康明斯 (CMI) 2003 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Cummins fourth quarter 2003 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, Karen Battin. Ma'am the floor is yours.

Thank you Peter.

Welcome everyone to our teleconference today to discuss Cummins results for the fourth 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 e-mail them to you at the end evident teleconference.

Participating with me today are Chairman, Tim Solso and our Chief Financial Officer, Jean Blackwell. We along with other members of our finance leadership team will be available for your questions at the end of the teleconference. This morning first I will take you through a summary of Q4 results and then Tim will make a few remarks about the business and finally with will have the question and answer period.

This teleconference will include certain forward-looking information. We will talk about power generation markets, 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 our [inaudible] in Asia, Europe, Latin America and other regions. We will discuss product cost, product coverage or warranty costs, and profitability improvement initiatives.

Any forward-looking statements about these and any other topics involve risks and uncertainties. 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 this call we will be discussing certain nonGAAP 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 want to reminds you that when we discuss earnings before interest or EBIT in our call today that measure also includes minority interests and preferred dividends.

In response to guidance provided by the SEC we will use GAAP measures where are at all practicable and will limit our forward guidance to GAAP measures or those that can readily be reconciled to GAAP financial measures.

In the fourth quarter of 2003 Cummins recorded sales of $1,736,000,000, 23% higher than sales of $1,414,000,000 in the fourth quarter of 2002. The higher revenue compared with fourth quarter last year reflects increased revenues in the majority of our markets and the significant fall off in demands in Q4 last year following the October, 2002, emission standards change.

Earnings before interest and taxes for the quarter were $84 million for 4.8% of sales compared with earnings before interest and taxes of $20 million, or 1.4% of sales in the fourth quarter of 2002. Net earnings in the fourth quarter of 2003 before the cumulative effect of the accounting changes were $47 million, or $1.07 per diluted share, compared with net earnings of $46 million, or $1.10 per diluted share in the fourth quarter of 2002.

Fourth quarter of 2002 earnings included an income tax adjustment of $57 million from settlement of IRS audit covering a six-year period. In the fourth quarter of 2003 Cummins recorded a charge of $4 million, or .07 per share for the cumulative effect of an accounting change resulting from the consolidation of a financing variable interest entity as of December 31, 2003. Including the cumulative effect charge fourth quarter net earnings were $43 million, or $1.00 per diluted share.

I will provide comments regarding each of our four business segments beginning with the engine business. Total sales for the engine business in the fourth quarter were $984 million, a 27% increase from sales of $776 million a year ago. Revenues in automotive markets were 32% higher than Q4 last year with increased demands in most segments due to the drop in demand following last year's prebuy ahead of the October, 2002, emission standards change.

Overall revenue from industrial markets was up 16% year-over-year with increases in all markets except rail. Earnings before interest and taxes for the quarter were $32 million versus a loss of $1 million in the fourth quarter last year. Fourth quarter 2002 results included an $11 million favorable restructuring adjustment.

The increased earnings compared to last year resulted primarily from this year's higher volumes when compared to the fall off in demand in North American automotive markets last year following emission standards change and improvement in base demand in most market segments.

In addition increased expenses for variable compensation and higher pension and healthcare costs were partially offset by cost reduction initiatives including the heavy-duty consolidation, Six Sigma and global sourcing. The segment also benefit from a significant increase in joint venture income.

I will briefly review each of the engine business markets. Turning first to the heavy-duty truck business, revenues for the heavy-duty segment as a whole were up 55% in the fourth quarter from a years ago, while unit shipments globally were up 95%. The variance between the revenue and the volume increase was due to part sales which increased 11% compared to fourth quarter 2002.

Unit shipments in North America were up 156%. The volume increase was primarily due to the impact of the October, 2002, emission standards change. Unit shipments to the rest of the world were down 13% with lower sales to OEMs in Mexico.

In the worldwide medium duty truck and bus market total revenues increased 39% for the fourth quarter year-over-year. Medium duty truck engine shipments were up 113% in North America, primarily due to the impact of the emission standards change last year.

International shipments were up 21% with higher OEM sales in Latin America, due to both market share gains and strong market demand, and increased sales in Europe. Global [inaudible] engine shipments were up 52% with a 55% increase in North America where the variances were affected by the 2002 change in emission standards and 50% higher internationally with increased sales primarily in China.

In the light duty automotive and RV business, revenue was up 6% this quarter compared to a year ago. Engine shipments to DaimlerChrysler for the Dodge Ram pickup truck were 30,800 units, essentially equal to fourth quarter last year. While demand in 2003 has been above 2002 levels fourth quarter volumes were flat as Chrysler worked to manage year end truck inventory levels.

Unit shipments for RV engines increased 73% year-over-year again due to the last year's emission standards change. Demand for RVs continues to be strong and Cummins remains the market leader for RV engine sales.

Sales to industrial engine markets in total were up 16% from a year earlier with increases across most segments. In the construction equipment market, worldwide sales were up 19% compared with fourth quarter 2002, with continued signs of improving demand and construction equipment market.

Unit shipments in North America were up 7% and shipments to international markets were up 14% compared to the fourth quarter of 2002, with higher sales to Asia and Latin America, more than offsetting sales declines in Europe.

Sales for the agriculture equipment market were 32% higher compared to the fourth quarter last year with the largest increases in Latin America and Europe. Revenue in the mining segment increased 18% quarter-over-quarter with improved demand for mining equipment driven by increased copper prices.

Sales in the power generation business for the fourth quarter were $392 million, up 21% from fourth quarter of 2002. In North America revenues were up 16% compared with a year ago, with increased demand in our commercial [inaudible] set business. Demand in our consumer business was at record levels with sales 16% higher than the fourth quarter of 2002.

Outside North America revenues increased across most regions with significant increases in Latin America, Mexico and parts of Asia. Sales of alternators increased 19% compared to fourth quarter last year with particular strength in the Middle East and China.

In the fourth quarter of 2003 power generation reported earnings before interest and taxes of $14 million compared to a loss before interest and taxes of $11 million last year. The profit improvement compared to last year resulted primarily from higher volume and benefits from the significant cost reduction actions taken during this past year. Segment earnings also increased due to higher joint venture profits during the quarter.

Revenues for the filtration and other segment were $282 million for the quarter, a 16% increase compared to the fourth quarter of 2002. Sales in North America accounted for the majority of the revenue increase with improvement across most markets. Emissions solutions sales continued to grow with a $9 million increase in sales. After market sales in Europe, Africa and the Middle East as well as the Asia Pacific region were also higher.

Currency contributed roughly $10 million to the sales increase. These segments earning before interest and taxes for the quarter were $25 million versus $28 million in the fourth quarter last year. The lower earnings were primarily attributable to incremental costs to fund this segments targeted growth initiatives, increased logistics costs and higher pension and employee benefit costs compared to fourth quarter last year.

Sales for the international distributor business were $190 million in the fourth quarter, an increase of 24% compared to fourth quarter last year with improvement across nearly all regions. The larger sales largest sales growth was in Australia and Europe, Africa and the Middle East. Currency added one-half of the total sales increase.

Earnings before interest and taxes for this segment were $13 million for this quarter compared to earnings of $12 million last year. The increased profit from higher volumes were partially offset by increased pension costs and unfavorable currency impacts.

Returning to the corporate level, I'll review our total sales by region. For the fourth quarter hour sales mix was 53% U.S. and 47% international, compared to 50% U.S. and 50% international in the fourth quarter of last year. The impact of the prebuy that North American automotive markets last year drove the lower percentage of U.S. Sales.

For the fourth quarter compared to a year ago sales in the U.S. increased 32% by international sales in total increased 14%. The U.S. sales increase was primarily attributable to the impact of last year's prebuy.

International sales increased in nearly all regions with sales to Canada up 23%, due also to the impact of the North American prebuy.

European sales increased 8% compared to fourth quarter last year with higher sales across all businesses. Sales to the Middle East were 34% higher than fourth quarter last year with increased demand for all products. Sales to Latin America were up 21% compared to last year with the majority of the increase in power generation sales. Sales to Asia in total increased 9% compared to last year with the largest increases in Korea and Southeast Asia. Mexico increased 20% primarily due to higher power generation and engine revenues.

Next I'll review corporate gross margin. The gross margin percentage for the quarter was 19.4% compared to 15.7% in the fourth quarter of last year. The margin improvement was primarily driven by higher volume compared to the post-prebuy period in 2002. This volume and absorption benefit was aided beside our cost reduction initiative.

Product coverage cost was 3.1% of sales, or $53 million in the fourth quarter, compared to 3.1% of sales or $44 million a year ago. For the full year 2003 product coverage cost was 3.4% of sales or $212 million.

The increase in margin was driven primarily by the volume and absorption impact of the higher North American automotive shipment and increased volume across our businesses. In addition improvements from our cost reduction initiatives including Six Sigma and global sourcing benefited margins.

Total selling, admin, and research and engineering or SAR spending in the fourth quarter what $279 million, or 16.1% of sales; compared to spending of $209 million, or 14.7% of sales last year. Selling and administrative expenses increased $55 million from the fourth quarter last year and research and engineering expenses increased $15 million.

The higher level of expense was due to several factors. Approximately $20 million of the increase was due to higher variable computation expense for most employees tied to the substantial year-over-year increase in earnings. Our accounting for these accruals is based on year to date profitability and with the majority of our annual profit occurring in the fourth quarter of 2003 the variable compensation expense was also heavily weighted to Q4.

Currency impact added $10 million at SAR expense. Pension and other employee fringe costs increased approximately 10 million, 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 by volume variable spending.

The $15 million increase in research and engineering expenses compared to fourth quarter last year was primarily due to R. and E. spending in Q4 2002 following completion of development work for our EGR product and the current year spending for product development to meet tier two and tier three '04 and 2007 emission standards.

Our income from joint venture and alliances in the fourth quarter was a record $26 million compared to $6 million in the fourth quarter last year. This increase was attributable to improved earnings across nearly all of our joint ventures with the most significant increase coming from our expanding joint venture with DONG FONG in China.

Other income and expenses in the quarter was income of $1 million compared to the expense of $1 million in the fourth quarter of last year. Interest expense for the quarter was $25 million compared to $17 million of reported interest expense in the fourth quarter last year.

Beginning in the third quarter of 2003 we now reflect a dividend on our preferred securities as interest expense on our financial statement due to the adoption of FAS 150. With both items combined interest expense increased $3 million compared to the years ago period, primarily due to higher borrowing rates.

The income tax provision for the quarter was $7 million, compared to a benefit of $53 million last year. Last year's tax provision included a one time favorable adjustment of $57 million relating to the settlement of IRS audit covering a six-year period.

For 2003 our effective tax rate for the year was finalized at 15%. The decrease from the 25% rate was driven by lower state taxes, better than expected export tax benefits and by the improved new Indiana research tax credit. The year to date tax rate adjustment benefited fourth quarter earnings by $8 million.

Due to lower benefit for research credits, expensing foreign tax credit versus taking them as credits, foreign tax benefits versus taking them as credit and having lower export benefits as a percentage of total earnings we presently expect our tax rate for 2004 to be 28%.

Minority interest in the fourth quarter was $5 million, equal to that reported in the fourth quarter last year. Net earnings for the quarter before the cumulative effect of accounting changes were $47 million, or $1.07 per diluted share on 46.7 million average share for EPS purposes. This compares to net earnings of $46 million, or $1.10 per share in the fourth quarter last year. Including the cumulative effect charge fourth quarter 2003 net earnings were $43 million, or $1.00 per diluted share. Our fourth quarter 2003 earnings reached a level that resulted in a dilutive effect of our convertible preferred securities. This dilution amounted to .07 per share. For the full year 2003 the convertible preferred securities did not have a dilutive effect on earnings per share.

Full year net earnings before the cumulative effect of accounting changes were $54 million, or $1.36 diluted earnings per share in 2003, compared to net earnings of $79 million, or $2.06 diluted earnings per share for the full year 2002. Including the cumulative effect adjustments net earnings for 2003 were $50 million, or $1.27 diluted earnings per share compared to net earnings in 2002 of $82 million, or $2.13 per diluted share. Q4 and full year 2002 net earnings included the positive income tax adjustments of $57 million.

Let's turn to cash flow. Free cash flow from an operation perspective was an inflow of $94 million for the fourth quarter of 2003. Our statement of cash flows, that you should have received, indicates a year to date cash inflow from operating and investing activities of $23 million. This reflects a $96 million inflow for the quarter from operating and investing activities.

To arrive at the $94 million free cash inflow we subtract the net $2 million inflow from the quarterly change in marketable securities now shown in the investing section of the cash flow statement. Changes in working capital represented a net cash inflow of $45 million for the quarter. Accounts receivable decreased $68 million during the period and day sales outstanding improved slightly from the third quarter.

Inventory decreased $16 million during the period and inventory turns continued to improve. Accounts payable decreased $39 million during the quarter, primarily due to year end payment prospecting.

Capital expenditures were $40 million for the quarter and were $111 million for the full year as we continue to aggressively manage capital spending. Investment spending and advances to join inventions and alliances for the fourth quarter of 2003 were an outflow of $7 million to mostly to working capital advances to some of our joint ventures. Year to date, we had a net $4 million cash outflow related to our JVs and alliances.

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

Good morning.

I am pleased with Cummins fourth quarter performance as results reflect continued improvement across nearly all of our markets. Solid earnings in Q4 delivered the majority of our profit for 2003. Sales increased in each of our business units compared to the fourth quarter of last year.

The filtration and international distributor businesses achieved record sales in the quarter and the international distributor business reported record profits. The power generation business returned to profitability in the fourth quarter with substantially improved results. Joint venture profits were at record levels for the quarter and the full year and continue to represent a growing portion of our business. Fourth quarter sales were 23% higher than Q4 2002, with increases across all market segments.

While the sales comparison to fourth quarter 2002 is distorted due to the abnormally low volumes in Q4 2002, following last year's prebuy in the North American automotive markets we continue to see moderate demand improvement across essentially all market segments. For the full year 2003 sales increased 8% compared to 2002. Earnings before interest and taxes for the fourth quarter were $84 million compared to $20 million last year. Net earnings for the quarter were $47 million, or $1.07 per share, and net earnings for the full year 2003 were $54 million, or $1.36 per share before the cumulative effect of accounting changes. Engine business results improved substantially from the fourth quarter 2002 due to the widespread improvement in our markets and also due to the effect of last year's prebuy.

Revenues were $208 million higher than the fourth quarter last year, an increase of 27%. Segment EBIT was a profit of $32 million compared to a segment loss of $1 million in last year's fourth quarter. In Q4 2002 segment results also included an $11 million favorable restructuring adjustment.

Excluding this adjustment the results reflect a 21% profit conversion on the sales level increase which continues to demonstrate our ability to achieve solid leverage as demand improves. Our emission compliant products continue to perform well in the field. We now have more than 34,000 ISX and ISM heavy-duty engines in use with over 1.4 billion miles of service accumulated.

We recently extended our up time guarantee program to include engines placed in service through December 31, 2004 this year, which exhibits our continued confidence in the performance of our engines. Our up time guarantee program has been in effect for more than a year and we have rented a total of only 23 trucks for customers with only one of those related to EGR. components.

Driver reaction to our engines have been very positive and we believe that our technology engine performance and reliabilities give us an immediate advantage in the marketplace. We recently received significant orders from industry leading truckload carriers and leasing companies including swift transportation, Wal-Mart, Penske truck leasing, Rider and many more.

We had record shipments of over 128,000 engines in 2003 for the Dodge Ram pick up. That is 8% above our previous volume record set in 2000 and 28% higher than 2002 unit shipments. The excellent performance and quality of our engines have allowed to us gain share in the diesel pick up market. Cummins engine for the Dodge Ram pickup truck was recently named one of the ten best engines for 2004 by wards communications.

Our next generation turbo diesel engine is now available in a 2004 in a half model year Dodge Ram beginning this month. This pick up is the most powerful in its class with 600 foot pounds of torque and 325 horse power, along with providing increased power and torque, our engine has significantly reduced noise levels while meeting tougher emission standards.

We set another new record with $26 million of income from joint ventures and alliances in the fourth quarter. This brings our total joint venture income for 2003 to $70 million, more than three times JV income reported in 2002. While our expanded joint venture with DONG FONG in China continues to be a major contributor to this increase we saw improved earnings across nearly all of our joint venture operations. Cash flow from joint ventures was $22 million in 2003 and we expect that number to grow substantially in future periods.

The power generation business reported sales of 392 million dollars in the quarter, a 21% increase over the fourth quarter last year. The business reported segment earning of $14 million, a $25 million improvement compared to last year's fourth quarter. Pricing is still under pressure but our cost reduction initiatives are gaining traction resulting in our return to profitability. We have moved production of some of our high horsepower engines to India which will provide us with more cost competitive products.

We have completed reengineering work for a number of our products aimed at cost reduction and upgrading specifications. As we were able to more fully penetrate our markets with these products we expect additional profit improvement.

Our consumer business which includes sales for recreational vehicles, recreational marine applications and home generator sets had a record quarter for both sales and profits. We have increased market penetration in this business due to our product quality and our strong brands owned and image.

The market outlook for the consumer business remains strong for 2004. The filtration and other business had record sales of $282 million this quarter, a 16% increase compared to the fourth quarter of last year. Segment EBIT was $25 million compared to last years record profits of $28 million.

The year-over-year profit decline resulted primarily from increased expenses to fund growth initiatives like emission solutions including incremental resources to support our long-term agreement partnerships and our emissions solution business, the start up of the new exhaust plant in Georgia and distribution and logistics improvements. The business also had increases in volume variable expenses including freight and logistics costs and in pension and other employee fringe benefits compared to last year.

In addition our turbo charger business had significant R&E investments to meet future customer requirements. Our solutions business continues to position us for significant growth opportunities and generate a profit through sales of retrofit products while investing in technologies required to meet future emissions standards. We believe these investments will secure our revenue base and provide strong returns well into the future.

The international distributor business reported record sales of $190 million for the quarter, a 24% increase over the fourth quarter last year. We saw improvement in 2003 in nearly every geographic region. Segment EBIT was a record $13 million compared to $12 million last year. In the two years since this business formation it has made significant progress that has enabled it to achieve returns within its target range.

Our free cash flow for the quarter was an inflow of $94 million. This brings our free cash flow for the full year to an inflow of $26 million. Working capital was a net outflow of $27 million for 2003, largely due to our increased sales.

Days sales outstanding decreased and inventory turns increased during the year, and we will continue our focus in these areas. Capital expenditures for the year to date period were were up $111 million, and we expect future spending levels to remain we will below depreciation for the next several years as we tightly manage our capital spending.

We are seeing clear signs of improvement in the majority of our end markets and we expect that trends to continue throughout 2004 and beyond. For 2004 we are forecasting an increase around 25% in the North American heavy-duty truck market. A 12% increase in global medium duty truck volumes, increases of 15 to 20% in most industrial markets, and essentially flat volumes compared to 2003 record year for Dodge Ram engines. We expect sales growth in power generation, filtration and international distributors to be near 10%.

With this revenue outlook and our continued focus on cost reduction including our Six Sigma and global sourcing initiatives, our earnings guidance for 2004 is in the range of $3.20 to $3.40 cents per share. We normally experience lower volumes in the first quarter due to the seasonality in our power generation, filtration, and international distributor businesses as well as softer demand in China.

With this seasonal pattern we expect first quarter earnings to be in the range of 40 cents to 50 cents per share with improvement expected in successive quarters. We will continue to control our capital expenditures and expect our spending for the year to be around $125 million to $135 million; with substantially higher cash flow from operations combined with aggressively managing cast investments we expect to make good progress on debt reduction in 2004.

With evidence that business conditions are improving in the majority of our markets our revenues are gaining momentum. All of our businesses have returned to profitability. Our cost reduction initiatives are in place to provide us with substantial leverage as volumes improve.

We have gained significant experience with our new engines and that experiences offers us a competitive advantage with our customers. Our products continue to perform well in the field and we are winning new business as a result. Our solid prospects for growth and our improved cost structure position us well for increasing profits going forward.

Now I will 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 number 1 followed by 4 on your touch tone phone at this time. Lastly, we do ask while posing your question that you please pick up your handset if listening on speaker phone, for optimum sound quality.

Please hold while we pole for questions. Your first question is coming from Gary McMannus.

Gary McMannus JP Morgan. Hi Tim and Karen.

Good morning.

With the first quarter expectations what are you assuming in terms of joint venture income and power general performances, profits or loss?

Let's see, Gary. For joint venture we think it will probably remain close to the sale run rates that we saw in Q4, maybe a little softer than that. For next year we expect joint venture earnings to be close to the same levels that we saw in '03.

We had a few one time items in the '03 number but we expect some increase in kind of like the operating earnings in our China joint venture at least makes up for that difference. So it will be a little softer because of some of those one time technology fees that I was discussing in Q4. So maybe down into the upper teens to 20 million range.

So I also asked on power general, but before I get to that, your saying that joint venture income is going to be near the 70 million for full year '04 despite the fact that the first quarter is going to be quite large year over year?

The China joint venture, China is usually soft in the first quarter and so I would not expect the same earnings from the DONG FONG, which is a significant part of our total. Also you shouldn't expect to see DONG FONG grow at the same rates because the tax holiday is over and the taxes are being faced in that's why the total of 70 billion same store sales the same. As far as power generation goes the first quarter for power generation is always the softest but we do expect power generation to be better than break even.

Okay. I'll get back back in the queue.

Thank you. Your next question is coming from David Raso. Please announce your affiliation then portfolios your question.

Smith Barney. Good morning. I have a question first, clarification, the $11 million, the restructuring charge that was reversed. Can you please explain that? Was that all in the engine division?

The 11 million that we were preferring to, David, in 2002, did relate to the engine, that was an engine business number. Really through, I guess through discussion with our auditors and guidance from the SEC we really only report one measure of segment profitability now which we have chosen to include all restructuring charges and adjustments.

That was 2002?

Correct.

We told you before that for '03 and beyond any restructuring charges would be absorbed through operations, so those were already included in our numbers such as some of the power general actions we took in '03.

My question is the sequential profit in engine.

You should make the $11 million adjustment when you are thinking about what we have viewed as operating earnings in the past.

I think if you do the math it's $44 million.

Okay. 2003, then. You had $36 million in third quarter '03 of engine profit. Fourth quarter 2003 you just reported 32.

Yes.

The $11 million.

Was a fourth quarter 2002 adjustment and did not have anything to do with either Q3 or Q4 of '03.

Exactly. So that's my question. So it is an apples to apples comparison, the fourth quarter engine profit 2003 declined sequentially from third quarter, 2003?

That is correct.

On a higher sales base.

That's correct.

I'm trying to understand and I recognize how profitable the Dodge Ram business is, and I would just the genesis of the question was the comment that Dodge Ram being flat next year I am trying to see the implications of what he fourth quarter is telling me of how significant Dodge Ram is to see the sales up for the whole division but profits down because the one piece of engine revenues that were down individually was the LC V and RV business of Dodge Ram.

So I am just trying to get a feel for, anything else happening third to fourth quarter that was unique and not give you a better sequential engine performance, or is the Dodge Ram just that significant a profit?

Well I think what's happening there has a pretty strong effect on profitability to the engine business has to do with some of our variable compensation accruals. Because those are driven, the accounting for those are driven by full year profitability and we made most of our profit in the fourth quarter and the largest number of our employees are in the engine business that we got a heavier hit to engine business profitability from those fourth quarter accruals. That is making up the majority of the difference, David.

On the flat Dodge Ram top line in '04 generally speaking flat, operating profit for that sub segment as well as, all the leverage will be in the heavy truck, the medium truck and industrial?

If in fact those volumes come in right at 2003 levels, yes.

I'll get back in queue. Thank you very much.

Thank you.

Thank you. Your next question is coming from Joanna Shatney. Please announce your affiliation and portfolios your question.

Good morning. Goldman Sachs.

I know you guys do a little bit different calculation of North American heavy duty truck markets than some of the other competitors. Can you just, give us the basis for '03 and talk about why the expectations adjust for 25% growth rate and not something bigger given the rate of increase we've seen in the order book in the last couple of weeks?

We think that the way we calculate the size of the market we think 2003 was the 164,000 our internal forecast, are somewhere between 200, and 205,000 for 2004. We are usually at the bottom end of the forecast and we want to build our plan around what we think is a very conservative estimate and we'll adjust our numbers if we continue to see some of the things going on that in maybe the last month or so. But we are preferring to see in that 200,000 range.

No one has really talked two much about this but there was another emissions deadline as of January 1. Can you talk about how that transition is working, how the products line is running? Are you able to gain share because you've had your product at a out a little bit longer than some of your competitors? Have you you had that out in October?

All our automotive engines were out in October of '02 and then with the bus engines and all that we also made the transition for the January 1. Every product we have out there right now is meeting our reliability standard and it's also meeting the customer requirements. It is hitting fuel economy performance reliability per hour predicted. And we are talking to and getting orders from large truck fleets that we haven't been able to work with for a long time, primarily because of one OEMs guaranteed residual values.

I was out in the marketplace with several customers in the 1st week of January, and essentially those that bought a lot of prebuy before October of '02 trucks have used them in the and the used trucks are getting old and the used truck values, the inventory is about normal so the pricing for used trucks is good so we are starting to see people trade. And those that have had our engines for six, six months to even a year are now comfortable with the reliability. So I think we will start to see some more significant orders coming in in the first quarter. The amount of discussion that's going on in the marketplace is up significantly.

Okay.

Then just last question, can you guys just help us out where warranty expense goes in '04 because it sounds like we've been talking to people in the field that the warranty expense isn't running as high as you guys have been accruing not just for '03 but before that is there a chance to reverse some of those accruals?

The answer is yes. We are conservative in our warranty accruals in that we need at least a years experience, so sometimes we want more than that. We are also continuing to introduce new products so we will accrue them at a higher rate.

I would say that the Dodge Ram truck engine which is the highest volume in the first year as measured by DaimlerChrysler, the new engine had better reliability than the engine it replaced and that's always been our target. I think we are seeing because of our new product introduction processes substantial improvement in new product introduction.

So I would be hopeful to see some of those accruals or costs of warranty come down but you have to remember it's also a function of volume and if our volume goes up the accruals would have, or the overall coverage would have to go up as well.

Could we end '03.

3.1% in the fourth quarter and 3.4% for the year.

One more comment I would we would expect to stay on a percent of sales basis about the same into '04 as we have a higher mix of heavy duty engines where warranty costs are more significant, that keeps the level higher even though we may be taking it down on a per engine basis.

Is this, is the warranty accrual assumption at least historically revisited on an annual basis?

No, on kind of a continual basis actually. But we have to have enough data that we can confident that we can see a clear trend before we are going to take it down. We are pretty conservative in that respect.

Okay. Thanks.

Thank you. Your next question is coming from Jeff Kauffman. Please announce your affiliation then pose your question.

Thank you very much. From Global Partners. Hi Karen, hi Tim. Good morning. Two questions.

One on order backlog and one on cash obligations. Let me start with order backlog.

Could you give us a sense for what is going on right now in terms of your order backlog in the heavy-duty business or the engine business, and from what you can tell of the new orders you're receiving, give us a sense for how your market share seems to be versus the industry orders, what direction that's heading.

Well, we don't really have a backlog in heavy-duty. Essentially the OEMs order on us and we produce them usually within a thirty-day lead time. I can just say that the build rate of the OEMs have been going up so their backlogs are still about what they've been.

Our market share back to November which is the last way you can do it is 22% in the heavy-duty and we won't see the market share increases until we start measuring I think into the first quarter of this year. But based on the order rates that we are seeing I think we will see some increase in market share. But we are just I think at the beginning of seeing a rebound in the heavy-duty truck market.

I will say that on power generation on the backlogs it's, and this is somewhat surprising to me in terms of prediction, I thought it would be well into 2004 and maybe 2005 before we saw the backlogs in power generation going up, but we are seeing especially on the higher sets a backlog starting to, and lead time starting to extends out.

The inventories are finally down to normal levels and the pricing has started to stabilize and quoting in North America has increased. So I think we are going to see some kind of rebound in power generation earlier than what we had anticipated the last time we talked to you.

That is very encouraging.

With respect to cash flow, I think Karen, you hinted in your comments about pension expense but I believe you are past your measurement date. Are you prepared to discuss where your pension plan is at this point in time and what you believe the cash expense over the accrual expense should be?

This is Jean Blackwell.

Our status at year end was still underfunded about $670 million. Obviously we had pretty good returns for the year and we did increase our funding. But with the discount rate still down and increased benefits payments and a lot of employee requirements we didn't see the year over year benefit that we might have liked.

We plan on continuing to fund slightly over $100 million for the year and while we are continuing to keep our asset returns at a modest level in terms of our projections we hope to continue to see some improvements this year.

Except this one comment, our expense for '04 will probably be about 20 million higher for the total companies than where we were for '03.

I caught that in your comments. Jean, thank you very much, Karen, thanks.

Thank you. Your next question is coming from Andy Casey. Please announce your affiliation.

Prudential Equity Group. Good morning. I have a few questions. First a couple on engines and then circling back on power generation.

On engines, on the truck side, on a heavy truck, there appears to be some extension of testing periods for specifically some [inaudible] engines out there by the ends use customers. Do you think that's driven by another competitor, not you, but another competitor discounting or is it really driven by unknown performance issues?

I think it's driven by unknown performance issues but you probably ought to talk to cat about that, not us.

Sure. Then second on off highway with the standards coming I believe January 1 of '05 can you remind us, are you pursuing EGR technology or a different technology to meat those?

We have a mixture and what we try and do is say the right technology for the right market. Several of the off highway industrial engines will not require cooled EGR in order to meet tier one or the new emission requirements. We also because of good combustion capability did not have to use EGR on new Dodge Ram pickup truck engines which is a distinct advantage.

So essentially we are using different technologies for different markets and essentially every engine that we make and will be making we are very confident that we will meet these emission requirements.

Thanks.

Now circling back on power generation, I think you mentioned that it's accelerating a little faster than what you would have thought.

Right.

Coming into the quarter there were two issues that were kind of looming on the horizon. One was the Iraq power general potential but the other kind of nearer to North America was the blackout. Have you seen given your performance in the quarter have you seen any benefit from those yet or was the quarter just kind of weak comparison, you had some sequential improvement in the bulk of the acceleration you are seeing is maybe these two things?

Well, there is no question that blackout created a lot more quoting activity in North America but it would have been too soon to have deliveries in the fourth quarter. I think that's one of the reasons we are seeing an increase in the backlog.

I've gone out and talked to our distributors and literally for a couple of years there was a lot of jobs on paper that were out in the marketplace. Now they are being quoted aggressively. So I think the blackout clearly helped.

As far as Iraq is concerned, there is still an awful lot of talk but there's not a lot of business because of the danger and the lack of security. But there has been a lot of other Middle East power generation projects and ones in the future, not just necessarily for Iraq.

Also there were some blackouts on the eastern provinces of China and so all of a sudden China has started to heat up again, and that was a big market back in 99. And the forecast is that they are going to have power shortages for some period of time. So that may be a sustained opportunity.

There has also been a, some activity in the north part of Brazil and Indonesia, so there tends to be more international quoting. I think that what I want to, if you look at power generation for next year, we say there will be 10% growth and we think 5% of that will be organic and 5% of it may be new market penetration with some of the remanufactured generator sets we have. But the significant benefit improvement in profits is going to come from their continued cost reduction and we are starting to see some traction there.

Lastly, not to detract from the performance improvement that you talked about in the last part but given your conserve Tim, if you will, traditional curve Tim on the North American heavy truck outlook would you say that pretty much carries over into your power generation outlook meaning the 10% ultimately if things hit could actual will be conservative.

I think it's reasonable is what I would say. I can't predict what the economies are going to be doing.

I can tell you having lived through four recessions in this last one for that three years, we are seeing a lot of activity in most of our markets and most of the geographical areas and we've put a plan together that I think is reasonable and our guidance I think is reasonable with clearly the economies get better and business picks up then we would make adjustments as the year goes on.

Thank you very much.

Thank you. Your next question is coming from John McGinty. Please announce your affiliation.

Credit Suisse First Boston. Good morning, Tim. Just a quick question because the call is just about over.

The power generation, if you get a ten plus percent volume gain and you return to profit when we look back historically I'm not sure what to take as the margin that that would get you particular as you are crossing the break even line we only have data back to earnings in the, Y2K year, [inaudible] should we look at a 3 or 4% operating margin with a ten plus percent sales gain what kind of profitability is this guess going to return to in '04 to get to the 320 to 340 that's implicit in there?

You know, I think the 3 to 4% is a fair assumption.

And, John, I don't know that you can look back and use history as a good measure. Pricing is still very weak in the market.

I'm not disputing that. I'm saying then we have nothing to go on if we don't use history if we don't use the question.

Another question if you see 10% plus gains in infiltration in international distribution there was some pluses and minuses some currency and other odds and ends. I guess the question is would you expect each of those businesses to show good incremental volume of, in other words you mentioned the 21% conversion, or 25% conversion in the engine business. Would filtration and international distribution with 10% plus volume gains give you the same 20, 25% conversion of.

Clearly in the international distributor business we are going to see earnings growth greater than revenue growth but part of our strategy there is that we want to stay at a, get to the eight to 10 percent, or the six to 8% EBIT and we want to start growing that business so you can see that we probably opened up six or seven locations last year and when you open up a location you usually don't get to a breakeven until about 18 months after that. So we will balance that. And then power generation I think again we will see earnings growth greater than revenue growth as we get through this. And the 21 percent, I'm sorry?

I think what we were talking about there was filtration.

Oh, okay.

Filtration is going to stay, I think what you can do is we are targeted 10% EBIT on filtration. And, again, we can control the level of investments into emission solutions. Essentially we are doing a lot of retrofit business which creates refuse newspapers profits and we use those to invest in the technologies that we are going to need for 2007 and beyond.

Would you remind us how big emissions solutions is as a portion of the billion dollars or so in revenue in filtration, or 1 billion plus revenue?

I think it was $60 million last year. It went from 24 million to 60 million I think it make 8 million last year.

Okay. Thank you very much.

Thank you. Sir, there appear to be no further questions in the queue. Do you have any closing comments you would like to make.

Thank you.

Thank you for joining us today.

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