As a reminder, this call is being recorded for replay purposes. I'd like to turn the call over to Mr. Mark Smith, Executive Director of Investor Relations. Please proceed, sir.
Thank you, Ian. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the first quarter of 2013. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger, our Chief Financial Officer, Pat Ward, President of our Engine Business, Rich Freeland. We'll all be available for your questions at the end of our prepared remarks. Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs, and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties.
More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed annual report on Form 10-K and any subsequently filed quarterly reports on Form 10-Q. During the course of this call, we will be discussing certain non-GAAP financial measures, and we refer you to our 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 are available on the website at www.cummins.com under the heading of Investor and Media. With that out of the way, we'll begin with our Chairman and CEO, Tom Linebarger.
Thank you, Mark. Good morning. I will start with a summary of our first quarter, including comments on performance of our businesses. Then I will talk about our outlook for the full year. Pat will then take you through more details of our first quarter financial performance and our full-year forecast. As anticipated, we experienced weak demand in a number of our end markets and geographies in the first quarter. Revenues were $3.9 billion, a decline of 12% year-over-year. EBIT for the quarter was 11.1% of sales, compared to 14.7% a year ago. Excluding the impact of acquisitions, all four businesses delivered reductions in SG&A costs for both year-over-year and sequentially, due in part to the restructuring actions we implemented last quarter. The components segment delivered very strong results this quarter, delivering record gross margins despite revenues being down 7% year-over-year.
EBIT was 11.7%, down from 13% a year ago, due to lower volumes and higher research and development spending to support future growth. However, EBIT percent improved 280 basis points from the fourth quarter due to higher volumes and overall cost improvement. We expect that the components segment will continue its strong performance this year as demand in on-highway markets in North America improve from first quarter levels. We have raised our full-year EBIT guidance for the components segment, as Pat will cover in more detail. First quarter revenues for the distribution business were flat year-over-year. EBIT margins at 12.2% increased 10 basis points compared to a year ago and improved 140 basis points sequentially due to a strong mix of aftermarket revenues. Our full-year EBIT guidance for distribution is unchanged.
The engine business experienced the most significant decline in demand, with unit volumes down 18% year-over-year and revenues lower by 19%. Unit shipments of high-horsepower engines declined by 24% due to weakness in mining, oil and gas, and power generation markets. EBIT margin for the quarter was 8.5% compared to 13.3% a year ago. Engine business margins were negatively impacted by the lower volumes, especially the sharp decline in shipments of high-horsepower units, as well as higher warranty costs. Performance in our power generation business fell short of our expectations in the first quarter. EBIT margin was 6.8%, down from 9.7% a year ago and the lowest level since the first quarter of 2010. As a result of the weak performance in the first quarter, we have lowered our guidance for power generation for the full year.
However, we have not changed our expectations for the business for the rest of the year, as we believe Q1 was a low point. In total, while we have adjusted our guidance up for components and down for power generation, we are not changing our overall guidance for the company. We still expect revenues to be flat to down 5% for the year, and we still expect to deliver EBIT in the range of 13%-14% of sales. Now, I want to talk in more detail about our sales and our key markets. As I said, overall company revenues declined by 12% in the first quarter, with revenues in North America declining 15%, international revenues declining 10%. In North America, our revenues were most heavily influenced by a decline in on-highway markets.
Our shipment of engines for North American heavy-duty trucks were 19,000 units in the quarter, a decrease of 37%. Demand declined as our industry continued to run at lower production levels following a period of overproduction in the first half of 2012. Retail sales for the industry have exceeded industry production for the last six months, and OEM backlogs are increasing. We do expect to see sequential improvement through the year, driven largely by replacement demand. For the full year, we are adjusting our forecast for the market size to 233,000 units, down from our previous forecast of 240,000. Our market share for the quarter was 41.6% through February, and we are maintaining our full-year market share forecast of 40%. We shipped 11,000 units to the U.S. medium-duty truck market this quarter, a decrease of 23% year-over-year.
Demand is expected to increase in Q2 and beyond as OEMs continue to ramp up their production of 2013 models. We continue to expect a full-year market size of approximately 109,000 units in 2013, an increase of 2%, and our market share to be approximately 52%. Demand from Chrysler decreased in the first quarter by 17% due to the planned model year changeover that started in January. For the full year, we expect shipments to decline by 10%, in line with our previous forecast. Our international revenues decreased by 10% in the first quarter of 2013, with the most significant declines in Europe and China and relatively flat markets in Brazil and India. In the Brazilian truck market, our unit shipments increased by 20% compared to very weak levels last year.
We are raising our estimate of 2013 industry sales to increase 19% compared to our previous forecast of an increase of 15%. We continue to be cautiously optimistic about improvement in the Brazilian economy, although truck industry sales declined 8% in quarter one, and industry inventory increased by approximately 12% from fourth-quarter levels. Continued growth in the economy and the availability of credit will be important factors determining full-year truck demand in Brazil. In total, our revenues in Brazil declined 8%, with the improvement in the truck demand more than offset by the impact of depreciation of the real against the U.S. dollar. Moving to China, o ur first quarter revenues in China, including joint ventures, decreased 11% year-over-year, with the decrease due to lower demand in most end markets. Demand for excavators remained weak in the first quarter, with industry sales down 26%.
We did observe a modest reduction in inventory levels at OEMs in the first quarter, but we continue to believe that it will take most of the year to normalize industry inventory levels. Our forecast for our own revenues in the construction market has not changed significantly in the last three months, with no growth expected in engine shipments this year. The truck market in China for medium and heavy-duty trucks combined declined by 12% in the first quarter, as uncertainty over the strength of the economy continued to impact the industry. The revenues of our Dongfeng Cummins joint venture were down 11%, in line with the market. We expect a modest increase in orders for the second quarter, and at this time, we are maintaining our full-year forecast for industry sales to be flat year-over-year.
Having said that, actual industry behavior is going to be heavily influenced by the final implementation rules for the new NS4 emission standard scheduled for July of this year. Just last week, there was a meeting of the largest eight domestic truck manufacturers, the so-called C8, and out of that meeting came a set of recommendations to the government on how to proceed with the implementation of NS4 regulations. We are still evaluating these recommendations. However, on first review, it appears that the truck manufacturers are seeking a phased approach to NS4 implementation, which would likely defer widespread adoption of fully compliant solutions, including aftertreatment, to 2014. It is not clear at this stage what impact, if any, these recommendations will have on the government's approach to implementation of NS4 or even when the government will respond to these recommendations.
As a reminder, our current forecast assumes slow adoption of aftertreatment in 2013. Volume and revenues at our light-duty joint venture with Foton continued to grow in the first quarter, with revenues for the domestic market up 90% off a low starting point. We continue to have high expectations for the growth of our light-duty engines, both in China and in other markets. The joint venture is now consistently operating above break even. Power generation revenues, including joint ventures, declined 13% year-over-year, with the pace of industrial activity in China still relatively weak. Orders for the second quarter currently indicate a modest improvement from the first quarter, and we expect the full year to be at least flat with 2012 levels. For the full year, we still expect total revenues in China to be up 5%, with growth in light-duty engines driving the increase.
First quarter revenues were in line with expectations, and our current full-year forecast is unchanged. In addition to the market-specific factors I have discussed, uncertainty remains about the rate of improvement of the Chinese economy as a whole, and we continue to monitor conditions in China very closely. Business conditions in India have weakened further, and we are lowering our outlook for the truck market. In prior calls, I' ve discussed measures taken by the government to address the fiscal deficit that have not been helpful to truck demand. Road building has also slowed in India, and overall confidence for capital purchases has weakened. Industry sales for the medium and heavy commercial vehicle market declined 33% in the first quarter. We are lowering our full year view of the market and now expect a full-year decline of 14% compared to our previous expectation of a decline of 5%.
In the power generation business, we experienced an 11% growth in revenues in the first quarter, driven by continued power shortages in the country. As a result, our full-year forecast is that revenues will grow by 10% despite weaker economic conditions, though clearly, the outlook is more uncertain. In Europe, we experienced a 12% decline in revenues year-over-year, with the power generation business most negatively affected. Power generation revenues in Europe were down 45%, with demand in Russia notably weaker in the first quarter. We do expect revenue growth for our components business next year with the introduction of Euro 6 emissions regulations, but for this year, Europe will remain challenging across all of our businesses. I will conclude my market comments with an update on our mining business. Three months ago, we predicted that our full-year revenues, including aftermarket, would decline by 25% for the full year.
Actual first-quarter revenues declined by 28%. Overall customer sentiment has been a little more negative over the last three months, and our revised mining revenue guidance is for a decline of 27%. Not a significant change, but certainly, we do not see any signs of improvement in the near term. Aftermarket revenues were down year-over-year but in line with the fourth quarter levels. Although uncertainty exists in a number of markets, we do expect that the first quarter marks a low point for revenues this year, and we expect to see sequential improvement in revenues driven most significantly by on-highway markets in North America, in which we have strong market share for engines and components, and by the construction market in North America. Power generation demand should also improve from first quarter levels, driven mostly by seasonality and increasing demand in North America.
I've covered a lot of ground on markets, but before I turn over to Pat, I would like to share some of the recent company news that highlights the strength of our partnerships and our ongoing focus on bringing new products to market. At the Mid-America Trucking Show in March, we revealed the new integrated engine and transmission combination of a Cummins ISX15 engine and Eaton transmission that will deliver both improved performance and 3%-6% better fuel economy for truck customers. Also at MATS, we highlighted the new Cummins Westport ISX12 G natural gas engine that is now in limited production and is generating a lot of interest among end users. At the recent bauma show in Munich, we displayed three all-new off-highway engines: the new QSM12-liter engine, the QSF3.8-liter engine, and the L9.3, made at our Guangxi Cummins Engine joint venture.
These engines are designed to offer leading performance and emissions at world-class cost levels for off-highway equipment. They are also the most recent examples of a strong pipeline of new products that will help drive strong, profitable growth as our global markets improve. Thank you for your interest today, and now I'll turn it over to Pat.
Thank you, Tom, and good morning, everyone. First quarter revenues were $3.9 billion, a decrease of 12% from a year ago, reflecting expected weakness across many markets and regions. As I said during the fourth quarter earnings call, we expected a tough first quarter, and it came out pretty close to what we were thinking back then. North America sales, which represented 50% of our first quarter revenues, were down 15% from a year ago, primarily as a result of lower demand from on-highway markets and also continuing weakness in the oil and gas market. International sales decreased by 10%, driven by weak demand in both power generation and in mining markets. Compared to the fourth quarter of 2012, sales were down 9%.
The decrease was driven by weakness in the North American bus market following the emissions change and in the Chrysler business due to the planned model year changeover, which occurred in January of this year. Mining revenues also declined sequentially as we had projected, and we experienced normal seasonality in the distribution and power generation businesses. Gross margins were 24.4% of sales, down from 26.8% last year. The decrease was driven by the impact of the reduced volumes, unfavorable mix, and higher warranty costs, partially offset by the benefit of improved pricing and lower material costs. Margins also decreased compared to the fourth quarter of 2012 due to reduced volumes and an expected increase in our warranty costs. Selling, admin, and research and development spending was down $30 million from last year and down $7 million from the previous quarter.
Both the sequential and year-over-year reduction in spending was concentrated in administration expenses. Joint venture income of $82 million was down 21% compared to a year ago and was flat compared to the prior quarter. The year-over-year decline was driven by a lower contribution from our joint ventures in China and in India, where truck demand was lower compared to the first quarter of 2012. Earnings before interest and tax were $437 million, or 11.1% of sales. This compares to 14.7% of sales last year and 12.4% in the previous quarter, excluding special items. As Tom said, we expect this to be the low point of our performance this year. Earnings per share in the first quarter were $1.49 compared to $2.38 a year ago, with a tax rate of 27.6% in the quarter.
Now, let's move on to the operating segments and further discuss first quarter performance and the outlook for the full year. All the numbers and comparisons exclude the $52 million pre-tax or $35 million after-tax restructuring charge that we took in the fourth quarter of 2012. In the engine segment, revenues were $2.3 billion, a decrease of 19% over last year. The decrease was driven by weak demand in on-highway and oil and gas markets in North America and by a 28% decrease in global mining revenues. This weakness was partially offset by improving demand in the Brazilian truck market, where revenues were up 26%, and across global agricultural markets. Compared to the prior quarter, sales were down 8%. Sequentially, we experienced weaker demand for Chrysler and North America bus engines, along with weakness in mining and in oil and gas markets.
Segment EBIT of $195 million or 8.5% of sales was down from 13.3% last year as a result of weaker volumes, unfavorable product mix, higher product coverage costs, and a lower joint venture contribution. This was partially offset by improved pricing and lower material costs. Sequentially, the decline in volume, a more unfavorable product mix, the higher product coverage costs, and increases in research spending resulted in lower margins. For the full year, we continue to forecast that revenue for the engine segment will be down 5%, driven by weakness in industrial markets, particularly in mining, p artially offset by improved demand in the Brazilian truck market. EBIT projections for the full year remain unchanged at 10%-11% of sales. In the component segment, first quarter revenue was $1 billion, down 7% from last year and up 8% from the prior quarter.
Compared to the prior year, the lower revenues were primarily driven by reduced demand in the North American heavy duty truck market and lower demand in Europe, partially offset by increased demand in Brazil. Sequentially, sales increases were driven by strengthening North American and Brazilian truck markets. Segment EBIT was $119 million, or 11.7% of sales, down from 13% last year. Continued technical investment on lower sales and higher coverage costs resulted in lower margins compared to a year ago. Compared to last quarter, EBIT margins increased almost 300 basis points on an 8% increase in sales. The sequential increase in margins was driven by higher volumes, improved pricing, and lower material costs.
We continue to expect revenue growth of around 2% this year, primarily as a result of increased penetration of after-treatment systems in the North American heavy-duty truck market and growth in the Brazil truck market being offset by weaker demand in both Indian and European truck markets. We are raising EBIT projections for the full year from 10.5%-11.5% of sales to 11%-12% due to strong gross margin performance. This compares to our full year 2012 margin of 10.8% of sales. In the power generation segment, first quarter sales were $746 million, down 4% from last year and down 2% from last quarter. Year-over-year, we saw weakness in Europe and Russia, partially offset by increases in India and in our North American military business. Sequentially, we saw deterioration in Europe and Russia, partially offset by continued strength in India.
EBIT margins were 6.8% of sales in the quarter, down from 9.7% last year. While lower volumes and an unfavorable mix contributed to this drop in profitability, we also had some unplanned costs that negatively impacted margins, including warranty costs in our alternator business and some gas project costs that were higher than we expected. We expect to see improvement in the second quarter as these costs don't repeat and volumes improve sequentially. EBIT margins were slightly lower than those reported in the fourth quarter as a result of higher product coverage costs, partially offset by reduced administration expenses and increased pricing. For 2013, we continue to expect sales to be down 3% compared to last year, primarily due to weakness in Europe and in Russia.
We are lowering our EBIT projections for the full year from a range of 9%-10% to a range now of 8.5%-9.5% of sales. For the distribution segment, first-quarter revenues were $778 million, an increase of less than 1% compared to the prior year and a 14% reduction compared to the prior quarter. During the quarter, the distribution segment acquired a North American distributor, which added revenue of $21 million. Excluding acquisitions, first quarter revenue decreased 11% compared to the prior year and 17% sequentially. In both comparisons, organic growth was lower due to weaker demand in power generation markets in Europe and in Russia, North American oil and gas markets, and global mining markets.
EBIT margins for the quarter were 12.2%, flat with margins a year ago, with positive mix being offset by reduced joint venture contribution and higher selling and administration expense, which were both impacted by acquisitions. Compared to last quarter, EBIT margins improved by 140 basis points, driven by positive mix and higher joint venture contribution. For 2013, we continue to forecast 10% growth in revenue over the prior year, including the impact of acquisitions, and expect EBIT margins in the range of 11.5%-12.5% of sales. As Tom mentioned, we continue to project total Cummins revenues to be flat to down 5% in 2013, with sequential improvement throughout the year, driven mostly by recovery in the North American on-highway markets, with modest improvements in a number of international engine and power generation markets also contributing to higher revenue starting in the second quarter.
We continue to project EBIT margins for the company will be in the range of 13%-14% of sales, compared to 13.6% last year. As we discussed on the prior quarter's call, for the full year, we expect pricing to add 50 basis points-100 basis points of margin and lower material costs to also benefit margin by 50 basis points-100 basis points. These will help offset the headwinds from lower volumes and unfavorable mix, as well as from higher product coverage costs. We are now projecting a tax rate for the year to be around 29.5%, excluding any discrete items. The increase in the rate over last year and over previous guidance is due to changes in the geographic mix of forecasted earnings. Finally, with regards to cash flow, we produced $428 million in cash flow from operations in the first quarter.
We did increase inventory levels in the quarter. In the fourth quarter of last year, we knew that some parts of the business would have very low volumes at the start of the year. For example, in our manufacturing plant that supplies Chrysler, we knew that with the model year changeover volumes, we'd be very light at the start of the year, so inventory levels were cut back at the end of the fourth quarter. Also, in some parts of our business, we expect that second quarter demand will be higher than first quarter. For example, parts of the engine and components businesses that supply on highway markets in North America. So inventory has increased in those locations.
In the parts of the business with the weakest outlook for the year, for example, in our high- horsepower engine business, we have made good progress in reducing inventory and continue to reduce inventory levels throughout the first quarter. There are always opportunities to improve our inventory management. We're not suggesting it was perfect globally, and we do expect inventory and working capital metrics to improve as the year progresses. Overall, we did reasonably well in managing cash flow in the first quarter. The company's financial strength is reflected by a single A credit rating from both Fitch and from Standard & Poor's. In addition, Moody's recently upgraded our unsecured debt rating to single A3 status. The strength of our balance sheet allows us the flexibility to continue to invest back into the company and also return value to our shareholders, even during periods of volatility.
As we discussed on our last call, we expect to invest $850 million in capital expenditure projects this year. We announced a new $1 billion share repurchase program last year and have started to repurchase stock in April and will continue to do more in the second quarter. Over the last three years, we've almost tripled our dividend and remain committed to further increases in a stable and sustainable manner. We are well positioned to continue to return cash to our shareholders in addition to funding our organic growth plans. The first quarter results represent an expected trough in both sales and profitability for the company in 2013 based on our current view of global markets.
Although revenues were down across most major markets, there are signs of improving demand from these low levels, particularly in on-highway markets in North America, where we continue to have a very strong market share. Now, let me turn it back over to Mark.
Thank you, Pat. We are now ready for questions. Please limit yourself to one initial question and one related follow-up, and then rejoin the queue. Operator, we are now ready for questions.
Thank you. Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touch-tone telephone. If your question has been answered or you wish to withdraw your question, press star followed by two. So that is star, then one to begin. Please stand by for your first question, which is from the line of David Leiker at Baird. Please go ahead, David.
Good morning, everybody.
Hi, David.
Morning.
Just want to make sure, one item first, and then to follow up on that. It sounds like this first quarter results were as you expected them to fall in the quarter. Is that accurate?
Yes.
Okay. If we look through the balance of the year, it looks like most of your end market assumptions really don't assume any sequential improvement in demand. Year- over- year, you have comps, but sequentially, it seems like you're expecting something pretty similar to what we saw here in the first quarter. Maybe North America truck will look better just given where the build rates ended up there.
I think if you look at the guidance we've given for the full year, David, we do expect sequential improvement in revenues beginning in the second quarter. We think that will help provide a platform for improved margin performance, too, for the company throughout the remaining three quarters of the year. The first quarter, as you mentioned, was expected to be low. As we went through the quarter, it was encouraging to see that the performance, both at gross margin level and at an EBIT margin level, improved month after month. So we started off the quarter close to 10%. We finished off the quarter close to 13%. So that made me feel good that we've got momentum going into the second quarter that can carry us forward towards this guidance.
Maybe it is more accurate to say, given the current level of demand that you are seeing here in April, that things generally are sequentially at the current pace. Is that fair?
Yeah, that's generally fair. The only thing I guess I would add is that, as I mentioned in my remarks, power gen was lower in margin than we expected. That was the one that-
Right.
Did get a disappointment. There were a number of items that occurred in the first quarter we did not expect. But overall revenue levels for them, even for them, we thought were right. The second thing that happened, as Pat was mentioning, our January was weaker than we expected. We had a lot of bus orders and other pre-buy orders at the end of last year. I will let Rich give you more details on that, but it just slowed down our first quarter, and as I talked about in my remarks, mining weakened even a little bit further. So things were weaker in January.
But again, as Pat said, we really started to strengthen through the quarter, and it began to look more like we expected in total for the quarter with the right trajectory. Now, we are expecting sales to improve Q2 through Q4 as we had planned. Again, it's not major market recoveries. Right?
Right. Okay.
It's like exactly-
I guess what I was trying to get at is-
Yeah, it's not. North America, as we said, people were basically producing below demand, and now they're going to-
Right.
Step up and produce a little above demand. We have seasonality in power gen, so there's nothing dramatic, but the result across all those markets is a reasonably decent step up in sales as expected, and without this kind of major adjustment in January that we had to fight through. Those things combined lead to better results. We also, of course, finished all of our restructuring actions. Those are all through. We're seeing benefits of those in our expense line. So we feel pretty good about the margin step-up we've laid out through the quarter.
Yeah, great. What I'm trying to get at, I guess, is that when you look at some of these end markets for other industrial companies, there's expectations that the second half is significantly better than the first half. You look at Eaton's estimate for Q4 North America truck production at 78,000. You're not baking those types of assumptions into your numbers, it sounds like.
Yeah. I'll let Rich get. That's a good question, so let me let Rich comment on North America truck.
Yeah, let me do it. Let me just add one more bit of technicolor around the mid-range side. Where we got a little surprised, quite frankly, was in the mid-range side around bus, RV, fire truck. We saw OEs increase their orders in Q4 and basically bought most of their Q1 demand in Q4. We got a little positive surprise in Q4 on that and a bit of a negative surprise on Q1 on that. That was part of the, we've seen that come through, and we've seen orders get back to kind of a normal rate kind of at the end of March, early April. On the heavy duty side, we've taken our overall forecast down from 240 to 233. That does imply an increase sequentially through the year, if you do the math on that.
Right.
While we do not give quarterly guidance, we are seeing that increase in production rates has started here in Q2, where we forecast it to be to get to that 233 rate.
Right. There is no magic surprise in Q4. We are already seeing build rates come up now, I guess, is the main point there.
Perfect. Thank you very much.
Thank you. We have another question for you. This one is from the line of Jerry Revich at Goldman Sachs. Please go ahead.
Good morning.
Morning, Jerry.
I'm wondering if you gentlemen can flesh out a couple of assumptions behind your guidance on the Navistar aftertreatment business. Specifically, what kind of sales contribution are you assuming, and what is your heavy-duty truck market share assumption? Tom, did I hear you right? You're assuming 52% market share in medium duty, where I think you are running a couple of points ahead of that in the first quarter. Would you mind just fleshing those points out a little bit?
Yeah, I think I'll let Rich add, if he wants to. I think heavy duty, medium duty, we are thinking 40% heavy duty, 52% in medium duty, and both of those were a little ahead in the first quarter. Basically, our general view is those things fluctuate based on the market shares of the end-use truck manufacturers and other variations. That's why we do it. We look across the year and take an estimate based on those fluctuations. We don't see major changes happening. It is the same progressions we have seen across all the markets. So far, we have seen good strength for people using our products, good feedback on our products, so that all remains good. With regard to aftertreatment systems, as you know, we did get our system on the 13-liter engine Navistar approved by the EPA. That was good news.
We don't give any specific forecast by customer on sales because obviously that's confidential to them, and those things vary quarter to quarter. But I would just say that we are pleased to see that. It was a lot of hard work by both companies to get them approved, and sales will start. They're starting now. They're Q2. We're going. So we're off and running on those things, which is a good sign.
Mark, you laid out pretty significant components content increase coming up on Tier 4 Final in one of the appendix slides here that you've used in the past. Can you just frame for us the Cummins opportunity on non-Cummins engines, and just help us understand the pace of the transition that you expect in 2014 versus 2015?
Yeah. So to comment on the pace, Jerry, I don't want to talk about so much on the new wins at this point in time. But on the pace, you've got the between 175 hp and 750 hp engine sizes going to Tier 4 Final next year. And quite frankly, the bigger dollar content per engine opportunity for components, both are important, but also comes 2015, 2016 on the high horsepower engines above the 750 hp. So those are going to come in two waves, if you like.
Yeah. Then we've also got, Jerry, remember, as I mentioned in my remarks, Euro 6 starting in 2014. So while we can't comment on individual wins until the customer does, because they still reserve the right to talk about their products, what I'd say is that we feel very good about our position with regard to Euro 6 and Tier 4 Final, both for our own products, but also for winning business with our components company on other people's engines. At bauma, for example, in Munich, Rich and I were both there, and if you looked around the construction business there, there were Cummins engines in just about every booth, except one or two obvious ones.
We were all over the show, and the reason is because we have a very good Tier 4 Final solution, and people see us as an opportunity to grow business both in their home market, but also as they spread their business internationally. I think our off-highway engine business, everything we said about people wanting to partner with us to be able to get the technology and to grow globally, was showing up there in that show.
Thank you.
Thank you. We have another question for you. This one's from the line of Jamie Cook at Credit Suisse. Please go ahead, Jamie.
Hi. Good morning, guys. This is actually Linda Yuan in for Jamie Cook.
Hi, Linda.
Hi. Could you go into a little more detail on your end market outlooks? I know you guys already went into mining, but sort of those other segments like oil and gas, ag, construction.
Yeah, sure. Okay. Construction for the full year, I think we're fairly flat across our markets. We had a fairly low Q1 in North America, following on from a weak-ish second half, but we do see improvement going forward. But in aggregate for construction across the globe, flat full year. Oil and gas is very weak, so we're going to be down heavy double digits still year-over-year. Natural gas prices have improved, but we still need to work through the excess equipment in the market in North America. We are seeing increased orders in China for oil and gas fracking engines, but the volumes there are still relatively low. And then mining-
Ag.
Ag is a relatively small part of our business, very low single digits, but up. It's one of the few segments that was actually up significantly in the first quarter, and will be probably up double digits for the full year, driven by North America and Latin America.
That is one of the questions we get is, why are we still seeing oil and gas business down with natural gas prices adjusting upwards? I think our view is that natural gas prices being up will certainly positively impact the industry. It just hasn't really that much yet. There is still a relatively high number of unused frack rigs out in the market, and while production has gone up, it has not gone up very much. So we still need gas companies to feel like the price is right, that they want to produce, put more out of the ground, and then they need to use up the frack rigs they have. So that's why we've still got a relatively conservative view. We do think the higher prices will help.
It just isn't going to do it yet, and it's going to still take a few more quarters, we think, before there's a move in our demand.
Okay, great. Moving over to engines, you guys saw a little bit of unfavorable mix this quarter. Going through the rest of the year, how should we expect that mix to trend through the rest of the year?
I don't think the mix is going to change very much as we go through the rest of the year. You heard Tom's comments in the mining business. If anything, it's a little bit more pessimistic than what we said three months ago. I wouldn't anticipate much change there. The one business that might be a little bit better, but only marginally, is power generation. That might pick up a little bit from a mix perspective more in the second half of the year, I would guess, than the first half of the year. But overall, I don't think we're going to see much change in the mix profile.
Great. Thanks, guys.
Thank you.
Thank you for your question. We have another question for you. This one's from Andrew Kaplowitz of Barclays. Please go ahead, Andrew.
Good morning, guys.
Hello.
Good morning, Andy.
Tom, so I like the color you guys gave on sequential margins in the quarter, but if you just take the quarter overall, if I'm doing the math right, it looks like almost 40% decrementals. It's not like you guys to some extent, and I guess maybe Pat, was there extra warranty costs that really threw the quarter off? I know R&D was up. What do you expect for that going forward? But I can't believe that you expected that result on the margin side. I know you talked about power gen being a little weaker than you expected, but on the engine business, that's what I'm focused on.
I think, Andy, it's exactly what we expected for the company overall. If I go back to, you obviously don't see the plan we share with the board, but if I look at our first quarter plan, where we came in, both on revenue and profits, it was within a very small range of number of a difference. So engine business came in exactly where we thought. We knew the margin was going to be hit because of the unfavorable mix with mining. They were taking a much higher warranty cost with the higher accrual rates in the 2013 engines. And for the engine segment, that warranty cost probably was a headwind of 1% relative to what you'd seen in the fourth quarter. So it was not a small number. Distribution came in exactly where we thought it would be.
Components, as Tom said, did a little bit better, and then the one negative relative to what we were anticipating was power gen. But overall, when you look at it for the company, it was pretty much in line with what we had expected.
That said, Andy, there's no question that your point about decrementals is right, that it is not what we are aiming for. I think Pat has talked a lot about what our goals with regard to decremental and incremental margins are, and this is definitely higher. This is not the kind of quarter we're aiming for, and while we knew it going in, it was a difficult quarter. Some of the things that we saw that we didn't expect until the very end were as much activity on pre-buy in the mid-range segments, and then the mining segment, while we knew it by the fourth quarter, as Pat said, it dropped really significantly in our high horsepower business. We had to adjust very quickly.
I think once you take the trend over a couple of quarters, I think you will see the decrementals in line with the way that we think about it. Just in terms of averaging the numbers, Q1 was not great on decrementals, not where we want to be. But if you take it over a couple of quarters, our view is that you will look back at us and say, "Yeah, that's the decrementals that they are looking for," and then you will see the same thing on the incrementals. But just in terms of timing, seasonality, pre-buys, a whole bunch of stuff hit this quarter that made it sting more than we would expect normally.
Tom, is it fair to say that by March, a lot of these things that were stinging stopped stinging? Whereas they were really bad in January, is that what you are trying to say?
Yes. Not to carry the insect analogy too far, yes. I would say that they were stinging less. No, you're definitely right. The reason we have confidence in our forward estimates is that we saw improvement month-over-month, where as we began to pick up orders, some, again, they were not gigantic increases, but they were enough. We were starting the negative adjustments, got through the system. We started to see improvements as we went January, February, March. By the time we left March, and now as we look into April, we're already seeing improvements that make us confident that we will get the kind of incrementals that we are looking for as volumes increase. There are uncertainties out there. I don't mean to overstate the position. I talked about them in my markets. There are uncertainties in markets.
But assuming we get the sales that we have got in here, our view is that we can make the margins based on what we have already seen this year.
Tom, a related question comes up then. How is this really different from last year? Last year, we had a strong North America that sort of dissolved as the year went on, and we were expecting an an improvement in emerging markets that didn't happen. This year, we are starting out weak again, and you are kind of expecting the whole business to rebound over time. I appreciate your comments very much on January through April. Is that what gives you more confidence in the rest of the year or something else?
Yeah. There are some pretty big differences. For one thing, the first half of last year, remember, North America was good.
Yeah.
What we saw was the fall. This first quarter, North America was not good. What we're seeing that's different is that, after several quarters of producing at less than demand, we are now seeing them begin to increase order rates. So as Rich mentioned, we've already seen increases in order rates. So it is a little bit different. The second thing, I guess I would highlight as a major difference is we were expecting improvements in the emerging markets, and we did not see them. This year, we are not expecting improvements in the emerging markets. So there is really none of that built into the forecast. What we've got built in the forecast from a sales point of view is seasonal improvements. The thing I talked about with North America.
The basic kind of things that just because Q1, they did a pre-buy, now they are just going to go back to regular order rates. So no heroic improvements in demand. Then just getting back to our normal order and shipment rates that fit that demand. That's all we're really expecting to do here. So there's really no heroic assumptions anywhere. I would say that, again, if something drops off dramatically, like happened in the second half of the year last year, then that would make things worse. We just don't expect that. We just don't see, given our conservative forecast in markets, that there's something that's going to drop off a bunch more. As you heard Rich's forecast for North America, it's not aggressive.
Yeah.
Yeah.
Thanks. Appreciate it, guys.
Yeah.
Thank you. We have another question for you. This one is from David Raso at ISI Group. Please go ahead, David.
Hi. Yes. Not to belabor the margin issue, but I think by far it's the major issue here with the release. We're just trying to better understand it. The rest of the year guidance implies basically 100% incremental margin. $117 million of sales gain year-over-year. You need $128 million of EBIT gain year-over-year. Right? So we have to see a big reversal on how the margins just played out. For this first quarter, the revenue decline year-over-year isn't much different than we saw in the fourth quarter and third quarter. Since then, we've laid off 2%- 3% of the headcount. I assume some other cost actions and maybe, without warranty, maybe it was bigger. I appreciate the mixed comment, but I'm still trying to appreciate why are the decrementals this much worse after some cost actions.
The next three quarters, I have to look at an incremental margin, which I know it's a low number, 1% revenue growth. So it's possible when the revenue growth's that low, but obviously 100% incremental is not a walk in the park. So can you help us better understand what happened and why the incrementals will be so positive the rest of the year?
Yeah. So David, let me take a shot at that. When we look at the incremental margins going forward, and if you look at it from a first quarter baseline, the numbers that take us to the midpoint of our guidance are closer to 35%- 40%. So you can talk to Mark afterwards about the calculation, but we've delivered that type of incremental margin improvement before. As I see the engine business picking up as we go through the first quarter, I'm pretty confident that trajectory is going to continue to play out. The fact that the decrementals in Q1 were as steep as what they were, I apologize because we're repeating ourselves here, but really, the negative mix impact, the engine business in particular suffered from the lower high horsepower volumes, was a very significant headwind.
In addition, we had the higher warranty costs that we tried to talk about on our last call and explain the impact of those. So there wasn't anything else in there. There was a couple of one-offs in the power generation business that hurt them in the first quarter. But the key drivers for that decremental was the lower volumes, the unfavorable mix, and the higher warranty costs, all of which we expected as we came into the quarter.
I would just add, David, we did see the improvements in SG&A from the reductions we made in Q4. On the other hand, we did stay the course on our R&D spending. That was something we decided strategically to do, was to continue to invest in our new products and make sure that we were ready. While other people may be hesitating, we're going to continue to release new products so that as markets improve, we position ourselves for growth. That was obviously a decision we made that we could have made differently, but we decided that was the thing to do. As a result, we have a lot of new products coming out, and we will have again next year. That, I think, positions us well for growth.
Those were decisions we made that, of course, impact quarterly results, but I think they were the right ones for the company long run.
Okay. Is there a price cost change? Because Pat, you can talk sequentially, but I'm looking at it properly year-over-year, first quarter down 40. The mix in the fourth quarter, we already had mining down, oil and gas down. Since then, we've taken some cost out, at least that was the way it was presented in October, about 1,000- 1,500 heads coming out. Again, I'm just trying to gain comfort. Is there something about heavy, high horsepower that you already have an order book that's notably improving on the high horsepower to make it clear the mix snaps back? Because again, it is 100% incremental year-over-year in the math for the rest of the year. I'm just trying to understand, because obviously the revenues were generally in line what people thought. It was similar to the clients the last two quarters. It's all about the margin.
Right. We are not expecting a snapback in the mix, David. The mining drop was much more significant in the first quarter, year-over-year than it was in the first quarter, significantly.
More in the first than the fourth.
More in the first than the fourth, sorry. That was that. We are not really, other than we expect seasonal improvement in high horsepower demand from the power gen business to the engine business going forward. That is really the only improvement in high horsepower going forward. Again, as Pat said, if you start from a Q1 base and look what we need to deliver from that base, which we accept has got some costs in there that we would not expect to see on a run rate basis, we are talking in the 30%-40% of incrementals going forward from where we are, and we feel comfortable with that.
Just one clarification, the tax rate. Before it was 26%. If I remember correctly, that did not include the tax benefit in the first quarter.
That is correct. The 26% did not include the discrete item, the R&D tax credit that relates to 2012 that we did book in the first quarter.
The 29.5% also does not include the tax help, correct?
29.5% is the operational rate for the full year, excluding discrete tax items.
All right. That's helpful. I appreciate it. Thank you.
Thank you.
Thank you. We have another question for you. This one's from Ann Duignan at JPMorgan. Please go ahead, Ann.
Hi. Good morning, guys.
Hi, Ann.
Can we take a step back and talk a little bit about your outlook for market share for the heavy duty business? It was very obvious at Mid-America Trucking Show that you and Eaton joining forces to deliver new products is more of a defensive move to react to the Freightliner and Volvo offerings of their own drivetrain. Should we think about the 40% market share as being the ultimate potential for this business? Should we expect market share to decline somewhat as we move forward?
Obviously, it's going to be our goal for it not to decline. The dynamics of the heavy duty truck business and engine sourcing really haven't changed in quite a while. We are now kind of the only independent engine company, at least in the developed country markets. What we're trying to do is make sure that we offer technologies and systems that make customers think that partnering with us, in addition to making their own, makes more sense for them and gives them more technology they can use to sell value to their customers. That remains our strategy, and our customers remain focused on ensuring that they have technology that they need, and that they don't depend just on one supplier. That hasn't changed either. All of our customers are thinking about what technologies they want to own and what technologies they want to buy.
We have very open and frank discussions with them about that. What that means as far as final market share, I think depends on which players make which decisions on there. But we've talked about this before. Market share is not our number one measure of success. We want to make sure we have profitable and profitable growth in the heavy duty business, and that's what we're aiming for. We think our market share reflects the fact that today we can still offer technologies that even though our customers make their own engines, they think that our technologies help them sell more trucks to customers. Again, I don't mean to get overly philosophical on you. I just mean it's really hard to say that there's a peak or a valley or whatever in market share. It just depends on how well we continue to do that.
Yeah, that's a fair point, and it's good to hear that market share is not the ultimate goal.
Yeah.
Switching gears a little bit onto natural gas. Could you give us an update on the 12-liter engine and where we are with that? Are you taking orders for that already, or is that for later in the year?
Let me let Rich update you, because obviously there's been quite a bit going on in that this year.
Okay. No, we are taking orders, okay? Beginning in April. We have some ratings. We'll offer some higher horsepower ratings later in the year, kind of in the August, September, October range. So we're right on track with what we said, with the April introduction.
That's a big deal because, of course, as more customers want to explore options of using natural gas, we really were limited to a 9-liter, and that engine just isn't big enough for some of the applications people want to try it on. The 12-liter really gives customers a chance to try it in a broader range of applications. Since there's so much interest in natural gas, it's just the right product at the right time, in our opinion.
Yeah. Final question, just a quick follow-up on that. If the 12-liter and the 15-liter are highly successful, then what's the impact on the aftertreatment business since for spark ignition, you don't need aftertreatment?
Yeah. It would obviously push aftertreatment demand down. From our point of view, we have a range of technologies and a palette of technologies we're looking at and using all over the world, and the impact of using one over another, there is cross-impact on the companies. There's no question that if natural gas grows, then the need for SCR on those engines isn't there, so that demand would go down for those products. Again, the good news for us is we're pretty high market share on natural gas engines, so the trade-off looks okay to us so far. We're always looking at technologies that are going to add value to engine systems and component systems. We do a bunch of work on component systems and natural gas too, just not SCR.
Okay, thanks, guys. I've got my time up.
Thank you. We have another question for you, sir. This one's from Tim Denoyer at Wolfe Trahan. Please go ahead, Tim.
Hi, thanks. Not to beat the engine segment margin too much, but a couple of other components, if you could just give us a little bit more color on how they go through the year. Did you see the full impact of the price increases in the first quarter? You've talked about warranty costs coming down through the quarter. I think you said there was a 1 percentage point increase in warranty costs in 1Q from 4Q. Can you give a sense of how that might ramp down through the year? I guess same kind of question on raw materials. Are you expecting a bigger benefit through the year?
Okay. I'll take a shot at that. A few things going on. We do see the volumes going up. To hit our midpoint, we need to be in that 35%-40% incremental margins, which is a place we've been before and feel very confident we can get there. There's a few pieces of it. One is, as the volumes come up, January was a pretty bad month for us. We saw some really low demand in many of our plants. We will get the incremental there. We are going to see warranty going down in the range of half a point. As you know, we set warranty on our new products at a higher rate, and then as we demonstrate that the products are doing well, we take our rates down. We will see warranty coming down through the year sequentially.
We are seeing and driving increased supply chain improvements, which is a key piece or action, which is logistics costs, but also on material costs. We're having success on driving material costs down. It's kind of the combination of normal incremental margins, warranty down, some material costs down, and then not continuation of some of the January issues that we had, which is a place we've been before in that 35%-40%.
Yep, sure. Then just as a follow-up on Brazil, there are a few truck OEMs building plants down there at the moment, who you have good relationships with. Can you give any sense of R&D activity and is there any market share pickup in Brazil baked into your guidance for this year? I think they are potentially opening these plants, the three of them, later this year.
Yeah, we don't expect a big impact this year, Tim. We have a lot of activities going on. I think this is just an extension of our strategy that said, "Hey, if we can use our global position and partnerships around the world to help our customers grow in the markets they want to grow into." I think Brazil is a perfect example of that. So there's a number of OEMs going into Brazil who are trying to be part of the growth of that market and who can use Cummins engines, both because we have leadership position at market, we have a strong brand name, and we have service operations there to help support them. So we are very active doing application work and other kinds of work with customers and potential customers in Brazil.
But I think although some will open, there aren't going to be significant volumes this year. Some of them, I think, it'll take them, even after they theoretically open, production won't begin for some time. So I think there may be some impact next year, but it's probably a year or two before we see significant volumes from most of those new players coming in.
Great. Thank you very much.
Lovely. Got time for one last quick question. Thank you.
Thank you. Question is from Rob Wertheimer at Vertical Research. Please go ahead, Rob.
Oh, hey. Thanks for fitting me in. Just one quick question on R&D. Was it any heavier than expected in the quarter or different seasonality this year? This just generally, power gen's been on a multi-decade uptrend. I'm just curious if you can split any more than you did on geography, whether it's credit related, the general weakness, prime power versus backup. Just any more color on that market. Thanks.
Yeah. Nothing really unusual in R&D. The only thing that kind of influences quarter to quarter swings are if we are buying significant prototypes and major programs, and there is a little movement each quarter, and we had less of it in Q4 and more of it in Q1, but that's just normal and what we expected. With regard to power gen, the geography I'd give you is that generally speaking, our developing country markets, which have been growing infrastructure at a pretty high rate, have clearly slowed down in the last couple of years. So places like China and India, infrastructure development has slowed down. India, we still see power shortages, which have held up the market, but the rate of growth has definitely slowed as infrastructure slowed. I think as those markets begin to pick up again, we'll see demand increase.
Think of that product primarily as prime power or at least part-time usage. It's not standby. Then generally, weak economies across the world have driven down non-res capital spending now in most markets. Of course, that's significantly true in Europe, but it's also been true in the U.S. now for several years, and low non-res capital means low standby markets. So really, the only places where we've seen improvements in power generation have been data centers, where we continue to see activity there, and then kind of spot issues, power shortages and other kinds of things where there's just these chronic shortfalls in power, we have continued to see strong markets.
But the basic trends on both developing country infrastructure, which require more grid support or companies needing generators to run their factories when the grid browns out or just basic standby markets have been down now in a slump for a couple of years, and that's what you've seen in revenues in power gen.
Thanks much.
Thank you very much, everyone. I will be available for calls shortly.
Thank you, ladies and gentlemen. That concludes your conference and presentation. You may now disconnect. Have a very good day.