康明斯 (CMI) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Cummins, Inc. second quarter 2003 earnings conference call. It is my pleasure to turn the floor over over to Karen Battin.

Thank you.

Welcome everyone to our teleconference today to discuss Cummins results for the second quarter of 2003.

Each of you should have received a copy of our press release with a copy of the financial statement. If you have not received these copies, please let us know, and we will fax them or mail them to you at the end of the teleconference.

Participating with me today are our Chairman, Theodore Solso, our Chief Financial Officer, Jean Blackwell, our Vice President and President of our engine business, Joe Loughrey, our Vice President of Finance, Sue Carter, and our new Corporate Controller, Marsha Hunt. We will all be available for questions at the end of the teleconference.

This morning I'll take you through a summary of Q2 results, then Theo has a few remarks about the business, then finally Q and A. This teleconference will include certain forward-looking information. We will talk about power generation market, the outlook for the northern American heavy-duty truck market, and other end use market for our product. We will talk about the prospect for our business in Asia, Europe, Latin America, and other regions. We will discuss product costs, product coverage or warranty costs, and profitability improvement initiatives.

Any forward-looking statement about these and any other topics involves risks and uncertainty. The company's future results may be affect by changes in general economic conditions and by the actions of customers and competitors. Actual outcomes may differ materially from what is expressed in any forward-looking statements. A more complete disclosure about forward-looking statements begins on page 20 of our 2001 Form 10-K and it applies to this teleconference.

Let me begin by explaining that I will summarize Q2 results without specific comparison to certain second quarter results last year. As you may remember, on April 14th, we announced we would re-state prior period financial statements. This re-statement required a re-audit of the 2000 and 2001 financial statements by our new auditors, Price Waterhouse Cooper, since our former auditors, Arthur Andersen, are no longer available to provide auditing services. We are pleased to announce that the re-audit is substantially complete. As a result of the re-audit, there will be changes to prior years' financials. We are completing those financial statements and (inaudible), but they were not finalized in sufficient time to provide historical comparisons and analysis today. I will make comparisons where appropriate to first quarter 2003 results and to items which remain unchanged from second quarter last year.

In the second quarter of 2003, Cummins recorded sales of $1.539 billion dollars, 6 percent higher of sales than $1.458 billion in the second quarter 2002, and 11 percent higher than sales of $1.387 billion in the first quarter of 2003. The higher revenue compared to second quarter last year reflects increased sales in the Dodge Ram segment and our filtration and international distributor businesses. Earnings before interest and taxes for the quarter were $46 million, or 3 percent of sales, compared to a loss of $14 million in the first quarter of 2003. Net earnings in the second quarter of '03 were $14 million, or 34 cents per share, compared to a loss of $34 million, or 86 cents per share, in the first quarter of '03.

I will discuss each of our four business segments. First I will begin with the engine business.

Total sales for the engine business in the second quarter were $889 million, a 5 percent increase from sales of $850 million a year ago. Revenues and automotive market were 6 percent higher than Q2 last year with increases in our light-duty (inaudible) automotive business, more than offsetting sales declines in medium-duty truck and bus sales. Overall (inaudible) from industrial markets was up 2 percent year-over-year with increases in mining and government sales and decreases in rail and marine revenues. Operating income for the quarter was $24 million, versus a loss of $23 million in the first quarter of this year. That represents a $47 million improvement on a sales increase of $73 million. The higher earnings resulted from improved gross margin on the increased volume, the avoidance of one-time costs incurred in the first quarter, and a significant increase in joint venture income. The engine business also benefited from cost reduction savings, including the consolidation of our heavy-duty operations, and global sourcing initiatives.

I will briefly review each of the engine business market. Turning first to the heavy-duty truck business.

Revenues for the heavy-duty segment as a whole were flat in the second quarter from a year ago while unit shipments globally were down 20 percent. The difference between the volume and the revenue variance was a result of higher pricing for the new product. Unit shipments in North America were down 22 percent. The volume drop was due to the impact of the October emissions standard change, but our market share remains stable.

Unit shipments to the rest of the world were down 10 percent with lower sales to OEM's in Europe, partially offset by increased sales to Mexico. In the worldwide medium-duty truck and bus market, total revenues decreased 10 percent from the second quarter year-over-year.

Medium-duty truck engine shipments were down 46 percent in North America, primarily due to the impact of the emissions standard change. International shipments were up 7 percent with higher OEM sales in Latin America. Global bus engine shipments were down 40 percent with a 67 percent decrease in North America where the variances are affected by the change in emission standards and a 15 percent decrease internationally, primarily in China.

In the light-duty automotive and RV business, revenue was up 27 percent this quarter compared to a year ago. Engine shipments to DaimlerChrysler for the Dodge Ram pickup truck were up 8800 units, an increase of 39 percent from second quarter last year, resulting from the launch of Chrysler's new model pickup.

Unit shipments for RV engines decreased 29 percent year-over-year, again due to the emission standard change. Cummins remains the market leader for RV engine sales with over 70 percent market share.

Sales to industrial engine markets in total were up 2 percent from a year earlier, with decreases in rail and marine sales more than offset by increases in the remaining segment.

In the construction equipment market, worldwide sales were up 2 percent compared to second quarter 2002. Unit shipments of engines in North America were down 19 percent with reduced capital spending driving continued weakness in construction equipment markets. Shipments to international markets were up 6 percent compared to second quarter of 2002 with higher sales to Asia more than offsetting the sales declines in Europe.

Sales for the agricultural equipment market increased 11 percent from second quarter last year with sales declines in North America more than offset by sales increases in Latin America and Europe.

Revenues from marine markets decreased 10 percent compared to second quarter last year, while unit shipments were down 8 percent. The primary reason for this decrease was the formation of the Cummins America Cruiser Joint Venture in March 2002 where recreational marine sales are now reflected on the joint ventures books.

Revenue in the mining segment increased 21 percent year-over-year where we have increased market penetration despite continued weak demand for mining equipment. Sales in the power generation business for the second quarter were $307 million, essentially flat with the second quarter of 2002.

In North America, revenues were down 2 percent compared to a year ago with continued weak demand in our commercial general set business. Demand in our consumer business remained strong with sales 2 percent higher than the second quarter of 2002. Outside North America, revenues increased 3 percent in total with decreases in Latin America and parts of Asia more than offset by increases in Europe and Australia. In the second quarter of 2003, power generation had an operating loss of $15 million, a $2 million improvement from the first quarter loss of $17 million. Continued pricing pressure and costs associated with additional headcount reductions taken during the quarter offset the progress we have made with our cost reduction initiatives.

The headcount reductions resulted in $5 million of costs during the quarter but will provide a $2 million quarterly benefit going forward. Revenues for the filtration and other segments were $265 million for the quarter, a 9-percent increase compared to the second quarter of 2002. This marks a record sales quarter for the filtration business despite continued weakness across most markets it serves. Sales in emission solutions was a major contributor to the sales increase. This segment's operating earnings for the quarter were $25 million versus $20 million in the first quarter this year. This improvement is primarily due to the higher volume level.

Sales for the international distributor business were $169 million in the second quarter, an increase of 17 percent compared to sales of $145 million last year with improvement across all regions except those impacted by SARS. Operating earnings for the segment were $12 million this quarter, or 7.1 percent of sales and reflected a record profitability quarter for this business. This increase was primarily driven by higher parts and service sales.

Returning to the corporate level, I will review our total sales by region. In the second quarter, our sales mix was 53 percent U.S. and 47 percent international, which was unchanged from the domestic/international split in the second quarter last year. For the second quarter compared to a year ago, sales in the U.S. increased 5 percent, while international sales in total increased 6 percent. The U.S. sales improvement was primarily driven by higher sales in our Dodge Ram business.

The international variances were mixed with decreased sales in Latin America and east Asia more than offset by increases in Europe, Australia, India, Japan, Canada, Africa, and the Middle East. European sales increased 11 percent compared to the second quarter last year with higher sales primarily in filtration and international distributors. Sales to Australia were 23 percent higher than last year with increases in all businesses except engines. Sales to India increased across all businesses. Sales to the Middle East increased for all product due to higher demand resulting from the war in Iraq. Sales to Latin America were down primarily in power generation, and sales to east Asia were down in all businesses due to the impact of SARS. Next I will review corporate gross margin.

The gross margin percentage for the quarter was 17.9 percent. This was significantly higher than the first quarter of 2003 due to the higher volume, lower product coverage cost, and improvement in product cost. Product coverage cost was 3.3 percent of sales, or $51 million in the second quarter, compared to 3.5 percent of sales, or $51 million a year ago. For the first six months of 2003, product coverage cost was 3.6 percent of sales, or $105 million. Excluding warranty costs, gross margin for the quarter was 21.2 percent versus 19.3 percent in the first quarter of 2003.

In dollar terms, gross margin was $327 million compared to margin of $268 million in the first quarter. Roughly half of the margin improvement was due to the higher volume level. The remainder of the increase was due to cost reduction initiatives, efficiency improvements, and the one-time costs incurred in the first quarter not being repeated. Total selling, admin, and research in engineering, or SAR spending in the second quarter was $250 million, or 16.2 percent of sales.

Compared to the first quarter of this year, expenses were $9 million higher on an absolute basis but decreased as a percent of sales from 17.3 percent. Selling and administrative expenses increased $5 million from the first quarter, primarily due to additional audit fees of $5 million. Research and engineering expenses increased $4 million compared to first quarter, largely due to timing. Total SAR expense in the quarter did include $2 million of costs related to severance actions that will not be repeated and that provide further cost savings going forward.

Our income from joint ventures and alliances in the second quarter was $17 million, compared to $7 million in the first quarter of this year. This increase was attributable to improved earnings across most of our joint ventures with the most notable increase coming from our recently expanded joint venture with (inaudible) Motors. Sinced this quarter's income included (inaudible) with the royalty and tech fees it does not represent a normal quarterly run rate, however, we do expect ongoing joint venture income to be significantly higher than historical levels.

Other income and expense in the quarter was income of $3 million compared to income of $6 million in the first quarter of 2003. This change was primarily related to a small foreign currency loss in the second quarter versus a currency gain recorded in the first quarter of this year.

Interest expense for the quarter was $20 million, equal to that recorded in the first quarter of this year. The income tax provision for the quarter was an expensive $5 million compared to a benefit of $10 million in the first quarter of 2003.

Minority interest in the second quarter was $2 million compared to $4 million in the first quarter of this year. This variance was primarily due to lower earnings attributable to our minority partners in India and China.

Net earnings for the quarter were $14 million, or 34 cents per share on 39 million average shares for EPS purposes. Now let's turn to cash flow.

Free cash flow from an operations perspective was an inflow of $25 million for the second quarter of 2003. A statement of cash flows that you should have received indicates a cash in-flow from operating and investing activities of $41 million. To arrive at the $25 million free cash inflow we adjust (inaudible) the net $11 million change in marketable securities now shown in the investing section of the cash flow statement.

As a reminder, these are primarily debt mutual fund investments in India that have to be reflected as investments versus shown as cash in our financial statements, even though such funds are available for use the same as our cash balances. We also address the $5 million inflow from the reduction in our receivable security at the sayings program. Excuse me, tha, would be an increase in the security at the sayings program. The $25 million cash inflow in the quarter provided for payment of our dividend and a modest debt reduction.

Our debt to capital ratio improved slightly during the period. Changes in working capital represented a net cash outflow of $60 million for the quarter. Accounts receivable increased $30 million during the period due to the higher sales level. The (inaudible) sales outstanding remained unchanged from first quarter at 51 percent.

Inventory also increased 18 million during the period, but inventory terms improved slightly. Accounts payable decreased $12 million during the quarter primarily due to timing of payment processing.

Capital expenditures were $27 million for the quarter as we continue to aggressively manage capital spending. Investments in and advances to joint ventures and alliances for the second quarter of 2003 was an inflow of $21 million due primarily to repayment of working capital advances by some of our joint ventures.

Thank you. Now I will turn it over to Tim.

Good morning.

The second quarter was a solid quarter for us. Three of our four businesses delivered improved profits, and power generation moved closer to break even while absorbing $5 million of restructuring costs. This (inaudible) was achieved despite continued softness in the majority of our market.

Our sales increased $152 million compared to the first quarter of 2003, and earnings before interest and taxes were $60 million higher. That means we converted roughly 40 percent of the sales increase into operating profits.

Our earnings per share went from a loss of 86 cents per share in the first quarter of this year to earnings of 34 cents per share in the second quarter. That's a $1.20 per share improvement in one quarter. We were able to accomplish this with very little demand improvement in most of our businesses. This demonstrates the operating leverage we have achieved through our cost reduction efforts over the past three years. Power generation mark and operating performance remain weak, but we have taken, and will continue to take, the actions necessary to ensure a return to profitability going forward.

The engine business results improved substantially from a quarter ago as demand in North American automotive market continues a modest rebound following the change in emission standards.

Construction sales also increased. Revenues were $73 million higher than the first quarter, and profits were up $47 million. Our new emissions compliance product continue to perform well in the field. We now have more than 16,000 ISX and ISM heavy-duty engines in use with almost 450 million miles of service accumulated. We are adding over 5 million miles of field experience a day, and by October we expect to have over 25,000 proven engines in service with close to one billion miles of reliable performance.

Order rates are continuing to improve, and with the positive performance of our product and experience gained by truck fleets, we are positioned well to take advantage of the increasing demand.

Our up-time guarantee continues to provide reassurance to our customers while also demonstrating our level of confidence in our new product. To date, we have only had to rent 14 trucks for customers with only one of those repairs related to exhaust gas recirculation components. The reliability of these new engine product launches has met or exceeded our, and more importantly, our customers' expectations.

We are pleased to announce that Cummins and Freightliner have reached an agreement to continue to install Cummins ISC and ISL engines in Freightliner and (inaudible) brand medium-duty trucks. Cummins engines will now be available in the new Freightliner business class M2 line of medium-duty and (inaudible), as well as the sterling product line. The agreement runs through 2006.

Our new engine for the Dodge Ram pickup continues to perform very well and has strong market acceptance. Shipments this quarter for the Dodge Ram were over 31,000 units, and sales volume over the last three-quarters creates a new record for Cummins. For the second consecutive year, our engine was named first among diesel engines for heavy-duty pickups by a leading consumer research firm and the 2003 Dodge Ram heavy-duty 2500 pickup won Motor Trend Magazine's Truck of the Year Award.

We reported a record $17 million of income from joint ventures and alliances in the second quarter. Our newly expanded venture with China was a major contributor to this increase. For 2003, we expect at least double the joint venture profits recorded in 2002 with increasing cash flow from these operations.

The filtration and other business had record sales of $265 million this quarter. Earnings before interest and taxes were $25 million, or 9.4 percent of sales. They achieve these rules by funding important initiatives to ensure their continued growth.

During the quarter, Fleetguard Nelson signed a new long-term supply agreement with (inaudible)Holland, the fifth such agreement signed this year with a major OEM. The value of these long-term agreements from this year through 2007 is over $1.4 billion. These supply agreements expand current business and lay the foundation to achieve future growth targets.

The emission standards business continues to increase profits through retrofitting existing engines to lower emission levels, this promotes a cleaner and healthier environment. At the same time, this business is investing in the technologies necessary to meet future emission requirements.

The international distributor business delivered strong sales of $169 million for the quarter and record earnings of $12 million, or 7.1 percent of sales. Despite the current soft market conditions, this performance meets our target range for the business of 6 to 8 percent which demonstrates stable earnings capability. The return on average net assets was also a record at 29 percent. This business is increasing its parts and service revenues and is benefiting from best practice sharing across distributors. Power generation business reported a loss of, before interest and taxes for the quarter, of $15 million, resulting from continued weak demand, further praise erosion, and redundancy costs. In addition, under absorption of fixed costs at our high horsepower engine plants continued to severely impact profit margins. As demand and other high horsepower engine market was also down, this segment received a greater allocation of the underabsorbed costs.

The operating results, however, did reflect an improvement of $2 million over the first quarter of this year, while absorbing $5 million of costs for the additional headcount reductions.

Going forward, in addition to not repeating the $5 million of costs incurred in Q2, we will have $2 million of savings per quarter from the reduced headcount. By the end of the third quarter, we will have reduced the headcount at our Minnesota facility by nearly 50 percent and reduced employment in our total power generation business by almost 30 percent.

The re-engineering of our product to provide more cost-competitive generator sets for our customer base is on track with several newly designed products being introduced in the second and third quarters. Additional products are planned for release later this year. We are achieving reductions in material price and continue to progress on moving production to lower cost supply sources. With these actions in place, we expect a return to profitability in the second half of this year.

Our free cash flow for the quarter was an in-flow of $25 million. Cummins typical seasonal pattern for cash flow is to use cash in the first half of the year and generate significant cash flow in the second half of the year, particularly in the fourth quarter. We continue to tightly manage capital spending and have intense focus on reducing working capital.

Demand in the majority of our market continues to be soft, and uncertainty remains regarding timing and magnitude of an economic recovery. We are, therefore, (inaudible) about volume expectations for the latter part of this year. While the recovery in the heavy-duty market is evident, the rate of recovery could well be delayed a quarter from our initial expectations. We expect third quarter earnings in the range of 60 to 70 cents per share. Our earnings guidance for the year remains in our previous range of $1.20 to $1.40 per share.

Our free cash flow for the year is still expected to be in the range of $70 million to $80 million, sufficient to fund our dividend and provide for some modest debt reduction in 2003. We expect our capital expenditures for the year to be below $110. And lastly, let me speak to the status of our re-audit work.

I am very pleased to announce that the re-audit work is substantially complete. Our employees have worked extremely hard to accomplish this, and I'm very grateful for their outstanding work. We are completing our financial statements and disclosures, and we expect to file our 2002 Form 10-K as well as our first and second quarter 10-Q's for 2003 in the near future. Once we have filed our Form 10-K, we will announce the date of our annual shareholders meeting. As we told you before, the extensive scrutiny of our (inaudible) and records, there is no evidence of willful misconduct on the part of any employee. We believe our results demonstrate that we are well positioned for the market upturn.

Three of our four businesses are performing well, and the fourth business has taken necessary actions to return to profitability. We are delivering the right, clean products to the market for our customers. We are generating cash flow while funding all important product development programs. We remain committed to paying an attractive dividend to shareholders and providing a good return to all our stake holders. We believe business levels are raising from the three-year recession with the fourth quarter of 2002 and first quarter of 2003 being the low points. Most importantly, we are positioned to take advantage of the recovery in sales due to the many improvements and initiatives we've undertaken including our (inaudible) program, which has provided over $400 million of savings since inception.

The direct and indirect material cost initiatives which netted over $315 million of savings, 17 percent work force reductions, restructuring actions, including the closure and consolidation of facilities, resulting in $80 million of savings, and working capital improvement of $279 million. We will continue to tightly manage spending and believe we will benefit strongly as our markets recover.

Now let's take your questions.

Thank you. Your first question is coming from David Raso. Please announce your affiliation then pose your question.

Smith Barney. Good morning.

My question is on the heavy-duty truck engines and total. The incremental margins we saw in the second quarter versus the first was very strong. Can you give us more insight into how we should extrapolate that kind of increase? I'm trying to get a feel, was there a big incremental jump this quarter that may not be continued because it was the big pop from closing Columbus and moving everything to Jamestown? Can you give us a better feel on that going forward and maybe integrate that into the comments you made about Freightliner? Is there any talk about getting back on the heavy side with Freightliner as well?

David, in terms of the heavy-duty consolidation, those benefits will be ongoing. We have estimated those to be at least $5 million a quarter, and there would not be anything -- I mean, so that would be the answer to your question, that would be the impact of the consolidation quarter over quarter. But we really got some absorption improvement efficiency improvement, and just general product cost improvement across all of our businesses.

This is Tim.

I would also say that the improvement, though, was exceptional, and I'm not sure we will see that same rate of improvement. I think we'll see significant improvement, but was, in my judgment, outstanding performance. As far as Freightliner is concerned, we're working with them on the mid-range trucks and have achieved some significant accomplishments going forward. There is n progress in terms of the heavy-duty truck engines in terms of us supplying Freightliner. And we have that built into our forecast and our guidance, that we will not be in Freightliner heavy-duty trucks.

One more comment. In the first quarter we did draw your attention to some one-time costs that we had that impacted our margins, so that was part of the improvement. We've said those would not be repetitionable, and, in fact, they were not. So that was probably a big contributor to the quarter-over-quarter change.

Lastly, on the JV income (inaudible), you used to have a JV with them, but this new one is a lot larger. The incremental income coming from them per quarter now is about three and a half, if I remember correctly, about 14 annualized. The comment made earlier, did I hear correctly, doubling of income from (inaudible) from '03 to '04?

What we've planned for is $9 million increase this year from April 1 so three-quarters, so four quarters would be about 12.

Right. And the comment about J V income is that we would expect to double total joint venture income roughly from '02 to '03 levels, not from '03 levels doubling them into '04. We're actually seeing improvement across a number of joint ventures, not just (inaudible).

Next question is coming from Gary McManus. Please state your affiliation then pose your question.

J. P. Morgan. Good morning, Tim and Karen.

Getting back on the joint venture income, I think you mentioned there was some annual lease -- I'm sorry license payments or, you know, that you don't expect to be repeated. Could you quantify what you thought was -- I don't know if I would call it unusual, but an annual payment that we won't see repeat in the third and fourth quarters?

Should well, I know, Gary, that we had like a $2 million payment in the quarter that was really more of an annual payment, but other than that, that would at least come close to representing, you know, like a normal quarterly run rate for us.

So the 17 million you would say would have been 15 million is kind of -- what's I guess, embedded in your second-half outlook, what kind of income from these joint ventures and alliances are you assuming?

We expect for the year to get to at least the 40 to $50 million dollar, so that will give you your answer.

And we'll get about somewhere between 15 and 20 million dollars of cash out of the joint ventures. I think the last teleconference, in some of our public statements, I point out to those that are watching our financial statements that the joint venture efforts that we've had are really now starting to pay off. This is both in India and China and also we have taken some equity positions with distributorships, and the dividends from that are also starting to pay off.

You mentioned you had 5 million of restructuring costs in power generation, and then separately, you said, Karen, there was 2 million of severance cost, I think was in the selling and admin.

Right.

Are they one and the same or separate? Do I assume there was like 7 million of non-recurring restructuring related costs?

No, it was 5 million, and the two was included in that five. It's just the other piece would really be in gross margin

So it's not seven, it's five in total for the total company

It is five, but we will not repeat that five and get two million per quarter going forward

Last question.

You expect, obviously, sequential improvement from the third quarter from the second, and implied in your forecast is improvement in the fourth over the third. Where do you see that happening?

Is it at power generation, returns to profitability? I think you said that. Or do you think, is it the engine side getting higher profits, or is it a combination of the two?

Well, you've got to remember that in the first quarter, which is a very low quarter for us, seasonally low for our international distributor business, for filtration, the heavy-duty business. Again, I think it was artificially low because of the repercussions of the pre-bay. So you're comparing it to a much lower base.

If you look at the second half of this year, we think we will see a recovery in heavy-duty, in medium-duty. I don't know that we will see a big recovery in power generation, but we're starting to -- I think we will see more of the cost reductions.

The filtration business is still going up, and the international distributor business. So, you know, we think we will see modest increase in volumes, and if you just take a 20 percent standard gross margin, that can be as much as $50 to 60 million.

Thank you.

Your next question is coming from Andrew Casey. Please state your affiliation then pose your question.

Prudential Equity Group. Good morning.

Hi, Andy.

On power generation, can you describe the inventory situation that you see out there right now? And, you know, any dynamics that are helping reduce that.

Just in terms of our own inventory, we reduced our power generation inventory by a modest $5 million, and we've also reduced the side of our rental fleet by $15 million. I think we're seeing 500 and below K VW. I think the inventories are starting to normalize. We're seeing an increase in quoting, although delivering those quotes is still a slower process than before.

One megawatt and above is starting to come down, but, again, we're managing that business assuming that there still will be excess inventory through next year. The one wild card is that there's a lot of quoting for power generation for the restructuring of Iraq.

And we've had some additional business, as well as our competitors, and that could become a significant piece of business, and if that were the case, then you would see the world inventories at the higher ratings, I think, reduce more quickly, which would bring the power generation demand back to a normal basis.

Just a follow-up on that.

Could you make any commentary on pricing? Is that starting to sequentially improve, or is it still pretty much under pressure?

It's still under pressure.

On the truck order rate, Tim, can you kind of describe what you've seen so far in July versus June? Has it been kind of flat, or have you seen any improvement?

Andy, this is Joe.

What we're beginning to see are truck OEM's, not all, but most, beginning to take their build rates up. For late summer and the fall. Most of this is beginning in August. And that's then beginning to reflect in sort of the orders being placed on us.

Okay. Great.

Lastly, on the new business, well, the business that you announced with Freightliner, is that sequentially incremental, or did you have it before and you just made sure you're on it with the new vehicle?

Andy, it's Joe again.

You've got to go back a ways but I think Freightliner made a statement sometime ago that at least they were going to go ahead with their own engine, and Catapillar, in their new M2 truck, series of trucks, for '04. So there's been a couple of changes since then. One is our ISD '02 is now engineered in the brand-new cargo truck at Freightliner. Second, the ISC, ISL is being engineered into the new version of the M2 truck in Freightliner and Sterling going forward. So we think, based on how our recipe looks, compared to the alternative, that this will be not -- will be in part a continuation of what we've had this year, but we have some opportunity for incremental share gains for engines those sizes in the M2 truck.

Thanks a lot, Joe. Thanks, Tim.

Your next question is coming from Jeff Kaufman. Please announce your affiliation, then pose your question.

Thank you. Fulcom Global Partners.

Tim, could you just review -- clearly the cash flow is in better shape, but could you review your available lines of credit that are there to be tapped, if necessary, and then back to the truck cycle.

This is Karen.

The availability -- you know our revolver is 385 million. We've got some of that reserved for letters of credit, so that's maybe roughly $90 million. And we've got a little bit of borrowing outstanding, like 30 something, at the end of the quarter.

We have our receivable security program that we kind of talked to a program size borrowing (inaudible) of maybe 170 million. That really changes, though, based upon receivables level at any point in time. So we have other lines of credit that really are not drawn at this point, so we feel like we've got sufficient liquidity.

Okay. That was my sense. Thank you.

The question has been asked on the heavy, so let me talk a little bit about currency impact in 4 X. Can you talk about how that affected you this quarter and where you stand going forward?

The currency, you know, we've got a pretty extensive hedging program in place, so the quarter, we actually had about a $1 million net unfavorable impact, so, really, you know, not a big issue to the company, and because of all of the hedging, the various hedging programs we have in place, we really wouldn't expect they major movement in that, you know, quarter and in future quarters.

Very well. Thanks and congratulations.

Thank you.

Your next question is coming from Mark Koznarek. Please ask your question.

Hi, I'm with Midwest Research.

Did you folks say on the heavy-duty engine side your engine shipments were down 22 percent?

Yes.

I just checked with the industry build data, and that appears to be down 8 percent over the same period. Can you talk about the difference there?

Yes, Mark. It must have been just in specific -- you know, in shipments. That is a North American number that we were giving. What you ought to be careful about is that we define the market a little bit differently than some of the other sources, so you may not have apples and apples.

But definitely our share has maintained or actually even increased slightly during the period, so it's not that we were having any declining share. So I think maybe off-line we can go through the numbers and make sure that what you're looking at is -- how that varies from our definition.

So you wouldn't assert there's any kind of underperformance relative to the market, the way you look at it?

Not at all. As a matter of fact, the last share data that was reported by ward's really showed slate increase with Cummins.

Last conference call, you guys had some commentary about the competing emission compliant engine technology, and now some of that is actually, you know, come commercial and we're able to see it in the marketplace, although there's still not too many data points.

But have you revised your point of view on that versus the competition?

Mark, this is Joe.

The simple answer is no. I think gaining in confidence in terms of how well positioned we will be as time goes on here. Maybe let me just contrast things a little bit.

As more and more information comes out about the Catapillar offering, I think I begin to draw certain conclusions. Some are, in fact, facts. First, it's a very complex solution, and looking like it's driving a lot of issues because of that complexity from a reliability point of view.

Second, weight is -- significant increase in weight from a truck point of view. The range is somewhere wean 360 pounds and 500 pounds, particularly on the heavy-duty side, heavy heavier duty side, depending on whether we're talking single stacks or twin stacks. So significant increase in weight.

There's no question that this recipe has higher heat and a lot of boost pressure and they're having problems trying to manage Delta P across their charge air cooler. As a result of some of those issues, they still have a lot of heat creating issues -- heat issues that are creating a lot of problems in truck installation, and parts are still changing. Muffler diameters, for instance, are still moving in the recipe itself.

In terms of looking at what we know about where they're headed from a fuel economy point of view, it looks like they're recommendation at cruise is 1300 RPM. If, in fact, that's the case which we believe it to be the case, that means doing things like a 13-speed double overdrive transmission, which is not very friendly from a driver point of view. It's lot of shifting. And the sweet spot seems to be very small, very narrow, and at very low RPM.

So a lot of issues we still see as we learn, and as you said, I mean, these things are just beginning to come out into production. On the other hand, if you look at kind of where we are I think first it's almost universal. Drivers love driving our product with the EGR application. Second, reliability to date is better than our plan, and our plan was pretty aggressive by historical standards, in terms of where we're coming out, and as already said in some of the comments. By the time Cat really gets ramping up on the heavy-duty side in October we will have a billion miles and 25,000 engines out there running, and the rely ability is just getting, and will get, better.

On the fuel side, it's very consistent that we're delivering what it is we told customers we would deliver. The range is from just as good as the previous product up to 5 percent deficiency. It depends a little bit on two things. What they were running previously and what truck the engine is in, but basically fuel economy is performing as we said it would. Oil drain intervals are hanging in there at 25,000 on oil change and 50,000 at fuel filter chang, versus Cat right now going out at 50/50 on both of those.

It's already been mentioned by both Tim and by Karen that the consolidation at Jamestown is going very well. It's a big factor in not only the improvement we've made so far in margins, but it will continue to be a factor, particularly as we'll continue to make improvements at today's volume but I think have a great opportunity, as volume increase, to leverage those.

Lastly, I will just say, we're a year that have in on the 2007, 2010 recipe, and at least with three of our partner OEM's, very engaged, and with our engines running in their trucks on the road at the '07 standard. We're working very hard to ensure that our recipe will be the best in the industry when the time comes.

So I guess, you know, proof is in the pudding, but the pudding is looking better, and I like how it's beginning to taste. And we'll see where things go as we go through the rest of this year and more engines actually get out there running.

Just a final thing. That last comment, did you say you actually have engines meeting the 2007 standard right now?

Oh, yes. In trucks. These are test trucks, but, oh, yes.

Great. Thanks for going through all of that.

Thank you.

Thanks for asking.

Your next question is coming from John McGinty. Please announce your affiliation and pose your question.

First Boston. Good morning. Couple of follow-up odds and ends.

The one-time costs that you delineated in the first quarter, the roughly three things that were like 30 cents or so, those are all gone. On a couple of things, like the vendor issues, you had thought you might get some recovery. Any luck on any of that? Or the 30 cent hit the quarter, it's gone, no further penalty, no further recovery?

I think that's the right assumption.

Then currency, Karen, you talked about currency being a $1 million negative, that's all in -- that's translation, that's balance sheet, that's income statement, that's everything?

Actually, that would be really the exchange loss. The translation probably had a negative $2 to $3 million dollar impact to the quarter.

My question was whether or not it hurt or helped the international distributor since that's almost all international. I wouldn't know what that affect would have been.

I don't think that there was a significant net impact to them, because they really serve a lot of the local market. So it's much affected by that.

And, Tim, it wouldn't be a call if we didn't ask you what truck number you have baked into the underlying.

For this year?

Yeah, and then for next year.

Should I'd say 150 to 160 this year. I think we're lacking at a 25 -percent increase in the second half over the first half, then next year we're saying 200,000.

This is Class 8 heavy, in other words, 250 horsepower on up, North America, right?

That's correct.

Ours is U.S. And Canada, kind (inaudible) that definition, John.

What was '02?

The '03 number would be slightly below the '02 number, based upon our 150 to -- like 160 would still be slightly below

Like 170?

No, low 160's, I think.

And then is there a reason we don't have a balance sheet, or did I just not get one?

John, we didn't put out one today because of the restatement of our financial statements, and we're really just completing that work and all of the related disclosures, and we're going to put that out very soon in a 10-K filing.

There will be changes to our equity as we reflect the adjustments that we told you we would need to be making in our prior period financials.

Didn't you say that was going to be like less than $15 million?

That is what we have publicly announced, and we feel like we need to wait until our balance sheet and all related public disclosures are made public before we provide that update

What about the debt? The debt, just absolute level of debt at January, it shouldn't have changed versus the '03, right? March '03.

Right. As I mentioned we actually had some modest debt reduction in the quarter. You can see that on the cash flow statement we provided. So we did slightly reduce that, and we slightly improved our debt to capital ratio. For the quarter.

Just two questions. Tim, you mentioned that you are going to get cash from the investments in advances. If I'm looking at a cash flow statement, you know, you always historically have ended up putting in $10 or $15 million. Should I assume your investment advance zeros out on a cash flow, or you're saying you will get $15, $20 million actual positive cash in '03 and '04?

I would say the conservative assumption would be that it's a net zero number.

So you continue to make the investments, as you always have, but then you will get enough back to fund it, if you will?

Yes.

Just to make sure I understand this, you did -- if we look at -- you did $22 million last year in the JV income. You're talking about doubling that, call it to 45. You're at $24 million in the first half, which would be about $10 million a quarter in the second half, but you talked about the run rate being the 17 minus the 2 non-recurring, which is $15 million a quarter. Should we be looking at 55, or, is, in fact, $10 million a quarter the run rate in the third and fourth quarter?

John, I don't think we can be that exact. We have a number of different joint ventures, and what their exact profitability in any quarter is going to be, we're not going to be able to get that precise.

We've said we expect conservatively $40 to $50 million for the year. So whether that's 45 or 50 or slightly above 50, but we feel confident that we've substantially improved our earnings from joint ventures and the cash. So that's about as precise as we can get for you.

Thanks very much.

Your next question is coming from Joanna shut knee. Please announce your affiliation.

Good morning. Goldman Sachs.

Good morning.

Versus the first quarter, since that's what we have, the incremental improvement from -- in the engine business profit margin from losing $23 million to making $24 million, I guess what I'm trying to get to is, where is the joint venture income being allocated? Is the $10 million improvement in income from joint venture we saw from first quarter to second quarter all in the engine business?

It's not all there, Joanna, but there's certainly a substantial piece of that. But, again, we talked about the one-time costs that we had in Q1 of about $15 million, and those were really primarily engine business costs. We also said that we have a $5 million improvement from the heavy-duty consolidation from Q1 to Q2, so, you know, that's another five. The improvement in the joint ventures is primarily there. So then we also -- so we just improved our efficiency had increase in volume. So all of that together drove the improvement.

Just what we've said before, as, one, our product mature, and, two, the volume comes back, and we've taken capacity out. So we have better absorption we are going up the learning curve, so our costs are coming down on the new products.

You're seeing a stabilized and I think a future reduction in coverage and warranty costs, and we're capturing more of the cost savings and the efficiencies that we've been talking about for the last 18 months as Joe referred, into Jamestown, and we've got a global direct material sourcing effort with new offices in India, in check companies La (inaudible) I can't, and Shanghai. And while we have seen some improvement there, I think we will see future improvement there. So there's a lot going on to get at the costs. And I think, as I said, we had a good first quarter, and there is some joint venture revenue or income in there as well as the -- not having the one-time costs, but this business is getting better.

I think it's hard to talk about this sequentially, so just assume the numbers that you gave us second quarter of last year, kind of use that as a base.

The incremental leverage just isn't as clear because it it's basically -- $14 million was the profit in that business a year ago, and incrementally it's $10 million of improvement year-over-year, and that's exactly what the improvement was in the joint venture. So I just want to make sure when I lack at this it's real improvement empty heavy-truck business and not just the joint venture business that has changed.

Definitely not just the joint venture. We've got improvements across a lot of the business. We've got new products that we're coming up the learning curve pretty fast, so we're pretty pleased if we could introduce new product across all of our product line and achieve, you know, similar margins.

What was currency in year-over-year in the engine business?

It might have been slightly favorable compared to Q2 of last year.

But not enough to break out?

No. It's about -- the improvement in cost.

Okay.

And could you just talk about your level of R&D spending and an annualized run rate for the next couple of years? We just feel comfortable with that. I think it stays at these lower levels, right?

Yes. I think as a percent of sales, as our sales go up, R&D will go down. We will stay really at today's levels. That's sufficient to bring out the 2007/2010 platforms. Those platforms are going to remain the same. Some will have pal EGR, some won't, but that's now technology that is current.

A lot of the new investment will be in after-treatment systems, and this will remind you that -- where we were doing research in after-treatment, both in power generation and the engine business, we consolidated that and put it in as a new business called emissions solutions in our Fleetguard Division. Last year, their first year of sales were $24 million, and they broke even, and still funded that research. And this year they're going to generate more sales and a profit and still fund that research. So that's a way that we can compete -- or bring our R&D down.

We're also doing more R&D work in our facilities off-shore. And so we think we will be getting productivity increases in our R&D which will allow us to do more at the same level of spending.

Last question.

Can you help with us what the pension situation is, if you can just give us the plan return assumption for this year, when that might change, what the discount rates and what the actual cash flow is required for this year and for next, because I know you gaze have credits that we can't see, so it's hard to really get a good feel for what the cash requirements are.

Okay. This is Jean Blackwell.

As you know, we reduced our pension return assumptions for this year to about.8.5 percent for the U.S. and 8 percent for the U.K.. And to date our returns have been around 14.5 percent for this year, which is about 11 percent for the period that we're talking about. And so we are currently planning on funding about twice what the minimum funding requirements are. We're funding about $105 million this year.

We won't review our pension assumptions again, for accounting purposes, until we get to our measurement date, which is the end of November. For funding purposes, those are set at the beginning of the year.

Thanks.

I think that concludes our call for today. Thank you very much for joining us.

Thank you, ladies and gentlemen. Thank you for your participation.