Cummins Inc.
Q2 2015 Earnings Call Transcript

Published: 28 Jul 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Cummins Second Quarter 2015 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I will now turn the call over to your host Mark Smith, Vice President of Investor Relations. Please go ahead.

[Mark Smith:]

Thank you, Stephanie. Good morning, everyone and welcome to our teleconference today to discuss Cummins' results for the second quarter of 2015. 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 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 on 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 Form 10-Q. During the course of this call, we will be discussing certain non-GAAP financial measures, and we refer you to our Web site for the reconciliation of those measures to GAAP financials. Our press release with a copy of the financial statements and a copy of today's webcast presentation are available at our Web site, www.cummins.com under the heading of Investors and Media. Now, I'll turn it over to our Chairman and CEO, Tom Linebarger.

[Tom Linebarger:]

Thank you, Mark. I will start with a summary of our second quarter results and provide an update on our outlook for the full year. Scott will then take you through more details of both our second quarter financial performance and our forecast for the rest of the year. Revenues for the second quarter were $5 billion, an increase of 4% compared to the second quarter of 2014. Second quarter EBIT was $721 million, or 14.4% of sales, compared to $657 million or 13.6% in the same quarter last year. This represents an incremental EBIT margin of 36%. Key to these strong results was an improvement in gross margin of 170 basis points year-over-year. Good performance from our manufacturing and supply chain organizations and solid execution on material cost reduction initiatives improved gross margin. Moreover the company was able to expand gross margin while launching new products and adjusting to weak demand in number of important markets. Engine business revenues increased by 2% year-over-year with strength in North American truck and bus markets offsetting lower demand for trucks in Brazil and in global off-highway markets. EBIT of 12.2% of sales improved from 11.3% a year ago, due to strong operational performance, lower material costs and higher joint venture earnings in China. Revenues in our Component segment increased 9% year-over-year with strong demand in North America and sales of new products in China more than offsetting weakness in Brazil and Europe. Revenues in China grew 29% despite a 28% decline in the truck market in the second quarter. As our investments in new NS core compliant products yielded strong results. EBIT of $223 million or 16% of sales was a record both in dollars and margin percent, reflecting strong performance in all four components businesses. Distribution revenues increased 21% compared to the second quarter of 2014 with the acquisitions adding 6% and currency negatively impacting sales by 6%. EBIT for the quarter was 7.6% down from 10.2% a year ago. EBIT percent decline due to currency primarily appreciation to U.S. dollar against the Australian and Canadian dollars and the dilutive effect of acquiring businesses previously held as joint-ventures. Excluding the impact of currency and acquisitions operating margins in existing businesses improved year-over-year. More over EBIT percent improved 160 basis points from first quarter levels due to strong incremental margins on organic sales growth. We remain on track to complete three further distribution acquisitions in North America in the third quarter. Our forecast for the positive impacted acquisition is unchanged from three months ago. We expect to add approximately $600 million in company revenues this year. In addition to more than $460 million adding 2014. Exceeding the $1 billion in revenues we projected for 2015 at our 2013 Analyst Day. We currently expect to add $0.20 to earnings per share this year on top of the $0.43 added in 2014 for a total of $0.63 also ahead of our 2013 projections of $0.50 a share. In the Power Generation business, revenues increased just 1% year-over-year, this low growth reflects a slow pace of global infrastructure investment. EBIT decline from 8.2% last year to 7.6%. The negative impact of currency primarily the appreciation of the U.S. against the Euro and lower pricing in the alternator business offset an 80 basis points improvement from cost reduction action. EBIT did improve 40 basis points from this quarter level. We completed the exit of our German alternator operations in the second quarter as planned and this will yield additional cost savings in the second half of the year. However with weak demand projecting for the remainder of the year a competitive market and continuing challenges from currency, EBIT for the prior generation business for the full year is expected to be in the range of 7% to 8% up from 2014 but below our original projections of 8% to 9% for this year. Now I'll comment on some of our markets starting with North America. Our revenues in North America grew 12% in the second quarter, due primarily constraint in on highway markets and distribution acquisitions completed in 2014. Shipments to the North American heavy duty truck market exceeded 28,000 units in the second quarter an increase of 18% from the second quarter last year. Our market share year-to-date is approximately 34.5% up from 33% in the first quarter. Based on current projections from our OEM customers, we expect our full year market share to remain in a range of 34% to 35% below our original projection of 36%. We expect full year market size to increase by 8% unchanged from our previous guidance. In the medium duty truck market we delivered 26,000 engines in the second quarter, up 18% from last year. We currently project that the market will grow by 4% for the year 3% stronger than our previous forecast. We are also raising our market share forecast with our full year market share now expected to be 76% up from 72% last year and higher than our previous forecast of 74%. Shipments to Chrysler increased by 5% in the second quarter and we forecast full year shipments increase 2% compared to 2014 up from our previous forecast of flat. Our engine revenues from the North American construction market decreased by 7%, compared to the second quarter last year. Our revenues will be lower in each quarter of this year compared to last year as OEM demand for engines was elevated in 2014 ahead of the tier 4 file emissions regulation, which went into effect on January 1st of this year. Prior generation revenues declined by 12% in North America in the second quarter due to lower sales of datacenter and Renault customers. Our global datacenter customers are expanding in Europe and Asia Pacific but the rate of investment in North America has definitely slowed. After several quarters of growth rental customer reduced their purchases as they focused on increasing utilization of their existing equipment with some reports of lower rental activity in oil and gas markets. Cummins International revenues declined by 6% year-over-year mainly due to the negative impact of appreciating U.S. dollar and weakness in all end markets in Brazil. Second quarter revenues in China including joint-ventures were $916 million, an increase of 6% year-over-year. The growth was driven primarily by stronger sales in new engines and components in our highway markets which more than offset very weak market conditions. Industry demands were heavy and medium duty trucks in China declined by 28% in the second quarter and is down by 30% year-to-date as the industrial economy continues to soften. We have lowered our full year forecast for the truck market to decline 30%, it's down from our previous forecast of down 15% as confidence in the economy has weakened and freight is fairly growing. The good news in this challenging environment is that our market share has increased and the Chinese government continues to plan for the adoption of more stringent emissions regulations which will be positive for our business longer term. Our engine market share is 15.5% year-to-date up from 10% a year ago as shipments of our new ISG heavy-duty engines to Foton increase. We have also increased share in a medium-duty market with Dongfeng motors. We currently project our full year market share will exceed 17%. Shipments of our light-duty engines in China grew 21% in the second quarter in a market that declined 5% as we gain penetration of Foton and some additional customers displacing local competitor engines. Our market share increased to 6% from 4% a year ago. Our power generation revenues declined by 2% year-over-year in a weak market due to lower infrastructure investment and a low rate of growth and electricity consumption consistent with the weaker economy. Demand for construction equipment remains suppressed in China due to the slowdown in real-estate development and infrastructure spending. Industry demand for excavators in China declined 34% in the second quarter and is down 42% year-to-date with no visible sign of near-term improvement. Our construction revenues declined by 25% in the second quarter so the impact is small due to low level of business at this point. Full year revenues in China across all segments including joint ventures are now expected to grow 6% for the year down from our previous projection of 15% growth due to very weak demand in most of end of markets. We continue to gain market share and grow our joint venture earnings in challenging conditions and with more emission changes ahead we're well positioned to outperform our end markets and build a sustainable leadership position in the largest truck market in the world. Second quarter revenues in India including joint ventures were $309 million, up 6% year-over-year due to growth in our truck and power generation businesses. Industry demand in the truck market increased 20% compared to the second quarter a year ago as the economy continues to show signs of improvement. We now expect industry truck production to increase 22% for the year, up from our prior forecast of 15% growth. Currently the truck industry is planning for introduction of broad stage for emission standards in the north of India in October this year and countrywide adoption is expected in April 2017 which should present opportunities for further growth for Cummins. Power generation revenues in India increased 8% in the second quarter as orders improved following two years of weak demand. We are maintaining our full year forecast for growth of 5% for this year. We remain optimistic that government plans for further investment infrastructure should stimulate stronger demand going forward. In India we project total revenues including joint ventures to increase 12% up from our previous forecast of 8% due primarily to stronger truck demand. Second quarter revenues in Brazil were $110 million, down 43% from the second quarter last year due to the severe slowdown in the economy and near 40% depreciation of the real against the U.S. dollar. Industry truck production declined by 40% year-over-year and our shipments declined 38%. We have lowered our full year projection for industry production and now expect to decline of as much as 50% worse than our previous guidance of down 27% due to deteriorating business and consumer confidence. We expect our engine shipments to decline by 45%. Revenues in power generation and distribution in Brazil have held up much better than in the truck business but conditions are very tough across all end markets. In summary we currently expect company revenues to increase between 2% and 4% for the full year unchanged from our previous forecast. We are also maintaining our forecast for EBIT to be in the range of 13.5% to 14%, in this challenging we delivered strong financial results in the second quarter, we gain market share it's an important market to the successful launch of new products and we increased cash return to shareholders through dividend growth and share repurchases. Thank you for your interest today, and now, I'll turn it over to Pat, who will cover our second quarter results and full-year guidance in more detail.

[Pat Ward:]

Thank you, Tom, and good morning, everyone. Second quarter revenues were $5 billion, an increase of 4% from a year ago. Organic revenue growth was 5%. The distributor acquisitions completed last year by 3% of revenues while currency movements reduced our sales by 4%. Sales in North America represent 60% of our second quarter revenues were up 12% from the year ago due primarily the stronger demand in on-highway markets and from distributor acquisitions. International sales decreased by 6% compared to the prior year as a result of negative foreign currency movements against U.S. dollar, weak demand in global off highway markets and extremely weak truck production in Brazil. Gross margins were 26.6% of sales, up 170 basis points from a year ago, strong operating leverage on higher volumes and lower material costs were the primary drivers of the strong performance more than offsetting a negative impact from currency. Selling, admin and research and development costs of $703 million of 14% of sales increased $11 million from a year ago and was 30 basis points lower as a percent of sales due to good cost control on the impact of currency movements. Joint venture income of $94 million decreased by $11 million compared to last year. The acquisition last year of North American distributors for the previously held joint ventures reduced the joint venture income more than offsetting earnings growth in China. Earnings before interest and tax were $721 million or 14.4% of sales for the quarter compared to $657 million or 13.6% of sales last year. The incremental EBIT margin was 36%, reflecting strong operating performance. Earnings per share were $2.62, an increase of 8% from the $2.43 reported in the same quarter of 2014. The tax rate was 29.5% for the quarter. Now, let's move on the operating segments and further discuss second quarter performance and the outlook for the full year. In the Engine segment, revenues were $2.8 billion, an increase of 2% over last year. On-highway revenues were up 8% driven by strong demand in North American truck and bus markets, partially offset by weaker demand in global industrial markets compared to a year ago. Segment EBIT was $341 million or 12.3% of sales, up from 11.3% last year. Reduced selling, admin and research expenses along with increased joint venture income provided the majority of the margin improvements. For the full year we continue to forecast the revenue for the Engine segment will be flat to up 2% primarily driven by North American on-highway demand. Compared to three months ago we now expect weaker truck production in Brazil and China as Tom just described. We're maintaining our EBIT projections for the full year at 11% to 12% of sales which compares to 11.2% reported last year. For the Distribution segment, second quarter revenues were $1.5 billion, an increase of 21% compared to the prior year. Acquisitions in 2014 added 26% to segment revenues year-over-year. Organic growth was more than offset by foreign currency movements that negatively impacted sales by 6%. EBIT margins for the quarter declined from 10.2% last year to 7.6% due to the diluted impact on its EBIT percentage and acquisitions of businesses previously held joint ventures and due to negative impact of currency movements. Strong operating performance and existing businesses added 60 basis points to EBIT margins. For the full year distribution revenue is now forecasted to grow by 20% to 24%, below our previous guidance of 23% to 27% growth. Due to our more negative impact from currency not anticipated at the start of the year. We are maintaining an EBIT margin for same guidance in the range of 7% to 8% sales. The Component segment delivered record sales of $1.4 billion compared to the second quarter last year, the higher revenues were primarily driven by increased truck production in North America and in Europe, an increased sales in China of the new National Standard 4 compliant products all of which offset the negative impacts of currency and weak truck production in Brazil and in China. Segment EBIT was a record $223 million or 16% of sales, up 150 basis points from last year, as a result of excellent operational performance across all four businesses. Strong operating leverage on higher sales and good execution on material cost reduction initiatives help drive the EBIT margin improvement. We still expect full year revenue growth of between 4% and 8% in 2015. And we are raising our EBIT projections for the full year to 14.5% to 15.5% of sales reflecting a strong performance. And this compares a full year 2014 margin of 13.4%. In the Power Generation segment, second quarter sales were $747 million, up less than 1% reflecting continued weakness in a number of important markets. Year-over-year international sales increased offsetting lower sales on North America and a 4% reduction in revenues resulting from currency movements. In international market's stronger demand in the Middle East and in India more than offset lower revenue from Russia and from Latin America. EBIT margins were 7.6% in the quarter, down from 8.3% last year. The negative impact of currency primarily depreciation of the euro against the U.S. dollar and lower pricing in the alternator business more than offset the benefit of cost reduction actions. For the full year our guidance range for power gen segment, revenue remains unchanged with revenues expected to be flat to down 4%. Although revenues are up 3% year-to-date weak recent order trends indicate that revenues in the second half of the year will be lower than second half of 2014. EBIT is expected to be in a range of 7% to 8% of sales, going from our prior range of 8% to 9% reflecting a continued headwind from currency and a more competitive pricing environment in some international markets. Well, guidance for total Cummins revenues to be up 2% to 4% in 2015 remains unchanged. Strong North American on-highway demand increased revenue from distributor acquisitions and growth from new products were more than offset the negative impact of currency and weakness in global off-highway markets. Joint venture income is now expected to decline 15% from 2014 compared to our previous guidance of down 10%. The driver of the lower earnings is our acquisition of this 30,000 North America previously held these joint ventures. Joint venture earnings will grow in China this year as a result of market share gains and new product sales but not at the same rate, we anticipated at the start of the year. Due to our weaker economy was just negatively impacted demand in our end markets. We continue to project EBIT margins for the company would be in the range of 13.5% to 14% of sales and the projected full year tax rate of 29.5% excluding discrete items remains unchanged. Finally cash flow generated from operations to the first half of the year was $569 million. We continue to expect our operating cash flow to be in the range of 10% to 15% of sales for the full year, but stronger cash flow generation in the second half of the year than the first as is typical in our business. Capital expenditure of will be between from $700 million and $800 million for the year. Earlier this month we announced a 25% increase in our quarterly dividend and we have now raised our quarter dividend by 457% since the beginning 2010. The company returns $794 million of cash to shareholders in the first half of the year through dividends and share repurchase, consistent with applying to its own 50% of operating cash flow. Year-to-date the cash balance is declining by $541 million due to the investment backing to the business and from higher returns of the shareholders to increase dividends payments and share repurchases. Finally I wanted to advice we have move the date of our Analyst Day to November the 10th in New York and invitations to the event will be sent this week. Now let me turn it back over to Mark.

[Mark Smith:]

Thank you, Pat. We are now ready for question-and-answer session. If you can please limit yourself to one question and one related follow up and then get back in the queue. Thank you. Stephanie we are ready to proceed.

[Operator:]

Thank you. [Operator Instructions]. Our first question comes from Ted Grace with Susquehanna. Your line is open.

[Ted Grace:]

I was just wondering if you can talk a little more granularly about what you are seeing in China, I know you talked about gaining share, I know you talked the market being tougher than expected but just maybe if you could give us your most current read and kind of where you think the market is and kind of what the back half looks like and really what that implies about the exit rates and how we should think about '16 in Middle East you haven’t given guidance on '16?

[Rich Freeland:]

Yes, Ted. This is Rich. Let me start out here and Tom can jump on to that. Obviously we don’t know as this has moved along but we've taken it down and there are some there is a little some growing confidence but the adjustment we made down 30% is solid for the rest of the year. Again we're on [montage] to increase share despite what happens there and so you've seen we've grown from 5 up to 15.5 and we plan in the year 17% in the heavy duty side. And so the product we get out there looks really good, we believe we're changing the market because we've got this low cost products, so we're competing with the China competitors but step function improvements general economy, reliability but putting telematics on it. So while there continues to be uncertainty in the market what our big picture what we're demonstrating showing us as we're growing share. Same thing on the light duty on the ISF, so with the market down 5 our ISF volumes will be up 21%. The potential macro market which was more your question, you see the uncertainty there the freight numbers are actually up a little bit so the freight numbers aren’t down to the level that demonstrate a 30%, so our view is there is still some kind of shake out would be going on here were a bit optimistic with the positive sign we see as in the freight numbers.

[Tom Linebarger:]

I guess. I would just add few two things Ted. First that as I mentioned emission standards if anything are tightening they've got a date now Euro 5 implementation, they've got cities like Beijing, Shanghai talking about implementing Euro 6. There is a lot of support from local and federal governments about pushing ahead with emissions standards can all that just drive people towards better technology, more focused on fuel efficiency and the quality of emissions equipments which if we think is good for us so just builds on the points that Rich was making that we've lowered our cost in are offering products that are competitive to local markets folks that we're able to apply technologies in a way that some of them are having a tougher time. So we feel very good about market share and I guess the second thing I would add it's obvious I think that the Chinese economy is going through a change and their governments are very serious about making this change. So, I don’t I'm not optimistic that we are going to see a big pump up in any of our end markets in a hurry because I think that Chinese government is going to try to keep going on this change of their focused in the government not so much on infrastructure and not so much on build and export a little bit more on consumer and a little bit more disciplined in the provinces, how they are going to succeed and what rate I don’t know but I also think there is some stabilization going on in the markets. So they're pretty low now and they definitely seem to be bottoming up and stabilizing as Rich was indicating, so we don’t see a further fall and we've indicated but we also don’t see necessarily a major turnaround in the near-term.

[Ted Grace:]

And so Tom to that point on taking share and the advantages Cummins has, I mean when we think about kind of the path looking up three, five years. Are there any structural considerations we should think about as maybe inhibiting you from getting to North America like market share, I mean is that a realistic goal that the way you should think about the potential or any handling there?

[Tom Linebarger:]

As we discussed our goal for 2018 that we set out was to get the 17% market share and of course we expect to achieve that this year, so that feels pretty good especially in the backdrop of some of the markets we're facing. But we also said we'd like to get ourselves up to a 25% share and that was kind of our -- if you want our stretch goal and we're still to have in mind. I do think the Chinese government pays attention to the role that foreign companies play in industries relative to the domestic companies in part we've addressed that by joint venturing the most of our major engine operations there are on joint ventures and we therefore are supporting local competitors and the industry in general and that's the posture we take. So I think that helps to sum on that but there is no question that the government pays attention to that. I really don’t know what that means with regard to market share, but I think it means you have to pay attention to where you are and make sure the government sees you as a positive force for the industry and not something else.

[Operator:]

Our next question comes from Jamie Cook with Credit Suisse. Your line is open.

[Jamie Cook:]

I guess just two questions, one, I think within the power gen business you alluded a couple of times to slightly more competitive behavior. I was just wondering if you could give a little more color as this has been ongoing if this short of a big change this quarter and I think you also mentioned oil and gas slowing due to rental or something like that, so any color you could provide there on the power gen business? And then I guess my second question, Tom, it's just a bigger picture question obviously what's weighing on Cummins stock while you're very diversified as concerned U.S. truck as it peak in '15, Volvo came out on the last during this call and said they think '15 is peak-ish and '16 is likely down although not materially, can you talk about sort of your view in how you're managing your business in that environment?

[Tom Linebarger:]

So on power gen a couple of things to give color on that I started on but I can give more. The competitive market a couple of things that are going on, I mentioned alternators, in the alternators business our business sales are a lot in Europe and Middle East and companies that export from there to other parts of the world. And we're competing with many companies that are based in Euro and so the price competition I talked about or the competitiveness is partly a function of the fact that the euro is still weak that some of the competitors especially given how low the demand has been have begun to take some of the cost advantages in term enterprise. It's not consistent it's not global, but it's happening. The second thing is in the alternator business is the copper prices have dropped a lot and of course alternators are made of a lot of copper and so some of our competitors that have done the same thing, turned some of the copper price the cost decreases into price decreases. In our case we hedge a lot of that copper, so we're protected when it goes up and we're unfortunately protected when it goes down a little bit which means our cost decreases don’t fall exactly in line with the market. Certainly some of that price competitiveness has hurt both our margins and our demand at the alternator business and there is a little bit of in the gen set business. As I said it's really not global it's not consistent and it really has got going pretty recently. We just haven't seen it very much and I would still say that it's not consistent. The thing I mentioned about oil and gas markets, we've had pretty good results selling gen sets to rental businesses and that's been going pretty well, it's been one of the parts of the U.S. market that's where my comments are coming from that's been going pretty well. And it's just recently turned down a little bit and some of our customers have said that oil and gas demand is a little lower, it's the first time we heard it. It's not surprising given what's going on in the market but first time we heard it and we don't know the rental business, rental guys are going to stop for awhile or what's going to happen, it's just that we heard this quarter. So as you know car generation business generally speaking is pretty low everywhere, so these are -- you're getting the highlights of which may not even made the news when our business was much larger, but it's pretty small amounts or small variations and these markets are having pretty negative impact. Can let me just let Rich talk a little bit about the truck markets just because he's been talking to customers more recently?

[Rich Freeland:]

Jamie, still continuous to be lots of positives in place and backlog still to 150,000 units, that's up from 120,000 a year ago, and it benefits the retail sales in fact they were up in Q2. And as I talked to fleet, I don't, I am not sensing a big change in sentiment. Folks are still generally positive and one kind of common comment we get is, the new trucks are significantly better in fuel economy and some of the safety systems we've put on board and so folks are -- want to continue on their place of replacing older fleet. These truck prices are pretty strong. Lower oil prices can tend to be net positive, so there is lots of kind of positive things. Where the nervous comes from there is now we've had after I think 14 months in a row where production was less than orders and the backlog was increasing, we've now had four straight months of production being higher than orders. And so while backlog is in a very healthy level -- almost 160,000 units, it's down for, it was approaching 190,000 units four months ago. So, it's kind of balancing these two things as our anticipation is we'll see orders -- the seasonal orders kind of come in Q4, Q1, if that doesn't happen obviously production will have to come down and better match what the orders are. But it doesn't feel like -- we all track these cycles. It doesn't feel like some of these past cycles where when production was greater than backlog. We had a bunch of fundamentals of the market that looked pretty bad. And so you saw these -- some of the major drops. The fundamental market looks pretty good. There hasn't been the big run up that we've had in other cycles. So I think the jury is still out as well as the market fundamentals turn in orders kind of in Q4, Q1. So that's the nervousness we're sensing.

[Operator:]

Our next question comes from Jerry Revich with Goldman Sachs. Your line is open.

[Jerry Revich:]

Pat I wondered if you could just say more about the capital deployment priorities. Longer term you mentioned in your prepared remarks, you drew down on the cash balance so far as this year. Any update to how you are thinking about capital deployment and slower growth macro environment? Any update there would be helpful.

[Pat Ward:]

Yes, so, we'll talk a little bit more on long-term capital deployment funds, we get to our Analyst Day in November. But now you should know as soon as major change in what we said before we want to reinvest back into the business where we see really good -- opportunity for profitable growth and we're trying to do that as best as you can in this environment. And we're also very conscious about delivery on our commitments to the total 50% of cash distributable on those, which we did last year, and we're on track to do again this year. So at this point in time, we know there's nothing we need to add, to what we said before on how we deploy our capital.

[Jerry Revich:]

And then on new product side, Tom can you please give us an update of how you're thinking about the Class 4 to Class 5 opportunity in the U.S., there have been a couple of product announcements. And I am just wondering if you just give us an update for the Cummins opportunity longer term and any update on how the high horsepower, hedgehog program is tracking?

[Tom Linebarger:]

So, on the Class 4 to Class 5 as you know, we were kind of -- we're more in the six, seven market and that's where we compete in North America. So, some of the recent announcements on folks entering the four and five are less of a direct impact on us. I guess just maybe another comment just looks in the mid range market -- it continues pretty strong in North America and in fact we're taking our share guidance up. We started the year and said potentially going down with the announcement of Ford introducing their own engine. And what we've found in that market quite frankly is we have got a traffic engine that's low cost, leading fuel economy and folks that used our engines have gained share and those who've moved away have lost share and that's proved out in this case also. On the -- before we leave that Richie, the two areas that you know about, V8 which will be launching with Nissan eminently. So, they'll plan to start selling those in the fourth quarter or at least produce them in the fourth quarter. So that will get us into -- that's not really a Class 4 or Class 5, that's a summer vehicle, but size of engine's probably in that and of course we are offering in the few other vehicles that you know are these buses and things like that which might be classed in that range and our hope is to gain some position there and we've got some star customers. The other area that we are definitely expanding and as you know is with the 38 engine, just not in U.S. today. And we'd love the chance to do at this just right now, it doesn't -- it's not the customer for -- and it doesn’t make sense today. But we are expanding with that engine around many markets in the world in that same segment. So we're definitely in it, as Rich said we're pretty small in it and in U.S. and over time we hope to change that and we're putting a bunch of markers in place that we can.

[Rich Freeland:]

Jerry maybe, I'll touch on the 9.5 liter. So, I guess I'll start out saying we're on track with what we've been saying for some time on the 9.5 liters. So, we've -- we're going in the production on the power gen business, we'll go into production on Q4 in the rail business. We've secured orders in the commercial marine business that we'll begin shipping next year. So, we're ramping up production, we'll be producing up to four week by Q1 of next year. And the products doing really well, and in fact much of the production, we're ramping up to -- we've in fact secured orders for already for that ramp up for next year. So, generally on schedule, remember we're -- with this new product, it gives us access to about a $5 billion market globally, that we've not had access to in the past. So, just getting started and the product doing well out of the shoe, securing customers was really important -- so, well it's not big numbers right now, it leaves us on track to what we want to do in the Hedgehog or in that 9.5 liter product line.

[Operator:]

Our next question comes from Tim Thein with Citigroup. Your line is open.

[Tim Thein:]

And maybe Rich just continuing on that thought. If you look at your the high horsepower volumes you are kind of running basically flat year-to-date through the first half in light of the step down in some of the industrial markets how should we think about just coming to the back half in terms of the quarterly pace of high horse power volumes.

[Rich Freeland:]

Yes I don’t much positive to say there but frankly as we took our guidance down on mining and we're not projecting recovery through the balance of the year there the oil and gas which started pretty good at the end of the year and you know that well and so again no step up in oil and gas. Our commercial marine we think would be flat for the year but we've and there is little bit of headwinds there, it's about 30% of our commercial marine business is tied to oil and gas and on the crew boats due to the offshore work, so we're getting a little bit of headwinds there. The hedgehog or the 9.5 liter is new business that we didn’t have before and we talked about power gen markets which remained pretty flat. So as we looked we've kind of settled down this number that has began nothing really positive from the second half of the year on the high horsepower range.

[Tom Linebarger:]

I would just say incremental changes is the summary Tim versus even at the start of the year incrementally little bit negative I would say to most of them but not dramatic changes to our overall guidance.

[Tim Thein:]

And then switching gears to components, just any implied step down in margins in the back half? What are some of the headwinds that we should we rethinking about there and I guess is somewhat related and I know you have some hedges in place but what if any impact should we expect to get just in light of it the recent sharp declines in some of the PGM markets?

[Tom Linebarger:]

We are not choosing hedging -- are you? I think we see components and normally third quarter of the year we see a softness in the non somewhat OEM like things, so that's going to deepen to the second half guidance. As of now I think we're looking for components to finish what that you had a put a strongly most there is an uptick in some of destructions of elements spending related to new products compared to the first three quarters of the year and they are on track to deliver a refuge of both top line and bottom line.

[Operator:]

Our next question comes from Ross Gilardi with Bank of America Merrill Lynch. Your line is open.

[Ross Gilardi:]

Tom I mean I realize you are not guiding for 2016 yet but wondering if you can just comment more broadly on just on what you think Cummins' ability to grow earnings over just more of the medium-term if indeed in North American heavy duty truck market is peaking and we remain in kind of this lousy emerging market environment?

[Tom Linebarger:]

Yes. Obviously that is something we've been thinking a fair bit about what given what we're seeing as far as opportunities for near-term improvement. Again like we've seen this year there is we are in a lot of markets and a lot of places around the world so inevitably something is doing little bit better which helps us, but as you said generically there is a lot of weak markets and there is not an obvious turnaround in very many of them, India as obviously is the notable exception and the U.S. markets isn't too bad generally. But in that environment our expectation is that we will continue to launch products and enhance our products through telematics and other value added that helps us gain share and sort have a different trajectory than the market on its own and we can't do that in every place and every market around the world but our general view is we're looking for opportunities like we've had in China this year, we think we'll be able to do some of that in India as broad stage 4 comes in and we will continue to look for opportunities to kind of different curve than the markets cutting. The second thing which you've heard from last many times is that we'll be figuring out ways to earn higher margins on the same sales, so driving cost out of our business through material costs has been a huge driver for us for improvement this year, supply chain improvements will complete our programs this year that we set out 2011 Analyst Day to try to drive 1% gross margins and supply chain I think we'll be able to report in our November Analyst Day that we'll be able to do that, so again will be continuing to drive costs out of our business everywhere we can while still delivering better value and better technology in our product that's a kind of our stick now and again that doesn’t add up to whole bunch of revenue growth if markets don’t improve but again we'll get -- we think we continue to drive some earnings growth. So again that's a pretty bad scenario for the market but we need to be prepared for that. We don’t know if that will be the case but we need to be prepared for this.

[Ross Gilardi:]

And then maybe just my follow on just on similar question just on components but specifically I guess you're implying a softer second half but you did see acceleration of the top line margins continue to improve off a pretty high base. Can that business continue to grow on a multiyear basis and could you comment on how would China reties in the components and in the contribution from China?

[Tom Linebarger:]

Our view is the components businesses benefitted from trends related to emission standard and fuel efficiency adding to engine technology overlap decades. That -- those when we said about to launch the components business and launch our emission standards business and hence our filtration business, this was the trend we were banking on, I am sure enough that’s what plan out. So as you asked about China, lot of our growth in the components business is in the last couple of quarters and I believe we've got some good growth in China, we've got great growth in North America. Truck market has been strong. We have a lot of emissions and other components content on our engines here even in Brazil which has been really rough market, if it weren't for Euro 5 coming in there and then asking us out to apply emissions equipment it would be much worse for us. So the components business has been one of the key areas for us to buck this trend where we can have a different trend than just the general market does. And so our ability to keep growing in there will depend on our ability to capitalize on spends related to emission fuel economy and other technology trends in our end markets, truck markets and off-highway markets. And so we’re looking to go in that market both on our exiting platforms and our new platforms. As you know a couple of years ago we added, we've acquired a doser business which is a key part of the emissions equipment and that has a pretty high growth rate. And so we'll be continuing to evaluate other trends and other ways to add platforms in our components business.

[Operator:]

Our next question comes from Joel Tiss with BMO. Your line is open.

[Joel Tiss:]

Just almost everything I was going to ask has been asked, but just can we drill down a little bit into the distribution business and just over the next couple of years whatever timeframe you want to give us, what's left to do on restructuring and what kind of margins do you think this business should normalize at after you've been able to run it for a couple of years?

[Tom Linebarger:]

Maybe I can comment a little bit on this strategy side and then Rich and Pat cab add a little bit on some of the underlying financial trends and things like that. At the strategy end as we talked about in our 2013 Analyst Day, we've got a couple of things to do in the distribution business to start with North America. We've, now by the end of this year, we have made the vast majority of the acquisitions. There will be two small businesses left that we'll acquire over the next couple of the years. And that means that we will have by the end of this year and to be fair maybe middle of next year we will have done the vast majority of integration. We've got integration left to do on HR systems and things like that which take a little bit longer time and that's why I think it will take middle by next to do all those things. But we'll then have back office integrate, we'll have all the businesses in and that will be great. I mean that's pretty good for us to do. We haven't lost key people, we haven't lost key customers and instead what we've seen is a lot of efficiencies already and very excited and loyal workforce which doesn't happen that often. So we feel pretty great about that from an acquisition point of view. Also we've had great accrual of earnings against relative to the costs of acquiring. The next step though, which is really the, even larger opportunity for the company is now to look at this geographically based distribution system and say, how can we serve our customers more effectively. So we have a bunch of end customers that are still kind of geographically based, you can think of truck fleets that are running across the U.S. and things like that. They're doing things a lot of stuffs. They need a lot of places that they want to be serviced. We also have some ones that are pretty focused in their geographies, things like mines and marine customers, while we don't really need to have locations in every single state that service that. We also have parts, depots and warehouses in nearly every single branch, so a lot of different opportunities for us and filled efficiencies in our distribution system which we think can drive up average margin. So just on a strategic level that's the opportunity and that we still have ahead of us and I think we'll continue to improve margin. Rich or Pat, I don't if you want to add anything to that.

[Rich Freeland:]

Not a lot to add on that. I think again what we've consciously put the focus on making the acquisitions and generally leaving distributors as they were, so not chasing a lot of synergies in step one. And as Tom said, we're generally through that and we do things the synergies are significant and Tom outlined several of them and you can expect redundant ADCs, call centers, our whole purchasing which as you've seen we're pretty good at as a company. We will be able to centralize the purchasing and take advantage of that, so we've yet to quantify that. The numbers will be significant kind of our next step and we've consciously delayed from that other than the back office. I think the further -- so we'll complete most of that, next year we have one more to do North America and then I'd say that we have some more to do strategically outside the U.S. from a material dollar standpoint not so significant more getting at what Tom talked about taking care of customers and serving customers better across geographies.

[Pat Ward:]

And the only think I'd add onto what Tom and Rich have added there. The organic performance from a same-store sales perspective has been really good. I think we're up 60 basis points compared to second quarter last year, so really pleased with that. Unfortunately the whole currency headwind is masking all that, and we've talked about 6% revenue headwind in the second quarter. I think for the full year is probably close to $250 million of our currency headwind on top line and not far away from the $100 million on the bottom line. So, if you set that currency segments, doing really well from an organic same-store performance. And Tom, if you could -- some of the acquisition numbers that are ahead of what we thought it would be, when we launch this two years ago, so the segment has to perform very well.

[Operator:]

Our next question comes from David Raso with Evercore ISI. Your line is open.

[David Raso:]

Question for Tom and Pat, I mean when I think about the stock, is less than 13 times this year's earnings, is less than eight times this year's EBITDA. You hear the questions around can you grow earnings next year. I mean, you have this analyst meeting every two years. Four years ago at the meeting, you had EM strong, two years ago you lost some but you had North America strong. This meeting is a little more of a debate of what do we really have the next couple of years and we can have market outgrowth, but people are concerned about the growth beyond this year, you see in a multiple. This is going to the ninth year out of 10 that you're net cash. So, you discussed this before but given you don't have one of the two major blocks, you had the last two meetings. What is keeping you from cashing what I would refer to as a rainy day track, I mean your net cash, you can write a cheque for $3 billion, buyback 13% of the company and still have net debt EBITDA out one-time, so I'm just trying to understand the philosophy of how you're managing the balance sheet, especially given some of the growth drivers that we've had in the past, maybe aren't quite as dynamic looking out going to this analyst meeting?

[Tom Linebarger:]

Let me just say two things in that David. First is, what you are asking will be the primary topic at the Investor's Conference. I mean I am conscious about not jumping ahead from just FD point of view and all that kind of saying -- and I feel strongly that we have to address the point that you're talking about. It's not lost on us at all -- that we were expecting organically this is not really happening in last several years given the market outlook. We've had some very good wins as we talked about in China and as you called it outgrowth where we outperformed the market and we think there's more but given we'll kind of run up -- down escalate from a market growth point of view. Our growth rates are not double-digit as we had hoped and therefore we don’t need the same amount of capital that's funded and we need to figure out a way to drive more shareholder value than we're doing. We agree with that and so the question is what's the right formula to drive even higher growth for -- or higher returns, so that's exactly what we'll be addressing and we'll be addressing it full and to our best ability because we agree with that. Right now though, I think we kind as Pat said we're on the same strategy until we change the strategy and so we're appearing on it as we are and again trying to make sure that our businesses is the best performing business in our industry and that we manage our cash well conservatively, effectively et cetera, but there is no question that the things on your mind are on our mind, in a big way.

[David Raso:]

And Tom, with the analyst meeting pushed back it's probably even more helpful. You can at least just give us, just some philosophical parameters on how you think of running a business like this when it comes to financial leverage? Because we could say well, we'll address in November, but your stocks on the trade for the next three or four months, thinking about this. So, if you can just give us some idea just philosophically would one-time leverage be something that you're uncomfortable with, I mean people are going to run their numbers, no matter what you say about waiting for November. So can you just help us a little bit on how you think about of these, nine out of 10 years being net cash, definitely has at least folks like me wondering. How do you think about the leverage that's appropriate for this business model?

[Tom Linebarger:]

As you said, there's stock where we are trading a number of months, between now and then, and frankly it's been trading on this issue for some time and so we are -- I am conscious to that and it concerns me. Having said that, I think talking philosophically about it is the same as talking about it. So, that seems like it's not a smart thing to do. We've talked about leverage before though David, and we have said that we are comfortable with much higher leverage ratio than we have now. And that we don't need to be A or A+, we are okay being investment grade through the cycle and carrying leverage appropriate for that. So, that is in our thinking and will be in our thinking when we talk about it. I'm sorry that I can't be more -- disclose it at this point, just feel like given that only enough, limited number of our investors are on this call and it's not what the call was about that I should wait until the Investor Conference.

[Operator:]

Our final question comes from David Leiker with Baird. Your line is open.

[David Leiker:]

I just wanted to circle back on China a little bit and talk about what your pipeline looks there and in terms of launching new engines, new products, new vehicles, new customers. Can you give us a little bit of perspective about where you are in that launch sequence and what we might be able to expect?

[Rich Freeland:]

From the new -- David from a new engine standpoint, I'd say we're just starting -- we're in the infancy of the new products, so kind of clean sheet of paper on 2A, 3A, the 10 and 12 leader, a new product that we've introduced in the real order market which is down to 9.3 liter and so I think that the next big thing is the emissions are going to continue to change and so Tom mentioned and as far as -- as early as 2016 and the east continue to grow so really investing in our components technology to be able to meet emissions and I think what we found is there is a learning curve on this starting out ahead we thought North America but picking the right technology so these are only going to get tougher so I think a lot that we are going to be doing is doubling down on the investments we've made in those areas as the emissions continue to improve. And it's a big opportunity really a big opportunity you had asked earlier on components also but as the emissions continue to grow and change you had seen it already but were not done with that so that's playing out in China. And as you move from Euro 4 to Euro 6 I mean you might think a lot of it five points is same as not that bigger change but that's exactly what happen between in U.S. between 2002 and 2010 and of course the engine has changed dramatically over that time none of those were platform changes same block, same head, just the lot of system changes and as big winners and losers across those years in the U.S. and the same transition is now going to happen in China. They are now they are going to finalize the Euro 60 pretty soon and it's not going to be 2025 it's going to be around 2020 maybe earlier depending on kind of how they get around I mean there is some people talks around 2018 that's really fast and that's a big change in technology. So I mean the drive from where we are to Euro 6 will be a major-major technical development for China for Cummins of course and for a lot of others and as Rich said that as we are shaking out for a lot of people and that should help us. So that I guess the only our thing I had mentioned about China as we are also brining new large engine technologies into the market. We have a very -- we don't talk about them much but we have a very good market share and large engines there 19 liter and above and we'll be brining in some updated technologies and through our joint-venture there too which again will be represented new launches to the market so there is pretty big pipeline there and I think there will be a still quite of bit of change ahead and which should position Cummins further ahead I guess.

[Tom Linebarger:]

Thank you very much everybody I will be available for calls later. Thank you.

[Operator:]

Thank you. Ladies and gentlemen, that does conclude today's conference. You may all disconnect and everyone have a great day.