康明斯 (CMI) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Cummins second quarter earnings conference call. At this time all participants have been placed on a listen-only mode and we will open the floor to 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 second quarter of 2005. Each of you should have received a copy of our press release with a copy of the financial statement. If you have not received these copies, please let us know and we will fax them or e-mail them to you at the end of the teleconference. Participating with me today our Chairman, Tim Solso, our Chief Financial Officer, Jean Blackwell, our President and Chief Operating Officer,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, business segment results and cash flow performance. Then Jean will comment on our performance target and finally we'll have the Q&A period. This teleconference will include certain forward-looking information. Any forward-looking statement involved risk and uncertainty. The Company's future results may be effected 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 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 website for the reconciliation of those measures to GAAP financial measures. Now I will turn it over to Tim for some opening remarks.

Good morning. Our results for the second quarter were the best in the company's history for both sales and profits. Demand continues to be very strong and our execution is driving record performance to the bottom-line. Net earnings were nearly double that of the second quarter of last year on a 17% increase in sales. Our ability to convert the sales growth into higher year-over-year earnings for the sixth consecutive quarter proves that our focus on cost reduction and execution is working. 2005 is well on its way to exceed the record performance of 2004 and to confirm our belief that 2006 will be even better. Cummins sales in the second quarter were $2.490 billion, an increase of 17% from the second quarter of 2004.

We continue to benefit from high levels of demand with increased sales in each of our segments but our pricing actions and efficiency improvements are allowing us to convert more of the volume increase into profits. In fact, our gross margin this quarter, at 22.1%, is the highest it has been in six years. Earnings before interest and taxes for the second quarter were $235 million or 9.4% of sales compared to $148 million or 7% of sales last year. EBIT margin for the quarter of 9.4% of sales was above the top end of our targeted range of 6 to 9%. This reflects an incremental return on sales of 24% in excess of our overall target of 20%. Net earnings for the quarter were $141 million or $2.83 per share compared to net earnings of $82 million or $1.76 per share in the second quarter last year, for a 72% increase in net earnings, again on 17% increase in sales.

The Engine segment achieved record revenues of $1.667 billion, up 21% compared to last year's second quarter, with double-digit growth in both automotive and industrial markets. Sales to automotive markets were up 19% over last year as both growth and market share and higher global and market demand have benefited the heavy duty truck, leading duty truck and bus markets. As you know, the North American truck and bus markets continue to report double-digit growth rates. However, these same markets internationally are also posting double-digit growth rates year-over-year and represent significant 28% of the total revenue of these markets, thanks to our market leadership in many parts of the world, especially Brazil, the UK and China. Our emissions compliant heavy duty engines continue to demonstrate leadership in engine reliability, performance and fuel economy.

Furthermore, with no major changes to our engines, we remain confident that we will deliver the best products to our customers for the 2007 emission standards. Our 2007 programs are on schedule and going well. Field test customers started receiving test units through our long-term agreement partners during this quarter and will continue to take delivery throughout the rest of the year. By the time of product launch, our engines with the emission solutions business diesel particulate filter will have accumulated over 11 million miles of field test. Shipments of 36,400 engines for the Dodge Ram this quarter, while down compared to last year, exceeded shipments from the last quarter. In anticipation of significantly higher volume for the Dodge Ram in the second half of this year, with the launch of the new model year Ram truck, we have shifted mid-range engine production within the U.S. to maximize production rates of engines for the Dodge Ram.

Sales to the industrial markets also reflected double-digit increases over last year with construction, mining and marine markets contributing to most of this growth. We also continue to achieve success with our penetration into oil and gas markets, a high growth market for Cummins. We are breaking through supply chain bottlenecks in our high horsepower plants to increase capacity and to meet market demand in both industrial and Power Generation markets. In total the EBIT margin for the Engine segment in the second quarter was a record 9.4% of sales, outperforming the segment's targeted range of 5 to 8%. Profit from consolidated operations, excluding joint venture income, was 8% of sales, also at the top end of the business's targeted range.

In the Power Generation segment. Sales were up 7% compared to the second quarter of last year with strong demand and global commercial Gensets and alternator lines of business and with an incremental return on sales of over 50%. Economic expansion in the Middle East and Asia Pacific combined with further penetration of the European markets with our redesigned lower cost products, have fueled our international growth. Demand for commercial Gensets in North America continues to exceed the 6 to 7% forecasted growth rate for private, nonresidential construction due to the secular drivers, such as standby power protection from regional blackouts and the reconstruction after natural disasters in the southern coastal states. Sale of consumer products, while down slightly from record levels last year in RV, have seen a favorable mix shift towards towable products, one the growth initiatives for this line of business.

In the second half of the year we will introduce several new products to provide additional growth for the important consumer business. We have gained margin expansion in the Power Generation through pricing actions, targeted improvement in sales mix, cost reduction initiatives and SAR spending control that together have allowed more of the increase margin to fall to the bottom-line. Overall Power Generation segment earnings were a record $35 million or 7.1% of sales, compared to $18 million or 3.9% of sales last year, nearly doubling EBIT margins in one year. Our Component segment reported revenues 15% higher than last year. Sales for the filtration and turbo charger businesses were strong for both aftermarket and original equipment manufacturer's customers. The high level of demand continues to drive some inefficiencies, primarily in expedited freight costs and both businesses are still experiencing a drag on earnings from higher commodity prices and from higher research and engineering expenses critical to meet the 2006 Euro 4 and 2007 US EPA emissions standards.

Holset is adding capacity with a new turbo charger plant announced this quarter and Fleetguard is making improvements in its Distribution system. We expect earnings improvement for this segment in the second half of 2005 and beyond. The Distribution segment posted very strong sales for the quarter, 17% higher than second quarter last year. Organic growth occurred in every region, but the recent acquisition of independent distributors in mainland Europe contributed nearly one-fifth of the total growth in sales. Earnings before interest and taxes were $26 million or 8.8% of sales compared to $20 million or 7.9% of sales last year. This segment continues to achieve its objective of growing earnings faster than sales. As I described before, Cummins is building a strong base of stable, diversified earnings from which we can grow the business.

Earnings from our global Distribution segment, plus the equity in earnings from joint ventures and emerging markets, contributed a solid 28% of EBIT in 2004 and 23% of EBIT year-to-date in 2005. Our joint ventures in emerging markets have widened our global manufacturing presence and opened new markets and supply bases to the company. Our joint venture with Dongfeng achieved higher earnings in this quarter and is in the process of investing in capacity increases to capitalize further on the growing local demand while still providing significant dividends to the partners. As our installed base of engine grows globally, we are focused on growing our parts and service business across all markets and have targeted growth in specific product applications that have higher parts usage.

This non-cyclical high margin aftermarket business adds further to this base of stable diversified earnings and represents as much as 28% of the Engine segment revenues during the trough and 20% at the peak of the economic cycle in our engine markets. Altogether the Distribution segment, our presence in emerging markets and the growing engine aftermarket diversify earnings away from the North America market cyclicality and position this company to deliver stronger more consistent shareholder returns. Now for a quick update on our guidance. With our strong performance in the first half of the year and the outlook for continued robust demand, we are raising our estimate of revenue growth to around 15% for 2005. We are also raising our earnings guidance for the full year from $9.00 to $9.20 per share to a range of $10.10 to $10.30 per share. For the third quarter we expect earnings between $2.40 and $2.50 per share. Let me close by reinforcing that this is one of our best quarters ever. We are clearly benefiting from strong demand across a number of our more cyclical markets and our execution has delivered excellent bottom-line results.

We are seeing margin expansion from our cost reduction initiatives and from greater price realization from actions we initiated in late 2004 and the beginning of 2005. We are growing share profitably, with discipline pricing, focus on cost reduction and superior product performance in existing and emerging markets. And finally, we are building on a core base of stable, diversified earnings that will continue to provide increased stability in our financial performance. As a result, we believe that 2005 will be an excellent year for Cummins and that 2006 will be even better. Now I will turn it back over to Karen to review the details of our second quarter results.

Thanks, Tim. Before I review segment results, I would like to briefly explain the financial reporting impact of the recent reorganization. As you know, we issued a 8-K yesterday that reflected the segment changes. First, the North American distributors, which were previously allocated between the Engine and Power Generation segment, are now included in the Distributor segment. One distributor is fully consolidated and the others are recorded as joint ventures just as they were prior to the reorganization. Next, our field system business, which was previously reflected as part of the Engine segment, is now included in the Component segment with an offsetting increase in sales elimination. Sales of fuel systems to the Engine segment are historically reflected at cost. Thus, the change only impact sales and EBIT margins for the Component segment.

In the third quarter of 2005, we will begin to reflect the fuel systems sales between the Component and the Engine segment at market base transfer prices. The overall impact of the reorganization on our segment reporting is not significant and as such we are not going to spend time on the call to go over the specifics. If you have questions regarding these changes, I will be glad to walk through the details with you after the call. Now, for comments regarding each of our four business segment beginning with the Engine segment. Total sales for the Engine segment in the second quarter were a record $1.667 billion, a 21% increase from sales of $1.374 billion a year ago. Revenues in automotive markets were 19% higher than Q2 last year with increased demand in all markets except light duty automotive and RV. Overall revenue from industrial markets was at 27% year-over-year with increases in nearly all markets.

Earnings before interest and taxes for the quarter were a record $156 million or 9.4% of sales, versus $90 million or 6.6% of sales in the second quarter last year. The increase in profitability during the quarter was primarily driven by significantly higher volume, the associated overhead leverage, greater price realization and the business's cost structure improvement. Revenues for the heavy duty truck market as a whole were up 30% in the second quarter from a year ago, while global unit shipments were up 27%. Unit shipments in the US and Canada were up 26% driven by growth in the heavy duty truck market and our continued strong market share. Unit shipments to the rest of the world were up 34% with higher sales to OEMs primarily in Mexico and Korea. In the worldwide medium duty truck and bus market, total revenues increased 39% for the second quarter year-over-year.

Medium duty truck engine shipments were up 46% in the U.S. and Canada with significantly higher volume at several key customers due to market growth and account penetration. International medium duty truck shipment, which represents 68% of of the total global shipment for medium duty truck, were up 14% with higher sales to OEMs in Europe and Brazil. Brazil, where we enjoy market share of 36%, achieved growth in market share at TOEMs with the introduction of our electronic engines. Global bus intern shipment surged 38% higher year-over-year due to improved demand at key North American, European and Latin American OEMs. In the light duty automotive and RV market, revenue slipped 8% this quarter compared to a year ago.

Engine shipments to Daimler Chrysler for the Dodge Ram pickup truck were 36,400 units, down 10% from the second quarter last year, as Chrysler continued to manage its dealer inventory ahead of its launch of the '06 model year truck. We expect the launch of the new model year Dodge Ram truck to run sales higher in the second half of 2005 and achieve another strong year of shipments to Chrysler. On the International front, unit shipments for light duty automotive posted year-over-year gains, specifically in Brazil where we experienced market share growth with Ford in their light duty truck. Sales to industrial engine markets in total were up 27% from a year earlier with increases across nearly all markets.

Revenue in the mining market continues to be strong, up 45% compared to last year with shipments up 47% globally, due to strength in North America, China, Russia and Europe fueled by increased coal and steel production and by high commodity prices in general. We have revised our 2005 year-over-year growth outlook for mining from 15% to 25%. In the construction equipment market, revenue increased 18% compared to the second quarter of last year. Unit shipments to North America were up 22%, while shipments to international markets were flat as improvements in Europe and Latin America were offset by top year-over-year comparisons in China. As you will recall, the Chinese government had not begun to slow its growing economy at this time last year.

The commercial marine market saw a 43% increase in sales compared to last year on a 14% increase in units. The favorable mix is a result of demand shift in China and Asia Pacific from mid-range to high horsepower engines which command significantly higher revenues per engine. Sales in the Power Generation segment for the second quarter were $493 million, up 7% from the second quarter of 2004. Sales of commercial Gensets were up 17% compared to second quarter of last year. All major markets remain strong, buoyed by economic activity in the U.S. and related markets, economic development in the Middle East and power shortages in China. In the U.S. Genset demand for standby power protection and natural disaster reconstruction are allowing us to grow at a rate greater than the rate of nonresidential construction growth.

Overall market conditions continue to be strong in Asia through Q2, '05. The outlook is for continued strength in most southeast Asia countries through the second half of this year. Demand is being driven more by power shortages and the impact of years of under investment in electricity generation by rapid economic growing. For the second quarter of 2005, Power Generation reported record earnings before interest and taxes of $35 million or 7.1% of sales, compared to $18 million or 3.9% of sales as year ago. The significant improvement in profitability for this segment was due to implementation of price increases, higher volume and product range management. Additionally, this segment achieved outstanding incremental return on sales by tightly controlling FAR spending with increased volume.

Revenues for the Component segment were $511 million for the quarter, a 15% increase compared to the second quarter of 2004. The four businesses in this segment, filtration, emission solutions, turbochargers and fuel systems, each had year-over-year quarterly growth in revenue with filtration and turbochargers reporting double-digit growth. In filtration, all geographic regions experienced increased revenue over the second quarter of last year, particularly in aftermarket sales with North America leading the way. Revenue also benefited from currency which added $5 million in sales. Turbocharger sales continued at strong levels to both OEMs in North America and Europe and in the aftermarket. This segment's earnings before interest and taxes for the quarter were $21 million versus $24 million in the second quarter last year.

The higher volume contribution was offset by manufacturing and logistics inefficiencies of $4 million as the turbocharger business, in particular, continues to operate above its optimal capacity. Steel and other commodity price increases, net of pricing action to customers, showed improvement but continue to represent a significant portion of product cost. However, we expect to see further improvements in the second half of 2005. R&E spending increased $2 million over the second quarter of last year as we prepare for EPA 2007 and Euro 4 emissions legislation product launches. Sales for the Distribution segment were $297 million in the second quarter, an increase of 17% compared to second quarter last year. Sales remain very solid across product lines and geographies with greater than half of the increase coming from engine and Fergus sales, particularly in Europe, due to a recent distributor acquisition. Currency added $7 million to the total sales increase.

Earnings before interest and taxes for the segment were $26 million or 8.8% of sales this quarter compared to earnings of $20 million or 7.9% of sales last year. Higher gross margin from increased volume, pricing actions and favorable mix was partially offset by increased FAR spend, primarily from the acquisition of the new European distributor. JV income added $2 million compared to second quarter of last year. Next for a few comments on gross margins. The gross margin percentage for the quarter was 22.1% up from 20.2% in the second quarter last year. The improved margin was driven by an absorption benefit from higher engine shipments across most global markets, greater price realization and lower product coverage costs.

We are starting to see signs of improvement in commodity prices materialized in our operating results, as macro economic factors bring downward pressures on prices. However, at this point we have not seen a material benefit. Due to our position in the supply chain, all of our business segments will see some lag in the implementation of commodity price reductions, with filtration being the first area to see relief. Assuming steel prices remain at lower levels, we expect to see commodity price relief across all of our business segments by Q4 of this year, as we actively engage our vendors in capturing the price decreases. Given this improvement in our commodity price outlook, we are confident that the pricing actions we have taken in all businesses at the beginning of this year should more than offset our current estimate of the full year incremental impact of commodity price increases in 2005.

As we have reported in the past, our results have been challenged by commodity prices as well as manufacturing inefficiencies. We can now report that the year-over-year impact of these items has improved from $30 million in Q1 to nearly $5 million in Q2. While we have made considerable improvement in both areas, we expect further improvement going forward and the impact should become favorable in the second half of 2005. The Engine and Power Generation segments have made significant improvements in managing premium freight and overtime. With our focus in this area, we expect to see similar improvements in the Component segment. Using Six Sigma tools to streamline processes and remove bottlenecks, we should realize measurable and meaningful cost reductions.

Product coverage cost was 2.7% of sales or $68 million in the second quarter compared with 3.3% of sales or $71 million a year ago. Product coverage cost on a per engine basis has continued to decrease, reflecting customer acceptance and the performance of our product. Total selling, admin and research and engineering or SAR spending in the second quarter increased from a year ago, but was slightly better as a percentage of sales. SAR spending for the quarter was $360 million or 14.5% of sales, compared to spending of $310 million or 14.6% of sales from last year. Within SG&A the year-over-year increase included approximately $7 million from the consolidation of additional entities in Power Generation and Distribution, $18 million from higher salaries and wages across the company, and $5 million from currency.

In addition, we had increased spending to fund our growth and improvement initiative, as well as some volume variable spending. Research and engineering expenses were 2.9% 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 second quarter was $35 million compared with $29 million in the second quarter last year. The increase in income was predominantly from the China joint ventures as we continue to benefit from higher production for both automotive and industrial markets. The second quarter income tax provision was 28% of profit before taxes and is net of a $4 million benefit reflecting further dividends to be repatriated under the Homeland Investment Act.

Without this benefit, our estimated annual effective income tax rate for 2005 is 30%, which is consistent with our guidance issued during our Q1 earnings announcement. Next to review total sales by region. In the second quarter our sales mix was 49% U.S. and 51% international, compared to 52% U.S. and 48% International in the second quarter last year. This is the second time in three quarters that International revenue was greater than U.S. revenue. Compared to the second quarter last year, sales in the U.S. increased 11% while International sales increased 25% with higher sales in nearly all regions. Canadian sales increased 37% as the recovery in truck engine volume continues. European sales were up 43% with significant increases across all business units. Sales for Latin America were up 32%, primarily due to higher sales in the Engine business.

Finally, for a few comments on cash flow. Cash flow from operating and investing activities was a net inflow of $159 million this quarter, compared to a net inflow of $147 million last year. Changes in working capital represented a net cash outflow of $129 million for the quarter. Working capital as a percentage of sales remain flat at 17.7% at the end of this quarter, yet days sales outstanding rose slightly from 53 to 55. Inventory rose during the period with higher sales, yet turns improved. As our markets continue to grow and revenues rise to meet demand, we are focusing on reducing global inventory and accounts receivable to improve working capital. Capital expenditures were $47 million for the second quarter and $78 million for the first half of 2005. We still expect CapEx in 2005 to be within a range of 220 to $240 million. Thank you. Now I will turn it over to Jean.

Good morning. I want to take this opportunity to remind you of the financial metrics we are focused on and what our targets are. First, the company's primary focus is not on top-line growth but on growth in profit and more stable, predictable earnings. Our key financial metric is return on equity and our target is to achieve ROE of 15% or greater over the cycle. In 2004 ROE was 21%. And for 2005 year-to-date ROE is 24%. Our EBIT margin and target is 6 to 9% and we delivered EBIT margins of 9.4% for the second quarter and 8.5% for the first half of 2005. With this strong earnings performance, we are generating significant cash flow and we are committed to using this cash to make prudent investments in the business and to strengthen our balance sheet. Our targeted debt to capital range has been 35 to 45%. We are currently within the top end of that range as we paid down significant debt in the first quarter of this year.

We remain committed to further debt reduction to get to the low-end of that range or below. We believe that we have achieved investment grade metrics, credit metrics and that rating upgrades would now be appropriate. We are focused on continuing to deliver strong financial performance and on growing the less cyclical parts of our business. This, coupled with an improved balance sheet, will position us well to perform well over the next business cycle. On the investor relations front, effective August 1st, Karen Battin will be leaving Investor Relations to take the position of Power Generation Controller working for Tom Linebarger. Through Karen's hard work and dedication, the investor relations area has improved in its mission to communicate positively and effectively with our shareholders. Karen will certainly be missed. We wish her well and look forward to hearing great things from her in her new role. Replacing Karen, as head of Investor Relations, is Dean Cantrell Dean has been with the company for nine years, holding various finance roles.

Most recently Dean was Director of Treasury, where he managed the relationship with our debt holders and analysts. Dean has been working closely with Karen since the beginning of the year to meet and interact with analysts and shareholders to assure a smooth transition. Finally, we are in the process of planning an investor conference to be held in New York City on September 26th. Invitations along with more specifics on the event should go out soon. We believe this will provide a good opportunity to communicate more about our strategic initiatives and our growth in key international markets. And to explain why we believe the company's performance will be much improved over the next cycle. Thank you, and now we will take your questions.

Thank you. Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments, please press the number one followed by four on your touch-tone phone at the time. Pressing one for a second time will remove your from the queue should your question be answered. Lastly, we do ask while posing your question that you please pick up your handset listening on speaker phone for optimum sound quality. Please hold while we poll for questions. Your first question is coming from David Bluestein. Please announce your affiliation then pose your question.

Hello?

Hello, David.

Actually this is Andy Keller. I am calling regarding higher commodity prices you guys are -- been looking over the past couple of years and I know they are going to be coming down later this year, by the end of Q4. Can you provide some color to us on the call today what you guys are planning on doing to reduce your commodity prices by establishing through collaboration with your supplier base and overall reduce your total cost of supply chain?

Well, we are continuing to work with our supply base in general across the organization to try and establish agreements that are clearly as we move forward continuing to improve favorability to us. But that's just a subject of ongoing conversations, as Karen suggested in her remarks. We expect as we make our way through the year, particularly as it relates to steel, that as steel prices come down we will capture some of that benefit in three to six month period lagging the actual reduction in industry pricing. But this is ongoing conversation both with our customers in terms of how we handle it as well as with our suppliers.

But are certain commodities still a concern to you guys, that you think they are still going to be a drag?

We are watching everything. Steel, we think is heading in the right direction. There's been a lot of rumors about aluminum, but so far we haven't seen it and sort of play through in our markets. Copper is significantly up and affects some of our businesses. And we are watching that very carefully in terms of which way it moves. There is some prospect it could move positively as opposed to negatively. But we are still unsure. And, of course, we are watching oil prices carefully. While it doesn't have a huge impact on commodity pricing, it does and particular for some of our more plastic oriented commodities as well. We continue to stay close. We get a lost of professional help in this regard, so we can do the best job we can anticipating which direction things are moving in and delay price increases and go after more quickly price decreases.

What's in your supplier feedback, are you guys working with them regularly to make sure costs stay as low as possible while overall improving your supply chain efficiencies?

Yes.

Okay. Thank you very much.

Thank you.

This next question is coming from Peter Nesvold. Please announce your affiliation then pose your question.

Hi, I'm from Bear Stearns. Tim, you talked about improved price realization in a number of your businesses. Can you prioritize, where are you getting the most and where are you getting -- where is the most room for improvement still?

Well, it comes in two forms. We've gotten price increases that we started to get at the end of last year and the first quarter of this year. Also with some of our long-term agreements we have gotten relief on guaranteed cost reductions. So it is in both areas. It comes across all of our businesses. I think that it is certainly reflected in the improvement in our gross margins so far and we would expect to capture similar amounts in the second half of this year. And we'll continue to review pricing but I think our focus remains on low cost production and being the low cost producer and that type of thing that I think we have benefited from our pricing actions but operating efficiencies are where we're really focused.

In terms of segment, how would you compare Engine versus Power GEN versus Components? I mean, how would that play out?

We don't give that out. That is basically confidential information. But I think you can assume that it is different in different markets, it's different in different geographies and it's much more strategic than something that's across the board and it depends on what the relationship is with both the OEM and the end user.

And speaking from a business point of view, from Power Gen's point of view, what I would say is that all us -- none of us are asleep on this point. We've all been really actively engaged in understanding where we can get price. And not just where we have commodity price pressure, but where we can get price across all our markets. And we have really been, as part of our margin improvement efforts over the last two or three years. So every one of the businesses has had pricing as one of its key areas to improve margins. And in the Power Generation Business, as I said, that's been going on for more than two years now. So I think there is nobody who needs improvement in the sense they are not focused on it.

If I could switch gears then for a quick second? On the Component business. It looks like our research and engineering expense going up year-over-year sequentially. Is that going to accelerate from here? Are you plateauing from here. How does that look for '06 and '07?

Well, I think the way I would look at it is that we are really investing in those businesses for the future. Specifically in Fleetguard and Emission Solutions, we substantially increase the engineering both because of the long-term agreements we have gotten with OEMs that take us well pass 2007 in most cases, as well as bringing new products out, both for Fleetguard replacing existing products and then the Emission Solutions for the year '04 and 2007 And then also in Holset, they have gained considerable market share, or will be with long-term agreements, and they have gone -- they have probably tripled the number of platforms that they are working on right now and I would expect this level of engineering as certainly through the rest of this year and probably through 2006. And this is something that I view as positive in the sense that I think we are really betting on these companies, both in terms of their own organic growth but also the technologies that will help your overall Components group gain market share around their emissions capability.

I don't want to read into your words, but it sounded like you are saying it is plateauing here. Is that right or is it going up?

I think you're probably right, Peter, I think it is going to stay at close to these levels. These are pretty significant levels of investment for the business and you are going to see it stay at close to those kind of levels for a bit.

One last quick line item question and I will hand it off. The other income line on the P&L, looks like it was improved $0.17 sequentially from first quarter. Can you describe what is in that line and what drove the strength there?

Almost the entire change there was driven by currency.

Currency, okay. I will get back in queue, thank you.

Your next question is coming from Gary McManus. Please announce your affiliation then pose your question.

J.P. Morgan. First congratulations on a great quarter and to Karen, best of luck. I thought you did an excellent job as the IR.

Thank you, Gary.

Tim, as you are looking at your portfolio of business units now, where do you think -- where are we on the capacity utilization and where do you see increasing production.

Well, we are stretched literally in all of our businesses, but you can see the improvement in over the last several quarters because we have been able to manage our supply base and, you know, have our people involved with the supply base and we are very close to it. I think we are doing the best job I have seen in that area and that's allowed us to incrementally increase our capacity over time. But you are seeing it build a new turbocharger plant in the United States. We have expanded turbocharger capacity in China, the same with alternators. We're doing the same with Power Generation in China. Our joint ventures in India and China are being funded by those joint ventures with significant increases in capacity. We invested a few million dollars in the heavy duty business a quarter ago and expect to see capacity increases in the fourth quarter this year. So, we are incrementally increasing that but we are not, you know, making an enormous investment in increasing capacity because we want to really operate at the most efficient level.

Okay. On the Engine side, I think you said, Tim, in your prepared remarks both on an EBIT and consolidated basis, they are above, I think, your targeted range. Do you think -- are you going to revisit those targeted ranges or do they have now the ability to show much better profitability than you would have thought -- over the cycle than you would have thought a few years ago.

I think in the second half of this year we are going to revisit our financial targets across the board with the new Components division being put together. And we did that because, again, all four of those technologies are aimed at emissions and I think by having them in one group we are going to capture a bunch of synergies. So we really need to look at that. I think Karen mentioned that we haven't really resolved the transfer pricing between the fuel systems and the Engine business. And also, the businesses are performing at the top of their level, so I think we want to revisit that to the idea that we can raise those standards. So we will look at that in the second half of the year. We'll probably talk more specifically at our September investor conference.

One last question I have is on the -- you said that with the Dodge model introduction coming, you expect stronger second half sales and strong year -- strong sales for the entire year. Can you kind of quantify that? What kind of growth are we looking at, rough order of magnitude?

Last year we were about 155,000, this year I think we are looking at 165,000.

Okay. What would that second half, I don't have that handy, second half year-over-year growth would be? Do you have that, Karen?

Let me turn it over to Joe. Karen has got it.

I think for the first half that probably has it at -- we are probably at about -- .

75 for the first half in terms of shipment. So, it is 75ish.

Okay.

Kind of range.

I will clarify in a second, Gary, but Joe is saying 75 for the first half of the year. So, it will be significantly better year-over-year in the second half of this year.

Little closer to 70. About 70.

That would be 90, 95,000.

There you go.

Do you know what the second half a year ago?

75.

Okay, great. Thank you.

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

Prudential Equity Group and I would like to echo Gary's comments on the quarter and for you, Karen and as well to Dean and Joe.

Thank you.

Quick clarification on the shift in mid-range production, Tim, that you talked about in the prepared remarks. Did that happen in 2Q and if so, was there any significant cost impact?

It is in the process now. Essentially because of the Chrysler demand going up, we are moving some production, some industrial production in other automotive products out of CMEP to CDC so we can increase the Chrysler production at CMEP.

That is a good thing from a cost point of view not a bad thing, Gary. Andy, sorry.

I have made mistakes, too, Joe, don't worry about it.

We can think of one, Andy.

We will talk about that over beers, Tom. Jean, and then I will get to the real question, Jean, on the cash usage priorities are we looking at debt paydown and if so, is it at maturity or something faster than that.

Well, as you know, we have got a lot of debt that has long maturities. But we have some opportunities over the next couple of years. And what we're trying to do is figure out what's the most cost effective way to continue to paydown debt. So don't have final decisions on things, but we are looking at some opportunistic ways to paydown debt over the next couple of years.

Thanks. And then if I could revisit this -- the pricing, it was substantially higher than I was looking for. Have you noticed any push back from either your distributors or customers, really especially given your comments on the expected input cost decline. And then go forward and you may have already answered this, but I want to ask it differently. Are you expecting any price decreases to be offset by decreased input cost? Thanks.

I think simple answer to the question depends on the business a little bit, Andy, but for the most part the price increases that we've secured aren't surcharges, they are just plain old price increases, right. While there may be a little pressure in some points of the business to push back on that, essentially, I think the vast majority of the pricing we have gotten will stick as is. We have already had what if conversations.

Thanks a lot.

Thank you.

Your next question is coming from Christopher Mauren. Please state your affiliation then pose your question.

Credit Suisse First Boston, good morning. Karen, in the past you've provided the actual dollar price realization. In Q1 it was about 35 million. Can you update us for that in Q2?

Yes, it is roughly the same for the second quarter as what we saw in the first quarter. While it is not a perfect process to estimate that, I would still stick with about a 35 million.

Great, thanks, I don't know if I am missing something on the Component segment. We did higher volume in the second quarter, you know, the operating profit was about the same, 21 versus 20. But inefficiencies and steel and the investments have all kind of dropped from what the $15 million impact you guys had set in Q1. Can you help me out? What else happened in the segment that held those profits down in relation to the volume increase?

I think there are really three things going on. If you compare first half '04 to first half '05, you will see a more significant impact of the steel pricing in this segment, particularly the Fleetguard Nelson Emission Solution portion of it. That's had a significant impact first half to first half in terms of comparison. Secondly, while it has been clearly mentioned by both Tim and Karen that we have really gotten our arms around reducing premium costs overall. We have seen a significant reduction from we were last quarter. The issues we still have are primarily in the Components group. They aren't yet where the rest of the business is in terms of significant reductions in the premium cost and we have, frankly, a little bit of work to do to improve efficiencies. And the third thing has already been mentioned, is we are putting more money into technology development for the future. Not only for both outside customers of the Components groups as well as Cummins in terms of our 2007 and getting ready for the 2010 recipes.

So the increased R&D that you are talking about is not specifically related to the 2 million increase quarter over quarter that Karen mentioned for the investments of EPA.

No, it is included in the numbers that Karen talked about in terms of the investments we are making there. And as she said earlier, we are expecting that this level of investment is something we will continue through '06 and maybe a little bit into '07.

Chris, you know the EBIT margins for that business are lower than what they had previously been because of some of the sediment reporting change that we discussed where we have the fuel systems revenue in that segment but because we were transferring at cost, we don't have any associated pocket at this point for the segment.

Thanks, that's helpful. And then just finally, Tim, you were talking about parts and service and the focus on that business, the higher margin business. And you mentioned 28% of the total Engine segment at the trough and 20% on peak. Is that we're at now or is that the goal that you guys want to get to at some point?

I think that's, you know, the peak, where we are talking about, that's roughly where we are at this point.

And where do you think, with the additional focus, where do you think you can get over time?

Not exactly sure is the honest answer. We think we can take it up a few points if what the work we are doing now, particularly outside the United States, is as successful as we hope it will be. But we haven't actually pinned the number down yet, but, we have got a very aggressive goals.

We have made some really good progress on growing the parts and service revenues but because of the strength in the OE side of the business, on a percentage basis, it has come down.

Thank you.

Thank you.

Your next question is a follow-up from Peter Nesvold. Sir, please go ahead.

Thanks. Karen, you made comments about strength in China in terms of both automotive and industrial. Do you include the trucks within automotive or was that left out?

No, We would actually include it. In general, we still feel that the market there is strong on the automotive side as well. There has been some issues, just more kind of near-term issues involving a regulation change in China. But we think that that's going to get sorted out and, in fact, the demands felt pretty strong.

Okay. You also made a comment about doing some work for the Ford light duty truck. That was new to me. Can you talk a little bit more about that.

That is not new. We have been supplying our engines to Ford for a light duty truck application in Brazil for some time.

I thought maybe it was the V6 project that's been talked about.

No, no, this is not the V6 project and all we were saying is our business is actually improving there with our current engine in the light duty application in the Ford truck in Brazil.

And two other really quick follow-ups. You've been pretty firm all throughout that the '07 engines would have fuel degradation no worse than the '02 engines. Is that still your view right now?

Yes. Field test is going very well, by the way, no delays.

And then in the release, there is a comment Insufficient in the engine, is the truck side of the business crowding that out or something that is compacting your I am pack for Power GEN.

This is Tom, Peter. It is not at all, it's not a crowding out issue. There's just not enough engines all the way around and we have a really good process to work through how we plan and distribute the engines around the business. It is kind of what we do. We work really closely together on that. So the point we are trying to drive by that is that our markets, including Power Generation, are stronger than we can supply today which is a good thing for us. And as Tim said, we are doing a lot of work all around the company all around the world that build capacity sort of step by step, in a smart way to keep our capital spending reasonable. But, you know, as a participant in that process, it is working well to make sure we get engines where we need them and where we take advantage of the best opportunities of the market, where ever they are around the world.

One last follow up, I apologize. When would you think you will have some guidance in terms of cost for the '07 engines? When can you actually start to quantify that?

Well, at some point that's a more appropriate question to the OEMs. We have been talking to the OEMs about where we think our range is and if anything can be done to influence those ranges, what might they be. They will make a determination as to what the pricing will be to the market. But we are very confident our pricing to the OEM will be very competitive,.

Okay. Thanks for the time.

Okay. So if there are no more questions, we appreciate your participation and we will be available for any questions after the call. Thank you for joining us.

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.