康明斯 (CMI) 2015 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cummins Inc. first-quarter 2015 earnings release conference call. (Operator Instructions). As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Mark Smith, Vice President, Investor Relations. Please begin.

Thank you, Latoya. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the first quarter of 2015. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger, our Chief Financial Officer, Pat Ward; and President and Chief Operating Officer Rich Freeland. We will be available for your questions after our prepared remarks.

Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934. Such statements express our forecast 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 disclosures statement in our slide deck and our filings with the Securities and Exchange Commission, particularly the risk factors section of our most recently filed annual report.

During the course of this call, we will be discussing certain non-GAAP financial measures. I would refer you to our website for the reconciliation of those measures to GAAP financials. Our press release with a copy of the financial statements and a copy of today's presentation are available on our website at www.cummins.com under the heading of investor and media.

Now I'll turn it over to our Chairman and CEO, Tom Linebarger.

Thank you, Mark. Good morning. I will start with a summary of our first-quarter results and provide an update on our outlook for the full year. 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 $4.7 billion, an increase of 7% compared to the first quarter of 2014. First-quarter EBIT was $562 million or 11.9% of sales, compared to $528 million or 12% in the same quarter last year. EBIT percent declined slightly year over year, with a 50 basis-point improvement in gross margin offset by a decline in joint venture income. Joint venture income declined in dollars and as a percent of sales, due to the acquisition of our North American distributors previously held as joint ventures and an impairment of our investment in an off-highway engine joint venture. Joint venture earnings in China increased 20% as we gained market share in truck markets.

Engine business revenues increased by 1% year over year, with strength in the North American truck market offsetting lower demand for trucks in Brazil and in global off-highway markets. EBIT of 9.7% of sales declined from 10.5% a year ago, as strong operational performance from our manufacturing plants and benefits from material cost-reduction issues were offset by higher warranty expenses.

As we have discussed in previous calls, we have a very strong focus on improving quality and have implemented changes that will lower our future warranty expense. We expect warranty costs in the second half of this year to be lower than the first half and lower than the second half of last year.

Engine business profitability is projected to increase from first-quarter levels as sales grow and we capture benefits from quality improvements and other cost-reduction initiatives.

Revenues in our components segment increased 6% from a year ago, with strong demand in North America driving the growth. Sales in China also increased, despite very weak end markets. EBIT of $195 million or 15% of sales was a record both in dollars and in margin percent. We had strong performance from four components businesses, three of which delivered clear improvement year over year.

Distribution revenues increased 55% compared to the first quarter of 2014, with acquisitions adding 57%. Currency reduced sales by 5%, primarily as the result of the appreciation of the US dollar offsetting organic growth of 3%. EBIT for the quarter was 6%, down from 8% a year ago. Currency was the main driver of the decline in EBIT percent, as strong operational performance largely offset the dilution from acquisitions.

We expect sales from existing distribution businesses to increase in subsequent quarters and EBIT percent to improve as we continue to capture strong incremental margin on organic growth. We are on track to complete three further distributor acquisitions in North America in the third quarter for a total of 10 acquisitions over two years.

Based on our current forecast, we expect to add approximately $600 million to Company revenues this year in addition to the more than $460 million added in 2014, exceeding the $1 billion in revenues we projected for this year at our 2013 analyst day.

Last year, acquisitions contributed more than $0.40 of earnings per share and we currently expect to add a further $0.20 this year for a total of at least $0.60, also ahead of our 2013 projections of $0.50 a share.

By the end of this year, we have successfully integrated more than 7,000 employees in Cummins, and I want to thank those employees for their continued focus on meeting the needs of our customers through this transition. I would also like to thank all of our employees who have been working hard behind the scenes to make the integration of these 10 formerly independent businesses go so smoothly.

In the power generation business, revenues increased by 6% compared to a very weak quarter last year. Gross margins improved year over year for the fifth straight quarter. EBIT improved from 3.9% to 7.2%, due to the improvements in gross margin and from lower operating expenses as a result of the cost-reduction actions taken in the fourth quarter of 2014. We do expect margins to improve further in the second half as we complete the exit of the alternator operations in Germany as planned.

Now I will comment on some of our key markets, starting with North America. Our revenues in North America grew 17% in the first quarter, due primarily to strength in on-highway markets and distributor acquisitions. Shipments to the North American heavy-duty truck market exceeded 24,000 units in the first quarter, an increase of 8% from 2014 levels.

Our first-quarter market share was 33%. We expect the full-year market size to increase by 8% and project our full-year market share to be 36%, unchanged from our previous guidance.

In the medium-duty truck market, we delivered almost 25,000 engines in the first quarter, up 14% from last year, primarily due to higher market share. We currently project that the market will go up by 1% for the year, consistent with our prior forecast.

Our market share improved to 80% in the first quarter and we expect to achieve full-year market share of 74%, 7% higher than our original projection, as OEMs with Cummins-powered trucks grow market share and we gain penetration at Navistar.

Shipments to Chrysler increased by 2% in the first quarter and we forecast full-year shipments to be flat compared to 2014, consistent with our view at the start of the year.

Our engine revenues from the North American construction market decreased by 12% compared to the first quarter last year. While North America is currently the strongest major market for construction equipment sales, our volumes are down as OEM demand for engines was elevated in 2014 ahead of the Tier 4 final emissions regulations, which went in effect at the beginning of this year.

Power generation revenues were flat in North America in the first quarter. Sales to the US military continued to decline as the current contract reaches maturity. Our core business, excluding military, increased 5% year over year. We expect full-year revenues in North America to be flat to up 2%.

Our international revenues declined by 6% year over year, with lower revenues in Europe and Brazil offsetting growth in China. First-quarter revenues in China, including joint ventures, were $807 million, an increase of 13% year over year. The growth was driven primarily by stronger sales of engines and components in on-highway markets, despite weak end-market conditions.

Industry demand for heavy- and medium-duty trucks in China declined by 33% in the first quarter, as the industrial economy slowed and the truck industry continued its transition to NS4 emissions standards. We estimate that approximately 70% of the industry truck production in the first quarter was NS4 compliant, up from 50% last quarter.

Our market share increased to 17% from 11% a year ago as shipments increased of our new ISG10 and 12 liter engines to Foton and we gained share in the medium-duty truck market with Dongfeng.

Shipments of our light-duty engines in China grew 50% in the first quarter as we gained penetration at Foton, displacing local competitor engines. We are on track to deliver more than 100,000 light-duty engines in China this year, representing growth of 28% in a market that is expected to be flat at best.

Our power generation revenues increased by 22% year over year in a fairly flat market. We are performing well and gaining some share in the data center and telecom sectors.

Industry demand for excavators in China declined 48% and orders in most categories of construction equipment deteriorated significantly in the first quarter as construction activity continues to contract.

Our construction revenues declined by 35%, consistent with very challenging market conditions. With weak demand likely to persist for some time, we did impair our investment in one of our off-highway joint ventures that supplies the China construction market during the first quarter. The impairment reflects lower projections for future cash flows than originally anticipated when we formed the joint venture.

Full-year revenues in China across all segments, including joint ventures, are expected to grow 15% for the year, consistent with our view three months ago. We have lowered our outlook for the heavy-duty and medium-duty truck market and other markets remain weak, but we have made faster progress in gaining market share than we anticipated three months ago, supporting an unchanged forecast for revenue growth.

First-quarter revenues in India, including joint ventures, were $385 million, up 22% year over year, primarily due to recovery in the truck market. Industry demand in the truck market increased 33% compared to the first quarter a year ago, as the economy showed some signs of improvement and truck orders picked up after two years of very weak demand. We now expect industry truck production to increase 15% for the full year, up from our prior forecast of 8% growth.

Power generation revenues in India declined 5% in the first quarter as industry order trends remained weak, especially at the start of the year. We are maintaining our full-year forecast for growth of up to 5% as we see some signs of modest growth in [high risk] of our products.

In India, we project total revenues, including joint ventures, to increase 8%, up from our previous forecast of 5%, due to stronger truck demand. Our operations in India has a much wider reach than the domestic market as our manufacturing facilities are an important source of low-cost engines and components that we leverage globally. We expect to grow our exports out of India by more than 10% this year, delivering globally competitive products that are helping the power generation business grow profitably in new markets -- for example, in Africa.

First-quarter revenues in Brazil were $124 million, down 32% from the first quarter last year, with a very weak economy exacerbated by low business and consumer confidence. Industry truck production decreased by 49% year over year, and our engine shipments declined 33% as the medium-duty trucks segment in which we are strongest held up better than the heavy-duty segment, which declined by 60%.

We have lowered our full-year projection for industry production and now expect a decline of 28%, worse than our previous guidance of down 15%. Very weak production in the second half of 2014 makes for easier comparisons later this year and explains why full-year production may be down only 28% after such a tough quarter.

In summary, we currently expect Company revenues to increase between 2% and 4% for the full year, unchanged from our previous forecast. North America remains our strongest market, with India showing tentative signs of improvement. We anticipated weak conditions in Brazil and China this year, but marketing conditions in both countries have dipped further.

Demand in high horsepower markets, including mining and power generation, also remain weak.

We expect EBIT to be in the range of 13.5% to 14% for the year, consistent with our prior forecast and reflecting improvements in future quarters of a number of cost-reduction initiatives, particularly in the engine business.

Despite challenging conditions in a number of important markets, we continue to invest in the technology, products, and distribution capabilities that will drive future profitable growth. Our successful start to the year in China reflects years of investment and partnership development in that country.

We're also winning business in other markets, despite weak conditions. You may have seen the recent announcement from Halliburton that it selected Cummins Engines to power the first Tier 4 final compliant fracking installation in North America, which is an important win and an example of the power of combining leadership in technology and emissions capability with a deep understanding of customer support in our distribution business.

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.

Okay, thank you, Tom, and good morning, everyone.

First-quarter revenues were $4.7 billion, an increase of 7% from a year ago as strong on-highway markets and the acquisition of North American distributors more than offset weaker industrial markets, as well as the negative impact of currency movements, which reduced our sales by 3%.

All four segments reported growth year over year.

Sales in North America, which represented [61]% of our first-quarter revenues, were up 17% from a year ago, primarily as a result of the higher demand in on-highway markets, along with your impact of acquisitions in our distribution segment.

International sales decreased by 6%, due to the negative impact of a strengthening US dollar and from weaker demand in both Brazil and in Europe.

Gross margins were 25.4% of sales, 50 basis points higher than last year. The improvement was driven by the stronger volume, lower material costs, and productivity improvements, partially offset by higher warranty expense and from unfavorable foreign-currency movements.

Selling, admin, and research and development costs increased by $37 million from the prior year, but were lower as a percent of sales. Acquisitions in our distribution segment accounted for $28 million of this increase.

Joint venture income of $68 million in the first quarter was down $22 million compared to year ago, with the impact of the distributor acquisitions and a $12 million asset impairment charge offsetting a 20% increase in joint venture earnings in China.

Earnings before interest and tax increased to $562 million or 11.9% of sales, compared to $528 million or 12% of sales last year. The positive benefits of the higher sales and raw material costs were partially offset by higher warranty costs, lower joint venture earnings, and the negative impact of currency movements.

The tax rate in the quarter, including discrete items, was 26.3%, compared to 29.9% last year. Net earnings increased by 14% to $387 million and earnings per share in the first quarter grew to $2.14, up from $1.83 a year ago.

Now let's move on to the operating segments to 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 1% over last year. Strong demand in the North American on-highway markets was partially offset by a decrease in off-highway revenues, primarily related to weaker demand in construction, milling, and mining markets.

Segment EBIT was $253 million or 9.7% of sales, down from 10.5% last year, as lower material costs and productivity improvements were offset by the higher warranty expense.

For the full year, we are maintaining our guidance for revenues to be flat to up 2%. Strong demand in North American on-highway markets, including a higher outlook for our market share in the medium-duty truck market, is expected to offset weaker demand in Brazil and in industrial markets.

We expect earnings from our China joint venture to grow as our share of the heavy-duty truck market increases with the ramp-up of our new ISG10 and 12 liter engines. EBIT projections for the full year remain unchanged at 11% to 12% of sales.

For the distribution segment, first-quarter revenues were $1.5 billion, an increase of 55% compared to the prior year. Acquisitions contributed 57% growth, with organic growth from higher engine and product sales in Asia-Pacific and North America and the stronger demand for power generation equipment in Africa being offset by the unfavorable impact of currency movements.

EBIT margins for the quarter declined from 8% of sales last year to 6%. Margin improvements in existing operations were offset by the negative impact of foreign currency movements, which reduced the segment margins by 170 basis points and by the dilutive impact on the margin percent of the distributor acquisitions.

For 2015, we continue to forecast revenue growth of between 23% and 27% over 2014 levels. We now expect EBIT margins to be in the range of 7% to 8% of sales, driving 100 basis points at the midpoint from our previous guidance, primarily due to currency. Our North American acquisitions remain on track to exceed the projections provided at the 2013 analyst day, as Tom just described.

In the components segment, first-quarter sales were $1.3 billion, an increase of 6% from last year, despite a 3% headwind from unfavorable currency movements. The higher revenues were primarily driven by increased demand in North America and highway markets. Revenues in China increased modestly as higher after-treatment sales more than offset the impact of a 33% decline in industry truck demand year over year.

Segment EBIT of $195 million or 15% of sales was a record both in dollars and as a percentage of sales, improving from the 13.6% we reported last year. Higher volumes combined with raw material cost drove this improvement.

We continue to project revenue growth of between 4% and 8% for the full year and we are raising our EBIT projections to between 14% and 15% of sales, which is up 75 basis points at the midpoint compared to our previous guidance, due to strong performance and cost-reduction initiatives.

In the power generation segment, first-quarter sales were $680 million, an increase of 6% year over year. Organic growth of 8% was partially offset by a 2% reduction due to currency. Year-over-year growth in most parts of Asia, in Africa, and in the Middle East more than offset lower motor demand in the US.

EBIT margins were 7.2% of sales in the quarter, up 330 basis points from last year. Improved operating leverage from higher volumes, along with the benefits of restructuring and from a weaker British pound, were the primary drivers of the margin improvement. We are maintaining our guidance for the power generation business, with full-year revenues expected to be flat to down 4% and EBIT margins to be in the range of 8% to 9% of sales.

Now let me summarize for the Company overall. For the full year, we continue to forecast total Company revenues to be up 2% to 4%, with a continued strength in North America on-highway markets, the distributor acquisitions, and revenues from new products offsetting weak off-highway markets.

Currency movements are now expected to reduce our revenues by 3.5% when compared to 2014 levels. We continue to project our overall joint venture income to be down 10% as a result of the distributor acquisitions, partially offset by stronger joint venture earnings in China.

We expect EBIT margins of between 13.5% and 14% of sales for 2015 and this compares to 13.2% for full-year 2014, excluding expenses from cost-reduction actions in our power generation business last year. As we indicated three months ago, the first quarter is expected to mark the low point for EBIT margins this year. Improvements in gross margin from material costs, restructuring, and higher volumes, coupled with stronger year-over-year joint venture earnings in China, will drive the EBIT margin this year.

An effective tax rate for the full year is forecast to be 29.5%, excluding any one-time tax items.

And finally, with regards to cash flow, we generated $173 million in cash from operations in the first quarter, lower than last year as the result of an increase in working capital associated with the higher revenues. We continue to expect our operating cash flow to be in the range of 10% to 13% of sales for the full year.

The combination of returns to shareholders and capital expenditures resulted in a decline in our balance of cash and marketable securities of $282 million from 2014 year-end levels.

We returned $277 million of cash to shareholders in the first quarter through dividends and from the repurchase of 1 million shares, and we expect to return 50% of operating cash flow to our shareholders in 2015.

Now let me turn it back over to Mark.

Okay, thanks, Pat. I think, Operator, we are now ready to turn it over for questions, please.

(Operator Instructions). Nicole DeBlase, Morgan Stanley.

My first question is around what you guys saw with respect to oil and gas this quarter. Did you start to see the deterioration in the first quarter of the year, and if so, has the deterioration continued into 2Q?

Yes, Nicole, this is Rich. Actually, the first-quarter sales to oil and gas were actually up 67%, which is a bit misleading, on very low comps. And we did start to see that deterioration at the end of the quarter. And so, we are now projecting, despite the up 67%, a 27% drop for the full year. So we've started to see a decline towards the tail end of the first quarter and we are projecting that going forward.

Okay, got it. That's helpful.

And then, my follow-up question is on the engine margin. Can you guys quantify the warranty headwind that you had during the quarter and what are your expectations for 2Q? And then, how much of a year-on-year tailwind might this be in the second half of the year? If you have any sort of visibility on that, it would be helpful.

Yes, so, Nicole, this is Pat. I will start off and then I think Rich wants to say a few words.

So in the first quarter in the engine segment, warranty expense was up 1.4% from last year, so 2.6% of sales Q1 last year, 4% of sales Q1 this year.

For the Company, warranty expense increased from 2% last year to 2.6% in the first quarter this year. For the full year, we are expecting warranty, as Tom said, to come down as we go through the second half of the year and we will probably end up around 2.5% for the full year, slightly above the 2.4% we reported last year.

Okay, that's really helpful. I will pass it on. Thank you.

Andrew Kaplowitz, Barclays.

Tom, I wanted to ask you a little more about China. So, 17% share is an impressive result, I think. What do you think is realistic for the end of the year and into next year for market share?

And maybe related, should we expect -- you talked about a material pickup in JV earnings. Is it really just the heavy-duty business turning to significant profitability for the rest of the year?

Well, first, let me just talk about market share. I know you were at our analyst conference, and the 17% number was what we had projected to say we want to get there by 2018, and somebody asked me is that your target and I said, no, my target is 25%. What I'm projecting is 17%, because there is risk in all those things.

We feel really good about being where we are. 17% is, as you said, it is a good accomplishment. It is where we wanted to be and that's terrific.

I don't see a lot more market-share gains this year. I think if we go out of the year at 17%, I will still feel pretty good because what we will have successfully done is we got our light-duty business going well now at 100,000 units forecasted for the year. We've got our heavy-duty business launched and that product, the ISG, is performing really well.

And we are gaining some share at Dongfeng back because our engine is doing better in their trucks than some of their competitor engines and their truck is doing better. Remember, they were losing a little share with NS4. Now they are getting some of that back as the NS4 compliance percentage of all the builders goes up, so those are all good things.

Again, I don't project a whole bunch more shift in those markets this year, but we still -- I still have the same target for where I would like to get over time in terms of market share. Anything you wanted to add on profitability, Mark, on heavy duty?

The heavy-duty profitability clearly came up as we significantly reduced or almost eliminated those losses in the first quarter, as we had said a quarter ago, so that will pick up. There's still opportunity for the light duty and things to grow in China as well, as you said.

Right, right. And we are still investing in products, so the joint ventures have investments, as well as revenues. Both are flowing through there, as you know. But right now, the revenues are going a lot better, so that's why we are seeing better joint venture earnings.

And we would expect to see a step up in those earnings in China, just to be clear, in the subsequent quarters, which is one of the drivers in engine business margin improvement.

Got it. And then, Tom, just about power gen, the quarter itself in terms of revenue growth was -- you gained some optimism after several years of not too much going on outside the US. So, maybe can you talk about have we seen or are we seeing any type of inflection in power gen or is that too early to call?

Not really. Just to call it like it is, we're not really seeing much of an inflection in power gen. I think what you are seeing in our results is a lot of improvement on costs over a long period of time, slower than we would have liked, as you know, but I think we're getting some traction now in the cost structure and that's why we're seeing better margins.

The sales increases are pretty hard fought, frankly. It is really not much better anywhere. As we noted, we have a little bit of optimism about India, but even that's pretty early, and it's optimism, not orders. So, we have got a little bit of signs, but not much, and most of the markets are pretty subdued. So there really hasn't been much change in the markets, I would say.

Just to add to that, Andy, the story in power gen is all about improving profitability on the same level of sales right now. So we feel pretty good about that. We saw the big step up in Q1, and just to recall, the restructuring we took in Q4, the majority of the benefits of that have yet to be realized, so they are second half of 2015 yet to come.

Okay, thanks, guys.

Joel Tiss, BMO.

I just wondered if -- I guess maybe it's not a fair question, but can you give us any sense if you feel like you are maxing out in the operating margins in the engine business? And I am just looking back at long-term history and companies who've had engine businesses have gotten to 10%, 11% and had trouble getting a lot higher than that.

I will go ahead and take that, Joel. The short answer is no. We're not capping out.

I'll give you just a couple reasons. So, the implied guidance you have for the rest of the year, if you say we were at 9.7% in Q1 and we have not changed our guidance for the full year, says that we will be in the 12% range for the rest of the year, 11% to 12% the rest of the year.

So we are going to see increased volume. We're going to see increased JV earnings we just talked about from the China growth. The warranty improvement, which has been a headwind for the last year, becomes a tailwind beginning second half of the year, and beyond, and then our high-horsepower engines are down at historically low levels. And so, while the heavy-duty truck is up, we still have the tailwinds, which are not here and we are not projecting them in 2015, but all of our high-horsepower markets are quite depressed right now.

Okay. And I just wondered, I am hearing a little bit from other companies about optimism in Brazil getting better in 2016. I am not asking for a forecast, just flavor of the market, and any thoughts you guys have about Indian strength continuing into 2016 also.

Both Rich and I have spent some time in Brazil and there was not much optimism while we were there. That doesn't mean it couldn't get better in 2016, it definitely could, but it was pretty bleak. And the problem, I think, not only is there some economic weakness, but there was a lot of uncertainty with this Petrobras investigation and other things that were hanging over.

There is a bunch of good things in Brazil which could help. They've got infrastructure development again coming. They have got a lot of investments potentially to be made in those oil and gas fields, so there is a lot of opportunity for Brazil to get better, but there is also a whole bunch weighing on it right now. So it would be really hard for me to be optimistic about fast recovery in 2016. It doesn't mean it won't happen, but I am not particularly optimistic.

South America in total, though, I think has a little bit more opportunity. We also spent time in Colombia, in Chile, in Peru, and frankly, some of those markets have more opportunity even in the shorter run. There is mining in those, which are a little depressed, but I would say all those markets are moving faster and have the potential to bounce a little bit quicker. Mexico is another. So the region, we see opportunity. Brazil, we hope comes back soon, but it's pretty down right now.

With regard to India, I talked about this, but there is a big infrastructure development program from the new government, a whole bunch of, whatever you say, bureaucracy-reduction programs and other things that they are trying to do to take decision-making times down, all of which sounds awesome. It's a big country to manage and all this stuff that he and his government wants to do are going to be hard to do. So we are very optimistic about the potential and realistic about the timing and pace.

Okay, that's awesome. Thank you.

Jamie Cook, Credit Suisse.

I guess a couple questions. One, with regards to heavy-duty market share, I think you said it's going from 33% to 36%. Can you talk about your line of sight and what's driving this? Is this a function of one of the major truck OEs just out of capacity? How much is predicated on Navistar?

My second question, I'm sorry, back to the engine margins. Did the first quarter -- you seemed confident in your ability to hit, I think, the 11% to 12% for the year, but did the first quarter fall short of your expectations? And what's embedded in engine margins in terms of material cost tailwind, as well as any cost-related initiatives outside of warranty?

And then, last, Tom, I think you mentioned quality issues. Can you just correct me if I am wrong there or elaborate? Thanks.

That's a lot of questions.

Sorry, it's been a busy day.

Let me start, and Mark, you could remind me on all the questions (multiple speakers)

Heavy-duty share.

Start just with heavy-duty share. We are leaving the guidance at 36%. We were lower than that in Q1. As you know, our share is based off of production, so we get some month-to-month variation and quarter-to-quarter variation just what's being produced even versus what's being sold.

So we can't -- we don't have a lot of visibility, but we can see into Q2 and we will see our share go up, so we have some confidence in that, that the share is going up and we can see it in the order books. And it mixes some, again, between OEs, and it mixes a little bit are people building 15 liter or 13 liter at a given time. And so, a little more 13 were built in Q1, but we haven't seen the overall demand shift in that.

Okay.

So with OEs, we're up in some and down in others, and I think you know generally where that looks, but no fundamental change there.

Let me -- I will jump in and take the engine margin question, Jamie. So, yes, it fell -- to be honest, it fell a little bit below where we would like it to be in Q1. We did get off to a very slow start at the beginning of the year. Things picked up as we went through February and March, so I feel good for where we are coming out of the quarter with regards to the guidance for the rest of the year.

Tom did make some comment about the asset impairment we took in the off-highway joint venture. That was a $12 million charge in Q1 that hurt the engine business. The material cost tailwind we got in Q1 was around 6/10 of 1 point. We expect that to pick up as we go through the rest of the year, so they were the key highlights, I think, for the Q1 result and why we feel as confident as what we do about the 11% to 12% margin guidance for the rest of the year.

And Jamie, the cost-reduction initiatives, the material costs, I will let Mark give you the numbers for material costs. The material cost things are -- programs are going well. We are seeing good benefits in those.

Plants are producing well. We are getting good productivity out of plants, and as Pat said, when we looked at the February and March numbers, our confidence went up a lot that we were going to be able to hit the numbers Q2 and beyond, even though the quarter was below and January, frankly, was just below our expectations.

And you asked me if I mentioned quality issues, and that was -- are you talking about the impairment charge?

I mean, you just mentioned quality, and I am sorry. You are the fifth company that has reported for me today, but I thought you mentioned quality issues. I just want to make sure. Can you just elaborate on that?

No, no, in fact, the quality issues -- Rich is in these things in detail, so he can comment, but we feel very good about where we are, which is why we are confidently projecting warranty coming down in the second half. Rich, you may want to just say a few words about that.

Yes, just recall, we took the rate up in Q2 last year -- at the end of Q2 last year, based on the cost for repair being higher than we had forecast. So we are tracking each of those improvements we put in place. I personally look at them. And then, with telematics we can actually see are the fixes working as we planned.

So what we really just need now is the miles to demonstrate the improvements and we're on track with that, so we are projecting the rates begin to come down second half of the year. We have had no new issues during that time, and in addition, just triangulating, talking to customers and saying, are you seeing the same thing? I have personally talked to dozens of them over the last several months and customers are seeing the same thing.

Thanks. I'll get back in queue.

Rob Wertheimer, Vertical Research.

I wonder if I can just go back to power gen for a minute. You answered it generally, but I am curious about general and specific. Are you seeing any major project activity? There is a couple of big countries, like Brazil and South Africa, you mentioned Brazil, which have maybe strains on grids for various regions. Is there a chance that you see a big backlog of orders building in support of the electric grids in situations like that?

And a more specific one, if I'm reading my numbers right, power gen was up 5 in 3Q, up 1, and then up -- I don't have it here -- 6 or something. Then stationary power within engines is up 14, 18, and 31, and I just want to understand the reason for the bifurcation between those two. Thanks.

Rob, I will just talk about the broad project markets. There is not a concentrated project demand now.

As you have said, it does happen and it happens pretty frequently where there will be someplace where there is grid support needed, and we did have a little bit of that in Brazil last year because the water -- we had water shortages. And again, it could happen again in Brazil. Their grid is very tight. They depend a lot on hydro and with -- if there's weak rain, they need more grid support.

Going the other way is their power demand is down because the economy is weak. So their reserve margin is a little bit higher than it was even last year, and so, again, it doesn't mean it wouldn't happen, but it's not as likely as it was last year. And it turned out to be some demand, but not as much as we would have hoped last year.

So, there are projects. Telecom is still a pretty active segment. Data centers are still pretty active, but not like they were. Just generally speaking, the global economy is not as strong, and so all this project demand, it exists, but the level is just lower.

And I think just in terms of some of the details you're getting into, Rob, yes, the engine business revenues for stationary power were up a lot. First of all, Q1 was a relatively weak comp last year. The revenues have been influenced by a little bit of a pickup in high-horsepower units, so the revenues indicate a much bigger pickup than the market match with the unit growth. So I don't think -- that's not a sign of some extraordinary pickup. It's a little bit of an improvement off the bottom on a larger gen set.

Perfect. Thanks, Mark.

Jerry Revich, Goldman Sachs.

I am wondering if you could talk about the off-highway share gains opportunity from now the Tier 4 final is being implemented and maybe throw in how the Hedgehog program is going as well. Based on your comments, Tom, it sounds like you are pretty optimistic on applications in pressure pumping. Where do you think your market share can move to? Can you just give us the broader landscape?

Let me start, Jerry. This is Rich. I will start on the Hedgehog. So we actually are -- we are really pleased with the -- where we are on Hedgehog, both in -- we have customers secured. We have products in the field now in the power gen market. We have secured business and will begin shipping product second half of this year in the rail side. We have secured customers in commercial marine. We're feeling pretty optimistic on that.

And again, having the Tier -- we will have a Tier 4 solution in rail that has provided that opportunity for us, so part of our overall strategy is introduce the emissions technologies in on-highway. We're using those same technologies in bringing these to the off-highway market.

So the Tier 4, we do believe, is an opportunity for share and currently for more content as we add aftertreatment and other components to the product.

And the markets, in terms of doing the share, as you know, Jerry, it's a pretty complex picture across all those segments, all those regions.

But we do believe there is a pretty significant share gain opportunity both in terms of this larger engine, which we don't even go in today, so that's just all share gain. Plus, as you know, the component side where we are getting more content is a pretty clear share gain.

On the oil and gas side, we are still a pretty small player in the overall scheme of things, and it will be several years with this new larger engine before I think we are a meaningful share of the overall oil and gas market. We have a long way to go there, so we are still at the small end of it, finding things to do.

We are just pretty excited about some big customers like Halliburton telling us, hey, your product is technically leading enough and you guys have the customer support we need that we are willing to depend on you for this fracking installation. That is a pretty good sign that we are in the market for real.

We are still nothing like the size of some of our bigger competitors, but that's a pretty good recognition of where we have come in just a few years.

Okay, thank you. And then on currency, in components, really strong margins this quarter even though the headwind was greater than in 4Q. Can you just talk about what has worked out well? And then in distribution, do you folks need price increases to push the margin structure and effectively make up for the currency rates or are there any other opportunities to improve margin distribution?

Pat will give you some more details on the currency and on the margin. I just wanted to say from components, as we talked about last quarter, we had a dip and we knew we were coming back. The components business is performing incredibly well, and we knew we would bounce back and this reflects that.

In terms of some of the improvements they continue to make, though, they are still managing costs incredibly well and driving material cost out, and this is one of the areas where we said we were going to focus on material cost. In weak markets, that's an area where we know we can make progress and it really had a big benefit here. But that group, not only are we getting good content on the sales side, as we talked about earlier, but we are keeping costs under control and performing and executing well on those cost reductions. They are doing a terrific job and I think that's why you are seeing the results you are seeing.

Pat, you may want to add on the (multiple speakers)

Yes, also on the numbers side, for components we took a 3% headwind on revenue. It wasn't such a big deal on the bottom line. It was like $7 million negative at the bottom line, so if you were to back that out, it had a dilutive impact of 1/10 of 1 point on [return on] sales.

So we will probably see that pick up a little bit as we go through the rest of the year in terms of a headwind, which is part of the reason why the gain. This is a little bit more than Q1 results, but, as Tom said, it was a really, really good first quarter for components, really pleased with that.

The second part of your question around what are we doing about pricing, it's really on a market-by-market basis. So in some parts of the world, in some parts of Asia, we have raised prices to try and offset the currency headwind. It is much more difficult in Europe when you're up against European competitors who have a built-in advantage with the cost structure. So where we can increase prices, we are doing that, and we will really do it on a market-by-market basis.

I would just say overall for the Company, the net earnings hit from currency wasn't particularly significant this quarter.

No, for the whole Company it was like $10 million. It wasn't a big deal.

Thank you.

Tim Thein, Citigroup.

Just a follow-up on distribution. There is obviously a lot of noise in these numbers, given what you had mentioned with FX, but also the amortization. Do you maybe have some kind of just an update in terms of a same-store sales type of metric? I am especially interested in North America, just given all the movement in terms of the buy-in of the equity stakes, just how the underlying business in North America, which is now pushing 60% of that segment? So, can you just update us on that, please?

Yes, so I think -- so last year in North America overall, if you ignore the ownership structure, we probably grew it about 9% in North America, Tim. This year, it's looking a little slower. You got a little slow with the oil and gas business, but still clearly single digit, low to mid single-digit growth with the strong parts business continuing.

I think beyond just the revenue growth, if you look at the same-store performance we are delivering consistently over several quarters 100 basis points or more in segment margin improvement from strong execution on those incremental sales. So that's really good. To your point, it is masked somewhat by the currency in particular. But overall, we are pleased with our performance.

And Tim, you are right there is a lot of noise, but here is -- the simple way to think about is we have a business where currency is pushing down sales and margins. We have got amortization, which is just a non-cash charge which is pushing done margins, and then we have operating performance pushing forward on margins.

And what we said is that we had about 100 basis-point improvement from just organic performance, just execution on same-store sales. We had about a 1% negative on amortization or just the overall kind of a dilution effect, amortization and dilution effect, and then we had negative currency.

So, we feel like the business is performing well. We are putting them in. We are getting the revenue and dollar growth. We are getting the operational improvements and we just got some headwind. And the headwind on currency is all sits in the distribution business, almost, a little bit in components, but mostly in distribution. It's just the way we do our intercompany pricing and that kind of thing.

So, it's just creating more noise. Overall, the Company is doing fine with currency. It is a headwind on revenue. It's not a gigantic headwind on margin; it's just it all sits in the distribution business.

So, again, it's going to take a little while for, I think, everyone to peel back these numbers, but the distribution business is doing incredibly well and we're adding dollar margin to the Company, better than we expected, even, and integrating -- we will have 10 businesses integrated by the end of this year that will be performing incredibly well.

Okay, got it. And just I guess somewhat related, can you provide a little bit of an update in terms of just part sales, what the guidance assumes, within engine? I see -- I am guessing it's a function of small numbers, but the industrial segment, I guess you're guiding to parts growth there. Maybe just a little bit of color in terms of what's contributing to that.

Sure, yes, overall we are still projecting growth this year, so 5% to 7%. Where that's coming from, a little bit of pricing. North America in particular with the heavy-duty truck, medium-duty truck is driving that. And then, we feel pretty steady to date on our high horsepower, so even though some of those markets are down, to date we have held just about flat to up 1 point or 2 there, so overall it adds to 5 to 7. We are down in areas where the markets are way down. For example, Brazil is a down market right now.

Great. Thanks a lot. Bye-bye.

Steven Fisher, UBS.

In terms of new products, which do you expect to have the biggest impact on revenues and profits this year, and was Q1 consistent with what you would expect the rest of the year to be?

Just in terms of one single product, there's a lot of them acting different markets, but one single product, definitely the ISG and then the ISF after that in China. Those are the places where we are seeing brand-new products launched going from no sales to good sales. The ISG is the 10 and 12 liter in China that we are selling to Foton, and then the ISF is the light-duty engine we are selling from our Foton joint venture both in China and outside of China. So those are the ones, I think, that are having the most revenue growth just on their own standalone basis.

I guess I will just add to that. What's included in that is the aftertreatment that goes with those products. We're up to 20% share in aftertreatment in China, for example, and so we have designed new aftermarket products there that have added to it.

We have got the 5 liter V8, but it's not a big number yet this year. We have introduced it. It'll go for sale very late in the year. We've talked about the Hedgehog, which is, again, not big numbers yet this year, but gaining traction, and then our low kVA business.

So we feel good about -- on track with each of those products where we said we would be.

Okay, great. And then on the China heavy-duty JV earnings, how quickly do you think you can get that running to a $10 million, $12 million a quarter profit from essentially the breakeven levels now?

It will be profitable, as we said, next quarter where -- we are there. When we get to $10 million to $12 million, we don't have a forecast we can give you on that yet, but we are moving towards profitability. We will get a good profit stream out of that product. We just don't have the date for that number yet.

Okay, fair enough. Thanks a lot.

Ross Gilardi, Bank of America.

I just had a couple questions. Just on components, your biggest customer saw a nice bump in parts margin by selling more company-branded parts. That was one of the reasons. And I'm just wondering, how is market share trending in components over the last six to 12 months? Do you feel like you are at any risk of losing share in components as PACCAR builds more of its engines internally?

Two comments. First, just with your opening comment, we may be confusing two things. One is the components business is a new equipment sale and a parts business. I think you know that. So, we are -- we sell our components as our brand always, and then, of course, we also have an aftermarket business associated with those. I think that's clear, but just to make sure.

Sure.

And then with regard to our power components business, as other companies make their own engines, if we lose our engine sale we gain most of the time in the component side because most of them use some of our components. PACCAR is the one example you mentioned, so the MX engine uses several important components from Cummins, and we think that's one of the ways that we want to support these OEMs.

So we definitely want them to buy engines if they need engines and we also want to help them with their engines, and we have got a bunch of component technology that can help them make their engines successful, and we're willing to go both -- do both things with customers, which I think makes us a better partner than if we were only willing to do one.

And so in the MX, every time an MX is sold, we feel good. We have good business with them on components.

Got it. Thanks a lot. And then just maybe shifting to the off-highway market, specifically construction and in North America. CAT seemed to benefit from a big dealer restock event that seems likely to unwind later in the year. Do you see the same thing at all? Are you worried about destocking in construction in North America and do you find that your North American off-highway customers are leaning heavier for price concessions, because we are hearing a little bit more about increased price competition downstream in the North American earth-moving equipment market?

What I would say -- this is Mark -- I would say North America represents probably the most stable to positive global market for equipment sales for construction equipment. It's low single digits.

We think our issue is really that OEMs ordered a lot of engines last year. They'll use their emissions credits to build product ahead of the Tier 4 final regulations. So I think the market is stable to improving very modestly, but our businesses -- new engine sales are impacted by that transition.

Yes, and we don't do any dealer stocking in this area, so it doesn't mean that our end customers don't, but we are not doing any of that. I think that's probably obvious to you, so we don't have any dealer stocking kind of issues.

Right, right. Okay, thanks a lot.

Your question on pricing, just to close on that, generally as a Tier 1 supplier we have long-term agreements with each of these, so the retail pricing pressure in the components business, we don't feel that.

Got it. Thank you.

Alex Potter, Piper Jaffray.

I guess a follow-up to that question. If you were to look at North America, all of your off-highway businesses put together -- obviously, there is a lot of moving parts, a lot of different segments. There is oil and gas in there, but there is construction, there is mining, everything. If you were to put that altogether, would you expect that to be up in 2015 or flat or down? What are you seeing in that regard?

Down slightly overall. Oil and gas will be down 20% from Q1 levels. It will be down a little for the full year. Mining will be down a little bit for the year. Construction for us will be down. That doesn't leave many other significant pieces. Probably commercial marine will be about flat. So in aggregate, a little down, part -- there will be parts growth to offset lower equipment sales, but low single digit down, I would say, Alex.

Okay, fair enough. And then, the 100,000 units you were alluding to at the Foton joint venture, that's just for light duty, I gather? But is that just for domestic sales in China or does that include exports as well in that total number?

That's just domestic. We'd tried to call out what we are doing in China versus the market. We'll be probably 130,000 plus. Now some of those other markets, like Brazil and Russia, are down a little this year, but still overall probably (multiple speakers)

(multiple speakers) market the volume, yes. So 100,000 to China and then another 30,000, 40,000 elsewhere is what the base numbers are.

Okay, very good. That's helpful. Thanks a lot.

Andy Casey, Wells Fargo Securities.

Thanks for sneaking me in. Just a question on pricing, but looking at regionally specific stuff within the US through your distribution lens. Are you seeing any incremental pricing in some of these annual contracts in the energy market -- priced down, I mean?

In the energy power gen market, you mean?

Yes.

Oil and gas. Okay, oil and gas. That's not the structure of our contracts. I'm not saying that some of our customers aren't seeing that, Andy; maybe, Rich, you have a closer view.

But right now, we are not getting much visibility to that. What we are seeing -- our structure of our products is that we are selling engines and the equipment sale then gets made and then somebody else is running the energy contract.

It's obvious, though, that the market is under severe pressure, as Rich was describing, and so I would be shocked if there aren't negotiations on operating prices and things like that. But for us, our engine pricing is holding up fine. The equipment pricing is holding up fine. It's just volume is just dropping like a stone now.

Okay, thank you, Tom. And then, looking at the North American truck market a little bit, you have had this nuance with the orders. I'm just wondering, are your customers asking Cummins to increase production rates for the second half or is it just stable and you get a little bit higher mix?

No, we have our customers have come to us, and, again, we are seeing it in Q2, to increase the rates to increase our share with them.

Second half of the year is out ahead of where our order board is, Andy, but the second quarter, as Rich said, is what we can see and that's where we can see the increased orders and requests for us to build more. They're building more, of course. They are increasing their production rates and then they are asking for engines from us.

You won't see it in the March data so much, but going forward after that.

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

Thank you, everybody. Appreciate your questions. Thank you.

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect at this time. Good day.