Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Cummins Inc. (NYSE:CMI)

Q2 FY08 Earnings Call

July 30, 2008, 10:00 AM ET

Executives

Dean A. Cantrell - Director of IR

T. M. (Tim) Solso - Chairman and CEO

Patrick (Pat) J. Ward - VP and CFO

Joe Loughrey - President and COO

Tom Linebarger - EVP and President - Power Generation Business

Analysts

Andrew Casey - Wachovia Capital Markets, Llc

Jamie Cook - Credit Suisse

Ann Duignan - JPMorgan

Eli Lustgarten - Longbow Securities

Charlie Rentschler - Wall Street Access

Henry Kirn - UBS

Seth Weber - Banc Of America Securities

Operator

Good day, ladies and gentlemen, and welcome to the Quarter Two 2008 Cummins Incorporated Earnings Conference Call. My name is Masha, and I will be your coordinator for today's call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions].

I would now like to turn the call over to Mr. Dean Cantrell, Director of Investor Relations. You may proceed, sir.

Dean A. Cantrell - Director of Investor Relations

Thank you, Masha.

Welcome, everyone, to our teleconference today to discuss Cummins's results for the second quarter of 2008. Participating with me today are Chairman, Tim Solso; our Chief Financial Officer, Pat Ward; our current President and Chief Operating Officer, Joe Loughrey; and our future President and Chief Operating Officer, Tom Linebarger. 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 our forward-looking statements begins on page 3 of over 2007 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 website for the reconciliation of those measures to GAAP financial measures. Our press release with a copy of the financial statements and a copy of today's webcast presentation is available on our website at www.cummins.com under the heading of investors and media.

Before we review our second-quarter performance, I would like to call your attention to our Analyst Day on November 12 in Charleston, South Carolina, where we will focus on the Components segment. So I'd ask you that you please save this date.

So, Tim, would like to say a few words about the quarter?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Good morning.

Let me begin by saying this was the best quarter for sales and net income in the company's 89-year history. These results are even more remarkable given the current state of the US economy and the decline in our consumer markets. Sales were $3.9 billion versus $3.3 billion for the second quarter of last year, a 16% increase year-over-year. Earnings before interest and taxes were $469 million, a 32% increase over the same period last year. Net earnings were $293 million compared to $214 million for the second quarter of 2007.

61% of our sales for the second quarter came from countries outside the United States. This compares to 51% last year. Our geographic diversification has significantly helped us during this time of uncertainty in the US and will continue to fuel our growth in the future. During the quarter, we once again grow earnings faster than sales. All four operating segments increased their margins over the same period last year. All segments were also add or above their target EBIT margins. Joint venture income for the quarter grew 33% as a result of growth in our North American distributors at our Dongfeng and Chongqing engine joint ventures in China.

Cash from operating activities increased $250 million in the first six months of the year compared to the same period in 2007. Other recent company related news or events included, we extended our long-term agreements with two major truck manufacturers, while our primary competitor announced plans to exit the North America on-highway engine business in 2010. We increased the dividend 40%, the third significant increase in the past three years and we are actively repurchasing shares as part of our second $500 million stock buyback plan. Fitch Rating Services upgraded the company's senior unsecured long-term debt to BBB+. The upgrade was largely due to our recent market share gains and improving results because of our geographic and business diversification. We continue to move forward with our plans to invest $3 billion in capital for growth and another $1 billion with our joint venture partners.

Going forward, global trends continue to play to our core strengths. As we said earlier, the economic uncertainty in the United States is weighing heavily on our domestic consumer markets. However, many of our international markets continue to show strong growth driven by long-term trends that we've identified in the past. Tougher global emission standards, the price and availability of energy and globalization, tougher emission standards around the world have already created a significant opportunity for Cummins in both on and off highway markets. In addition to market share gains in the North American heavy-duty and medium-duty truck, bus and RV markets, we've increased business in the off-highway Tier 2 and Tier 3 markets for engines used in commercial marine and construction equipment.

We believe new emission standards will provide us with near-term additional business opportunities in Mexico, China, India, Brazil, Europe and the United States. The next trend benefiting both our engine and power generation businesses is the price and availability of energy. The rising cost of oil is driving demand for greater fuel economy, which is one of the key advantages of the diesel engine. We believe diesel engines with light duty trucks and SUVs in United States would be a big growth opportunity. Chrysler and Nissan will be our first customers for Cummins new light duty diesel engine, which will be available in 2010.

We also believe that our leadership in engine technology and the relative subsystems like turbochargers and fuel systems will provide additional growth opportunity. Cummins and our partners are working to provide our customers with the most fuel efficient and reliable products. The need for energy is also playing the Cummins [inaudible] generation business. The demand for electricity in many regions is greater than the supply and often the reliability of supply is on acceptable. As a result people and businesses will invest in generated [inaudible] in electrical components, ensure they have electricity when they need it.

The final trend that favorable impacts Cummins is globalization and the resulting development at infrastructure within developing countries like India and China. As you know we're well established in markets like India, which is growing at 8% a year and in China a growth rate of 9% to 11% per year. This growth requires investments in highways, power plants and other commercial development projects, which fuels the demand for our products. Nearly 30% of our sales this year come from China and India and along with other emerging economies of Latin America, Eastern Europe and the Middle East. These regions are growing nearly 3 times faster than the U.S. and Western Europe. For example, our China construction markets continue to be strong as a result of domestic economic growth and exports. In India, major domestic and global manufacturers also are expanding or planning new plans. So, based on these significant trends, the tougher emission standards, the price and availability of energy and globalization, we remain very optimistic about growth in our long-term future.

Before concluding, I want to talk about the recent flooding in Columbus, Indiana, and the earthquakes in China. Four Cummins facilities were hard hit by historic flooding in June, especially our research and development center and the plant where our light-duty diesel engine is being developed. Despite the significant issues created by high water levels, our employees responded quickly to minimize the disruption to our operations in the company. We are confident that our insurance coverage will limit the impact of this event.

In May, earthquakes in China resulted in devastating humans and infrastructure cost. Fortunately Cummins employees in our facilities were not harmed by the disaster. But in both this instances, Cummins employees went above and beyond in contributing money and time to help others less fortunate. Their efforts were just simply amazing, which makes us all proud to be a part of Cummins.

Now, I will turn the teleconference over to Pat, who will provide more details on the second quarter and discuss the revised outlook for 2008.

Patrick (Pat) J. Ward - Vice President and Chief Financial Officer

Thank you, Tim.

As Tim mentioned, our second quarter was extremely strong. Revenues were 16% and earnings before interest and taxes grew 32% compared to the same quarter of last year. All four operating segments had record sales, delivered record profits, and achieved or exceeded their return on sales targets.

Our initiatives to diversify the business through end-markets and geographies continue to pay off. The company's financial performance is less dependent on any one market or region, therefore strengthening our ability to [inaudible] like we are seeing in the North America consumer markets.

Our fastest growing markets outside of the U.S., 61% of total sales this quarter came from international markets. While sales from the U.S. were down 6% compared to the same quarter of last year, international sales increased 37% mainly driven by Asia-Pacific and Latin American countries and also growth in Europe. We believe most of the international markets and demand from non-consumer related products in U.S. will continue to show year-over-year growth for the remainder of 2008.

For example, the strength of mining, marine, and power generation markets is continuing to drive strong demand for high- horsepower engines. We continue to benefit from market share gains in North America truck and bus markets. Medium-duty truck sales in Brazil will grow 30% in 2008 buoyed by a strong economy, and construction markets outside of the U.S. and Western Europe remain strong, driven by infrastructure investment in emerging markets.

Demand remains strong and we are now confident that Cummins can deliver 15% revenue growth in 2008, which is up from our 12% expectation last quarter. We expect to deliver 10% EBIT which equates to more than 20% year-over-year growth. We do expect a more challenging environment in the second half of 2008 from the higher impact of commodity costs, a slowdown in truck markets in China and Mexico and the heavier investment and development programs for future growth opportunities. We are also revising our guidance for the full-year effect of tax rate to 33% due primarily to higher forecasted earnings generated in the U.K.

Let's now review each of the individual segments. The Engine segment had a record quarter for both revenues and earnings. EBIT was 19% higher on sales that were 13% greater than the same quarter last year. For on-highway, higher sales and heavy duty truck in Mexico in anticipation of new emissions standards, medium-duty truck spend in Brazil, and market share gains in North America bus more than offset the weaker pick-up truck and RV markets in the U.S. Industrial sales were strong driven by international demand in construction, marine and mining markets. Margins for the quarter improved as well, mainly due to improved pricing, and the sale of more large engines.

You can see on slide 20, that we expect to OEMs to keep North American Class 8 truck builds at 2007 levels. However, Cummins productions of heavy-duty truck engines will experience 45% to 50% growth because of our increased share in this market. For the same reason, as well as the strength of the market in Brazil, we expect shipments to the global medium-duty truck and bus markets to grow 25% to 30%. Our shipments to the pick-up truck market are expected to decline by 40% to 45% due to U.S. economic uncertainty. We have revised our guidance on revenue growth to 13% to 15% and maintaining an operating margin close to the 8.5% target for the Engine segment in 2008. We still expect higher expenses in the second half of the year related to the development and pre-production activity for our four new engine platforms and lower joint ventures income in China due to emission standard changes as we discussed last quarter.

In addition, we now foresee a larger impact of rising commodity cost compared to the first half of 2008.

The Distribution segment had a record quarter with a 58% increase in sales. Organic growth in all product categories and in every geographic region represented most of the increase. The acquisitions in North America added $63 million to revenue this quarter. The segment reported 48% higher earnings from a strong performance of our international distributors and acquisitions in North America. The outlook for Distribution continues to improve. We are now forecasting revenue to grow 37% to 40% from last year and EBIT margins to be close to the 11% segment target for the full year.

The Components segment reported a strong quarter with record revenues and record profits. Earnings were 60% higher than last year and achieved segment target margin this quarter. All four businesses within the segment increased sales and operating margins.

The Turbo business revenue increased 24% driven by growth in the truck market in North America, Europe and China. Fuel systems experienced 21% higher revenues, mainly driven by the strength of our truck engine sales into North America and China. Increased demand for clean diesel engines in on-highway markets in North America and in Europe led to a 17% revenue growth in the Emission Solutions business, and Filtration reported flat sales this quarter. However, excluding revenues from the exit of two businesses last year, sales increased by 9%.

We are pleased with the performance of all of our components business this quarter. The significant profitability improvement was driven mainly by the combination of improved manufacturing efficiencies in the Emission Solutions and Turbocharger business and some targeted pricing actions. For the full year, we project the component revenue growth at 13% to 15%, slightly below previous guidance due to softening European markets for engine OEMs. However, operating improvements in Turbo Technologies and Emission Solutions along with greater price realization are outweighing the higher impact of commodity costs. We are now forecasting the segment to earn at least a 7% return on sales this year.

The Power Generation segment reported 22% higher revenues than last year. Our commercial business increased 35% with strength across all regions. The performance of the commercial and alternative lines of business more than offset the weaker demand in the Power Gen consumer market. Total Power Gen segment earnings rose 31% to 12.3% of sales as we continue to benefit from increased pricing and leveraged our operating expenses with higher sales. Due to stronger price realization, we expect Power Gen segment earnings as a percent of sales in 2008 to be equal to last year at 11%.

Before we open the teleconference to the question is, let me remind you that we are prioritizing our use of cash. One, we will continue to invest in profitable growth opportunities. We have a disciplined approach to capital investments and we will invest approximately 4% of our sales in new projects this year. Most of those investments are directed at future business, which we have already won.

Two, we're focused on returning value to our shareholders. Tim mentioned that we are using both the share repurchase program and sustainable growth in our dividend to return value to our shareholders. You should continue to see us use them in future.

And three, we will continue to maintain a strong balance sheet. Over the last several years, you have seen us reduce our debt to a much healthier level. We are comfortable with our current capital structure in this uncertain economy, but still have opportunities to improve our working capital.

In summary, we had a record quarter for sales and profitability in all four operating segments. We are increasing our revenue growth outlook for the year to 15%. And while we see more challenges in the second half of 2008, primarily due to material costs increases and softening in some markets, we expect to deliver earnings before interest and taxes of 10% of sales, which equates to more than 20% year-over-year growth.

We will now take your questions.

Question and Answer

Operator

[Operator Instructions]. Your first question comes from the line of Andrew Casey. Please proceed, sir.

Andrew Casey - Wachovia Capital Markets, Llc

Thanks. Good morning, everyone.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Good morning, Andy.

Andrew Casey - Wachovia Capital Markets, Llc

A question on the guidance specifically with respect to the light commercial... the light duty auto and RV, it appears as if you are guiding to shipments to the [inaudible] down somewhere in the neighborhood of 65% to 70% which would be a significant deceleration from what happened in the second quarter and realizing that that market is significantly weaker than we would have expected may be eight months ago. Is that all concentrated in Q3, because you've fairly easy comps going into Q4?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

I don't think it's aimed at any one particular quarter. Our assumption is that our consumer markets which would not only be the pickup truck, the recreational marine, RVs, both engines and generator sets are down anywhere from 40% to 50%, and we expect them to be operating at that level at least the rest of this year and we are not making any assumptions of increases for next year. Our Chrysler volumes peaked at a 160,000 a year in 2006 and we're forecasting somewhere between 50,000 and 60,000 this year and then on top of that you've go the new cab chassis which would be another 20,000. So that's kind of roughly where we are with that.

Joe Loughrey - President and Chief Operating Officer

Andy, I think our guidance that we put out there was for light duty automotive and RV, you'd see our shipments decline for the full-year by 40% to 45%.

Andrew Casey - Wachovia Capital Markets, Llc

Right. And you had a decent first quarter, we can talk about that offline. On the components margin, I mean spectacular performance there. How does that not continue going forward? Is that just you're expecting input cost to start to impact that in the second half or can you help me with that?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Well, it was a terrific quarter for the components, but we are anticipating some material cost increases that we'll have in the second half of the year. I am just particularly pleased with the turbochargers and Emission Solutions that the turbochargers have improved quarter-to-quarter since the fourth quarter of 2006. So, I think we're getting good -- really good progress there. And

Emission Solutions is starting to get traction. They are still a year away and there is a lot of volatility in that market, so I don't know that -- I think it's hard to forecast where we are, so I think we're really comfortable at 7%.

Joe Loughrey - President and Chief Operating Officer

Yeah. Andy, it's Joe. Hey, thanks for the acknowledgment.

Andrew Casey - Wachovia Capital Markets, Llc

It's rare, Joe.

Joe Loughrey - President and Chief Operating Officer

I know. But anyway, you know as Pat and Tim said, we feel really good about the quarter given it ended up at the high-end of the range we have been talking to you about. But let me just add, we don't... we can't ... there are... there will be wider variation in EBIT performance as a percent of sales going forward in this group for a while yet. Because, in addition to... there are several causes for this variation, one of which, Tim has mentioned, is just what's going on in several of the business in terms of pressure on material pricing. But, also we have a large number of new products that are coming now, we've have got... still though we're close to the end valuating all the products we have made, and as you know, we have made decisions in the last year to close a plant at Waynesborough and to sell our USI business, and these things are causing investment in new plants, given the opportunities ahead of us around the world, and some changing of mission, which are underway at current plants, which are causing some rearranging between places. And so a lot of these things are still underway and quarter-to-quarter for a little while will create some variation in performance. But I thank, and I hope, that you take away from this that where this quarter has demonstrated very clearly what's possible in this segment and confirms our feeling about what a great opportunity this is for profitable sales growth for Cummins in the future. And so variation will be wider here than it has been in others segments for a while going forward. But it's a steady climb up in terms of where we will end up from a performance point of view.

Andrew Casey - Wachovia Capital Markets, Llc

Thank you very much. I'll get back in queue.

Operator

Your next question comes from the line of Jamie Cook. Please proceed.

Jamie Cook - Credit Suisse

Hi. Good morning and congratulations. Tim, my first question, when we think about what your... what your new guidance, what it implies for the back half of the year, you are only growing your earnings about I think 9% or 10% relative to the 35%, 40% in the first half, and I recognize the challenges you have. But I'm just trying to get a feel for, is there anyway you can give us a better hand on exactly how much of that is the material cost headwind, just a little more granularity on that versus just weaker market?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Well, first of all our accuracy in this is not as precise as everyone wants, but our current thinking is that material price increases would be about 1.2% on our margin... hit on our margin. And on the SAR line, we are seeing... we are doing four engine platforms plus the fuel system, plus some turbochargers. So our product development costs are at a peak level right now. And also we are into pre-production, which increases our expenses, and we think that would be somewhere around 0.3%. And then if you look at JV income, particularly China, where there is... they're implementing the Euro 3 standard and it's predicted that truck market will go down 50%. So we will see lower results from Dongfeng and Chongqing. And also our investment in Foton is increasing. This is the time where we are building plants and again doing that kind of thing, and that will probably be about 0.4% and then some of that will be offset with pricing. And we priced on almost all our businesses in January and there are some pricing that will hit in the second half of the year. Parts would be one area. And wherever we can price for material cost increases, we will try and recover, but we won't get all of that back.

Jamie Cook - Credit Suisse

All right. And then I guess just as a follow-up question, we've had some time to digest your largest competitor, eventually exiting the truck engine business. Can you just talk about sort of what you are hearing from your customers initially, and then also any preliminary outlook. There's a lot of different outlook as we look out to 2009 both in the U.S. and Europe. Can you comment on just sort of what you are hearing anecdotally from your customers?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

I will let... Joe is going to respond to that.

Joe Loughrey - President and Chief Operating Officer

Couple of things. One is, generally speaking, we've been getting great reaction from a number of customers who use products from both Cummins and CAT, primarily because our products have been running relatively better, and so the reaction has been for the most part positive. Obviously some concern among some end-users about availability of options going forward, but overall very positive. So if you look at North America for our outlook, it's a little... still a little hard to say, but we have been running lately in between 40% and 44% and 42%, low 40s in terms of our share of the heavy-duty market. We set our own target going forward to get up to the high 40's, but there is a lot of uncertainty there, some knowns, some unknowns. I think pre-2010 the factors are really going to be, how well does our product perform, right now doing very well versus the other guys. Second factor will be related to the one we just talk about and to what degree will end-users be concerned and will they buy more CATs because they can't get anymore after 2009 or will they be concerned about resale value of their truck with a CAT engine and therefore move to Cummins faster. And that's lot of anecdotes out there, but not a clear line yet as to where that will end up. And of course it will depend a little bit on how well the new Freightliner Cascadia truck does with... as we have announced Cummins engine that's going to be available at the beginning of next year.

Post 2010, I think it's pretty clear, our 15-liter share will increase, and it will be basically not the only engine out there, given what Volvo and Daimler are doing. But we expect a freight... 15-liter share will increase based on us continuing to offer a product that's relatively better. However, on the sort of medium bore side, it's a little more cloudy or uncertain. As we have already announced, we are discontinuing in our ISM in 2010. So, our 11-liter that we have been offering for many years to the market will no longer be offered in 2010. And as you know, some of the OEMs PACCAR and International are introducing new engines within the 11-liter to 13-liter range within their trucks. But as you also know from our announcement, we are also introducing a brand new engine, 11.9-liter engine into this market place. So, the uncertain factors are how the other... how the new engine is going to do that the OEM's are introducing, will they introduce them on time and how well will they do versus how our engine will do. We are very confident about what we will be able to bring to the market with our engine and then it will be very competitive compared to what we know about the other introductions. But that still remains to be seen in terms of how that will actually play out. So, I guess while we are targeting to work our way to the high 40's, and we're confident with where we are going to end up on the 15-liter side in the first several years or next year, there is more uncertainty into the 11-liter and 13-liter range right now given what everyone is doing, but we are very confident about the product we are going to bring to the marketplace, and feel it will compete very well versus other products that are being introduced pre 2010 and post 2010.

Jamie Cook - Credit Suisse

And just my... the other part of the question that I asked though, any chance of giving initial outlook for '09 and just the industry forecast, both U.S. and in Europe, how you feel that plays out with a weaker...

Joe Loughrey - President and Chief Operating Officer

The size of the market?

Jamie Cook - Credit Suisse

Yeah, I'm just trying to get a feel for how much you think the market will be up in '09 versus '08 both in the U.S. and in Europe?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Yes. Generally speaking, and we're still trying to tie down from the European point of view market size as we've seen some shifts recently. But if you look at North America, I think as we've said, '08 right now looks an awful lot like '07. And right now our best shot is that '09 will be 35% to 40% greater than '08, right? So there has been lot of forecast put up there as you've seen from the industry. But that would say if you do the arithmetic, it's sort of, in the way we count, it's somewhere in the 235 to 250 plus kind of range for next year, given what we know now.

Jamie Cook - Credit Suisse

In Western Europe, any chance?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Not yet. We are kind of looking at where are things and we haven't yet... we are not yet ready to say where we think that one will go.

Jamie Cook - Credit Suisse

All right, thank you. I'll get back in queue.

Operator

You next question comes on the line of Ann Duignan. You may proceed.

Ann Duignan - JPMorgan

Hi, it's Ann Duignan here from JP Morgan.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Good morning, Ann.

Ann Duignan - JPMorgan

Good morning. Can we talk a little bit about building on heavy-duty engine business? Can we talk a little bit about capacity for 2009? PACCARD noted on it's recent conference call that they are... they didn’t use the word hoarding but they did said that they were building inventory at heavy-duty engines in anticipation of a pickup next year. And could you talk about what your capacity will be at Jamestown to meet both the industry demand and your share gains? And then could you talk about in that context, could you talk about your recent change in relationship with CMH and what that might do to free up some capacity for next year?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

I'll start it and Joe can fill in. First of all, we are increasing capacity at Jamestown in the second half of this year somewhere between 15% and 20%. Next year, I think... again, we talked about a market size of 235 to 250 to 240. And the flow although again it's very uncertain would be less in the first half and more in the second half, and if there is a big spike at some point in time in the year, then there will be capacity issues. But if you look at the overall year, we'll have enough capacity to meet the requirements of all of our customers in both heavy-duty and medium-duty. The change at Consolidated Diesel really has nothing to do with heavy-duty market. We make medium-duty engine in that plant. And this was just an amicable mutual agreement with Case, New Holland, where we've had a partnership going clearly back to the 1980s and essentially they are taking less than 20% of the engines, less than 30,000 this year and that's going down. So it make sense for us to have all of that plant and we've been running it and consolidating it from the beginning anyway so there is no change to our financials. And we will continue to buy some machine components or castings from Turin, and so we still have a relationship with New Holland. But it doesn't impact our capacity capability for North American heavy-duty.

Ann Duignan - JPMorgan

Okay. And I just want to make sure I have got your capacity increase correct. Is that off of the peak, last cycle's peak of a 123,000 or is it 115,000 I think was what you produced at Jamestown. Now how should I think about your full capacity next year in absolute trends as opposed to growth?

Dean A. Cantrell - Director of Investor Relations

Yeah, Ann this is Dean. The numbers that Tim referred to, it is off of the peak production that we had in Jamestown in 2006. In our publicly disclosed numbers in 2006 we did, of the heavy-duty engines that we disclosed, about a 115,000 of that was in Jamestown and about... close to 80,000 of that was from... was ISX production. So, the...

Ann Duignan - JPMorgan

So, we ought [ph] to think about that in terms of 15% to 20% increase in the ISX?

Dean A. Cantrell - Director of Investor Relations

Correct.

Ann Duignan - JPMorgan

Okay, okay. I just want to make sure I get the absolute number correct. Just one real quick follow-up. You noted that you are at about peak for new product introduction or new product development. How should we think about '09 and beyond in terms of warranty costs, should we be assuming that warranty costs, they could step up at least for a short time period, because of the introduction of new products?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

I think that essentially the first eight quarters after we introduce a product, we accrue at a higher rate, and that's been our experience. After the products starts to mature then we lower that accrual and I think going forward, we will have some increase with the new products but also existing products that are new today will lower, so I don't see anything changing. It's going to be in the 3%, 3.1% of sales.

Ann Duignan - JPMorgan

Okay, thank you. I'll get back in queue, thanks.

Operator

And your next question comes from the line of Eli Lustgarten from Longbow Securities. Please proceed.

Eli Lustgarten - Longbow Securities

Good morning, and I would say wow for the quarter. It was quite a quarter.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Thank you.

Eli Lustgarten - Longbow Securities

I'll start with a question... clarification, one, the base... your forecast that you just mentioned for heavy-duty truck for '09, it's off of what, 175 numbers for this year?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Yes.

Eli Lustgarten - Longbow Securities

Okay. I just wanted to make sure it's right basis. And the tax rate of 33% this year, does that continue into next year or do you have any feel for that yet?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

No, we don't… we haven't communicated yet what our tax rate will be for 2009.

Eli Lustgarten - Longbow Securities

Is it [inaudible] goes up a little bit or you have any feel directionally or what do you --?

Dean A. Cantrell - Director of Investor Relations

We haven't given any direction yet on that, Eli.

Eli Lustgarten - Longbow Securities

Okay. And can we talk a little bit about the guidance also, if you look at the implied guidance, you talked about 15% sales gain. That implies 11% sales gain in the second half of the year, a couple of quarters of close to 20%. And you gave me some indication that the EBIT margin drops were like 9.4 % I think from double-digits. Can you give us more color on what's the big sales change, is it the comparisons, is it... just to get an idea what's going on to drive the sales number dramatically downwards? I mean I think, by the way, you've been using a higher number in sales anyway, so just to get a feel for what went wrong with the sales, and is it more than just the material cost and the inefficiencies, is there anything else on the JV income that we should know about lower EBIT margin?

Patrick (Pat) J. Ward - Vice President and Chief Financial Officer

Sure. Eli, this is Pat. On the sales, I think the comparisons are a little bit difficult. When you look at the first half of 2008 and compare it to the first half of 2007, remember it is a very light first quarter in 2007. So, we always expect that first half bump to be of a fairly significant magnitude. Second half will be up; second half will be up around 11% compared to the second half of last year. What you always see and what you probably figured there already from the guidance is that the earnings before interest and tax will continue to grow at a higher rate than sales even through the second half of the year. I think Tim pretty much covered the key deltas, what Tim was expecting earlier on was the delta from the first half performance to the second half performance, and he pretty much captured all the salient point though.

Eli Lustgarten - Longbow Securities

Okay. And can we talk a little bit about the power gen market which seems to be on fire and continues to be on fire [indiscernible] how much more is pricing? Is there a strengthening demand and can this demand level continue over into next year? That's probably the biggest wildcard that we'd worry about more than anything else.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Before Tom answers that, you had a second part in your question about is there anything going on with the JVs other than what we talked about, and the answer is no. The JVs are doing fine.

Eli Lustgarten - Longbow Securities

Yes, you raised your guidance from 10% to 15 % from up 5% to 10%, is that because of the second quarter result more than anything else?

Tom Linebarger - Executive Vice President and President - Power Generation Business

Yes.

Eli Lustgarten - Longbow Securities

Yes. Okay. Can you talk a little bit about the power gen market as we look out --

Tom Linebarger - Executive Vice President and President - Power Generation Business

Yes. power gen, yes... power gen we do think we do expect it next year to continue to be strong. The trend that Tim talked about in his overall remarks about trends with regard to energy requirements are continuing to drive the market and developing countries especially are adding infrastructure at a rate that's driving significant growth in those markets. So, we do see more international business today obviously than US business, and particularly in some of these developing countries is our bigger percentage of the total. But we're pretty, broadly diversified across the markets. We have standby and prime power products now and we have a very strong distribution capability building up over the last five or seven years going from some distributors were okay and some were good. Now we have most on-board pretty capable Power Gen distributor. So strong markets and strong capability are, we think driving the market.

Eli Lustgarten - Longbow Securities

How much more pricing then you had... I think you indicated that was a part of the second quarter strength that we didn't expect.

Dean A. Cantrell - Director of Investor Relations

We have... yes, the pricing... there is no surprises in the pricing. The pricing has been pretty steady. We've been trying to put in price increases each year and try... again we've kind of giving guidance that we're sort of 4% to 5% is what we are aiming for across the year. They phase in because you're dealing with orders that are already in the books, we are not going to increase the prices, but you're looking for new orders coming in. And since there's lead times in there, they phase in. But... and they are done regionally rather than globally, but all in, I think 4% to 5% for this year and again as long as we continue to see strong markets, and increases in cost factors, we'll try to continue to push prices to the market next year too.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

One other thing on looking at next year, I'll remind you. We've been capacity constrained both on high horsepower engines above 30 liters and larger alternators. And we have increased the capacity this second half, are increasing the capacity, high horsepower engines above 3 liters by 15%, and we will do another 15% on top of that for next year, and we are also matching those capacity increases with our alternator business. So we still right now have lead times in the high horsepower of over a year. So with this capacity online we think we'll be able to one, lower some lead times, but two, we'll increase the business.

Eli Lustgarten - Longbow Securities

Right. Thank you very much.

Operator

Your next question comes from the line of Charlie Rentschler from Wall Street Access . You may proceed.

Charlie Rentschler - Wall Street Access

Thank you. Great quarter. I am really happy to see components doing so well. That's always been the red haired stepchild. My question, you commented Tim about [inaudible] but the other piece of that Fiat deal which was dissolved, can you comment about why that happened and what are the implications for Cummins, the European [inaudible] or whatever you call it?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Yes. The other part of the deal, Charlie, was really a three-way joint venture in Turin making blocks and heads, a joint venture between Iveco, CNH and Cummins. And frankly it made no sense, practical sense for us to remain involved in that as one-third owner, investor in the business. So, basically we worked out on arrangement with our long time partner to basically swap assets in a way that works for both companies. So, Case will continue, CNH will by the way will continue to be a loose engine customer in the heavy-duty size as they are today and continue to be a customer for medium duty engines at least through 2013 based on the arrangement we've made with them. So, as Tim said earlier, very amicable parting, the CDC has been a terrific partnership for both companies and just given things that have happened over time, our strategic interests have varied enough that both parties felt like it was time to amicably end a great partnership and move on.

Charlie Rentschler - Wall Street Access

Okay. And as a second question, is Cummins continuing to look for more joint venture deals around the world? Can we expect more of this coming?

Joe Loughrey - President and Chief Operating Officer

Well, Charlie, it's Joe again. I think joint venture deals are a means to an end, all right, not an end. So, Cummins continues to look for new markets everywhere where we can bring our skills and products, current and future, to bear in capturing new customers and new profitable growth. And from time-to-time the method we will use to do that will be a joint venture with a partner, with whom we have enough in common. So, we're chasing like hell and I'm sure the team will continue to chase like hell, new opportunities everywhere and will use joint ventures as the method or means where it makes best sense to ramp up fastest and most profitably.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

I would say Charlie that any one point in time there is probably two to three potential joint venture partners that we're talking with or they are talking with us. So, our joint ventures is a really important part of the overall strategy, the corporation and we feel that our expertise and capability there is good and unique and we do that better than historically we've done in mergers and acquisitions, so that's why we do joint ventures.

Charlie Rentschler - Wall Street Access

Okay. Thank you.

Operator

You next question comes from the line of Henry Kirn from UBS. You may proceed.

Henry Kirn - UBS

Good morning, guys.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Good morning, Henry.

Henry Kirn - UBS

A question for you on the shift of 13 liter engines to 15-liter engine or vice versa, how do you expect that to play out as we approach 2010 and then as we get past that?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Good question, don't really know. But there has been a lot of talk for many years about some shift from higher horsepower engines to... sorry higher liter engines, 15-liters to 13... 12 to 13-liters engines. There's been a lot of conversation about that possibility, but very little has actually happened if you look over the period of time of the conversation itself. And so, as we look to the future, while we remain focused on the possibility of that to make sure we're paying attention and we are in the game with our 11.9-liter engine, we are feeling as though going up to 2010 and beyond 2010 that 15-liter engines are going to be a strong offering given the power they bring for the job and the efficiency with which they run versus the alternatives. Now, the question will really be determined to large extent by what I said earlier and that is how good do these 12 and 13-liter engines turn out to be. We know what we offer the marketplace is terrific and how good do they turn out to be versus what we will also offer at the 11.9-liter range and that will be the determining factor in the future. In the mean time, between now and 2010 and at least for a period of time after 2010, we think 15-liter will hold its own very strongly.

Joe Loughrey - President and Chief Operating Officer

One of the factors that's been again through the years is the 15-liter truck holds its resale value. So, it factors into the total cost of operations. And so, I think it will always be given the mission of that truck, it will always be a significant part of the market.

Dean A. Cantrell - Director of Investor Relations

And clearly as we look over into China, and where we see the truck market starting to migrate forward into larger trucks, larger displacement engines, we're obviously are positioning ourselves there today with the 11-liter engine in our joint-venture with Shongqing, but we're also in the process of launching a 13-liter engine in cooperation with our Dongfeng Cummins joint venture in China, so that we will be very well positioned in every displacement size for the on-highway markets in China.

Henry Kirn - UBS

Okay. And on the light-duty market how bad do you think that end market could get over the next six months to a year. When do you expect it to bottom? And then on the pricing in that market have you seen any pricing degradation from the weakness?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

You are talking about the --

Henry Kirn - UBS

The light-duty auto and truck market?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Okay. The businesses that we have with Chrysler and RVs and that business --

Henry Kirn - UBS

Right.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

-- is light-duty is the one we refer to that as smaller engines that we're introducing in 2010.

Henry Kirn - UBS

Okay.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

So, you're referring to today's business?

Henry Kirn - UBS

Yes, today's business?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Okay. Now I think, as I said, it's down 50%. We don't anticipate it getting worse although there is still a lot of uncertainty in that market. So, it's going to... that market is going to be flat for next year. And as far as pricing is concerned, I think that truck particularly the 35... the heavy-duty pick up truck is really held its won, and I think it will be able to maintain its price in the marketplace.

Henry Kirn - UBS

Okay. Thanks a lot, good quarter guys.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of Joe Otis [ph] from Buckingham. You may proceed.

Unidentified Analyst

How is it going, guys.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Hi, Joe.

Unidentified Analyst

I wonder... you sort of skated around one part of Ann's question earlier that we heard Pat talking about stockpiling engines and I just wonder if that had any impact on the second quarter or say in the first half just so we can gage 2009 relative?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

From a Cummins point of view?

Unidentified Analyst

Yes.

T. M. (Tim) Solso - Chairman and Chief Executive Officer\

Minimal impact.

Unidentified Analyst

Okay.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

In the first half in terms of shipments and that's what you're after from a Cummins point of view.

Unidentified Analyst

Right. Okay. And then can you give us a little bit more granularity on what's going on at some of the end markets in China, India and Russia as well? We hear a lots of wiggles back in forth and it's hard to tell what the real trends are and I think you guys will deal lot closer on the ground to some of what's going on there?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Well, in India the power generation business continues to be very, very strong and we would expect that to continue. The truck engine business has been good and the components business is associated with that is good. And as in China the infrastructure development of roads and so forth play into the businesses that we have. So the end markets almost across the board in India are very strong. It's similar in China, although again because of the Euro 3 introduction, we would expect the truck markets to be down somewhere in the 50% range for the rest of this year. But if you look at on a long-term basis their highway system will be second only to the United States and they are going to go to more trucks, bigger trucks, it won't go faster. So as Dean said I think we are covered. If you look at mining, you look at power generation, it's still very strong in the high-end and it fluctuates on the lower end, but those markets are good. As far as Russia is concerned, oil and gas, mining, large power generation continues to grow and is very strong and then we have the truck engine joint venture with KAMAZ. And while that is not large volumes compared to what we do in some other places, it is a growing business and we have an foothold there, and again their domestic truck market is going to become a strong market over a period of time and will be a player there.

Dean A. Cantrell - Director of Investor Relations

And I think just to round out the BRIC countries, Iet's talk about Brazil. Right now we are seeing, the Brazil truck market is been up about 30% year-to-date, so we are seeing a lot of strength their. Obviously we have a market leadership presence in Brazil in the truck market their with about a 34% market share. We are also seeing strength in the construction markets in Brazil in addition to the agricultural markets there. So, kind of rounds it out for all of the four BRIC countries.

Unidentified Analyst

Okay. And as long as we are doing the global talking, can you just update us on your South African plant... some of the productions issues that we had before. It sound like they are starting to work their way through?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Yeah, doing much better. I mean, we are not everywhere where we want to be, but we spent a lot of time there. There have been significant improvements in manufacturing efficiencies and flow. Over time is way down carefully; airfreight is way down, those are contributing factors to why the Components group in general did much better. So we talked about in general manufacturing efficiencies being better well as it relates to the South African plant overtime and freight, airfreight are significantly down enabling us to improve profitability.

Unidentified Analyst

Okay, great. Thank you very much guys.

Dean A. Cantrell - Director of Investor Relations

I think we have time for just one more question.

Operator

Your last question comes from the line of Seth Weber from Banc Of America. Please proceed.

Seth Weber - Banc Of America Securities

Hi thanks. Good morning everybody.

Dean A. Cantrell - Director of Investor Relations

Good morning, Seth.

Seth Weber - Banc Of America Securities

Just following up on Henry's question, I think you... on the light-duty business, I think you took some actions there recently. But in the event that the business continues to get worse, do you have contingency [ph] plans in place or are there more leverage that you could pull if you continue to see weakness there?

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Simple answer to your question is yes. I mean most of the actions we have taken recently while we have adjusted headcount at CMEP have been part of our[inaudible] defense activity in our plants and in this case with our local union, the diesel workers union, and has involved really two things. One is some employees choosing to take voluntary leave for a portion of the summer and that has helped us reduce employment in the plan and the other is, we have both needs in some of our other plants, in Southern Indiana, that our... where business, their business has been growing and have a need for people who also use some temporary folks. So we have moved people from the CMEP plant to the other plant to help out the other plants while this is going on. And so we have what we call our range and defense and will work our way through that range and defense process if we need to with any future volume adjustments.

Seth Weber - Banc Of America Securities

Okay, thanks. And then just a quick follow-up on the pricing question. I mean, can you give us an idea where you feel like you have a better ability to adjust to prices or to rising input cost more quickly across your categories. Maybe some business are in the shorter order or you just have more... feel like you have more pricing power with the customer, can you just give us an idea where you think the best, better or worse across your portfolio?

Tom Linebarger - Executive Vice President and President - Power Generation Business

This is Tom. I think a simple way to think about it is that we have some products in markets where we're selling directly to end-users and some that were signed OEMs. In general those that were signed directly to our end-users, you can respond more quickly, and more broadly by region, and those with OEMs, tech negotiation. That's just typically the way it is. So you in power gen markets and parts business and distribution business, we typically can raise prices faster than we can in an OEM businesses which take like the engine business in some of that components. But in fact all of them we move prices up over some period of time and we respond input prices as one of the reasons where we're raising prices.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

But in our long-term agreements with the large OEMs, we do not have the ability to price. In some cases, we can pass on some of the material cost increases, but we don't price. The only time we really... price in those markets is when we're introducing new technology, and wherever we introduce new technology, we do price for that. I think in the components businesses, a couple of those businesses have been very aggressive on the pricing, even with the existing contracts or in the case of our filtration business we just got out of some businesses. So if we can see a way of earning a return on our capital, an acceptable returns, then we've exited those businesses. So, again a lot of times the pricing really happens in the January timeframe and a lot of times that doesn't kick in until the middle of the year. We're doing some pricing for the second half of the year as well.

Seth Weber - Banc Of America Securities

Okay. Thanks very much.

T. M. (Tim) Solso - Chairman and Chief Executive Officer

Thanks.

Dean A. Cantrell - Director of Investor Relations

Well, thank you everyone for joining us today for our second quarter earnings call. And again just as a reminder, I would ask that you save the date for November 12th, in Charleston, South Carolina, where we are going to hold our Analyst Day focusing on the Components segment. Thank you everyone and I will take questions in my office later today, thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Cummins, Inc. Q2 2008 Earnings Call
This Transcript
All Transcripts