康明斯 (CMI) 2004 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Cummins fourth quarter earnings 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, Michele. Welcome, everyone, to our teleconference today to discuss Cummins results for the fourth quarter of 2004. 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 email them to you at the end of the teleconference. Participating with me today are our Chairman, Tim Solso; our Chief Financial Officer, Jean Blackwell; President of our Engine Business, Joe Loughrey; and President of our Power Generation Business, Tom Linebarger. We will all be available for your questions at the end of the teleconference. This morning, first, Tim will start our conference call. Next, I will review the details of our income statement and business unit results, then Jean will cover some miscellaneous items and our cash flow performance, and finally we'll have the question-and-answer period.

This teleconference will include certain forward-looking information. Any forward-looking statement involves risk 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 2003 Form 10-K, and it applies to this teleconference. During the course of this call, we will be discussing certain non-GAAP financial measures, and we refer you to our website for the reconciliation of those measures to GAAP financial measures. I want to remind you that when we discuss earnings before interest and taxes, or EBIT, in our call today, that measure also excludes minority interest and preferred dividends. Now, I will turn it over to Tim for some opening remarks.

Good morning. 2004 was an outstanding year for Cummins, setting records across our Company. The year came with its set of difficulties, including rising commodity prices, very rapid volume increases, capacity constraints, and all the other challenges that faced our industry. However, our people rose to the challenge, and together we delivered record sales, record earnings, significant gross margin improvement, tremendous growth in JV earnings, dramatic improvement in cash flow, and substantial improvement in our balance sheet. We see the next few years as being quite good, although not as dramatic in the rate of increase, but showing steady improvement over 2004's record performance. In addition, we will continue to work to convert more of our sales growth to the bottom line, through global sourcing, improved manufacturing efficiencies, Six Sigma, and other efforts across the Company.

We ended the year on a strong note, well positioned as we head into 2005. Cummins achieved record sales and record earnings in the fourth quarter of 2004. We benefited from strong demand, increased market penetration, significant joint venture contributions, and further geographic diversification. Sales for the full year were also a record at $8.4 billion, reflecting a 34 percent increase over 2003, and a 27 percent increase over Cummins' prior peak revenues in 1999. Fourth quarter sales were 35 percent higher than the fourth quarter of 2003, with record sales in each of our businesses. Earnings before interest and taxes for the fourth quarter were $173 million or 7.4 percent of sales, compared to $84 million or 4.8 percent of sales last year. Our quarterly performance is near the midpoint of our targeted financial goals of 6 to 9 percent EBIT margins, and our year-to-date EBIT margin is also within our targeted range at 6.5 percent of sales. We have achieved these results in the first full year of the cycle's market recovery, reflecting the benefits of both our strong volumes and our cost structure improvements.

Net earnings for the quarter were $119 million or $2.41 per share, compared to net earnings of $43 million or $1 per share in the fourth quarter last year, for 177 percent increase in net earnings. Engine business revenues were up 55 percent compared to last year's fourth quarter, with increases in every market segment. In our automotive markets, this quarter's sales were 45 percent higher than last year, driven by growth in end market demand, and significant increases in market share. Our ISX and ISM engines continue to perform very well for our heavy-duty customers, and shipments of the Cummins turbo diesel engine for Dodge Ram set another record year in 2004, at 20 percent above 2003 levels. In industrial markets, we saw increases in every market segment, with significant increases in North American construction and agriculture shipments, in international marine, and in global mining sales. In total, the EBIT margin for the Engine Business in the fourth quarter was 7.5 percent of sales, demonstrating strong performance against the business' targeted range of 5 to 8 percent. Profit from consolidated operations, excluding joint venture income, was 5.6 percent of sales, also within its targeted range.

In Power Generation, sales continue to strengthen for commercial Gensets, with very good demand in both domestic and international markets. Sales of alternators, excluding newly consolidated entities were up 38 percent compared to last year's fourth quarter. Demand for Power Generation products in China remains strong, and we believe 2005 will be another good year in this market. North America, we are now seeing significant improvement in our commercial business, and sales of consumer products continue at robust levels. Overall, Power Generation sales were up 37 percent from from the year ago quarter, and earnings nearly doubled, with EBIT margins at 5 percent of sales. While this business is only beginning to realize the full benefit of its restructuring efforts, I believe it is well on its way to restoring the business to targeted profitability levels.

Our Filtration and Other Business continues to experience significant demand increases, particularly in North American OEM sales, and Holset turbocharger sales in China. In both Fleetguard and Holset, we have seen major revenue growth resulting from long term agreements, as well as a significant market recovery. Profits for the Filtration Business, however, have decreased compared to last year, due to margin pressure in a couple of specific areas. The filtration side of the business, which is predominantly after-market, remains at healthy margins. The exhaust operations, however, have been plagued by several factors. These include higher commodity prices, which have had the greatest relative impact in this business. We continue to take pricing actions with our customers, to mitigate these increases, but the net impact is still unfavorable. Manufacturing and logistics inefficiencies resulting from significant demand increases have also led to substantial pressure on margins. We have developed a recovery plan and are implementing initiatives focused on addressing these issues. We expect improvement in this area in 2005, but the rate of recovery will be gradual. Combined, these items resulted in $18 million of additional costs compared to the fourth quarter last year. Lastly, we continue to invest in the business in the form of research and engineering expenses, to support the business' long-term agreements, and to support the development after-treatment systems for emission solutions business. We are confident that these investments will result in significant growth and future sales, and allow us to participate more broadly in future market opportunities.

Our International Distributor Business had a very good quarter, setting records for both sales and profits. Sales were higher in nearly every geographic region, with significant increases in Europe, the Middle East, and Southeast Asia. Earnings before interest and taxes were $17 million, or 6.8 percent of sales. Since this business was formed in 2002, sales have increased at a compounded annual growth rate of 15 percent, and profits have grown at an even higher rate of 21 percent. This business and its results are a prime example of our strategic focus to diversify away from more cyclical portions of our business. This business does not require significant capital investment, and provides more stable financial performance. Income from joint ventures continues to grow, with a record $38 million of income in the fourth quarter, and $111 million for the full year 2004. Our successful joint venture with Dongfeng was the primary driver for the increased earnings for the quarter, as we benefited from continued strong demand and a favorable adjustment to local income tax rates. All indications are that demand in the Chinese diesel truck market will remain at these high levels throughout 2005 and beyond. In addition, we continue to see significant profit contributions across our joint venture operations, and across all geographies, including the North American distributors, Cummins MerCruiser, and our joint ventures in India.

Our emissions compliant, heavy-duty engines continue to demonstrate very good performance for our customers. And we now have nearly 90,000 engines in the field, with a total of over 7 billion miles of service. Our engines are showing improvement in both fuel economy and reliability, and we are seeing product coverage costs trend downward. We gained a substantial amount of market share in 2004, going from 21.5 percent share in 2003, to 26.7 percent share in 2004. Our product success has earned us an unprecedented increase in business with the top 200 fleets, where we achieved approximately 40 percent share in 2004, versus 27 percent share in 2003. We remain confident that we will deliver the best products for our customers for 2007 emissions standards, and are on track to have 2007 EPA-compliant engines available for field tests with fleets during the middle of this year. In addition, our technical productivity initiatives are resulting in sizable reductions in development costs for these new engines. We are leveraging our computer analysis led capability in India to provide local cost high-quality engineering analysis to accomplish these objectives. During the fourth quarter, we also announced the commitment to fund a technical center in China to tailor products specifically for the important Chinese market. These efforts are critical to leveraging our capabilities across the world, to serve our global customer base.

We continue to make great strides in our off-highway engine development as well. And we are well on our way to the introduction of our Tier 2 engines for high horsepower applications, and Tier 3 engines for other horsepower ranges. Cummins has a drop-in solution for these applications, which requires little change to the equipment design and provides for low cost insulation by our customers. This solution is evidence of our ability to provide the right technology to the right market. The technology development for these products results from our unique synergies between engines, fuel systems, Holset turbochargers, Fleetguard after treatment systems, and in-house combustion research and electronic controls. We delivered very good results for the quarter, despite having experienced significant cost increases in 2004, from commodity prices and production and logistic inefficiencies, driven by the quick ramp up in demand. Combined, these items resulted in $57 million in additional costs during the quarter. We are implementing pricing actions to offset the commodity price increases across all of our businesses. We have raised prices for engines, generator sets, alternators, turbochargers and filtration products. In addition, we are aggressively pursuing Six Sigma and other improvement initiatives to address the operational inefficiencies. This should provide further profitability improvement going forward.

As we move into 2005, we continue to see growth in the majority of our end markets, albeit at more moderate rates than experienced in 2004. At this point, we estimate revenue increases for 2005, in total, to be 7 to 8 percent. We expect commodity prices will continue to drive material costs higher, but we expect our pricing actions with customers will offset this increase. But we believe we can achieve some improvement in efficiencies with the 2005 rate of growth and demand slowing, compared to 2004. We estimate earnings per share for 2005 will be in the range of $8 to $8.30 per share, assuming a 28 percent tax rate. Excluding adjustments to the tax rate in 2004, this reflects an improvement in earnings of around $2 per share, at least a 30 percent increase in earnings on an 8 percent increase in revenues. With the seasonality typically experienced in our Power Generation, Filtration and International Distributor Businesses in the first quarter, we expect earnings per share in the range of $1.50 to $1.60 per share, for the first quarter of 2005.

Cash flow generation in 2005 is expected to be significant, driven primarily by the earnings improvement. Capital expenditures for 2005 will increase to support 1) our growth, including investments to increase capacity, and 2) to fund our new products. Our investment in capacity improvement are very focused, cut across all of our businesses, and are designed for rapid return on investment. We continue to invest more of our capital in low cost regions of the world to further leverage our opportunities for cost reduction. In total, we expect capital expenditures to be in the range of 220 to $240 million to support these initiatives, while still remaining below depreciation and amortization. With the expected continued increase in demand, we are anticipating some additional investments in working capital, yet the rate of growth in demand slowing, we believe we can achieve some improvement in working capital as a percentage of sales. We will continue to fund our pension plans above minimum levels, in keeping with our strategy to return to an appropriate funded status. At this point, pension contributions are expected to be around 130 to $140 million in 2005.

2004 was a great year for Cummins. We experienced strong market demand, with revenue increases of 34 percent over 2003. In earnings, we delivered profits of $7.39 earnings per share in 2004, compared to $1.27 per share in 2003. We accomplished this in the face of significant increases in commodity prices and cost pressures from inefficiencies, driven by the rapid demand improvement. We generated a substantial amount of cash, and are committed to using that cash for debt reduction, and efficient investment in the growth of the businesses, including repayment of our debt maturity in March, while still funding future growth. We have delivered what we said we would do, and we feel our outlook for further earnings improvement is significant in 2005 and 2006. Now, I will turn it back to Karen to review the details of our fourth quarter results.

Thanks, Tim. First, I will provide comments regarding each of our 4 business segments, beginning with the Engine Business. Total sales for the Engine Business in the fourth quarter were $1 billion $530 million, a 55 percent increase from sales of $984 million a year ago. As we discussed in previous quarters, our change to market-based transfer pricing results in increased sales in the Engine and the Filtration and Other Businesses, with the corresponding offset in eliminations, along with somewhat lower EBIT margins for those businesses. For the Engine Business, the segment reporting change added $139 million in sales in the fourth quarter. Excluding the change, Engine Business sales increased 41 percent compared to the fourth quarter of last year. Revenues in automotive markets were 45 percent higher than Q4 last year, with increased demand in all segments, driven by the broad market recovery. Overall revenue from industrial markets was up 29 percent year-over-year, with increases in all segments.

Earnings before interest and taxes for the quarter were $114 million or 7.5 percent of sales, versus $32 million or 3.3 percent of sales in the fourth quarter last year. Excluding the segment reporting change, EBIT margins for the Engine Business were 8.2 percent of sales. The increase in profitability during the quarter was primarily driven by the significantly higher volume, the associated leverage, and the business's cost structure improvement. Revenues for the heavy duty truck segment as a whole, were up 53 percent in the fourth quarter from a year ago, while global unit shipments were up 78 percent. The variance between the revenue and the volume increase was due to the mix of engine versus parts sales. Part sales increased 12 percent compared to fourth quarter 2003, but were a lower percentage of overall revenue in this year's fourth quarter. Unit shipments in North America were up 89 percent, driven by nearly 50 percent growth in the heavy duty truck market, and by Cummins most significant year-over-year share gain in 20 years. We continue to benefit from our long-term agreements with our OEM partners, and have seen increased penetration under these agreements. Unit shipments to the rest of the world were up 22 percent, with higher sales to OEMs, primarily in Mexico, where the growth in the heavy duty truck market exceeded 30 percent versus last year.

In the worldwide medium duty truck and bus market, total revenues increased 41 percent for the fourth quarter year-over-year. Medium duty truck engine shipments were up 94 percent in the U.S. and Canada, with significantly higher volumes with several key OEM customers, due to market growth and account penetration. International shipments were up 39 percent, with higher OEM sales in Brazil, Mexico, and Europe. Global bus engine shipments dropped in the quarter, decreasing 28 percent year-over-year. Shipments were up 10 percent in North America, due to improved demand and our engine's availability in additional OEM vehicles, and down 44 percent internationally, primarily in Europe and east Asia, where our Dongfeng JV is now providing certain Cummins accounts in China with its locally sourced engines. In the light duty automotive and RV segment, revenue was up 35 percent this quarter compared to a year ago. Engine shipments to DaimlerChrysler for the Dodge Ram pickup truck were 37,300 units, up 21 percent from the fourth quarter last year. Unit shipments for RV engines in the fourth quarter experienced an 18 percent increase, due primarily to unusually low sales following the introduction of new products in last year's fourth quarter. Overall, demand for RVs has held up relatively well compared to last year's record levels. For the full year, RV shipments are down 3 percent, while sales have increased 6 percent versus 2003.

Sales to industrial engine markets in total were up 29 percent from a year earlier, with increases across all segments. In the construction equipment market, sales increased 7 percent compared to the fourth quarter of last year. Unit shipments in North America were up 42 percent, and shipments to international markets were down 1 percent, compared to the fourth quarter of 2003, due primarily to the slowdown in activity in China, mostly offset by increases in Latin America. Sales for the agricultural equipment market were 32 percent higher than the fourth quarter last year. Unit shipments in North America, up 21 percent, drove the increase, while international shipments were down 8 percent, with sales decreases in Brazil leading the decline. Revenue in the mining segment continues to be strong, up 77 percent compared to last year, with shipments up 111 percent in North America, and 83 percent internationally, with increases in Russia and Europe. The demand continues to be fueled by increased commodity prices. The commercial marine segment saw a 27 percent increase in sales compared to last year, on a 5 percent increase in units, due to a favorable mix in its international market, particularly China and Asia Pacific.

Sales in the Power Generation business for the fourth quarter were $538 million, up 37 percent from the fourth quarter of 2003. The Power Generation segment continues to benefit from its worldwide market presence and strong demand in Southeast Asia and China, where our Genset business continues to be at strong levels. Volumes increased in the Middle East and Europe for both Gensets and G-Drive engines, with order activity continuing for high horsepower engines being placed in anticipation of Iraq-related activities. In addition to the consolidation of 2 Newage operations in 2004, sales of alternators were driven by a steady increase in demand for Gensets in the Middle East and the Americas, and by new accounts in Europe. The commercial market experienced growth across all major geographic regions. An improving U.S. economy and increasing capital goods orders are driving higher Genset demand. North America saw its highest order intake since 2001. The relief work and rebuilding of infrastructure in Asia Pacific is expected to increase demand further in 2005, primarily for generator sets less than 1 megawatt.

In the fourth quarter of 2004 Power Generation reported earnings before interest and taxes of $27 million or 5 percent of sales, compared to $14 million or 3.6 percent of sales a year ago. The profit improvement compared to last year resulted primarily from the benefits of the higher volume, cost reduction actions, and some pricing improvements. Revenues for the Filtration and Other segment were $399 million for the quarter, a 41 percent increase compared to the fourth quarter of 2003. Excluding the segment reporting change, sales increased $65 million or 23 percent. In Filtration, North American sales continued to contribute heavily to the revenue increase, while some improvement was seen in Europe, Mexico, and Asia Pacific. Holset turbocharger sales continued to be at strong levels in North America and in China. This segment's earnings before interest and taxes for the quarter were $15 million, versus $25 million in the fourth quarter last year. The higher volume contributed approximately $12 million in additional profit, but was partially offset by continued cost pressures in several areas. Manufacturing and logistics inefficiencies, resulting from the significant increase in volume added $8 million of cost, compared to last year's fourth quarter. Steel and other commodity price increases contributed a net $10 million of the variance, and higher research and engineering spending for new product development cost $3 million. As Tim mentioned, we expect improvement in this area in 2005, as we have taken steps to address the operating inefficiencies.

Sales for the International Distributor Business were $250 million in the fourth quarter, an increase of 32 percent, compared to fourth quarter last year. Sales were very solid across product lines and geographies, with roughly half the increase from engine and PowerGen sales, particularly in Europe and Asia. Currency accounted for $8 million of the total sales increase. Earnings before interest and taxes for the segment were $17 million, or 6.8 percent of sales this quarter, compared to earnings of $13 million or 6.8 percent of sales last year.

Returning to the corporate level, I will review our total sales by region. In the fourth quarter, our sales mix was 49 percent U.S. and 51 percent international, compared to 53 percent U.S. and 47 percent international in the fourth quarter last year. For the fourth quarter compared to a year ago, sales in the U.S. increased 25 percent, while international sales in total increased 47 percent. The higher U.S. sales were attributable to increased market demand for heavy duty and medium duty trucks, power generation equipment, and filtration products. International sales increased in nearly all regions. Sales to China continue to be strong, with a 53 percent increase over last year, led primarily by strength in the Power Generation and International Distributor businesses. Sales to Asia in total were up 26 percent, with increases across all markets except Korea. Canadian sales reflected a dramatic increase of 123 percent, due to the recovery in truck engine volumes. European sales were up 71 percent, with significant increases across all business units. Sales to Latin America were up 22 percent compared to last year, primarily due to higher sales in the Engine Business.

Next I will review corporate gross margins. The gross margin percentage for the quarter was 20.1 percent, up from 19.4 percent in the fourth quarter last year. The absorption benefited the higher North American automotive shipments, and increased volume across our businesses was the primary driver for the improved margins. Partially offsetting the benefit from the higher volumes were several negative factors, including manufacturing inefficiencies totaling $28 million, resulting from the significant volume increases, including premium freight and overtime. And the impact of commodity prices was $29 million net of price recovery. The total of these items was $57 million or 2.3 percent of sales. While we expect that commodity prices will remain high in the near term, we have aggressively taken action to offset the impact on earnings, which Jean will address in a few minutes.

We have addressed the manufacturing and the logistics efficiencies in 2 key ways. We have made improvements in capacity in our supply base through global sourcing efforts, and at our facilities with targeted capital spending. We have also used Six Sigma to streamline processes and remove bottlenecks in our vendors and our own processes, to reduce the amount of operating inefficiencies in future periods. In the fourth quarter we changed our definition of product coverage expense, and have presented it on a comparable basis to include only base warranty costs. We believe that base warranty is the more meaningful measure of our product reliability. Our current business model is to sell extended coverage, and not to impact the Company's gross margin dollars negatively. Product coverage cost was 2.6 percent of sales, or $62 million in the fourth quarter, compared with 2.6 percent of sales or $46 million a year ago. Product coverage costs on a per engine basis has continued to decrease, reflecting the improved performance of our products. The absolute dollar increase in the engine business was driven by the higher volume and a greater percentage of heavy duty engines, which typically have a higher per engine warranty cost.

Total selling, admin and research and engineering, or SAR, spending in the fourth quarter increased from a year ago, but declined as a percentage of sales. SAR spending for the quarter was $347 million or 14.7 percent of sales, compared to spending of $279 million or 16.1 percent of sales last year. Within SG&A, the year-over-year increase included approximately $15 million from the consolidation of additional entities, $15 million from higher salaries and wages, $8 million due to unfavorable currency impacts, and $8 million to support stocks controls assessment. In addition, we had increased spending to fund our growth and improvement initiatives, as well as some volume variable spending. Research and engineering expenses were 2.8 percent of sales, but increased on an absolute basis by $14 million to support new product development. We continue to tightly manage the spending, while providing the necessary funds for all major technology development.

Our income from joint ventures and alliances in the fourth quarter was $38 million, compared with $26 million in the fourth quarter last year. The increase in income was broad based across all joint ventures, but the largest contributors to the quarter's earning were $24 million from the China joint ventures, and $6 million from the North American distributor joint ventures. For the full year, joint venture income was $111 million, a 59 percent increase over the 2003 level of $70 million. Interest expense for the quarter was $31 million compared, to $25 million of reported interest expense in the fourth quarter last year. Increases of $2 million, attributable to the consolidation of additional entities, and $3 million from capitalized leases, more than offset reductions due to lower borrowings. Minority interest in the fourth quarter was $6 million higher than last year, due to the consolidation of additional entities. Thank you. Now, I will turn it over to Jean.

Good morning. There are several miscellaneous items I will cover this morning, and then I will provide some comments about our cash flow. As we explained in last quarter's earnings call, the Working Family's Tax Relief Act, signed in early October, provided an 18 month extension of the research credit that expired in June 2004. The benefit to Cummins from this legislation was $5 million, and was recorded in the fourth quarter. In addition, deferred tax assets were increased by $9 million in the quarter, to reflect a higher state tax benefit rate than previously measured. This accumulates to a total additional benefit in the quarter of approximately $0.25 per share that was not anticipated in our guidance. Excluding these fourth quarter benefits and the $16 million of one-time tax benefits reported in the third quarter, the Company's effective tax rate for the year approximated 20 percent. Our 2005 guidance, as used in ETR, of 28 percent. The 2005 rate is higher in 2004 because we have now fully recognized all foreign taxes as U.S. tax credits in 2004.

Next, commodity prices continue to impact our businesses, so let me provide an update. Commodity prices, primarily steel, continue to have a significant impact on material costs for several of our businesses. Steel prices appear to have peaked in Q4, after moving up 50 to 60 percent over 2003, but will likely remain high in the first half of 2005. We believe there -- there may be a slight reduction in the metal steel market during the second half of 2005. Although our primary focus remains on controlling costs through cost reduction efforts and global sourcing, we have had success in getting price increases accepted, even in our long-term agreements. Based upon our commodity price outlook, we believe that the pricing actions we have taken in all businesses at the beginning of this year should offset our current estimate of the full year incremental impact of commodity price increases in 2005.

Finally, for a few comments on cash flow. We are continuing to generate solid cash flow, with cash inflow from operating and investing activities of $180 million for the quarter, and a record $425 million for the full year. Changes in working capital represented a net cash inflow of $52 million for the quarter, driven by a strong receivable collection effort at year end. Working capital, including receivables, inventory, and payables, was 16 percent of sales, and has continued to improve from the prior quarter and prior year. Accounts receivable decreased $87 million during the period, while day sales outstanding remained at 49 days. Inventory decreased $8 million during the period, but our inventory turns remained essentially flat from last quarter. Accounts payable decreased $43 million for the quarter. Capital expenditures accelerated, with spending of $73 million for the quarter and $151 million for the year. Investments in, and advances to, joint ventures and alliances finished the year at $19 million outflow, after no change in the fourth quarter.

We have substantial liquidity, and currently have no borrowings outstanding under our domestic short-term credit facilities, which have a combined availability of nearly $750 million. In addition, at the end of the quarter, we had short-term investments in the U.S. and U.K. of $538 million. We will use these funds to reduce our debt by $255 million in the first quarter of 2005, and intend to further reduce our debt with ongoing cash flow generation. We closed on an unsecured $650 million, 5-year revolving credit facility during the quarter. The new revolver replaced a secured $385 million 3-year credit facility that was due to expire in November of 2005. The agreement is an important step in Cummins' efforts to improve its credit rating, as the unsecured feature of the lines of credit acknowledges the strengthened financial performance of the Company. With our strong cash performance, and continued focus on debt reduction, we expect to achieve investment grade metrics as early as March of this year, although we cannot predict when any action would be taken by various rating agencies. Thank you, and now we'll take your questions.

(OPERATOR INSTRUCTIONS) Gary McManus.

J.P. Morgan. Looking at your '05 guidance, can you tell me what joint venture income expectations you have baked into that? And also for the first quarter, as well?

Okay, Gary. We actually are expecting relatively modest improvement in joint venture income into next year. We are thinking that -- and most of that is due to the fact that our China Dongfeng joint venture will have a higher tax rate. So even though their operating earnings will be higher, the net earnings coming to Cummins will not convert at the same rate. So a slightly higher joint venture income into next year.

And how about in first quarter? I mean you had $38 million in the fourth quarter. I assume it goes down quite a bit sequentially?

Yes, I think you would see it probably follow levels we saw in '04. The reason that the fourth quarter was particularly high, as we noted in addition to the strong market, they had a favorable tax adjustment on the Chinese side, there at Dongfeng in the fourth quarter.

How much did that favorable tax adjustment help the joint venture income number?

I don't have the specifics of that. It was on a really good run rate as it was, but it provided some additional benefit in the fourth quarter. We've been operating with some tax holidays, as they refer to them there, because of kind of new investment in China, and those will trend downward over time. So, the rate will go up.

Okay. My second question on -- you say 7 to 8 percent revenue growth assumption in '05. Can you break that down by the 4 segments and major end markets?

I think you won't see a significant difference from that rate across our businesses. So, we've grown rapidly this year, and we're pushing capacity in a number of areas in the industry. So I think it will be similar across the businesses.

So the Engine you would expect up roughly 7, 8 percent, or whatever -- in that area. And that is in all the different subsectors within Engine, or do you think any of those areas down?

Yes, I mean, I think -- I mean we expect North American truck to be above that level. I mean, there's just so many different markets and international markets. So, the truck markets in the U.S. will be a little higher than that. But on balance, still in line with the corporate rates.

And Dodge Ram is still pretty good, or is that -- ?

Definitely higher volumes in '05 from '04, from the record we saw in '04.

Andrew Casey.

Prudential Equity Group. I've got a few questions on the CapEx outlook. Given the acceleration in fourth quarter, is the 2.20 to 2.40 front end loaded, or is that kind of spread throughout the year?

It's spread throughout the year. To give you some examples, that number is a little bit higher than what we've given before. But 40 percent of the capital expenditures for next year is for fairly rapid capacity expansion, and 36 percent of it, I think is for new products for next year. So it's really funding the growth. Examples of that would be that we're buying some flexible machining for capacity for heavy duty, that could increase our capacity by 20 percent in the latter half of the year. And the biggest item is about 14 or $15 million for a new cylinder block -- cylinder head line for Brazil B&C engines. So the investment is across all the businesses. There's no big platform items and that type of thing. But with the demand that we've seen in 2004, we'll be able to incrementally increase our capacity for fairly modest investments.

Okay. And if -- I think you answered this question, but if I can ask it. Just with your comments, first on how you answered that first question, and the quick return for investment, is it correct to presume that there's really no long-term return, meaning a 3-year to revenue realization embedded in that CapEx number?

No.

No there's not, or no that's incorrect?

Your statement is correct. The investments are primarily to just meet the capacity requirements that we have right now. And so we're also investing in supplier tooling, which would be in the capital account, where we're bringing on some new suppliers, and primarily overseas and in lower cost markets. Part of it also would be for some of the 2007 models, and that might have a return after 3 years. But it's not the $300 million and a new engine platform that you don't see a return for several years. So it really is a fairly efficient investment strategy.

Andy, I would just add - this is Tom Linebarger - that we're also -- the mix of the investments is trying to expand our capacity and low-cost operations faster than elsewhere. So the mix of the capital is also outside the U.S. on a relative basis.

Okay. Thanks. And then just 1 question on the Filtration and Other, and then I will get back in queue. The performance kind of appeared to worsen in 4Q from 3Q, if I'm looking at it correctly. And your statements about a -- kind of a steady pace of recovery in that business, in terms of margin performance. Should I look at it as if we're at bottom, and 1Q should show an improvement from where we are now? Or are you still kind of saying, 1Q might dip a little bit, then 2Q, 3Q, 4Q -- ?

No, my expectation is that we bottom in the fourth quarter, but I said gradual, and I don't want to make statements about Fleetguard's performance until we start to see that improvement. But my expectations and the plans calls for modest, gradual improvement in the first quarter, then growing over the year. And if you really dig down into the operating issues, I'm not talking about necessarily the steel or the investment in OE and emission solution engineering, but if you look at the inefficiencies, 80 percent of it is tied to 1 particular plant. And this was a new start-up, and as a result, we've got a fairly strong recovery program going into that plant. And I think if we can get our arms around that, we'll see some improvement.

The other thing is that they have really been really hard hit with steel availability, as well as steel pricing. So they would get into a situation where they wouldn't have the parts, and so they would have to have people standing around or send them home. And then they come home -- come back, and have to work the overtime, and there was a lot of premium freight in that. And I think they have got a strategy around their logistics that should start to see improvement, too. But -- and that's -- again that tends to be on the exhaust side of the business. The filtration side also got hit with some steel in the fourth quarter that wasn't anticipated. So I think we understand what the issues are, and it's -- if you look at the full quarter and all the businesses that we have, the area that I was most concerned about is the exhaust business and filtration.

John McGinty.

Credit Suisse First Boston. A couple of clarifications. Tim, you mentioned, and it was quantified later, the 57 million, which is the combination of steel and inefficiencies, and I believe that 18 million of -- that 18 million you mentioned in filtration, is that same number, right? In other words, that 18 million of the 57 is in filtration?

Yes.

Could you give us where the remaining, whatever that is, 39 million is? If I'm doing my math right?

Well, it's across all of the businesses.

Well, I know. But you quantified 1, can you quantify the other 3?

Yes, I would be glad to do that. Can I -- can I do that offline, because I don't have every bit of it added up that way. Obviously beyond that, it's the biggest numbers are in the Engine Business, just because of size.

Okay. Yes. I will get that offline. Second question, while you don't have the tax number available for the benefit of Dongfeng, you are talking about a much more modest increase because of it. But I guess the question is: You go from 70 to 111 to whatever moderate increases for '05. If you strip the taxes out, is the rate of growth really slowing all that much? In other words, it really comes down to how big -- if there was a $10 million benefit, then it's still, I assume, there's still a slowing in the growth. But I'm trying to find out what the actuals -- are we coming to a level that we're now going to see high single-digit growth from the JVs going forward? I mean let's make the adjustment.

One of the issues, and we'll answer this together, one of the issues at Dongfeng and at Tata Cummins Limited in India, these joint ventures are at capacity right now. So being funded by the joint ventures will be increasing those capacities throughout 2005. So both managing their supply -- their supply base and increasing their capacity is going to take some time. So it would be very unrealistic to expect to see the kinds of growth rates that we've seen over the last 18 months to 2 years. However, I will say, that if you look long term at the markets in China and India, and how we're positioned there, we will see very, very healthy growth.

Okay. Yes, I mean, it would be -- it would be I think helpful -- not in the near term, but helpful if you can at some point in the future, to help us to understand that, to get a flavor. I mean, it doesn't make any difference what tax adjustments shift from 1 year to the next, but I think more visibility in that longer term would be a plus.

Point taken, John.

Can we talk about the 7 to 8 percent volume increase, right? Does that include price or is that a -- like a real increase? Or what is the embedded price assumption, because there's -- price is going to offset material cost. So is that 5 to 6 percent with 2 percent price, or what is that number?

Yes. Price on a percentage basis isn't that significant to us in the overall Company, John. So I think it's maybe like in a 1 percent, a 1 to 2 percent range, and the rest of it would be market growth or penetration.

Okay. So it's only 1 -- did you say 1 to 2, or just 1?

1 to 2.

1 to 2 price. Okay, and that will offset the material costs that you are looking for?

Yes.

But -- okay. And then just a couple of specifics. The interest expense, you mentioned you have an increase in what you have brought in, and the capitalized leases versus the lower borrowing. I guess the question is: Should we use 31 million a quarter next year for interest expense, or should we use the 113 that we saw? Can you just give us what's embedded in your 8 to 8.30 for an interest expense?

Right, you will see some decrease in interest expense in '05. You know we're paying off the debt maturity, 225 million in early March. So that will drive the biggest piece of the decrease. The capitalized leases and the newly consolidated entities, as far as we know, are going to stay. So our kind of current run rate of interest is higher than it used to be, and that piece will remain. I think -- .

So it's 31 million a quarter minus whatever we assume -- what are you paying on the 225 you are paying off?

It's about -- about 6.5 percent.

Okay. So that's basically a $15 million reduction, except we have to only do that for 9 months?

That's exactly right. And, again, we brought some of the new stuff on this year. I think it's -- we'll look for maybe a 10 million improvement in interest expense next year, something in that neighborhood.

10 million from what, I'm sorry?

From the 2004 levels. Total year.

So in other words the 113 goes down to 103, despite the -- okay.

It goes down by about 10 million for the full year.

Okay. And then the minority interest, we went up -- we were running at, 4,5,6. Then we went up to 11. Can you give us what rate we should we -- do we annualize the 11? Do we use the year, do we go back to 5 a quarter? That's a tough one, but it is a lot of dollars worth -- a lot of cents per share, with a few number of shares.

Right, John. It will not -- we don't expect it to remain at the $11 million level. It is higher because we have consolidated entities. Those are primarily manufacturing joint ventures, where we have different pricing arrangements. So the reason I think it will go down in '05, is we reset those pricing arrangements. So at the joint venture level, they will not be generating the same amount of profit.

So could you give us a number that -- that we should be looking for?

That's a little hard, but I would go a little higher than our past trend rate. Not to 11, though.

Okay. So something like 7 or 8 per quarter then? And then finally, just so Joe doesn't get off easy. Joe, the mid '05 introduction of '07 engines to the test, is there any slippage on that? I mean, in other words, you have been saying that. But "middle" is a very broad range. Is there any slippage on that? Are you right on track on the '07? And can you reaffirm, I hope, or not, your comments about the mileage on the '07 engines versus the current engines?

Miles per gallon. This will be a short answer, John. The answer to your question is, no, we're right on schedule. No slippage.

Okay.

And things are going well there.

Okay.

Too, we're optimistic. I will leave it at that. In talking to a lot of our -- we're optimistic about where we're going to come out on fuel economy relative to where we are now. Fuel economy in general on our engines, because of improvements we've made since we introduced them in late '02, is getting better.

Right.

And we have a shot at it being even a little bit better in '07.

In other words, so -- I mean forget about better. You are at least going to match -- at this point you are not confident, but you are comfortable that you've got a shot at least at matching the current mileage with the the '07s, and maybe beating it?

Yes, if you are talking heavy duty engines, the answer is yes.

Excellent. Thank you very much. I will get back in queue.

Joanna Shatney.

Goldman Sachs. The production and efficiencies got worse by 17 million. You gave us 4 million in filtration. I'm assuming that -- well, I'm sorry, that's the total of raw materials and inefficiencies. Are you guys experiencing continued inefficiencies in the heavy truck facilities at this point?

Let me just -- if you are talking about heavy truck, we make those engines in our Jamestown plant. And they are at record levels. Through Six Sigma projects they increased their productivity with no investment by 30 percent. And they are turning their inventory 42 times. Their people per engine day cost is at record levels. Their safety is at level. So the heavy duty business, in terms of manufacturing efficiencies and logistics, is performing very well. I don't know, Joe, whether you want to add anything to that.

Yes. I mean, internally, especially at Jamestown, I mean we couldn't ask for more. Things are going very well. Efficiencies we've had in the business have been more related to -- inefficiencies more related to having to use premium freight to get last-minute supplies to the plant on time to build engines. And we have been continually working with those suppliers who -- with whom we have this problem, on continuing to improve the situation, so we can reduce the premium freight efficiencies. But the Jamestown plant is doing really well right now, and will do better as we go through the year.

Okay. So the bottleneck is not necessarily within Cummins, it's within your supplier base?

Right now that's true, right.

What kind of things are you short in? It's just the forging?

Generally speaking, it tends to be in and around steel connected, and forgings. Or in some cases, castings that may be related to that. But, yes our shortages tend to be in those areas. That isn't new news to us. We have been working on it for quite a while, and depending upon the commodity, we're either improving the current suppliers' capacity we have, or as Tim mentioned earlier, in some cases we're adding new suppliers from low-cost countries to increase our capacity for our bottleneck areas.

Okay.

I think it's really important to understand when we talk about capacity constraints, in almost all of our businesses, it is in our Tier 2 and Tier 3 supply base. And so the management challenge that we have is helping our suppliers increase their productivity and/or capacity. And we have been doing that for several months in 2004, and we'll continue to do that, and, in fact, are doing even more right now. So, again, when we tie that back to the capital investments, it's really managing the supply base, more than increasing our assembly and test capacity. And I'd say that's really true in most of our businesses

I want to make sure that I understand this. Let's talk about the top line first. If you use your base of 165,000 units in '03, on your measurement, where did we end '04 and what is your best guess on '05 at this point? Just for heavy.

Heavy duty volume.

I think, our numbers suggest we ended '04 at about 245. And at least the number as we see it right now, is between 280 and 290. So somewhere in that range, 285ish is kind of the number we're looking at right now for '05.

What if demand comes in closer to 300 or something better than that? Are the bottlenecks going to be an obstacle that the industry just can't get around so you can't ship that or -- ?

I can't speak for the whole industry. I know some of the portions of the industry that are struggling, but our whole plan is trying to work on improving capacity in a step-by-step basis, so that if the market goes to 300,000ish or so, particularly as we get to the latter part of the year and next year, we would be in a position to meet market -- to increase our share incrementally in that size market. So our whole strategy is based on that, and our investment activity and the improvement work we're doing with our suppliers, et cetera, is all geared towards trying to be in a position to increase share in a 300,000 market, which isn't currently in our forecast, by the way, but that's what we're looking at. And because we think, given how well our product is running, how well the '07 program is going, that we have an opportunity to continue to increase share profitably, which as you know, Joanna, is our objective. Profitable is a very important word as we go through the rest of this decade to 2010.

And just the last question, and I will go back in queue. One of the suppliers to the industry, and one of the other power train components, talked about maybe some of the units from January slipping into December. Did you guys experience any significant level of -- I think they quantified it at a couple thousand units.

Not -- no. I have to say, if we did, I don't know about it. So -- .

David Raso.

Yes, Smith Barney. Clarification. The cost, the increased costs, you gave a $29 million number, net of price. What were the total impact of cost pressures, commodity cost pressures in '04?

Net of pricing, those -- .

Well, not net of price. Just the absolute number.

Yes, almost $90 million of on commodity pricing.

Okay. So I'm just trying to think through, then later the comment about '05 price increases should offset -- ?

Increases in '05 compared to '04.

So net/net the $90 million in '04, as a percent of your cost of goods was nearly 2 percent. So you are saying the increase this year would be about 1 percent. Thus you raised price 1 percent, and that's all you need to net out, so offsetting.

David we took price increases at several different places across 2004, but we're taking much more aggressive actions in 2005, because the commodity prices have risen and are remaining high. So we are saying that we are going to be able to offset the increase in commodity prices coming from 2004, into 2005. That doesn't necessarily make the Company entirely whole back to 2003. That's not what we are saying.

No, I'm not saying that. But what I'm implying is 1 percent pricing doesn't appear like it's going to offset the cost. I would think your price increases in '05 are not going to get offset with just a 1 percent price increase.

But we had revenue of $8.4 billion, and we're saying that we expect roughly an 8 percent increase. So when you -- when you do the math on that, I think 1 percent works.

The other thing is that we are, again, managing our supply base and there are certain parts of the business -- certain parts of the world we have contractual price reductions, as well as I said we are resourcing. That takes a long time in some cases, but we're resourcing. So it's not just pricing to our customers. We're also managing our supply base which factors into it.

Okay. So the 1 percent kind of out-the-door is also, when you say you will offset your costs with pricing actions, also the pushback out the other side to your suppliers? So you are get some cost reductions from your suppliers on some contracts?

Yes.

And we are also implementing our own cost reductions.

And lastly, on the sales outlook. Not to beat a dead horse here, but I'm trying to understand 6 to 7 percent, and basically 5 to 6 percent on units, and maybe I will address this to Tom first. Clearly, Tom, the comps get hard for you on PowerGen, I understand that. But would you characterize your backlog currently in that mode of 5, 6 percent unit? Or is there a big back half degradation in the growth rate? I'm trying to understand, the unit growth just seems a bit modest when you look at the end mark momentum starting the year.

Yes, there's no question that there's a lot of order momentum. But remember, as we sort of finish the year, we're operating from an engine supply, particularly, at the high end, pretty much at capacity. So we are growing at the high end, with growth that Joe's business is doing and growing capacity. So all the investments he's making to up capacity, help me capture more of the market. Now, at the lower end, we have more ability to grow, because we have less capacity constraint. We don't really have much capacity constraint in assembly, Genset assembly capacity, but we do in engines, and we do in alternators. So in both those areas we're investing, just as Tim said, incrementally to get fast return and get capacity up. So a little bit of what you are seeing is from a growth rate point of view, is just us dealing with the fact that we've got more orders than we've got capacity to ship today. But I think we're incrementally making progress on that. And the more progress you make, the more we'll be able to up that revenue. At least for the first half of the year, you are right to say that orders look stronger than our ability to serve.

As I'm trying to understand it, if you are selling to a PACCAR Freightliner, I can understand, if you can't build them the product, you still can't hit them for a full price offset, and get a big price increase to let the revenue grow, more that way than unit volume. But, Tom, you, or even the Filtration Business on the MRO, or even the distributor business, why are you not looking at the economics of, if we can't build the engine, and we're restrained that way, but demand is that strong, raise prices more?

Yes, it's a really good question, David. And, in fact the numbers Karen gives you are averages. So in the PowerGen business, our increases are higher than that. And so we have now increased prices in generator sets and G-Drives in every major market around the world, and we have increased it by more than those averages. And by the way, we're looking to increase it more. So we are clearly pushing prices. There are parts of the business where we haven't seen matches by competitors, and so there are still places that are discounting, which make it difficult. But to the point you are raising, our view is that we are trying to push prices up pretty much everywhere. And in places where we're capacity constrained, we're pushing up faster. So, that's exactly what we see too.

So it's the negative truck engine pricing getting offset by a lot more than 1 percent in other parts of the company? Essentially. To get down to 1 percent, it's got to be the math on the truck engines.

Yes, well in some of our long-term truck agreements, we have committed to price reductions over the initial period of the agreement. So that's a negative number, in the 1 to 2 percent that Karen talked about earlier. Though, we have been somewhat successful so far in negotiating some price increases, despite those cost reduction commitments, relative to what we signed up for in the agreement. But, yes, we -- that is -- that has a modifying effect on the size -- the overall average price increase across the business.

And last related question, maybe Tom specifically, but really across the board, are your competitors -- do you feel as capacity constrained, where there isn't any market share loss risk here? Say specifically, Tom, PowerGen. Obviously, I'm thinking CAT or Jenbacher. Where do you see their capacity and their ability to serve demand relative to you?

In general, I would say in the large engine market, so in our place, that's sort of 1 megawatt and above, it looks to us like there's a lot of capacity constraints across the industry. Now, again, I can't speak to every one of the competitors in every region, but I would say that generally, there are capacity constraints across the industry. I think in the lower, smaller sizes, that's less of an issue.

Let me -- we're going to have to wrap it up. But, I think it's -- the point I tried to make, and I'm not sure that I made it well enough, is that the key for Cummins, and I think for some of our competitors as well, is to manage the Tier 2 and Tier 3 supply base to increase capacity. And your assumptions about revenue growth need to be tied back to at least Cummins assumptions on our ability to manage that, because we are at capacity in several businesses. And I would like to just summarize, because we got into - as we should - some details in the quarter. But if you step back, and compare where we were a couple of years ago, the Engine Business had a terrific quarter, and had a terrific year. They've got new products coming out. They gained market share. And really looks good for the next couple of years. In Power Generation, Tom has taken a business that was really struggling a year to 18 years ago, we're at 5 percent of sales, and the recovery is in place. We have got a good market to go after. We think that's going to be strong.

The International Distributor Business goes from 1 record to the other. And the Filtration Business has struggled in 2004, but we think we've got some of the issues isolated, and we're putting in a recovery plan in place. You look at China and India from a standpoint of growth in our joint ventures. We've had some improvement in the gross margin. There's more to go after. So, I think it's really important to, 1) focus on those positives and also, I think we've got an awful lot going for us. As I said publicly, I think that we are positioned as well as I've ever seen us, for 2005 and 2006. So, I want to thank you for your attendance today, and we'll be talking with you.

Thank you for joining us. Please feel free to give me a call with additional questions.

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