CMI
#Thank you, <UNK>
I'll start with a summary of our second-quarter results and finish with a discussion of our outlook for 2017. Pat will then take you through more details of both our second-quarter financial performance and our forecast for the year
Revenues for the second quarter of 2017 were $5.1 billion, an increase of 12% compared to the second quarter of 2016, due to stronger demand for trucks and construction equipment in North America and China and improving orders from customers in mining and oil and gas markets
EBIT was $620 million or 12.2% compared to $591 million or 13.1% a year ago
EBIT decreased as a percentage of sales and was below our own expectations primarily due to higher warranty costs
Variable compensation costs also increased both year-over-year and versus the first quarter as a result of our improved outlook for full-year earnings
Warranty costs were 3.7% of sales in the second quarter, up from 2.2% a year ago
Two unrelated issues caused most of the increase
In our Power Systems segment, engine testing at our manufacturing plant identified a component quality issue that may impact engine performance
Although no performance issues have yet occurred in the field, we are taking actions to protect our customers and we record a $31 million charge to reflect the estimated costs of the campaign
Secondly, we experienced higher warranty claims associated with late light components in on-highway applications in North America that caused us to increase our warranty reserve by $36 million for products delivered in 2012 and 2013. This additional charge primarily impacted the Components segment
We've made significant improvements to the quality of our products and especially in our new product launches
Cummins' products are performing at record levels of reliability and our market share reflects that strong performance
On the other hand, the complexity of our products has increased significantly to meet tough emissions regulations
Customer expectations have also increased and the environments where our products are used are more demanding than ever
Thus, we are redoubling our efforts on improving product quality and developing new techniques using telematics and Big Data to complement our existing quality tools
We expect to resolve the specific quality issues we experienced this quarter quickly and we expect warranty costs to decline as a percent of sales by 50 basis points in the second half of the year
Engine business sales increased by 15% in the second quarter compared to a year ago due to higher industry truck production and growth in our market share
We also experienced strong growth in demand from construction OEMs in China and North America
EBIT for the quarter was 12% compared to 10.3% for the same period in 2016. Benefits from higher volumes and stronger joint venture earnings in China and the absence of a loss contingency charge recorded a year ago more than offset higher variable costs and warranty costs
Sales for the Distribution segment increased by 12% year-over-year, resulting from 6% organic growth, net of currency, and an additional 6% increase resulting from the acquisition of a last remaining distributor joint venture in North America in the fourth quarter of last year
Stronger parts and service revenues in oil and gas and mining markets in North America and higher parts sales in China drove the improvement in organic revenues
Second-quarter EBIT was 5.6%, flat compared to the second quarter of 2016, as the benefit of higher sales were offset by higher variable compensation costs
Second-quarter revenues for the Components segment increased by 14%
International revenues increased by 25% due to strong growth in truck demand in China and the sale of new products in India to meet the broad Stage IV emissions regulations introduced in April this year
EBIT for the second quarter was 13.1% compared to 14.9% in the same quarter a year ago
The benefit of the higher volumes and material cost-reduction programs were more than offset by the increase in warranty costs that I discussed earlier
Power Systems sales increased by 10% in the second quarter, primarily driven by an increase in engine and parts sales to mining and oil and gas customers
EBIT in the second quarter was 6% compared to 9.8% a year ago
The primary driver of the lower EBIT margin was the accrual for the estimated cost of the quality campaign
The business also experienced an increase in commodity costs and higher variable compensation costs associated with the company's improved outlook for the full year
Excluding the campaign and some additional one-time costs, the business is operating at approximately 10% EBIT margin
With improving market conditions in some key markets and the benefits of our UK manufacturing restructuring still to come in 2018, we are confident that we will see a significant step-up in profitability in the coming quarters
Now, I will comment on the performance in some of our key markets for the second quarter of 2017, starting with North America and then I will comment on some of our largest international markets
Our revenues in North America improved 13% in the second quarter, primarily due to higher levels of industry production and increased market share in on-highway markets
We also experienced growth in sales of engines and parts to customers in construction, oil and gas and mining markets
Industry production of North American heavy-duty trucks increased 4% in the second quarter of 2017, while sales of our heavy-duty engines increased 16% due to higher market share at 32%, up from 29% a year ago
Production of medium-duty trucks increased 15% in the second quarter, while our engine shipments increased 27% as our market share improved 600 basis points reaching nearly 80% in the quarter
Total shipments to our North American pickup truck customers increased 6% compared to a year ago due to strong demand from FCA
Engine sales for construction equipment in North America increased 31% in the second quarter, compared to a weak quarter a year ago with some OEMs optimistic about the prospects for increased infrastructure investment
Sales of engine shipments to high-horsepower markets in North America increased 147% compared to a very weak quarter a year ago, driven by higher sales to oil and gas customers
Revenues for power generation showed little change from weak levels a year ago with shipments of mobile generators for recreational vehicles helping to offset lower military sales
Our international revenues increased by 11% in the second quarter of 2017 compared to a year ago
Second-quarter revenues in China, including joint ventures, were $1.2 billion, an increase of 28% due to continued strength in truck and construction markets
Industry demand for medium and heavy-duty trucks in China increased by 46% compared to a year ago and our market share for the quarter was 14%, slightly below the level a year ago, reflecting a mix shift in industry sales to dump trucks in which we have a lower share of the market today
Penetration of our products with our key OEM customers remains very strong
Shipments of our light-duty engines in China increased by 35%, above the overall increase in the market of 10%
Our market share rose by 150 basis points from a year ago to more than 8% as we continued to displace local competitors from Foton's vehicle lineup
Chinese industry demand for excavators in the second quarter increased 102% from a year ago, reflecting a rebound in construction activity
Our shipment of engines to construction customers across all equipment categories increased 125%
Revenues for our Power Systems business in China increased 4% due to higher demand from mining and rail customers
Second-quarter revenues in India, including joint ventures, were $431 million, a 5% increase from the second quarter a year ago
Revenues for power generation equipment increased 6% and sales of construction engines increased 25%, reflecting growing investment in infrastructure
Industry production of trucks in India decreased 25% year-over-year, following the introduction of the Bharat Stage IV emissions regs in April
In Brazil, our revenues increased by 16%, primarily due to an increase in truck production in the quarter and the appreciation of the Brazilian real
Now, let me provide our overall outlook for 2017 and then comment on individual regions and end-markets
We are now forecasting total company revenues for 2017 to be up 9% to 11%, higher than our previous projection of up 4% to 7%, due to stronger demand in on-highway and construction markets in both North America and China and improving orders from global mining customers
We've raised our forecast for industry production of heavy-duty trucks in North America to 205,000 units, up 2% compared to 2016 and above our prior forecast of 195,000 units
We expect our market share to be above the midpoint of our prior projection of 29% to 32%
In the medium-duty truck market, we've raised our outlook for the market size to 115,000 units, an increase of 6% compared to 2016 and 2% higher than our previous forecast
We now expect our market share to be at the top-end of our prior forecast of 73% to 75%
Consumer demand for pickup trucks in North America remains strong with our full-year shipments of engines expected to increase 5%, above our previous projection of 1% growth
In China, we expect full-year domestic revenues, including joint ventures, to grow 26% compared to our previous projection of a 3% increase
Revenues for the second half of the year are expected to decline by approximately 20% compared to the first half, reflecting an easing in demand for trucks and typical seasonality in construction markets
Industry sales of medium and heavy-duty trucks are expected to reach 1.25 million units, a 28% increase from last year and higher than our previous forecast of 1 million units, driven in part by demand resulting from the introduction of regulations last year, aiming at curbing overloading
We expect truck market to grow 3% in 2017, unchanged from our previous guidance
Our market share in the medium and heavy-duty truck market in China is expected to be 15%, flat with 2016. And in light-duty, we expect our share to exceed 8%, up from 7% in 2016. We currently project revenue from all off-highway markets in China to grow by 15% to 20%, up from our previous guidance of 10% to 15%
In India, we expect total revenues, including joint ventures, to be flat to up 3% year-over-year with a 5% increase in off-highway demand and growth from new product sales in our Components business, partially offset by a 12% decline in truck production
In Brazil, full-year truck production is projected to increase 10% in 2017 compared to a very weak 2016, when the industry experienced the lowest level of truck production in more than a decade
We expect our global high-horsepower engine shipments to increase more than 30%, up from our prior forecast of 10% to 15% growth, as demand from mining customers continues to strengthen
Engine demand from oil and gas customers in North America has exceeded our previous expectations for this year, although visibility into 2018 remains limited
In summary, we've raised our full-year outlook for sales to increase 9% to 11%
We've maintained our forecast for EBIT to be in the range of 11.75% to 12.5%
Comparing second half to first half performance, we expect lower warranty costs in the second half of the year balanced with weaker demand in China, targeted investments in critical new technologies and some risk from higher commodity costs
With improving demand in a number of important markets, our leading market share and strong operating performance, we remain very confident in the future earnings power of our business
During the quarter, we returned $241 million in cash to shareholders in the form of dividends and share repurchases and also announced a 5.4% increase in our quarterly cash dividend, consistent with our plans to return 50% of operating cash flow to shareholders in 2017. Finally, we announced earlier today that we have formally closed our deal with Eaton to form the Eaton Cummins Automated Transmission's joint venture
We are excited about working with a capable partner to offer customers leading technology in both automated transmissions and now fully-integrated powertrains
Rising demand for automated transmissions around the world should drive growth for the joint venture and opportunities for our customers and partners
Now, let me turn it over to Pat
Yeah, that's right
I mean the variable compensation cost thing does normalize
What we have is when we are performing worse than planned because markets negatively surprise us, we have lower variable compensation costs, which bolster our financials
And when things bounce up faster than we expected, the reverse occurs
But in the end, they work themselves out
So, I just agree with Pat's point of view, we feel like the earnings power of the company remains the same and we still think 20% incremental margins is what we're capable of and what we're demonstrating when we pull out these kind of one-time or unusual period costs
So, we feel just as strong as we ever did about that
That's great
I'll take that one, <UNK>, and let me start with the second question first
As I mentioned in my remarks, we've made a lot of improvement in quality, especially related to new product launches and that has dramatically improved the liability of products over the last several years and our products are performing well in the market as a result of that
But also, as I mentioned, the complexity of the products continues to increase
There are many new markets like China and other markets where the use of the products is really demanding and used in various ways
And so, what we're trying to do is utilize the benefits of data we're getting from our telematics system to begin to use new methods to improve quality of products, both at launch, but also in longer mileage situations
Because, again, expectations of performance of these products over sustained periods of time have gone up by customers
I think that's normal for every industry
So, we've got to have the ability to maintain quality over a long period of time and, again, over multiple owners and multiple applications
So, that's why we're using a lot of this new data with new techniques to mine that data and make – correlate that data with how products perform in the field
So, again, this is not new
We've been working on that for some time, but we now have some pretty useful tools we think we can apply to our quality efforts and we need to do that
That's what I was mentioning in my remarks
With regard to supplier recovery, it is an area of focus for us
And in the specific quality issues we have in the second quarter, we do think there're some potential for supplier recovery, but right now, what we're focused on is improving the situation for customers, making sure there's no negative impact on customers, getting the products right
Again, we just feel like we're in a really strong position with our products in terms of how they're performing
And, of course, that's shown up in market share
So, we want to make sure we get that right, get the issues behind us and move on and then we'll deal with the supplier recovery issues
Mining seems to be demonstrating a more sustainable improvement path
We have more visibility to it also based on the number of OEMs we serve and our participation in the market, we have more visibility
Again, right now, we don't have long visibility in mining
We don't know where it reaches relative to previous peaks or anything, but it looks like it's on a relatively sustained recovery
And, of course, we're experiencing some of the reasons for that in our commodity costs
We're seeing higher commodity costs coming in as costs which again says that that's more favorable conditions for mining
So, we're seeing some benefit on revenue and some hit on costs
On the oil and gas side, I'd say we don't see that
First of all, we have less visibility, but secondly in fact, we're seeing and hearing more conservatism in that market
We saw a lot of rebuilds, a lot of redeployment of products, but we didn't see so much new equipment being built and going out in the markets
And what we're hearing is that people wanted to get things redeployed, but there's not a lot of growth in equipment yet
It doesn't mean it won't come, but right now, I think the market's kind of leveling off at best is kind of what we're hearing
Again, there's other people that may be closer and be able to give you more data, but that's what we're hearing
And then, just (34:35) mining is about five to six times the size of our oil and gas business, even on current depressed levels
Yeah
I've actually heard that question a fair number of times too
And we will, by the way, be talking at our Analyst Day a lot more about our electrification efforts, including kind of what parts we intend to participate in
But clearly, we don't know yet
I mean there's essentially none sold and those that are sold are ones and twos and they're prototypes
So, we don't really know what the profitability's going to be like
But let me just say two or three words about how we're thinking about it
We believe that the segments in the market that we serve, some will find electrified powertrains to be advantageous in the next 5 or 10 years, some will not
And so, we don't think that all the markets are going to move
We think they're going to move in phases and some will move relatively soon to at least try some
And bus is what you mentioned, it's one of the areas that we'll see some activity in buses relatively soon and that we intend to provide a fully electrified powertrain as well as hybrid or range-extended powertrains, we also intend to electrify some of the auxiliaries on our diesel engines and natural gas engines
So, we will be active in the market and we will approach the problem in the same way that we've approached other power solutions problems
We'll look from the customers' lens, try to figure out what their application is and figure out what the best technology to serve them is
In order to ensure profitability in those efforts, we'll make sure that we have a leading position, which means our technology provides customers with monetary advantage
So, they get fuel economy benefits, they get cost reductions, they get other things of value to them, because that's how we maintain profitability
I don't think one technology is necessarily more or less profitable than the other
What creates profitability is advantage for customers and advantage versus competitors and that's what we're going to see
Hi, <UNK>
It's worth saying that we are not recalibrating our target at all, <UNK>
We are adding new tools to get to our target, but we still believe that we can reduce warranty costs significantly from where we are and do it in a way that improves customer performance and customer experience
So, that's what we're targeting
So, we haven't changed and we still see the same kind of targets in reach that we did before, because we made improvement on our prior efforts
So, we kind of took away a lot of challenges and now we're facing new challenges
I think that's just part of being in a competitive industry
Thanks, <UNK>
So, let me start with the last one, because I think that's one we've talked about a couple times
The answer is that there has been some conversation with WABCO
Of course, we've paid close attention to that
We have continued with the same strategy on M&A and – sorry, it may sound a little boring, but same strategy we laid out at the investor conference, which is that we are going to be disciplined about ways to add value through both making sure that it drives profitable growth for the company and does so in a way where we can demonstrate returns over time
And that, of course, means that not only do we have to find – have a strategy that makes one plus one equals three
It means, if we acquire something, it has to add up to something more than just the combination of the two things
And, secondly, we have to be able to do it at a cost to generate returns for our shareholders
And so, that's – as you get, that's a challenge
Having said that, we've been working on it for some time
We have some very good prospects
We are actively working on those
We feel confident that we will be able to make positive moves in the M&A and joint venture front, which will add value to the company
The size of that will depend on which of our projects succeed, so – how big each one is
Frankly, we are not trying to make sure that we have a big one
We're trying to make sure that the combination of our organic growth, our joint ventures and partnerships and our acquisitions add up to profitable growth and returns for our shareholders
And so, whether that's in several acquisitions and joint ventures or in one or two is really not our main focus
So, it is a challenging environment
As it turns out, it's no easier to grow in a profitable high-return way through acquisition than it is organically
They both take a lot of effort and serious-minded work and that's the way we're approaching it, but let me now switch over
Pat, I think you wanted to say a couple words about the incrementals
And I think, <UNK>, you asked too, have we changed our outlook on investment in critical technologies
There's no question that we are speeding up some of our investments in both electrification and digital accelerators, the sort of telematics effort
We talked about those earlier
We are definitely speeding up efforts
And the reason we're doing that is we're noting that in some of the shorter-distance markets, the urban markets, there is significant interest from our customers in electrified powertrains and, again, not for gigantic volumes this year, obviously, but it's going to take us some time to get a product range out and ready and we've heard from them and people are interested
So, we are trying to make sure that our efforts are aggressive enough to make sure we meet customer demand there
So, that's what's happening
It's not a huge amount as Pat said, but it is an increase from what we were anticipating
With regard to the large – go ahead, you want to talk about large engine markets, just I'll close that and then you can follow up on that
So, on large engines, we are feeling pretty confident about the mining growth, as the earlier question said, oil and gas, we don't see a lot of – we're not expecting a lot of growth in the second half, but we are seeing continued strength in mining, which gives us confidence that we'll continue to see some sales growth in the large engine markets and incremental margins there have been good as we mentioned
I mean we had some issues in the second quarter that we think were one-off related, but with regard to engine growth and incremental margins, we're feeling good about that
<UNK> - Credit Suisse Securities (USA) LLC Okay
But I think it's fair to say that from a power gen point of view, we would not yet say we're at the bottom and stabilizing
It could be, but we're really looking for some quarter-to-quarter stabilization infrastructure building rates and things like that around the world before we would say okay, now I think we expect things to consistently get better
A couple of times we thought we were at the bottom and stabilizing and then things got a little bit worse
So, I guess, we'd like to see a few more quarters in the power gen space to say that
Good morning, <UNK>
Well, again, we'll spend a fair bit of our time on this in the Analyst Day in Indianapolis
I hope you can join us for that
So, given the time, I'll make my remarks brief
Let me just say that I think both autonomous vehicles if we mean not fully autonomous, but using autonomous technologies are certainly going to be a reality in the trucking market
So, just as we've seen in car markets, we'll see safety systems come in very quickly and already we're starting to see those and those will increase and offer more, more opportunities for customers in places like yards and ports and places where they want to control how vehicles move around
Those could provide significant value to customers
Over what period of time those will become economically viable and how many customers will buy them, that's sort of the charge ahead
But you know just by the investments that people are making in the truck market that, that technology is moving and people are definitely going to find ways to implement that technology and to try to figure out how to add value for customers
I think the same is true on electrified powertrains
What an electrified power train looks like in different applications, as I mentioned earlier, remains to be seen, but it'll be driven by how the customer can best operate their applications
So, in places where things go out and back in relatively limited miles, carry loads that are not so heavy, then things like fully electrified or range-extended electrified make sense and especially in urban environments where they're trying to reduce noise, pollution and fueling
So, those are all things that they care about
Electrified powertrains can provide a solution that meets multiple objectives
And I believe that cities will be pushing for solutions like that, which will mean they'll show up in those areas
And I think it'll happen
In five years or so, we'll start to see some of those buses and pickup and delivery vehicles with electrified powertrains
The question is how many and how many cities really can afford to replace that many of the fleet, that will depend a lot – on a lot of different factors
But – so, I think it's coming, both of these technologies are coming and it will be while we're still sitting here working on it
The question is, in what volume and how many applications and a lot of that is playing out right now
As you heard from me, Cummins intends to be in the middle of those technologies, especially electrified powertrains, because we think we understand customer applications
It's a great question, <UNK>
Anyhow, there's many, but let me just put the one out there, which is that infrastructure takes a long time to build
So, the more that your technology depends on common infrastructure or things like it, the less likely it is to occur quickly
The more that local infrastructure or a customer base, customer purchases can allow you to use the technology, the more likely it is to succeed at least in the shorter timeframe
Good morning, Andy
Thanks, Andy
Hi, Steve
I mean, that's the idea
We set a plan out, which is based on what we think we can achieve and guidance we give, we set a plan out and if we end up with that plan and that that pays out at a 1.0 (55:53) and that's what we put in plans so everything is as expected
If it's stronger, then we pay out more, and if it's weaker, we pay out less
So, to your point, we reset each year and assuming we hit to the plan in 2018, it would be 1.0 (56:06)
Again, the surprise here is that sales growth happened faster than we thought, just as it surprised last year when things were lower than we thought
No, I always want to be paying out what we planned
Yeah, I mean, we don't know that yet, but that's the way it's leaning
I mean, again what we're trying to do is make sure that we can deliver to customers on two broad new technology areas
One is to deliver much more value in telematics and other services that go along with engines and the vehicles that they operate and secondly, to be able to make sure that we can be in the market in 2019 and across at least several applications in 2020 with electrified powertrains and range-extended powertrains
So, we will need to increase investments, especially in the electrified powertrains space over the course of the year
How much that is year-over-year, we'll see, but that is a reasonable expectation those costs will ramp up
And, again, we're looking at how we structure that business to make sure that it looks like a long-term growth opportunity for Cummins' shareholders
Here is my view, it's not clear how big a deal it would be and I think we've talked a little bit about some of the reasons and again we'll talk more in November about that, but it clearly depends on how many of the customers these technologies actually give them a better deal
And, right now, it's pretty clear that in some buses, it could
There's a whole bunch of other markets where it's not clear yet, especially because diesel continues to improve, electrified trucks with diesel engines continue to improve, light hybrids continue to improve
So, there's a lot of technologies competing for the same space
And then – and I think you can expect from us that we will be all-in in the sense that we will lead in technology
We will not be all-in in the sense that we will not be building infrastructure
We will not be betting on one technology
We'll be betting to serve customers better than others with the range of technologies where the best one is what they need
Same return guidelines we use for everything, though
