康明斯 (CMI) 2002 Q2 法說會逐字稿

in the first quarter of this year. Earnings per interest and taxes for the quarter were $45 million, compared to $31 million in Q2, 2001. These results exclude special charges of $125 million, reported in the second quarter of 2001 and $1 million net adjustment to restructuring accruals reported in the second quarter of 2002. Net earnings in the second quarter were $12 million, or 31 cents per share, compared to $2 million or 6 cents per share in the second quarter 2001, excluding special charges. As reported, net earnings in the second quarter were $13 million or 33 cents per share compared to net loss of $82 million or $2.14 per share in the second quarter last year. I will discuss each of our four business segments. First I will begin with Power Generation. Sales in the Power Generation business for the second quarter were 304 million dollars, down 21% from the second quarter of 2001. In North America, revenues were down 26%, compared to a year ago, with lower demand in Commercial Gensec business due to lower economic activity generally, reduced emergency power needs, and high inventory levels in the marketplace. This decrease was partially offset by increased demand in our consumer business, primarily recreational vehicle sales. Consumer revenue increased 23% compared to second quarter of 2001. Outside of North America, revenues decreased in Europe, India and China, compared with the second quarter of last year, due to lower demand across most of our markets. Revenues were up 17% in Latin America, due to the continued effects of the energy crisis there. In the second quarter of 2002, Power Generation had operating loss of $2 million, compared to operating profit much $32 million last year. There were three main factors that led to this variance. The volume decrease and product mix had significant increase on earnings with the unit decline being primarily in larger Power Generation equipment that typically has higher margins. Second, the substantial sales decline in North America and Europe resulted in under absorption of fixed overhead cost at our plant. Third, excess inventory in the marketplace continues to create pricing pressure, forcing heavier discounting to retain market share. We expect gradual improvement in this business over the remainder of the year, returning to stronger demand levels in 2003. Revenues for the Filtration and Other segment were 243 million for the quarter, an 8% increase compared to second quarter of 2001. Filtration business revenue was up in North America, primarily due to higher OEM sales where we had increased market penetration. Revenues at the Holset turbo charger business (inaudible) higher sales in China. This segment's operating earnings were $23 million versus $16 million last year. This improvement is primarily due to the volume increase and the discontinuous of goodwill amortization. In addition, incremental expenses for the segment's new emission solutions business were offset by benefits from restructuring and Six Sigma cost reduction efforts. Sales for the international distributor business were $145 million in the quarter, compared to $143 million last year. Increased sales in Australia and Asia were partially offset by sales declines in Europe. Operating earnings for the segment were $10 million this quarter, compared to $7 million in the prior year's quarter. This increase was driven by improved parts sale in some favorable currency impact. Moving to engine business. Total sales for the engine business were $850 million and 8% increase over sales of $seven86 million a year ago. Revenues in automotive markets, which as a whole were up 13% year over year, reflect increases across all segments. Overall revenue from industrial markets was down slightly year-over-year with decreases in mining and construction sales partially offset by improved sales in agricultural and rail market. Operating income for the quarter was $14 million, versus a loss of $24 million in the second quarter last year. A 38 million dollar improvement on $64 million sales increase. This improvement and profitability was attributable to the increased volume, with better fixed cost absorption at heavy duty plant and continued focus on cost reduction, which improved margins and drove down selling, administrative and research spending. Product coverage costs also showed improvement in the quarter. I will briefly review each of the engine business markets. Turning first to the heavy duty truck business. Revenues for the heavy duty segment as a whole were up 13% in the second quarter from a year ago, while unit shipments globally were up 14%. Unit shipments in North America were up 19%, reflecting the recent uptick in OEM order rates by unit shipments to the rest of the world were down 7%. The reduction in international shipments was due to drop in sales to European OEMs. In the worldwide medium-duty truck and bus market, total revenues increased 7% for the second quarter year-over-year. Medium-duty truck engine shipments were down 30% in North America, with reduced shipments to OEMs. International shipments were up 13%, with higher OEM sales in Latin America and Europe. Global bus engine shipments were down 7%, with a 24% drop in North America and a 16% increase internationally, primarily in China, which was partially offset by decreased shipments in India. In the light duty automotive and RV business, revenue was up 19% this quarter, compared to a year ago. Engine shipments to DaimlerChrysler for the Dodge Ram pickup truck were 1500 units - were up 1500 units, increase of 7% from second quarter last year, resulting from less construction constraint at Chrysler and unit demand. Unit shipments for RV increased 71% year over year from weak levels, reflecting recovery in consumer markets, growth in the diesel-powered segment of the market and common increase share with OEM. Sales to industrial engine markets in total were down 2% from a year earlier. In the construction equipment market worldwide sales were down 2% year over year. Unit shipments of engines in North America were down 9%, reflecting the continued weakness of construction equipment markets. Shipments to international markets fell 11%, compared to the second quarter of 2001, due to decline in sales to Europe and Korea. The sales decrease was less than the unit decline, reflecting mixed shift with increased sales of higher-priced engines. Sales for the agricultural equipment market increased 6% from last year, also a very low base, with increases in Europe and Latin America. In the marine market, unit shipments were down 32%, due to formation of the commons America Cruiser joint venture. All marine sales of mid-ranged engines are reported on the joint ventures books. Higher horsepower engines offset the decline in mid-range engine shipments. Revenue in the mining segment decreased 9% year over year, reflecting weak demand in the marketplace. Returning to the corporate level, I would like to review total sales by region. In the second quarter, our sales mix was 53% U.S. and 47% international. Compared to 54% U.S. and 46% international in the second quarter of last year. For the second quarter compared to a year ago, sales in the U.S. were flat and international sales in total were also flat. International sales variances were mixed with increased sale necessary China, Australia, Latin America and India, offsetting revenue decline in Europe and Canada. Sales to china were up due to strong bus, international distributor and turbocharger sales more than offsetting declines in Power Generation demand. Australia's sales were higher year over year with increases in engine, power generation and international distributor sales. The energy crisis in Latin America boosted sales there. Sales to India increased year over year with strong international distributor sales offset by lower power generation sales. Sales in Europe, Africa and the Middle East were down substantially primarily due to drop in power generation demand. Next, I would like to discuss corporate gross margins. The gross margin on sales for the quarter was 18.8%, compared to 18.4% in the second quarter last year. Product coverage costs was 3.5% of sales or 51 million dollars, compared to 3.6% of sales or $53 million a year ago, reflecting better performance of our newer engine models where we have focused significant quality improvement efforts. This allowed us to lower coverage cost, despite higher concentration of heavy-duty engine shipment in the quarter. Excluding warrant costs, gross margin for the quarter was 22.3%, versus 22% in the second quarter last year. In dollar terms, gross margin was $325 million, up from $322 million a year ago, a difference of $3 million. The impact of decreased high horsepowered sales for power generation was more than offset by benefit of cost-reduction efforts and improved manufacturing cost absorption at our heavy-duty plants. Total SAR or selling, admin engineering spending in the quarter was flat year over year. Selling and administrative expenses increased $3 million in the quarter, due primarily to Sunbeam focused growth initiative. Research and engineering expenses decreased $3 million compared to last year due to cancellation of major engine development program in the second quarter of last year. Our income from joint venture and alliances in the second quarter was $7 million, compared to 3 million in the second quarter last year. This increase resulted in improved earnings across China joint ventures. Other income was $5 million, compared to income of 0 a year ago. Profit on the sale of a U.S. distributor and certain distributor properties and the discontinuous of goodwill amortization were the most significant items contributing to this variance. The one million dollar net credit for restructuring charges in the second quarter of 2002 was due to a reversal of excess restructuring accruals. This adjustment reflects both new actions being taken and excess related to prior charges, which equal net one million dollar credit. Interest expense for the quarter was $17 million, compared to $23 million in tworks2-2 of last year. This was a result of lower borrowing due to issuance of convertible preferred securities in the second quarter of 2001 and lower interest rates. The $5 in dividends on preferred securities are shown as separate line item on our income statement. Interest expense in the quarter did include a $2 million power period adjustment to properly state our interest accrual. Net earnings for the quarter were $12 million or 31 cents per share on 38.5 million shares for EPS purposes. This compared to earnings of $2 million or 6 cents per share a year ago, excluding special charges. Including in the charges net earnings for the second quarter of 2002 were 13 million dollars or 33 cents per share. For the second quarter of 2001, we reported net loss of $82 million or $2.14 per share. Let's turn to cash flow. Free cash flow from operations perspective for the quarter was in-flow of $40 million, compared to in-flow of $78 million a year ago. Our statement of cash flow that you should have received, indicates cash outflow on year to date basis of $12 million from operating and investing activities. This includes a $53 million inflow for the second quarter of 2002. To arrive at the $40 million free cash flow - free cash inflow for Q2, we removed the effect of items we consider to be financing activities for free cash flow purposes. A $20 million outflow from receivables, as we decreased the funding under receivable securitization program. And a 33 million dollar net inflow related to disposition of business activities. The biggest driver of the cash inflow was the level of earnings adjusted for depreciation and amortization providing $67 million for the quarter. Receivables, including the security program used (inaudible) for the quarter due to high level of June sales, but was offset by increase in accounts payable and accrued expenses. Inventory levels were up slightly in the second quarter, an increase of $7 million. Inventory turns increased during the quarter. We expect to reduce this level of inventory in the second half of the year with gradual demand improvement across many markets. Capital expenditures were $16 million for the quarter, down from $60 million in last year's second quarter, as we continue to aggressively manage capital spending. Investment and advances to joint ventures and alliances represented outflow of $32 million for the second quarter of 2002. This amount includes both long-term investment and short-term funding for working capital needs of our joint ventures. We expect working capital need of these businesses to be lower in the second half of the year, providing cash inflow to companies. Thank you. Now, I will turn over to (inaudible).

UNKNOWN SPEAKER:Good morning, as Karen reviewed, we surpassed guidance for operating results in the second quarter. On flat sales compared to a year ago we delivered $14 million higher earnings before interest and taxes providing a 25 cent improvement in earnings per share for the quarter. The majority of end-markets remain at low levels, but it appears the first quarter of this year represented the bottom for most of the markets. We are now seeing order increases, although relatively small. We expect this trend to continue. We are seeing particular strength in three of our markets: Dodge Ram pickup trucks, RVs and the temporary higher order rates for heavy-duty trucks. Power Generation markets generally remain weak. Demand is lower, especially in the United States. There is still excess inventory in the marketplace, which continues to have a substantial impact on new order rates and pricing. As I just stated, the one bright spot is the RV market, which is very strong right now, providing some offset to weakness in the commercial business. Our commercial business in North America is down over 40%, compared to the second quarter last year. We don't see substantial improvement for the rest of this year. However, there is still demand for large energy products, especially outside of the United States. For example, we continue to gain new business in Latin America, and have additional opportunities there for the near future. Rental business demand is improving, as it is seasonally strong during the summer and fall months. Overall, most Power Generation markets are likely to remain well below last year's levels through the second half of this year. As the first quarter is a seasonally weak quarter for Power Generation, we don't expect substantial improvement in demand until at least the second quarter of next year. In the meantime, we are aggressively focusing on cost to lessen the impact of the sales decline. We are concluding or have concluded restructuring actions we previously announced, including one, the closure of Gensec plant in Australia and two, the move of alternator production from the United States to Mexico, providing lower manufacturing cost going forward. In addition, we reduced Power Generation headcount by 400 people and will further reduce headcount by another 200 people during the remainder of this year. We cut selling, admin and research costs by $10 million and we are resourcing more alternators to India and china facilities. As a result of the cost reduction activities, we expect to improve Power Generation profitability in the second half of the year. The Filtration and other business delivered strong profits in the second quarter, with earnings before interest and taxes of 9.5% of sales. We achieved these margins without substantial market improvement. When the markets rebound, we feel confident of our ability to deliver our target margins for this business, of 11 to 13%. The integration of Nelson products is now complete. We are gaining business through system selling of our full-range of products from intake through exhaust. The benefits of restructuring and Six Sigma cost reduction efforts are providing improved profitability, while funding important growth initiatives such as the new emission solutions business. We believe this segment will continue to improve profitability through ongoing cost reduction programs and as demand rebounds in key markets. Our international distributor business also had a good quarter with earnings before interest and taxes of nearly 7% of sales. Sales were up in Asia and Australia, but continue to be weak in Europe and non-existent in Argentina. We expect this business to remain at this level of revenue and profit for the remainder of the year. We are just beginning to implement Six Sigma process improvement and apply common business practices that will reduce cost and improve profitability and customer service across all 17 of our company-own distributorships. The engine business results reflect cost-reduction benefits achieved in this business over the last year. On 64 million dollar increase in sales, we brought $38 million to the bottom line. We reduced break-even level for this business by approximately 20%. We are seeing some improvement in most of our engine markets with particular strength in a few of them. The recent improvement in order rates for the North America heavy duty truck market boosted engine business sales in the second quarter and we expect it to provide even greater benefit to Q3. We expect decline in sales for this market in the fourth quarter of this year when the new emission standards take effect. We believe this decline will not be sustained and we expect demand to improve as customers gain comfort with new engines and as freight demand increases. Cummins was the first engine manufacturing to receive EPA certification for October of 2002 emission standards. We are confident in both the performance and reliability of our new product and believe it will help us achieve our strategic plan for the heavy duty business. We are encouraging the regulators to stick to the agreements and not delay the destruction of the new standard or lower the proposed penalties for noncompliance. The Dodge Ram pickup business with Chrysler is continuing to improve with shipments in the first half of 2002, 16% higher than the first half of 2001. We expect sales in the second half of 2002 to be 15 to 20% above first-half levels. Chrysler introduced its new model pickup two weeks ago. We believe it will be very well received in the marketplace. Cummins turbo diesel for this truck was ranked as top engine among all Chrysler group vehicle engines and the number one diesel pickup engine, according to a recent J.D. Power study. Sales for the recreational vehicle market continue to improve due to increases in both demand and our market share. Cummins has a vast majority of share for diesel engine and generator sets for RVs, so, we are benefiting from this market rebound. Cash management remains absolutely a primary focus for us. We generated $40 million of free cash flow for the quarter. We made progress on working capital reduction in the quarter, but we have more work to do, especially in inventories. We are very tightly managing capital expenditures with 34 million dollars spent this year. We now expect capital spending for 2002 to be at or below $130 million. We still expect free cash flow for the year to be in the range of $60 to $80 million. We are maintaining our guidance for the full year of 2002, 70 to 80 cents per share. We expect to deliver profit in the range of 90 cents to dollar per share in the third quarter. Total company sales for the year are expected to be flat to up to 5% compared to 2001. We expect Power Generation sales to be down at least 10 to 15%, with engine business sales up nearly 10% compared to last year. For the remainder of 2002, we expect some improvement in the majority of the markets, with the exception of the heavy-duty truck, where we expect volatility across the two quarters. We believe the heavy-duty truck segment will provide stronger earnings than we previously forecasted for the third quarter, with lower earnings in the fourth quarter. We continue to make progress on our cost-reduction efforts, allowing us to substantially lower our break-even point. This combined with strength in our Chrysler and RV businesses will prevent us to maintain profitability, despite short-term fall-off in the heavy-duty truck market. Before we take questions, I want to take a moment to discuss the topic of corporate responsibility and accountability that has been appropriately raised in the public arena. We follow good board governance practices and have done so for years. We are reviewing our policies in light of the new recommendations being discussed and will make future changes if appropriate. At Cummins, we formed our company on the basis of integrity. Integrity is the core value instilled in the culture of this country from our start 83 years ago. We do what is right and we do what we say we will do. Doing what is right in this competitive business environment is not ales easy, yet we remain true to our core belief. Our board of directors share this belief. The Cummins board is comprised of 10 directors. I am the sole representative from senior management. Our audit and compensation committees of the board consist entirely of independent directors. Cummins pro-actively took a number of steps to become more transparent in our financial transactions and to make that information readily available to all shareholders. We improved and expanded disclosure in 10-k filings with the SEC. In April, we split our internal and external audit work to ensure the independent status of external auditor. We moved from Arthur Anderson to Price Waterhouse Coopers, who have provided a fresh set of eyes to oversee disclosures. We are proud of our track record and committed to continue to do the right things on behalf of shareholders in the future. We will take your questions.

Ladies and gentlemen, the floor is open for questions. If you have questions or comments press 1, followed by 4 on your touchtone telephone at this time. Pressing 1, 4 a second time will remove you from queue. While posing questions, please pick up the handset if you are on speakerphone for optimum sound quality. One moment to pull the questions. The first question is coming from Mark Koznarek of Midwest Research. Your line is live.

Thank you. Good morning. Couple of questions on the Power Generation business. You mentioned inventory levels are high. Can you quantify that in units and particularly compare that to what expected sales would be? Are we talking about 6 months, 9 upon months worth of inventory overhang or less than that? Also, discounting was mentioned. Can you help give us an idea of the amount of margin impact due to discounting?

UNKNOWN SPEAKER:Yeah. I can't quantify the absolute units because there are so many different segments and regions in the world. Primarily in North America, after September 11th, in particular, the demand just crashed. Also with the telecommunications business. And all generator set manufacturers kept building inventory with the expectation that the market would come back. When it didn't, especially in the fourth quarter, that inventory went into the marketplace in the first quarter and is being burned off now. I don't know how long that will take. Our expectation is that we will see some recovery in the North America generator set business maybe in the second quarter of next year. So, that is why we are focused on cost reduction. Again, the discounting varies from prime power applications and standby applications, but in the standby area and the lower sets where it tends to be most competitive, we have season 10 to 15% types of discounts.

Okay. So, the bottom line to the inventory question - you did mention your outlook is down 10%. You are ratcheting production down 10% and you expect that is sufficient to burn off the inventory. You are underproducing expected demand at 10% decline?

UNKNOWN SPEAKER:We have cut production more than 10%.

UNKNOWN SPEAKER:Remember the segments, Mark. The biggest segment was this 1 to 2 megawatt size. That was quite a good market for the Power Generation business last year. That is the one where the most inventory was built. The RV business on the other hand, is stronger than expected. The 10% looks on balance across the markets. So, some markets were cutting back more than 10, some not increasing.

Maybe my confusion. Sorry to beat on this. This will be my last one. I am getting the sense the inventory is (cut out).

UNKNOWN SPEAKER:Hello. Everyone is still connected. I am not hearing volume from Mark's line.

UNKNOWN SPEAKER:Maybe he dropped off.

Next question. Mark come back into the clue. Next question from David Rosso from Salomon Smith Barney. Your line is live, sir.

Good morning. On heavy-duty truck, trying to forecast fourth quarter first quarter next year. What are you planning for shut down at Jamesville and Columbus right now? Maybe some view of the industry production from third quarter to fourth quarter?

UNKNOWN SPEAKER:It is Jamestown, not Jamesville. I want to be clear on that. We have basically we take a shut down from 1 to 2 weeks in the summer months and we postponed that to the fourth quarter. We also have the ability to take additional shutdown days. So, we aren't certain exactly what that production rates and demand will be. But, we have what we call rings of defense. We stop overtime. We probably have 100 temporary employees right now, which would be let go. We could take the shutdown days. Some people take voluntary leaves of absence and the last course is to do lay-offs. We don't know exactly what that would be. The industry number that people are most commonly using right now would be 28,000 trucks in the fourth quarter. And there would be less engines because of the engines that would have been in the pipeline already. I think that is as good a number for anybody to use. Then, again, it would be guessing on our part, I think - in fact, anybody's part, to say what the first quarter would be next year because there is so much uncertainty around the volatility of the market. So, we have the flexibility to reduce our variable costs quickly in that business and also we are stopping our m-14 production in the fourth quarter as we will ship some industrial engines and? Engines to Mexico and then transition all of the remaining m-14 business into the ISX model as soon as possible, which will allow us to take additional cost out.

Do you have the data in front of you what percent of backlog is for the new ISX? Is it freight?

UNKNOWN SPEAKER:First of all, I think at this stage, we wouldn't be comfortable saying. None of us know right off the top of our head anyway, so we are safe there. It is something we wouldn't share in terms of orders at ISX.

For the profitability in the fourth quarter for engine. If we have that type of decline, you lose freightliner business in the fourth quarter. It would assume engine - is the goal break-even or should we assume a loss in the quarter? This is total engine, but the Dodge Ram and so forth.

UNKNOWN SPEAKER:The goal, if you look at - we think we have reduced our breakeven point around 20%. The goal would be to break even. I wouldn't commit to that. I think we have a shot at it.

For Power Generation when could that return to profitability?

UNKNOWN SPEAKER:This quarter.

Third quarter profits?

UNKNOWN SPEAKER:Yes.

Last question. On the pension, the status is it is a material number the biggest swing from 2000 to 2001. Can you summarize what the impact of the pension is this year? What the contribution needed in this year? Any projections going forward?

UNKNOWN SPEAKER:David, we basically we set out a long-term funding strategy. We are funding over expense. We did last year, we are there year. We will next year and the year after that most likely fund overexpense in the range I don't know the exact number. We will forecast and fund over. It is probably in the 10 to 30 million dollar range, depending on which year you are talking about we will fund overexpense. That is basically over time we were funding minimum amounts and went more to a balanced funding strategy to - we should try to fund more smoother amount every year, total to keep our pension fully funded. That is why you see funding amount in the cash above the expense. Is that what you are thinking about, funding?

Absolutely. I guess the long-term rate of return at 10%, is that year-end or not adjusted at all during the year?

UNKNOWN SPEAKER:That is right, evaluation date is September 30th. We would take and look at return rate and decide if we wanted to change it. It would be affected the following year. We are having a look at it, obviously, a lot of major companies have changed their return rate. When we set it and reviewed it last year, we were comfortable on it. We saw September 11th evaluation s as temporary and looked at long-term rates and felt comfortable. We are taking a close look at it now. Just from a general purposes every percent we cut it, it changed pension expense by 13 million f. we reduce it by a percent, it would add $13 million in expense.

UNKNOWN SPEAKER:It wouldn't change funding necessarily by that much. We are already funding above expense.

That was helpful. Thank you very much.

Thank you. Your next question is come Gary McManus of J.P. Morgan Securities. Go ahead.

Hi, Tim, Tom and Karen. On the earnings side, take the mid-point of everything you said. You are suggesting fourth quarter, somewhere around 15 cents or so. That is up from a year ago, fourth quarter '01. I am wondering heavy truck volumes will be down year-over-year. What makes up the difference? Is power gen going to be strong? Do you expect it to be stronger there? I assume Dodge Ram will be a factor. Just reconcile the increase you expect in the fourth quarter of this year versus last year?

UNKNOWN SPEAKER:I think Chrysler, RV, Power Generation will have a better quarter than what it has had in the first half of this year. We will see continued improvement in cost reduction from Six Sigma and our material cost reduction and that type of thing.

UNKNOWN SPEAKER:The other two factors would be Filtration business, as Tim talked about. Fourth quarter is their strongest quarter. They have been improving steadily year over year. They will have good comparison. Distributors are better. We have - although trucks are down and power gen is doing better than the first half, but still weak, most of the other businesses are improving year over year.

UNKNOWN SPEAKER:Tim, in your remarks you said there is movement going on to try to convince the EPA to delay the October deadline or reduce the penalties, can you size up how successful or you think that will be? What is the milestones that between now and October that you look for? I mean, is it something like if this is not done by September 15th, it will not get done? How do you look for it in terms of the ability for those who want to push back the standard to be successful?

UNKNOWN SPEAKER:This is unchartered water for me. I don't know what the milestones are or that type of thing. I can just say in the discussions that we have had with the regulators, they have been steadfast in stating there will be no delay in the introduction of the standards on October 1, and that they have done their analysis on nonconformance periods. There was a period where everybody could comment. The comment are in the process of making modifications they plan on doing. Once that is done, it is sent to OMB for the final ruling. Quite frankly, they have been talking about doing that relatively soon, but I don't know when that will come out. I think you could plan on certainly the next few weeks. I think that would then set the tone for what is going on. There are one of our competitors has several pieces of litigation on various issues, most of them have been dismissed at least once. There is an appeal process. My guess is the legal track of people are on will go beyond October 1. It is unlikely that all of those rulings would take place before that. But, on balance, we think we have a certifiable engine and will get the B-engine certified any day now. We have got really excellent reliability. We have got over 6 million miles of field tests and 115,000 hours. The reliability results indicate a successful launch, compared to other product launches that we have. So, you know, we are planning on ready to go and we think the rules will stick the way they are now.

Okay. Two quick questions on the cash flow. What is $38 million and this position of business? Secondly, we are seeing folks being up 193 million. How would you rate your working capital performance year to date and expectation for working capital for the entire year?

UNKNOWN SPEAKER:Okay. On the distributor piece or the disposition piece, we had a sale of a U.S. distributor and then we actually invested in a joint venture of a consolidated group of distributors. We also had disposition of asset that is went into our America Cruiser JV with Brunswick. The marine Jv.

UNKNOWN SPEAKER:Gary, my view is we continue to improve on working capital focus. So the receivables increase was really a function of timing at the end of the month. So, you can see there is an equal upswing in payables and accrued expenses. That will be normal working capital swings. There is no question we think there is more opportunity, particularly in inventory and receivables in terms of improving past dues and day sales. We still have our same process where we are setting targets by business and by area to drive those down. I am confident we will hit our target there. We are keeping our eyes closely on it. I don't think the results at the end of the quarter indicate slippage of that at all.

Thank you.

Thank you. Your next question is coming from Andy Casey of Prudential Securities. Your line is live.

Good morning. Got a few questions, just briefly, Tim, on heavy truck. Can you update the field test? You eluded to reliability being good. Have there been any issues you have run into. Second, I guess, the question I have is some of your competitors have had engines at the EPA or engine results at the EPA waiting for certification for quite a while. Do you have insight what is going on?

UNKNOWN SPEAKER:I don't have any insight. Let me answer the last. I don't have insight into the EPA and what they are doing with competitive engines. Your are best talking to both engine manufacturers and the EPA. I don't have much to add on reliability thing. Any time we have a product launch, you will have reliability issues. We have had field tests going on since 1999. As I said, we have over 6 million miles and produced several hundred ISX engines. We see no significant problems. If you look at the reliability data, it suggests a successful launch from reliability standpoint. The reaction from the drivers that have been driving it in mixed fleets, the drivers prefer the ISX-02 engine versus the older engines. We are optimistic about the success of that engine.

UNKNOWN SPEAKER:Just one point. Some of the numbers that - giving regarding our engine, that is by October we will have that amount of miles. So, we actually have been told that we have information to believe that Mack has received certification.

Thanks. On Filtration, given it is an exposure to truck, do you expect a normal 3Q seasonality or sequential improvement?

UNKNOWN SPEAKER:I think the Filtration business for the third quarter will be similar to the second quarter.

Okay. I guess on working capitol and one on the power gen business. Working capital, if I recall correctly, you were looking at building an inventory bank for the Dodge Ram new model start-up. Did that show up in inventory receivables or how did that end up coming out? Secondly, on power gen, given the weakness in the market and the commercial category, have you or are you taking similar shutdown time as one of your competitors have announced for the U.S. facilities?

UNKNOWN SPEAKER:I will do the working capital issue first. On the bank with Chrysler, we did build up some bank and the answer is some of both. Some in receivables and some in inventory.

UNKNOWN SPEAKER:The other piece was on power gen -

UNKNOWN SPEAKER:We are not closing.

UNKNOWN SPEAKER:We do not have total plant shutdowns.

Thanks a lot.

Thank you. Your next question is coming from Joanna Shatney of Goldman Sachs. Please go ahead.

Good morning. Can you guys just talk about what you are thinking moving back into the fourth quarter for warrant coverage to get to the 24 cents? If you walk it through us a quarter, not to say you will have an issue. Is the (inaudible) to be more conservative until you get a couple of months behind you? It is one product. I don't want to make a big deal out of it.

UNKNOWN SPEAKER:On per engine basis, we would expect a warranty increase on the new product. But, in total, we would not expect our warranty accruals across the company to increase in Q4.

It should stay around the 3 and a half percent range for sales?

UNKNOWN SPEAKER:Correct. Close to it.

Can you just remind me how you define free cash flow, before or after dividend to get the 60 to 80 million?

UNKNOWN SPEAKER:Before. Our guidance is we will be able to pay a small amount of debt down at the end of the year.

Can you comment on the dividend policy and how married you are to continuing the dividend?

UNKNOWN SPEAKER:We revisit the dividend regularly with the board and discuss it. We think it is a - right now, an effective way to return money to shareholders. We are not proposing a change. We review it regularly. It is not a religious thing as you are pointing out, or marriage thing, it is function of how we best earn roe and return money to shareholders. We review regularly. We are not changing it.

Okay. No change. I guess just on the last question here, obviously the power gen market has taken another nosedive. You have done a lot of work to restructure the business. I know before you thought you were done in taking restructuring charges. Is this new lower level of demand for the next 6 to 9 months going to be a big enough issue you need to take another charge?

UNKNOWN SPEAKER:We will do it within the confines of the business.

Okay. So, the 600 people in total is enough?

UNKNOWN SPEAKER:Well, you make these decisions on a case-by-case basis, but clearly we will do that and if there are other actions we need to take, we will do them. We have put together almost a room or swat team around that business in order to get a much cost out as we possibly can. We have an action plan and will be executing that action plan and will be reviewing it if we need to do other things. That is all within the context of running the business. We don't plan restructuring charge associated with the power generation business.

Okay. Last question, are (inaudible) yesterday in their conference call reported they are seeing still shortages. Are you running into anything like that and talk about field price increases? Not just this year, but next year.

UNKNOWN SPEAKER:The only steel shortage that is have affected us is within the supply base. It hasn't affected our production yet. We haven't seen any big increases in steel prices.

we are working hard to make sure we don't get - we try to offset movement on steel prices with suppliers.

Great. Thanks.

Thank you. Your next question is coming from John McGinty of Credit Suisse First Boston. Your line is live, sir.

Good morning. Just a couple of specifics. First of all, what tax rate should we be using? We don't really have one for the half. If you earn money in the second half, what tax rate are we assuming?

UNKNOWN SPEAKER:25%, John, after giving effect to the preferred dividend.

Which is what we were or lower -

UNKNOWN SPEAKER:Same.

Same. Okay. Second question is if we are building a model, I understand exactly what we are saying about the fourth quarter, in other words, the national run, call it 10 million a quarter power generation, maybe you will earn that to get you to a profit marginal or profit for the year. Filtration hits the second quarter rate again in the third quarter. The question is if truck volume disappears in the fourth quarter, just the 28,000 is right, will that impact Filtration? There is oe component, but I am never sure how big it is.

UNKNOWN SPEAKER:It will have impact, but the after market at that time of the year is pretty not cyclical. They should be okay.

We can drop it off a little bit from the 23 area, but still very, very strong quarter is this

UNKNOWN SPEAKER:Yeah, pretty small oe effect. The business before Nelson was 90% after market and 10% OEM. The effect is not that large.

UNKNOWN SPEAKER:Nelson is larger, though.

UNKNOWN SPEAKER:It is. Nelson has broader markets.

UNKNOWN SPEAKER:The other thing is with the new models that are coming out, we have had the system selling approach where we combine the fleetguard Nelson. You do it all the way from air intake through exhaust. We have used Cummins as a way of getting into customers they were not into before. We are starting to see oe business come through. It is still early, but seeing some of that.

Okay. Then, let me ask David's question little bit different. You didn't have the percentage of the backlog, but any orders for the ISX other than the two you shipped to California? Less than two owe 3000 is what the industry talks about, less than 500?

UNKNOWN SPEAKER:We have orders more than two for the ISX.

More than 500?

UNKNOWN SPEAKER:We will not comment on that, John.

Okay. Fine. The 28,000 units in the fourth quarter, kind of the conventional wisdom, that is 18,000 in October truck build because basically people like the way it has been put forth. People will build with pre-October built engines and then it goes down to call it 5000 a month. Do you see the fourth quarter moving off that - the first quarter moving - I mean, if you in essence look at engine build, it will be lower than the 28,000. Do you see it picking up in the first quarter ?

UNKNOWN SPEAKER:I think you need to - again, I realize the 00:59:39 need for people to try to get some kind of a feel. 00:59:43 I think the first quarter and the second quarter 00:59:45 next year is going to be a function of several variables. 00:59:49 How good are the product launches, how is the strategy 00:59:53 each engine manufacturer and then truck manufacturer 00:59:56 has. How much increase in demand there is. And, you know, I really truly believe that there is speculation on the first quarter for our own planning purposes, we think it will be better than the fourth quarter of this year. It will grow back to normal production levels. So, is the disruption two months or four months or six months? I don't know and I don't think anybody else does, either.

Do you expect to make money in the first quarter? Normally a seasonally weaker quarter for you and you haven't done it in the last couple of years. God knows it looks like you have a challenge this year. - I mean, next year.

UNKNOWN SPEAKER:We are still putting together our plan for next year, John. I don't feel comfortable giving guidance for first quarter.

You admit it is a challenge?

UNKNOWN SPEAKER:I always admit our business is a challenge, John.

With regard to coverage, it is okay on higher basis when you are not selling any, but by the time we get to the second half of 03, presumably things are normal. How is that percentage 3 and a half we are running now, going to compare with the second half of 03?

UNKNOWN SPEAKER:Again, we haven't done and wouldn't want to give guidance. Your point is right. Indeed the mix of heavy-duty engines goes up it is critical we get warranty costs down the line in order to make sure we can keep our warrant overall product coverage costs down. We have that in our plans and plan to do it.

The only macro economic related issue if you look at problematic stock market and questioned economy and so on, to what extent are we at risk on RV sales, just only - I don't know anything about it, but one assumes given economic uncertainty concerns and stock market wealth, from what you see in talking to your RV customers, the guys that are building them, are they thoroughly comfortable we stay at current levels?

UNKNOWN SPEAKER:They are adding capacity in order to meet it. In some ways, I am surprised the market is as strong for precisely the reasons you said.

Are they doing 0 percent financing like automotive companies?

UNKNOWN SPEAKER:No. If you ask them the question they talk about demographics of the baby boomers who are retiring and have interest in RVs. Two is that there is a dieselization moving away from gasoline to diesel engines. That is moving and people tend to be trading up for bigger units. We tend to be more diesel-like units. My own personal belief is that we shouldn't be planning going forward at today's levels f. they stay, that is a benefit for us. We think it is a solid business.

Two financial questions. Follow up. One percent change in the pension fund would be basically - the one percent reduction for each one percent reduction in your assumed earnings on the pension fund, the 13 million dollar is a pre-tax or after-tax number?

UNKNOWN SPEAKER:Pre-tax.

What about stock options? I recall 12 million dollar after-tax hit - looking from what I saw, what is your thoughts on that?

UNKNOWN SPEAKER:Our thought about what? Are we -

Couple of people have gone out and said they were going to charge them you know, going to recognize them?

UNKNOWN SPEAKER:We are going to wait and see what transpires from all of the discussion around them, rather than lead the pack. You know, we will do whatever is the responsible convention. But, I don't think we need to make that decision today. Clearly, we discuss it with the board and will review it with the compensation committee and the board the next time we meet.

Thanks.

That will be all for today. Thank you for joining us.

Thank you, ladies and gentlemen. That does conclude Cummins second quarter earnings conference call. You may disconnect at this time. Have a good day.