected, our cash and marketable securities balance decreased by over $500 million in the quarter. This reduction was driven by a $419 million outlay in share repurchases, as well as from the acquisition of a North American distributor.

The Company returned $534 million of cash to shareholders in the first quarter, including the repurchase of 3 million shares, consistent with our commitment to return 50% of operating cash flow to shareholders. And finally, as we discussed in our last call, we still expect to invest $700 million to $800 million on capital expenditure projects this year, and between $400 million to $500 million related to the previously announced acquisition of the North American distribution channel. Now, let me turn it back over to Mark.

Thanks, Pat. And, Steve, we are now ready to move on to our question-and-answer section. I would request that everybody try to limit yourself to one question and one related follow up, and then please get back in the queue. Okay? We're ready to proceed, thank you.

Thank you. (Operator Instructions) Alex Potter.

Hi, guys; good quarter. First of all, just starting off on India, it sounds like there have been a couple people out there starting to make some incrementally more positive comments on (technical difficulty) demand in India. It sounds like you guys aren't seeing that. What do you think about that?

Yes, Alex, I would just say that it's way too early to call the turnaround in India. We obviously have a bullish medium- to long-term outlook on India. We think there's a lot of positive trends in the country about developing middle class and all the other things we've talked about before at our investor days.

But short term, the economy is in pretty bad shape. They have got budget deficits. They have got a divided government. The elections aren't even complete. I don't think they finish for another couple of weeks counting of the votes.

There's still quite a bit of turmoil, so there's no direct action from the government to resolve some of the critical issues. Road building is slowed to a halt. A lot of things that were going well have really slowed down over the last year, not to mention just the basic macroeconomic effects.

Our view is it's too early to call. As you mentioned, our results are pointing out that things have definitely not turned around. If anything, we should see some stabilizing and given the comparisons in the second half, we'll see some improvements, I think, but that's just because the second half comparisons are so much weaker.

Okay. Fair enough. And then I guess secondly on restructuring in power gen, if you could just give an update there, where do we stand? When do you think you start to see some positive margin normalization as a result of restructuring in power gen? Thanks.

We do expect, Alex, to be largely done with the restructuring that we talked about by the end of this first half. So the second half, we'll begin to see results. We've done significant restructuring in the large alternator business.

We've reduced headcount in our European operations there and also moved some of our production into lower cost plants, so we've done quite a bit of work. It's taken a long time.

And unfortunately, volumes have been slipping away while we've been taking actions, making the incremental benefit of those, each step of the restructuring, seem less good, because each time we make steps, the volume slips lower. But we do expect those actions to be done by the first half and to begin to see improvements in the second half and, as again, what we hope is that volumes stabilize and then begin to improve.

If they do, we'll see significant improvements in margins in power gen. We have lowered our costs. We are positioned well to ramp up our plants, very low utilization today almost across the board in power gen. And as volumes start to ramp up, we'll see benefits.

Okay. Very good. Thanks a lot.

Alex, just a quick follow up. You didn't -- on the India piece, Tom mentioned we've got a lot of capacity there because we invested as the market fell. But part of our gross margin improvement you're seeing is we're utilizing those plants to export more and more product.

And so be it on engines, components in the turbo area, or even from a technical standpoint, getting more of our engineering capability out there. So we've been able to use the investment we've made there to apply it to the rest of the business.

Thanks, Rich.

Okay. Interesting. Thanks a lot.

Thanks, Alex.

And your next question is from the line of Jamie Cook.

Hi, good morning.

Good morning, Jamie.

Just a couple questions, just on the engine, on the new engine guidance. I'm surprised we're not taking our margins up given the revenue increase. Is that just sort of high horsepower? Can you just talk through the puts and takes on that, or do you see that a decline is more likely?

And then on the power gen side, you talked a little bit, I think, about sounds like order trends might be improving in North America. Can you just give a little more color on what you've seen post the first quarter in terms of order trends and any particular markets? Thank you.

Pat, why don't you talk about margins and I'll talk a little bit about power gen.

Yes, so we left the engine segment margin consistent with the previous guidance of 10.5% to 11.5%. We did 10.5% in the first quarter, Jamie. We are expecting to see improvement as we go through Q2 through the end of the year. But at this stage, it's still a little bit premature to think about increasing that.

As Tom mentioned, we are a little bit uncertain about how China is going to play out in the second half of the year. That was a big help to Rich's business in the first quarter. And so at the moment we're fine with 10.5% to 11.5% and we'll see how things are three months from now.

And the answer to what you said about high horsepower, so we are seeing mining decline further on the negative side. And we are -- but we are seeing, of course, North America stronger, China stronger, and marine markets stronger. But there are some puts and takes even within the --

How much worse was mining in the quarter relative to last?

It was 28% in revenues.

It was down 28% from a year ago.

Yes, down 28%. Units would have been more than that.

Okay.

So you see there is further deterioration there. Again, fortunately marine, commercial marine has come back a little bit, so that's helping a little bit. Generator, still weak.

In high horsepower, we're still not really improving much. It's really been in the truck side that we've seen improvement both in China and North America. And on the power gen side, do your question one more time.

I just wondered if you could give a little more color just on order trends with the optimism around non-res improving and then just what you're seeing in the emerging markets?

Yes. We just saw orders increase through the quarter. So we saw orders step up each month. January was very low, which, again, is not atypical for power gen to get seasonal low orders in January. And then during the quarter, they picked up.

And so that's why we feel confident that second-quarter revenues will improve for power gen North America. We also saw some improvement coming in China and in the Middle East. Again, all those are against a backdrop of pretty weak markets.

So it's not that things are booming or anything, but we definitely saw improvement through the quarter, and so we believe we'll see revenues step up. Some places that aren't really stepping up yet, I mentioned.

Big project markets, so the big, large rental markets. Stuff like a business that Aggreko is in, they are a very large customer of ours, big projects that we sell those large alternators to, those really aren't improving still. And again, we do expect them to at some point. But I think that's a function of general economic improvement in markets outside the US.

And sorry. I hate to ask this. But did you have any weather impact in the quarter, on the quarter, or in terms of order trends or anything like that?

I can't speak so much to order trends. I can say logistics costs were higher. We definitely saw some increase in logistics costs due to weather and trucking around the US.

And I talked to quite a few people and that seems to be a pretty common theme. Logistics costs were higher due to bad weather.

And are you willing to quantify that or no?

I'm not unwilling. I'm just unable to quantify at this point. But I know Mark will have some figures for you he can share with you.

Okay, great. Thank you.

And your next question is from the line of Adam Uhlman.

Hi, guys. Good morning.

Good morning, Adam.

Could we talk through the China NS4 transition a little bit more? I'm trying to understand better how difficult it would be for OEMs to switch back to NS3, if they feel like they have a little room to sell more of those trucks, and if there's any risk to the components guidance from that?

Yes, so they definitely can switch their production at least until the end of the year. It seems like they can do it largely at their choice. There's a couple of problems.

One is that have some of the cities are requiring NS4. So depending on how vehicles are registered, that impacts the customers' demand. Second thing is that many of the OEMs have put in significant investment in technology, Dongfeng included. I mentioned them.

But many of the others as well have put in significant investments, and therefore, they would like to use those investments. And they, of course, have launched new products with good features and good capabilities and they would like to get the new customer -- the customers to see those features and buy those features.

And so they have in part what is a regulatory issue to deal with, and in part which is just new vehicles, new capabilities kind of moving the technology of the market up. And since they have made the investments, they would like to transition the customer.

So they have a vested interest frankly in moving production to NS4, but as I mentioned in my remarks, the market is still uncertain as to how quickly that uptake is going to be, how many customers are willing to pay for the new features, as well as the other benefits, and yet have to pay for the emissions technology.

And then the enforcement techniques even after the end of the year are not clear. The government has talked about enforcement techniques they are going to use in the past. We just haven't seen much practical, on-the-ground evidence of those enforcement methods yet. Anyway, a lot uncertain I guess is what I would say to you.

With regard to components forecast, clearly, we have components content that we're selling on NS4 that we're not selling on NS3. We do have significant components content on NS3, too, but we won't have aftertreatment on NS3, so it will affect our forecast depending on how big of a change it is.

Remember, we have a pretty conservative ramp-up forecast for the year, so I think the downside risk to our emissions-related equipment forecast for China isn't very large. Right now, it's looking better than we planned. But there's not much -- I don't think there's a big upside potential, given the way I'm seeing things play out and there's not a big downside either.

Got you, thank you. That's very helpful. Then I might have missed it, but Pat, could you walk through the currency impact to sales and profits for the quarter, and then what is embedded in the guidance for the year, please?

Yes. So for the quarter, Adam, year-over-year currency impacted sales by $90 million, nine zero. And for the EBIT line of the income statement, the impact comes by around $25 million, $26 million.

So that is the 30-basis point headwind. I made reference to it earlier in my remarks. For the full year, probably looking at somewhere around $150 million to $200 million sales impact year over year, and somewhere in the region of $80 million to $100 million EBIT impact if currency rates stay where they are today.

Great. Thank you.

And your next question is from the line of Nicole DeBlase.

Yes, good morning, guys. Congratulations on a good quarter.

Thank you.

So maybe just elaborating a little bit on what you're seeing in Brazil, I think you mentioned that production there was down 19% in March. Has that decline continued into April? Or could it get even worse than that due to the inventory issues?

We are seeing -- hey Nicole, it's Mark. We are seeing OEMs planning significant shutdowns into the second quarter. I think without commenting specifically on that one numbers in April, we are expecting a big cut in industry-wide production in the second quarter. Then the outlook for the third quarter is somewhat uncertain with World Cup going on, other events, how much commercial activity there's going to be.

Typically, Q3 is seasonally the highest quarter in the year, but it's hard to see that right now. So I think clear move down and not clear what the catalyst for improvement in the short term.

Okay, got it, that's helpful. And then just going back to maybe the engine margins, I know you guys kind of walked through the headwinds.

But I mean, you guys did do 29% incrementals this quarter, which was really, really impressive. Maybe what could cause moderation in incremental margins for the rest of the year in that segment?

Let me start and then I'll ask Rich to jump in. If you go back to the first quarter of last year on the call, that was a pretty weak quarter for the engine segment, especially North America medium-duty truck revenue. So that had a significant impact on Q1 last year and made the incrementals, probably look a little bit better than what they really are on a normal trend basis. Going forward, I think what we're looking at, 20% incremental EBIT margins for the segment for the rest of the year, and I'll let Rich make any comment he wants to add on to that.

No, I think that covers it, Pat. Thank you.

The only thing I would add is both Rich and I have been out to a bunch of plants this last quarter and the thing I would say, is our plants are just doing an amazing job of figuring out how to get costs and productivity in weak demand environments. I was at Daventry in the high horsepower plant, our midrange plant in the UK.

I was in India, where, again, demand, we're at 40% utilization in some of these plants. And these people are finding ways to reduce costs, break even, even make a little bit of money at 40% utilization.

So as things ramp up, we will make significant incremental margins in the engine business. There's no question about it. What we just don't know is what's the ramp-up rate, especially outside the US, North America?

That's the place that looks like it's improving. You see clear trends. Most of the other places in the world, the markets are still not that great.

China was good, but, again, a lot of uncertainty and a whole bunch of other places, not great. But we do think that those markets will turn around at some point. And when they do, our plants are really going to generate terrific incremental margins and, again, we just got a taste of it I think in Q1 and we're getting a little bit more of it through the year.

But really, it's not that strong of an economy in most for Cummins yet, and our hope is that switches around pretty soon and we'll really be able to demonstrate the power of the Company and the engine business in particular to generate incremental margins.

Okay. Thanks, Tom. That's really helpful. I'll pass it on.

And your next question is from the line of Jerry Revich.

Good morning.

Good morning, Jerry.

Tom, on the new product side, I'm wondering if you could just talk about the expected startup of the Cummins Foton heavy-duty production, given the fact that you're seeing some NS4 sales now in the market overall? And then, Tom, if you could just touch on any Tier 4 final market share developments that you could talk about?

I know you were optimistic about a few more releases. How is that shaping out and how does that factor into the outlook for your industrial business this year?

Okay. Since I've got Rich here, I know he's been following both of those really closely. I'll let him start on those.

Start with China in the ISG product. We're on track to introduce in Q2, which we've been saying for some time. The ramp-up in 2014 is tied to the NS4.

So we think we've got a fairly conservative ramp-up through this year and then see the big step up will happen in 2015. So product on schedule, reliability on schedule, cost on schedule, some uncertainty still on the NS4. But we will go into production as planned. And then the second question was on --

It was on Tier 4.

Yes. So we had a bit of a prebuy that we went through. We're now introducing the product. We'll see the big ramp-up will be in our high horsepower that will begin to happen.

So we're excited about that in a sense that we feel we're the one company that's already demonstrated this technical capability, because we've been doing this for almost a decade now in on-highway markets. And so we're excited about that.

There's some different technologies being introduced, people are having different solutions, and once again, we've played through this before in other markets, be it SCR, not SCR. And we like our product, we like our position there as we roll out the high horsepower.

And we were the first, just recently by the way, the first company to receive Tier 4 certification in the large, the higher horsepower generation equipment. So just to Rich's point, we're out there first. We have a clear solution.

We've had it at the shows and available for people to see now for some time, so we think customers are ready for it. There's clearly a price premium that people were trying not to pay. So as long as they could find Tier 4 interim or use credit, they did that.

Now it's getting harder and harder to do that with Tier 4 final. So we'll begin to see transition to those technologies, and we think we have a good position with regard to our competitors in terms of the quality of the product and people's knowledge of how it works and why it's going to be a better cost of operation for them.

Thank you. And Pat, on the currency, are there any markets where you might be able to offset those headwinds from a transactional standpoint with pricing? And then if you could just break out the impact on distribution of FX versus the acquisition cost, that would be helpful?

Yes, we are, Jerry. We're looking, particularly in the distribution segment, at where we can take some actions to offset the foreign currency headwinds and that will obviously be more around pricing than anything else.

So that's what Pamela and her team are looking at just now. And I don't have any other update to give you on that at the moment. And the second question was the impact on the currency?

The distribution business.

That was about $40 million in revenue and about $20 million on EBIT, when you compare Q1 to Q1.

And I think Australian dollar, Canadian dollar were the two biggest hits on the DBU.

Thank you very much.

And your next question comes from the line of Ted Grace.

Hey, guys. Congratulations on the quarter.

Thank you.

Thanks, Ted.

I apologize if I missed this earlier, but in power gen, the revenue guidance is unchanged at plus or minus 3%. The operating margin target was reduced 75 basis points. Was that mix or cost? Or can you just maybe quickly step through what the changes were there?

Yes, Ted, so this is Pat. Let me take a crack and Tom may want to jump in. The major change from taking it down by three-quarters of a point from the midpoint is foreign currency movements, and that's the British pound.

So we have a high cost structure in the UK with power gen, and the strength of the British pound compared to year ago is having a significant impact in the profitability of the segment. There's a smaller impact on restructuring from what we said before on our last call.

We're seeing volumes continue to deteriorate in Germany in particular, and that's going to mitigate some of the benefits that we anticipated getting from the restructuring benefits in the second half of the year. But the real driver is the foreign currency impact.

Yes, so Ted, just from 30,000 feet, for the power generation business, because we had a disappointing year last year, we really wanted to set a target that represented good improvement, but was achievable. And as Pat said, we gave up all of our room in our plan because volumes were weaker, and then the pound came in and just made it go down.

So we really, obviously, lowering guidance is not something we want to do, and we're working really hard to improve the profitability in that business. And Tony and his team have really put a lot of effort into reducing costs while still trying to make sure that we're gaining share and winning business around the world and keeping our market position. And that's a tough balance they're striking.

But we did give up our sort of room with the volume side and then this pound thing now looks like it's just going to carve three-quarters of a point right off the top. Again, we'll see what happens with the pound, but that's how it looks right now, which is why you see the guidance lowered to where it was.

Okay. That's really helpful. And then the second part is related. Could you just step through the geographies within power gen and help calibrate us for full-year expectations?

I think you said North America was down mid-teens, but how are you thinking about the North American power gen market for the year? And then same thing for EAME, which I think you said was up in the first quarter, and in Asia-Pac which I think you said was up on China?

Yes, so it's a good question. So if you just look at longer-term trends, North America has been improving. North America, even though it was down quarter over quarter, we had a good group of sales to the data center market last year, so the comparisons were a little worse.

But broadly speaking, North America is on an improving trend in power gen, so we're seeing good improvement there. The other place we're seeing some improvement is the Middle East. Middle East had a weaker year last year. A lot of the rental companies cut back a lot in Middle East and we're seeing Middle East kind of steady out and improve.

Where we're seeing deterioration is in India. So India was a significant drop-off in the second half of last year and that weakness continues. And though we're going to have this transition to a new standard, which should increase the price and value of gen sets, that was delayed. What that means as far as transition rates and all that kind of stuff, we're not sure, but it just adds to the weakness of the problem.

In Europe, the European market is improving a little bit, but the big downside in Europe is there's a lot of the project kind of work and project companies. Aggreko, I mentioned already, large generator set project companies that we sell to there that are selling across the world in these big projects.

They are all doing quite -- the revenues are very weak. They are all doing poorly and they are not buying hardly any equipment. And right now, I don't see any improvement in that trend. So that trend has been bad for a while and it continues to be bad.

So that at least gives you a sense of well, Europe is fine, just generator sets to Europe, it's not a great market. The economy is still pretty weak there, but it's improving slightly. The broad, our European sales that we report, include all these kind of project sales, which are not going very well.

Okay. That's really helpful. Best of luck this quarter, guys.

Thanks.

And your next question is from the line of Rob Wertheimer.

Hi, good morning. It's Joe O'Dea on for Rob.

Hi, Joe.

First question is just on NAFTA heavy duty. You took your production outlook up about 3% for the year. But when you frame that against the continued strength in industry orders that we've seen, it seems like there could be more upside.

Could you just talk about your order book for Class 8 heavy-duty engines? And is it just more that the recent orders are more spread out and longer dated?

Yes, okay. Thanks. That's a good question. The way -- we took it up, as you said, and the way we're paying attention to it is what's the backlog look like and what's the OEM order board look like and when will they be taking build rates up?

And so I think where we stand right now is as an industry, order boards are in pretty good shape. So there's actually some, not backlog, but some future orders out there, kind of in the four- to eight-week range.

And so I'd look at it, we'll see production better matching what sales are. So you look over the last four or five months, production has been less than sales as those order boards have filled up. They are at a nice healthy rate right now. Not too big, not too small.

And so I think there will be a little less volatility in there, in the production rates, given that that's been a steady increase. We're a little bit behind ACT. ACT is a little bit higher than us. I think 10,000 units.

And clearly, that's a scenario that could happen. There is scenario for either more upside or downside. But we think we're pretty well matched kind of at a likely rate for right now.

And just at a broad, in terms of just estimation, if your question is, is there potential strong growth? Of course there is. But as Rich said, we've been in a market that's had some volatility in it and had brief ups and turns down. We're trying to strike the middle of that range and think about what's going to happen next.

But we're prepared. We've been working on making sure we have capacity to deal with fluctuations in the market, even if orders strengthen quite a bit, to make sure we can supply all of our customers when they need it with the right products.

So we're ready for more upside. That would be terrific. But we made the estimate at where we think the most likely case is and there is some risk on either side.

Okay. That's very helpful. And then on the components side, is the adoption curve of technologies trending faster than you had expected in any particular areas?

And then specifically, within emissions solutions, the 1Q revenue was pretty strong. Is that a reasonable run rate or was there anything unique in the quarter there?

I don't think there was anything unique. I think we do -- the adoption rates depend on the implementation enforcement of the regulation, so all the business is planned around the timing of those regulations.

So if you went back two years, Joe, of course China is much slower than we thought. If you go back to our guidance at the start of the year, certainly the first half of the year is a little bit better than we thought. Again, enforcement is going to be the longer term driver of the business beyond the next couple of quarters.

Great. Thank you.

I think the other thing I would say is we baked in a pretty dire scenario in Europe for emissions solutions, given the Tier 4 final emissions regulations and the Euro VI on-highway regulations. And I would say at least OEM build of trucks, not so much construction, is a little ahead of what we saw in the first quarter. Not so much construction.

Your next question is from the line of Andrew Kaplowitz.

Hey, guys. Nice quarter.

Thank you.

Tom, maybe it's a little unfair, this question, but after a quarter like 1Q and given a better North American truck market, are you guys feeling better about your ability to deliver sales in the range you predicted for 2015? You know, somewhere above that $20 billion number?

Again, I know it's early, but you have that guidance out there. So any better visibility as we sit here today, or do we still have to worry about the international markets when it comes down to it?

Yes. I mean, Andy, you know, I'm the CWO, the Chief Worrying Officer, so I do quite a bit of worrying about markets. As I mentioned a little bit earlier, there aren't that many good markets now.

There's markets that aren't a disaster. And there's markets that are doing better. I mean, the North American truck market is the one market I can say it's actually getting pretty good.

Still not a boomer yet, as we were discussing. But it's maybe on its way to one. But really, most of the other markets are not very good.

So, again, we'll see what happens from here, but I do believe that if we get some turnaround in just the basic economic growth rates across the world, and I think Europe is doing a little better than we thought and US is definitely picking up, if we get some of these other emerging markets to get going, we'll see very, very good growth. And then I could comment much better about where we see the end of 2015.

Right now, I think it's pretty uncertain about what 2014 is going to finish out like and how that sends us into 2015. So I guess while I would love to give you more or less confidence, I just right now I don't feel like I have any more visibility than I did three months ago or six months ago.

I do think that we are positioned incredibly well, as I mentioned. Our plants are ready to take the volume. They are working at very efficient and productive levels. Our products are leading in their markets across the world.

As these things, as these markets take off, we will grow and we will grow incremental profitability significantly. So I feel very good about that. What I'm just having trouble calling is, so when do some of these emerging markets and these other project markets and things start to turn back, and that's really difficult for me to say.

Tom, let me ask you a related question about China then. That's another place that's been very difficult to forecast. It's done better actually for you over the last year.

But how do you reconcile the negative macro that we hear pretty regularly on China these days versus your performance here? And how worried are you that things could turn? Because we get that question all the time, and we know you're putting a lot of new products into the market, you're getting share. Is that really the answer, but how much visibility do you have?

Yes. So couple of things to think about with China. One is that the infrastructure growth rates in China have definitely slowed down, and that's why you see construction markets, power gen markets, have slowed.

That has happened. It is definitely happening. You can see it almost everywhere, just number of cranes deployed definitely slowed down. And we really haven't seen significant improvement in that.

They have still got a very robust economy, right? GDP growth rates are still going, very large urban populations that are making products and buying products and things like that, and so that's driving trucking. Trucking is still going.

And they have a lot of big road infrastructure. They have gigantic logistics costs in the country that they are trying to reduce. Trucking, while it's not unrelated, trucking growth rate can continue even if infrastructure growth rates, things like buildout of cities, new factories, et cetera, airports slow down.

And that's exactly what we're seeing now. There's also this weird instability in the truck market related to these new technologies. And that's kind of an overlay that makes it hard to -- creates more noise than signal in the short run about what's going on in the economy.

I would just tell you that from our perspective, the Chinese economy is still significantly weaker than it was just a couple of years ago. And that's related to these infrastructure things. Construction equipment sales are way down. Yes, they are up a little bit, from year over year, but the comparisons are dismal. So this is very small growth.

Power gen market is not back. So there's still a lot of growth left to come in China when the global economy starts to heat up again and they start building infrastructure. Even mining of course is impacted by the Chinese economy in this way.

Whereas I think trucking can proceed and still move ahead as they try to just move goods around China, even as they switch more to consumer versus infrastructure, versus build and export, that also still promotes trucking. So that's kind of how I would reconcile those comments.

Only thing, so we're feeling good about the truck market in China. We're just uncertain about with the overlay of emissions, which products are going to be sold when, and what kind of impact is that going to have on customers.

I guess I might add one thing. Just you mentioned the hedge we've got on the overall market is just the new products we've got going in.

As a couple of examples, the heavy duty market, we virtually have no market share. As we introduce the new product, regardless of what happens in market size, we are going to see growth there.

The same thing in LiuGong, our joint venture, where we've not been in the dump truck market, we're now there and we're producing. And as emissions comes, we're going to have components and we're going to have a lot of volume on our 2.8 and 3.8. We've got some tailwinds on that regardless of some of the macro market.

Thanks, guys. Appreciate it.

Thanks, Andy.

I think we've got time for one more question.

That question comes from the line of Stephen Volkmann.

Thanks. A couple of you guys had mentioned materials costs a little bit lower in some of your prepared comments. Just anything to tease out there? How should we look at that going forward?

All right, so here's Pat. Pat will tell you about material costs.

Yes, Steve, it was a real positive in the quarter, close to 1% benefit year over year. And as you look out for the full year, I think we're still looking at a 1% type of number.

None of that's really coming from metal markets, Steve. That's all what was going on within the purchasing supply chain organization. We're assuming metals are pretty much flat for the full year.

Okay, great. That's helpful. And then I guess just to quickly go back to the engine business, it looks like your biggest increase was in the heavy duty.

I assume that's North America, which I would think of as kind of your best margin in the segment there, which sort of begs the question of mix getting a little bit better here. But I guess maybe you can dissuade me from that, or are we looking a little conservative with the flat margin?

Just a caution on mix. I would say, Steve, I think you know this, but the way to think about mix for our Company usually is where we have strong market positions and leading technology, you tend to get, retrieve better margins than when we're entering markets we have weak market positions or our technology lead is not so big.

So heavy duty broadly is a difficult one, but I would say that heavy duty North America, you know our market positions. They are pretty good. What's more is now because of the content that we have on the engines.

We now have the technology components on there, a lot of them are ours, that helps us with thinking through incremental margins. So you not only have margins in the engine, but you have margins in the components, which helps you.

So I guess broadly speaking, I would say the North American truck market is a good market for us, but saying is it better mix, it just depends on compared to what, right? Compared to markets where we're not very big and just entering, yes; compared to some other markets, you know, not so much. So it just depends.

But we do like -- we are good in the market. We do have a good position. We do like it, and it is generating good margins for us now. And again, part of the incremental thing you're seeing, though, is again, at plants that are not even near capacity, adding incremental volume, that really generates good incremental margins.

Okay, great. I appreciate it.

Thanks, Steve.

All right. I think our time is up. Thank you very much. And I'll be available for you for calls later on. Thank you.

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Good day.