Cummins Q1'16 Earnings Conference Call: Full Transcript

Operator:

Good day, ladies and gentlemen, and welcome to the Cummins Incorporated First Quarter 2016 Earnings Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. If anyone should require assistance during the conference, please press star then zero on your touch tone telephone. As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Mark Smith, Vice President of Investor Relations. Sir, you may begin.

Mark Smith: Vice President of Investor Relations:

Thank you Kelly. Good morning everyone and welcome to our teleconference today to discuss Cummins results for the first quarter of 2016. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; our President and Chief Operating Officer, Rich Freeland. We'll all be available for your questions at the end of the teleconference.

Before we start, please note that some of the information that you will hear or be given today will consists 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 subsequently filed quarterly reports.

During the course of this call, we will be discussing certain non-GAAP financial measures, and we'll 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 our website at cummins.com under the heading of Investors and Media.

Now, I'll turn it over to our Chairman and CEO Tom Linebarger.

Tom Linebarger:Chairman and Chief Executive Officer:

Thank you for that warm introduction Mark. Good morning everybody. I'll start with a summary of our first quarter results and provide an update on our outlook for the full year. Pat will then take you through more details of both our first quarter financial performance and our forecast for the full year.

Revenues for the first quarter were $4.3 billion, a decrease of 9% compared to the first quarter of 2015. First quarter EBIT was $484 million or 11.3% of sales compared to $562 million or 11.9% in the same quarter last year. Our decremental EBIT margin was 19% as the benefits of restructuring actions, improved quality, lower material costs, all helped mitigate the impact of lower sales. Engine business revenues decreased by 10% year-over-year due to lower demand in North American heavy-duty truck market and weaker sales to global off-highway and power generation markets. Shipments of high horsepower engines declined by 20% and reached the second lowest quarterly total in the past 12 years.

EBIT of 8.6% of sales declined from 9.7% a year ago, as strong operational performance from our manufacturing plants and benefits from restructuring, material cost reduction initiatives and improved quality were offset by the lower impact--impact, excuse me, of lower volumes.

Revenues in our components segment decreased 5% from a year ago with lower demand in North America more than offsetting growth in China. Sales in China increased by 27%, outpacing our end markets as we continue to capitalize on tighter emissions regulations and capture increased content and market share. EBIT of $173 million or 14% of sales declined from $195 million or 15% due to impact of lower volumes and currency.

Distribution revenues decreased by 1% compared to the first quarter of 2015. The negative impact of currency and weaker sales to off-highway markets more than offset the positive impact of acquisitions made in the second half of 2015. EBIT for the quarter of 6.5% improved from 6% a year ago with operational improvements more than offsetting in the negative impact of currency.

In the power generation business, revenues declined by 19% year-over-year with weaker sales in most markets, especially Asia and Latin America. EBIT declined from 7.2% to 5.6% as the impact of lower sales more than offset a 17% reduction in operating expenses.

The first quarter is typically the weakest quarter for revenues in the power generation business and we do expect sales and margins to improve in subsequent quarters due to improving order intake in Europe and North America. Over the past three months, we've announced plans to further rationalize our manufacturing footprint including the closure of an alternator facility in Mexico, a generator assembly plant in India and the exit of generator set assembly operations in Kent, England. These actions will start to generate savings in the second half of 2016 with additional savings in 2017 and 2018 and should help us stay ahead of any further risk of declining volumes.

Now I will comment on some of our key markets starting with North America. Our revenues in North America declined by 10% in the first quarter due to weaker demand in our highway markets, especially heavy-duty truck. Shipments to the North American heavy-duty truck market exceeded 16,000 units in the first quarter, a decrease of 33% from 2015 levels. First quarter market share was 29%.

We have lowered our projection for full year industry production to 210,000 units, at the mid-point of our guidance, down from our prior forecast of 22,000 (sic) units as slower freight activity has contributed to weak industry orders and higher dealer inventories.

We currently expect our market share to be in the range of 27% to 30% for the year, down from our prior forecast of 30% to 33% as Daimler has reduced the number of engines that it plans to order from Cummins and Navistar's market share has declined.

In the medium-duty truck market, we delivered almost 22,000 engines in the first quarter, down 13% from last year. Our market share in the first quarter was 78%, down from 80% a year ago when we completed our final shipments to Ford. We expect full year industry production to be 123,000 units, down 1% compared to 2015 and our market share to be 75%, unchanged from our prior forecast. Our engine shipments to North American pickup truck OEMs increased by 29% in the first quarter.

Shipments to Chrysler increased 9% to more than 34,000 units, the highest first quarter volume in 10 years. Sales also increased to Nissan following the launch of our 5-liter v8 engine in our fourth quarter of last year. We currently expect our revenues in the pickup segment to increase by 12% in 2015, unchanged from our prior forecast.

Our engine revenues from the North American construction market decreased by 9% compared to the first quarter of last year. While housing and commercial construction activity remains positive, demand for new equipment from rental companies has declined due to a slowdown in business in the oil and gas market.

Power generation revenues declined 4% in North America in the first quarter due to lower orders from data center customers. We expect full year revenues in North America to be flat to up 2% as order rates have improved this year following the weak close to 2015.

Our international revenues declined by 8% year-over-year with weaker sales in Latin America and Asia driving the decline. First quarter revenues in China, including the joint ventures, were $767 million, a decrease of 5% due to the negative impact of depreciation of the RMB against the U.S. dollar, and weaker demand for power generation equipment. Industry demand for heavy and medium-duty trucks in China increased by 9% in the first quarter.

We continue to increase our penetration at Foton, which is now at 74%, up from 55% a year ago and at Dongfeng, which is up more than 5% to 50%. Our overall market share was over 15% in the first quarter, down slightly from year ago as both Dongfeng and Foton adopted a more cautious start to the year than some of their competitors and underproduced relative to the overall industry. We still expect that our share will reach 18% for the year as our partners increase production, sales more in line with the industry and our penetration continues to grow. We currently forecast full year industry sales to decline by 4%, unchanged from our previous forecast.

Industry demand for the first quarter was stronger than expected, but visibility to demand in the second half is limited. We believe it is prudent to be cautious about market improvement.

Shipments of our light-duty engines in China grew 9% in the first quarter compared to 3% decline for the overall market as we increased penetration at Foton displacing local competitor engines. Our share of the overall market reached 7% in the first quarter, up from 6% a year ago. We currently project industry sales to decline by 4% for the year, again unchanged from three months ago.

Our power generation revenues decreased by 27% year-over-year compared to a strong quarter a year ago. Sales weakened in the second half of 2015 as the industrial economy slowed and we haven't seen any signs of improvement yet. Industry sales of excavators in China increased by 15% in the first quarter as OE dealers pushed sales of Tier 2 inventory ahead of the transition to Tier 3 emission standards that came into force in April. Overall numbers of excavators sold though remains low, and while there is little downside risk left, there is no obvious catalyst for significant growth in the near term.

Full year revenues in China across all segments including joint ventures are expected to be flat for the year, consistent with our view three months ago with no major changes to any of our market assumptions.

First quarter revenues in India including joint ventures were $390 million, up 7% year-over-year, primarily due to recovery in the Indian truck market. Industry demand in the truck market increased 25% compared to the first quarter a year ago as the economy continues to improve. Our market share in the first quarter was 38%, down from 39% due to stronger growth in sales of the vehicles below 10 tons in weight where our penetration in the market is lower. We now expect industry truck production to increase 10% for the year, up from our prior forecast of 8% growth.

Power Generation revenues in India declined 1% in the first quarter, with the weaker will be offsetting 3% growth in volumes. We currently project full year revenues including joint ventures to be flat to up 2% with higher domestic volumes, largely offset by the depreciation of rupee against the US dollar.

First quarter revenues in Brazil were $72 million, down 42% from the first quarter last year with the economy in recession and the real having depreciated a further 16% against the US dollar. Industry truck production fell 36% year-over-year while our engine shipments declined 35%. Revenues in all of our businesses were lower than a year ago due to the economic challenges in the region. We currently expect a full year decline of 20% in industry truck production with slightly easier comparisons to come in the second half of the year.

Let me now make a few comments on high horsepower markets. As I said in my opening remarks, volumes are extremely weak with the first quarter's volumes down 20% due to lower demand in commercial marine, mining and power generation markets. New orders in the US oil and gas markets are very scarce. We expect full year shipments of high horsepower engines to decline by 6%, helped by growth in sales of our new QSK95 diesel engine and easier comparisons in the second half of the year.

We were very pleased to receive EPA Tier 4 final certification for our QSK95 engine for rail applications recently, allowing us to win some important business in the high-speed passenger rail market.

In summary, we currently expect company revenue to decrease between 5% and 9% for the year, unchanged from three months ago. We did lower our outlook for heavy-duty truck production in North America, offset by an additional North American distributor acquisition and a less negative impact from currency in our forecast from three months ago. We expect EBIT to be in the range of 11.6% to 12.2% for the year, consistent with our prior forecast. We made solid progress in executing our cost reduction plans in the first quarter and every organization throughout Cummins remains focused on driving further productivity and cost improvement. As one example, starting in April, we combined our power generation segment and high horsepower engine business into a newly-formed segment called Power Systems.

This reorganization will consolidate two businesses that are already strongly interdependent and will allow us to streamline business and technical processes to accelerate innovation in those markets to grow market share and more efficiently manage our supply chain and manufacturing operations.
Dave Crompton, previously Leader of the engine business is now leading the new Power Systems segment and Srikanth Padmanabhan heads the remaining Engine business. Tracy Embree and Tony Satterthwaite will continue to lead Components and Distribution segments respectively.

Finally, we returned $745 million to shareholders in the first quarter through dividends and execution of our accelerated share repurchase program, consistent with our plan to return approximately 75% of our operating cash flow to shareholders in 2016. Thank you for your interest today.

Now I will turn it over to Pat who will cover our first quarter results and full-year guidance in more detail.

Pat Ward: Chief Financial Officer:

Thank you, Tom, and good morning everyone.

First quarter revenues were $4.3 billion, a decrease of 9% from a year ago with currency movements reducing our sales by 3%. Sales in North America represented 61% of our first quarter revenues, declining 10% from a year ago due primarily to low demand in North American truck markets and continued weakness in industrial markets.

International sales declined by 8% as a result of low demand in power generation and industrial markets and the impact of the stronger US dollar.

Gross margins were 24.6% of sales , a decline of 80 basis points from a year-ago. Lower volumes and an unfavorable product mix were partially offset by improvements in the fuel costs and warranty expenses and the benefits from the restructuring actions.

Selling, admin and research and development expense of $656 million or 15.3% of sales decreased $56 million from a year ago after taking restructuring actions in the fourth quarter of last year. This was 20 basis points higher as a percent of sales due to lower revenues.

Joint venture income of $72 million increased by $4 million compared to a year ago. Results in the first quarter a year ago included an impairment of our investments in an off-highway joint venture, which did not repeat.

Earnings before interest and tax were $484 million or 11.3% of sales for the quarter compared to 11.9% of sales last year and this equates to a decremental EBIT margin of 19%.

Net earnings for the quarter were $321 million or $1.87 per diluted share compared to $387 million or $3.14 per share from the year ago. And the effective tax rate for the quarter was 28.4%.

I will now highlight the performance of the individual operating segments during the first quarter. In the Engine segment, revenues were $2.3 billion, a decrease of 10% from last year. Industrial revenues declined by 13% from weak global demand for engines in marine, mining and oil and gas markets. On-highway revenues decreased 8% as production in the North American heavy-duty truck market declined compared to a year ago.

Segment EBIT was $200 million or 8.6% of the sales compared to 9.7% last year.

The benefits of the restructuring actions, material cost savings and more warranty expense were more than offset by lower volumes and an unfavorable products mix primarily from reduction in North American heavy and medium-duty truck volumes and a 20% reduction in high horsepower engine shipments.

For the distribution segment, first quarter revenues were $1.5 billion, a decrease of 1% compared to the prior year. Foreign currency movements negatively impacted sales by 4% while organic sales declined by 5% with lower sales in North American off-highway markets more than offsetting growth in China and in Europe. Acquisitions added 8% to revenues. EBIT margins for the quarter increased from 6% to 6.5% despite a 70 basis point unfavorable impact from foreign currency.

Excluding the currency impact, margins improved by 120 basis points due to the benefits of restructuring, a stronger mix of aftermarket revenues, and positive pricing.

The components segment recorded sales of $1.2 billion, a decrease of 5% from a year ago. Sales in China increased in the first quarter by 27%, which helped partially offset the decline from more heavy-duty truck production in North America and a negative impact of foreign currency.

Segment EBIT was $173 million or 14% of sales compared to 13% of sales a year ago as more volumes, unfavorable pricing and currency more than offset the benefits of material cost reductions and restructuring actions.

In the power generation segment, first quarter sales of $550 million, down 19% from last year. International sales declined 27% with Asia and South America experiencing the largest decline year-over-year due to the slow pace of investment in infrastructure projects. EBIT margin was 5.6% in the quarter, down from 7.2% last year. The benefits from the restructuring actions and more material costs partially offsets the impact of the volume decline and helped keep decremental margins to 14%.

For the company, cash flow from operations was $263 million, better than same quarter last year by $90 million due to lower working capital requirements as sales declined.

As we indicated at the beginning of the year, we plan to return approximately 75% of cash generated from operations to our shareholders in the form of dividends and share repurchases this year. During the first quarter, we repurchased 4.9 million shares, primarily resulting from the previously announced $500 million accelerated share repurchase program and we made dividend payments totaling $170 million, up from $140 million a year ago.

Our cash and marketable securities balance declined in the quarter by $537 million, primarily due to the share repurchases, the increased dividend payments of $170 million and capital expenditure of $71 million.

As Tom mentioned, our guidance for our full year performance is unchanged from three months ago. We are projecting total company revenues to be down 5% to 9% in 2016. Lower levels of production in the North American on-highway markets, reduced demand globally for off-highway and power generation equipment and the negative impact of currency movements will drive the majority of the reduction in revenue. We expect some offset from the introduction of new products and increased revenue from distributor acquisitions.

We expect EBIT margins of between 11.6% to 12.2% for 2016 and this compares to 12.5% for full year 2015 excluding the restructuring and impairment charges and represents a decremental EBIT margin of 25%. Benefits from material cost savings, restructuring and other actions will help mitigate the impact of lower volumes.

Joint venture income is still expected to be flat compared to 2015. We anticipate operating cash flow performance in 2016 will be within our long term guidance range of 10% to 13% of sales and capital expenditures are expected to in the range of $600 million to $650 million in 2016.

As Tom just discussed, effective April, we reorganized the company into new operating segments. We will issue restated results for the first quarter of 2016 and results for 2015 and 2014 to reflect of new operating segments before we report second quarter results. We will also issue full year guidance for each of new operating segments when we report second quarter results. And just to inform, our current full year guidance for the company is unchanged from three months ago.

Now let me turn it back over to Mark.

Mark Smith:

Thank Pat and now will move to the Q&A section of the call. In respect of the feedback that many of you give me, I would like to ask that you limit your questions to one question and one related follow up to give everybody the chance to ask a question. Thank you very much and now we are ready for questions.

Question & Answer

Operator:

[Operator Instructions] Our first question comes from the line of Joel Tiss with BMO. Your line is open.

Joel Tiss: BMO:

How it is going guys?

Tom Linebarger:

Good morning Joel.

Joel Tiss

I wonder if you could break out the impact of the warranty, the warranty change in the quarter and are we getting towards more normalized levels or is that going to be a number that continues to come down?

Pat Ward:

Yes, so let me start on that one. So warranty in the quarter was 2.2% of sales for the company that was down from 2.6% last year. We are very comfortable with our full year guidance of 2%, we are right on track with that. So no real difference from what we can talked about three months ago, Joel, with regards to our outlook for warranty and improvements in the quality of our products throughout the company.

Joel Tiss

Okay. And just sort of a bigger picture question, it seems like PowerGen in general has been declining for kind of five years or so, are we getting towards the end of that process or you think there is still pockets of weakness out there that are going to last for the next two years or so?

Tom Linebarger:

Yes. It's a good question Joe, I don't really know the answer for sure, but it's-were certainly been declining for much longer than we expected, I think that's why you have seen us take succession of actions as opposed to just one bigger one, which in retrospect would have been better. But we are of course preparing, as you can tell from these actions, for continued weakness for some time. I think that's why we decided to take further actions in the business, when we did our restructuring in the fourth quarter, we did much more out of the power generation segment, we have now taken some plant capacity-significant plant capacity out now with these three exposures.

So, we are anticipating that we may be weak for some period, hopefully it improves faster than that, but we are prepared for it now after watching that decline for quite some time.

Joel Tiss

That's great. Thank you very much. Okay, sorry.

Tom Linebarger:

Joe, if I could just add that the combination of our segment also I think gives us the opportunity now to begin the share overhead, drive improvement and efficiency in our processes between the large engine and the PowerGen business, which we think not only will help us in this tough time, but as the market sprints back, we'll be able to capture more share and respond more quickly. So, we think it's good for the short run to reduce cost, but it also I think drives productivity and launch and ramp up processes much better in the future.

Rich Freeland: President and Chief Operating Officer:

Joe, it's Rich. Just one more comment is I agree with Tom, the overall markets, we're not too optimistic on, but we are restructuring like we talked about, but also creating several growth opportunities. So, most to the QSK95 sales that we have are into the power generation market and they are into places we weren't there before. So, trying to grow share at the time when the markets are low, we're having some good success.

Joel Tiss

That's great. Thanks and I am not getting back in queue. Thank you very much.

Joel Tiss

Thanks Joel.

Operator:

Our next question comes from the line of Stephen Volkmann with Jeffries. Your line is open.

Stephen Volkmann: Jeffries & Co. Inc.:

Hi, good morning. May be let's just go one step further with that line of questioning and you've talked about, Tom, the margins in PowerGen getting better sequentially, I guess, on the back of the restructuring that you've been already.

If the markets don't recovery and sort of stay in this depressed period situation, where do we think these margins can kind of normalize just based on what you've done so far?

Tom Linebarger:

Yes. We have some work to figure that out, Steve. Of course we are, as you know, we've talked before about trying to get back to double-digit margin even in weaker markets. The markets have clearly fallen far more than any of us anticipated and we've now taken a set of actions that we think normalizes us to these volumes.

So, we have some work to do to figure out where we think we can get margins at these levels. Clearly it would help a bunch if revenues stabilize and stock dropping, but we are--it won't take us long to figure that out. The reason we still have work to do is, as you know, we just combined the segments. We just figured out, we are just now eliminating some of the capacity and the comparison likes for like will be a little complicated given the combination of segments, but expect us to be figuring that out pretty quickly and we have the set guidance for what the combined segment is and where we can take that in the future.

But we are targeting all our segments at double-digit margins even in tough times. So we are trying to figure out how to get there again. There is no question that right now we are not there and we've got work to do to get there.

Stephen Volkmann:

Okay, fair enough and my follow up is just more on the heavy-duty track side, can you just tell us what you are seeing relative to cadence as we go through the quarters? I assume, will sort of march down again here in the second quarter, but then what happens in the second half if you have any visibility there, do you think stabilize, does it turn up a little towards the end of the year, do we just kind of continue the glide slope?

Tom Linebarger:

Yes, so the way we are looking at what's implied in our guidance is actually it's a more downward pressure in the second half of the year. So if you just look at where we were in Q1, that would be a 224 market if you just multiply that by four. And so, I think actually Q2 hold in okay, and I just--past history says that with backlog down to as low as it is that we start to see some reductions in production in the second half of the year. We need order boards more full, that is a normal reaction that we see.

So that's what we are putting into while we've taken the guidance down to 200 to 220 from the 220 range before as potentially some back-end, but most of the reduction happened. We are down 33% already. Q1 to Q1 and so most of the reduction is in place, what we saw in Q1.

Stephen Volkmann:

Okay, that's helpful. I appreciate it.

Operator:

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

Jerry Revich:Goldman Sachs & Co. Inc.:

Hi. Good morning everyone.

Tom Linebarger:

Good morning Jerry.

Jerry Revich::

Tom, I'm wondering if you could update us on your plans for the distribution back office integration now that you're on the tail end of wrapping up the acquisitions over with timeframe are you looking for to complete the back office integration at this point and can you just calibrate us on the magnitude of cost savings opportunities we should look for when that plays out?

Rich Freeland:

I'll go at it and take that, Jerry. It's Rich here. So, the pieces that's behind is, or a lot of it is the most of back office work has been done and so we've got little more integration work to do there, but some of the bigger ones are still in front of us. So, like the distribution we talked about we had 15 distribution centers, we want to go to much smaller.

We have put two in place, we will put three more in place this year. And so by over the next couple of years we'll get that savings. The purchasing savings which is to build in, we've got a really good purchasing process. You've seen the results we've had in the business of driving cost down, we're just now beginning that one.

So we talked about getting $100 million in synergies kind of maybe 40 to 50 of it in costs and the rest in sales. We are just really getting started. We're probably a quarter away through that on the cost side and more to come over the next couple years.

Tom Linebarger:

And Jerry, I would just add that the processes due to back office work, we have now sent all those in place. There is still some follow through work to do on those, but as Rich said, it's really going to have just a little bit of, it's just follow through on making sure that all that HR processes are working on still acquiring a distributor so each time we acquire we got to do them again. The opportunities are still in premise. So we've actually had to go negative before we gone positive.

We have added cost in various processes is to make it yes to make sure that everybody is on the same page, systems and pension system so we are going to be the benefits really trying to flow now. So we are pretty excited about those and both from a sales and support and service point of view for customers but also for our on the cost and return side which Rich talked to you about.

Jerry Revich:

Thank you and Pat can you talk about where engine margins should count in the quarter relative to your internal expectations? It looks like decrementals were 25%, I think the full year guide at the midpoint would imply 17% decrement and improvement is that inline with your plan and I guess what's the offset to the weaker volumes to heavy-duty truck based on new market and market share forecast?

Pat Ward:

I was really pleased with kind of engine segment came out in the quarter and decrementals my number -- 20% EBIT margin decremental EBIT margin for the quarter which have been in the face of a reduction in North America heavy-duty truck volumes and a 20% in high horsepower I think is a very very good performance. Clearly we are seeing benefits from material costs, we are benefits from the lower warranty expense. I was talking to Joel about a few moments ago and the restructuring actions at the engine versus third and the fourth quarter and resulting more SAR spend I think is all helping to keep those decrementals below normal and acceptable level for them. So I think we are off to a pretty good start this year.

Jerry Revich:

And the comps are easier is your point Pat in coming quarters because I think the guide at the midpoint implied better decrementals than the first quarter.

Pat Ward:

Yes I think as you look at the engine segment last year segment fourth quarter it was a very difficult fourth quarter following to the second half I would expect to see a little bit better performance year-over-year.

Jerry Revich:

Okay. Thank you very much.

Operator:

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

Jamie Cook:Credit Suisse:

Hi. Good morning. Sorry just a couple of more questions on power gen and high horsepower. Can you talk about how comfortable you feel with your inventory levels and what's in the channel in both of those segments? And as I think about the restructuring you've announced in combining those segments, does that imply you think things could take another leg down, could 17 potentially be up I am just trying to think if there is any read through with regards to what you're doing and what that means for what how you are thinking about demand if you more negative or positive? And then I guess my second question relates to market share on the heavy duty truck side.

You brought that down again you talked about Navistar, you talked about Freightliner, Tom confidence level in your longer term market share goals in North America heavy duty truck with I think Pat are saying on another call a couple of weeks ago their addresseable market is now I think 80% to 85% versus before they were targeting a 50% market share. Thanks.

Tom Linebarger:

Thanks Jamie. So I am not going to let Rich talk a little bit about inventory in heavy duty truck but again just getting back to the high level question about when we get -- do we think there is more downside to come in the power gen side and then the large engine side generally. What we decided to do is prepare ourselves for that potential outcome. We just don't know.

The truth is we don't know if there is more downside to come. We do not see obvious signs of turnaround today and so what we decided to do at this last set of actions both in terms of the restructurings in Q4 , the manufacturing footprint reductions and the combination of this and reorganization businesses to prepare ourselves for whatever is in front of us. That's what we committed to do, that's what we're doing. And so, and we've said that all along with we need to take more actions we'll take them.

So, these are an example of that.

So, we just don't know what's going to happened in the future but we feel more prepared to deal with it, whatever it is and we feel like we got our cost structure in place for what the business is now and if again this is not virtual figure that out and take actions when we need to. But we really like the actions we've taken as better positioning us for a really really challenging market that exists today. Rich, want to talk about the inventory.

Rich Freeland:

I take your last question first, Jamie, and then I'll get to the high horsepower inventory. So, the long term view on share let me just repeat I think what's going on in the market today what we see as we took it down as we saw our share with that and we forecasts are down, but I think in an environment of excess capacity we are fairly seeing more pressure to utilize internal resources and more incentives in discountings to do that. We also assume some modest increase in Navistar this year nothing major but we have actually seen that go down so those two things we're behind the immediate changes.

Our approach we're going to stay disciplined and we're not going to chase share with discounting. Products performing well and so we're going just value to the customers to get buy back and same time align our across to deliver really good financials in this environment. I think longer term as we think about the share, our view is it's still 50% thick bore or 50% medium bore market. So, today we compete really with the 50 liter product and that was part of our announcement we made in New York that we will be bringing a medium bore product to the market in 2017 to compete on the other end where we used to have ISM product, we're going to have a terrific product in the year at that end.

So we see our share with Packard kind of in that 50% or 57% range now the market tends to be a little more big bore than medium bore and so we see while from the horsepower range in the 30-liter product, we cover a larger part of the horsepower range and so just the wrong product and the customer kind of draws that to more 50-50. So that's what's behind our guidance looking forward.

Pat Ward:

I think on the inventory side, I'll let Rich come in more, we don't feel any concern about our inventory horsepower engines we produce to demand where it's a really easy thing to look at and we dont have any issues with that and genset's same thing. In our distribution network we also don't have extra inventory. We have been planning well but the market has been down for some time. There is not a big -- there wasn't a nig shift.

The biggest concerns I think is the market place really is unused equipment is where people have parked equipment. In the Mining market this is an issue and the oil and gas market's an issue and what that means is as business starts to pick up, there will be a lull before we start to see the kind of equipment orders that we'd like to see when that business picks up. That's just the reality of what we see in some of these markets and so that's what we are planning for. But in our system our inventory levels are as they should be previous level business.

Jamie Cook:

Okay. Thank you.

Operator:

Our next question comes from the line of Ann Duignan with JP Morgan. your line is open.

Ann P. Duignan:JP Morgan:

hi. Good morning. Just a couple of follow up questions and I know you won't guide for 2017 and that's not the purpose of this question but can you talk a little bit about the heavy-duty in North America on highway side.

Do you see 2016 as a kind of a mid cycle slowdown that we just too much inventory and we need to clean that up in next year would be a more normal year. Are you seeing cracks in the fundamental side that I mean -- had rest of somewhat with the unused idles trucks that are at that but just kind of philosophical thinking on 2017 for on highway.

Rich Freeland:

The way I would answer that, the actual amount of freight moving is pretty reasonable and especially if you are in the consumer side, the housing side, the car side, some of the industrial folks are down but the freight actually, those indicators look pretty good. Last year we shipped the backlog came down 60,000 units. So we shipped 60,000 units of backlog last year and that's just not needed this year. And I just think we are in more of a normal replacement cycle right now which is in kind of the 220 to 240 range is where we are.

I think this year could be potentially lower because the backlogs are pretty low. And it's hard to run plans there are just no future visibilities. I think what we'll see what we're projecting anyway, not that we have a great insight just happened in cycles in this, production rates come down a bit in the second half of the year to build up a little bit of backlog and then I would look, then we're back to kind of macroeconomic for 2017 in which you know your guess is as good as mine but right now the general freight looks pretty good.

Pat Ward:

And my comment about unused equipment is really in the high horsepower market and not about trucks and really just to add to Rich's comments, I mean the only real negative on the freight side has been the oil and gas business is down and they do buy a lot of trucks and in and around that market there is a lot of trucks. You know the currencies are all strong so some of the exporters have been down but that's been true for a while.

That's not really changing very much. So the freight activity that we have seen is been pretty steady as Rich said so I think it is normalizing. We'll see obviously the macroeconomy in the US I think will be the primary driver of what do we see further reductions from here or whether we kind of stabilize and hang out at the levels of second half on into 2017.

Ann P. Duignan:

Yes I guess I would share your view in that. So I appreciate that and just a follow up on think when you were at our conference in March there was some discussion that if there were any upside risks that you beat your JV income, can you just talk about the pluses and the minuses what you are seeing in the joint ventures.

Rich Freeland:

Yes. I think, I'll say a couple of them and let Pat or Rich add but you know you heard us comment on China. We had a strong quarter in China the first quarter and there are some signs that things maybe good and be improving and we are just remaining a little cautious. So we left our forecast where it was and partially because we have just seen China better and beat the market not be that strong rest of the year a couple of years in a row so we just want to be prudent and watch and see a couple of quarters before we really call an upside and also just fundamentals don't look that much different.

So I think that's the place where maybe things are improving that some people suggest. We could have some upside in JV income there but right now our view is we think we are going to stay where we are from the point of view of forecasting. On the off highway side, maybe its the opposite. Its not that things are great now but I just feel like its weak market all over the place and so make maybe there is a little bit of down type on highway but again there is not much to go.

The good news is that we are still low but there is not much to go but it's just lot of equipment and a lot challenge in those markets. So again I think we are pretty balanced on our forecast. I think our JV income line's pretty well balanced and Rich do you any...

Rich Freeland:

I think from a market standpoint 100% agree. I think just our positioning in that market we have a couple of positive things still good about. One is the enforcement of the rigs are pretty good and probably better than a year ago as we introduced which is good for us. And second we saw that the growth in market share is we displaced competitive engines especially with bolt-on with the ISF and ISG engine.

These engines are doing a terrific job and Steve's here. Steve talk about revolutionary and they in fact are. They are lighter weight, they are higher performance. They don't break down in just one number the our RISG engine is a 150 pounds per liter and all the competitive engines are 200.

And so the engines it's a different market were old model was you had an engine that was easy to fix if it broke their parts were inexpensive. We are change in the market within engine you don't have get into you don't have change -- and so we had the rapid rise with just -- now we are going to be working with the partners to grow share versus competitors and that will take some -- with customers to get used to a new technology the in really products what they are used to. So I like where we stand in that race.

Operator:

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

Ross Gilardi: Bank of America Merrill Lynch:

Yes, good morning. Thank you. Just wanted to stay on that China discussion. So you mentioned that your market share took a little step backward and obviously you guys have been growing share pretty rapidly over there.

You kind of characterize it as more of a it sounded like a customer downtime issue but I am just wondering has there been any stronger competitive response from HI or any of your local competitors there given how quickly you had taken share in that market and is that part of the reason why the shares stepped back little bit?

Tom Linebarger:

Thanks the question Ross. No, in fact that's what I highlighted in my comments that in our penetration at our customers which also buy other engines has grown. So, to the contrary we continue to make inroads for exactly the reasons Rich mentioned. The engines are doing really well.

They're advantaging our customers. What happened was our truck customers basically didn't discount as much and didn't participate in the market as much in the first quarter. That was quiet a bit of activity in the market and quiet a bit of discounting by a couple of folks but just more activity they didn't participate in that same sort of thing and so they stepped back in their truck share. We are not the least bit worried about that.

We think that all works itself out over the course of the year. So we feel very good about our market share projections. In fact our penetration's ahead of where we'd hoped it would be so we're feeling really good about that so very good position very strong. The real question really is going to be how well the market did.

Market does well, we'll see good pick up were is better position we've ever been and so that's we just wait for the market picked back up.

Ross Gilardi:

Thank you and I think you mentioned 25% to 30% growth in China components if I got that correct and is that shown up on your components segment or your JV income and assuming it's in the segment, is that a major reason why you were sort of able to hold like a 14% margin in components and that sale off with you have to give some of that back do you think over the course of the year and I am talking on the way you are currently reporting it obviously as opposed to the restatement.

Pat Ward:

Yes. So components will not be affected by the restatement just where restructuring is clear but the point about components that China the business that you talked about 27% increase and that was resulted again as they are enforcing their standards and so we are having much equipment go on Chinese engines both after treatment the mainline but also fuel systems going into these electronic fuel systems are now pretty much required in order to meet the standards so what we are seeing is more content on our customers engines and our own engines in order to meet these new standards. That's really what driving that. They do good business it does contribute to our business but its not a higher mix in terms of margin or anything else so I would say our $0.14 margin is good all way around.

Tom Linebarger:

Yes but the reason by the margin stayed up strongest but it doesn't components even more but those place significant is a gain by across focus using terrific improvement in the crossing component segment but darn to all set the volume and all set to a significant foreign currency impact. Is still 14%.

Ross Gilardi:

Thanks very much.

Operator:

Our next question comes from the line of David Raso with Evercore. your line is open.

David Raso: Evercore:

Hi. Good morning. I was curious six months now since the analyst meeting and obviously the tone there was very positive about looking for deals. I was just curious if you can give us some update six months later, are we closer or further way and what are some of the impediments to getting the deal done.

Tom Linebarger:

Great, thanks David. Thanks for the question. Yeah, so we remain actively engaged in that process as I mentioned at the investor conference. I have got a group of people that I am working with directly on that front.

I am very engage personally and we are dutifully looking along the tracks that we talked about there where we think we can leverage our capabilities to grow. We are also of course remaining disciplined in terms of what we think is value added to the shareholders in terms of how we do it. Unfortunate thing is about, thing like this is first nothing to report and something report and anything in the would be just with tries our own process. So, unfortunately, I can only say that we are remaining active and very optimistic that we're looking in the right places and thinking about the right things,and that whatever we do when we do something it will be beneficial to our shareholders and beneficial of company long run.

On that part I am sorry, that I can provide you more details and shift because anything I say would does not help us in anyway and help our shareholders but I will just tell you that nothing is changed about a process, we're feel very active and I still feel good about what we're looking at.

David Raso:

Yes maybe wait and to little bit, are you six month later a lot further down the road on narrowing and focusing on what you lot of can target and think deal good could occurred or just feel as wide as it was six months ago?

Tom Linebarger:

No, we've done a lot of work to focus, and think it out what most important to us a lot of work on that.

David Raso:

Got it, thank you very much appreciate it.

Operator:

Our next question comes from the line of Steven Fisher with UBS. Your line is open.

Steven Fisher: UBS:

Thanks, good morning. Just talk about how expect to manage higher input cost in the second half of the year given higher commodity prices and what 's your latest thinking on pricing impact overall for the year?

Pat Ward:

Pricing impact for overall for the year is pretty much remember what we said I think three months ago some of the range 0.4% to 0.5% negative impact on margins, so we've seen that in Q1 we clearly overcame that and see a cost improvement and we will change and update as we look forward through the rest of the year. In first part of question was...

Steven Fisher:

How do you expect to manage that in the second half?

Tom Linebarger:

I think that what we have looked at it will be there will be minimal impact on us so we do some of that and we also have agreements with both customers and suppliers and do some hedging in that area. So at least at the level that we are projecting commodity price increases second half of the year that it would be minimal impact on our EBIT. The good thing for us is we are kind of operationally hedged in the sense of that as commodity prices increase of course so does demand for mining products. So there are short term differences where things move a little bit and mining doesn't pick up but in cost field but generally speaking if when commodity prices rise in a significant amount it's hard for us to offset in our cost structure we also see mining business improve which more than offsets it.

So in a way commodity prices improving is a good thing rather than a bad thing for us.

Steven Fisher:

Okay. And then outside of M&A that David was asking about to what extent has the weakness in the heavy-duty truck market cause you to accelerate --- other strategic plans maybe product oriented that you talked about at your Investor Day I thought you was there in the Investor Day the 10 liters and 12 liter was a 2018 and I think on this Call you said 2017 to are you accelerating some of those maybe more product strategy .

Tom Linebarger:

No. We are actually bring product here in 2017 late in the year which is pretty much what we intended to say at the investor conference and really go into production in 2018.

Rich Freeland:

Yes in terms of the strategy to work that David asked about, we are accelerating now we are accelerating then we are fully focused on efforts that important to our strategically so there is not a change but we are looking pretty quickly that figure out what's most important for us to do and figure out how to do it.

Steven Fisher:

Okay. Thank you.

Operator:

Our next question comes from the line of Tim Thein with Citi Group. Your line is open.

Tim Thein:CITI Investment Research (US):

Good morning. Thank you. Question on distribution, first off just in light of the updated currency assumptions which obviously hits that segment especially hard in both ways. How should we think about the update there and as well as the distributor acquisition.

I know at this point there is probably only small ones but maybe any color on those items in terms of how it potentially impacts the balance of the year.

Pat Ward:

I think on foreign currency, I'll answer really for the company and then we distribution if you want. In the first quarter we had a 3% negative impact in sales and $19 million impact on profitability and negative for the company. Given the currency rates currently we expect the foreign currency headwind on the company for the rest of the year to be much less than what we see in the past year and a half. We have make for the three year and currency $200 million in sales so 1% and fairly neutral on profitability for the full year.

So can you just back into the rest of year that was implied the the sales and practice is going to be a lesson to 1% negative as opposed to 3% in the first quarter and profitability should be a little bit better across all the segments and what we seeing in Q1 and for most of last year and obviously distribution -- the segment is been most expose to comes in moments so that's should help us as it -- because in all we found that I think you know that -- sometimes because distribution operates in every currency so we can have currencies which are strengthening and weakening relative to the US dollar but on balance they can work the way out and some might be going the other way but I think distribution still has currency exposure but hopes with passed that on balance will see a little bit lesser than negative impact. The one thing I would to highlight here is that we did see improvement in margin this quarter and that's the despite currency and other challenges there.

So, that's a pretty good evidence that some of the synergies and other work we've been doing it and start to pay off to the question earlier. I think with the distributor acquisition your right their shift to one -- North America less to do that's the one we finish this year that's in California so it's not that's small -- actually not the biggest but it's recent size and will be acquiring that in the second half of the year and when that's complete will now then on all the North American distributors and to the process will be complete for North America and as Rich highlighted earlier with the end kind of fall in to figure not how we captured this synergies that we know are available to us.

Tom Linebarger:

I think to just to summarize till then little bit more negative on the engine business revenue outlook given how we do to truck market little bit better on distribution from currency and from the acquisition is -- visibly in the -- overall for the company and then will request segments -- with the new reported structure next quarter.

Tim Thein:

Okay. Understood, and just may be one quick clean up on components and again surprised it how few questions relative to the contribution of profits there but just I know that, that segment you can have some lumpiness just in terms of how some of the engineering costs flows through the quarter. Was it seasonally low in the first quarter and it will pick up or was that not much of a factor either way in first quarter.

Pat Ward:

That was not much of in the first quarter.

Tim Thein:

Yeah very good Thank you.

Operator:

Our next question comes from the line of Joe O'Dea with Vertical Research Partners. Your line is open.

Joe O'Dea: Vertical Research Partners:

Hi. Good morning. Could you talk a little about the heavy-duty truck revenue you talked about some of the challenges and instead of OE volumes into North America but the overall kind of revenue there better than what we're seeing in North America new equipment trends. So what are you seeing on the part side whether owning distribution is improving some of the demand there as you manage that process but some of the offsets in North America heavy-duty truck volumes within the reported heavy-duty truck segment volumes.

Tom Linebarger:

The parts revenues have remained pretty steady and actually continue to grow slightly and through this in the heavy-duty side. The distribution piece is more indirect on the parts sales. So we think our regional distribution strategy increasing availability etcetera will get some upsides there but it's more around the synergies of getting product out there. So I wouldn't attribute the acquisition to increasing parts sales although now we participate in those where we really didn't used to within the joint ventures at the same level.

The other thing that I just going to mention indirectly to your question and relates to move us the component since the every thing space. In our strategy is to we tell engines to people who are vertically integrated and so sale engine that we really don't sell engines, we sell components so some of the movements between engines and components the components business continues the benefit form there and our share and goes over 60% and that's remain share after treatment over 50% until we continued to maintain that in a time for going to well on market share on the engine side.

I just end the specific for selling us in over reaching the revenue segment to we really North American on time with as change dist between planned around revenues for the year that still the assumptions we are not seeing any executive the projectories will not seeing any significant change in some of the international markets like Australia or South Africa then rest of the our segments. The lower outlook to the overall heavy-duty year asking that question.

Tim Thein:

Yes. That's perfect. Thanks very much. Good job.

Tom Linebarger:

Okay thank very much everybody and I will available for your called. Thank you.

Operator:

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.