康明斯 (CMI) 2005 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Cummins, Inc. first-quarter teleconference. 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, Michelle. Welcome, everyone, to our teleconference today to discuss Cummins' results for the first quarter of 2005. Each of you should have received a copy of our press release with our financials. If you have not received these copies, please let us know and we will get 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. 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 the forward-looking statements. A more complete disclosure about forward-looking statements begins on Page 59 of our 2004 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 Web site for the reconciliation of those measures to GAAP financial measures.

Now, I will turn it over to Tim for some opening remarks.

Good morning.

The first quarter was another good quarter for us with net earnings nearly tripling that from the first quarter of last year on 25% increase in sales. We have shown significant year-over-year increases in profits for the last five quarters, reflecting increased market demand but also our ability to convert those sales into higher earnings. Our cost structure improvements and focused execution have enabled us to deliver bottom-line results. 2005 is shaping up to be another record year for Cummins, and our expectations for 2006 are even better.

Cummins' sales in the first quarter were $2.208 billion, an increase of 25% from the first quarter of 2004. We continue to benefit from high levels of demand with increased sales in each of our businesses. Earnings before interest and taxes for the first quarter were $163 million, or 7.4% of sales, compared to $78 million or 4.4% of sales last year. This reflects an incremental return on sales of 19%, which is near our overall target of 20%.

Cummins, along with others in the industry, continue to face a number of challenges, including supply chain constraints and commodity price pressures. We are seeing improvement in supply-chain bottlenecks and we've implemented pricing actions to mitigate the commodity price impact. Our businesses executed better than in previous quarters, and we achieved increased production that met customer demand in most markets. We also achieved better operating efficiencies, as demonstrated by this improved financial performance. We are operating at the midpoint of our targeted EBIT range of 6 to 9%, and we expect to move higher in the range across the remainder of the year as we achieve greater price realization, further improvement in manufacturing efficiencies, and additional cost-reduction benefits.

Net earnings for the quarter were $97 million, or $1.96 per share, compared to net earnings of $33 million, or $0.76 per share in the first quarter last year, for a 194% increase in net earnings.

Sales for the Engine business were up 31% compared to last year's first quarter, with increases in most market segments. In automotive markets, this quarter's sales were 23% higher than last year, as we continue to benefit from both higher end-market demand and growth in market share. Our heavy-duty and medium-duty engines continue to perform very well, and we have gained additional business as a result.

Shipments of 33,400 engines for the Dodge Ram, while down compared to last year's first quarter, remained at healthy levels. We are expecting significantly higher volume for these engines in the second half of this year with the introduction of Chrysler's new model truck.

In industrial markets, we saw increases in nearly every market segment with significant increases in international mining and marine sales and North American construction and agricultural demand. We are also benefiting from increased penetration of oil and gas markets.

In total, the EBIT margin for the Engine business in the first quarter was 7.6% of sales, near the high end of the business' targeted range of 5 to 8%.

Power Generation sales were up 19% compared to the first quarter last year, driven by growth in demand for commercial gen sets. We continue to see robust demand in the Middle East, driven by economic expansion, and we are gaining penetration in our European markets with our redesigned lower cost products. Sales in North America were also higher, primarily driven by increased capital spending.

Sales of consumer products, while down slightly from last year, continue at very healthy levels. Overall, Power Generation earnings were $17 million, or 3.9% of sales, compared to $6 million or 1.6% of sales last year. This increase reflects the benefit of higher demand and price realization but also significant improvement resulting from the business' cost reduction work.

Our Filtration and other business had a strong sales quarter, with revenue up 16% compared to the first quarter of last year. The business continues to experience significant demand in North America and in Holset turbocharger sales in China. Higher commodity prices and manufacturing supply chain inefficiencies continue to have a greater relative impact on the filtration business, although the business is performing better in addressing these issues. Earnings for the segment were $4 million lower than last year's first quarter but improved $5 million on relatively flat sales compared to the fourth quarter of last year. The business implemented additional price increases at the beginning of this year and numerous operations and supply improvement initiatives are in process. We expect to see continued improvement across the remainder of the year.

Our international distributors performed very well in Q1 in what is typically a seasonally weak quarter for the business. Sales were 26% higher than the first quarter last year with increases in every region except China. Distributors in Middle East and Europe experienced significant increases in revenue. Earnings before interest and taxes were $12 million, or 5.6% of sales, compared to $8 million, or 4.7% of sales, last year. This reflects a 50% increase in profits on the 26% sales increase, which is in keeping with the business' objective of growing earnings much faster than sales.

Our joint venture operations are on track for another strong year, delivering income of $31 million for the quarter. While we continue to benefit from earnings across our joint ventures, the significant increase over last year's first quarter was with our JVs in China. Our joint venture with Donfeng is performing very well, and we are investing in capacity increases that will enable us to further capitalize on the growing local demand. These investments are being funded by the joint venture while the joint venture is still providing significant dividends to the partners.

In the first quarter, we announced a feasibility study regarding a future joint venture with Shaanxi Automobile Group to produce heavy-duty engines in China. We believe there is a tremendous opportunity for growth in the Chinese truck market. With the expansion of the road system and the continued strong growth in the economy, there will be a need for more and larger trucks to haul freight. With our long-standing presence in China, our strong partnerships, our superior products and our extensive service and distribution network, we are very well positioned to capitalize on this opportunity.

Our emissions compliant heavy-duty engines continue to deliver very good performance for our customers, and we now have over 100,000 engines in the field with a total of 9 billion miles of service. Evidence is growing that our engine reliability, performance and fuel economy are the best in the industry. At the Mid-American Truck Show, we shared data from a 600,000-mile engine tear-down the ISX engine. We now believe the ISX EGR engine will be at least as durable as the N14. Our market share remains at strong levels with further opportunity to gain business with our heavy-duty truck-going partners. With no major changes required to our engines, we remain confident that we will deliver the best products for our customers for the 2007 emission standards. Our 2007 programs are on schedule and going well. Field test customers will start receiving test units through OEMs before the end of this quarter and throughout the rest of the year. By the time of product launch, our engines will have accumulated over 11 million miles.

In addition to our financial achievements, we've recently been honored with a very special recognition. Cummins has been named number one among the 100 best corporate citizens by Business Ethics magazine. The ranking is based on performance in a number of categories, including return to shareholders, community, governance, diversity, employees, environment, human rights, and product. This is a tremendous honor for Cummins and I personally am very proud of the Company's long-standing tradition of ethical and social responsibility behavior and all that our employees have done to merit this award.

Now, for a quick update on or guidance, with our strong performance in Q1 and the outlook for continued robust demand, we are raising our estimate of revenue growth to around 10 to 12% for 2005. We are also raising our earnings guidance for the full year from $8 to $8.30 to a new range of %9 to $9.20 per share. For the second quarter, we expect earnings per share of between $2.25 and $2.35 per share.

This was another good quarter for us. We are clearly benefiting from strong demand across a number of our more cyclical markets, and our execution has delivered excellent bottom-line results. At the same time, though, we're making significant progress towards our strategic initiative of growing the more stable, less-cyclical and less capital-intensive parts of our business.

Our international distributor business has grown sales at a compound annual rate of 15%. It has gone profits at a compound annual rate of 25% since formation of the business in 2002. Our business with Chrysler for the Dodge Ram has grown each year and every year since 1998 -- I'm sorry, 1988 -- except during their model changeover year in 2001 and 2002. We are confident of increased demand in the second half of this year and more in 2006.

Our joint ventures are delivering outstanding performance and the full range of JVs provides a diversified earnings stream to yield greater stability in income, going forward. Income from joint ventures grew by $48 million in 2003, by another $41 million in 2004. While the rate of growth is expected to slow in 2005 and beyond, this income will provide steady growth over time.

We are also focused on growing our parts and service business across all markets and are targeting growth in specific product applications that have fire parts usage. These areas of the business combined will contribute a higher percentage of our earnings over time. This has already provided and will continue to provide increased stability in financial performance. In addition, as we manage our investment in the more cyclical parts of our business very carefully and our stable product architecture lowers development manufacturing morning (ph) costs, we are positioned to weather future downturns in our cyclical markets much better than in the past. We do not, however, anticipate any downturn this year or next. We are also taking significant actions to strengthen our balance sheet to position us well over this cycle.

For the present, we are benefiting from strong demand across nearly all of our markets, and 2005 should be an excellent year as a result. We believe 2006 will be even better.

Now, I'll turn it back over to Karen to review the details of our first-quarter results.

Thanks, Tim. I will provide comments regarding each of our four business segments, beginning with the Engine business.

Total sales for the Engine business in the first quarter were $1.495 billion, a 31% increase from sales of $1.139 billion a year ago. Revenues in automotive markets were 23% higher than Q1 last year with increased demand in all segments except light-duty automotive and RV.

Overall revenue from industrial markets was up 57% year-over-year with increases in nearly all segments. Earnings before interest and taxes for the quarter were $114 million, or 7.6% of sales, versus $40 million or 3.5% of sales in the first quarter last year. The increase in profitability during the quarter was primarily driven by the significantly higher volume, the associated leverage, improved pricing, earnings from unconsolidated joint ventures, and the business' cost structure improvement.

Revenues for the heavy-duty truck segment as a whole were up 47% in the first quarter from a year ago while global unit shipments were up 69%. The variance between the revenue and the volume increase was due to the mix of engine versus part sales.

Part sales increased 12% compared to first quarter 2004 but were a lower percentage of overall revenues in this year's first quarter. Unit shipments in the U.S. and Canada were up 71%, driven by nearly 50% growth in the heavy-duty truck market and by year-over-year share gains. 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 59% with higher sales to OEMs, primarily in Mexico, where the growth in the heavy-duty truck market exceeded 30% versus last year.

In the worldwide medium-duty truck and bus market, total revenues increased 18% for the first quarter year-over-year. Medium-duty truck engine shipments were up 37% in the U.S. and Canada with significantly higher volume with several key OEM customers, due to market growth and account penetration. International shipments were up 28% with higher OEM sales in Brazil and Europe. Global bus engine shipments edged 19% higher year-over-year, due to improved demand at key North American and Indian OEMs.

In the light-duty automotive and RV segment, revenues slipped 5% this quarter compared to a year ago. Engine shipments to DaimlerChrysler for the Dodge Ram pickup truck were 33,400 units, down 13% from the first quarter last year, as Chrysler managed its dealer inventory and of its launch of the '06 model year truck. However, unit shipments for North American RV and light-duty automotive outside of the U.S. posted year-over-year gains of 18% and 11% respectively. We expect the launch of the new Dodge Ram mega-cab with the full-sized crew cab to run sales higher in the second half of 2005 and achieve another record year of shipments to Chrysler.

Sales to industrial engine markets in total were up 57% from a year earlier with increases across nearly all segments. Excluding the revenue of entities not consolidated last year, the increase was 42%. Revenue in the mining segment continues to be strong, up 57% compared to last year, with shipments up 62% internationally, due to increases in Russia in Europe fueled by increased commodity prices.

The commercial marine segment saw an 84% increase in sales compared to last year on a 27% increase in units due to a favorable mix in its international market, particularly China and Asia-Pacific.

In the construction equipment market, excluding the revenue of entities not consolidated last year, revenue increased 29% compared to the first quarter of last year. Unit shipments in North America were up 23%, while shipments to international markets edged up 1% due primarily to improvements in Europe and Latin America that offset the softness in China from excess dealer inventory.

Sales in the Power Generation business for the first quarter were $439 million, up 19% from the first quarter of -- (technical difficulty). Half of the revenue increase, or $35 million, is attributed to two operations that were not consolidated in Q1 of last year. The commercial line of business represents the rest.

Commercial reported revenue of 43 million, or 22%, and experienced growth across all of its major geographic regions but primarily in North America and EMEA. Driven by the recovering economy, North American demand in Q1 2005 has been stronger than previous years and produced (indiscernible) seasonal decline from Q4, 2004. Favorable commercial investment in the EMEA region this quarter should continue to drive demand for our products, especially in Iraq.

Overall market conditions in Asia continue to be strong through Q1, 2005. Sales to gen set OEMs in China and Singapore, primarily driven by China demand, continue at record levels with OEMs having ordered engines for delivery through Q3 '05. Expectations for summer power shortages in China, similar to last year, continue to drive demand for gen sets above 500 kva. In the first quarter of 2005, Power Generation reported earnings before interest and taxes of $17 million, or 3.9% of sales, compared to $6 million, or 1.6% 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 pricing improvements.

Revenues for the Filtration and Other segment were $403 million for the quarter, a 16% increase compared to the first quarter of 2004. In Filtration, all geographic regions experienced volume increases over the first quarter last year with North America leading the way. Revenue also benefited from pricing actions taken and a favorable currency impact in Europe and Canada. Holset turbocharger sales continue to be at strong levels to OEMs in North America, Europe and China. This segment's earnings before interest and taxes for the quarter were $20 million versus $24 million in the first quarter last year. The higher volume contributed $11 million in additional profit but was exceeded by continued -- by improving cost pressures in several areas. Manufacturing and logistics inefficiencies resulting from the increase in volume added $8 million of costs, compared to last year's first quarter.

Steel and other commodity price increases contributed $4 million net of pricing actions to customers and higher research and engineering spending for new product development costs $3 million more than last year. The initial steps taken to address the operating inefficiencies experienced in the last half of 2004 have become evident, as the segment EBIT improved $5 million versus the fourth quarter of 2004 on the same level of sales.

Sales for the international distributor business were $215 million in the first quarter, an increase of 26% compared to the first quarter last year. Sales remain very solid across product lines and geographies with greater than half of the increase coming from engine and power gen sales, particularly in EMEA and Asia. Currency added another $6 million to the total sales increase. Earnings before interest and taxes for this segment were $12 million or 5.6% of sales, compared to earnings of $8 million or 4.7% of sales last year.

Next, for a few comments on gross margin -- the gross margin percentage for the quarter was 20.7%, up from 19.5% in the first quarter last year. The absorption benefit of the higher North American automotive shipment increased volume across our businesses and price realization were the primary drivers for the improved margin.

Partially offsetting the benefit from the higher volumes were a few key items. Manufacturing inefficiencies totaled $21 million, resulting from the significant volume increases, including premium freight and overtime, and the impact of commodity prices was $9 million net of price recovery. The total of these items was $30 million, or 1.4% of sales, and has improved from the $57 million we reported in our Q4 earnings announcement. While comparisons to the first quarter of last year remain unfavorable, we've made considerable improvement in both areas and expect the impact to become favorable in the second half of 2005.

Price realization in response to commodity increases is one side of the improvement, which Jean will address in a few minutes. On the manufacturing-cost side, we have made improvements in capacity in our supply base through global sourcing efforts aimed 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 cost.

Product coverage cost was 2.8% of sales, or $61 million in the first quarter, compared with 3.7% of sales or $65 million a year ago. Product coverage costs on a per-engine basis have continued to decrease, reflecting the improved performance of our products.

Total selling, admin. and research and engineering spending in the first quarter increased from a year ago but declined as a percentage of sales. SAR (ph) spending for quarter was $322 million or 14.6% of sales compared to spending of $279 million or 15.8% of sales last year. Within SG&A, the year-over-year increase included approximately $12 million from the consolidation of additional entities, $14 million from higher salaries and wages, and $4 million from currency. 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 2.9% of sales but increased on an absolute basis by $7 million to support new product development. We continue to tightly manage this spending while providing the necessary funds for all major technology development.

Our income from joint ventures and alliances in the first quarter was $31 million, compared with $18 million in the first quarter last year. The increase in income was predominantly from the China joint ventures, as our partnership with the second-largest truck OEM in China allows us to participate in the expansion of the automotive markets there and build brand leadership.

Interest expense for the quarter was $28 million, compared to $27 million of reported interest expense in the first quarter last year. Although the consolidation of additional entities and capitalized leases added $4 million of interest expense this quarter, we expect the savings from the retirement of the 225 million bond on March 1 to reduce interest expense in subsequent quarters.

Thank you. Now, I will turn it over to Jean.

Good morning.

Let me provide some greater detail on taxes and commodity prices before making some comments about our cash flow. Income taxes for the first quarter were 25% of profit before taxes. This tax rate is lower than we expected for the remainder of the year because it includes a $6 million, one-time benefit on a foreign dividend we have determined will qualify for reduced taxes under last year's Jobs Act. We are assessing the potential qualification of additional foreign dividends during 2005 that may produce additional tax benefits of 5 to $10 million. Without the Jobs Act benefits on foreign dividends, our 2005 effective tax rate is about 30% of profit before taxes. Including these benefits, we expect income taxes for the remainder of 2005 to approximate 28% of pre-tax earnings.

Next, although we did experience some additional commodity price increases in our businesses in Q1, we are seeing improvement. Commodity prices, primarily steel, continue to have an impact on material costs for several of our businesses where we buy steel directly or indirectly through the bought-out finished components we source. Steel market prices appear to have peaked in late Q4, after moving up as much as 100% over 2003, but we are beginning to see some softening on some select types and grades of steel. Based on feedback from CRU other industry analysts, further improvement in steel pricing is predicted for 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, at a minimum, offset our current estimate of the full-year incremental impact of commodity price increases in 2005.

After severe market tightness in mid-2004, availability of steel has improved significantly. While some grades and sizes remain in a tight position, we are having no major problems getting the steel we need to run our business. We do not expect availability of steel to be an issue for the remainder of 2005.

Finally, for a few comments on cash flow, although cash flow from operating and investing activities was a net outflow of $80 million this quarter, compared to a net inflow of $27 million last year, we expected the unfavorable change in receivables in the first quarter due to the termination of an accelerated Accounts Receivable payment program provided by Chrysler through GE Capital. Excluding this change, we would have had a net inflow from operating and investing activities nearly two times greater than that of a year ago.

Changes in working capital represented a net cash outflow of $216 million for the quarter. Excluding the change in financing programs mentioned above, working capital as a percent of sales increased slightly to 16.2% at the end of this quarter, and Days of Sales Outstanding edged up to 55. Both inventory and Accounts Payable increased during the period but much less than a year ago. We have renewed our focus on tightly managing our working capital.

Spending on Capital Expenditures, internal use software development and investments in joint ventures and alliances for the quarter was nearly equal to the same period a year ago. However, as we communicated in our Q4 earnings teleconference, we expect Capital Expenditures to run higher in 2005, within a range of 220 to $240 million. We reduced our debt by $259 million in the first quarter and intend to further reduce our debt with ongoing cash flow generation. Combined with the renegotiation and removal of bank liens on our revolving credit facility last December, we believe we have achieved investment-grade credit metrics, which is consistent with our belief that we should return to an investment-grade rating in 2005.

Thank you, and we will now take your questions.

Thank you. Ladies and gentlemen, the floor is now open for questions. (OPERATOR INSTRUCTIONS). Peter Nesvold.

I'm from Bear Stearns. On your increased revenue guidance, can you maybe sum up a little more specifically what areas are trending better than you previously expected on the fourth-quarter call?

Peter, actually I think it's just a combination of (indiscernible) across-the-board increases, so some of our revenue guidance before we indicated that we -- there were -- with the capacity constraints, you know, demand is exceeding what we can actually produce at this point. So it's really that we made some improvements and we've gotten more comfortable with what we can actually get out the door and we are just taking it out across the board.

Okay, that's great. You mentioned you're getting some pricing out of the long-term agreements from materials. What about anything from pure (ph) pricing?

There's not really a perfect way to separate commodity price, pricing adjustments and general pricing for us, so we've kind of put it all together and in total, we are probable that we're going to get enough pricing, as we said, to at least offset the commodity price increase in 2005 and maybe additional pricing.

The pricing is permanent pricing, though; it's not surcharge pricing. We've also changed the discount structure in some of our businesses, for example power generation, so we're realizing better margins in that area. Also in some long-term agreements, there are cost reduction, shared cost reduction agreements and we've changed some of those over time, so it's not just straight pricing.

Okay, that's helpful. On the SG&A side, it looks like it came down about $22 million quarter-over-quarter. Seasonally that's not normally what happens. What drove the improvement in SG&A, and is that sustainable?

Right. Peter, that's really more a function of exactly how our accounting periods work, but this year in the first quarter, we had a one-week shorter period, so we had like a 12-week quarter. If you would look at that kind of run-rate, the Q4 rate would probably be more indicative of what you'd expect across the rest of this year.

Okay. Last question and I will hand it off -- can you give us a sense for the engine profitability year-over-year, excluding the joint ventures?

Well, I mean, it's easy for you to be able to do that math, I guess. In terms of the 31 million that we reported for joint ventures, 26 of that in Q1 came from the Engine business.

Okay.

In last year, with 38 million for the total -- excuse me, no, no -- 18 for the total company, 15 of that came from the Engine business a year ago.

Perfect, thank you.

So you are seeing improvement on the Engine business performance, excluding joint ventures.

Terrific. Thanks for the time.

Gary McManus.

JP Morgan. While we are on the joint venture, you know, can you break out the remaining 5 million with the other three segments?

Sure, Gary. Two would be for power gen this quarter, two for filtration and other, and one for the international distributors.

Okay, great. I remember your guidance on the joint venture income for 2005 that you talked about on the previous conference call was only slightly higher income. I remember you were saying that you expect to have a higher tax rate there, but at 31 million, I do not know what you were expecting in the first quarter specifically but that was very strong and certainly a lot stronger than first quarter '04. So can we revisit on what your expectations are for joint venture income this year?

I don't think it's really different than what we told you before, Gary, because I think we are seeing the same things in China that we're seeing in some of our markets here -- is that demand is very, very strong and so that the industry is kind of struggling a little bit with the capacity. So I think you're going to see it more even across 2005. We've actually demonstrated really good earnings, even with the higher tax rate, but it's going to be similar to that run-rate.

So I should expect low 30s or so per quarter for the rest of the year?

I said similar to what we did. We're really not going to get more exact than that.

I mean, similar to what you did in the first quarter or similar to what you --?

Similar to what we did in Q1, exactly.

Okay, I wanted to make sure that's right. You had a big fourth-quarter number with a low tax rate. What is the difference in the tax rate, you know, between this year and last year? I mean, if we looked at that?

You mean on a numbers basis? For Donfeng, it's actually at 15% right now for 2005, and that's double the rate that we had in 2004.

I guess what I'm saying is, how much is the higher tax rate overall will all of your joint ventures? How much is that constraining the joint venture income relative to last year?

The tax issue is primarily associated with Donfeng, where we've had kind of tax holidays. As the business was new, the government gave us incentives for foreign investment, so we had a lower tax rate. That really provides -- I mean that is really associated with the Donfeng joint venture. Again, it does that by 7.5%.

In terms of how much impact is, you know, that will depend some on the operating earnings of the joint venture for the year in terms of what the absolute amount of that difference is.

The second question is can you talk a little bit about your overall capacity and the ability to raise capacity not just on the heavy truck engine market but perhaps in some of your other product areas as well?

(technical difficulty) -- different parts of our business and it's different for some of our components business. I think the most constrained was our Fleetguard exhaust business, and they are starting to have bottlenecks and the operations are better there.

The Power Generation business on commercial gen sets is constrained from the supply base. Primarily engines and alternators have been the main issue. However, they also have been able to get more out of the supply base and therefore have shipped more. The tightest part would be above 500 kw (ph) with some of the bigger engines.

Most of our engine businesses and plants have increased capacity through Six Sigma efforts, and I will let Joe talk about Jamestown here in a minute, because I think that's a big success story. But we've also had an enormous amount of people in the supply base that are supplier quality engineers, as well as our Six Sigma belts, so we've seen incremental.

Then finally, we have invested some incremental capital that we should see some increased capacity in the fourth quarter of this year and in 2006. I will remind you that our capital was expected to be between 220 and 240 million and almost 40% of that is addressing capital or addressing capacity constraints. The biggest investment of that I think is around $14 million, which is a block (indiscernible) in Brazil, so there's lots of 5 to 7, $8 million investments all over that are busting short-term capacity, so we think we'll see some incremental improvement.

Joe, why don't you talk a little bit about Jamestown that gives you an example of increased productivity?

Yes, I think that our approach in general in terms of capacity improvement, not just in heavy-duty but particularly here, has been a step-by-step approach in terms of gradually taking up capacity within the Company as well as working with suppliers. The basic tools we've been using are Six Sigma, and while focusing on trying to improve capacity in Jamestown, we've also managed to make significant improvements in safety incidents; the plant was already better than national average. It's gotten much better in that regard -- and significant reductions in quality defects to customers.

I expect that, coming out of this year versus where we came into this year, we will be, capacity-wise for ISM and ISX, somewhere in the 12 to 15% higher range coming out of this year versus where we entered the year. We're doing that, again, on a step-by-step basis, because some of it is paced by the rate and pace at which suppliers can improve capacity. We've tried to help that. We put our own Six Sigma belts and quality improvement people in the plants with the key suppliers; we've worked with them on targeting Six Sigma projects; we've worked with them on targeting specific capital-improvement projects to get the results. So, right now, we are feeling like we are going to make -- continuing to make steady improvement in our ability to ship heavy-duty engines while not significantly investing in the capacity we might not need in the future and using Six Sigma as a way to kind of get ourselves and our suppliers to work significantly better from an efficiency point of view.

Okay, great. Thank you.

David Raso.

David Raso, Smith Barney. I know you don't usually like giving the detail on the engine profitability broken out by the divisions, but can you just help us a little bit with the strong incremental margins on the Engine division? Can you help us understand? Are the incremental margins right now stronger on the industrial piece than the heavy trucks? I'm just trying to get a feel for the transition. You know, looking into a potential truck downturn, what can the other pieces of engine do for you?

Okay, David, I think that, as you said, that's not the way we talk about it, the pieces of the engine business profitability, but you know, we're seeing improvement really across the board in all of the different engine markets. You know, we've made a lot of cost structure improvements and you've just seen those being reflected in the results, but we are definitely getting incremental margin from our industrial business, so it's just not all coming from heavy, if that's what you're trying to drive at.

I think the only thing to add, maybe, David is just, as a result of a lot of the work we did in late '02 and '03, we've cut our breakeven point in heavy-duty in half. So one of -- and we think, we know that our product is doing significantly better from a reliability/fuel economy and now durability point of view. So, I think, as we go into whenever the next downturn happens, whether it's economically driven or emissions-driven, I think we are well-positioned better than we've ever been, from a cost point of view, and also in a terrific position to increase share, relative to the other guys, based on how well our product is doing and the demand increasing for it out in end-user markets.

To that point, clearly cutting the breakeven point in half and even the most bearish thoughts on '07 is coming from pretty a high level, so if you cut the breakeven in half, you should be still nicely profitable in heavy truck, probably anywhere above 200,000 units in '07. I was just trying to get a feel for what can be tacked on in industrial and Dodge Ram? Is there any help you can give us, Tim, where, if we did 220, 230,000 in North America in '07, just order of magnitude, the different level of profitability, the way it's configured today versus --?

I can't answer that, David.

Okay, I appreciate it. Thank you.

Andrew Casey.

Prudential Equity Group. Good morning. Just a couple of detailed questions and then one back on the constraints -- the first detail -- was there a change related to the preferred convertible dividend (indiscernible) back? It looks a couple of pennies lower year-over-year, or should I check my math again?

I think you need to check your math, Andy. There should be no change in the impact of how the convert shows up in our results. Once it became dilutive, it's been in every quarter, so we can talk to you about that off-line is that will help, but no change.

Thanks. On the tax work you mentioned, is any of the incremental that hasn't been achieved at this point included in the guidance?

Help me with your question then on the incremental --?

Yes, I think Jean mentioned something like 5 to 10 million that you are still working on that really isn't --.

Yes, all of that is included in our 28% guidance for the rest of the year.

Our guidance implies the 28 for the year.

Okay. Then, on the engine constraints, I think Tim mentioned, in response to one question ,that you're still constrained on some of the upper ends of the power gen business. Does that also apply for your mining customer-related engines?

Yes. This is Joe, Andy. The constraints apply virtually equally across the markets, but let's be clear. I mean, we came out of the first quarter, for instance, in terms of our highest volume engines producing about just shy of 10% higher than the number of units we were producing coming out of the fourth quarter. We have a very step-by-step, slow-but-sure program to increase capacity shipments as we go through the year out of India and out of the UK and also now working very aggressively with our partner, CCEC, on increasing capacity at the lower end of that range. So yes, we are constrained; we're not meeting all the demand that is out there at a moment, but our capacity has steadily improved and will continue to steadily improve through the course of the year.

Andy, I would add that the capacity shortfall in the larger engines is also helping the industry a little bit because, as you know, back in 2001, pricing fell significantly in that larger generator (indiscernible) industry and some of it -- we are covering some of the pricing in the industry as a result of the general shortfall. So, we are definitely doing more work to increase capacity but we're also trying to do a lot of work, as Tim mentioned, on trying to get pricing up, given what we experienced a few years ago.

Thanks. Then the last question on ISX and ISM, the 12 to 15% capacity improvement that you talked about end of '05 versus '04, when we are sitting here looking back at the end of the first quarter versus end of '04, you know, is that a quarter of the way there or is that more than that?

It's less than that.

Brian Rayle.

FTN Midwest Research. A question for you with regards to Power Gen sort of thinking longer-term -- you know, we continue to hear that there are -- the power constraints in China and India might actually be worse than originally expected with, you know, basically oil prices coming up and sort of market controls there. Is it possible that the Power Gen business ends up being stronger than you guys are expecting in your guidance, you know, even through '05 or even sort of out a couple of years, again kind of going to that, the thought process of what '07 looks like if Power Gen continues to grow solidly through there? Just any thoughts on that?

Brian, this is Tom. There's no question that there are scenarios which drive higher volumes in Power Gen than we are assuming. This year, definitely that we have capacity limitations, particularly in the large engines that (indiscernible) discussing that limits a little bit our upside. As Joe discussed, our opportunity really is working together to get incremental capacity out through the Six Sigma projects and other efforts which keep capital down but increase capacity, and those have been really successful. So I think we've still got opportunity there, but further out, there's no question that there are scenarios, and China would be one of those, that could potentially drive higher volumes. I think the watch-out in China is that the market there is for -- today is for a lot of this -- what we would call sort of semi-prime power where the grid cannot provide power to factories every day of the week, so they are making them take a day off or two days off the grid. They need to run all the days of the week so they buy a generator and run it all the whole day, when they don't have grid power. That market is typically a temporary market in most countries. India has been -- it's been a significant market for a long time, but most countries add capacity and distribution capability to kind of get back to a normal state of affairs, at which time our Power Generation market shifts to more standby kind of power. That's still a good market for us, standby. We are a very large standby provider and I think that will still be a bit opportunity for us, but as the race is on now to put in these semi-prime units and that's the market that we think will cool and some point. What year, how China keeps up with its power demand is very difficult to predict. We definitely think their shortage is going to last longer than most people thought a year ago, but how much longer is unclear. They are definitely building, adding capacity at a pretty good clip, so we'll see how long it does. But there's always someplace in the world where there's a shortfall and we will be ready to provide it. Then our view is that, as all countries get more needs for power, even as the grid improves, their needs for standby increase, which is, again, a good opportunity for us.

A follow-on to that -- if you look at the sub-prime market that you're talking about as it switches to standby, you know, obviously the power gen capacity would have to get better. I mean would you expect to have more standby I guess per factory or per unit, sort of that mix, compared to North America, just given there will still be concerns about the power grids?

I think, on a per factory basis, the answer would still be no. The reason is that there are -- in North America, there is legislation essentially, or safety rulings or whatever, that require people to use it, so there's several drivers. One's economic; I don't want to be down when I want to produce products. But there's also safety and legislative drivers, which sort of, in the U.S., kind of make everybody of a certain type has to have a standby generator.

I think, in China, the economic driver is stronger, as you just discussed, and there's more likely that they will have an outage, therefore the more likely they want to have a generator that can drive their production. So they may buy larger standby units but in sheer numbers, still the legislation in the U.S. means more percentage of factories and office towers and things have standby units and probably will for some time.

Thanks and great quarter.

David Bleustein.

It's UBS. Following up on Gary McManus' question, can you talk about where the supply-chain bottleneck still exists? Where are you still having trouble sourcing parts?

Most of the issues have been around a variety of major castings, either in some cases the casting itself, in some cases the machining of the casting, so most of the bottlenecks have been in and around those areas, and so that's the areas where we have been doing a significant amount of work to make improvements.

But hydraulic components are better?

For us, at least, in terms of -- yes, simple answer, yes.

Okay. Another question -- another industry player mentioned that they were doing some stockpiling of raw materials. Are you doing any of that? Do you see your customers doing the same?

Stockpiling of raw materials? No.

Terrific. Thank you very much.

Christopher Martin (ph).

Hi. It's John McGinty of First Boston. Good morning. Joe, one question -- the 12% between the beginning of '05 and the end of '05, 10 to 12%, were you talking all engines or were you talking Jamestown? On a simpler level, does that mean that, if demand were there, that your production in '06 could be 12% higher than your production in '05, or is it something that's scaled? That just wasn't quite clear.

Yes. First of all, I'm talking Jamestown, okay?

Secondly, my reference point is where we were coming out of '04, not into first quarter of '05, okay?

To answer your question, yes. If we are successful in doing what we're set out to do, you could expect that, if you compared where we were at the end of '04, that our ability to ship in '06 would be 12% or better, better.

Okay, I just wanted to clarify that. Thank you.

The second question -- Karen, you kept like teasing us -- price, you kept saying price and then you say would offset this or offset that. Could we just get what the price was in the first quarter?

Compared to first quarter a year ago, John, we had about $35 million of price improvement.

Could you refresh our memory on what that was in the fourth quarter over the fourth quarter?

I certainly can; just give me a second on that. We would have -- I think we were looking at about 25 million of price in the fourth quarter.

So one of the things I'm trying to understand is at least the implication in the fourth quarter, at least the implication that was drawn was that pricing was still under some pressure because of the long-term agreements. Without going into detail because I know you can't disclose what the details were, is that -- have the pricing pieces of the long-term agreement been totally satisfactorily resolved as far as you all are concerned?

We have gotten pricing across all of our business, including with our LTA partners, if that is what -- (multiple speakers)?

All that you wanted, all that you needed is what I am really saying.

We always want more pricing, always want more pricing (LAUGHTER)!

John, I think it's -- essentially I think we were very aggressive and I think we've made some real progress with the pricing. We had to price-protect some backlogs, which we've historically done for a long, long period of time, and so -- and some of the pricing didn't begin until January 1, so I think that you will see improvement of pricing in the second half of this year, based on the decisions that we've taken so far.

So you'll see better pricing and better margins as a result of that in the second half or second quarter or both?

Second half.

Not the second quarter?

You'll see some improvement but --.

Mostly in the second half.

Exactly.

John, I need to fix what I just said because I looked at the number incorrectly. The fourth quarter was $11 million of pricing.

Okay, so that makes more sense. That's a much -- I mean the increment is obviously much better.

Then I apologize. I had trouble getting on the call, and if you covered this at the first, just tell me and I will get it from you off-line. But in a couple of different places, you talked about changes in sales being the result of one thing and then also about entities being included this year that were not included last year. What was that and where were that (sic)? And if you've covered it, then fine, and I will ask it of you later.

I think we can do it real quickly in terms of, in Power Generation, we added some entities starting in the second quarter, I believe, of last year and we called out that that was about $35 million of increased sales compared to last year's first quarter. We also talked about, just within our explanation of industrial markets, when we consolidated -- consolidated diesel last year because of FIN 46. We tried to carve that out and give true market comparisons so that it wouldn't be distorted by just adding the case volume from CVC.

I got it. Thanks very much.

Thank you. I think that takes care of our time for today, and thank you for joining us. We will all be available for questions across today. Thank you.

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