康明斯 (CMI) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 2014 Cummins Inc earnings conference call. My name is Tia, and I'll be operator for today.

(Operator Instructions)

I would now like to turn the call over to your host for today, Mark Smith, Vice President of Investor Relations. Please proceed, sir.

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the fourth quarter of 2014. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; and our President and Chief Operating Officer, Rich Freeland.

Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934, such statements express our forecast expectations, hopes, beliefs, and intentions on [structure] regarding the future. Our actual 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 are available in the forward-looking disclosure statement, in the slide deck, and our filings with the Securities and Exchange Commission, particularly the risk factor section of our most recently filed annual report on form 10K and any subsequently filed [4b] reports on form 10Q.

During the course of this call, we will be discussing certain non-GAAP financial measures. And we refer you to our website for the reconciliation of those measures to GAAP financials.

A copy of our press release and financial statements and today's website presentation are available on our website, at www.cummins.com, under the heading of investors and media. With that out of the way, I'll now toss it over to our Chairman and CEO, Tom Linebarger.

Thank you, Mark. Good morning. I'll start with a summary of our fourth-quarter and full-year results and finish with a discussion of our outlook for 2015. Pat will then take you to more details of both our fourth-quarter financial performance and our forecast for this year.

Revenues for the fourth quarter were $5.1 billion, an increase of 11% compared to the fourth quarter of 2013. Fourth quarter EBIT was $661 million, or 13% of sales excluding one-time items compared to $566 million or 12.3% of sales a year ago. For the full year, Cummins sales were $19.2 billion, up 11% year over year.

Our full-year EBIT margin was 13.2% in 2014, excluding one-time items, an increase up from 12.5% in 2013. Incremental EBIT margins were 19%. The components and distribution businesses delivered record revenues and earnings in 2014, and the performance of the engine business also improved.

There were two areas in which we performed below our own expectations. First, profitability in the power generation business did not improve in 2014 as we expected, which was disappointing. We have taken further actions to lower costs including exiting alternator operations in Germany and combining two global lines of businesses to improve efficiency and reduce cost.

EBIT margins in the power generation business are expected to improve from 6.9% in 2014, excluding one-time costs, to between 8% and 9% in 2015, assuming no revenue growth. Second, quality costs, as we've been talking about throughout the year in the engine business, exceeded our expectations in the first half of 2014 and resulted in full year warranty costs increasing by 0.5%, as a percent of sales.

As you know, we've been improving the quality at launch of our new protects and reducing quality costs for more than four years, so our expectations for performance in this area are high. Beginning in the third quarter, we focused significant resources on driving improvements in product quality and customer service operations, both to improve product performance, and to ensure that our customers were not impacted.

Our products are performing extremely well, even in the eyes our most demanding customers. And we expect that quality-related costs will be lower in 2015. This will remain an area of high focus for us this year.

Now, I will comment on some of our key markets in 2014, starting with North America. Our revenues in North America grew 20% in 2014 with approximately 6% of the growth coming from acquisitions in our distribution business.

The North American heavy-duty truck market reached approximately 268,000 units in 2014, an increase of 23% from 2013 levels. Our full-year market share was 36%. The medium-duty truck market size was approximately 127,000 units in 2014, up 13%.

We strengthened our position as the market leader in the medium-duty truck engines market in 2014 with our market share increasing to 72%. Shipments to Chrysler increased by 9% in 2014. Also in North America, revenues in our power generation business decreased by 9%, with shipments to the US military down 39%.

Sales to our traditional market segments, including nonresidential construction, were flat year over year. Our international revenues increased by 2% in 2014. With growth in China offsetting weakness in Brazil and India.

In Brazil our revenues decreased 17% due to weakness in the truck market. Industry truck production decreased by 26% as the economy slowed. Revenues in our power generation business increased as water shortages reduced hydroelectric power output and increased the need for generator sets.

Our performance in China was strong despite weak economic conditions and was one of the highlights of 2014. Full-year revenues in China, including joint venues, were $3.3 billion, an increase of 13% year over year, reaching record levels.

The growth in 2014 was driven primarily by stronger demand for engines and components for on-highway markets, as the truck industry began the transition to the new NS4 on-highway emissions standards. Industry demand for medium and heavy-duty trucks in China decreased by 7% for the full year, as orders slowed ahead of the broader transition to NS4 compliance.

The proportion of industry truck production that was NS4 compliant in the fourth quarter of 2014 was estimated to be 45%, with some customers increasing to 70% by the end of the year. Our full-year engine market share increased from 10% in 2013 to 12% in 2014. And we also experienced strong growth in our components business.

Shipments of our light-duty engines in China increased by 78%, as Foton increased the proportion of its trucks powered by the 2.8 and 3.8 litre engines manufactured in our BFCEC joint venture, displacing competitor engines. Industry demand for excavators in China dropped 20% in 2014, the third consecutive year of decline.

The market for power generation equipment in China was flat in 2014, with slower growth in infrastructure and weak power needs reflecting underlying weakness in the Chinese economy. Our revenues increased 4% year over year, due in part to increased market penetration especially in the telecom sector.

Full-year revenues in India, including joint ventures, were $1.3 billion, flat year over year with improving demand in the truck market offsetting continued weakness in power generation. Industry truck production increased 10% to 249,000 units and our market share increased by 5% to 42%. Revenues for our power generation business declined by 23%, as market demand remained very weak due to the overall pace of the economy and the impact of a transition to new emission regulations in mid-2014.

Now, let me provide our overall outlook for 2015 and then comment on individual regions and end markets. We are currently forecasting total company revenues to grow between 2% and 4% in 2015, with growth in North America, new products, and distributor acquisitions offsetting continued weak international markets and the negative impact of a stronger US dollar.

The market size for heavy-duty trucks in North America is projected to be 290,000 units in 2015, an increase of 8% year over year, with our market share projected to be stable at approximately 36%. In the medium-duty truck market, we expect the market size to increase by 1% to 128,000 units. And we project our market share to be 67%. Shipments to Chrysler are forecast to be flat with 2014.

In China, we expect domestic revenues, including joint ventures, to increase 15% in 2015, as revenues from new products and emissions-related content more than off set continued weak industry demand. We expect the market size for medium and heavy-duty trucks in China in 2015 to decline by 6% from 2014 levels.

Current industry forecasts project that 70% of truck production in 2015 will be NS4 compliant, up from an estimated 38% in 2014. Despite the anticipated decline in market size, we expect our revenues, including joint ventures, to grow as volumes of our new ISG engine increase and we gain more market share. Revenues for our components business will also improve.

Demand for our light-duty engine in China is expected to grow by 30% in 2015, despite no growth in the market as Foton continues to use a higher proportion of our engines. We expect industry sales of excavators to decline by a further 9% in 2015. However, this will have little impact on our financial performance given the already weak levels of demand.

In India, we expect total revenues, including joint ventures, to increase 5%. The new government has made infrastructure investment a big priority, and we're cautiously optimistic that demand will improve in the second half of 2015. We expect industry truck production to increase 8% to 270,000 units and demand for power generation equipment to increase modestly up to 5% for the year.

In Brazil, we expect truck productions for 2015 to decline a further 15%. As you are aware, the government-backed finance program, called [Tsunami], has been an important source of financing for the commercial vehicle market. And recently, the government tightened terms of the program for the second year in a row, raising interest rates 400 basis points and limiting loans to 70% of the vehicle price. This will not help truck demand given the already weak state of the economy.

We will see an increase in volumes of a number of important new products this year. There's a lot of excitement in China surrounding our new ISG heavy duty engine, which launched last year with volumes expected to grow throughout 2015, increasing our market share in the largest truck market in the world.

Our largest engine, the new QSK95 will go in to production in 2015. We've already secured customers in power generation, rail, and commercial marine markets. In addition, you may have seen the Cummins V-8 light-duty engine feature the new Nissan Titan pickup truck at the detroit auto show, and we are looking forward to the production of this vehicle later in the year.

The benefits from our distributor acquisitions continue to exceed our original estimates, as Pat will cover in more detail. We completed seven distributor acquisitions in 2014, with a further three planned for this year. And I want to thank all the employees in our distribution business for their support and ongoing commitment to our customers through the transition.

Although there are a lot of positives to look forward to in 2015, risks remain, particularly in the global off-highway markets and emerging markets. Weaker infrastructure, spending in China and Latin America, declining commodity prices, and the transition to new emissions standards in developing economies all present risks to off-highway market demand.

I'm confidence that our market position will improve in 2015 as our leadership in tier 4 final emissions regulations and the introduction of new products will enable us to outgrow weak end markets. Our revenue guidance for 2015 assumes that our industrial revenues in the engine business will decline by 4% in 2015, with weak demand expected in global mining and construction markets.

Naturally, there is concern about the risk from the decline in oil prices. Our direct engine sales to oil and gas extraction activity currently represents less than 1% of company revenues. And while it's very appropriate to be cautious about the outlook, at least in the near term our volumes should hold up better than the overall market given our advantage in having tier 4 final products available ahead of our competitors.

Our commercial marine business also has some exposure to offshore activity, and our power generation business supplies power to oil-dependant regions, such as the Middle East. Our current projection for off-highway engine and power generation revenues already reflect flat or declining revenues in most markets.

In this environment of uncertain demand, particularly outside of North America, it's important that we continue to find ways to reduce costs and improve productivity in our business, while making critical investments in our future. We expect EBIT margins to be in the range of 13.5% to 14%, up from 13.2% in 2013, with lower material costs, the benefit of actions in the power generation business, and improvements in quality all contributing to margin expansion in 2015.

In closing, I would like to comment on recent changes to our leadership team. First, I want to thank Pamela Carter, our distribution business leader, for her outstanding contribution to Cummins over the past 18 years. We will miss her leadership and her commitment to our customers, our people, and the communities in which we operate.

Second, I want to congratulate Tony Satterthwaite and Antonio Leitao as they assume leadership of the distribution and power generation businesses respectively. I'm confident in their new roles they will continue to drive profitable growth in those businesses by insuring that our customers succeed.

Thank you for your interest today. And now, I'll turn it over to Pat who will cover our 2014 performance and our 2015 guidance in more detail.

Thank you, Tom, and good morning, everyone. I will start with a review of the full-year 2014 financial results before moving on to the fourth-quarter performance. All the numbers in comparisons will exclude charges totaling $32 million or $21 million after-tax related to cost reduction activities within the power generation business.

Full-year revenues for the company were $19.2 billion, up 11% compared to the prior year and a record for the company. As Tom described, our revenue growth in 2014 was driven by strength in North American and highway markets, along with the impact of acquisitions in our distribution segment and record revenues in our parts business.

The acquisitions within the distribution segment accounted for 3% of the revenue growth. North American revenues increased 20% last year and represented 36% of total 2014 revenues. And that's up from 32% in 2013.

International revenues increased by 2% compared to 2013, with higher sales in China partially offset by weakness in Brazil and in India. Unfavorable currency movements negatively impacted full-year sales by 1%. While total sales increased by 11%, earnings before interest and taxes increased by 17%.

Gross margins of 25.4% were 70 basis points higher than in 2013, with higher volumes, raw material costs, and positive mix, partially offset by unfavorable currency movements and increased costs related to quality improvements. Selling, admin, and research and development costs increased by $309 million in the year. The acquisitions in our distribution segment accounted for $94 million of the increase.

Joint venture income increased $9 million compared to last year, with higher earnings in China, partially offset by the impact of the distributor acquisitions in North America. In total, earnings before interest and tax were 13.2% of sales in 2014, up from 12.5% of sales in the previous year and this equates to a 19% incremental EBIT margin.

Net income was $1.65 billion, or $9.02 per share, or $9.13 per share, excluding the costs associated with the cost reduction actions in the power generation business. This compares to $1.5 billion or $7.91 earnings per share in the previous year.

The operating tax rate for the full year was 28.4%, with [discrete] items increasing this to an all run rate of 28.7%. The operating tax rate was lower than the guidance we provided back in October, primarily due to the impact of the research and development tax credit which was passed late in 2014.

Now, let me comment specifically on the fourth quarter and provide some more details on our performance. Revenue of $5.1 billion was 11% higher than the previous year and 4% higher than third-quarter levels, representing a record quarter for the company.

Acquisitions accounted for 5% growth year over year. Compared to the prior year, North American revenues were up 22%, due to continued strength in on-highway markets along with the impact of acquisitions in our distribution segment and strong growth in parts.

International revenues were down [3%] due to weak demand in the Brazilian truck market, general weakness in Eastern Europe and Russia, which impacted more [specialty] segments, and from unfavorable (inaudible). Compared to the third quarter revenues increased 4% due to acquisitions and stronger demand across all four segments.

Gross margins for the quarter were 25.4% of sales, an improved 60 basis points year over year. With benefits from higher volumes and raw material costs, partially offset by unfavorable currency movements and from increased costs related to quality improvements.

Sequentially, our gross margins declined from the prior quarter, primarily due to an increase in quality costs and from the adverse impact of currency movements. Selling, admin, and research and development, as a percent of sales, increased by 30 basis points, compared to the prior year, and declined by 30 basis points compared to the fourth quarter.

Joint venture income was $76 million, 5% lower than the prior year and 23% lower than the prior quarter, due to the impact of the acquisitions and lower earnings in China. Earnings before interest and taxes, was $661 million, or 13% of sales, up 70 basis points year over year and equates to an incremental EBIT margin of 19% compared to the fourth quarter of last year.

EBIT margins were down from third-quarter levels as a result of the lower gross margins. Net earnings for the quarter were $444 million, or $2.44 per diluted share, and $2.56, excluding the charges associated with the cost reduction activities and the power gen segment. The oil and tax rate of 24.2% included a $24 million benefit from the research and development tax credit that was passed late in the year.

Moving on to the operating segments, let me highlight their performance during the year and in the fourth quarter and conclude with the revenue and profitability expectations for 2015. In the engine segment, fourth quarter revenues were $2.8 billion, an increase of 11% compared to last year and 1% compared to the third quarter.

Compared to last year, North American on-highway revenues were up 19%, driven by strong demand in truck and bus markets. [Pass] revenues were up 18% driven by strong demand in North America. Sequentially, revenues increased less than 1%, with modest growth in on-highway revenues offsetting the weakness in construction and agricultural markets.

Segment EBIT margins were 11.1% of sales in the quarter, compared to 9.2% last year and 11.7% in the prior quarter. Compared to last year, increased volumes, raw material costs, and cost leverage more than offset higher warranty expense. Sequentially, the margins were lower by 60 basis points due primarily to lower joint venture income.

For the full year, revenues were up 9% from a year ago. And earnings before interest and taxes grew 18% and improved from 10.4% to 11.2% of sales. In 2015, we expect revenues for the segment to be flat to up 2%.

On-highway revenues in North America will improve as industry production grows in heavy-duty truck market. And we expect another record year in our parts business. We expect global industrial revenues will be down in 2015, due to lower demand in construction, mining, oil and gas, and agricultural markets.

Due to the continued weakness in industrial and in power generation markets, we expect high (inaudible) volumes will be then 5% to 10% in 2015. 2015 EBIT margins are now forecasted to be in the range of 11% to 12% of sales, compared to 11.2% for full-year 2014.

Raw material costs, quality improvements, and higher joint venture earnings in China are expected to drive the majority of the EBIT margin improvements. The component segment delivered record sales of $1.3 billion in the quarter, up 16% over the prior year and 3% from the prior quarter.

Compared to last year, the higher revenues were driven by increased truck demand in North America, along with increased revenues for our after treatment systems in Europe and China related to the new emission regulations in both regions. Sequentially, higher revenues were primarily driven by increased demand in China due to the new emission regulations.

EBIT margins for the quarter were 12.1% of sales, compared to 12.3% of sales last year and 13.4% in the prior quarter. The decrease in margins over the prior year was driven by unfavorable currency movements and higher warranty costs, partially offset by raw material costs.

Compared to the prior quarter, higher warranty expense and unfavorable currency movements negatively impacted margins. 2014 was a record year for our components segment in terms of revenues, EBIT dollars, and EBIT percent. Revenues were up 18%, and EBIT grew 30% and improved from 12.1% of sales to 13.4%.

We expect another record year in 2015 with revenues projected to be up 4% to 8%, primarily due to stronger demand for all four businesses in the North American heavy-duty truck market and growth in China related to their implementation of new emissions standards. EBIT margins are expected to be in the range of 13.25% to 14.25% of sales, which compares to 13.4% recorded in 2014.

In the power generation segment fourth-quarter sales were $760 million, flat compared to last year and up 1% sequentially. Compared to the fourth quarter of 2013, weakness in India, as well as in eastern Europe and Russia, was partially offset by stronger demand in Africa, Latin America, and in the Middle East.

Sequentially, revenues increased in North America, Latin America, and the Middle East and was partially offset by lower demand in China. In the fourth quarter, we recorded a $32 million charge associated with cost reduction actions.

Our actions included reorganizing the power generation business into three lines of business, reducing overhead in the process, as well as the closing of a large alternator facility in Germany. We expect to realize the full quarterly benefit of these actions beginning in the second quarter of 2015.

EBIT margins were 7.1% of sales in the quarter, compared to 6.1% in the prior year and 8% last quarter. Compared to last year, the improvement was due to a 50 basis point improvement in gross margins and from lack of one-time expense that occurred in the fourth quarter of 2013 that impacted join venture earnings. Sequentially, a lower joint venture income negatively impacted margins by 50 basis points.

For the full year, power gen revenues were down 4% from 2013 levels, and EBIT margins dropped from 7.2% to 6.9% of sales. Gross margins did improve by 60 basis points despite the lower sales. However, this was offset by the unfavorable impact of foreign currency movements, in particular, from the British pound.

For 2015, we expect power gen revenues to be flat to down 4%. In the United States, lower military revenue will be offset by moderate growth in our base business along with revenues from our new [connect-wired gen sets]. International markets remain weak, and we anticipate lower oil prices could result in lower demand in several markets.

EBIT margins will improve in 2015 to between 8% and 9% of sales, and this compares to 6.9% for full-year 2014. The increase in margins will be driven primarily by savings related to our previously announced actions and from some currency benefits given the recent depreciation of the British pound against the US dollar.

For our distribution segment, fourth quarter revenues were a record $1.7 billion, an increase of 58%, compared to last year, and 31% sequentially. Acquisitions accounted for 51% of the growth year over year. Organic growth of the 11% before currency impacts was driven by stronger [parts] demand in North America and higher demand from oil and gas customers, compared to very weak levels a year ago.

Unfavorable currency moments negatively impacted sales by 360 basis points compared to the prior year, primarily due to the depreciation of the Canadian and Australian dollar. EBIT was a record $158 million in the fourth quarter, an increase of 48% compared to last year and 21% compared to the prior quarter.

Margins decreased from 10% of sales last year to 9.3%, due to unfavorable currency movements, which negatively impacted the margins by 100 basis points and from the dilutive impact on the EBIT percent from the acquisitions. For the full year, the segment delivered record sales and record profits. Revenues were up 38%, and EBIT dollars improved by $103 million or 27%.

EBIT as a percent of sales declined from 10.3% to 9.5%. For 2015, we're forecasting revenue growth of between 23% and 27%, with the majority of the growth coming from acquisitions. We expect EBIT margins to be in the range of 8% to 9% of sales.

Based on current exchange rates, currency will negatively impact margins by 90 basis points. We completed seven acquisitions of North American distributors last year, which added approximately $0.40 to earnings per share. We will complete an additional three acquisitions this year and expect that the aggregate impact of all the acquisitions will exceed the $1 billion in revenue and $0.50 in earnings per share that we projected at our last analyst day for 2015.

Finally, let me come to cash flow. We generated a record $2.3 billion in cash and operating activities last year, which it brings to 12% of sales. We continue to use that cash to reinvest back into the company and to return value to our shareholders.

We returned 52% of the cash generated from operations to shareholders in 2014, a total of $1.2 billion, which represents an increase of 48% over the amount returned in 2013. We increased our dividend by 25% last year and repurchased 4.8 million shares for an (inaudible) of $670 million.

We continue to invest in the business with $743 million in capital expenditure projects and a net $436 million for acquisitions. We also contributed $205 million into our pension plans, and they are now fully funded. As Tom mentioned, we're projecting total company revenues to be up 2% to 4% in 2015.

Growth in on-highway engines and components in the US and China, distributor acquisitions, and revenues from new products will drive most of the growth and offset a 3% headwind from currency, bases on currency exchange rates. We expect EBIT margins of 13.5% and 14% for 2015. And this compares to 13.2% for full-year 2014.

Similar to 2014, the EBIT margins will be at their low point in the first quarter. Improvements in gross margins from material costs, restructuring, and quality improvements coupled with stronger joint venture earnings in China will drive the EBIT margin this year.

We're currently projecting the tax rate to be approximately 29.5% this year, excluding any [discrete] items compared to an operating tax rate of 28.4% in 2014. Our tax-rate guidance does not assume that the US research and development tax credit has extended into 2015, which will negatively impact the rate by 1 percentage point when compared to last year.

We anticipate operating cash flow performance in 2015 will be within our long-term guidance range of 10% to15% of sales. Our capital expenditures are expected to be in the range of $750 million to $850 million. We expect our cash balance to decline this year as we execute the distributor acquisitions and remain committed to returning 50% of operating cash to shareholders in 2015.

As Tom said, [though there are] always areas to improve upon, we are pleased with our 2014 results with growth in both revenues and in earnings. We also saw improvement in our return metrics, both return on net assets and return in equity over 2013 levels, and we expect further improvement in 2015.

Now, let me turn it back over to Mark.

Thanks, Pat. And we're now ready to enter into the Q&A section. If you can limit your first input to one question and a related follow-up, please. Okay, we're ready to start.

(Operator Instructions)

Alexander Potter, Piper Jaffary.

Hi, guys.

Hi there.

I was wondering, first, if we could touch on EBIT margins in the engine business. Back at the analyst day in 2013, I think you expected 12% to 13% EBIT margins by 2015, and then today, the guidance is 100 basis points lower than that on the top and bottom end of the range.

Just wondering what you think the biggest [Delta] now versus back then was? Presumably 4X has some impact, but was wondering if you could elaborate?

Yes, let me pick that one off and then maybe and then Rich can jump in. When you look at it, Alex, I find that there's probably three areas, one, as you mentioned [4 mix] having a headwind across the company, given where the rates are now versus 2013.

Secondly, we still see weaker demand for high horsepower industrial engines, weaker demand in emerging markets than we had anticipated back then, which has had an impact on our margins. And then finally, as we've talked about, we are working through some quality issues.

Now although the one (inaudible) as a percent of sales came down, we are incurring more costs in our manufacturing facilities to make sure we protect customers. And that's running higher than what we were anticipating back in 2013. So, Rich, anything you want to add to that?

The only thing I'd probably add, Alex, is just I'll comment a bit on the quality costs. So when we talked back then, we've been on a path to reduce quality costs over multiple years. In fact, from 2009 to 2013, we took warranty costs down 180 basis points.

We assumed continuing that in 2014. As we talked in Q2, we had a bit of a set back on that on some of our high dollar costs. And we've invested some mitigation efforts.

And in fact, we've seen the warranty costs come down a little bit better than we what we told you back in Q2. But we're incurring some costs to do that, be it in testing, be it in premium freight, and in the field. The three that Pat outlined are the three, and I just wanted to give a little more technicolor on the quality cost.

Alex, as you know, this is Tom, China is the story where we actually are on our estimates from those dates, despite the market being pretty weak, especially in infrastructure spending. So that, unlike the high-horsepower story, which worsened from our estimates and we had trouble figuring out a way to catch up in China, we have been able to get back to our estimates at the analyst day despite pretty weak markets.

Okay, yes. That segues into the next question. I was wondering if you could comment on the ISG. Appreciate the break-out in the release, talking about profitability by segment there at the Foton joint venture.

Was wondering, A, your outlook on market share internally at Foton with the ISG. And then, B, the point at which you think that particular segment can start turning a profit. Thanks, guys.

Okay, I'll go ahead and take that, Alex. Let me talk in market share at a higher level, and then we can, offline, we can break that down or give you more detail. What we said, back at analyst day, is we wanted to take the market share up to 17%, from the 10% to 17%.

With the ISG, we're now exited at about 12% this year. We'll be at 12% for this year with the addition of ISG. And in fact, we will -- our plans call for ending 2015 at 15% market share in this space, and that's really on the strength of the ISG.

From a profitability standpoint, we incurred some pretty high launch costs in Q4, and so when we move into profitability in 2015 immediately on that [product]. You'll see the improvement there, and that's reflected in our guidance.

Okay, great. Thanks, guys.

Jerry Revich, Goldman Sachs.

Hi, good morning.

Hi, Jerry.

I'm wondering if you could talk, now that we've seen just greater enforcement on NS4 standards in China, how much higher is your market share on after treatment than on engines in the country? Or were you successful in converting all of the Dongfeng business and some of your other partners? Can you give us color there?

Yes, I'll take a shot here. Tom, jump in. But we're -- you've been there more recent than I have. Just a little bit on NS4.

We ended the year about 45%. I think we said 38% for the full year on NS4 compliance. And it looks -- we're more certain now that that grows to 70% for the quarter, so that's the growth.

From an after treatment standpoint, we'll be at 20% market share in the after-treatment business, primarily with both our join venture partners. So with both Dongfeng and [Protong].

And again, Jerry, I think you know this. But the market for after treatment is still a volatile market because although there is stronger enforcement, it's still not consistent across the country. And it's still developing.

So there's still a number of different products out in the market. And I think our view is that where our products are making very good progress, our partners are using our products and getting good performance out of them. So it's just going to take some time to settle out for us to have any view really about what stable market share is.

Right now we're wanting to make sure that our products earn the reputation of reliability, and durability, and performance. And that's really important for the long run, I think. It's a huge market, and we want to make sure we have a long-term sustainable share in that market.

Okay. Thank you. And then on currency, it sounds like you had a transactional headwind in distribution and components in the quarter. Can you just talk about any opportunities to push pricing to offset the transactional headwinds in 2015, and any opportunities to switch sourcing at the margin? Maybe lean towards one supplier versus another to mitigate the headwind in 2015? Can you give us color there, please?

Yes, I think it's something that we're always looking at to see if we can move the needle on that, Jerry. I don't think I would expect anything eminently to change on our currency profile, given the different geographies that (inaudible).

No, I'd just say, just from a sourcing standpoint. We've got a broad base of sourcing opportunity. We tend not to chase currency rates around with that, but where we see they will stick for some time, we do have the capability to do that. We do some of that.

I think the simplest way to think about currency for comments is that we've built a lot of natural hedges in our business because we manufacture in lots of locations. The places where we have more costs than revenues, as you guess, would be in the US, so strong US dollar is not ideal for us.

That said, we use a lot of global sourcing. We source products, materials from all over the world, almost no matter where we assemble it, which helps us on that. The business unit that's most exposed to currency is distribution business because we have revenues and profits in all of these countries.

And so we get translation. In essence, they come back to the US as we translate them into US dollars. And those are hard things to figure out a natural hedge to. And frankly, as Rich said, by the time you figure it out, it'll be switched to something else.

That said, in our core business, we are always looking for ways to build natural hedges, and we've been really successful in that. And we're going to continue to do that in our sourcing side.

Just a little bit more color on that. For the full-year 2014, the currency movements negatively impacted sales by $174 million, so 1% in EBIT by just over $50 million. So when you look at that as a percent of sales, it moved the EBIT from 13.3% to 13.2%.

And as Tom just said, the most significant impact was in distribution. So the EBIT margins dropped by about 1% because of currency. But overall for the company, we do have a profile that helps us, maybe more than some other companies do when it comes to managing this.

Thank you.

Ann Duignan, with JPMorgan.

Hi, good morning, guys. It's Ann Duignan here.

Hey, Ann.

I just wanted to follow up on the distribution business. You talked about your exposure, direct exposure in engines to oil and gas. Can you talk about your distribution's exposure to oil and gas?

Yes, we have distributors, of course, our distributors in Texas and we have distributors in the Middle East. And in my remarks, I was talking about how we have power gen sales in regions which are impacted by oil and gas.

And I think all those regions will be impacted. So the distributor will be impacted, of course, by the sales of oil and gas equipment, which you know about. But we kind of figured that fits in that less than 1% of sales idea. But the general business conditions in those regions will likely be negatively effected.

And we don't have a quantification for that, per se. But every one of those distributors that's in one of those regions has a potential for being more broadly affected just because business activity goes down. So we don't know what that's going to be, but we think it will be kind of limited to those regions.

And we think it'll kind of be -- we'll see what it is when we get there. Again, we're not trying to make the exposure seem less. We just don't have those direct sales, but there is a lot of indirect things. And that's why we were pretty conservative in our view about where high-horsepower engine sales are going, as well as where large power generation equipment is going.

Just a couple of comments. So first of all, cost distribution, half of the revenues are in after market. And even, let's say, in mining, which has been hit very heavily negative on the engine side, after-market sales have been flat or up even through the last three years. So we'd expect the impact there on distributors to be less severe than any impact on engines.

And as Tom said in his remarks, at least for now, we're better positioned for tier 4 final, across not just oil and gas and some other segments. So we think we can hold up relatively well.

Okay. I appreciate the color. On the quality costs, can you just give us a little bit more color? It's so uncharacteristic of Cummins to talking about warranty issues or premium freight or increased testing.

Can you just give us a little bit more color on what exactly is going on there, which region, which segment? Is it isolated? Is it across the board? Just so we understand what exactly is going on.

Yes, I'll let Rich come in too. As I said in my remarks, we have just been driving a much stronger expectation for how we're going to launch product. I think I mentioned in one of our previous calls, we're launching north of 70 new and improved products a year now.

So our company, on a global basis, we're basically in the new product introduction business. And that's the way our customers can get ahead of their competitors is because they have new and improved products to go against them with.

So what we've tried to build over the last decade is this new product introduction machine where we can launch new products that come out at quality levels that are as good or better than the ones they're replacing, which if you go back to the 1990s, was not our history. And so that's the activity that I've been talking about.

And what we had is a bunch of new product introductions in recent years that, especially related to on-board diagnostics and things like that. Our launch rate was not as good as we wanted. And as Rich said in his comments, it wasn't that we had more failures, it's that our failures were more expensive and more complicated.

And so we just wanted to make sure that we invested in resolving the issues quickly, which we always do, but also making sure customers had no impact. So that's making sure our customer service operations are on the spot right away to make sure customers have no impact.

Again, a lot of other companies had issues with on-board diagnostics and other things, too. We just wanted to make sure we did better than anybody else. So we wanted to invest extra attention in making sure customer impacts were low, and then also just get all the product issues resolved.

So it's investments across the board there to make sure that the impact is limited. And again, that's the kind of thing where, with increased focus, we expect to have lower and lower launch quality costs as we go through as a company. That's where we want to be placed; we want to be world class as a new product introduction leader.

Okay, guys. Thank you. I appreciate the color.

Jamie Cook, Credit Suisse.

Hi, good morning. I guess just to follow up on --

Hi, Jamie.

Hey, how are you? Just to follow up on Anne's question and then I have a separate question. Can you quantify what the cost to fix these quality issues, what it is in 2015? Or what it was relative to your expectations just so we can get a sense for what the incremental spend is? And also, how we think about warranty year over year? And then just quantify?

And then, my second question is, can you just comment on the order trends that we've seen in heavy-duty truck over the past couple of months? In October, I think, in November, they were really weighted towards one OE in particular. I know what you said with your market share opportunities, but can you talk about, one, why those orders were abnormally high?

Do you think market share for the OEs normalizes throughout the year? And does the strength, also in the orders that you've seen, make you view the truck-build forecast for 2015? Is there more upside, or did the orders that we've seen recently pull from the latter part of the year? Sorry, there were a lot of questions in there.

Yes. I'll let Rich do the order board [tea leaves]. Just on the quality side, I would just say, Jamie, in terms of quantification, I mentioned the 0.5% increase in the year for the engine business, and again, how we've been trying to bring it down.

I don't want to -- I'm not going to give more quantification of all that. We did talk about, as Pat said in his remarks, that it was impacting gross margins, so there's a lot of areas we're investing in. But as we also said, we expect as we go through 2015 to see improvements in those areas.

But you won't quantify what the improvement is, 2015 versus 2014? That's what I'm trying to figure out.

Well, we did. That's what's in our margin guidance.

Okay, but not a number? Just that that helps margins?

Right.

Okay.

Okay, then on the -- heard a lot of questions in there, Jamie, on the [build for] truck --

Yes, sorry.

Let me take a shot at it, if I missed a piece of it, I'll follow up. I'll start with the market size, which I don't think we have a view different than anyone else. All the things we look at around freight activity, without question, is multi-year highs. Used truck price is up. We look at 10% in 2014.

And then the orders remain high, even in January, with 35,000 plus in truck orders. The backlogs are strong with the OEs. This lower oil prices, lower diesel price, I think it helps carriers profitability. So most of the signs look pretty good on the overall market.

So are we too conservative or aggressive? We've gone up 8%. And that feels about right in a balance. Is there a scenario better or worse? Yes, there is. But that's what we've assumed.

On the market share, we're projecting 36% going forward. And we came in -- that looks solid. If you look at our placement at OEs, it's about where we thought it would be. And yet we missed a little bit in 2014. We thought we'd be at 37%.

And I think two things happened there that are not big. It added up to 1%. They're not a change. But our share is high at [NAV], right at 75%. And their share is down below what they would have expected.

That's public information. So a little bit lower there that cost us. And then, while it's not a big number, we'd assume natural gas growing to 3% of the market, and that didn't happen. And that's worth about 1.5 points of share being at 1% versus at 3%, given that we have 100% share in natural gas.

So we don't see a fee change in market shares by OEs. We don't see a big change in what our share is with those OEs. It's about where we thought it would be. And I wouldn't read too much into any one month. As you know, there's lots of variation month to month.

All right, thanks. I'll get back in cue.

Thanks, Jamie.

Andrew Casey, Wells Fargo.

Thanks, good morning, everybody.

Good morning, Andrew.

Question on the implied incremental EBIT margins in the guidance. If I'm doing the math right, it looks like they're about 30% to 35%, despite a 10% drop in JV income and then your comments about the weak high-horsepower demand. Given you touched on the lower warranty expense and power gen restructuring benefit, is there anything else that you want us to consider when we look at those incremental margins?

Yes, Andrew, this is Pat. The one other important item to keep in mind is material cost. So in 2014, material cost benefited our margins by just over 1% of sales. We're expecting a number similar to that, maybe slightly below. But certainly close to 1% improvement in gross margins that would fall to the bottom line in 2015. So when you take material costs with [purge] and restructuring, the quality costs that Tom was just talking about.

We will have more joint venture income. We will have some more other income, as we've been booking some one-time gains this year on distribution acquisitions. All that gets us into that guidance range of 13.5% to 14% on relatively modest revenue build.

Okay. Thank you, Pat. And then, just going back to the topic of the day, of the week, are oil prices. Given your distribution breadth, can you comment on whether you're seeing any project delays or cancellations in the US or elsewhere? And if so, can you give us some regional detail?

I think in North America right now, Andy, we haven't seen any cancellations. Again, we've got new emission compliant products out on the market. So for those products, we can say we've had zero cancellations.

Of course, it's appropriate to be concerned with it being zero. I think more broadly, power gen, some concerns about what's going to happen in the Middle East is one area. But no big rush of cancellations or big changes in trajectory yet.

Okay. Thank you very much.

Thanks, Andy.

Ross Gilardi from Bank of America.

Good morning, thank you. First, I just had a question on components. When you're baking in a lot of deceleration on the top line into components, and how much of that is FX? And are you actually seeing that deceleration in your order book now, or is that an attempt at conservatism?

I think, firstly, obviously, whilst North America continues to grow it's Class A builds. Of course, they're not growing at the same rate as we saw in 2014 versus 2013, medium-duty North America is also actually going to be relatively flat.

And those are the areas where today we have the highest revenue. Offsetting that will be growth in China, so we'll have significant growth in China. And I think Brazil we'll be the other area.

We're forecasting another 15% decline in Brazil. So you combine those with a little bit of currency, that's how you get into the range that we're --

And just to help you, Ross, on the currency question. In the fourth quarter, Q3 to Q4, the currency impact on component revenues was about 1.5% of sales. And as we look at 2015, it's going to be closer to 3% for the segment.

The US and China will be the biggest determiner of top line growth this year.

Yes, Mark, I understand all the components of your forecast, but I was just asking, are you actually seeing this type of deceleration in your orders now? Or is this just more of a forecast on what these different regions will do?

Only in Brazil.

Only in Brazil you're seeing a deceleration?

Yes.

(multiple speakers) in North America, (inaudible) in China, (inaudible) Brazil is where the opposite is.

Right, okay. And then for engines, I was just wondering if you can comment on just broadly medium-duty versus heavy-duty. You've got a pretty tepid outlook for North American medium-duty, up only 1%. In your mind, when you look at all of the drivers of medium versus heavy, what do you think accounts for the biggest difference in heavy being so much stronger than medium over the last year, and it looks like into 2015 as well?

I think, just at a little different place in the cycle where we are in that. So the medium-duty tends to have less variation and less peaks and valleys in the cycle. So it's been a little steadier on that. I think it's more just where we are in the cycle is what I'm looking at here.

Okay. Thanks a lot.

Joel Tiss, BMO.

Hi, guys, how's it going?

Hi, Joel.

I just had some more small questions. I just wondered why when this new burst of cost cutting or whatever, maybe it's not new, but when you look at 2014, the SG&A was up 15%; inventories were up 20%; and the accounts receivable up 11%. So if we're going into this slower growth environment, especially on the inventory side, what's going on there?

Yes, Joel, it's a great question. As you guessed, we spend a fair bit of time talking about those things ourselves. So let me just start with inventory side.

The mix of business is definitely changing. As we acquire distributors, we definitely acquire more inventory. So essentially, our chain lengthened is the way to think about it.

We now have inventory one step closer to the customer. If you look at the total asset intensity, it's got less capital, and it looks fine. But from an inventory point of view, there's definitely more inventory in the system. And that's affecting working capital ratios a bit. So when we talk in our analyst meeting, we'll try to update our working capital stats, which are changing a little bit. It's not dramatic change, but it's a little bit of a change with more distributors in there.

But, still, we could do better on inventories. There's no question about it. And one of the challenges is when we operate our plants, and especially in the high-horsepower area, at very low utilizations, and then people are dropping in orders, and you're taking whatever you can get, your inventory turns suffer.

So I've talked on many times on this call about how important it is for your operations to be able to adjust up and down to variation revenue. And this is the kind of thing where, if we're doing the best in the industry at responding, we can do a little better on the ratios. So we're very focused on them.

On the SAR side, that's another area of really big importance for us. We have to keep our costs down, and they're growing, as you quite rightly noted.

And we're trying to balance between how do we make sure we remain a technology leader, and relevant, and launching new products so that we can continue to partner with people and that they feel the need to use our engines and use our generators and components. And that's a big investment.

And we're doing it globally now. And we've got to make sure we have systems and infrastructure to support that. On the other hand, we've got to keep our costs under control, so we're striking that balance.

It's one of the things our management team spends the most attention on. And as you heard from us in these remarks, we're striking the balance a little differently in the power gen business than we did two years ago.

And we made one change last year, and we make another change this year to strike that balance a little differently. And those decisions are tough to make, but they need to be made in order to make sure we can continue to grow profitably.

Yes, let me just come back to the working capital. We spend a lot of time looking at working capital, Joel. We focus on the (inaudible), as you know. When you look at the growth in inventory, you're right. It's gone up by $450 million year over year.

The vast majority of that, like $360 million at least, were acquisitions. So we acquired all that inventory at day one. We've not had the full benefit of actually being able to trade that inventory out into sales. When you look at inventory terms, they're actually better than what they were going to be this time last year.

In terms of actually going down, which we expected for the reasons Tom gave, went from 5.4 times down to 5.3 times. And when I look at working capital as a percentage of sales, we've gone from 18.9% fourth quarter of last year to 19.3%. So I think we're actually doing quite well managing that, but, of course, it always means we can do better.

We could do better. Yes.

Awesome, thank you so much. Very helpful.

Thanks, Joel.

Tim Thein, Citigroup.

Great, thanks. I'll just cut it off here at one. Just on the, you talked earlier about the raw material costs and the benefits there. Can you just update us on what we should be thinking about from a pricing perspective?

Obviously, you've got outlining pretty tough conditions for high-horsepower and then the power gen being down, contrasting with higher North America on-highway. Which you put all those things together, it's not the best setup in terms of your ability to get pricing. So how should we be thinking about price overall in 2015?

You're exactly right, Tim, the way you just described it. We're not assuming any overall benefit from pricing in our guidance for 2015 for the reasons you just gave.

All right. (multiple speakers) Thanks a lot.

And Tim, you didn't ask the question, but I'm sure people are wondering about it. Are we seeing raw discounting in power gen, places like that, and we are not. There are places where we see it, business [starts], but it's still not broad.

And there's not a consistent move on pricing, which is good. And we hope that remains. And so that's why we think we can maintain our flat-pricing environment in the year.

Thanks a lot.

Okay. Thank you very much. I'll be available for calls later on. Thanks a lot.

Ladies and gentlemen, thank you for your participation in today's conference. That concludes the presentation. You may now disconnect. Have a great day.