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Cummins Inc (NYSE:CMI)
Q2 2018 Earnings Conference Call
Jul. 31, 2018, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to Cummins, Inc. Second Quarter 2018 Earnings Conference Call. (Operator Instructions) And as a reminder, this conference call is being recorded.

I'd now like to turn the conference over to Mark Smith, Vice President of Financial Operations. Please go ahead.

Mark Smith -- Vice President of Financial Operations

Thank you, and good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the second quarter of 2018. And with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Pat Ward; and President and Chief Operating Officer, Rich Freeland. We'll all be available for your questions after 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 our forward-looking disclosure statement and in our filings with the Securities and Exchange Commission, particularly in the Risk Factors section of our most recently filed annual report, and any subsequently filed quarterly reports.

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 financials. 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 Tom.

Tom Linebarger -- Chairman and Chief Executive Officer

Thank you, Mark. Good morning. I'll start with a summary of our second quarter results and finish with a discussion of our outlook for 2018. Pat will then take you through more details of both our second quarter financial performance and our forecast for this year.

We delivered record quarterly sales and profits in the second quarter. Revenues were $6.1 billion, an increase of 21% compared to the second quarter of 2017, with growth in all of our operating segments and most of our major geographic markets. EBITDA was $897 million or 14.6% of sales, compared to $764 million or 15% a year ago.

During the second quarter, we finalized our plans and our forecast estimate for a previously disclosed product campaign to address the performance of an aftertreatment component in certain on-highway engines, produced between 2010 and 2015. In determining the best course of action to support our customers, we have elected to increase the number of aftertreatment systems to be addressed through hardware replacement compared to our estimate last quarter.

As a result, we recorded a charge of $181 million or 3% of sales in the second quarter and we believe that we have now fully provided for the expected costs of this campaign. The charge was shared between the Engine and Components segments. We've reached agreement with the appropriate regulatory agencies regarding our proposed actions and we will launch that campaign in phases starting in the third quarter of this year, and expect to substantially complete the campaign by the end of 2020. This issue does not affect any of our current products, which are performing very well, and our market share remains strong.

And to that point, Engine Business revenues increased 17% compared to a year ago, due to strong demand in on-highway markets in North America and growth in construction markets in both China and North America. EBITDA for the quarter was 13.4% of sales compared to 14% a year ago. EBITDA percent declined as the benefits of higher volumes, improved pricing and increased joint venture earnings in China were more than offset by a $91 million charge related to product campaign.

Sales for our Distribution segment grew by 16% year-over-year, driven by higher demand for new engines, parts and service in off-highway markets, as well as some targeted price increases. Second quarter EBITDA was 7.3% compared to 7.4% in the second quarter of 2017. EBITDA increased 14% in dollar terms, but declined slightly as a percent of sales, due to a lower mix of part sales.

Second quarter revenues for the Components segment rose by 30%. Sales in North America increased 36% and revenues in international markets grew 22% as a result of rising market demand, strong market share and the success of new products aimed at lowering emissions. Sales of the Eaton Cummins Automated Transmission business contributed 10% to Components segment growth. EBITDA for the second quarter was 12.6%, compared to 15.7% in the same quarter a year ago. EBITDA declined as the benefits of stronger sales and material cost reduction programs were more than offset by the charge of $90 million related to product campaign.

Power Systems sales in the second quarter grew 23% year-over-year, driven primarily by higher demand for power generation equipment and an increase in sales to oil and gas and mining customers. EBITDA in the second quarter was 14.9%, compared to 8.8% a year ago. The benefits of stronger volumes, improvements in quality, cost reduction programs and stronger joint venture earnings in China, all contributed to EBITDA margin expansion.

In our Electrified Powertrain business, second quarter EBITDA was a loss of $21 million, in line with our projections. Given the potential for this technology, especially in urban and short-range applications, we will continue to invest in development and new product programs ahead of broad market adoption.

Now, I will comment on the performance of some of our key markets for the second quarter of 2018, starting with North America, and then I'll cover some of our largest international markets.

Our revenues in North America grew 22% in the second quarter, due to growth in demand in most of our end markets and the ramp-up of the Eaton Cummins Automated Transmission joint venture. Industry production of North American heavy-duty trucks grew 20% in the second quarter of 2018, while sales of our heavy-duty engines increased by 38%. Our year-to-date market share through May was 33%, in line with last year. Industry production of medium-duty trucks improved 16% in the second quarter, while our engine shipments grew 15%. Year-to-date, our market share in the medium-duty truck market was 81% through May, up from 79% a year ago.

Total shipments to our North American pickup truck customers were decreased by 20% compared to a year ago, due to a short-term adjustment to production by one of our OEM customers. Engine sales for construction equipment in North America increased 18% in the second quarter, reflecting general strength in the economy. Engine shipments to high horsepower markets in North America rose 42% compared to a year ago, driven by higher demand from both oil and gas and mining customers. And revenues for power generation grew by 9%, due to higher demand in the data center and recreational vehicle markets.

Our international revenues increased by 18% in the second quarter of 2018. Second quarter revenues in China, including joint ventures, were $1.4 billion (ph), an increase of 9% due to higher sales in off-highway markets. Industry demand for medium- and heavy-duty trucks in China increased by 13% compared to a year ago. Year-to-date, our market share was 11% through June compared to 14% last year. We are confident that we will regain this market share as we increase penetration of our engine at Foton, ramp up our new market -- our new partnership with JAC and launch new products for NS 6 with all of our partners in China.

Industry sales of light-duty trucks grew by 25% in the second quarter and our engine market share was 7%. Demand for excavators in the third quarter increased 74% from a year ago in China. Our market share through June increased to 14%, up fully 2% year-over-year, driven by strong performance by our OEM partners. Revenues for our Power Systems business in China increased 53%, due to growth in engine shipments to mining customers and higher demand for power generation equipment for data centers.

Second quarter revenues in India, including joint ventures, were $575 million, an increase of 33% from second quarter a year ago. Industry production -- industry truck production more than doubled year-over-year, following the introduction of Bharat Stage IV regulations in April last year. Year-to-date market share was 42% through June, up 2% from 2017, with Tata trucks powered by our new BS IV-compliant engine systems.

In Brazil, our revenues increased by 29%, primarily due to a moderately recovering economy, resulting in improved demand for trucks compared to a weak 2017.

Now let me provide our overall outlook for 2018 and then comment on individual regions and end markets.

We are now forecasting total Company revenues for 2018 to be up 15% to 17%, higher than our previous guidance of up 10% to 14%, reflecting a stronger outlook for industrial, power generation and construction markets, as well as stronger market share in North America on-highway markets.

We are maintaining our forecast for industry production of heavy-duty trucks in North America at 286,000 units, up 29% compared to 2017. We expect our market share to be between 31% and 34%, which is unchanged from our view last quarter. However, we now expect to be at the higher end of this range.

In the medium-duty truck market, we've increased our forecast for industry production to reach 133,000 units, up 13% year-over-year and above our prior forecast of 124,000 units. We expect our market share to be in the range of 75% to 78%, an increase from our prior guidance of 72% to 75%. We expect our engine shipments for pickup trucks in North America to be flat for the full year of 2018, compared to a very strong 2017.

In China, we expect domestic revenues, including joint ventures, to be up 1%, compared to our previous guidance of being lower by 2% in 2018. We have raised our outlook for medium- and heavy-duty truck market demand slightly to 1.3 million units from our prior forecast of 1.2 million units, representing a flat market compared to last year.

In the light-duty market, we now expect growth of 5% in 2018, up from our previous guidance of no growth. We expect our market share in the medium and heavy-duty market to be 12%, up from the first half of this year, but down from our prior forecast of 14%. In light-duty, we expect our full year's share to be 7% compared to our previous guidance of 8%.

In India, we expect total revenues, including joint ventures, to be up 18% year-over-year, lower than our previous forecasted growth of at least 20%, due to a lower outlook for truck demand. Earlier this month, the Indian government surprised the industry by introducing regulations that allow higher loads per vehicle. The new regulations have caused a sharp decline in truck sales, as customers await upgraded models from OEMs in response to the regulations. Underlying demand for trucks remains strong and we expect growth in truck sales to resume once the OEMs and customers adjust to the new regulations.

In Brazil, we now forecast truck production to increase 20% in 2018, up from our previous guidance. We expect our global high-horsepower engines to increase 35%, up from our previous forecast of 30%, reflecting strong demand from mining customers and an improved outlook for sales of power generation equipment.

In summary, we've raised our full-year outlook and expect to deliver record sales, EBITDA, operating cash flow, and earnings per share in 2018. We revised our forecast for EBITDA to be in the range of 14.8% to 15.2%, down from our previous guidance of 15.4% to 15.8%, with the benefit of stronger sales, offset by the charge for the product campaign in the second quarter and the addition of approximately $100 million of trade tariffs and tariff-related cost inflation in the second half of the year. Full-year incremental EBITDA margins are projected to be 20%, excluding the impact of the Eaton Cummins joint venture and our electrified powertrain business, but including both the product campaign and the tariff-related costs.

During the quarter, we returned $393 million in cash to shareholders in the form of dividends and share repurchases, and recently announced a 5.6% increase in our quarterly cash dividend. We now plan to return 75% of our operating cash flow to shareholders in 2018, up from our previous plan to return 50%.

At our Analyst Day last November, we discussed several growth platforms that we're working on to drive future profitable growth. For each platform, we said that we would evaluate the best options for growth, between organic investment, partnerships, and acquisitions. And we continue to make progress in executing the strategy.

Consistent with our goal to be a leader in electrified powertrains for commercial vehicles, we recently announced that we'll acquire Efficient Drivetrains, Inc. or EDI. Based in Milpitas, California, EDI develops and produces hybrid and fully electric power solutions for commercial vehicle applications. The acquisition of EDI will complement our existing capabilities in electrified powertrains and we expect to complete the acquisition in the third quarter of this year.

For those of you planning to attend the IAA Truck Show in Hannover in September, you have the opportunity to view a range of Cummins products, including our electrified powertrains in commercial vehicles.

In discussing our plans to grow in attractive markets last November, we covered an approach to growth in the light commercial vehicle market, which we said would be likely through consolidation or partnership. And we said that we will pursue with discipline acquisitions that could increase our participation in larger horsepower power generation, oil and gas, rail and marine markets. In May, we announced plans to form a joint venture with JAC Motors in China, building on our 20-year relationship between the two companies.

This joint venture will be focused on the light commercial vehicle in China, the largest market in the world, and global export markets. In forming this new alliance, Cummins will acquire Navistar's interest in the joint venture with JAC. The change in ownership will go into effect upon completion of regulatory reviews. And we are continuing to actively pursue acquisitions and partnerships in the larger horsepower industrial markets.

Thank you for your interest today. We had a strong quarter and are on track for a record full-year results, extending our track record of improving performance over prior cycles and continuing to return cash to shareholders. We are also making significant strides in executing our strategy to drive more profitable growth in the future.

Now let me turn it over to Pat.

Pat Ward -- Vice President & Chief Financial Officer

Thank you, Tom, and good morning everyone. I will start with a review of the Company's second quarter financial results before discussing the performance of the operating segments in some more detail. I will then provide an update on our outlook for the remainder of the year.

Second quarter revenues were $6.1 billion, an increase of 21% from a year ago and a quarterly record for the Company. Sales improved in each of our operating segments, driven by stronger demand in global on-highway, industrial and power generation markets. Sales in North America, which represented 59% of our second quarter revenues, grew 22% from a year ago, due to increased sales of engines and components to meet higher levels of heavy- and medium-duty truck production and stronger demand for industrial engines. Our international sales increased by 18% from a year ago, due to higher demand in China, India, Europe and Latin America for on-highway, construction and industrial markets, as well as benefiting from a weaker US dollar.

Gross margins were 23.5% of sales, down from 24.6% a year ago, primarily due to the product campaign charge that Tom just discussed. The campaign charge negatively impacted our gross margin by 300 basis points, offsetting positive effects of the stronger volumes, favorable pricing, and material cost reductions.

Selling, admin and research and development costs of $832 million were $51 million higher than last year, with most of the increase occurring in research and development. As a percent of sales, selling, admin and research and development spending was 13.6%, a decrease as a percent of sales by 180 basis points from a year ago.

Joint venture income of $110 million, increased by $12 million compared to last year. Earnings before interest and tax, depreciation and amortization were $897 million or 14.6% of sales for the quarter, compared to $764 million or 15% a year ago. EBITDA as a percent of sales declined due to the campaign charge, which more than offset the benefits realized from the stronger operating performance in the quarter. Excluding the campaign charge, EBITDA was $1.1 billion or 17.6% of sales.

Net earnings for the quarter were a record $545 million or $3.32 per diluted share, compared to $424 million or $2.53 from a year ago. Effective tax rate for the second quarter was 22.5%, in line with our full-year guidance of 23% and down from 26.4% last year.

Moving on to the operating segments, let me summarize their performance in the quarter and the outlook for the full year and then I'll review the Company's revenue and profitability expectations for the full year, and conclude with some comments on cash flow.

In the Engine segment, revenues were $2.7 billion in the second quarter, an increase of 17% from last year, due to a 16% growth from on-highway sales and a 20% increase in off-highway revenues, primarily due to growth in construction markets. The segment EBITDA in the second quarter was $362 million or 13.4% of sales. This compares to $323 million or 14% from a year ago. The benefits from the stronger volumes, higher contribution from joint ventures, and very good operating leverage were partially offset by the campaign charge and investment in new products. Including (ph) the campaign charge, EBITDA margins for the segment were 16.8% in the quarter.

We now expect full year Engine segment revenues to be up 17% to 19%, compared to our previous guidance of up 10% to 14%, due to continued strength in North American truck and international construction markets. We are forecasting EBITDA margins to be in the range of 13.25% to 13.75% of sales, which includes the campaign charges booked in the first half of the year, and compared to 13.5% to 14% in our previous guidance.

For the Distribution segment, second quarter revenues were $2 billion, an increase of 16% compared to last year. The growth in sales was primarily driven by higher demand for both new engines and parts and service in North America, favorable pricing and the impact of a weaker US dollar. EBITDA margins for the quarter increased by 14% to $145 million or 7.3% of sales, which compares to $127 million or 7.4% a year ago. The EBITDA percent declined due to a lower mix of part sales.

For 2018, Distribution revenue is now projected to increase 9% to 11% compared to our previous guidance of up 6% to 10%, due to strong off-highway demand for engines and parts. We are now forecasting EBITDA margins to be in the range of 7% to 7.5% of sales versus our previous guidance of 7.75% to 8.25%.

For the Components segment, revenues were $1.9 billion in the second quarter, a 30% increase from a year ago and a quarterly record. The Eaton Cummins joint venture contributed 10% to growth. Sales in North America increased 36% due to higher medium -- higher heavy-and medium-duty truck production, while international revenues grew 22% as a result of strong growth in Europe and India and the depreciation of the US dollar. Segment EBITDA was $237 million, or 12.6% of sales, compared to $228 million or 15.7% of sales a year ago. The positive impact of the higher sales and favorable material cost were offset by the product campaign charge. Excluding that campaign charge, EBITDA margins were 17.3% of sales in the quarter.

For 2018, we now expect revenue to increase 23% to 25% compared to our prior guidance of up 18% to 23%. Stronger than expected demand in both the North America truck market and in Europe are the main contributors to the improved outlook. EBITDA is projected to be in the range of 14% to 14.5% of sales, which includes the campaign charges booked in the first and second quarter, compared to 15.25% to 15.75% in our previous forecast.

In the Power Systems segment, second quarter revenues were $1.2 billion, an increase of 23% from a year ago. Industrial sales rose 37% as a result of stronger oil and gas and mining demand. Power generation sales grew by 17% as a result of higher demand for power gen equipment in North America and in China. EBITDA more than doubled in dollar terms to $186 million or 14.9% of sales in the quarter, up from $90 million or 8.8% last year, driven by the positive impact of the higher sales, favorable material cost and higher joint venture earnings.

For 2018, we now expect Power Systems segment revenues to increase 15% to 17% versus our prior guidance of up 7% to 11% as a result of stronger demand in industrial and power generation markets. EBITDA margins are forecasted to be between 13.5% and 14% of sales, compared to our previous guidance of 13% to 13.5%.

And in the Electrified Power segment, EBITDA losses were $21 million, due to our investment in new products. For the full year, we expect a net expense of between $60 million and $80 million, in line with our previous guidance, as we continue to invest in new products.

And as you heard from Tom, for the Company, we're raising our outlook for revenues to be up 15% to 17% this year versus a previous guidance of up 10% to 14%. The increase is driven by continued strength in North American on-highway markets and an improved outlook in power generation, construction and mining markets. Foreign currency, primarily driven by a weaker US dollar, is expected to increase revenues by approximately $100 million this year. Income from our joint ventures is now expected to be flat in 2018 compared to our previous guidance of down 10%.

We're forecasting EBITDA margins to be in the range of 14.8% to 15.2% for 2018, down from our previous forecast of 15.4% to 15.8%. Full year incremental EBITDA margins are forecasted to be 20%, which excludes the impact of the Eaton Cummins joint venture and the Electrified Powertrain business, but does include all the campaign and tariff-related costs.

Turning to cash flow. Cash generated from operating activities for the second quarter was $590 million, $143 million higher than last year. Capital expenditures during the quarter were $114 million, bringing the year-to-date total to $186 million. And we still a expect our full year capital expenditure will be in the range of $730 million to $760 million.

In the second quarter, we returned $393 million to our shareholders through dividend payments and share repurchases. For the first six months of this year, we've returned $734 million, which includes the repurchase of approximately 2.5 million shares. As Tom mentioned, our Board of Directors recently authorized an increase in our quarterly dividend of 5.6% to $1.14 per share., And we now plan to return 75% of operating cash flow to our shareholders this year in the form of dividends and share repurchases.

In summary, we had a very strong operating performance in the second quarter and we are on track to deliver record sales, EBITDA, operating cash flow and earnings per share in 2018.

And before I turn it back over to Mark, I would just like to take a moment to recognize and thank Adam Schumm for all his contributions in Investor Relations over the last two and a half years, as he prepares to move on to this new role in our Emission Solutions business. And at the same time, I'd like to welcome James Hopkins who has taken over from Adam into Investor Relations.

Now let me turn it back over to Mark.

Mark Smith -- Vice President of Financial Operations

Great. Thanks, Pat. We now are ready for questions. We do have plenty of time available, so please, if you can limit your first question to one question and one related follow-up, and then get back in queue. Thank you very much. We're ready to start.

Questions and Answers:

Operator

(Operator Instructions) Our first question comes from Adam Uhlman with Cleveland Research. Your line is now open.

Adam Uhlman -- Cleveland Research Co. -- Analyst

Hi, good morning everyone.

Tom Linebarger -- Chairman and Chief Executive Officer

Good morning, Adam.

Adam Uhlman -- Cleveland Research Co. -- Analyst

Yes, I was wondering if we could start with the discussion around material cost. It sounds like that was favorable across several segments; Components and Power Systems and the others. Could you expand on your expectations for the second half of the year? And then related to that, how you're thinking about price realization for the second half of the year?

Rich Freeland -- President and Chief Operating Officer

Okay. Hey, Adam, this is Rich. Let me start with that, and I'll just talk a little bit, since we referenced the whole area of metal market's material cost and tariffs, and then we'll come back to the impact, kind of, for the second half.

So roughly the way, I think, you should think about it, it's about $200 million of impact to the Company annually. So roughly half of that in the second half of this year. And it's split between material cost, so metal market increases, and tariffs about 50:50. And the way that we'll manage the kind of the metal market material cost piece of that is through contracts that we have both with suppliers and with customers. And so, there's -- there can be a lag effect on those, but those we'll -- we'll manage those through the channel kind of over two to four quarters, a little faster in Components, a little slower in Engines.

On the tariff standpoint, so again, about half of that $200 million, and there's a couple of actions we'll take, which relates a little bit to your question. So we can make some short-term supply chain changes where we already have supply bases set up around the globe. And maybe a third of those, we can mitigate in the shorter term. The balance of that -- of the tariff- related will either be done through pricing. Much of that you will see a little bit yet in the second half, but most of that will begin in 2019. And also, we'll look at kind of longer-term supply chain changes to address that.

Tom Linebarger -- Chairman and Chief Executive Officer

Just to add -- Adam, this is Tom, the only thing I'd add is, we've been pretty successful in finding cost reductions in our material cost area. That's -- you mentioned the first half being favorable. And we are still seeing -- we have been in an inflationary environment, but we've been working hard to find reductions. In our view, in our industry, as we have the most efficient supply chain, from a cost point of view, we've got a very effective global supply chain. We have a bunch of folks on the engineering and purchasing side that work to find reductions all the time. And so, we are getting that net $50 million benefit from cost reduction every year -- I mean, every quarter in the last couple of quarters. And that was hard work and we feel great about that. We're going to continue that work; that doesn't change.

The frustrating thing about the tariffs and steel and aluminum tariffs as well, they just drive inflation. So what's happening is, we're just adding taxes and inflation to our cost structure, which was already inflating, given how strong the economy was. So that's just going to drive more cost into the business. We'll do our best to pass that on to other people, and of course, readjusting our supply chain to deal with tariffs is frustrating, because it's a really cost-effective and efficient supply chain. It is what it is. We'll have to do it, but it's a frustrating situation to be in, considering how well we're positioned today as the manufacturer with our global supply chain.

Adam Uhlman -- Cleveland Research Co. -- Analyst

Okay, got it. Thank you. And then secondly on the lowered truck market forecast for India. I'm wondering if the weight regulation change means that there could be a change in the size of engines that your OEM customers are looking to buy going forward.

Tom Linebarger -- Chairman and Chief Executive Officer

Yeah, it's a good question. I think, while we're sorting through kind of the timing of the new introductions, it's a positive to us. So it's going to move to bigger engines. We are positioned really well, especially in the six-cylinder side, where Tata uses their own engine with a four cylinder. So we're going to see more and more volume move up into a higher horsepower, which will be a positive for us.

Adam Uhlman -- Cleveland Research Co. -- Analyst

Great, thank you.

Mark Smith -- Vice President of Financial Operations

Thanks, Uhlman.

Operator

Thank you. Our next question comes from Jerry Revich with Goldman Sachs. Your line is now open.

Jerry Revich -- Goldman Sachs -- Analyst

Yes, hi, good morning everyone.

Tom Linebarger -- Chairman and Chief Executive Officer

Hi, Jerry.

Jerry Revich -- Goldman Sachs -- Analyst

Tom, I'm wondering if you could talk about how the JAC acquisition fits in within the broader China partnership structure for you folks. What's the ultimate market share opportunity that you folks are targeting now? Does that add to the 20% target you had before? And then from a near-term standpoint, you mentioned lower market share in the quarter. I'm wondering if you folks can just flesh that out a bit in terms of the path to get back toward prior-year market share levels too?

Tom Linebarger -- Chairman and Chief Executive Officer

Yes, thanks for that Jerry. Yes, as you highlighted, in the China situation, we've gone backwards a little bit in market share. I mean, our business has been great and the market's been incredible. So, our business has been doing well. But our market share has dropped a little bit and we could have been doing even better. And part of that was related to the quality issues we had with the ISG some time ago. We have now resolved those. But we're still regaining penetration at Foton as a result of that. We feel confident we will do that. I was just in China, I've met with Foton and we did meet with them extensively, we're very confident that we will restore our penetration into the heavy-duty market and that will drive up some.

Second thing is, this JAC partnership fits in, in the sense that there is a very large light-duty market, it's the largest one in the world in China. Plus, JAC also has a relatively significant export market. Again, they're mostly targeting markets that are similar emissions levels to China. So -- and of course as China moves to China VI that expands their potential export markets. They make an inexpensive, but quite capable small truck and so we're happy to add them into the partnerships. We see that as being able to drive our light-duty market share from something like 7% or 8% today to 15% over some number of years, where our plan says five. We'd like to move faster, but our plan says five years, we get back up to 15-plus. So with that, and the heavy-duty penetration.

And then NS 6, that's -- again, we'll have another shake-out, where some of the smaller players will be unable to get to China VI. That's a very, very tough standard and we think our partners using Cummins engines will again gain share, which we think will bring us back to our old numbers and passed again. We need to get a little further on the NS 6 work to kind of figure out exactly where we'll get by when. But that's where I said in my remarks, I'm highly confident that we will get back to our old market share numbers and passed again, based on these three things. The JAC numbers, again, they will take a little bit to ramp up, because we're just getting started with them, it's not even approved yet. But I think the Foton work will start. We're probably at our low point today. So in the next few quarters, we'll start to see that ramp back up again, and then China VI and JAC follow on.

Jerry Revich -- Goldman Sachs -- Analyst

Okay, thank you. And then it was nice to see the better operating leverage in Power Systems. Can you just talk about whether you folks are completely done with the manufacturing transition that you're working through and consolidating some of the facilities and just give us an update if you think we are on a path to meaningful improvement, incremental margins starting with this quarter?

Rich Freeland -- President and Chief Operating Officer

Yes. No, I'm really pleased with the progress that's been made there. It's kind of been a three-year journey, both in taking cost out, restructuring that business and gaining share, introducing new products. And so you saw that kind of for the first time coming through. We've introduced a lot of the cost saving pieces, but there is still another -- and there is still a piece left, which was our plant closure that -- in Stanford that we're just now finishing. So we've had -- it's actually been a negative synergy this year, so we've had the restructuring costs. We will have an additional $20 million savings with that one beginning in 2019. So lots of good work there kind of from cost, product introduction, market share gain, we feel really good about.

Tom Linebarger -- Chairman and Chief Executive Officer

And then we're really -- Jerry, we're really at mid-cycle there too. So our view is that not only are we seeing the benefits of the cost, but we are also really midway through the ramp. So we expect to continue to see benefits from increased revenues as plants get fully utilized. And we feel good with our supply chain, we're having to work hard to make sure our supply chain stays on good lead times. But that's the work we're good at. So we feel confident about that.

Jerry Revich -- Goldman Sachs -- Analyst

Okay. Thank you.

Operator

Thank you. Our next question comes from Jamie Cook with Credit Suisse. Your line is now open.

Jamie Cook -- Credit Suisse -- Analyst

Hi, good morning. I guess two questions. One, Tom, just a little more color on the decision to return 75% of operating cash flow to shareholders. I mean, is that to signal larger M&A is over, or is that just signaling you think your stock is really cheap right now and we're all missing something. So I'm just trying to understand what you're trying to tell the market with that statement?

And then my second question, can you comment on any markets where you have visibility into 2019, because lead times are extended? And that as I think about sort of normalized incremental margins, I'm just thinking about 2019 versus 2018. I'm assuming the product campaign cost, obviously, they go away. Is the JV and EV investment, does that change? It made it (ph) all in sort of risk that tariffs or price increases are an incremental negative to '19, because some companies are already talking about that. So I'm just trying to think about, how I think about one-time items in '19, I can make my own forecast on the end markets. Thanks.

Tom Linebarger -- Chairman and Chief Executive Officer

Thanks, Jamie. Thanks for those questions. So on the 75%, as I mentioned in my remarks in my opening, we are continuing with our strategy. So we are still seeking to drive partnerships or acquisitions in the large power area. We're still driving -- trying to drive growth in our distribution and telematics area. So the strategy hasn't changed. But what we are trying to signal with the 75% is three things really. Number one, our performance this year is really good, our cash flow is really good, and our needs for investing in the business are less than the cash flow we are generating. And so we want to make sure that we don't -- we don't need to inventory cash. We have very strong balance sheet. We can return cash flow to shareholders and still meet all our needs and that's a good thing.

Second thing is that there are no imminent needs for the cash. Obviously, if we were months away from a large acquisition, we would not do that. But -- so what we are saying is we are not imminently doing things. We are still actively working on that. And again, there's been a lot of rumors and things about what we've been involved with. I think, what, I guess, I wanted to remind everyone is that our intent in all of our growth partnerships, acquisitions etcetera is to remain disciplined and to make sure that the result of the acquisition is a positive impact for shareholders, not just more revenue. And so, we are continuing to do that. And as we look at the field today, we are active, there are a number of things which would be attractive to put into Cummins. But we just don't see it imminently happening. But we are active on a number of partnerships and acquisitions as we -- we announced two more this quarter and we will continue that. So the signal is still moving, but nothing imminent. I think that would be the safest way to say.

And the third thing we want to signal is that we think the stock is significantly undervalued. I mean we -- it's obvious that in the last quarter with the emissions issue and maybe people getting worried about cyclical peaks that our stock got -- had a pretty heavy wet blanket on it, and we think it's overshot. Our view is the earnings of the Company are incredibly strong, our incremental margins are good, and we don't think we're at the peak. We think we've got quite a bit more room to run. And, by the way, in each cycle -- down cycle, we do better and strengthen again each up-cycle. So, we do believe in fact that our stock is a good investment now. So it's all three of those things. And thanks for giving me a chance to talk about that.

With regard to 2019, obviously, we don't want to forecast 2019. But a couple of things, you mentioned, I think, do deserve some highlights. We are expecting to finish our warranty numbers around 2.4% this year, as Pat said. So we are coming down into that same low 2% range that we said we would get to. And we have done a lot of work to improve the quality of launches, and the quality of the products. So we believe that that's going to be a good tailwind going into 2019.

In addition, from the point of view of all the tariffs and material costs, there's no question that right now we're fighting an uphill battle. But it's not clear how long all these last, it's not clear what the administration plans are there. So we're trying to remain as resilient as we can. We have a very cost-effective supply chain, we're going to try to keep that in place. We're going to make the moves that we need to make short-term to try to minimize the impacts and we're going to pass on prices where we can, as Rich said. But we have a very good supply chain organization that's working to continue to drive cost down. So, again, we're planning to mitigate, I guess, is the main point. So while it's a -- short-term a pretty nasty hit, we will work hard to mitigate those plans, and I think we will have some positive impact on those. So while it will be a headwind, we'll make that headwind smaller by the time we get to next year. So, I guess, those were both worthy of commenting on.

Jamie Cook -- Credit Suisse -- Analyst

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

Tom Linebarger -- Chairman and Chief Executive Officer

Thanks, Jamie.

Operator

Thank you. Our next question comes from Alex Potter with Piper Jaffray. Your line is now open.

Alex Potter -- Piper Jaffray -- Analyst

Hi guys.

Tom Linebarger -- Chairman and Chief Executive Officer

Hi, Alex, how are you?

Alex Potter -- Piper Jaffray -- Analyst

I'm doing OK. Couple of questions, both related to China. So first on the JAC joint venture, I was just wondering if you could comment on the risk of any overlap or perceived overlap with the Foton 2.8- and 3.8-liter engines, to the extent if that creates any, I guess, friction between your two OEM partners?

Tom Linebarger -- Chairman and Chief Executive Officer

Yes, I mean, both Rich and I have spent time with Foton recently about that, and there's no question there was some friction about it. They do compete in the market. And by the way, this is a thing we deal with everywhere, we're an independent engine maker. So everyone loves the fact that we're independent, so we have lots of volume and we'll work with them, but then they are annoyed that we work with their competitors. So it's both, right, it's always both. And so, I think those are things that we work through pretty regularly. They were frustrated, we did have a lot of discussions. I think we're through that now. I think the Foton has now said, we understand where our opportunity to work with you is and they're excited about that. Again, Rich had good discussions. Anything you would add, Rich?

Rich Freeland -- President and Chief Operating Officer

No. I mean, like we always do, we're building scale to try to find win-wins in this. So we will be able to utilize existing capacity and share that across the different ventures to help mitigate that. So everyone will see a lower cost out of it too. It's a piece we always try to implement.

Alex Potter -- Piper Jaffray -- Analyst

Okay, very good. And then the second one, I know this is maybe a bit unfair, given the amount of uncertainty here with tariffs and everything. But was wondering whether you've had the opportunity to reevaluate or look more closely at the plants that import the 12-liter blocks from China into the US Class 8 market, the extent to which the landscape has changed at all, you're clearly trading things between China and the US, it looks as though it's going to become incrementally more difficult. So I guess, any comments on that, as well as maybe an update on that program in general would be helpful. Thank you.

Rich Freeland -- President and Chief Operating Officer

It's a very fair question, and we've been looking at it. So we do pick up some headwinds on some tariffs that hit some of the products that we're introducing. At this point, the high dollar ones, the block and head are not included on the tariff list. And so, I think we feel pretty good we can mitigate those costs that are coming in. It's a nice low-cost engine that we've got. We're able to use the scale we've got in India, the whole strategy of --

Tom Linebarger -- Chairman and Chief Executive Officer

China -- in China.

Rich Freeland -- President and Chief Operating Officer

I'm sorry. Thank you. In China. So building -- introducing the product in China, building scale, building a low-cost supply base and then moving it across. So we give back a little bit of that with this plan, but we're going to move -- we're moving ahead with the program.

Tom Linebarger -- Chairman and Chief Executive Officer

And, by the way, sorry for this late political announcement, Alex. But this is a little bit of my frustration is, you know, that product was developed with engineers, purchasing people, et cetera, a whole bunch of people in the US. And so the fact that we might use some of the volume, or some of the components from China to help build up and then, of course, assemble in the US, and have assembly jobs here that we might lose those because of this -- it just seems exactly backwards of what we're trying to achieve. So it does seem -- to say that I am frustrated with this would be an understatement.

And, again, I'm hopeful that what we're in for here is a lot of tariffs to get everybody to the table, and then we get to the table, and then we take this away, because this doesn't seem to be helping very many people. So I'm -- that's what I'm hopeful for. But in the meantime, as Rich said, we are actively looking for ways to mitigate and to figure out which of these things we keep in place -- these supply chain keep in place and which ones, if they have longer-term impacts, we switch around.

Alex Potter -- Piper Jaffray -- Analyst

Okay, understood. Thanks guys.

Operator

Thank you. Our next question comes from Noah Kaye with Oppenheimer. Your line is now open.

Noah Kaye -- Oppenheimer & Co. Inc. -- Analyst

Good morning. Thanks for taking the questions. So you kept your NAFTA Class 8 outlook intact. At this point, is that mainly a function of production capacity? How backed up do you see orders and what does that tell us as an early indicator for '19?

Rich Freeland -- President and Chief Operating Officer

Yes, you're exactly right. So when we looked at the backlog, right now the backlog at 235,000 units is the highest it's been since July of '99, OK? So it's a very robust backlog. I think you're going to see that backlog continue through the end of the year, just for the reason you gave. So the OEMs, the truck production is being constrained by a variety of supplier constraints. I think you might see some relief here and there, but I think that limits how quickly the backlog can be addressed and how much production will go up the second half of the year. So it gets me a little more bullish that we're going to end the year, this year with a really strong backlog. And again, the fundamentals look pretty good also. I mean, the retail sales, the stuff we all look at, the freight, the rates. And so, the underlying fundamentals are pretty good. The -- and like you said, the production is being constrained right now. So I think that bodes well for us going into 2019.

Noah Kaye -- Oppenheimer & Co. Inc. -- Analyst

Great. And then if we could get an update on your electrification program, seeing that spending ramp up and you did agree to acquire EDI this quarter, as you mentioned. So now you'll have a short-haul Class 8 offering with -- actually a track record in transit bus. And that we are seeing the short-haul market appear to be developing. Some of the industry data we've seen is pointing to several tens of thousands of confirmed orders for electric trucks and buses to be delivered over the next six years. Wondering if you could provide us with some color on any pre-orders you're seeing for your electric powertrain offering and just generally, how we should think about the state of the program.

Tom Linebarger -- Chairman and Chief Executive Officer

Yes, I think from a segment point of view, you've got it right, is that essentially a transit bus is the number one, where I think if we have a good offering, we'll have customers that want it. In transit buses, the big cities, especially have committed to moving toward electric or hybrid or some combination of these things. And they are wanting to step-by-step it, because the charging infrastructure and all the challenges related to running electric powertrains are still in front of most of them. They don't have that all figured out, but they all want them. And so, our first launch at the end of next year is there, and we have a number of pre-orders for those. In fact, we are -- our first months of production will only be supplying orders that we already have.

And then with regard to the light-duty vehicles, especially again urban, short range vehicles, there is a lot of interest in that area. And again, when you do the math on it, you can make it work, is long again, as you have a way to manage the charging and charging infrastructure. So those that go away and come back to the same place are going to have a lot easier time of it than those that have to go and stop and then go somewhere else and go somewhere else. This is kind of challenge, same as we saw with natural gas, will be an issue for electric vehicles. But, again, lots of interest. And as you said, I mean one of the reasons we were interested in EDI is not only do they have -- have they already fulfilled orders, but they have a really good ability to put together prototypes, demonstrators, pretty quickly, so people can actually get out and try it, because I think today, there's a lot of interest. But again, most of the interest is, we'd like to try some, we'd like to try it on this leg, see how it goes, see what the charging is like and it's really difficult to know if you want to move your whole fleet there, or your business model can work on this, unless you can actually start dealing with some of the practical issues.

And now with where lithium-ion batteries are and the system in total is as compared to several years ago, you're at a place where you actually have some practical jobs you can do. So, I think that's why people are interested in trying it.

So we do feel like there's plenty of interest relative to our capacity. What we're trying to do is make sure that we have a commercially viable powertrain, so that we're not just doing demonstrators or prototypes forever, that this is actually a thing that can work in larger scale. And so we have both efforts going on, making sure people can try things and see that, and that will really start at the end of next year, we'll start putting production units in. But right now we're doing mostly trials and prototypes. We want to be able to do that, so people can try, but then also move to this commercially viable long-run segment replacing kind of powertrain. And that's still in the development and launch phase next year.

Noah Kaye -- Oppenheimer & Co. Inc. -- Analyst

Really appreciate the color. Thank you.

Operator

Thank you. Our next question comes from Andrew Casey with Wells Fargo. Your line is now open.

Christopher G. Laserinko -- Wells Fargo Securities -- Analyst

Hi, guys. This is Chris Laserinko on for Andy. I just have a quick housekeeping item. The press release this morning didn't have the unit shipments for Power Systems. Can you provide that or will you be providing that going into the future?

Tom Linebarger -- Chairman and Chief Executive Officer

Yes, we provide -- we can provide them, yes. As you know, unit shipment for those is because of the -- the revenue varies by a good lot by unit. It's not as meaningful as heavy duty ones, where there's a -- unit prices are very similar. But we will definitely provide it to you. And I think, Mark actually --

Mark Smith -- Vice President of Financial Operations

Well, I see it in the copy of the 8-K, but I'll follow up with you and make sure.

Christopher G. Laserinko -- Wells Fargo Securities -- Analyst

Okay, excellent. So the next question is that the Engine segment updated guidance implies about 15% to 18% incremental EBITDA margins, kind of relative to the 20%. Just wanted to know the difference between. But also that 15% to 18% suggests a little bit better operating leverage from the first half of 2018 and the second half of last year. Just wondering if you can provide some color around the cadence of the incrementals in the back half of the year between Q3, Q4, and what's giving you guys the confidence that you can generate that additional leverage?

Mark Smith -- Vice President of Financial Operations

I think there's two factors going on. One, we've got -- we're going to have lower earnings in China in our joint venture. So that's going to be -- that's typical seasonality. We forecast for the market to decline in the second half. So that's going to be a drag. On the other hand, obviously, we don't have the charges and the warranty in the first half of the year, and generally volumes are remaining strong with higher North American heavy-duty truck production. So those are the puts and takes really and a little bit of the tariff costs.

Christopher G. Laserinko -- Wells Fargo Securities -- Analyst

Okay.

Mark Smith -- Vice President of Financial Operations

I mean, underlying operating performance is very strong.

Tom Linebarger -- Chairman and Chief Executive Officer

Yes, underlying operating -- I guess that's maybe Chris, just backing up a step. Underlying operating performance throughout the year is quite good and I know it's frustrating to get these incremental margins, because it depends on what you include and what you exclude from last quarter and this quarter. But, simply put, underlying operating margins are good. We had a campaign in the first half of this year and a little bit of last half of last year; that kind of distorted the numbers some. I mean, those are real issues, so they belong there, but they are distorting the numbers. Then we've got, as Mark mentioned, in the second half, you've got this -- these incremental cost-related tariff and material cost inflation, and then a little bit of dip in China sales. But other than that, if you kind of move those around in your model, the basic operating performance goes, you're seeing sales grow, and you're seeing 20-plus incremental margins on an operating basis across the whole way.

Christopher G. Laserinko -- Wells Fargo Securities -- Analyst

Okay. And then in the Power Systems segment guidance, you increased the revenue outlook pretty handily and there is just kind of a -- I hate to call it 50 basis point move swipe (ph), but the 50 basis point move in the EBITDA margin guidance. Just wondering if there's something embedded in this? Is this conservatism or is it kind of a real-time look at what's going on with production costs, freight or other supply chain issues?

Mark Smith -- Vice President of Financial Operations

No, it's the same two issues, really the engine business. The buying patterns in most of our end markets in China are typically weaker in the second half than the first half. So that's true for Power Systems, which has a large joint venture in China off-highway markets. And then they will also suffer a little bit on some of the tariffs and related inflation. But overall, we're expecting a very strong year, as Tom said earlier and Rich said too.

Christopher G. Laserinko -- Wells Fargo Securities -- Analyst

Thank you. Appreciate it.

Operator

Thank you. Our next question comes from Steven Fisher with UBS. Your line is now open.

Steven Fisher -- UBS -- Analyst

Thanks, good morning. I'm wondering if you could give us just a little more color on your domestic oil and gas exposures, how fast that piece is growing, where is it relative to peak and trough levels and where you see it going from here?

Rich Freeland -- President and Chief Operating Officer

Let me go ahead and start here and then -- so it's doubled this year off of very low numbers. So it's been really solid as we started the year. I think it's going to continue to grow, but it's going to be bumpy kind of quarter-to-quarter, how we're going to see new orders going in. And so we've actually projected a little bit of a decline in the second half of the year of new orders. Having said that, we're putting a lot of population out there, we are gaining share. And so, I think the trend remains really good. It's hard to say what normal cycle is on this quite frankly. But I think -- at least my view is there's more -- lot more upside than down. If you look over an annual basis, quarter-to-quarter, there's just going to be some big orders and then some periods of shorter or smaller orders kind of quarter-to-quarter.

Mark Smith -- Vice President of Financial Operations

Yes, I think, it's hard to measure against peak just on revenue, because we're selling more advanced products now with the introduction of Stage IV emissions regulations. And then with all this extra new equipment going into the field over the last 12 months, we expect that rebuild in parts and service activity to continue to build. But yes, through the first half of this year, we've already delivered more than all of last year, but probably a little bit of a pause while this equipment is put to work, but the underlying demand seems pretty stable right now.

Steven Fisher -- UBS -- Analyst

Okay, that's very helpful. And then just on the Eaton joint venture, when do you think you'll hit a breakeven level on EBITDA in that business? I think you're targeting profitability next year, but what about a breakeven level?

Rich Freeland -- President and Chief Operating Officer

I think what you're going to see is, again, it's a loss this year. We're looking really at 2020 till we get to that -- to a profitability standpoint. So the rate of losses kind of think of it half next year and then move toward profitability in 2020. The good thing is the products -- part of the strategic investment in the product was that we develop the best powertrain in the market. In that piece we feel -- so both the financials are on plan, but what I feel even better about is, and you see it in our market share numbers, is that the combined powertrain product is doing terrific, as we've introduced the new product and more importantly, as we've done the integration work between the engine and the transmission.

Mark Smith -- Vice President of Financial Operations

So the key to the profitability is expanding those gross margins and we have seen steady progress so far, we just need to continue that going forward.

Steven Fisher -- UBS -- Analyst

Thanks very much.

Tom Linebarger -- Chairman and Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from Joe O' Dea with Vertical Research. Your line is now open.

Joe O' Dea -- Vertical Research -- Analyst

Hi, good morning. Tom, you guys have provided some helpful details on costs related to tariffs and trade. Could you talk a little bit about demand? Is there any demand impact factored into back half of the year guide? Certainly, backward looking it doesn't look like we've seen any impact, but based on customer interactions and what you're hearing out there and in particular North America and China, is there any direct demand impact that you're seeing at this point?

Tom Linebarger -- Chairman and Chief Executive Officer

Not really. I mean, I'm grateful that we're not. It's a good question. Both in terms of just -- but I was just in China, I was looking for signs of people are beginning to change preferences and saying well, we don't want to buy American products, and I didn't see any of that on the consumer level, no less in the industrial level, which would be kind of secondary, which is good. I mean, I think that's always a possibility in China. And the problem is once you lose the share, it is pretty hard -- I mean, if you lose the customer, it's pretty hard to get it back. And so far I haven't seen any of it. I mean, I didn't hear a whiff of it, and I asked around a lot. I asked customers, I asked our employees, just what are they seeing, and nobody has seen any of that. There is definitely some negative feeling about the negotiations or about the administration, but nothing against American or American companies today, so far. And vice versa in the US. And I think in the US, I do -- I'm very worried about the inflationary effects, but the economic numbers now are good enough that people seem to be driving right through it.

So, I guess, mostly what I'm worried about now is, when and if things turn down, how bad is that and are we going to have inflation and economic downturn at the same time, because of the inflationary effects. So again, I'm worried about that, but right now it is just not visible anywhere. People are busy, they are buying stuff, fleets are -- as Rich said, fleets are so busy and making so much money, they are just busy buying trucks and trying to put more trucks to work and find drivers. So far so good, is what I'm seeing.

Joe O' Dea -- Vertical Research -- Analyst

Okay, I appreciate those details. Last one is on the $200 million cost impact that you've sized, it sounds like pricing will be able to address the raw materials side of that and then some supply chain switching can address a portion of the tariff side of that. Basically sounding like, it's a $100 million back half of the year headwind, but rolling into 2019 we shouldn't be thinking about a $200 million headwind. In fact, it sounds like that headwind might be down year-over-year overall.

Tom Linebarger -- Chairman and Chief Executive Officer

It's hard to know about the net -- the way you're thinking about it is right. The net, we just don't know yet, because again, there are some decisions as Rich was highlighting about, do you move the supply chain or do you feel like the tariffs are temporary. So you just suck it up. Do the price things you're trying to stick or not. As you said, on the whole material cost side that mechanism is pretty much in place; that's likely to go, there's always delays on either side. We try to delay them from putting it in our cost side and our customers try to delay it from putting it in the price side. But broadly speaking, the agreements are in place. It's the other ones where there's just more left to play for. So our supply chain group, as you guess, is super busy trying to figure out how to mitigate that.

So we'll have a much better view of what we think the net effect is when we do our 2019 plan. And of course, the environment is changing pretty quickly too. I mean, my guess is between this call and next call they'll be another announcement, either to add tariffs or take them away. And we're not sure what it is. I would know which one I hope it is, but we'll see which one it is. So I think we need to be pretty nimble in terms of thinking about how we mitigate the costs.

Joe O' Dea -- Vertical Research -- Analyst

Hoping for the latter. Thanks very much.

Tom Linebarger -- Chairman and Chief Executive Officer

Yes, thank you.

Mark Smith -- Vice President of Financial Operations

Thank you very much. And James and Adam will be available for your calls later.

Tom Linebarger -- Chairman and Chief Executive Officer

Thanks so much you guys. Thanks.

Operator

Thank you, ladies and gentlemen. That does conclude today's conference. Thank you very much for your participation. You may all disconnect. Have a wonderful day.

Duration: 63 minutes

Call participants:

Mark Smith -- Vice President of Financial Operations

Tom Linebarger -- Chairman and Chief Executive Officer

Pat Ward -- Vice President & Chief Financial Officer

Adam Uhlman -- Cleveland Research Co. -- Analyst

Rich Freeland -- President and Chief Operating Officer

Jerry Revich -- Goldman Sachs -- Analyst

Jamie Cook -- Credit Suisse -- Analyst

Alex Potter -- Piper Jaffray -- Analyst

Noah Kaye -- Oppenheimer & Co. Inc. -- Analyst

Christopher G. Laserinko -- Wells Fargo Securities -- Analyst

Steven Fisher -- UBS -- Analyst

Joe O' Dea -- Vertical Research -- Analyst

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