Cummins Inc.
Q4 2014 Earnings Call Transcript

Published: 5 Feb 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Q4, 2014 Cummins Inc. Earnings Conference Call. My name is Tia, and I’ll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct the question-and-answer session towards the end of the conference. [Operator Instructions] I would now turn the call over to your host for today Mark Smith, Vice President of Investor Relations. Please proceed, sir.

[Mark Smith:]

Thank you, and good morning everyone and welcome to our teleconference today to discuss Cummins results for the fourth quarter 2014. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; and our President and Chief Operating Officer, Rich Freeland. Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs and intentions on strategies regarding the future. Our actual results could differ materially from those projected in such forward-looking statements because of the number of risks and uncertainties. More information regarding such risks and uncertainties are available in the forward-looking disclosure statement in the slide deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed Annual Report on Form 10-K and subsequently filed quarterly reports on Forms 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. A copy of our press release and financial statements and today's website presentation are available on our website at www.cummins.com under the heading of Investors and Media. With that over the way and I’ll now pass it over to our Chairman and CEO, Tom Linebarger.

[Tom Linebarger:]

Thank you, Mark. Good morning. I will start with a summary of our fourth quarter and full year results and finish with a discussion of our outlook for 2015. Pat will then take you through more details of both our fourth quarter financial performance and our forecast for this year. Revenues for the fourth quarter were $5.1 billion, an increase of 11% compared to the fourth quarter of 2013. Fourth quarter EBIT was $661 million or 13% of sales excluding one-time items compared to $566 million or 12.3% of sales a year ago. For the full year Cummins sales were $19.2 billion up 11% year-over-year. Our full year EBIT margin was 13.2% in 2014 excluding one-time items, an increase from 12.5% in 2013. Incremental EBIT margins were 19%. The components and distribution businesses delivered record revenues and earnings in 2014 and the performance of the engine business also improved. There were two areas in which we performed below our own expectations; first profitability in the power generation business did not improve in 2014 as we expected which was disappointing. We have taken further options to lower cost including exiting alternative operations in Germany and combining two global lines of business to improve efficiency and reduce cost. EBIT margins in the power generation business are expected to improve from 6.9% in 2014 excluding one-time cost to between 8% and 9% in 2015 assuming no revenue. Second quality cost as we've been talking about throughout the year in the engine business exceeded our expectations in the first half of 2014 and resulted in full year warranty cost increasing by 0.5% as a percent of sales. As you know we've been improving the quality at launch of our new products and reducing quality cost for more than four years, so our expectation for performance in this area are high. Beginning in the third quarter we focused significant resources on driving improvements in product quality and customer service operations both to improve product performance and to ensure that our customers were not impacted. Our products were performing extremely well even in the eyes of our most demanding customers and we expect that quality related cost will be lower in 2015. This will remain an area of high focus for us this year. Now I will comment on some of our key markets in 2014 starting with North America. Our revenues in North America grew 20% in 2014 with approximately 6% of the growth coming from acquisitions in our distribution business. The North American heavy duty truck market reached approximately 268,000 units in 2014 an increase of 23% from 2013 levels. Our full year market share was 36%. The medium-duty truck market size was approximately 127,000 units in 2014, up from 13%, excuse me up 13%. We strengthened our position as the market leader in the medium-duty truck engines market in 2014 with our market share increasing to 72%. Shipments to Chrysler increased by 9% in 2014. Also in North America revenues in our Power Generation business decreased by 9% with shipments to the U.S. military down 39%. Sales to our traditional market segments including non-residential construction were flat year-over-year. Our international revenues increased by 2% in 2014, with growth in China offsetting weakness in Brazil and India. In Brazil, our revenues decreased 17% due to weakness in the truck market. Industry truck production decreased by 26% as the economy slowed. Revenues in our Power Generation business increased as water shortages reduced hydroelectric power output and increased the need for generator sets. Our performance in China was strong despite weak economic conditions and was one of the highlight for 2014. Full year revenues in China including joint-ventures were $3.3 billion, an increase of 13% year-over-year reaching record levels. The growth in 2014 was driven primarily by stronger demand for engines and components for on-highway markets as the truck industry began the transition to new NS4 on-highway emission standards. Industry demand for medium-duty and heavy-duty trucks in China decreased by 7% for the full year as orders slowed ahead of the broader transition to NS4 compliance. The proportion of industry truck products that was NS4 compliant in the fourth quarter of 2014 was estimated to be 45% with some customers increasing to 70% by the end of the year. Our full year engine market share increased from 10% in 2013 to 12% in 2014 and we also experienced strong growth in our components business. Shipments of our light-duty engines in China increased by 78% as Foton increased the proportion of its trucks powered by the 2.8 liter and 3.8 liter engines manufactured in our BFCC’s joint venture displacing competitor engines. Industry demand for excavators China dropped 20% in 2014, the third consecutive year of decline. The market for power generation equipment in China was flat in 2014, with slower growth in infrastructure and weak power needs reflecting underlying weakness in the Chinese economy. Our revenues increased 4% year-over-year due in part to increased market penetration especially in the telecom sector. Full year revenues in India including joint ventures were $1.3 billion flat year-over-year with improving demand in the truck market offsetting continued weakness in power generation. Industry truck production increased 10% to 249,000 units and our market share increased by 5% to 42%. Revenues for our power generation business declined by 23% as market demand remained very weak due to the overall pace of the economy and the impact of a transition to new emission regulations in mid-2014. Now let me provide our overall outlook for 2015 and then comment on individual regions and end markets. We are currently forecasting total company revenues to grow between 2% and 4% in 2015, with growth in North America, new products and distributor acquisitions offsetting continued weak international markets and the negative impact of the stronger U.S. dollar. The market size for heavy-duty trucks in North America is projected to be 29,000 units in 2015, an increase of 8% year-over-year with our market share projected to be stable at approximately 36%. In the medium-duty truck market we expect the market size to be -- to increase by 1% to a 128,000 units and we project our market share to be 67%. Shipments to Chrysler are forecast to be flat with 2014. In China we expect domestic revenues including joint ventures to increase 15% in 2015, as revenues from new products and emissions related content more than offset continued weak industry demand. We expect the market size for medium-duty and heavy-duty trucks in China in 2015 to decline by 6% from 2014 level. Current industry forecast project at 70% of truck production in 2015 will be NS4 compliant up from an estimated 38% in 2014. Despite we anticipate decline in market size we expect our revenues including joint ventures to grow as volumes of our new ISG engine increased and we gained more market share. Revenues for our component business will also improve. Demand for our light-duty engine in China is expected to grow by 30% in 2014 despite no growth in the market as Foton continues to use a higher proportion of our engines. We expect industry sales of excavators to decline by a further 9% in 2015. However this will have little impact of our financial performance given the already weak levels of demand. In India we expect total revenues including joint ventures to increase 5%. The new government has made infrastructure investment a big priority and we are cautiously optimistic that demand will improve in the second half of 2015. We expect industry truck production to increase 8% to 270,000 units and demand for power generation equipment to increase modestly up to 5% for the year. In Brazil we expect truck production for 2015 to decline a further 15%. As you all aware the government backed finance program called tsunami has been an important source of financing for the commercial vehicle market and recently the government tightened [churns] of the program for the second year in a row raising interest rates 400 basis points and limiting loans to 70% of the vehicle price. This will not help truck demand given the already weak state of the economy. We will see an increase in volumes of a number of important new products this year. There is a lot of excitement in China surrounding our new ISG heavy duty engine which launched last year with volumes expected to grow throughout 2015 increasing our market share in the largest truck market in the world. Our largest engine the new QSK95 will go into production in 2015. We have already secured customers in power generation, rail and commercial marine markets. In addition you may have seen the Cummins V8 light duty engine featured a new Nissan type pickup truck at Detroit Auto Show and we're looking forward to the production of this vehicle later in the year. The benefits from our distributor acquisitions continue to exceed our original estimates as Pat will cover in more detail. We completed seven distributor acquisitions in 2014 with a further three planned for this year and I want to thank all of the employees in our distribution business for their support and ongoing commitment to our customers through the transition. Although there are a lot of positives to look forward to in 2015 risk remain, particularly in the global off-highway markets and emerging markets. Weaker infrastructure spending in China and Latin America, declining commodity prices and the transition to new emission standards in developing economies all present risks to off-highway market demand. I am confident that our market position will improve in 2015 as our leadership in tier four final emissions regulations and the introduction of new products will enable us to outgrow weak end markets. Our revenue guidance for 2015 assumes that our industrial revenues in the engine business will decline by 4% in 2015, with weak demand expected in global mining and construction markets. Naturally there is concern about the risk from the decline in oil prices. Our direct to engine sales to oil and gas extraction activity currently represents less than 1% of company revenues, and while it's very appropriate to be cautious about the outlook at least in the near-term our volumes should hold up better than the overall market given our advantage in having tier four final products available ahead of our competitors. Our commercial marine business also has some exposure to offshore activity and our power generation business supplies power to oil dependent regions such as the Middle East. Our current projection for off-highway engine and power generation revenues already reflect flat or declining revenues in most markets. In this environment of uncertain demand particularly outside of North America it's important that we continue to find way to reduce cost and improve productivity in our business while making critical investments in our future. We expect EBIT margins to be in the range of 13.5% to 14% up from 13.2% in 2013 with lower material cost, the benefit of actions in the power generation business and improvements in quality all contributing to margin expansion in 2015. In closing I would like to comment on some recent changes to our leadership team. First I want to thank Pamela Carter, our distribution business leader for outstanding contribution to Cummins over the past 18 years. We will miss her leadership and our commitment to our customers, our people and the communities in which we operate. Second I want to congratulate Tony Satterthwaite and Antonio Leitao advancing leadership for the distribution and power generation businesses respectively. I am confident in their new roles they will continue to drive profitable growth in those businesses by ensuring that our customers succeed. Thank you for your interest today and now I will turn it over to Pat who will cover our 2014 performance and our 2015 guidance in more detail.

[Pat Ward:]

Thank you, Tom and good morning everyone. I will start with a review of the full year 2014 financial results before moving on to the fourth quarter performance. All the numbers in comparisons will exclude charges totaling $32 million or $21 million after-tax related to cost reduction activities within the power generation business. Full year revenues for the company were $19.2 million up 11% compared to the prior year and a record for the company. The strongest stride of revenue growth in 2014 was driven by strength in North American and highway markets along with the impact of acquisitions in our distribution segment and record revenues in our parts business. The acquisitions within the distribution segment accounted for 3% of the revenue growth. North American revenues increased 20% last year and represented 36% of total 2014 revenues and that's up from 32% in 2013. International revenues increased by 2% compared to 2013, the highest sales in China partially offset by weakness in Brazil and in India. Unfavorable currency movements negatively impacted full year sales by 1%. While our total sales increased by 11% earnings before interest and taxes increased by 17%. Gross margins of 25.4% was 70 basis points higher than in 2013 with higher volumes, lower material costs and positive mix partially offset by unfavorable currency movements and increased cost related to quality improvements. Selling, admin and research and development costs increased by $309 million in the year. The acquisitions in our distribution segment accounted for $94 million of the increase. Joint venture income includes $9 million compared to last year with higher earnings in China partially offset by the impact of the [indiscernible] acquisitions in North America. In total, earnings before interest and tax were 13.2% of sales in 2014, up from 12.5% of sales in previous year and this increased to a 19% incremental EBIT margin. Net income was $1.65 billion or $9.02 per share or $9.13 per share excluding the cost associated with the cost reduction actions in the power generation business. This compares to $1.5 billion or $7.91 earnings per share in the previous year. The operating tax rate for the full year was 28.4% with discrete items increasing this to an all run rate of 28.7%. The operating tax rate was lower than the guidance we provided back in October, primarily due to the impact of the research and development tax credit which was passed late in 2014. Now let me comment specifically on the fourth quarter and provide some more details on our performance. Revenue of $5.1 billion was 11% higher than the previous year and 4% higher than third quarter levels, representing a record quarter for the company. Acquisitions accounted for 5% growth year-over-year. Compared to the prior year North American revenues were up 22%, due to continued strength in on-highway markets along with the impact of acquisitions in our distribution segment and strong growth in parts. International revenues were down 2% due to weak demand in the Brazilian truck market, general weakness in Eastern Europe and Russia which impacted most business segments on from unfavorable currency movements. Compared to the third quarter revenues increased 4% due to acquisitions and stronger demand across all four segments. Gross margins for the quarter were 25.4% of sales and improved 60 basis points year-over-year, with benefits from higher volumes and lower material costs partially offset by unfavorable currency movements and from increased cost relating to quality improvements. Sequentially the gross margins declined from the prior quarter, primarily due to an increase in quality costs and from the adverse impact of currency movements. Selling, admin and research and development as a percent of sales increased by 30 basis points compared to the prior year and declined by 30 basis points compared to the third quarter. Joint venture income was $76 million, 5% lower than the prior year and 23% lower than the prior quarter due to the impact of the acquisitions and lower earnings in China. Interest before interest and tax -- earnings before interest and taxes was $661 million or 13% of sales up 70 basis points year-over-year and increased to net financial EBIT margin of 19% compared to fourth quarter of last year. EBIT margins were down from third quarter levels as a result of the lower gross margins. Net earnings for the quarter were $444 million of $2.44 per diluted share and $2.56 excluding the charges associated with the cost reduction activities in the power gen segment. The oil and tax rate of 24.2% included a $24 million benefit from the research and development tax credit that was passed late in the year. Moving on to the operating segments let me highlight their performance during year and in the fourth quarter and conclude with the revenue and profitability expectations for 2015. In the Engine segment fourth quarter revenues were $3.8 billion, an increase of 11% compared to last year and 1% compared to the third quarter. Compared to last year North American on-highway revenues were up 19% driven by strong demand in truck and bus markets. Products revenues were up 18% driven by strong demand in North America. Sequentially revenues increased less than 1% with modest growth in on-highway revenues offsetting the weakness in construction and agriculture markets. Segment EBIT margins were 11.1% of sales in the quarter compared to 9.2% last year and 11.7% in the prior quarter. Compared to last year the increased volumes, lower material cost and cost leverage more than offset higher warranty expense. Sequentially the margins were lower by 60 basis points due primarily to lower joint venture income. For the full year revenues were up 9% from a year-ago and earnings before interest and taxes grew 18%, and improved from 10.4% to 11.2% of sales. In 2015 we expect revenues for the segment to be flat to up 2%. On-highway revenues in North America will improve as industry production grows and heavy-duty truck market and we expect another record year in our parts business. We expect global industrial revenues will be down in 2015 due to lower demand in construction, mining, oil and gas and agriculture markets. Due to the continued weakness in industrial and power generation markets we anticipate high (horse power) [ph] volumes will be down 5% to 10% in 2015. 2015 EBIT margins are now forecasted to be in the range of 11% to 12% of sales compared to 11.2% of full year 2014. Lower material costs, quality improvements and higher joint venture earnings in China are expected to drive the majority of the EBIT margin improvement. The component segment delivered record sales of $1.3 billion in the quarter up 16% over the prior year and 3% from the prior quarter. Compared to last year the higher revenues were driven by increased truck demand in North America along with increased revenues for the after-treatment systems in Europe and China related to the new emission regulations in both regions. Sequentially, higher revenues were primarily driven by increased demand in China due to the new emission regulations. EBIT margins for the quarter were 12.1% of sales compared to 12.3% of sales last year and 13.4% in the prior quarter. The decrease in margins over the prior year was driven by unfavorable currency movements and higher warranty cost partially offset by lower material costs. Compared to the prior quarter higher warranty expense and unfavorable currency movements negatively impacted margins. 2014 was a record year for the components segment in terms of revenues, EBIT dollar and EBIT percent. Revenues were up 18% and EBIT grew [13%] and improved from 12.1% of sales to 13.4%. We expect another record year in 2015 with revenues projected to be up 4% to 8% primarily due to stronger demand for all four businesses in the North American heavy duty truck market and growth in China related to the implementation of new emission standards. EBIT margins are expected to be in the range of 13.25% to 14.25% of sales which compares to the 13.4% recorded in 2014. In the power generation segment fourth quarter sales were $760 million flat compared to the last year and up 1% sequentially. Compared to the fourth quarter of 2013 weakness in India as well as in Eastern Europe and Russia was partially offset by stronger demand in Africa, Latin America and in the Middle East. Sequentially revenues increased in North America, Latin America and the Middle East and was partially offset by lower demand in China. In the fourth quarter we recorded a $32 million charge associated with cost reduction actions. Our actions included reorganizing the power generation business into three lines of business reducing overhead in the process as well as the closure of a large automotive facility in Germany. We expect to realize the full quarterly benefit of these actions beginning in the second quarter of 2015. EBIT margins were 7.1% of sales in the quarter compared to 6.1% in the prior year and 8% last quarter. Compared to last year the improvement was due to 30 basis points improvement in gross margins and from the lack of a one-time expense [probably] fourth quarter of 2013 that impacted joint venture earnings. Sequentially lower joint venture income negatively impacted margins by 50 basis points. For the full year power gen revenues were down 4% from 2013 levels and EBIT margins dropped from 7.3% to 6.9% of sales. Gross margins did improve by 60 basis points despite the lower sales however this was offset by the unfavorable impact of foreign currency movements in particular from the British Pound. For 2015 we expect power gen revenues to be flat but down 4%. In the United States [indiscernible] Military revenue will be offset by moderate growth in our base business along with revenue from our [indiscernible] line of gensets. International markets remain weak and we anticipate lower oil prices could result in lower demand in several markets. EBIT margins will improve in 2015 to between 8% and 9% of sales and this compares to 6.9% for full year 2014. The increase in margins will be driven primarily by savings related to our previously announced actions and from some currency benefits given the recent depreciation of the British Pound against the U.S dollar. For the distribution segment fourth quarter revenues were a record $1.7 billion an increase of 58% compared to last year and 31% sequentially. Acquisitions accounted for 31% of the growth year-over-year. Organic growth of 11% before currency impacts was driven by stronger parts demand in North America and higher demand from oil and gas customers compared to very weak levels a year ago. Unfavorable currency movements negatively impacted sales by 360 basis points compared to the prior year primarily due to the depreciation of the Canadian and Australian dollar. EBIT was a record $138 million for the fourth quarter an increase of 48% compared to last year and 21% compared to the prior quarter. Margins decreased from 10% of sales last year to 9.3% due to unfavorable currency movements which negatively impacted the margins by 100 basis points and from the dilutive impact on the EBIT percent from the acquisitions. For the full year the segment delivered record sales and record profits. Revenues were up 38% and EBIT dollars improved by $103 million of 27%. EBIT as a percent of sales declined from 10.3% to 9.5%. For 2015 we're forecasting revenue growth of between 23% and 27% with the majority of the growth coming from acquisitions. We expect EBIT margins to be in the range of 8% to 9% of sales. Based on current exchange rates, currency will negatively impact margins by 90 basis points. We completed seven acquisitions of North American distributors last year which added approximately $0.40 to earnings per share, we will complete an additional three acquisitions this year and expect that the aggregate impact of all the acquisitions will exceed the $1 billion in revenue and $0.50 in earnings per share that we projected at the last Analyst Day for 2015. Finally let me turn to cash flow, we generated a record $2.3 billion in cash from operating activities last year, which brings to 12% of sales. We continue to use that cash and invest back into the company and to the some volume to our shareholders. We returned 52% of the cash generated from operations to shareholders in 2014, a total $1.2 billion, which represents an increase of 48% over the amount returned in 2013. We increased our dividend by 25% last year and repurchased 4.8 million shares for a [outlay] of $670 million. We continue to invest in the business with $743 million in capital expenditure projects and a net $436 million for acquisitions. We also contributed $205 million into our pension plans and they are now fully funded. As Tom mentioned we are projecting total company revenues to be up 2% to 4% in 2015. Growth in on-highway engines and components in the U.S. and China, distributor acquisitions and revenues from new products will drive most of the growth and offset a 3% headwind from currency based on current exposures. We expect EBIT margins of 13.5% and 14% for 2015, and this compares to 15.2% for full year 2014. Similar to 2014 the EBIT margins will be at the low point in the first quarter, improvements in gross margins material cost, restructuring and quality improvements coupled with stronger joint venture revenues in China will drive the EBIT margin this year. We are currently projecting the tax rate to be approximately 29.5% this year, excluding any discrete items compared to an operating tax rate of 28.4% in 2014. Our tax rate guidance does not assume that the U.S. research and development tax credit is extended into 2015 which will negatively impact the rate by one percentage point when compared to last year. We anticipate operating cash flow performance in 2015 will be within a long-term guidance range of 10% to 15% of sales. Capital expenditures are expected to be in the range of $750 million to $850 million. We expect our cash balance decline this year as execute and distributor acquisitions and we remain committed to returning 50% of operating cash to shareholders in 2015. As Tom said, [indiscernible] improve upon we are pleased with the 2014 results, with growth in both revenues and in earnings. We also saw improvement in our return metrics, both return on net assets and return on equity over 2013 levels and we expect further improvement in 2015. Now let me turn that back over to Mark.

[Mark Smith:]

Thanks Pat. And we are now ready to enter in the Q&A session. If you could limit your first input to one question and a related follow-up please.

[Operator:]

[Operator Instructions]. The first question comes from the line of Alexander Potter with Piper Jaffray. Please proceed.

[Alexander Potter:]

Hi, guys. I was wondering first if we could touch on EBIT margins in the engine business. Back at the Analyst Day in 2013 I think you expected 12% to 13% EBIT margins by 2015 and then today the guidance is 100 basis points lower than that, on the top-end and bottom-end of the range. So just wondering what do you think the biggest delta now versus back then was presumably ForEx had some impact but I was wondering if you could elaborate?

[Tom Linebarger:]

Let me pick that one of and then maybe Rich will jump-in. When you look at Alex I was talking about was most probably three areas. One, as you mentioned foreign exchange is having a headwind across the company, given the rates on those versus 2013. Secondly, we still see weaker demand for high horsepower industrial engines weaker demand in emerging markets, than anticipated back then which is having an impact on margins. And then finally as we have talked about, we are working through some quality issues although the [indiscernible] as a percent of sales came down, we are incurring more cost in our manufacturing facilities to make sure we protect customers and that’s one in higher than what we have anticipated back in 2013. So Rich if anything you want to add to that?

[Rich Freeland:]

The only thing I would add Alex is just I will comment a bit on the quality cost. So we talked back then, we have been on the path to reduce quality cost over multiple years, in fact from 2009 to 2013 we took warranty cost down to 180 basis points. And we assumed we are continuing that in 2014. And as we talked in Q2 we had a bit of a setback on that in front of our high dollar cost and we have invested in some litigation efforts and the fact we have seen the working cost comedown a little bit better than what we told you back in Q2, but we are incurring some cost to do that, we've been testing albeit in premium freight and [indiscernible]. So I'll say that the three that Pat outlined are the three, just want to give a little more technical on the quality cost.

[Tom Linebarger:]

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

[Alexander Potter:]

Okay. That segways into the next question. I was wondering if you could comment on the ISG. Appreciate the breakout in the release talking about profitability by segment there at the Foton joint venture. I was wondering I guess A your outlook on market share internally at Foton with the ISG and then B the point at which you think that particular segment can start turning a profit? Thanks guys.

[Tom Linebarger:]

So let me talk at market share at a higher level and then we can offline we can break that down or give you the more detail. But what we said back at Analyst Day is we want to our market share up to 17% kind of from the 10% to 17%. With the ISG we're now -- we will exit that about 12% this year we will get 12% for this year with additional ISG. In fact we will -- our plans call for India in 2015 at 15% market share in this space and that's really on the strength of the ISG. From a profitability standpoint we incurred some pretty high launch cost in Q4 and so we move into profitability in 2015 immediately on that price, so you will see the improvement there and that's reflected in our guidance.

[Operator:]

The next question comes from the line of Jerry Revich with Goldman Sachs. Please proceed.

[Jerry Revich:]

I am wondering if you could take about now that we have seen greater enforcement on NS4 standards in China, how much higher is your market share on after treatment, are there non-engines in the country or were you successful in converting all of the stock bonds business and some of your other partners, can you give us some color there?

[Pat Ward:]

Yes, I'll take a shot and Tom can jump in but we've been -- more recently I have -- just on the NS4, we ended the year about 45% and I think you said 38% for the full year on NS4 compliance. It looks -- we're certain now that that grows to 70%, so that growth. From an after treatment standpoint, we'll be at 20% market share in after treatment. Primarily with our joint venture partners both with [indiscernible].

[Tom Linebarger:]

But again, you know I think you know that the market for after treatment is still volatile market because although there is stronger enforcement it's still not consistent across the country and it's still kind of developing. So there is still a number of different products out in the market. I think our view is that where our products are making very good progress, our partners are using our products and getting good performance out of them, so it's just going to take some time to settle out for us to have any view really about what stable market share is. Right now we're on to make sure that our products earn the reputation of reliability and durability and performance and that's really important for the long run. It's a huge market and we want to make sure we have a long-term sustainable share in that market.

[Jerry Revich:]

Okay and then on currency it sounds like you had a transactional headwind in distribution and components in the quarter, can you just talk about any opportunities to push pricing to offset the transactional headwinds in '15 and any opportunities to switch sourcing at the margin or maybe lean towards one supplier versus another to mitigate the headwind in '15, can you give us some color there please?

[Tom Linebarger:]

Yes I think it is something that we're always looking at to see if we can move the needle on the Jerry, I don't think I would expect anything later to change on our currency profile given the different geographies that we are in [indiscernible].

[Pat Ward:]

No, I just think just from a sourcing standpoint while we have -- we've got a broad base of sourcing opportunity as we tend not to chase currency rates around with that but where we see they will stick for some time we do have a case where we do that -- we do some of that.

[Tom Linebarger:]

I think the simplest way to think about currency for Cummins is that we have -- we built a lot of natural hedges in our business because we manufacture in lots of locations. But places where we have more costs than revenues as you guess would be in the U.S so strong U.S dollar is not ideal for us. That said we use a lot of global sourcing, we sourced products -- materials from all over the world almost no matter where we assemble which helps us on that. The business unit that’s most exposed to currency is distribution business because we have revenues and profits in all of these countries and so we get translation hits as they come back to the U.S we translate them into U.S dollars and those are hard things to figure out and naturally hedge too. And frankly as Rich said by the time you figure it out it will be switched to something else. That said in our core business we're always looking for ways to build natural hedges and we've been really successful on that and we're going to continue to do that in our sourcing side.

[Pat Ward:]

And just a little bit more color on that. For the full year 2014 the currency movements negatively impacted sales by $174 million, so 1% in EBIT by just over $30 million. So when you look at as a percentage of sales that moved the EBIT from [’13 3 to ’13 2], and as Tom just said the more significant impact was in distribution. So their EBIT margins not by but 1% because of currency but overall for the company, we do have a profile that helps us simply more than just some other companies do when it comes managing us.

[Operator:]

The next question comes from the line of Ann Duignan with JPMorgan. Please proceed.

[Ann Duignan:]

Hi, good morning guys this is Ann Dulgan here. I just wanted to follow-up on the distribution business. You talked about your exposure, direct exposure engines to oil and gas. Can you talk about your distribution’s exposure to oil and gas?

[Tom Linebarger:]

We have distributors -- of course our distributors in Texas and we have distributors in the Middle East and when we were talking -- in my remarks I was talking about how we have power gen sales in regions which are impacted by oil and gas. And I think all those regions will be impacted. So the distributor will be impacted of course by the sales of oil and gas equipment which you know about but we kind of figured that’s fits in that kind of less than 1% of sales idea. But the general business conditions in those regions will likely be negatively affected. And we don’t have a quantification for that per se, but every one of those distributors within one of those regions has the potential for being more broadly affected just because business activity goes down. So we don’t know what that’s going to be, but we think it will be limited to those regions and we think it will be -- we will see what it is when we get there. Again so we are not trying to make this exposure seem less, we just don’t have those direct sales but there is a lot of indirect things and that’s why we were pretty conservative in our view about where high risk our engines sales are going as well as where large power generation equipment is going.

[Pat Ward:]

Couple of comments, so first of all of course distribution half the revenues are in aftermarket. Needless to say in mining which has been very heavily negative on the engine side in our aftermarket sales are being flat or even for the last three years so we'd expect the impact there on distributors to be less than any impact on engines. And as Tom said in his remarks at least for now we are better positioned for tier 4 final of course not just oil and gas but in some of the segments. So we think we can hold it relatively well.

[Ann Duignan:]

Okay, I appreciate the color. On the quality cost, can you just give us a little bit more color it's so uncharacteristic of Cummins to be talking about warranty issues or premium freight or increased testing. Can you just give us a little bit more color on what exactly is going on there? Which region? Which segment? Is it isolated? Is it across the board? Just so we understand what exactly is going on.

[Tom Linebarger:]

As I said in my remarks, we have just been driving a much stronger expectation for how we are going to launch products. I think I mentioned in one of our previous calls, we are launching north of 70 new and improved products a year now. So our company on a global basis, we are basically in a new product introduction business. And that’s the way our customers can get ahead of their competitors is because they have new and improved products to go against them with. And so what we tried to build over the last decade is this new product introduction machine where we can launch new products that come out at quality levels that are better as good or better than the ones that they are replacing, which if you go back to the 90s was not our history, and so that’s the activity that I have been talking about. And what we had is a bunch of new product introductions in recent years that especially related to onboard diagnostics and things like that. Our launch rate was not as good as the one and as Rich said in his comments it wasn’t that we had more failures, it's that our failures were more expensive and more complicated. And so we just wanted to make sure that we invested in resolving the issues quickly which we always do, but also making sure customers had no impact so that’s making to our customer service operations are on the spot right away, we make sure customers have no impact. Again a lot of other companies had issues with onboard diagnostics and other things too, we just want to make sure we did better than anybody else. So we want to invest extra attention in making sure customers impacts were low and then also just get all the product issues resolved. So if investments across the board there to make sure that the impact is limited. And again that’s the kind of thing where with increased focus, we expect to have lower and lower large quality costs as we go through as a company, and that’s where we want to be world-class as the new product introduction leader.

[Operator:]

The next question comes from the line of Jamie Cook with Credit Suisse. Pease proceed.

[Jamie Cook:]

Just to follow-up on Ann’s question and then I have a separate question. Can you quantify what the cost of 60s quality issues, what it is in 2015 or what it was relative to your expectations so we can get a sense for what the incremental spend is and also how we think about warranty year-over-year and then just quantify. And then I guess my second question is can you just comment on the order trends that we have seen in heavy duty truck over the past couple of months in October. I think in November they were really weighted towards 1OE in particular. Can you talk -- I know what you said with your market share opportunities but can you talk about one, why those orders were abnormally high. Do you think market share for the OE sort of normalizes throughout the year and does the strength I guess also in the orders that you have seen make you view I guess the truck build forecast for '15 is there more upside or did the orders I guess that we've seen recently pull from the latter part of the year? Sorry there were a lot of questions in there.

[Tom Linebarger:]

Yes. I will let Rich do the order board release and just on the quality side I will just say Jamie in terms of quantification I mentioned the 0.5% increase in the year for the engine business and again how we have been trying to bring it down. I don't want to -- I am not going to give more quantification of all that. I did -- we did talk about as Pat said in his remarks that there was impacting gross margins so there is a lot of areas we're investing in. We also said we expect as we go through 2015 to see improvements in those areas.

[Jamie Cook:]

But you won't quantify what the improvement is '15 versus '14 I guess that's what I am trying to figure out?

[Tom Linebarger:]

Well we did. That's within our margin guidance.

[Jamie Cook:]

Okay but not a number just that that helps margins?

[Tom Linebarger:]

Right.

[Jamie Cook:]

Okay.

[Rich Freeland:]

Okay. There were a lot of question in there Jamie -- on the South America truck but let me take a shot at it if I have missed a piece of it I will follow-up. Just on the -- I'll start with the market size which I don't think we have a view different than anyone else and so all the things we look at around freight activity, to that question kind of multiyear highs, used truck prices are up if you look at 10% in 2014. And then the orders remain high even in January with 35,000 plus old truck orders the backlogs are strong with the OEs, this lower oil price is lower, diesel price I think helps carrier's profitability. So most of the signs look pretty good on the overall market, so are we too conservative or too aggressive we have got an update for share and that feels about right kind of the balance is our scenario better or worse yes there is but that's what we've assumed. On the market share we're projecting 36% going forward and we came in and that looks solved, if you look at our placement at OEs it's about where we thought it would be, okay and yet we missed a little bit in 2014 we thought it would be a 37 and I think two things happened there -- they are not big it added up to 1% they are not a change but our share is high at NAV, right at 75% and their share is down below what they would have expected and that's public information, so a little bit lower there that cost us. And then while it's not a big number we had assumed natural gas growing to 3% of the market and that didn't happen and that's worth about 1.5 points of share being at 1% and those two at 3% given that we have 100% share in natural gas. So we didn't a sea change in market shares by OEs, we don't see a big change in what our share is with those OEs it's about where we thought it would be. And so and I wouldn't read too much into any one month as you know there is lots of variation kind of month to month.

[Operator:]

The next question comes from the line of Andrew Casey with Wells Fargo. Please proceed.

[Andrew Casey:]

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

[Pat Ward:]

Yes Andrew this is Pat one of the important items to keep in mind is material cost. So in 2014 material cost benefited on margins by just over 1%, sales we're expecting it somewhat similar to that and maybe slightly below but certainly close to a 1% improvement in gross margins as it fell to the bottom-line in 2015. So we take material cost, the power gen restructuring, the quality cost that Tom was just talking about. We will have more joint venture income, we will have some lower other income as we've been picking some one-time gains this year on distribution acquisitions all that kind of gets us into that guidance range of 13.5% to 14% or relatively modest revenue growth.

[Andrew Casey:]

And then just kind of going back to the topic of the day the weaker oil prices, given your distribution breadth can you comment on whether you are seeing any project delays or cancellations on U.S or elsewhere and if so can you kind of give us some regional detail?

[Tom Linebarger:]

I think in North America right now and we haven't seen any cancellations -- again we saw new emission compliant products out in the market so for those products, we can say zero cancellations because it's appropriate to be concerned but that being zero. I think more broadly power gen some concerns about what’s going to happen in the Middle East is one area, but no big rush of cancellations or big changes in trajectory yet.

[Operator:]

The next question comes from the line of Ross Gilardi with Bank of America. Please proceed.

[Ross Gilardi:]

First I just had a question on components, when you are baking in a lot of deceleration on a top-line in the components and how much of that is FX and are you actually seeing that deceleration in your order book now or is that an attempt at conservatism?

[Tom Linebarger:]

I think firstly obviously whilst North America continues to grow its Class A bills and so is been growing at the same rate as we saw 2014 versus ’13. Medium-duty North America is also this can actually going to be a relatively flat. And those are the areas where we are at. Today we have the highest revenue. Offsetting that will be growth in China so a significant growth in China and I think Brazil is another area we are forecasting another 16% decline in Brazil. So you combine those with a little bit of currency that’s how you getting arranged with.

[Pat Ward:]

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

[Tom Linebarger:]

The U.S. and China will be the biggest top-line growth.

[Ross Gilardi:]

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

[Tom Linebarger:]

Only in Brazil.

[Ross Gilardi:]

Only in Brazil you are a seeing a deceleration?

[Tom Linebarger:]

Yes.

[Ross Gilardi:]

Okay. And then...

[Tom Linebarger:]

I think in North America, up in China up also, Brazil [indiscernible].

[Ross Gilardi:]

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

[Tom Linebarger:]

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

[Operator:]

The next question comes from the line of Joel Tiss with BMO. Please proceed.

[Joel Tiss:]

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

[Tom Linebarger:]

Yeah Joe it is a great question, as you guessed, we spent a fair bit of time talking about those things ourselves. So let me just start with the inventory side, the mix of business is definitely changing as we acquire distributors we definitely acquire more inventory. So essentially our chain lengthened is that to think of it. We are now have inventory one step closer to customers. Now if you look at the total asset intensity it’s got less capital and it looks fine, but from an inventory point of view there is definitely more inventory in the system and that’s affecting working capital ratios a bit. And also when we talk in our analyst meeting we will try to update our working capital stats which are changing a little bit and it’s not a dramatic change but it’s a little bit of a change with more distributors in there. But still we could do better on inventories there is no question about it and one of that challenges is when we operate our plants in especially the high horsepower area at very low utilization and then people are dropping in orders and you are taking whatever you can get, your inventory turns suffer and so that’s -- I talked on many times on this call about how important it is for your operations to be able to adjust up and down to variation revenue and this is the kind of thing where if we are doing the best in the industry responding we can do little bit better on those ratios so we are very focused on. On the SAR side that’s another area of really big importance for us. We have to keep our cost down and they are growing as you quite rightly noted. And we are trying to balance between how do we make sure we will remain a technology leader and relevant in launching new products so that we can continue to partner with people and that they feel the need to use our engines and use our generators and components and that's a big investment and we're doing it globally now and we got to make sure we have systems and infrastructure to support that on the other hand we got to keep our cost under control. So we're striking that balance it's one of the things our management team spends the most attention on. And as you heard from us in these remarks we're striking the balance a little differently in the power gen business than we did two years ago. And we made one change last year and we will make another change this year to strike that balance little differently. And those decisions are tough to make but they need to be made in order to make sure we can continue to grow profitability.

[Pat Ward:]

Let me just come back to the working capital, we spend a lot of time looking at working capital Joe we focus on the [indiscernible] as you know and if you look at the growth in inventory you are right it's been up by $450 million year-over-year with vast majority of it, $360 million was through acquisitions. So we acquired all that inventories build -- we have not had the full benefit of actually being able to trigger inventory and to sales, when you look at inventory turns, but I actually [indiscernible] last year probably the [indiscernible] which we expect it for the reasons Tom gave that from 5.4 times down to 5.3. And when I look at working capital as a percentage of sales we have gone from 18.9% fourth quarter of last year to 19.3%, so I think we're actually doing quite well monitoring that but of course we always can do better.

[Tom Linebarger:]

We could do better.

[Operator:]

The next question comes from the line of Tim [indiscernible] with Citigroup. Please proceed.

[Unidentified Analyst:]

Just on the -- you talked earlier about the raw material cost and the benefits there, can you just update us on what we should be thinking about from a pricing perspective obviously you have got outlining pretty tough conditions for high horsepower and then power gen being down contrasting with higher North America on highway which just you put all the things together it's not the best setup from in terms of your ability to get pricing. So how should we be thinking about price overall in 2015?

[Pat Ward:]

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

[Tom Linebarger:]

And Tim you didn't ask the question but I am sure people will wonder about it, are we seeing broad discounting in power gen things like that and we are not. There still are -- there are places where we see it in system starts but broadly it's still not broad and there is not a consistent move on pricing which is good, and we hope that remains and so that's why we think we can maintain the spot price environment in the year.

[Unidentified Analyst:]

Thanks a lot.

[Tom Linebarger:]

Thank you very much. I will be available to callers later on, thanks a lot.

[Operator:]

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