康明斯 (CMI) 2003 Q3 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the Cummins 2003 third quarter earnings release conference call. At this time, all participants have been placed on a listen-only mode. And we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Mrs. Karen Battin. Madam, the floor is yours.

Thank you. Welcome, everyone, to our teleconference today to discuss Cummins results for the third quarter of 2003. Each of you should have received a copy of our press release, with the copy of the financial statements. If you have not received these copies, please let us know and we will fax them or E-mail them to you at the end of the teleconference.

With me today are Chairman, Tim Solso, our Chief Financial Officer, Jean Blackwell, our Vice President Finance, Sue Carter, and our Vice President and Corporate Controller, Marsha Hunt. We will all be available for your questions at the end of the teleconference. This morning, I'll take you through a summary of Q3 results, then Tim has a few remarks about the business.

And finally, we'll open it up for question and answers. This teleconference will include certain forward-looking information. We will talk of power generation market, the outlook for the North American heavy-duty truck market and other end use markets for our products. We will talk about the prospects for 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 statements about these and any other topics involves risks and uncertainty.

The company's future results may be affected 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 statement. A more complete disclosure about forward-looking statements begins on page 48 of our 2002 Form-10 K and it applies to this teleconference.

During the course of the call, we will be discussing non-GAAP financial measures, and we refer you to the supplement in our press release, and to our Web site for the reconciliation of those measures to GAAP financial measures. I need to mention that when we discuss earnings before interest and taxes or EBIT in our call today, that measure also excludes minority interests and preferred dividends.

In the third quarter of 2003, Cummins recorded sales of $1,634,000,000, 1% lower than sales of $1,648,000,000 in the third quarter of 2002, and 6% higher than sales of $1,539,000,000 in the second quarter of 2003. The slightly lower revenue compared with third quarter last year, reflects the impact of the October 2002 pre-buy, offset by higher sales this year for the Dodge Ram pickup, and increased revenue in the remainder of our business segments.

Earnings before interest and taxes for the quarter were $61 million or 3.7% of sales. Compared with EBIT of $83 million or 5% of sales in the third quarter of 2002. Net earnings in the third quarter of 2003 were $24 million, or 60 cents per diluted share, compared with net income of $44 million or $1.05 per share in the third quarter of 2002.

I will review each of our four business segments beginning with the engine business. Total sales for the engine business in the third quarter were $942 million, a 9% decrease from sales of $1,033,000,000 a year ago. Revenues in automotive markets were 15% lower than Q3 last year, with decreased demand in most segments due to last year's pre-buy ahead of the October 2002 emission standards change, partially offset by increases in our light duty automotive business.

Overall revenue from industrial markets was up 14% year over year, with increases in construction, mining and government sales.

EBIT for the quarter were $36 million, versus $51 million in the third quarter last year, and $24 million in the second quarter of this year. The decreased earnings compared to last year, resulted primarily from the lower volume due to the pre-buy in North American automotive markets last year. Higher pension and healthcare costs were offset by cost reduction initiatives, including the heavy-duty consolidation, Sixth Sigma and global sourcing.

The segment also benefited from a significant increase in joint venture income. Turning first to the heavy-duty truck business, revenues for the heavy-duty segment as a whole were down 26% in the third quarter from a year ago, while unit shipments globally were down 49%. The difference between the volume and the revenue variance was the result of higher pricing for the new products.

Unit shipments in North America were down 55%. The volume drop was due to the impact again of the October 2002 emission standards change. Unit shipments for the rest of the world were up 9%, with higher sales to OEMs in Europe and Mexico.

In the worldwide medium duty truck and bus market, total revenues decreased 27% for the third quarter year over year. Medium duty truck engine shipments were down 50% in North America, primarily due to the impact of the emission standard change. International shipments were up 15%, with higher OEM sales in Latin America due to both market share gains and strong market demand.

Global bus engine shipments were down 71%, with an 89% decrease in North America where the variances were again affected by the change in emission standards and 1% lower internationally with decreases in Mexico and China. In the light duty automotive and RV business, revenue was up 12% this quarter, compared to a year ago.

Engine shipments to Daimler Chrysler for the Dodge Ram Pickup were a record 34,400 units, an increase of 28% from third quarter last year, resulting from strong demand for Chrysler's new model pickup. Unit shipments for RV engines decreased 26% year over year, again due to the emission standard change. Cummins remains the market leader for RV engine sales, with over 70% market share.

Sales to industrial engine markets in total were up 14% from a year earlier, with increases across most segments. In the construction equipment market, worldwide sales were up 18% compared to third quarter 2002, with some signs of improving demand in construction equipment markets. Unit shipments in north America were up 1% and shipments to international markets were up 12% compared to the third quarter of 2002.

With higher sales to Asia more than offsetting sales declines in Europe. Sales for the agricultural equipment market increased 7% from third quarter last year with sales declines in North America more than offset by sales increases in Latin America and Europe. Revenue in mining segment increased 20% year over year, where we have increased market penetration and some improvement in demand for mining equipment. Sales in the power generation business for the third quarter were $363 million, up 15% from third quarter of 2002.

In North America, revenues were up 2% compared with the year ago with increased demand in our commercial Genset business partially offset by lower pricing. Demand in our consumer business remains strong with sales 10% higher than the third quarter of 2002. Outside North America, revenues increased across most regions with significant increases in the Middle East, Mexico, Australia and parts of Asia.

In the third quarter of 2003, power generation achieved break-even results compared to earning before interest and taxes of $3 million last year. Compared to second quarter 2003, profit before interest and tax improved $15 million.

The profit decline compared to last year resulted primarily from lower pricing and unfavorable mix, with the lower percentage of high horsepower sales this year, higher warranty expense, due partly to the higher volume, as well as higher employee fringe costs in 2003. The lower pricing essentially negated the impact of the higher year over year volume.

Revenues for the filtration and other segment were $255 million for the quarter, and 8% increase compared to the third quarter of 2002. Sales in emission solutions accounted for over half of the sales increase, and currency contributed roughly $5 million. This segment's earnings before interest and taxes for the quarter were $16 million versus $19 million in the third quarter last year.

The lower earnings were attributable to incremental costs to fund the segment's targeted growth initiatives, higher pension and healthcare costs, and several one-time costs incurred during the quarter including the settlement of legal and product coverage claims.

Mix was also a factor, as incremental sales were primarily in OEM business which has lower margins than the after-market sales. Sales for the international distributor business were $174 million in the third quarter, an increase of 14% compared to sales of $152 million last year, with improvement across most regions. Currency added roughly one third of the sales increase. Sales to the Middle East, particularly in power generation equipment, were also a significant contributor.

Earnings before interest and taxes for the segment were $9 million this quarter, or 5.2% of sales compared to earnings of $10 million or 6.6% of sales last year. The mix of sales including lower parts and a higher percentage of power generation equipment was the primary driver of the lower profitability during the quarter.

Returning to the corporate level I'll review the total sales by region. In the third quarter, our sales mix was 53% U.S. and 47% international, compared to 61% U.S. and 39% international in the third quarter last year. The pre buy in North American automotive markets last year drove the higher percentage of U.S. sales a year ago. For the third quarter compared to a year ago, sales in the U.S. decreased 13% while international sales in total increased 18%.

The U.S. sales decrease again was primarily attributable to last year's pre buy, partially offset by higher sales in the Dodge Ram business this year. International sales increased in all regions except Canada where declines were also driven by the pre buy last year and east Asia with lower sales due to the impact of SARS.

European sales increased 15% compared to third quarter last year, with higher sales primarily in the engine and filtration businesses. Sales to Australia were 30% higher than last year, with roughly two thirds of the increase being driven by currency. The balance of the increase was in higher sales for power generation and international distributors. Sales to the Middle East were substantially higher than third quarter last year, with increased demand for all products, particularly in Iraq.

Sales to Latin America were doubled compared to last year with the majority of the increase in engine sales and some in power generation. Sales to Mexico increased 34%, primarily due to higher power generation revenues.

Next I'll review corporate gross margin. The gross margin percentage for the quarter was 17.9% compared to 19% in the third quarter last year. The margin decline was primarily driven by lower volume compared to the pre buy period in 2002, particularly in our heavy duty segment where fixed cost absorption is a significant profitability driver. This volume and absorption impact was partially offset by benefits from our cost reduction initiatives and lower product coverage costs.

Product coverage costs was 3.3% of sales, or $54 million in the third quarter, compared to 3.6% of sales or $59 million a year ago. For the first nine months of 2003, product coverage costs was 3.5% of sales or $159 million. Excluding warranty costs, gross margin for the quarter was 21.2% versus 22.6% in the third quarter of 2002.

In dollar terms, gross margin was $347 million, compared to margin of $372 million in the third quarter last year. The decrease in margin was driven primarily by the volume and absorption impact of the lower North American automotive shipments, particularly heavy duty truck.

In addition, the margins on our newer products are still lower than that of the mature products which they replaced.

However, as we gain experience and the volumes continue to recover, gross margins are improving. These negative impacts on margin were mitigated by improvements from our cost reduction initiatives, particularly Six Sigma efforts.

Total of selling, admin. and research and engineering spending in the third quarter was $259 million or 15.9% of sales, compared to spending of $242 million or 14.7% of sales last year. Selling and administrative expenses increased $19 million from the third quarter last year due to several factors. Approximately one third of the increase was due to higher pension expense.

Currency added $4 million of expense, and our funding of growth initiatives, particularly in the filtration business added about $5 million. The balance of the increase was primarily in selling expense, that was driven some by volume variable spending. Research and engineering expenses decreased $2 million compared to third quarter last year, due to the completion of development work for our October 2002 EGR products.

Our income from joint venture and alliances in the third quarter was a record $20 million compared to $9 million in the third quarter last year. This increase was attributable to improved earnings across most of our joint ventures with the most notable increase coming from our expanded joint venture with Dong Fong in China.

Other income and expense in the quarter was income of $7 million, compared to income of $3 million in the third quarter last year. This increase was primarily related to a favorable foreign currency effect, partially offset by some one-time income items recorded in Q3, 2002.

Interest expense for the quarter was $25 million, compared to $15 million of reported interest expense in the third quarter last year. Beginning in the third quarter of 2003, we now reflect the dividends on our preferred securities, as interest expense in our financial statements due to the adoption of FABS 150.

With both items combined, interest expense increased $5 million compared to the year ago period primarily due to higher borrowing rates. The income tax provision for the quarter was $9 million, compared to a provision of $16 million last year.

Our effective tax rate for the year remains at 25%. Minority interest in third quarter was $3 million equal to that in the third quarter last year. Net earnings for the quarter were $24 million or 60 cents per diluted share on $45.9 million average shares for EPS purposes. This compares to net earnings of $44 million or $1.05 per share in the third quarter last year.

Our third quarter 2003 earnings reached a level that resulted in a dilutive effect of the convertible preferred securities. This dilution amounted to one cent per share.

Let's turn to cash flow. Free cash flow from an operations perspective was an in flow of $10 million for the third quarter of 2003. Our statement of cash flows that you should have received indicates a year to date cash outflow from operating and investing activities of $73 million. This reflects a $10 million outflow for the quarter from operating and investing activities.

To arrive at the $10 million free cash in flow, we adjust for the net $15 million outflow from the quarterly change in marketable securities now shown in the investing section of the cash flow statement. We also adjust for the $5 million outflow from the reduction in our receivable securitization program.

Changes in working capital represented a net cash inflow of $4 million for the quarter. Accounts receivable increased $43 million during the period, due to the higher sales level, but day sales outstanding improved slightly from the second quarter.

Inventory also increased $8 million during the period, but inventory turns improved for the quarter. Accounts payable increased $55 million during the quarter, due to the higher volume and timing of payment processing.

Capital expenditures were $27 million for the quarter, and were $70 million year to date as we continued to aggressively manage capital spending. Investments and advances to joint ventures and alliances for the third quarter of 2003 was an outflow of $12 million, due partly to working capital advances and some permanent investment made in some of our joint ventures.

Year to date, we have a net $3 million cash inflow related to our JVs and alliances.

Thank you. Now I'll turn it over to Tim.

Good morning. Third quarter results were in line with our expectations and reflected steady improvement compared to the first two quarters of this year. There were several key areas of success during the period, the engine business continued to demonstrate progress on cost reduction, which is driving increased profitability.

We had record shipments to Chrysler for the Dodge Ram pickup this quarter, and expect a record sales year for the business. The power generation business achieved break even results of $15 million improvement over the second quarter of this year.

Joint venture profits were at record levels and they continue to represent a growing portion of our business, particularly in China, where we believe there is significant opportunity going forward.

In total, third quarter sales were only 1% lower than Q3, 2002. Sales volumes were mixed with difficult year over year comparisons, in the North America and automotive markets due to last year's pre-buy, largely offset by revenue increases across our other businesses.

Shipments for North American heavy-duty truck market, where fixed cost absorption is a significant profitability driver, were 55% lower than the third quarter last year. However, this market has shown sequential improvement across 2003, and we expect that trend to continue.

Sales for the Dodge Ram business were substantially higher this quarter and most industrial markets improved compared to last year. Revenues in power generation, filtration and international distributors all increased year over year.

Compared to the second quarter this year, our sales increased $95 million or 6%. Profit before interest and taxes was $61 million, $22 million lower than Q3 last year, but $15 million higher than Q2 of this year. Engine business results declined from last year's third quarter due to the effect of the pre-buy, but improved considerably compared to the second quarter of this year.

Revenues declined $91 million compared to the third quarter last year, and increased $53 million compared to the second quarter this year. Profits before interest and taxes were $15 million lower than last year, but $12 million higher than the second quarter of this year.

Due to our continued cost reduction efforts, the decline in sales compared to last year, resulted in 16% lower profits, while a revenue improvement from the second quarter of this year reflects much better performance, a 23% profit conversion on sales level increase which continues to demonstrate the leverage we can achieve with increasing demand.

Our emission compliance products continue to perform well in the field. One year after the new emissions standard went into effect, we have over 25,000 ISX and ISM heavy duty engines in use with almost 1 billion miles of service accumulated. We have rented a total of only 23 trucks for customers under our uptime guarantee program and only a few of those were related to exhaust gas re-circulation components.

Customer feedback continues to be very positive and we believe that our technology, engine performance and reliability gives us an advantage in the market place going forward. We remain confident that demand is recovering, and we are well positioned to benefit from the market rebound.

We are pleased to announce that Cummins and Chrysler have extended our exclusive supplier agreement for diesel engine, using the Dodge Ram heavy-duty pickup truck. Although the specific terms of the agreement are confidential, the engine system agreement includes consideration of Cummins as a supplier for diesel engine after-treatment systems.

In addition, the agreement paves the way for collaboration on diesel engine technology beyond the length of the contract. This is a very important relationship to us that began in 1988 and continues to provide opportunities for growth.

Shipments this quarter for Dodge Ram were a record 34,400 units. We are on track to have a record volume year for this business reflecting Chrysler's excellent sales year for these trucks. Engine performance and quality continued to drive customer demand.

Our new engine has already demonstrated higher quality performance as defined by our customer than the engine, which it replaced. We are also very optimistic about the prospects for growth in Mexico, where Cummins will supply a new heavy-duty truck and bus plant that Volkswagen recently announced it will be building to serve that local market. Volkswagen is Targeting growth in Mexico modeled after the production in Brazil where VW is the market share leader.

We set a new record with $20 million from joint ventures and alliances in the third quarter. Our expanded joint venture with Bon Fun Motors in China continues to be a major contributor to this increase.

For 2003, we now expect joint venture profits to approach $60 million, over 2.1/2 times the income recorded in 2002 with nearly double the cash flow generated from this operations last year. We are forecasting continued growth in both profits and cash from joint ventures, with established processes for regular dividend payments.

We expect to convert a greater percentage of the profits into cash in future quarters. The power generation business reported sales of $363 million in the quarter, a 15% increase over third quarter last year, and an 18% higher than the second quarter this year.

The business achieved break-even results in the third quarter which was $3 million lower than last year, but a $15 million improvement compared to the second quarter of this year. Pricing continues to be an issue but the incremental demand is helping to absorb the excess inventory levels in the marketplace.

Our manufacturing inventory decreased again this quarter, our rent of fleet has declined $34 million this year, and utilization has improved substantially. Power needs in Iraq continue to present future sales opportunities, but they have been slow to translate into orders due to government contracting issues.

However, Cummins is participating in the early contracts for the reconstruction of Iraq. And we expect to capture additional business as it is awarded.

Our cost reduction initiatives are allowing us to return to profitability, we are achieving reductions in material price, and continue to progress on moving production to lower cost supply sources. Savings from our product re-engineering and outsourcing initiatives are slightly behind schedule, but we are on track to realize full benefit from this actions by the end of this year.

Our consumer business which includes sales for recreational vehicles and recreational marine applications is performing at record levels. We won a new three-year exclusive supply agreement with Monaco coach, the industry leader in diesel motor homes. We continue to be the dominant supplier in this market with over 90% market share. The filtration and other business have sales of $255 million this quarter, an 8% increase compared to the third quarter last year.

Earnings before interest and taxes were $16 million compared to $19 million last year. The year over year profit decline resulted from several areas. First, there were increased expenses to fund growth initiatives including the new exhaust plant in Georgia. Our emission solutions business and the distribution and logistics improvements. The decision to open a new exhaust facility in Georgia won us a new contract with Honda to sell exhaust systems for ATVs. The emission solutions business continues to offer significant growth opportunities and generate a profit while investing in a technologies required to meet future emissions standards.

Second, we experienced higher concentration of OEM versus after-market sales during the period which results in lower margins. This is consistent with our strategy of securing OEM business through our long-term agreements in our emission solutions business which will provide more after-market revenue over time.

Lastly this business like all segments has higher costs related to pensions and other employee fringe benefits compared to last year, as well as several one-time expenses in the period including settlements for legal and product coverage claims, none of which were individually significant.

The international distributor business reported sales of $174 million for the quarter, a 14% increase over the third quarter last year. Earnings before interest and taxes were $9 million, down $1 million compared to last year's third quarter. The mix of sales with lower percentage of parts revenue in a higher percentage of power generation sales in the quarter was the main drive fore profit decline.

Parts and service revenues in general though had been growing in this business and we expect that trend to continue. Though there was some seasonal weakness in this quarter particularly in Europe.

In addition, earnings decreased compared to a year ago due the one-time commission in Q3 year and the elimination of a network fee due to the expanded JV agreement. Our free cash flow for the quarter was an in flow of $10 million. Third quarter cash flow include $70 million of pension funding due to timing required for IRS tax deductions which lowered our cash flow for the quarter.

Working capital while showing improvement was affected by the disproportionately higher amount of third quarter sales recorded in September. Day sales out stand having decreased since year end and inventory turns have increased. We project significant reductions in working capital in Q4 in keeping with our normal trends.

Capital expenditures for the year to date period are $70 million, and we expect them to remain well below depreciation for the next several years as we tightly manage spending. We expect to generate significant cash flow in the fourth quarter of this year, consistent with our typical seasonal pattern.

We continue to see signs of recovery in the majority of our end market, although we still believe the improvement will be gradual. Our earnings guidance for year remains in our previous range of $1.20 to $1.40 per share, although we expect it will likely be at the bottom of the range.

Free cash flow for the year is still expected to be in the range of $70 million to $80 million, providing cash to fund our dividend and allow for some modest debt reduction. We have kept tight reins on capital expenditures this year and expect our spending to be below $100 million, while still funding the key development programs in growth initiatives.

We remain confident that the business conditions are improving in the majority of our markets, and our revenues are gaining momentum. Three of our four businesses are profitable and our power generation business has returned to break even. We expect all four of the businesses to be profitable in the fourth quarter.

The engine business is positioned to benefit strongly from the leverage as our volumes increase, particularly in the heavy duty market. Our filtration and power generation businesses are generating new business, and positioning us for the future.

The international distributor sales are increasing and profits are improving at an ever-greater rate. Our positions are in the higher growth regions around the world and are growing profits in cash flow.

Through our distribution network both in North America and international markets we are growing our after-market and service business that provides for more stable earnings for our future. Our cost reduction initiatives are on track to achieve significant leverage as our markets rebound.

Our products continue to perform well in the field, and we are gaining incremental business from new customers as a result. We are generating sufficient cash flow to fund our dividends and provide for a modest amount of debt reduction while funding programs necessary to meet emission standards across the globe.

We continue to tightly manage spending and believe we will benefit strongly as our markets recover.

Now we'll take your questions.

Thank you, ladies and gentlemen. The floor is now open for questions. If you have any questions or comments, please press the numbers "1", followed by "4" on your touch-tone phone at this time. Pressing "1, 4" a second time will remove you from the queue should your question be answered.

Lastly we do ask while posing your question that you please pick up your handset if listening on speakerphone for optimum sound quality. Please hold while we post the questions. Thank you.

Our first question is coming from David Raso. Please take your affiliation and pose your question.

Smith Barney, good morning.

Hello David.

I had a question regarding the implied fourth quarter guidance. You need roughly $1.12 to hit the low end of the $1.20, $1.40 and with the guidance you just provided for full year on JV income, and I assume that they prefer the converter, uses equity, to do the math on the fourth quarter. And implies the core operating process, is going to have to roughly, double if not a little more. And that $1.12 would represent your best quarter in over three years.

I'm trying to understand the swing factor, of course Powergen, gave you pretty good profit performance in the third quarter. But maybe I misunderstood when you said that the filtration, the one-time cost, the legal settlement, some other issues. First clarification, did you quantify that? Like how large an amount was that? I'm trying to think through the fourth quarter filtration to bounce back?

All of the Fleet guard issues were roughly somewhere between $4 and $5 million in the quarter that we think were one-time events.

That's helpful. Then regarding the sequential, the big driver, the heavy-duty truck, obviously, your top line, that's been in the third quarter tracks pretty close to the sequential improvement in industry build. What are you seeing in your order book, to obviously imply that the strong sequential improvement to get the $1.12 of earnings? Are we looking at 15 or 20% sequential growth in heavy truck in the fourth quarter?

David A couple of things. One, your $1.12 is not really the right number to think about for Q4 on a reported basis, because as we talked about the preferred securities are dilutive for Q4, but not in getting to our $1.20 for the full year.

OK.

So the Q4 number that we're looking at will be somewhere between, you know, will probably be closer in the mid 90 cent range.

OK. That's very helpful. Again, using 45.3 million shares for the fourth quarter, but full year using 39, the net income won't be high enough to trigger that handling of the converts.

That is correct. But, that's just the EPS calculation piece.

The bridge to, from the third quarter to fourth quarter to get to the bottom of our range, we need to increase our EBIT by about $25 million. We see about 2 to 3,000 more heavy duty units which give us $5 to $10 million, and then both in terms of mix and volume in Fleet guard, our international distributor business and Powergen, we think there could be as much as $20 to $25 million, and we think we'll have lower Chrysler volume so we will take $5 million after that gets us around somewhere the $25 million range. That's how we bridge from Q3 to Q4 in our guidance.

OK. And one quick comment though you just said 2 to 3,000 more units, for heavy if used sequentially? If you're roughly doing 20% market share that is implying the industries that do 10 to 15,000 more sequentially. Which would imply, you said sequential growth of 22 to 33% sequentially for the industry. Is that what we are saying? I think that's stronger than what people are thinking.

I think we have seen in orders, David is consistent with what, you're hearing in the general market. But so Ted is talking about total heavy duty engines, that serve of course other than just the North American heavy duty truck market.

OK.

A little bit -- a little bit different numbers there.

The last question, I apologize for the last question. On the Dec covenants, when you redid the revolver, correct me if I'm wrong, but the way that the banks do the debt to cap you're fine. But the new covenant that kicked in, the coverage ratio, the 1.5 EBITDA minus CAPEX trailing, the way I ran the numbers looks like you're below the 1 1/2 is that triggered if it's four straight quarters of being below the 1 1/2? Or I am doing the math wrong?

You're doing the math wrong. If done on trailing 12-month calculation.

Which I'm running.

Exactly. So let's work through that off-line because we're in clearly good shape on the loan covenant.

Thank you very much.

you're welcome.

Thank you. Our next question is coming from Gary McManus. Please state your affiliation and pose your question.

JP Morgan. Good morning, Ted and Karen. Talking of the joint venture income, first, can you split that out between the four reporting segments now that it's become pretty meaningful at $20 million?

Of course we can. You know, we do have some of its across all of the businesses, the biggest piece of it goes into the engine business. I believe -- hold on just a second, Gary, I'll come back to you in a quick second. You want to ask a different question?

Maybe I should get into the numbers. What kind of growth we expect over the next several years from these joint ventures and alliances? It went from $22 million in 2002 to you're assuming or expecting $60 million this year. You know, I mean, that's phenomenal growth. What kind of growth should we be modeling in for if next several years there?

I think wow won't see the same level of growth. For next year our plants we're looking some were at around $70 million contribution EBIT. But more importantly, or just as importantly, we think we'll double the cash flow. We have put in more processes to capture the dividends.

Also, what's contributing on the joint ventures is that we have taken minority equity positions in some of our North American distributors, and we're benefiting from that as well.

I have noticed, you know, sometimes that this is not viewed as part of our core business where it has actually become a very integral part of our strategy. It's how we go to market, particularly in Hindi and in China. We manage these businesses, most of it is associated with the engine side of the business. And as I think I started talking about a year ago, just how important this was to our strategy. So we're -- I think this is one of the real highlights that we're seeing a lot more of these things come to fruition now.

Gary, let me follow up with the break out of the $20 million, 15 of that went to the engine business. $2 million to Powergen to $2 million to infiltration and one in the IBBU. international distributes.

If I recall in the second quarter conference call, I mean, the $17 million included a few million of non -- it was annual licensing payments I believe.

So there was a big pickup between the second and third quarter like 15 to $20 million, and now you have it going back down in the fourth quarter to $16 million roughly to get to the $60 million for the year is so there anything going non fourth quarter why it should be going down sequentially of having a good pickup between the second and third quarters?

Not necessarily, Gary. Mine, we were giving you the number of the foul year of around 60. It could actually be a little above that as well. So the Q3 strength is driven by just some of the strong performance, particular in China. So good market.

So the $60 million is kind of a conservative number? There's no reason necessarily to believe that the fourth quarter should be sequentially worse than the third quarter?

Yes, it is impossible to predict that number on a quarterly basis but we feel good about the $60 million number.

Thank you.

Thank you. Our next question is coming from John McGinty. Please state your affiliation an pose your question.

Credit Suisse First Boston. Could you talk for a second about the heavy truck orders? They were fairly good, the couple of months have been lackluster. There has been some debate among different people about what is going on. How do you see the rest of the year going from what you have in hand and what's your current outlook for '04 at this point?

Well, we have seen, John, a gradual increase quarter over quarter, starting with the lowest being in first quarter of this year, and the rate of increase as I have said is being gradual. We are seeing that in fourth quarter over the third quarter that we have just completed.

And I want to emphasize that it's gradual. There's no big spike. We're saying pretty much what the industry is saying for next year, and that would be somewhere around 200,000. So we'll see the increase. I will say that we have in the past couple of months had more interest from large fleets and more inquiries than we have had earlier in the year, and we're just seeing some activity from that. I think that if you look at the average age of the fleets, and the requirement is going to be that people are going to start to come to the market.

The other thing is that several of these fleets have now been running the new engines for some period of time and are comfortable with the reliability and the drivers are giving it a very positive remarks. So some of the hype that happened around the pre buy, I think, is being resolved and we're getting a positive reaction from that as well. It is not a booming recovery though, John.

No, but can you just, cause everybody uses a slightly different number. What's that 200 versus in '03?

160.

160, OK. And then as you're getting these orders, are you yet seeing people placing full-year '04 orders or they are just of kind of going out, you know, just a little bit at a time as they move?

There's been one or two talking about multi year buys, but most of them are going out slightly.

OK, and then two numbers questions. One, you mentioned currency a couple of different places, can you give us some feel, was currency for the quarter a plus or a minus in the order of magnitude?

The revenues, due to currency were $30 million. The gross margin was $4.5 million, and the SAR are $3 million and the SAR was $4 million. So we have got $30 million of increased revenue and nothing to the bottom line on currency.

In order, the gross margin was helped by three and the SAR was hurt by four?

Right.

Or help, or higher by four. Then final question. On -- when Karen was giving us the gross margin variance analysis, in the past you all have quantified it a bit more. The one thing I was curious about as you talk about the benefits from all of a cost saving programs, Six Sigma, the other things that you're doing, Karen, can you give us any kind of a quantification in the quarter or year to date as to what those savings are?

From six sigma in total?

Well, the cost savings, you know, as you talked about the cost savings been an important thing about offsetting the penalties from volume, you know, lower volume and absorption and the margins on the newer products being lower those were the negatives, but the positives were cost reduction, six sigma and others, I was wondering if you can quantify the cost savings from purchasing six sigma, all of the different programs that you have, global sourcing and so on?

Well, we have got a lot of variables moving around in the quarter, John. I think that, you know, from the engine business side which is a lot of the piece that you're talking to there, you know, we had probably in the range of, you know, $10 million number in the quarter that would have benefited us. But, you know, we've got big volume decreases in some of our most sensitive businesses in terms of profitability. So it's just hard to be able to break that out.

In the heavy-duty business, if you go back to the business model what we talked about benefits from the long-term agreements and global sourcing in the consolidation of manufacturing. There was a net savings target over a three-year period of time of over $100 million and we have captured about 40% of that so far with again the expectation of capturing most of that by the end of next year.

So I think in terms of looking at the engine gross particular gin, that would be the most significant factor. If you look at gross margin in the power generation business, we're still seeing, you know, very, very aggressive pricing. The good news is the inventory starting to go down, but I think that that's -- you know, still being reflected in -- and when it's averaged in to the overall gross margin it hurts.

I will say though that the power generation folks are starting to get some traction with their cost reduction efforts and with their re-engineering. We saw that reflected from Q2 to Q3, and then in some of the international sales in this past quarter, power generation sales were up particularly in Iraq and some other places, and that impacted our distributor business in international. Hurt, that the gross margin a little bit there as well.

Great, thanks very much.

Thank you. Our next question is coming from Joanna Shatney. Please state your affiliation and pose your question.

Good morning. Goldman Sachs. Can we just spend a little more time on the SG&A, increase year over year? Because if we look in the second quarter there wasn't as dramatic an increase. So I'm guessing was there a change in the pension assumptions or something that caused a third of the increase year over year to come from pension? Because we didn't see it so significantly in the first half of the year?

Yes, this is a good question because this is an area that I'm disappointed in, in our results in the third quarter being very straightforward. The $19 million increase reflected $6 million of an increase in pension, $4 million in currency and then there was about $4 million in selling volume variable kind of things. The remainder I would refer to as expense creep. What we -- it has our full attention, and we will correct that going forward in the fourth quarter and certainly next year.

OK. And can you just try to -- how much of the sales increased in Powergen, the 15% was from currency?

Not a big piece in power generation, Joanna. So a whole lot of the sales increase was really driven by higher volume. The problem was the pricing environment, so that it just didn't really matter any -- any margin improvement.

The volume in power generation in the third quarter, we had several events going on. One is that we had a large contract for a rental unit in Mexico.

And we started to see the revenue from that. And then in terms of the blackout and the hurricanes, we got some incremental business from that. Which is reflected in the sales volumes. Then we got about $15 million more in Iraq. We went from about $20 million to $35 million --well I should say the Middle East, and so that's where the revenues came in power Gen.

What's the power range that you guys are selling the most of? It sounds like part of the issue here, is we're not getting as positive a mix?

Yes, it's the lower end. The 750 or 550 kilowatts -- or below of where the one megawatt and the two megawatts are still very depressed. There's also, you know, in terms of the distributed generation, which is where you use the one and two megawatt set, that's not -- that market still not recovering.

OK. Similar to what you did on the heavy-duty side, can you talk about what you're seeing on order book for the Powergen business and maybe talk a bit about what might happen to that mix?

Well, I think the sales volume for the fourth quarter would be similar to the third quarter. We're not -- we're not building in a lot of revenue because I want to make sure we're focused on the cost side of the equation. I think the wild card though is that there is a lot of quoting activity and discussion around the reconstruction of Iraq. And the numbers are very large. We have already moved considerable inventory to our operations into Dubai.

We like our competitors are pursuing this business from different places, and it's been very slow so far primarily because of the security issues. If and when that gets resolved, I would expect to see significant business in Iraq and I think all of us would get, you know, some share of that. And we're not reflecting that in any of our revenues, so that, you know, has some upside potential. Also, in the earlier part of the year, our rental fleets were really underutilized and the utilization of the rental fleets has improved, plus we have been able to reduce the size by some $34 million. So we're getting more efficiency there as well.

OK, thanks.

Thank you. Our next question is coming from Andrew Casey. Please state your affiliation and pose your question.

Good morning. Prudential Equity Group. A question on the sequential improvement in engines margins from Q2 do Q3. If I assume most of the change in the JV income comes right from the engine line that's about 20 or 30 basis points. How much of the rest is mix with higher Dodge Ram business and then how much can be attributed to what's going on within the heavy duty plant consolidation? Thanks.

Well, the plant consolidation I'm not sure -- I'll let Karen do the first one, but the plant consolidation, we're saving now about $5 million a quarter. So we're $20 millions -- we'll get $15 millions this year because in consolidation really was completed in -- around April 1st. So we're getting that kind of improvement.

And for the other part of the question, Andy, it's probably about half and half, coming from the Dodge Ram sales improvement and the heavy truck market improvement demand improvement.

OK, thanks. Then last question on filtration and other -- you know, it is really the surprise area for me during the quarter. You had talked about $4 million to $5 million hip to margin on one-time issues that you kind of delineated. How much if you look at it on a sequential basis was that still $4 million to $5 million, and if not, what else contributed to the sequential decline in profitability there? Thanks.

Yes. I think, again, the -- this is another area that I was disappointed with or not pleased with for the quarter that, you know, fleet guard is just been a stellar performer in our portfolio of businesses, both in terms of profitability and cash and has been growing. And they had a couple of things happen to them right at the end of the quarter.

And one was a legal settlement that goes clear back to the '90's and was a product coverage problem associated with Nelson that also went back to the late '90s and both of those were somewhat of a surprise. In terms of other issues that they have is that they opened a new plant in Georgia as a result of some small engine companies wanting exhaust systems. Or that's why we got the Honda business. So we had some start-up costs there.

Also, there are some funding associated with emissions solutions which is a really good investment. Finally, their gross margin was hit slightly because they're getting a lot more OEM sales versus the after-market. And that impacts their margin. I expect Fleetguard to get back to their target is 11 to 13% EBIT. I expect them to get back in the 10% range right away, and I think this was a bad quarter for them. And we have clear understanding going forward of what the targets are and I have great confidence that we will get back to where we need to be.

Thanks a lot.

Thank you. Our next question is coming from Jeffrey Kaufman. Please state your affiliation and pose your question.

Thank you. Fulcrum Global Partners. A lot of my questions have been answered but let me probe a little bit more too. You mentioned across a couple of your divisions that there was some lower prices realized and in some cases you attributed this to the mix as you have delineated with Andy. In other cases you talked of achieving sales goals. To what degree, I guess is the best way to put it, did you take a hit this quarter just because you strategically decided to clean out some inventory?

And therefore, I should think of it as shorter term versus maybe the market pricing for the product is deteriorated and this is more of a longer term issue?

A couple of things. One is that we didn't do some things strategically on inventory that particularly hurt the quarter. We actually still had slight inventory increase during the period. We do have strategic initiatives to grow the OEM business, particularly in the filtration segment. And with that, over time, come higher after-market sales.

So introductory pricing basically?

Right. How that sales split falls out in any given period, you know S a little hard to predict but we did get hit with that in the period. Then part sales in the international distributor business hurt it, but more than anything it was the percentage of power generation sales and that's market-driven because of pricing.

So that sticks around. Second question when you were talking about the increase of about 2 to 3,000 units in heavy duty, should I think about as that's where you think you'll be on your announced book order book or that's where you're going to be based on orders you may be expecting to come in the next quarter that aren't public domain at there point?

I think that's a pretty firm order board right now.

OK. So that represents what you have seen, not necessarily what's not in numbers yet?

That's correct.

And consistent with what you're seeing in industry reports.

OK. Final question. Thank you. You mentioned the 4 to $5 million of transitory costs you incurred with Fleetguard. Were there any other what we would consider to be one-time investment start-up types that we incurred during this quarter that we would not expect to see going across any of the divisions?

None that stand out in my mind, no, Jeff.

So Fleetguard is primarily it. Thank you very much.

Thank you.

Thank you. Our next question is coming from Mark Koznarek. Please state your affiliation.

It's Midwest Research good morning still, barely. Just a quick follow-up on this filtration and other business where I thought I heard Tim mention we'd get back to 10% margin pretty quickly, which I'm assuming means this current quarter.

And, you know, with the mix shift seeming pretty permanent with the high level of OEM production plans and that's only going up sequentially, you know, I know some of the stuff you have already called out as short-term in nature but this seems like a pretty aggressive return. So I want to make sure I understood that correctly or whether there's other elements that are part of that equation?

Well, Mark, we think that Q3 was the anomaly. If you'd look at the trend rate, they were performing very, very well with the exception of this quarter. So that's why we're confident that it's not something that Q3 is now the trend rate going forward. It was really the trend rate we were on prior to that time.

Solso of the items that you talked about that detracted from profitability, mix would be the bottom of the list rather than the top of the list?

Correct.

OK. Then I'm wondering if we can explore a little bit more the Daimler Chrysler announcement? You know, it is sort of cryptic the way you have disclosed it, and, you know, I understand there's sensitivities with the customer, but there's language in there that suggests that there might be possibility even beyond the Dodge Ram and, you know, can you speak to that at all to give us some idea of the new scope of the programs?

Mark, our customer is -- I mean, the agreement is a confidential one. It is a -- let me just say this is that it's something that we have been working on for a long period of time. It really secures that business for the future, and it gives us future opportunities to work more closely with Daimler Chrysler and Chrysler in terms of some their diesel engine needs. That's about as far as I can go. But it is a considerable -- it's a good news story for Cummins and I think for Chrysler as well. The truck's doing really well right now. And the relationship with Chrysler has never been better.

So we could conclude there's a possibility outside the Dodge Ram over time?

I didn't say that.

We'd certainly like to think so, Mark.

OK. All right. Thanks very much.

Thank you. I think that concludes our call for today. I'll be available for questions if you have any follow-ups and thank you for joining us.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect at this time and have a wonderful day. Thank you for your participation