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Cummins Inc. (NYSE:CMI)

Q1 2010 Earnings Conference Call

April 27, 2010 10:00 AM ET

Executives

Dean Cantrell – Director, IR

Tom Linebarger – President and COO

Pat Ward – VP and CFO

Tony Satterthwaite - President, Cummins Power Generation

Analysts

Jamie Cook – Credit Suisse

Tim Dinan (ph) – Wolfram (ph)

Jerry Revich – Goldman Sachs

Henry Kirn – UBS

Ann Duignan – JPMorgan

Andrew Casey – Wachovia Securities

Eli Lustgarten – Longbow

Meredith Taylor – Barclays Capital

Operator

Good day ladies and gentlemen and welcome to the first quarter 2010 Cummins Incorporated earnings conference call. My names is Eric, I’ll be your audio coordinator for today. At this time our participants are in a listen-only mode and we’ll facilitate a question-and-answer session towards the end of the presentation. (Operator Instructions)

I would now like to turn your presentation to Dean Cantrell, Director of Investor Relations, please proceed. 

Dean Cantrell

Welcome everyone to our teleconference today to discuss Cummins results for the first quarter of 2010. Participating with me today are Chairman and Chief Executive Officer Tim Solso, our President and Chief Operating Officer Tom Linebarger and our Chief Financial Officer Pat Ward. We will all be available for your questions at the end of the teleconference.

This teleconference will include certain forward-looking information. Any forward-looking statement involves risk and uncertainty. The company’s future results may be affected by changes in general economic conditions and by the actions of customers and competitors. Actual outcomes may differ materially from what is expressed in any forward-looking statement. A more complete disclosure about forward-looking statements begins on page three of our 2009 Form 10-K and it applies to this teleconference.

During the course of this call we will be discussing certain non-GAAP financial measures and we refer you to our disclosures on our website for the reconciliation of those measures to GAAP financial measures. Our press release with the copy of the financial statements and a copy of today’s webcast presentation is available on our Web site at www.cummins.com under the heading of investors and media. 

With those formalities out of the way, we’ll begin our remarks with our President and Chief Operating Officer, Tom Linebarger. 

Tom Linebarger

Thank you, Dean. Good morning. I’ll start today by sharing some thoughts on our performance in the first quarter. Pat will then provide greater detail on the quarter and our updated 2010 outlook, and Tim will build on the comments we made at last month’s analyst day regarding our long-term prospects.

Clearly it was a very strong quarter despite the weakness in key U.S. and European markets. Sales at $2.5 billion in the first quarter were 2% higher than the same period a year ago with gains in our distribution and components businesses offsetting declines in the engine and power generation segments. Despite the modest revenue growth from last year, our earnings before interest in taxes improved significantly to $266 million or 10.7% of sales compared to $94 million or just under 4% of sales.

In terms of the first quarter volumes, the North American truck market turned out as we had expected. As you know we experienced strong demand in the final month of 2009 in advance of the U.S. emissions change reducing demand in the first half of this year. Our shipments fell by approximately 90% from fourth quarter levels in the heavy and medium duty trucks, bus and RV markets and we’re down about 80% in the same market compared to the first quarter of 2009.

On the other hand, our business improved significantly in several markets outside the U.S. in the quarter particularly in China, India and Brazil where their economies are recovering quickly from the recession. Our strong global position has enabled us to quickly capture the growth now occurring in these regions.

Cummins’ first quarter results represent a continuation of our strong performance throughout the downturn. We have generated consecutively higher margins in relatively weak revenue environments by lowering our cost structure and improving the productivity of our manufacturing operations. As mentioned in previous quarters we have worked hard to align our manufacturing capacity with the real demand for our products. Our employees have done an outstanding job executing the company’s strategies for dealing with the volatility in our markets during the recession. We also took advantage of the downturn in the first half of last year to better synchronize the flow of products through our plants making heavy use of six sigma.

The improved efficiency in our manufacturing operations is the most evidence in the performance of our engine and components segment in the first quarter. For example, our high horsepower engine plant in Daventry, England instituted operational improvements last year that have allowed us to manufacture almost the same number of engines in a single shift that took three shifts to complete a year ago. We have also seen productivity gains at our other high horsepower plants around the world, which will be crucial to meeting expected future demand in this market.

Engine production per hour at our mid range engine plants in Columbus and Rocky Mountain, North Carolina improved 13% and 10% respectively from the same period a year ago. Productivity has also improved at our turbo charger manufacturing facilities around the world. For example, the per person equivalent production rate at our turbo charger plant in Huddersfield, England has improved by 67% from the first quarter of last year and 27% in our plant in Dewas, India. And production of exhaust after-treatment devices at our mission solutions plant in Mineral Point, Wisconsin increased 31% in the first quarter compared to the same period last year with only a modest increase in head count. This productivity improvement comes at a time when the plant has transitioned to manufacturing the more complex 2010 products.

These are just a few examples of the tremendous work our people have done in our manufacturing plants to improve productivity and operating leverage. Such improvements have helped us to keep our first quarter EBIT at similar levels to what we deliver in the fourth quarter despite a 27% sales drop.

From a geographic perspective, our strength in China, India and Brazil continues to be an advantage as the economies in those countries were even stronger than we expected in the first quarter. We are seeing an improving demand in the truck, construction, mining, and distributed power generation markets in all three countries. In addition, business has increased with OEM customers in Europe and Korea that export to China, India and the Middle East. Tim will talk in greater detail about the importance of these markets to our future success. 

So let me give a few examples of the current strength in these countries. China’s commercial truck and industrial markets continue their strong recovery. Compared to the first quarter of 2009, our truck engine sales in China grew by more than four times, and we’re up nearly 10% from the strong fourth quarter levels. Sales to the industrial engine markets increased 74% from the first quarter of 2009 and 24% from the fourth quarter.

In India our truck engine sales more than tripled compared to the same period a year ago and increased 26% from the fourth quarter of 2009. Industrial engine sales increased 41% compared to the first quarter of 2009.

We also continued to benefit from the strength in the Brazil truck and construction markets. Our truck engine shipments in the first quarter improved 81% from the first quarter in 2009 and 14% from the fourth quarter of 2009.

As we look ahead to the rest of 2010, our priorities and outlook have not changed. We remain well positioned to take advantage of the continued strong economic growth we are forecasting for China, India and Brazil. We expect revenue in the U.S. this year to be flat to 2009 levels with some improvement coming in the second half of the year. In Europe we do expect modest improvement in demand year over year.

We will continue to focus on cost reduction, productivity improvements, working capital management, and investment in new products and critical technologies. We are positioning the company to take advantage of growth opportunities that we are seeing already in some markets and expect to see in others once the economic recovery takes hold.

Finally we are committed to serving our customers better than anyone else every time. In particular we are working hard to ensure that our 2010 product introductions are successful as possible for our customers. As of mid April we have shifted 3500 2010 compliant engines and the early reviews have been very positive. We logged more than 8 million test miles on the 2010 engines before putting them into production, and the feedback from that work is being confirmed by our customers in the field today.

We are seeing the type of fuel economy improvements that we expected; a 5% improvement from our 2007 heavy duty engine and a 3% gain our medium duty engines. Many customers are seeing even larger fuel economy gains and some have even reported double-digit percentage improvements.

I believe we are well on our way toward delivering on our promise to produce a better performing, more reliable and more fuel efficient engine in 2010. We are devoting significant resources to supporting these products during the launch period to ensure that our customers are able to realize the benefits of these improvements in their businesses. We are very pleased with how the company has weathered the downturn and the first quarter of 2010 is no exception. We still have significant challenges ahead of us in many of our major markets, but I’m confident that we are focused on the right thing and have solid plans in place to build on our performance in the first quarter. I will now turn it over to Pat who will give you some additional details about the first quarter.

Pat Ward

Thank you, Tom and good morning everyone. First quarter revenues of $2.5 billion were relatively flat from the year ago but the geographic mix was significantly different. Revenues in our international markets increased by 28% due to stronger demand in China, India and Brazil which offset a drop of 23% in our North American markets. Compared to the prior quarter total revenues were down 27% with sales in the US down almost 50% mostly due to the transition to the 2010 emission standards in the US.

EBIT margins of 10.7% were significantly better than a year ago and remains strong compared to the prior quarter on much lower revenues. The main reasons for the strong EBIT margin performance were the operational improvements as mentioned by Tom, more material cost compared to the first quarter of last year, pricing increases, stronger joint venture income particularly engine joint ventures in China and India and lower warranty costs.

The effective tax rate for the quarter was 34% which was 3% higher than our projected full year tax rate due to a $7 million discreet items related to the sales tax rate burn as a result of the recent tax changes in federal healthcare laws.

Earnings per share was $0.75 in the quarter.

Now turning to each of our four business segments I will highlight the performance in the first quarter and updated 2010 revenue and profitability for each of them. Starting with the engine segment, revenues of $1.4 billion were 34% lower than the prior quarter. Engine shipments to the truck, bus and RV markets in North America were down 90% as expected due to the effect of EPA on highway emission changes. This (big) volume was slightly offset by demand improvement in most industrial markets particularly in mining and construction. Compared to the prior year, revenues were then 5%. The drop in North America truck and bus markets were offset by stronger truck markets outside of North America by improvement in demand in construction and mining market and by increased shipments (inaudible).

Segment EBIT margin of 9.3% was slightly down from a 9.7% reported in the prior quarter on revenues which were 34% lower. Margins were much better in the first quarter of 2009 when the segment reported a loss of $16 million. The improvement in margins were mainly driven by operational improvements in our manufacturing plants, stronger joint venture income, more material costs, benefits from pricing actions, a favorable aftermarket mix and lower warranty cost.

For the full year we now expect revenues to grow 10%. Heavy duty truck revenue will decline 19% in 2010. We continue to forecast production of (inaudible) class 8 heavy duty trucks to grow 30% this year. Well, as a result of EPA 2010 transition, our global heavy duty truck engine shipments will drop 35%.

Revenues from the medium duty truck and bus markets will be 10% higher this year. Strong demand in Brazil and the recovery of OEM truck production in Europe will more than offset the drop in North America due to the EPA ‘10 transition. Light duty automotive and recreational vehicle revenues are projected to grow 31% due to the ramp pickup truck recovery in North America and strong demand for (school) pickup trucks in Brazil. We are now forecasting industrial revenues to increase 40% this year, less stronger demand from mining and oil and gas markets, driving by rising commodity and oil prices and the recovery in construction markets in emerging economies supported by infrastructure projects and economic growth.

Our engine joint ventures are expected to perform at record levels of production this year. Our Dongfeng-Cummins joint venture in China and our Tata-Cummins joint venture in India were both running at record levels in the first quarter where volumes in our joint venture with Komatsu in Japan supporting global industrial markets are recovering nearly by about 2008 levels after declining 60% in 2009.

We now project full year engine segment EBIT margins in the range of 7.5% to 8.5% of sales. Margins in the second half of the year will face some challenges from the production ramp up of new EPA 2010 engines, which initially will carry a high advantage from higher research and development investment and the reinstatement of (inaudible) increases with the potential slowing of demand in China and India as a result of government efforts to control economic growth and rising commodity costs as we see metal market prices are increasing and do expect some impact on that in the second half of the year.

In the components segment, revenues were down 14% from the prior quarter driven by the EPA ’10 transition in North America on highway markets particularly embarking the turbo charger and fuel system businesses. Compared to the prior year, revenues were up 19% as a result of strong orders from top OEMs in China and India, global after market demand improvement, production recovery from European truck OEMs and favorable currency movements. Even margins of 9% of sales this quarter compares well both for the 10% EBIT margins in the prior quarter given the 14% drop in revenue onto the breakeven performance a year ago. Compared to the first quarter of 2009, margins improved due to stronger volumes and operational improvement arising from the restructuring actions taken last year.

For the full-year, we are now forecasting revenues for component segment to increase 20% as a result of higher price in technology transparent on EPA 2010 products, recovering global aftermarket demand and stronger demand from OEMs in China, India and Europe. Component EBIT margins for the year are now expected to be between 8 and 9% of sales. Revenues for the distribution segment was slightly low sequentially and up 15% from the prior year.

The consolidation of rest from Canada distributor added $54 million in revenue and favorably impacting the profitability of the segment due to a onetime gain of $12 million in the quarter. Excluding the consolidation on product, sales were relatively flat from a year ago. Year-over-year excluding the distributing and consolidation revenues for aftermarket parts and services improved by 17%, well also a revenue of power generation and engines declined by 16%.

The EBIT margin of 15% of sales this quarter includes $12 million onetime gain and that makes exclude the segment with a reported 12.5% margins. For the full-year, we forecast revenues to be up 25% with about half of the growth coming from the recent (inaudible) consolidation. EBIT margins are now projected at between 12 and 15% of sales. And finally revenues for our power generation segment were down 21% from the first quarter of last year and down 14% from the prior quarter, which wasn’t away with our expectations.

Compared to the first quarter of last year, we are seeing much lower demand in Western Europe, the Middle East and North America partially offset by stronger demand in China and India. Sequential EBIT margins for the power gen segment improved from 5.7 to 6.6% of sales this quarter despite lower revenues, with cost reduction initiatives, operational improvements and lower material costs more than offsetting the sales volume decline.

For the year, revenues for the power gen segment are now expected to grow 10% from the recovery in most markets to say of North America and Western Europe. All does particularly for larger gensets were increasingly but by infrastructure projects and economic growth in the emerging economies as well as some benefit from the channel inventory correction in the prior year. Segment EBIT margins are now projected to be in the range of 7.5 to 8.5% of sales for the year. As a result of the improved outlook for all four operating segments, we now expect the company to deliver $12 billion in revenue and EBIT margins of 10% of sales in 2010, compared to our previous guidance of $11 billion in revenue and 7% EBIT margins.

Finally, let me turn to the balance sheet and cash flow. Working capital levels were lower in the first quarter mainly due to strong collections from receivables. This was partly offset by an increase in inventory levels as we began to ramp up to meet stronger demand. Cash balance have remained a strong even after contributing $111 million into the pension fund and our debt-to-capital ratio was 15.8% at the end of the quarter.

For the full-year, we do expect further investment in working capital to support the increasing demand that we now project, we will invest $400 million in capital expenditure, a 30% increase over 2009 levels in order to support capacity expansion and new product introductions. We will continue to focus on returning value to our shareholders through for the stock repurchases and we remained committed to sustainable increases in our dividends and we would have viewed as a work over the next few months.

As Tom said, it has been a very good start to the year particularly given the challenges we face in our North American markets. On the increasing in guidance reflects a confidence that we will continue to see further improvements in the months to come. Now before we take your questions, Tim would like to say a few words.

Tim Solso

Thanks Pat and good morning. I would like to start by reinforcing a couple of things you already have heard from Tom and Pat this morning. Our first quarter performance was good. Our leadership position in the emerging markets particularly in China, India and Brazil enabled us to take advantage of the strong growth in these economies. The first quarter results illustrate a success of our geographic diversification strategy over the past two years. Especially considering a significant slowdown in the North American heavy and medium duty trucks.

Remember what Tom and Pat said, our North American heavy duty truck, medium duty truck and RVs were down 90% in the first quarter compared to the fourth quarter last year. That’s the biggest drop I can remember. As I said, during our last quarterly call our ability to handle the volatility in demand over the past several months is an indicator or a type of performance you can expect from us in the future. The actions we have taken before and during this recession have resulted in excellent performance through the economic cycle and also will service well for what we think will be an extended period of profitable growth over the next several years.

As you may recall, from our recent analyst day presentation, Cummins has identified all long term macro trends working in our favor. Let me quickly recap them because they will have a significant positive impact on the performance of the company over the next few years. The first is price and availability of energy. Over the long term, fuel prices are almost certain to increase which is driving our research and development to dramatically improve fuel economy. As you’ve heard Tom already say, our 2010 engines are delivering 5% better fuel economy than our 2007 engines.

We have ongoing technology projects that will further improve fuel efficiency. Over the long run, we expect this to result in dramatic improvement in the efficiency of our customers products. At the same time, demand for electrical power is expected to increase by as much as 8% a year in developing regions and 4% overall. This will increase the gap between supply and demand offering great opportunities for our power generation business.

The second trend is the implementation of more stringent emission standards around the world. We talked a lot about 2010 emission changes in the United States, but that has really just the start of a broad wave of new and tougher emission regulations around the world over the next few years. Every major economy in the world is going to be adopting tighter emission standards over the next five years for both on-highway and off-highway applications. Thos standards are going to require our OEM customers to adapt new technologies which Cummins is well positioned to provide.

That means more engine sales for Cummins, an increased use of our components on our own engines as well as by our OEM customer who make their own engines. This will also continue to draw our key partners to Cummins who want technical help in meeting these standards. The third trend is the increase in infrastructure spending around the world. An estimated $35 trillion is forecasted to be spent on infrastructure development such as for roads, bridges, power supply and telecommunication facilities over the next 20 years. These are all markets in which Cummins has a leadership position. In fact the increased infrastructure spending in China and India as part of economic stimulus packages implemented last year was a primary reason for our increased sales and profits in the first quarter.

In China, the total construction equipment market grew 55% in the first two months of the year compared to the same period last year. We are also seeing increased demand in key power generation segments supporting transportation and data center investment. The story is similar in India. Road construction has increased across the country, approaching an average of 20 kilometers of new highways being built every day. In addition, the Indian government said it expects $20 billion worth of highway construction contracts to be awarded this year.

The final trend is the globalization of our business, especially as it relates to our strength in the large emerging markets at China, India and Brazil. All of these economies are expected to grow faster than the more developed markets of US and Europe for the foreseeable future. Annual GDP growth in China is expected to average between 8.5 and 9.5% percent over the next five years, between 7 and 8% in India and between 4.5 and 5.5% in Brazil. In addition to the infrastructure investments , I’ve already mentioned, all three countries have a large and growing middle class which is increasing demand for a wide range of products and services.

Also our OEM customers in these countries are beginning to export from their domestic markets. This is especially true in China and India where core companies are aggressively looking to export their products as these customers become more global, they’re demand for our products and distribution is support and effort both increase.

As Thomas said, we are already seeing strong demand increases in China, India and Brazil as those countries have rebounded quickly from the downturn. We expect that growth to continue well into the future and we are making necessary investments to capture the additional demand in our plans and distribution channel as well with our joint venture partners.

As we’ve been saying for more than a year now, our emphasize is earning a solid profit, generating cash, investing in critical technologies and providing outstanding support for our customers. As the economic recovery takes hold, we have some significant growth opportunities in front of us. Our market share is strong in most markets around the world, giving us a solid foundation from which to grow. We also have developed excellent relationships with our key OEMs and joint venture partners with whom we are growing.

We have demonstrated technology leadership not in just meeting emission standards on time every time but also providing the most reliable and best performing products for our customers. As we have said, our long term plan is to grow revenues to $20 billion in 2014 and earn an average EBIT margin of 10% across the next business cycle. Given our current strong financial condition, the outstanding performance of our employees during the recent global downturn and the opportunities we have in front of us, I am confident that we are well positioned for just that kind of growth long term.

Dean Cantrell

Thank you Tim. As an improvement to our last quarterly call, an out of consideration to others on the call. I would ask that you limit yourself to one question and a related follow-up. If you have additional questions you are free to rejoin the queue. (Eric), we’re now ready for our first question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jamie Cook with Credit Suisse. Please proceed.

Jamie Cook – Credit Suisse

Hi good morning. Congratulations. I guess my first quarter just in, my first question I guess, just in general is related to when I think about the quarter, how it played out relative to history revenues were essentially inline but the margin performance was much better. So in general, I guess what surprised you guys about the quarter, on the margin front and what do you view a sustainable versus not sustainable and I guess the related question to that is just the engine margins, I have a hard time believing your engine margin target for 2010 and your engine margin target for 2014 that you provided at your analyst day, given we haven’t even really seen a huge recovery in volumes on the truck side and I would some of the emerging markets or commodity markets sort of remained strong. So if you could help me out on those two measures.

Pat Ward

I’ll try Jamie. The first part of your question, in terms of what surprised us. I think the areas where I was more surprised, the performance of our manufacturing plants and convention cost that they achieve given the volatile volumes was outstanding across all four businesses and so that was definitely benefit, than what I anticipate to going into the quarter and secondly I think the strength of the emerging markets and the (flow trend) that we are seeing in joint venture income was obviously back from what we anticipated at the start of the year. We did anticipate improved material cost. We knew we were going to get some benefits for on the cost restructuring actions we took a year ago. So really joint venture income and the fact our plans really did so well in the engines segment, the components segment and the power gen segment.

Jamie Cook – Credit Suisse

But there wasn’t a material cost benefit in the four, I’m just trying – was material cost a big benefit in the queue in the first quarter that we’re not – or can you quantify that?

Pat Ward

Sure I can, if you look at material cost year-over-year, it was above 1.7 benefit, 1.7% benefit Q1 to Q1.

Jamie Cook – Credit Suisse

Okay.

Pat Ward

So it was significant, wasn’t so significant versus the fourth quarter but it was definitely much better year-over-year. And in the second part of your question on the –

Jamie Cook – Credit Suisse

I don't believe your engine margin target.

Pat Ward

Yes it’s unbelievable, I don't know why. Let me just say a few words, because I think this question might come up from a few people as to why the first quarter margins of 10.7% are higher than the full-year guidance of 10%. We are going to see some headwinds I guess is the word we use coming out. The warranty costs are going to be higher in Q2, Q3, and Q4 as we introduce more of the new 2010 products. Warranty costs were 1.7% of sales in the first quarter. Our previous guidance when the question came up three months ago, we said we will be running at 4% and that is going to be closer to 3.5%, but they will increase.

Commodity costs are going to be higher in the second half of the year. We still expect overall material cost to be favorable year-over-year, but we have already seen much of that benefit in the first quarter. And our projection just now as a commodity cost could be as high in Q3 and Q4 by as much as $20 million, $25 million higher a quarter than what we’ve seen in the first quarter. So again, that's another 6-7/10th of a percentage point.

Jamie Cook – Credit Suisse

Okay. And then anything specific to just engines in particular in your 9% to 10%, I think goal that you spoke about.

Tom Linebarger

Warranty, I think as Tim and Pat said, warranty is going to – will go up in the engine business as we add more. I mean the mix of 2010 engines in the first quarter is very low and it will start to increase over the year, and so our warranty of course will go up and that's the major one.

Jamie Cook – Credit Suisse

But I am talking more about your 2014.

Tom Linebarger

Yes, with 2014, there is a long way to go to 2014. And as we talked about in our targets, there is a – we are going to – we have got another set of introductions, we have got a lot of stuff to do between now and then. And so we will continue to update our margin targets as we see things beginning to move and change. But starting from our recessionary period, I think we set out some targets that were aggressive, that represents significant improvement, we will continue to have look at those can we will talk to you about them. But as we stand now, what I think what we feel good about is if you just compare this first quarter to fourth quarter what you see is a continuation.

It looks very dramatic compared to Q1. But compared to fourth quarter, what we said is we are doing a whole bunch of work in our plants, in our engineering areas, even in our overhead areas to try to improve productivity, keep costs down. So even in a relatively weak recessionary revenue environment, we can continue to improve margins, and I think that's what you really see in Q1. And as Pat said, China, India, and Brazil markets definitely went faster than we thought, we knew they would recover, they recovered faster, and we really benefit from that, because we were positioned to capture them.

Jamie Cook – Credit Suisse

Alright, I will look for those upward revisions, congratulations.

Tom Linebarger

Thanks Jamie. Next question.

Operator

Your next question comes from the line of Tim Dinan (ph) from Wolfram (ph), please proceed.

Tim Dinan – Wolfram

Hi, good morning, guys.

Tom Linebarger

Hi Tim, how are you?

Tim Dinan – Wolfram

Good, thanks. Can you provide a bit more color on the second half recovery you were expecting in North American truck demand and relative to that? It sounds like you are kind of expecting the China and India growth to maybe decelerate in the second half, so can you discuss those two.

Pat Ward

Sure Tim. The way I would look at the North American truck demand for the year, second quarter is going to look somewhat similar to the first quarter. And if you look at the full-year volumes, I would project that 30% will be shipped in the first half of the year and 70% will be shipped in the second half. So that gives you a kind of feel for how this is going to grow as we get into the third and fourth quarter of the year. And your second question on China and India, the question was why is it going to soften?

Tim Dinan – Wolfram

Yes.

Pat Ward

Well, I think you have read about both the Indian authorities and the Chinese authorities have been a little bit concerned about inflation with India and just how fast the economy is growing in China. And both have taken monetary actions to not turn off the growth completely, but just to manage it better and I think listen to a Chinese customer (inaudible), we are going to see a little bit of a smooth out in the second half of the year, but it's not going to turn off completely.

Tim Dinan – Wolfram

Sure.

Pat Ward

Which is our projection for the full-year (inaudible) of China I think we are looking at sales consolidated and joint venture sales in the range of $2.6 billion, that's up from $1.7 billion last year, so close to a 30% increase. And in India, we are looking at close to 40% increase year-over-year.

So first quarter was terrific. It’s going to be great year in both countries. We might see a little bit of a slowdown as we go into the second half of the year.

Tim Dinan – Wolfram

Okay great. And then one quick follow-up, Tata has been reported – is looking to sell a 24% stake in Tata Cummins Limited. Can you us a sense of if there are any limitations on your side to that stake or what your involvement is there?

Tom Linebarger

That report by the way was false. We have called up the printers. We have a very good and deep relationship with Tata, we were able to call them right away. Tata has been going through a review of their holdings to figure out what's core and what's not, which I think is probably the origin of the report, and they have indeed sold off some businesses over the course, this is not one of those that they are interested in selling, and our relationship with them remains solid and that joint venture is really key to both parties.

Tim Solso

As evidence of that, I think the relationship is strong today as I can ever remember. And the evidence is that it is completing a second joint venture plan that will have a capacity of 60,000 units a year with the ability to go to a 120,000. And remember the first plant has a 120,000 units per year capacity which is operating at full capacity. So if we had any issues with Tata, we wouldn't be making those investments. So I agree with Tom, we checked up on it, there's no truth to those rumors or the articles.

Tim Dinan – Wolfram

Got it. Thanks very much.

Tom Linebarger

Thanks Tim.

Operator

Your next question comes from the line of Jerry Revich with Goldman Sachs

Jerry Revich – Goldman Sachs

Good morning.

Tim Solso

Good morning Jerry.

Jerry Revich – Goldman Sachs

Tim, for Tier 4 interim products, can you talk about any new platforms or customers that will be using Cummins engines or components perhaps in the context of new piece of equipment that included Cummins products at BAMA (ph), if there hadn't been a formal product announcement releases, thank you.

Tom Linebarger

Yes Jerry, I think let me give the broad answer and then we can follow up with you with specific piece of equipment. But I guess what I want to say about Tier 4 both interim and Tier 4 final is that's another part of the overwhelming trend Tim talked about emissions spreading across the world. And Tier 4 interim and final and their equipments will affect both European and US manufacturers in significant ways. And it's unlike the US EPA think we just went to; it's not going to be a cliff event.

There are requirements by horse power range that begin to hit at different phases. There is also this complex T-PAM (ph) arrangement where people can sort of do sort of fleet mixing and figure out how they wanted to deploy which level of emissions. So we expect manufacturers to get on the bus if you will at different points in time and we are working with all our major OEMs on this. We have made announcements with Camaro (ph) for example. But many of the other OEMs are actually still figuring out exactly what they want to do and how they want to do. We are actively talking with all of them and we are in fact doing more than talking; we are working on emissions releases with them, but they haven't announced theirs, and I don't want to get ahead of them on that.

But in terms of specific product announcements, we can definitely get back to you on specific ones that we announced BAMA for example if there are any. But what you should expect from Cummins is this is our strength, this is where we are good, we are good in emissions both in terms of the engines and the component, we will see increased business as a result of Tier 4 interim and final by the end, and we will see expansion of OEM partnerships that we have as well as some new piece of equipment. But in terms of how it's going to play out between now and 2014, there is a lot ground and cover, and the OEMs are still doing a lot of planning about how they want to manage it.

Jerry Revich – Goldman Sachs

And as a follow-up, can you talk about, if you are more optimistic on the engine part of the business or on the component side as part of your 2014 plan, can you tell us roughly what portion you expect the increase business to be both on engine and components versus just the components? Thanks.

Tom Linebarger

Yes, I am optimistic about both as you probably expected me to say. But we are projecting higher growth rates in the components areas broadly and that's – our targets are set that way in the engine business. And the reason of course is we are sort of starting from a smaller base, right? We are really adding some of the after treatment technologies to off-highway engines for the first time in Tier 4. So we will begin to see higher component growth rates really than engine growth rates. So from that point of view, I guess that's more optimistic. But both will be growing and both will be benefiting from the fact that we have technologies that we think our customers can use and we intend to help them make their equipment successful by deploying them with those customers.

Jerry Revich – Goldman Sachs

Thank you.

Operator

Your next question comes from the line of Henry Kirn with UBS, please proceed.

Henry Kirn – UBS

Hi, good morning guys. Let me add to the round of congratulations.

Tim Solso

Thank you.

Henry Kirn – UBS

Is there any way you can address how your share may have progressed in China, India, and Brazil? Especially given the outperformance, how did your share progress in the quarter?

Tom Linebarger

Yes, I think and let me first talk about China. I don't think there was significant share moves during the quarter for example. Over time our expectation is we will continue to expand share in China primarily by – because we are entering now in the light commercial vehicle market which is a new area for us. And so we will continue to expand share in the truck market by entering in a different parts of the market. But with regard to the primary truck market that we have been in for sometime, there we were not significant share movements and we really don't expect significant share movements in the near term anyway. Over the long run of course, we are trying to pursue with our customers gaining share, but I think it's not a short term issue.

And with India, I mentioned before as well, the truck share movements are not so dramatic. What we have done is grown share with Tata. And really over the last 18 months, I would say is a better comparison period, we have increased the share of our engines in their trucks by making our engines more and more competitive from a cost point of view as well as improving the quality of those engines, and they are finding that more and more customers are ready to pay a little bit more for engines with newer technology as the roads develop in India, that's part of building on the thing that Tim talked about is as infrastructure improves and wealth grows in those countries, the willingness to pay for technology is increasing. So I guess from a share point of view that's driving up our share, but mostly as we think about our share at Tata.

And then Brazil which I did not mention yet is again relatively level from a total market point of view. We are with some leading customers there in Ford and Volkswagen MAN, where their share is about even, but we are seeing very, very good volume as the market grows there. So, I think all the quarter one stories are market stories, but our position has grown over the years and remains strong.

Tim Solso

I think one thing that I would add in China what has been helping is we are seeing more of the enforcement of the Euro 3 compliant engines using electronic fuel systems. And so as that compliance or that enforcement increases that helps to benefit our sales at the Dongfeng Cummins joint venture.

Henry Kirn – UBS

That's helpful. And for my unrelated related follow-up, what are your North American fleet customers saying about the timeframe for when they are going to start placing orders in higher numbers?

Tom Linebarger

Well, as you would guess, it varies a lot by fleet. And what we are seeing is that almost all fleets want to start trying, so they are all in the market trying to figure out when they can start trying the technology which I think is a positive sign. Because in our view is once they try it and they begin to see the benefits in the fuel economy and that sort of thing, then they will begin to see why it's worthwhile despite the higher prices to invest in new trucks and that's what we see want to happen.

There is a high price hurdle and so it's going to take some folks time to get used to that and figure out how they want to utilize this particularly in this still difficult freight environment. But we are seeing in people putting orders in, we are seeing people try it much more aggressively across the market, and some of buying making larger orders. But I don't think there's one comment I can make that average is across all the fleets. I think some are going in right now, some are going in with their tail in the water, and some are still waiting and figuring out what they want to do.

Tim Solso

Let me add a little bit to the new product introduction. We produced 3,100 engines, 2,010 engines in the first quarter and Tom said set it's increased to 3,500 to date. They have gone to 80 end users, 90,000 hours of testing, 8 million miles as Tom said in over a 180 vehicle instillations with the 63 OEMs. So we are out there. And the feedback we are getting from these early customers is very, very positive. And I think as more try it, we will start to see the orders come in, and I would hope will start to see that in the second quarter, but certainly in the second half of the year.

Henry Kirn – UBS

That's helpful, thanks a lot guys.

Operator

Your next question comes from the line of Ann Duignan with JPMorgan, please proceed.

Ann Duignan – JPMorgan

Hi, good morning guys, it's Ann Duignan.

Tom Linebarger

Hi Ann.

Ann Duignan – JPMorgan

Hi. I just wanted to build on your comments that you just completed there. You said that in your opening remarks that in some applications, you are seeing as much as double-digit fuel improvements. Could you be a little bit more specific? Is it in certain applications? Is it in over the road or short haul or maybe you can just give us a little bit of color or are there too few engines out there to get a grasp on that?

Tim Solso

Yes, it is. Those comments I made, we had a couple of fleet customers who actually saw very, very large benefits. And as I think about that, it was situational of them. I think the way they were using their engines and the way they had them setup in their trucks, we were able to do a lot with them, but the new ones that really made a big benefit.

So I think it’s – the intent is to just to say that we think the engines are offering very good fuel economy improvements and we want to help customers realize those to maximum benefits. So we did see those were customer-specific as opposed to application-specific kind of improvements. So right now, there is too few out there to say which ones are going to see the best.

I think the important technical point though and that with our – with the SCR technology, the copper zeolite that we are deploying, we see a very wide map that people can operate in and still capture this fuel economy benefit. That’s been a kind of a challenge for the industry before you find a good fuel economy point, but as soon as a different driver drives it or they do a different road, they don’t realize those fuel economy benefits.

On the real positives of this technology is the map they can operate in this wider and still get the benefit. So we think we are going to see more customers realizing the full benefit of the fuel economy and with this technology, which again we think as we kind of finish the deployment, the industry is really going to be pleased with what’s out there.

Ann Duignan – JPMorgan

Yes, funny, when I was down at the World Truck Show, Kenworth said the exact same things, so good that you are all consistent at least.

Tim Solso

They are excellent partner by the way and I think they utilize the technology as well as anybody.

Ann Duignan – JPMorgan

Yes, and just my follow-up on that very (inaudible) is on the 15 liter; you had anticipated regaining the Navistar share. You are still not weighing Navistar and Kenworth and Peterbilt are all at their aggressively trying to promote 13-liter engine. What’s your color on the 15-liter segment and whether customers will really migrate?

Tim Solso

I think the 15 liter and 13 liter discussion really comes down to how the customer wants to use it, and secondly, how good each engine is. So we are, of course, we recognize that our 15 liter will compete with 13 liters on the road. A whole bunch of them have loads that a 15 liter just handles better and that – in fact that trend has been going more that way for many years. And so our view is the whole bunch of customers that have got used to the 15 liters and seen what they can do for them are reluctant frankly to switch. They have got a lot of benefits after moving to 15 liter.

Second thing is that if we continue to produce engines with leading fuel economy and including being competitive 13 liters on fuel economy, it’s going to reduce the number of reasons to switch. There is no question that a good 13-liter engine will do well in the market, but we also think there is going to be a place both short run and the long run for 15 liters, again provided that we continue to make the offering competitive and that’s really the thing we said all along that the gain here is try to introduce technology reliably and with – working closely with your customers, so the integration goes well. And as long as we continue to do that, we think we will have a place for the 15 liter.

Tom Linebarger

If you historically and I mean over a long period of time look at the mix between 15 liter and 13 liter, it has not changed. And I don’t see anything in the marketplace today that that’s going to change today. So I think if you want some more data, you could do some research in that area and be able to predict it.

Ann Duignan – JPMorgan

Okay. So you are still confident that you can regain that loss to Navistar share?

Tim Solso

Well, again, I think the loss Navistar share, remember that’s less of a 13, 15 point and more a question about which truck customers are going to gain which share. What we said is we think we have a very good partnership with PACO, we will continue to work with them to make sure they have good trucks to sell.

We are also working closely with Freightliner and Volvo that their offerings were competitive. And what our view is that those three truck manufacturers that use our engine will then be competing with Navistar with their engine offerings. And our view is that our truck customers are pretty well positioned with our technology and their own technology to compete and we will be hoping them every place we can to compete in the market. And so I think that’s what we will find drive share. Whether or not we fully recover every percentage point or not is not clear. There is a lot of ground to play. We just think we have a good offering and good partners and we are going to go out there and fight it out in the market.

Ann Duignan – JPMorgan

Right, okay, thanks so much. I will step back in line. Appreciate it.

Tim Solso

Thanks Anne.

Operator

Your next question comes from the line of Andrew Casey.

Andrew Casey – Wachovia Securities

Good morning. Nice transformation over the last decade. Look forward to seeing what impact actual improvement in developed markets would have on performance, so congratulations.

Tim Solso

Thanks Andy.

Tom Linebarger

Thank you, Andy.

Andrew Casey – Wachovia Securities

Similar to Jamie’s engines question on the 2010 components EBIT margin 8% to 9% outlook versus kind of bouncing around the 4% to 5% range over the last few years, and then longer-term the 10% to 11% you have given at the Analyst Day, if we look out directionally do you think margins would benefit from a full year of developed market truck and off-highway equipment recovery with the incremental content for vehicle that you touched on, along with the pricing, but holding everything else equal?

Pat Ward

Yes. And this is Pat. I think the answer is yet to that that we have seen a very good first quarter. We reached the guidance for the full year. And as we start to see more of the components products go into both developed and developing markets, I think we would expect to see that business continuing to grow top line and bottom line.

Andrew Casey – Wachovia Securities

Okay, thanks. And then, kind of in that spirit of the last decade comment, you have really improved your capital structure. As you are determining how to allocate your cash, what sort of net debt to total cap do you really feel is optimal for Cummins as this point?

Pat Ward

We talked a lot about that three or four weeks ago in New York. And to be as relative, 15%, 16% and we are not trying to stay there forever. But we now have sufficient flexibility in our capital structure to do a number of different things and we are very focused on returning value to the shareholder. We are buying stock again. We purchased 630,000 shares in the first quarter and a little bit more as we move through the year. We then increased a dividend last year that was the first year in the last fall (ph), we didn’t increase it.

And clearly we will be talking to the Board, again as I said in my earlier remarks over the next few weeks. But there is a significant amount of investment that we will be putting back into the company both in terms of capital investment, we are doing $400 million this year and we expect to see that continue to grow as the business expands over the next few years. Working capital investment is going to have to go up too. We can’t become a $20 billion company by 2014 without seeing further investment in working capital. And I also look at research and development as investment not necessarily as an expense. So we are going spend plenty, we use to utilize that money to grow the business effectively.

Andrew Casey – Wachovia Securities

Okay, thank you.

Operator

The next question comes from the line of Eli Lustgarten with Longbow. Please proceed.

Eli Lustgarten – Longbow

Can you talk a little more about component and you touched on it. The volume is up 20%, you are up (somewhere) around that in the first quarter, you have pretty good volume gains the whole year. You got margins falling. How much of that – is that material cost or is that a new product introduction cycle that has low margin? You had great margin in the first quarter and keeping that going (inaudible) much as you are suggesting it?

Pat Ward

Yes, I don’t you should follow up dramatically. I mean we have given guidance of 8% to 9% in Q1, just a little above that. We will see increasing residual cost as we go through the year. There is absolutely no question about that. And first quarter, the common (inaudible) aftermarket mix certainly impacted the components business. So as we start to sell more products to OEM plus the OEM customers, that margin we see in aftermarket, which is that doubling plus the OEM will dilute a little bit. So as (inaudible), a great year for components it’s really not moving enough for well for first quarter levels.

Tim Solso

I think we are also going to see higher research and development as the year progresses in components as well. Again, thinking about what the work that they are doing to get ready for tier 4 interim as well as work that we talked about the Analyst Day, that’s more longer term, thinking about fuel efficiency improvements that we want to get.

Eli Lustgarten – Longbow

A quick follow-up with the use of capital. Acquisition is not something we talk much about in companies in quite a while. Is that something that's coming back on the horizon, or is it something that you would like to fill in anywhere around the world, the new venture that you would like to start around the world.

Pat Ward

No. Our view as we have talked about before, Eli, is acquisitions are not a particularly successful strategy in our industry in our view. We are not particularly good at them and we don’t think that’s – they have generally been very successful for most folks. So what we are thinking about though is trying to expand our global position which has involved us either creating or buying into new distribution businesses across the world. So you will still see that. Those are small pieces of small acquisitions but you still can see us enhancing our distribution and support position around the world in order to meet some of the trends that Tim talked about and we are looking for opportunities to expand our components business in the most strategic. But I really don't think you should be looking at acquisitions as significant use of capital by the company or significant additions to revenue in terms of driving growth. What you should see is organic growth as our overwhelmingly – the way we will be growing in the company. And we see enough in our organic growth plan that we think we can meet our targets using that.

Tim Solso

The alternative to acquisitions from our perspective is joint ventures. And over the last 10 years, I think we have become much better joint venture partners and we have selected and have been selected by excellent companies. And I think if you watch us in the future, you will see more of that, new joint ventures, perhaps a new geographic territory, and you will also see us grow the joint ventures we have. And that's where our emphasis is going to be. Historically when we have done an acquisition, we paid too much money and we take too long to integrate into the company. And so, we are going to play on our strengths, which is the joint venture management process, rather than do acquisitions.

Operator

Your next question comes from the line of Meredith Taylor with Barclays Capital.

Meredith Taylor – Barclays Capital

I am hoping we can talk a little bit about on the power gen business. Could you give us a sense of how the order board progressed over the course of the quarter and a little more specific detail about regionally where you saw the greatest area of the strength within the emerging markets?

Tim Solso

We just happened to have to Tony Satterthwaite with us. So we are going to let him, who runs our power gen business, we will let him answer that.

Tony Satterthwaite

The order board took us by surprise in the first quarter and we saw a much bigger jump than we had expected when we talked about 2010 in the fourth quarter. The strength was entirely outside of North America and Western Europe. China and India were very strong, Brazil was incredibly strong and we also started to see some comeback in orders at least in the Middle East and in some of our very important rental customers like (Gretco) have started to see the business come back.

So, it was pretty broad but I do want to say it was all emerging markets. There was really nothing of interest in North America and Western Europe but we are seeing a much stronger order board than we had expected and that's playing into our guidance pretty clearly.

Meredith Taylor – Barclays Capital

Okay, so basically no change over the course of the quarter in terms of the tone of orders that you were seeing in the developed market?

Tony Satterthwaite

No, the developed markets have pretty much done exactly what we expected and that is they are continuing drift kind of downwards North America and Western Europe are coming in lower, which is exactly what we expected and really it’s been the emerging markets that have come in much stronger from an order perspective.

Meredith Taylor – Barclays Capital

Great. And then can you just remind us specific to maybe North America and the Europe, how much your revenues in power gen last year were tracking below end market retail sales, just given the inventory reduction dynamics in the market?

Tony Satterthwaite

It’s a good question, Meredith. We don’t know exactly, it’s kind of hard to track. We think the inventory reduction was fairly significant throughout the channel last year but not so much in North America. It’s not an inventory market in North America much more inventory market, much more outside of North America. So we think that was less the case in North America than it was in, for instance, the Middle East.

Tim Solso

Meredith, the proxy that I have used, I think best answer to that question is if you track the factory sales from power gen that run through our own distribution channel, you could see that factory was down about 30% last year. But when you looked in the distribution channel, their power generation sales were only probably down 19% or 20%. So there was about 10, 11 percentage point difference between the factory and what we were seeing in the channel. Obviously this year that – there is a little bit different mix there as the factory is back up at the – depending upon where you are in the distribution channel, you are seeing either flat or continued weakness in power generation sales if you are in the developed markets, but in emerging markets, there is restocking as well as real demand taking place.

Meredith Taylor – Barclays Capital

Thanks, great. Thanks so much and like everybody else, congratulations on the quarter.

Tim Solo

Thank you. Thanks everyone for your attendance today on our earnings call. Again, (inaudible) and I will both be available for your questions after the call all day. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes our presentation. You may now disconnect and have a good day.

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THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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Source: Cummins Inc. Q1 2010 Earnings Call Transcript
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