康明斯 (CMI) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cummins Inc. First Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this call is recorded.

I would now like to turn the conference over to our host for today, Mark Smith, Vice President, Financial Operations. You may begin.

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the first quarter of 2018. 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. We will all be available for your questions at the end of our prepared remarks.

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

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

Now I'd like to turn it over to Tom.

Thank you, Mark. Good morning. I'll start with a summary of our first quarter results and finish with a discussion of our outlook for 2018. Pat will then take you through more details of both our first quarter financial performance and our forecast for the full year.

Revenues for the first quarter of 2018 were $5.6 billion, an increase of 21% compared to the first quarter of 2017. EBITDA was $700 million or 12.6% compared to $705 million or 15.4% a year ago. During the first quarter, the company recorded a pretax charge of $187 million for the expected cost of a product campaign. The charge was shared between the Engine and Components segments. This voluntary campaign is part of a proactive plan to address the performance of an aftertreatment component in certain on-highway products produced between 2010 and 2015 in North America.

We disclosed in our third quarter 2017 earnings release that we identified an issue caused by the degradation in performance of this aftertreatment component and that further analysis was required to understand the extent of the problem and the appropriate remedy. The product campaign recorded in the first quarter represents the next step in our process to proactively address this aftertreatment degradation issue. We are working collaboratively with the regulatory agencies, and we will need to get agreement from the agencies to finalize our action plans, and only then will we know the full cost and timing to resolve the problem.

The charge of $187 million reflects our best estimate of the cost of implementing our proposed plan. We have also estimated a range of additional costs should the regulatory agencies ask us to replace more aftertreatment hardware than our proposed plan, which we believe to be between $0 and $400 million in the worst case. It's important to note that this issue does not affect our current products, which are performing very well, and our market share remains strong.

Excluding the charge for the campaign, EBITDA for the first quarter was $887 million or 15.9%, reflecting an incremental margin of 19%. Strong operating performance in our manufacturing plants, positive pricing and the benefits of material cost-reduction initiatives all contributed to the improved performance.

Engine business revenues improved by 21% in the first quarter compared to a year ago. Increased production and strong market share in North America truck markets and strong demand from global construction customers, especially in China and North America, drove most of the growth. EBITDA for the quarter was 11.7% compared to 13.5% for the same period in 2017 due to $93 million of costs recorded in the quarter for the product campaign. Excluding the campaign, EBITDA was 15.5%, reflecting an incremental margin of 25% year-over-year. Improved pricing, strong performance from our manufacturing plants and lower operating expense as a percent of sales drove the margin expansion.

Sales for the Distribution segment grew by 13% year-over-year, driven by higher demand for new engines, parts and service in off-highway markets. First quarter EBITDA was 6.6% compared to 7.9% in the first quarter of 2017. EBITDA percent declined due to lower earnings in Africa and the Middle East as a result of weak demand and currency volatility and a lower mix of part sales in North America. We do expect EBITDA to improve in dollars and as a percent of sales in the second quarter as a result of stronger part sales, targeted price increases and cost-control measures.

First quarter revenues for the Components segment rose by 30%. Sales in North America increased 35%, and revenues in international markets grew by 25% as a result of rising market demand, strong market share and the success of new products aimed at lowering emissions. Sales of the Eaton Cummins Automated Transmission business contributed 9% to segment growth.

EBITDA for the first quarter was 12.9% compared to 16.1% in the same quarter a year ago and declined due to a charge of $94 million related to the product campaign. Excluding the campaign charge, EBITDA was 18.3%, reflecting an incremental margin of 26%. The improved margins resulted from strong operational performance and the benefits of material cost-reduction programs.

Power Systems sales in the first quarter grew 22% year-over-year, driven primarily by an increase in engine and part sales to mining and oil and gas customers. Sales of power generation products improved year-over-year for the third straight year -- third straight quarter, excuse me. EBITDA in the first quarter was 13.2% compared to 9.6% a year ago, resulting in an incremental margin of 30%. The benefits of stronger volumes, cost-reduction programs, better execution on power generation projects and stronger joint venture earnings in China all contributed to the margin expansion.

In the first quarter, we reported results of our Electrified Powertrain business for the first time. EBITDA was a loss of $10 million for the first quarter, and losses will increase in subsequent quarters this year as we accelerate our investments in new product programs.

Now I will comment on the performance in some of our key markets for the first quarter of 2018, starting with North America. Our revenues in North America grew 22% in the first quarter, primarily due to higher levels of truck production; growth in sales of construction equipment; and increased demand for engines for mining, oil and gas and power generation customers.

Industry production of North American heavy-duty trucks grew 44% in the first quarter of 2018 while sales of our heavy-duty engines increased 48%. Our market share through February was 34%, up 2% from last year. Production of medium-duty trucks improved 9% in the first quarter while our engine shipments grew 26%. Our market share in the medium-duty truck market was 82% through February, up 70 -- from 75% a year ago. Total shipments to our North American pickup truck customers decreased 22% compared to a year ago due to a short-term adjustment in production by one of our OEM customers.

Engine sales for construction equipment in North America increased 47% in the first quarter, reflecting increased customer confidence. Sales from engine shipments to high-horsepower markets in North America rose 79% compared to a year ago, driven by higher demand from oil and gas and mining customers. Revenues for power generation grew by 6% due to higher demand in the data center and recreational vehicle markets.

Our international revenues increased by 20% in the first quarter of 2018 compared to a year ago. First quarter revenues in China, including joint ventures, were $1.2 billion, a decrease of 3% due to lower sales in on-highway markets. Industry demand for medium- and heavy-duty trucks in China increased by 9% compared to a year ago. Our OEM partners underproduced relative to the market in the first quarter, and our share dipped to 12% from 14%. We expect the first quarter to mark the low point for our market share, with improvement expected in subsequent quarters.

Industry sales of light-duty truck grew by 7% in the first quarter, and our engine market share was 7%. Demand for excavators in the third (sic) [first] quarter increased 48% from a year ago in China. Our market share increased by 3% to 13%, driven by strong performance by our customers, including LiuGong and Hyundai.

Revenues for our Power Systems business in China increased 57% due to growth in engine shipments to mining customers and higher demand for power generation equipment for data centers.

First quarter revenues in India, including joint ventures, were $581 million, an increase of 43% from the first quarter a year ago due to growth in on- and off-highway markets and strong sales of new products in our Components business. Industry truck production increased 18% year-over-year, driven by growing industrial activity and government investments to develop infrastructure. Our market share in the quarter was 42%, up 300 basis points compared to the same period last year, largely due to strong market acceptance of our engine system technology for the Bharat Stage IV emissions regulations introduced last year. Our penetration at Tata rose to 90% in the quarter, with both Tata and Cummins benefiting from strong product performance relative to the competition. Power generation revenues also grew 6%. In Brazil, our revenues increased by 46%, primarily due to a moderately recovering economy, resulting in improved demand for trucks and compared to a weak 2017.

Now let me provide our overall outlook for 2018 and then comment on individual regions and end markets. We are now forecasting total company revenues for 2018 to be up 10% to 14%, increasing our prior guidance of up 4% to 8%, reflecting a stronger outlook for truck production in North America, India and Brazil and increased demand from mining and oil and gas customers. We've raised our forecast for industry production of heavy-duty trucks in North America to 286,000 units, up 29% compared to 2017 and above our prior guidance of 266,000 units. We expect our market share to be between 31% and 34%, unchanged from our view last quarter.

In the medium-duty truck market, we are maintaining our forecast for industry production to reach 124,000 units, up 5% year-over-year, and we expect our market share to be in the range of 72% to 75%, also unchanged. We expect our engine shipments for pickup trucks in North America to be flat for the full year compared to a very strong 2017.

In China, we expect domestic revenues, including joint ventures, to be down 2% compared to our previous guidance of being down 5% in 2018. We have raised our outlook for medium- and heavy-duty truck market demand slightly to 1.2 million units from 1.15 million, representing a 10% decline from 2017. In the light-duty truck market, we expect demand to be flat in 2018, in line with our previous guidance. We expect our market share in the medium- and heavy-duty truck market to be 14%, and in the light duty, we expect our share to be 8%, both up from first quarter levels.

In India, we expect total revenues, including joint ventures, to be at least 20% year-over-year relative to our previous guidance of up 15% due to stronger truck demand. In Brazil, we now forecast truck production to increase 9% in 2018, up from our previous forecast of no growth. We expect our global high-horsepower engine shipments to increase 30%, up from our previous forecast of 10% growth, reflecting strong demand from mining and oil and gas customers and rising demand for power generation equipment.

In summary, we've more than doubled our sales growth outlook for the year to 10% to 14%. And excluding the charge for the product campaign, we revised our forecast for EBITDA to be in the range of 16.2% to 16.6%, reflecting a full year incremental EBITDA margin of 28%. Demand in several of our core markets is improving. Our products are performing well, and we are excited about the investments we are making for the future. During the quarter, we've returned $341 million in cash to shareholders in the form of dividends and share repurchases, consistent with our plan to return 50% of operating cash flow to shareholders.

Now let me turn it over to Pat.

Thank you, Tom, and good morning, everyone. I will start with a review of the company's first quarter financial results before discussing the performance of the operating segments in more detail. I will then provide an update on our outlook for the rest of the year.

First quarter revenues were $5.6 billion, an increase of 21% from a year ago and a quarterly record for the company. Sales increased in each of our operating segments, primarily driven by stronger demand in global on-highway, construction, mining and oil and gas markets.

Sales in North America, which represented 58% of our first quarter revenues, improved by 22% from a year ago due to increased sales of engines and components to meet higher levels of heavy- and medium-duty truck production and an increase in demand for industrial engines. International sales improved by 20% from a year ago, primarily due to stronger demand in on-highway and industrial markets as well as benefiting from a weaker U.S. dollar.

Gross margins were 21.5% of sales, down from 24.7% a year ago, primarily due to the product campaign charge that Tom referred to. The campaign charge negatively impacted our gross margin by 340 basis points. This offset the benefits realized from stronger volumes, favorable pricing, material cost reductions and the lower base warranty rate.

Selling, admin and research and development costs of $787 million or 14.1% of sales decreased as a percent of sales by 130 basis points compared to the first quarter of 2017. Joint venture income of $115 million increased by $7 million compared to last year.

EBITDA was $700 million or 12.6% of sales for the quarter compared to $705 million or 15.4% of sales a year ago. EBITDA as a percent of sales declined, primarily due to the campaign charge, which more than offset the positive impact of the higher sales, favorable pricing and cost improvements referred to earlier. Excluding the charge, EBITDA was $887 million or 15.9% of sales in the quarter.

Net earnings for the quarter were $325 million or $1.96 per diluted share compared to $396 million or $2.36 from a year ago. In addition to the product campaign charge which lowered earnings per share by $0.87, first quarter earnings were negatively impacted by $78 million in discrete tax items or $0.45 per diluted share, most of which related to the tax reform bill passed back in December of 2017.

The effective tax rate for the quarter was 37.9%. Excluding discrete tax items, the effective tax rate was 23%, in line with our full year guidance and down from 26.1% last year.

Now moving on to the operating segments. Let me summarize our performance in the quarter. And then I will review the company's revenue and profitability expectations for the full year and conclude with some cash flow highlights.

In the Engine segment, revenues were $2.4 billion in the quarter, up 21% from last year due to the 20% increase in on-highway sales as well as from stronger demand for engines for construction equipment in China and in North America, which led to 23% growth in off-highway revenues in the quarter. Segment EBITDA in the first quarter was $286 million or 11.7% of sales. This compares to $273 million or 13.5% a year ago. The campaign charge and investments in new products more than offset the benefits from higher volumes and lower base warranty expense. Excluding the campaign charge, EBITDA margins for the Engine segment was 15.5% of sales.

We now expect full year revenues to be up 10% to 14% compared to our previous guidance of up 4% to 8% due to an improved outlook in most of our markets. Our forecast for EBITDA margins for the segment is in the range of 13.5% to 14% of sales, which does include the campaign charge booked in the first quarter, and that compares to 14% to 14.5% previously.

For the Distribution segment, first quarter revenues were $1.9 billion, an increase of 13% compared to last year. The growth in sales was primarily driven by stronger demand for both new engines and parts and service in North America, Europe and in China. The EBITDA margin for the quarter was $123 million or 6.6% of sales compared to 7.9% a year ago. The EBITDA percent declined due to lower earnings in Africa and in the Middle East as a result of weak demand and currency volatility and a lower mix of part sales in North America.

For the full year, Distribution revenue is projected to increase 6% to 10% compared to our previous guidance of up 2% to 6% due to stronger off-highway demand for engines, parts and rebuilds. As Tom mentioned, we do expect profitability to improve in the second quarter and are forecasting full year EBITDA margins to be in the range of 7.75% to 8.25% of sales, unchanged from our previous guidance.

For the Components segment, revenues were $1.8 billion in the first quarter, a 30% increase from a year ago and a quarterly record. Excluding revenues from Eaton Cummins joint venture, sales were 22% higher than a year ago. Sales in North America increased by 35% due to higher heavy- and medium-duty truck production. International sales increased 25%, primarily due to growth in sales of aftertreatment sales in India. Segment EBITDA was $227 million or 12.9% of sales compared to $216 million or 16.1% last year. The benefits of higher sales, favorable material costs and strong operational performance were offset by the product campaign charge. Excluding the charge, EBITDA margins were 18.3% of sales in the quarter.

For 2018, we now expect revenue to increase 18% to 22% compared to our prior guidance of up 8% to 12%. Strong demand in the North American truck market and in Europe are the key drivers behind the improved outlook. EBITDA is projected to be in the range of 15.25% to 15.75% of sales, which, again, includes the campaign charge booked in the first quarter, and that compares to 15% to 15.5% in our previous forecast.

In the Power Systems segment, first quarter revenues were $1.1 billion, an increase of 22% from a year ago. Industrial sales grew by 51%, driven by stronger mining and oil and gas demand. Power generation sales also increased by 9%. EBITDA margins were $142 million or 13.2% of sales in the quarter, up from $85 million or 9.6% last year, driven by the positive impact of stronger volumes, favorable material costs and higher joint venture earnings.

For 2018, we now expect Power Systems segment revenues to increase 7% to 11% versus our prior guidance of up 4% to 8% as a result of stronger demand across industrial and power generation markets. EBITDA margins are expected to be between 13% and 13.5% of sales compared to our previous guidance of 12.25% to 12.75%.

In the newly established Electrified Power segment, EBITDA losses were $10 million, in line with our forecast. For the full year, we expect a net expense of between $60 million and $80 million, in line with our previous guidance as we are in a period of investment in new products.

And for the company, we are raising our outlook, as Tom said, for revenues to be up 10% to 14% versus our previous guidance of up 4% to 8%. This increase is driven by higher levels of truck production in North America, increased demand for both engines -- new engines and engine rebuilds for oil and gas and mining customers and the appreciation of foreign currencies against the U.S. dollar.

Foreign currency tailwinds are expected to increase our revenues by approximately $300 million this year. Income from our joint ventures is now expected to decrease by 10% in 2018 compared to our previous guidance of down 15%. The improvement in guidance reflects stronger market demand in China and India than we had previously forecast.

We expect EBITDA margins to be in the range of 15.4% to 15.8% for 2018, down from our previous forecast of 15.8% to 16.2%. Excluding the impact of the first quarter charge for the product campaign, full year EBITDA is expected to be in a range of 16.2% to 16.6%, reflecting a 28% incremental margin at the midpoint.

Finally, turning to cash flow. Cash used in operating activities for the first quarter was $117 million due in part to higher working capital requirements associated with higher revenues as well as the payout of 2017 variable compensation. We anticipate operating cash flow in 2018 will be within our long-term guidance of 10% to 15% of sales. Capital expenditures during the quarter were $72 million, and we continue to expect our investments will be in the range of $730 million to $760 million for the full year.

For the first quarter, we returned $341 million to shareholders through dividends and from the repurchase of approximately 1 million shares. For 2018, we continue to plan to return at least 50% of our operating cash flow to our shareholders, which is in line with our previous guidance.

Now let me turn it back over to Mark.

Okay. Thanks, Pat. We're ready to turn to the Q&A section of the call.

(Operator Instructions) Our first question comes from Jerry Revich of Goldman Sachs.

I'm wondering if you could talk about the size of the field population that's impacted by the field campaign, the cost per repair. And obviously, you've been leveraging the technology platform across markets and emission standards. Can you talk about if there's any other potential application that could be impacted by the field campaigns that you're doing now? Can you just frame that for us?

Okay. Jerry, this is Rich. Let me cover a couple of things there. You had a few questions in there. So first, the piece we're looking at is a component on the aftertreatment system that we used only in North America. It was for engines 2010 through 2015, predominantly 2010 through 2012, okay, because we phased that product out beginning in 2013. What we've done is we've looked at the entire population over that, so it's a fixed amount of what the population is. And what we proposed here to the agencies and what we've recorded in the $187 million is a combination of, in some cases, no action, that these products are going to be fine; in some cases, a software fix; and in some cases, a hardware fix. Okay? So that's what the charge is related to. Of course, we'll have to get approval from the agencies on this. The discussions are collaborative and good with the agencies. It does not affect any other products anywhere else in North America or any other part of the world. This was a very specific component that was used that is under evaluation right now.

Okay. And then separately, it sounds like within Power Systems, you're seeing an inflection in orders within power generation for the first time in probably 5-or-so years. Can you just give us some context on which applications for power gen that you're seeing the most momentum, which markets? And can you just give us a sense for how much visibility you have based on the order cadence so far this year?

Jerry, it's Mark. So we've seen an improvement in most parts of the world except the Middle East, which remains patchy. I would say the common theme across the regions is strong demand from data centers. And then it varies by segment, but, generally, a steady increase across most markets. And that's the third straight quarter of year-over-year increase. So not -- it's not extraordinary acceleration, but it feels like we've got some momentum. Typically, we have an order board that runs multiple quarters, but, obviously, high confidence in the next 90 days.

And Mark, just a clarification. It sounds like that order board has built in terms of the visibility. Is that -- am I parsing the comments correctly?

Yes. You are, yes.

Our next question comes from Andy Casey of Wells Fargo Securities.

I'd like to return to Jerry's question. I'm trying to assess the customer dissatisfaction risk related to the field campaign. Could you help us with the failure mode? Is it purely emissions falling out of compliance? Or are there any, what I'll call, operational performance degradation like seemed to occur in the light vehicle campaign a few years ago?

Okay, yes. So as far as performance, either what the customer feels on productivity of the vehicle or fuel economy, there's no impact there. So it's purely an emissions issue, kind of late-life emissions beyond even the warranty of the product that -- as the product degrades. So the impact on customers will be, like I said, in some cases, nothing. In some cases, we'll bring it in and do a calibration. In some cases, we'll bring it in and change the hardware out, and it'll be a voluntary recall.

Okay. And then within the -- we're all trying to figure out if the charge may get closer to $400 million, and I'm sure you're not going to talk about that given the discussions with the regulatory agencies. But could you talk about the failure rate that you're observing in the field? I mean, is this pretty widespread? Or is it, at this point, concentrated?

Yes. I mean, what we know is what we're saying right now, is the population that we've got today. So anything else, I'd be really speculating on. What I will say is we're driven to resolve this thing over the next 2 quarters. And so we'll work with agencies, and we'll get a final answer to this and kind of get this thing behind us.

I think, Andy, just from my point of view, too, I -- this is Tom talking, by the way. I -- we wanted to make sure that the investors could at least put a box around what we think the total size could be. We have taken, as we have to, we have taken the accrual for what we think is the best estimate for what it will cost us across all this work. But because the agencies have the right to ask us to do other things, we have to be -- and we will have to respond to that. We want to make sure that investors could -- after some quarters of uncertainty, which is not terrific, we want to make sure at least people could put a box around it. Again, we are very -- we think our plan is a good one. That's why we're proposing it. And we intend to take care of customers as well as take care of the environment. That's kind of our commitment to both. So we're acting proactively on that. But again, just to try to make sure you've -- everyone had a box to put it in. And again, we are working really aggressively, and we expect to be through these discussions relatively quickly, in 6 months or less. So hopefully, we'll have all of it behind us. But again, it's not -- we are now at a spot where we are confident we can address this problem proactively. It will have minimal impact on customers. And our products are performing well in the field. It's not going to impact the company's future or our ability to carry out our strategy plans. So that's -- we're feeling good about that.

Okay. And then just to dot the I, does the $400 million include the $29 million from Q3?

No, the $400 million is not trying to sum up everything in the past. It's trying to say, "Here's the maximum exposure that we could see in a worst case for what -- our actions going forward."

In addition to what we've booked.

Yes.

So it's in addition to the $187 million?

So the $187 million is what we've already booked and the old ones we've already booked. And we're saying this is the maximum future exposure in addition to what we booked in this quarter and previous quarters.

Our next question comes from Jamie Cook of Crédit Suisse.

I got a few questions. Tom, the product campaign cost, how do you guys think about this in the context of how it impacts incentive compensation for you guys? Are you guys excluding this? Do we include this? And then my second question, could you -- a lot of other industrial companies have talked about supplier constraints, higher freight constraints, labor constraints. Can you talk about to what degree this is impacting your customers or yourself and how much that's constraining demand, if at all, and how that sort of impacts your thoughts on 2019 as the market is concerned about sort of achieving the peak in 2018?

Thanks, Jamie. I'll let Rich take the second one. I'll take the first one. So this charge, along with all similar charges related to quality of our products, we take directly against our variable comp. So our view is our management and our people are responsible for producing quality products. When we have to take a charge against our quality, we take the charge -- we take the hit in our bonus and other plans. So we will take -- this accrual we took this quarter and previous ones all count against us in both our 1-year compensation plans as well as our 3-year compensation plans.

And Jamie, this is Rich. On the constraints, we're certainly seeing all the constraints that you read about and everyone else sees. But what we are -- I think where we're positioned right now and we've talked about over some time, our supply base is pretty flexible. And we actually see and we're seeing some evidence of it today that, as things have ramped up, we're ramping up a little better than other folks, and it's actually an opportunity to pick up share. So we're seeing some small bits of this. We are paying some incremental premium freight, those type of things like everyone else is paying there. But so far, so good. So nothing has caused us to increase lead times, put product on allocation, et cetera.

Okay. And then to what degree does that impact your sales on '19? Just as the market's concerned about the markets are too good, we're getting overheated, where does this impact? Does this, to some degree, lengthen the cycle?

To be determined. I'd say the nice thing that we are seeing is we get the ramp-up, and we're seeing the back orders go up, you look particularly in North America. The underlying fundamentals are pretty good though. As to what freight -- how freight is doing, what rates are doing, which we're all seeing -- or we're seeing into some of those, but the underlying fundamentals look pretty good right now, kind of supporting that increase in demand.

Our next question comes from Noah Kaye of Oppenheimer.

Maybe a follow-up to that. I mean -- I think, certainly, price-cost trade-off has been kind of a key theme of earnings for the industrials so far this quarter. And if we just strip out the warranty charge, it looks like you may be expecting slightly lower incremental margins than before. Can you talk about how you're managing your cost input inflation?

Noah, this is Tom. It's a great question. As you said, price-cost is really the struggle for industrial companies, but I think we're in really good position on that. We are now -- as we showed in this forecast, we're expecting quite significant improvement in incremental margins. So we -- again, we think we're doing well there. We mentioned as we came into this year that we're going to have -- we have benefits on warranty. The warranty rates this year relative to last year are improving. We've got strong incremental margins in our plants in both the Power Systems business and the Engine business, and you saw it very strong in the Components already. So we feel like we're not only doing well in incremental margins, but they're getting better as the year goes on, both because we're able to get some pricing and we're moving costs down. So that -- so we're feeling pretty good about that. Again, one way you might want to think about our incremental margins is to, again, even taking out the product campaign, if you also looked at the costs associated with the Eaton Cummins joint venture and the new electrification view, which are sort of long-term investments, if you take those out, you'd get a like-for-like comparison on incremental margins across the years. And I think, again, you'll find not only was Q1 good but the rest of the year looks very strong relative to Q1.

Okay. And actually, anticipating my next question. If you could touch on some of those newer growth initiatives. It looks like you've increased your Eaton JV contribution expectations for the year. Our checks are saying AMT adoption is going quite well. It looks like you lowered electric revenue contribution a little bit for the year, again, off of a sort of very small base. But could you give us a little bit of color on how you see both of those initiatives proceeding?

Sure. I'll comment a little bit on electrification, and I'll let maybe Rich talk about Eaton Cummins and AMT. So on electrification, as you said, we did touch down revenue a little bit. That just reflects, basically, the rate of new product introduction and acceptance as you -- very low level. Our product -- our programs are still going well. We're just very early days. And really, the big launches come sort of the end of next year. We'll see some -- that's where our new electrified powertrain gets launched in the buses. And so -- but we're feeling really good about where we stand. We've got small products going into forklifts. We've got these bigger powertrains going into buses. We're clearly -- we're talking to nearly every customer out there about electrified power in some way. So our position from a few years ago, where we have a lot of work in the lab and a lot of really good ideas to where we've got a pretty significant position now in the market in terms of what we're planning to offer and who we're working with, I think, has been a really good change and really good transition. Now of course, we've got to launch the products and see successes in them, so that's our big focus over the next 2 years or 1.5 years. So Rich, let me turn this to you.

Yes. So on the Eaton joint venture, just a couple numbers. So the AMT, you asked about the transition. We're up to 73% now. So that's coming along as we thought, potentially a little higher. Our market share is where we thought it would be. So the Cummins-Eaton joint venture market share is good. The transition has gone quite well. So the cultures -- anytime you're merging 2 things together, there's some risk. Eaton has come together really well. The culture's been good. The teamwork's good. And so really, so far, so good. The sales forecast, so last year, $163 million; we'll be over $450 million this year in revenues out of the joint venture.

Our next question comes from Joe O'Dea of Vertical Research.

First, on the mining side, I think, last quarter, you were looking for up about 10%. That's moved higher. But any context around how much higher you think mining is at this point? And then if you could talk specifically to the equipment side of things versus parts side of things and, regionally, where you're seeing some of the activity pick up.

Okay. I'll take a first shot at this, Mark, and you make sure I get the numbers right. Right now, we're projecting 30% up on mining for revenues, so improved from where we were last quarter. We pay attention to what the utilization is, so what is -- how is the equipment really being utilized. And we're seeing that continue to increase, which helps drive parts demand and rebuild activity. Primarily, the activity -- the biggest increases are in North America and China, which wouldn't surprise you on that. Mark, anything you would add to it?

No, I'd just say Q1 was probably the easiest comp for the year. We were up about 48%, but we guided for 30%, so I think that's good. And we're seeing good growth in new engines and parts, and that strengthened a little bit since the start of the year.

Okay. And then some interesting news yesterday with the launch of a new transmission into frac rigs. And just kind of the time line for how long it'll take for you to get enough experience on the ground with that transmission for the expectation that you get some decent customer adoption. And then just a clarification on whether that's just to pair with Cummins' engines or whether that could be paired with competitor engines as well.

I think that's principally to be paired with Cummins' engines at this point in time.

Okay. And then, I guess, maybe just one more then. You're talking about market share and seeing opportunities for gains on maybe being a little bit more agile in terms of response to supply chain tightness. You're not really calling for increases in market share in medium duty. It doesn't look like increase in market share in engines in North America heavy duty. So should we just think about that maybe now favors the high end of the range or a little bit of conservatism there?

I think, primarily, in the high end of the range, we bounce back pretty well. In fact, we've seen some share gains in surface mining, whether it's -- only attributable to the ramp-up. But again, we're keeping our lead times low in all of our high-horsepower markets. They're down in the 8-week range, which is good and which is better than the competition at this time.

Our next question comes from Steven Fisher of UBS.

Wondering if you could talk about how the warranty issue might affect your thinking or execution of anything strategic that you've been thinking about. It seems like it will be a cash-out-the-door issue at some point, but maybe it doesn't dramatically alter your balance sheet on what you might do. But curious how you're thinking about that.

Yes. Thanks, Steve. Yes, it hasn't really changed our strategic thinking. The -- as you say, the cash flow and balance sheet is manageable. That's a little bit why we wanted to make sure we put a box around even the worst case. And again, we have a clear view about what we want to do, but we want to make sure everyone saw the worst case. It goes out over 2 or 3 years. We feel very, very good about where our strategic position is. But again, the way that we've been thinking about this, we talked about in previous quarters, is that the complexity of the systems that we're offering is pretty high, and the quality tools that we're using have needed to get more sophisticated as a result. So we've been making significant investments in using analytics and other things to get a better system view of the quality of our products, which we think is reflected in the products we're launching today. And we'll continue to enhance those quality tools as we go forward. And again, from a strategy point of view, it's difficult. We feel frustrated and disappointed with, obviously, with the cost of this quality campaign. But again, we are pushing on the cutting edge of offering systems that meet emissions: very, very stringent emissions targets, have very, very strong fuel economy and high levels of performance at the edge of -- at the very edge of technology. And I think part of what we're trying to do is make sure that we stay at the edge there while improving our quality costs, and that's a tough deal. I mean, that's not going to be easy, and that's why a lot of people aren't going to make the journey. And we think, by getting better in those capabilities, we can stay in it and make good returns for our shareholders by getting better at the sort of execution, small details of being there at that edge of technology. So that's the way we're thinking about it strategically. And it's a -- the harder the challenge, the less people want to do it. And so from strategy point of view, that's a good thing as long as we can make -- continue to improve how our system quality goes out the door and how customers experience our products.

And Steven, we expect -- I think I said this in my remarks, but we expect another very, very strong year in terms of the free cash flow we generate through our operations. So as Tom said, this will have no impact at all on what we want to do from a strategic perspective.

Okay. So just to follow up on the M&A angle here. How are you finding the competition for deals at the moment? I mean, how does it vary depending on size of the deals that you may be looking at?

Yes. There are -- as you guessed, there is still competition for M&A today. There's [a lot of] players in the market. Valuations are still relatively high. Money, while getting a little bit more expensive, is still pretty cheap. So there's no question that the cost of acquisitions still -- especially if we were going to maintain the ROIC discipline that we intend to, that's going to play into it. We're going to have to be thoughtful about how that goes, and that remains a challenge. But again, we continue to think about our strategy first, where do we think Cummins can bring our capabilities into a new market, adjacent market and using capabilities we already have and leveraging them so that we can -- whatever we acquire or joint venture with, we can add value to it so that we can pay for the acquisition price as well as try to get an attractive one. And that, of course, limits the field, right? That means there's only so many things that are going to work, and we're making sure that we maintain patience with that. We are looking at a lot of things though. There are things to look at that are pretty interesting. And so we're just trying to put those together. I feel better about it now than I have in the past. I mean, it was -- the prices, while still high, are not nearly as bad as when we started looking at them. So I'm optimistic that they're beginning to come into the range where we think we could make it work.

Our next question comes from Alex Potter of Piper Jaffray.

I had a couple of questions, I guess, on the lighter-duty side of the on-highway business. First of all, in Europe, I'm wondering the extent to which you think you can pick up any business from OEMs that you maybe historically had struggled to do business with because of Dieselgate or any of the other stigma associated with diesel engines in general?

Thanks for that question, Alex. So I would say that we do believe that -- kind of to follow-on to Steve's question, that, indeed, many of our customers are looking forward at the market and saying where do they want to place their investments strategically. Do they want -- they've got a lot of challenges in front of them, autonomous vehicles, electronic -- electrified vehicles, all of the investments they need to make for just the truck -- making the truck work, telematics, you name it. And then now with the challenges for diesels in some of the European cities, they're asking themselves, "How much investment do I want to make?" And the light-duty side is the most challenged. It's one that had the most likely substitution from electrified powertrains. So again, each investment they make there, they're wondering how many more diesels they're going to sell. So if we have a product that's relevant to what they are trying to do, they're much more likely to buy from us than do it themselves these days than they were, say, 10 years ago. So we believe that this is a trend that will continue, where OEMs will continue to wonder how many more investments, how many more platforms in the light-duty space. And even in the medium-duty space, do I really want to make, given I could buy this from Cummins and I would, therefore, not have to make that investment and I can focus on my vehicle instead? So again, we'll see how it goes, but we are talking to a lot of people about that and more people than we were talking to, for sure, 5 or 10 years ago.

Okay, that's helpful. I guess, one maybe follow-up on that. You mentioned medium duty. That market, I know is -- clearly, the cyclicality is less violent than it is in Class 8, but that market just seems to continually march higher and higher and higher. I'm wondering the extent to which you think there's been a structural change to the way that cycle functions, to the extent you can even call it a cycle. Or if you think it's a secular story there as a result of last mile and some of the changes that are occurring to the way the freight markets function in general.

Yes. Alex, I'm not sure we know the answer to that, but it does appear -- it has been less cyclical. It has been steadily, steadily growing, okay? So our view is all the underlying cases, I wouldn't want to speak -- I wouldn't be able to speak to. But I do think it feels pretty sustained, and it's tied to more than just the on-highway. It's tied to the construction market, infrastructure being invested in around the world. And so it does seem to have more staying power, and we're kind of reflecting that now: less cyclicality, more staying power. Has there been a fundamental step-up, I guess, is still to be determined.

Our next question comes from Rob Wertheimer of Melius Research.

Your discussion on the EPA CARB issue is fairly clear, and thanks for bounding the lower end as well. Could you just give a more general overview of how you've approached quality as the issue has popped up over the last year and you mentioned a renewed focus? Have you changed monitoring or proactive looking at stuff? And do you feel that there's less of a chance of future issues popping up as a result of what you're seeing? And how is your quality trending in general?

Yes. Thanks for the question. As you can imagine, while this is -- there's a specific cause here, we're using this as a call to action. So how do we make some incremental improvements on where we are now or even step-function improvements from where we are? So we are investing heavier in analytics, in modeling, in looking at all of our processes to drive improvement. We've been in the kind of the low 2% range for some time, okay? With warranty periods being extended, more expectations, we've maintained kind of that 2% to 2.5%. And so we're doing a couple of things. One is we're putting actions in place, how this would never ever, ever happen again, okay, modeling. And so we've got those in place. But we're also saying, let's bring an outside look in and say use this as a call to action to how do we drive this down over the next 5 years to a much lower number. And I think you know our track record. And when we put our resources and put our efforts towards things, our track record on delivering that is pretty darn good. And so this one's getting a lot of attention, as you can imagine, even though the one case is somewhat isolated.

And just as a follow-up to that, Rob, you recall last year, our warranty was around 3.1%, 3.2% of sales, and [we were able to] drive that lower. We did see that in Q1. Q1 was right around 2.4% and we're still pretty consistent with the previous guidance and full year forecast of 2.4% for the full year. So to Rich's point, we are making progress with the base warranty.

Our next question comes from Ann Duignan of JPMorgan.

This is [Rigdal] on for Ann. All my questions have been answered.

Our next question comes from Joel Tiss of BMO.

Just can you give a little more granularity on China? It seems like most people were expecting it to be down this year. And it surprised to the upside in the first half, and I think people are a little cautious about how the second half is going to flow. And you guys have a great -- lot of feet on the ground there.

Yes. Joe, I think we would agree with that caution. I think if we just look at the truck equipment purchases versus what we perceive trucking to be -- growth rates to be doing and freight rates and everything. It just doesn't seem like the same rate of growth in the -- from the previous year can hold. So that's why we sort of forecasted it tipping over and heading down. A couple of things that have driven a little stronger truck performance in the first quarter was more construction, which we, of course, we saw in the excavator numbers. So dumper sales increased a lot, which is, again, one of the reasons that our OEMs kind of underproduced relative to the market. That's not their big segment, the dumper market. Those tend to be bigger displacement engines and older technology. But nonetheless, those sales were really quite good in the first quarter, the dumper sales so -- again, which is towards construction market. So I think what we're seeing in China is, yes, there is -- the equipment being purchased for just on-highway trucking is likely to level out or head down. At least, that's our expectation. We'll see what happens, but that's our expectation. But this construction market is definitely buoying the market. It's better than we expected, and it's great news. I mean, we're seeing much -- a lot of good demand for construction engines as well as these off-highway kind of dumper sort of truck engines.

Just to put a number on that. So on the off-highway, we were projecting an 8% increase. We're now saying 20% to 25%, which is what we said first quarter. That felt more sustained and less cyclical than what was going on in the truck market. And both of those seem to be playing out a little bit.

And maybe second, just maybe a little bit of a delicate question. But in terms of the rail business, obviously, the industry consolidation is not really happening or maybe it is a little bit. But I just wondered if you could talk about how you feel that -- like you're positioned in that market. And do you feel like you have the product lineup and kind of your toe in the water there enough to continue to gain share and really compete effectively in that market?

Joel, thanks for that question. Not delicate, it's fine. Our -- we're pretty small in the rail market overall. If you just kind of think about rail globally, we're a pretty small player, and we have participated essentially in the diesel part of the rail rather than the diesel/electric side, which was driving much larger engines. And again, that trend has continued. So we have had a segment that we participate in. Now the introduction of the Hedgehog engine got us into more of that, but still, we're really just getting into it. And I think what's helped us get a little bit of a toehold there has been the fact that we were ready with our Tier 4 engines before other people, and I think our solution's better. It's a better long-term total cost of ownership, and so we have a bit of an advantage. We don't have the same advantage of being a large player already in the market. Everybody knows our product and, therefore, long history. So I still think it's -- while we're excited about it because it's incrementally larger for us, it's still a small piece of the market. And I think if we don't add more products to our portfolio, that's kind of where we'll play, sort of on the edge of the market, trying to grow our position with the business we have but not a big player in the overall scheme of things globally.

And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Mark Smith for any closing remarks.

This is Tom Linebarger. Thanks for that.

I just want to make a couple concluding remarks, especially given the fact that we were finally able to put a box around that product campaign. And obviously, we're really disappointed about the financial exposure, and we know that it's not the first one we've done in the last 2 years. It's been a series of them. And again, as you'd guess, we feel disappointed and personally accountable for that. And we are, as we talked about in the call, working really hard to make sure that we do not see a repeat of that. And of course, that's what we think the core of our business is.

The good news looking forward, though, is we do have a box around this. We do have a proposed plan. We will get the full plan resolved in the next 6 months or something like that, and it's not going to impact either the long-term performance of the company or our strategy. So we -- and it's not impacting customers today.

Customers today are experiencing great quality, good-performing engines and continue to see Cummins as the technology of choice.

We've raised our outlook for this year. Again, it will be a second terrific year for the company. Our sales growth forecast has now doubled. Our incremental margins are strong. Our businesses are performing well. We had -- 3 of our 4 had terrific incremental margins in Q1. The DBU, while not as good, we'll see much improved margins in the next 3 quarters. So we feel like we are in a really good position to generate strong cash flows and strong earnings this year and our strategy's right on track.

So I just want to make sure that everyone knew that about what we feel about where the company, is we feel like we're moving right towards strength here. And we're very optimistic about this year. And we're going to get this emissions issue behind us, and customers are still going to see Cummins as the technology of choice. So thanks very much.

Thanks, everybody. We'll be available for questions later. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.