Cummins Earnings Call Nuggets: Components Margin and Competition in China

Cummins Inc (NYSE:CMI) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Components Margin

Andrew Casey – Wells Fargo: Couple of questions. First on, Components margin was quite a bit higher than I expected. Could you run through what the material cost impact was on margins?

Pat Ward – VP and CFO: You are talking year-over-year or quarter-over-quarter Andy?

Andrew Casey – Wells Fargo: Year-over-year. Thanks, Pat.

Pat Ward – VP and CFO: So for year-over-year, there was about 1.5 percentage improvement in material costs for the Components margin through material costs.

Andrew Casey – Wells Fargo: Then on the Engine side on the joint ventures that Beijing Foton Cummins had quite a sequential improvement and increased to $9 million in the quarter from $1 million in the first quarter. Is there anything special behind that or is that all – it’s hard to see the volume improvement from the retail sales data that we have.

Rich Freeland – VP and President – Engine Business: Andy, this is Rich, couple of things. About half of that is volume, and so leveraging the volume going forward. The other – there is a one-time – not a one-time, but a warranty improvement that we’ve seen there. So that product is performing very well. So, we’ve been able to adjust the accrual rate down in Q2, so about half of that gain was warranty and about half of its incrementals from the volumes.

Andrew Casey – Wells Fargo: Would that warranty level be a catch-up or would it continue into…

Rich Freeland – VP and President – Engine Business: It’s a catch-up and we also adjust the rates down going forward.

Tom Linebarger – President and CEO: Remember all those work, Andy, so we said a rate and then we have actual experience. And then if our actual experience is different enough then we adjust the liability and that’s the point that when you say catch-up what you are doing is adjusting liability but then you also lower the rates going forward which means you are lowering ongoing expense. So, we do both things at once and of course if the reverse is true and warranty goes up you have to do the other thing you have to figure out how to add the liability and then increase. In Foton, we’ve had good experience on the engine quality which has allowed us to lower the liability and lower the ongoing rate going forward, which is good news.

Competition in China

Jerry Revich – Goldman Sachs: Tom, as we think about your business once the China National 4 standards are ultimately implemented whenever that is. Can you just give us a sense for how your discussions with other engine manufactures are tracking? Can you get your after-treatment market share to similar levels as you have in your Turbo Charger business and can you give us your latest sense on content per unit or after-treatment based on the latest sets of configurations that you have seen?

Tom Linebarger – President and CEO: The after-treatment business is still, I would say, it is unclear what the competitive landscape is going to be because there has just been such uncertainty about the NS4 standards. Obviously, we are coming to market with a set of competitive products, not just one. We will have set of competitive products in the after-treatment business with our full intention of gaining significant market share with our JV engines as well as with other people’s engines. But I would just say right now the landscape is unclear because the enforcement of the standard is unclear, how fast it is going to move. One thing is clear at least to me that it’s not going to go fast this year. Other than that, it’s not so clear how fast it’s going to go. I think the stronger the enforcement of the reg, the higher our market share will be, and weaker the enforcement more competitive other products might be, so we just don’t know – we’re ready to compete in whatever thing turns up, but I just would say that how higher market share we can reach relative to turbo’s is uncertain, that’s certainly our target, that’s where we’re headed. Our view is that we are competing in China like it’s our home market, so we compete on the terms of competition there and we’re going to win.

Jerry Revich – Goldman Sachs: In the U.S. components business, pretty massive win on the Navistar medium duty after-treatment. Can you just flush out for us your production plan to support the additional businesses that as and simple as adding a shift do you have capacity to do that just so we can get a sense for operating leverage next year?

Tom Linebarger – President and CEO: I think we have capacity. We had to do some significant planning as you’d guess for that, especially on the supply side. So we’ve had to do bunch of work with suppliers to make sure that we have adequate capacity. You remember in the past when things peaked out we had capacity limitations on the insides of the after treatment system both coatings as well as bricks. So we have done a lot of planning on not to make sure we have adequate capacity, not just for the start, but for when things get stronger. I think we’ve got a good position on that. I’m worried about our ability to ramp with them. The midrange business that they’ve transferred to us is not all ramping at the same time, so we have plenty of ability to ramp up with them, but as I said the important thing is making sure we’re planning to have adequate capacity for all customers at the peak of the market, not just at the start. So we feel good about that.

A Closer Look: Cummins Earnings Cheat Sheet>>