康明斯 (CMI) 2006 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Cummins Inc. conference call. At this time, all participants are placed on a listen-only mode, and the floor will be open for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Mr. Dean Cantrell. Sir, the floor is yours.

Thank you, Deena. Welcome, everyone, to our teleconference today to discuss Cummins' results for the first quarter of 2006. 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 are 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 teleconference will include certain forward-looking information. Any forward-looking statements involve risk and uncertainty. The Company's future results may be affected by changes in general economic conditions, and by the actions of customers and competitors. Actual outcomes may differ materially from what is expressed in any forward-looking statement. A more complete disclosure about forward-looking statements begins on page 60 of our 2005 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, some comments regarding each of our 4 operating segments, beginning with the Distribution segment. Sales for the Distribution segment were up 25% compared to the first quarter of last year. Sales in the Middle East were particularly strong in Power Generation, driven by investment of petroleum revenues in the regional economies, and continued opportunities for rebuilding in Iraq. European sales showed strong year-over-year growth, primarily as a result of a distributor acquisition during the second quarter of last year. Revenues from Power Generation, Parts, Engines, Service, and Filtration were all higher compared to the first quarter of 2005, and growth was evident in nearly all geographic regions. We expect strong growth in Distribution for the remainder of 2006, as demand for our products and services remains high. Segment earnings increased 55% year-over-year, largely in part to a 50% increase in joint venture income, and higher volume in the Middle East, China, and Australia. Currency had a minimal favorable impact. Earnings for the segment were 9.8% of sales, better than the 7.9% from last year, and near the top end of its targeted range of 8 to 10% across the business cycle.

Power Generation segment sales were up 26% over the same quarter of last year, with strong double-digit growth in nearly all lines of business. While the first quarter is seasonally our softest revenue quarter, sales were exceptionally strong, off only 7% from our record revenue in the fourth quarter of 2005. Commercial generator sales were up 32% over last year, due to strong demand in North America, the Middle East, Latin America, and India, and further realization of previously announced price increases. Alternators were up 28% with increased sales across all regions, especially in China, North America, and India. Consumer generator sales were up 14% as we continue to penetrate the RV towable market with a 13% increase over last year. Motorized RV continues to be weak, with shipments down 12%, but we are seeing a favorable mix shift at the high end and low end of the diesel RV market.

Elsewhere in the consumer market, marine and commercial mobile both grew over the same quarter last year. In the remaining Power Generation businesses, power electronics grew 53% through an expanding product line, and increased market share for its automatic transfer switches and switch gear. Energy solutions grew 36%, led primarily by Europe and Russia. And the rental business grew 22%, driven mainly by its Middle East power projects. We expect 2006 demand for our product to remain strong, particularly in the commercial markets for North America and the Middle East. First quarter Power Generation segment earnings were 3 times higher than the first quarter of last year, increasing from 3.5% of sales, to 8.4% of sales, which is within its targeted range of 7 to 9% across the business cycle. Absorption benefit from higher volume, further price realization, and favorable mix all led to the improvement in profit. Currency had a small favorable impact.

Total sales for the Engine segment were up 23% compared to the first quarter of last year. Within the segment, revenues from on-highway markets were up 23%, and off-highway markets were up 21%, as nearly every end market saw year-over-year growth. Earnings for the Engine segment grew 53%, increasing from 7.9% of sales, to 9.8% of sales, which is near the top end of its targeted range of 7 to 10% across the business cycle. Absorption benefit from higher volume, and some price realization in aftermarket and industrial markets, helped offset a reduction in JV income and higher research and engineering spending. Global shipments for the heavy duty truck market were up 22%, and revenue was up 23% compared to the same period last year, led by strength in the North American heavy duty truck market. Capacity increases for our ISX engine and higher demand for our ISM engine have both contributed to the increase in shipments. We still expect 2006 volumes for the North America heavy duty truck market to be up slightly over 2005, at a level of 315,000 units, with growth being limited primarily because of industry and supply chain constraints.

Worldwide shipments to our medium duty truck and bus markets grew slightly this quarter compared to last year. Medium duty truck shipments in North America grew 24% as we continue to increase our availability in this market. This growth was partially offset by a drop in medium duty truck shipments in Brazil, due to the launch of the Euro 3 electronic engines this year. However, revenue was higher due to price increases for the emission compliant engines. Global bus engine shipments grew 35% compared to the same period last year. We continue to grow our market share in North America, both in school buses through our recently announced business with BlueBird, and more significantly, in the transit bus market, as some competitive products in the transit bus market exited last year.

In China, against strong international and domestic competition, we successfully secured the right to supply the Beijing Public Transit with 100% of its Euro 4 diesel engine requirement, the first of their kind in China, and 66% of the Euro 3 diesel engine requirement. About half of the units were shipped in Q1, with the remainder to be shipped in Q2 and Q3.

In the light duty automotive and RV market, shipments to the global LDA market increased 36% year-over-year, more than offsetting a slight 3% decline in North American RV shipments. Shipments to the LDA market should continue to be strong this year, with record shipments forecast for the full year. For the North American RV market, we are increasing our availability through new product offerings, and market share gains at our OEMs, helping to offset the industry recession that continues to impact overall sales in this market. We expect to see further benefit from these actions through the rest of 2006, allowing us to grow in a market that will be down year-over-year.

In our off-highway markets, shipments to the construction equipment market increased 29% over Q1 of 2005, as global construction remained robust, particularly in China, North America, and the Middle East. Nonresidential construction spending in these regions continues to drive higher demand. We are also benefiting from growth at the low end of the market, as our A Series and B3.3 engine offerings in light construction, are gaining traction in the marketplace and demonstrating significant growth. Engine shipments to the oil and gas market were up 74%, driven by sustained oil and natural gas prices, which are driving investment in new equipment for the oil and gas fields. Mining shipments were up 26% with growth, both domestically and internationally. Continued strength in commodity prices are sustaining investment in mining capacity. Additionally, we are benefiting from improvements in high horsepower engine capacity, allowing us to increase shipments to the oil and gas, mining, commercial marine, and power generation markets.

Revenue for the Component segment increased 17% compared to the first quarter of 2005, with 3 of the 4 businesses in this segment achieving strong double-digit growth in revenue. Filtration benefited from strong aftermarket and OEM sales in North and Latin America. Turbochargers experienced increased sales to OEMs in North America and Europe, and higher aftermarket sales worldwide. Fuel system revenue benefited from higher shipments to Scania and Cummins engine assembly plants. The component segment should see continued aftermarket growth in 2006, and share gains in Europe, as our OEM customers launch Euro 4-compliant products. Revenue growth will carry into 2007, as emission-related products are launched with Cummins and other North American diesel engine manufacturers. The Component segment earnings for the quarter were 5.6% of sales, better than the 4.9% of sales from the first quarter of last year. Absorption benefit from higher volume and some aftermarket price realization, offset higher research and engineering spending, as we continue to invest in the critical technologies for new product launches in 2006 and 2007.

First quarter results were slightly better than expected, as we are starting to see the initial signs that our operating improvement plans are taking hold earlier than expected. We are expecting continued profit improvement by the fourth quarter of this year. In addition, increased commercial opportunities in 2007 will help the segment reach the lower end of its targeted range of 7 to 9% across the business cycle, toward the end of 2007. Now I'll turn it over to Jean to comment on our consolidated income statement, cash flow, and revised guidance.

Good morning. Our earnings before interest and taxes were 9.5% of sales, better than the first quarter of 2005, which was 7.4% of sales. This is the fourth consecutive quarter that our EBIT was greater than 9% of sales. This is a testament not only to our strong market position across all of our end markets, but also of our continued focus on diversified and profitable growth. Net earnings for the quarter were $135 million or, $2.70 per share, compared to net earnings of $97 million, or $1.96 per share, in the first quarter last year, for a 39% increase in net earnings on a 21% increase in sales. Gross margin improved from 20.7% in the first quarter of last year, to 22.4% this quarter. The absorption benefit from higher volume, along with greater price realization and improved plant efficiency, all contributed to the higher margin.

We closely track and monitor the commodities market, and are seeing some pressure for price increases in some commodities, especially aluminum and copper. We actively hedge our copper exposure, and use global sourcing initiatives to help mitigate any material cost increases related to commodities. Additionally in some markets, we have the ability to pass commodity cost increases through to our customers. Commodity market movements have not had a material impact in our financial results in the first quarter, and we believe these actions will offset any potential full year incremental impact of commodity cost increases.

Total selling, admin and research and engineering, or SAR, spending in the first quarter was 14.3% of sales, compared to 14.6% of sales last year. The year-over-year increase of $61 million included approximately $29 million attributable to the fact that our first quarter of 2005 had 1 less week than our normal accounting calendar, $16 million from higher salaries and wages across the Company, $12 million for new product launches related to future emissions regulations, and offsetting these was a favorable $4 million from currency. In addition, we had increased spending to fund our growth and improvement initiatives, as well as some volume variable spending.

Income from joint ventures and alliances in the first quarter was $31 million, slightly lower than the first quarter of last year, and in line with our expectations, as outlined during our fourth quarter teleconference. Distributor JV income grew 50%, primarily from growth in North American markets serviced by our distribution channel. In our emerging markets, we saw growth from our Chongqing and Tata joint ventures in China and India respectively. The Dongfeng JV, while lower year-over-year, is in line with our expectations for this quarter. We still expect the Chinese truck market to improve in the second half of this year, which will increase earnings for this joint venture.

During the first quarter of 2006, Indiana enacted legislation which will reduce Cummins future state income taxes. The immediate effect of this legislation reduces the value of our long-term deferred tax assets by $12 million. In accordance with income tax accounting rule, this special $12 million, or $0.23 per share charge, has been recorded entirely in the first quarter income tax provision. The long-term effect of this legislation will be a reduction in Cummins future state effective tax rate. In our previous guidance, we had assumed Congress would pass a tax bill that would extend the research tax credits into 2006. This did not happen during the first quarter, as evidenced in our 32% effective tax rate for the quarter. However, we continue to assume in our full year effective tax rate guidance of 31%, that Congress will extend the research tax credit retroactively to the beginning of 2006.

Cash flow from operating activities was an inflow of $18 million this quarter, compared to a cash outflow of $62 million in the first quarter of last year. Seasonally, the first quarter is usually the lowest operating cash flow quarter. However, we were able to generate positive operating cash flow, in spite of the higher working capital balances from seasonally stronger global sales.

Last fall, we announced a share repurchase of $100 million. During the quarter, we purchased an additional $36 million, to bring our total repurchase to $74 million. We will continue to repurchase our shares to complete the initial $100 million.

Finally, I would like to take a moment to summarize and update our guidance. Revenue growth of 8 to 10%, capital expenditures of $250 million, joint venture earnings will be in line with 2005, an effective tax rate of 31%, and pension funding of $170 million to $180 million. With respect to earnings guidance, we expect to make between $3.35 and $3.45 per share in the second quarter of 2006, and between $12.40 and $12.60 per share for all of 2006. Now I'll turn it over to Tim.

Good morning. I am very pleased with the results from our first quarter. Although this is usually our weakest quarter, sales were up 21% from the same period last year, demonstrating continued strength across all of our markets. Our gross margin of 22.4% of sales was well ahead of last year, and nearly equal to the fourth quarter of last year. Our incremental return on revenue was 20%, and our net earnings rose 39% over last year, even with the 1 time charge of $0.23 per share, resulting from the new Indiana tax legislation. This is a very strong start to what will be another record year for Cummins, and as reflected in our increased guidance for the full year. At our investor conference in September, we said that our 2007 earnings before interest and taxes as a percent of sales, would meet or exceed 6.4%. That was our EBIT in 2004, and at the time, it was a record year.

While I'm not going to give you 2007 guidance in April of 2006, I will say that my confidence in our ability to meet or exceed that EBIT target remains very high. We are talking about this now, because I believe you are comfortable with the idea that Cummins will do well in 2006, and you should be. 2006 is going to be another record year for us, providing further evidence that this is a new Cummins. A Company that is less cyclical, more diversified, more results-oriented, and committed to turning a greater share of our sales into profits. I believe that many of you, like all of us at Cummins, already are focused on 2007. Not only are we confident about our position for 2007, we are committed to sustaining our performance through 2007 and beyond.

Although we have many areas of strength, I'm going to concentrate on 3 factors that have provided significant benefits for the Company, and will continue to do so, well into the future. The influence of these 3 factors on our business today, is reflected in the outstanding first quarter earnings we announced this morning. Tomorrow, those factors will play an even more important role in our success. The first factor is global opportunities we have for profitable growth. The second is our ongoing cost structure improvements. The third is Cummins' technology leadership, which will result in products with superior performance, reliability, and fuel economy, not only for the 2007 EPA emissions standards, but for other markets around the world.

Let me elaborate. You've heard me say before that our OEM sales to North American heavy duty truck market are only 14% of our revenues. Even though the heavy duty truck market is operating at near -- at, or near record levels. That number, which was much higher in the past, reflects Cummins diversified growth across all of our markets worldwide. And this diversified growth is the foundation of less cyclical earnings that can mitigate the impact of an emissions-related drop in the North American heavy duty truck market in early 2007. Our less cyclical stream of earnings includes our globally diversified portfolio of joint ventures. As much as 70% of our JV earnings are from outside the U.S. and provide balance. For example, we had higher income this quarter from our joint ventures in India, from our high horsepower engine joint venture in Chongqing, and from our distributor joint ventures. These businesses offset the softness in the results from Dongfeng, our truck joint venture in China.

The sale of new and reconditioned engine parts worldwide also contributes to a less cyclical stream of earnings. We are experiencing a nearly 10% growth rate in aftermarket profits for the Engine segment, which last year produced 750,000 new engines. By 2008, we will have doubled the size of or parts business. This growth is due to the expanding global population of Cummins engines, and also to our increasing market share.

Our worldwide Distribution business is another major factor in this less cyclical stream of earnings. This business has quadrupled its earnings over the past 5 years. We anticipate it will continue to grow earnings faster than its sales, as we consolidate our distribution channels and increase global market share.

Finally, we are expecting further diversified growth from commercial and consumer power generation, aftertreatment emission control devices in both the U.S. and Europe, and industrial off-highway markets that are not regulated by upcoming emission standard changes. We are also anticipating increased market share at key medium duty truck and bus OEMs in North America, along with increased turbocharger sales to both U.S. and European truck engine manufacturers. Along with growth in our global opportunities has come a significant improvement in our cost structure. This improvement will play a major role in our ability to handle any downturn in the North American heavy duty truck market. It will also help in our other businesses.

Let me remind you, that within the heavy duty engine business, we've reduced the break-even point by more than 50% over the past few years. We have formed long-term OEM supply agreements, that eliminated aggressive engine discounting. We consolidated our heavy duty engine manufacturing assets into 1 facility in Jamestown, New York, to reduce overhead by $30 million annually. And the pervasive use of Six Sigma and increased global sourcing initiatives at Cummins have increased manufacturing productivity, improved product quality throughout the Company, and reduced costs by more than $1 billion over the past 5 years. We believe these changes will lead to a dramatic improvement in the profitability of the heavy duty engine business in 2007, compared to the results that occurred during the last emission regulation changes in 2002.

The third factor is the breadth and depth of our technological expertise. Cummins has an edge in meeting emission standards. Not only do our people have the superior technical ability needed to integrate the critical engine components with the rest of the vehicle, they also work together in an open environment that fosters innovation. It's a competitive advantage for Cummins, and will continue to give us an edge well into the future. Our technology leadership extends to different markets and emissions standards around the world. And probably most important, we work closely with our customers to design and integrate products to meet their needs.

Our field test program and manufacturing readiness are building confidence with customers that we are ready for 2007. As you know, our on-highway engine product line is using the proven Cooled EGR technology with a Cummins particulate filter in a crank case ventilation system. This technology is consistent on all Cummins on-highway diesel engines for North America, including the heavy duty ISX, and ISM, as well as the mid-range ISL, ISC, and ISB engines. And we have 40 end users field testing our products to affirm the quality of our significant up-front analytical work. We have more than 300,000 Cooled EGR engines on the highways, and more than 30 billion miles of experience. That alone gives us confidence that our products will provide the superior reliability, durability, fuel efficiency, and low cost of ownership for our customers.

Let me conclude by saying that the record monthly levels of heavy duty truck orders for 2006, and remaining truck OEM build slots are not the harbingers of an economic downturn in North America. Far from it. Cummins has profitable growth opportunities to mitigate the anticipated decline in earnings from the North America heavy duty truck market in 2007. We have made significant improvements in our cost structure of our heavy duty engine business, our technology leadership, and our relationships with customers, have put us in a strong position for 2007, and beyond. I am confident that Cummins will not only meet our expectations for 2006, but for 2007 as well. In addition, all of these factors, along with a strong balance sheet, position Cummins for a very bright future and profitable growth across the globe. Thank you, and now we'll take your questions.

[OPERATOR INSTRUCTIONS] John McGinty.

Credit Suisse. Very impressive quarter. And I understand kind of where you are. You talk about where the growth opportunities are. You talk about what you can do. And then you have to end up talking about the orders and everything else. The question I have about '07 is this. Would you care to comment -- everyone has been using a kind of -- the act, kind of the worse case scenario of down 40%. Mark [Piggott] the other day, and some of the smaller suppliers, have actually come out on some of their conference calls, and talked about, given the strength of the , that they are in fact, their opinion, if you will, would be that the the market might be off substantially less than the 40%, the ACT numbers. Which I think assume a weaker economy, as well. But in any event, do you want to make any comments at all about your, Tim Solso's, thoughts about '07? Not what Cummins can do, but at least a comment on where you are in terms of where people, like the Paccars are, about maybe not being as bad as people think that it would be?

My honest answer is, I don't personally know, and I'm not sure that anybody does, at this point in time. I will say that we used the 40% for economic modeling, and we think that is a conservative number. And the truck market, whether it's the used truck prices, the need to have good equipment to attract drivers, available credit, ton miles growth, all of that is extremely positive right now. Which would argue for something less than 40%. But my honest answer, John, is that I don't know. We're only building a model so that we're confident about our statements about our financial performance going forward.

Well, so in other words, the comments that you were talking about, because of where Cummins is less cyclical, more diversified, and your comment was, you weren't going to give an '07 estimate. But you did say that you felt more confident in that you can meet or exceed -- September was 6 months ago. As you have looked as things in a worse case environment, is the 6.4% margin target, or floor, if you will -- I don't mean to put words in your mouth. But is that looking conservative? Do you want to upgrade that at all?

As I said, I think we will do that, or better.

But you don't want to go any further than that?

No, sir.

All right. Thanks very much. I'll get back in queue.

Joel Tiss.

I'm still at Lehman Brothers. I wonder if you could talk just a little bit about more of a flavor of what's happening in the market. We heard lots of sort of strong, and up, and all that. Can you talk at all about sort of like backlog levels? I don't just mean trucks, I mean across the board, and maybe order rates on sort of like an annualized basis? You know what I mean? Just a little more flavor about what's going on in the end markets.

Well, Joe will talk about his businesses, and then Tom can comment on Power Generation.

It's right or wrong, we don't really calculate it the way you're asking. We don't roll it all up. But generally speaking, when you look at market by market, particularly globally, the order boards for us are quite strong, separate from North American heavy duty truck. So construction markets, mining markets, oil and gas markets, our components businesses. So right now, they're as strong as we've seen them in a long time looking forward. And so that give us at least some confidence to support some of the statements we're making about how we view the future and our opportunity, given the quality of our new products, to not only participate in the stronger orders, but to gain share in that environment.

I just echo Joe's comments, and add that while there are this spot or that spot where markets are weaker. But by far, the overwhelming majority of markets are stronger and ahead of our ability to supply. What's helped our sales grow in Power Gen is an increasing ability to supply. So Engine business capacity has grown each quarter, and grew again in Q1. Our ability to make the supply chain work for us has grown each quarter. Which means that we're getting more sales against continued strong order boards.

Okay. And then maybe another cut at the same question. Is the order growth rate the same, or a little better or worse, than what we saw in the first quarter? Can you give me a sense there?

You mean in the first quarter last year?

In the first quarter that we just saw. I'm trying to gauge the rest of the year, versus what we've seen in your guidance, to see how conservative you are?

I'm not sure we can say anything more. We have a very strong order board, we've got long lead times with our high horsepower products, which again, would be the mining trucks and large power generation units, and so forth. The markets are strong. Really, the only market that is not really strong right now, is the Dongfeng truck engine market in China, and the Power Generation business in China remains soft. But other than that, things are very strong. Our Distribution business is also seeing a lot of demand, as well. So it's a good quarter, and we think that will continue throughout the rest of the year.

And Joel, if you remember in our scripted remarks, we did raise our top line guidance around revenue. If you remember in our Q4 teleconference, we talked about a 5 to 7% top line growth. We have given the increased visibility to our end markets here in '06. We have increased that to 8 to 10%.

Okay. And I don't want to hog all the time, but just can you give us a sense -- you sound very confident on the ability to gain market share in the medium duty engine business. And it sounds, between the lines, like you already have something locked up. Is there any more color that you can -- any more light you can shed on that? If you do have a contract that's already in hand, or is it just a bunch of little pieces that you're seeing? Thank you.

All of the above. I think basically, all we can say right now is what's been publicly said already. But I'll make a couple of comments. First of all, the new product introduction work with our OEMs for our '07 product, is going very well. And dare I say, better than it is with the other guys. The only public announcements that have been made so far are, earlier late last year, when BlueBird announced that we were switching from CAT back to Cummins. And secondly, at the Mid-America Truck Show, Freightliner announced that Cummins ISB, ISC, and ISL is being engineered into all of their medium duty trucks, school bus, and specialty vehicles. And as you know, in 2002, that was not the case. So we are being engineered into every vehicle within Freightliner, and they talked about that at the Mid-America Truck Show. But things are going well in medium duty markets for us right now.

Okay. Thank you.

Peter Nesvold.

Bear Stearns. Maybe a quick question on the guidance, first. I guess if I take the midpoint of second quarter, and add in first quarter, and I look at the last peak, the years leading up to the last peak. It was typically about 52% of the year. That would imply you're on a run rate of about 11 75 for '06. And the full year guidance is about 6% higher. So what happens in the back half of this year that makes the earnings actually accelerate modestly from the first half?

Sorry -- I'm trying to do some calculations in my head. [inaudible]

I just took the midpoint of the guidance. It's 610 for the first half of this year, if I take the midpoint, divided by 0.52, and I get 11 75 versus guidance, I guess of about 12 50.

I think, Peter, your -- the 52% used was last year's number.

Well, no, I took '98, '99 and 2000 into the last peak, because -- on an average basis.

I think the issue you're going to run into with that, is that because the downturn occurred in the second half of 2000, that -- I just think the 52 48 thing is not a good average. So I think as a general rule, our second half earnings will be slightly stronger than first half, as a general rule. That doesn't mean it's true in every year, or every time. But, so I guess that's -- I think that's the problem with your math.

Okay. Okay, fair enough. Maybe a question on the heavy engine duty shipments -- or truck, heavy truck engine shipments you cite in the release. It says, up 22%. How much of the heavy duty global truck shipments are Class 8 North America?

Probably in the range of -- it varies a little bit year to year, but it will be in the range of around 85%.

So then, I'm looking at -- the ACT data shows that Class 8 builds were up 13% year-over-year in first quarter. Your global shipments were up 22. And when I look at the Ward's data, it doesn't show you gaining any major share in January, February. Last year there was an easy comp from March, because of Navistar's production constraints, and the March data for this year isn't out yet. So it seems to suggest -- and that Ward's data is based on factory shipments of trucks leaving the OEMs. So I'm trying to understand. Are the OEMs stockpiling engines? Because when we talk to the OEMs, they're saying no. I'm not really seeing major market share gains at you guys yet. Your engine shipments for heavy truck are significantly higher than the industry.

I'm not quite sure how to answer that question well, other than clearly, OEM truck shipments lag our engine shipments. While -- and we are expecting -- I mean, just to be clear, we're going to probably see for the year, as opposed to the quarter, for the year-to-year comparison, our ISX shipments will be up 10 to 12%, somewhere in that range. And our ISM shipments will be up probably at least 15% in '06, compared to '05. So overall, that's total shipments, all markets. We're expecting increased shipments as we work our way through the course of the year.

From a stockpiling point of view, I think as we talked about the last time, I mean it's -- stockpiling did happen in '02. The OEMs, we know are concerned about making sure that they have a smooth transition as they introduce their trucks next year, with the engines in it. And they want to be able to do that in some steps, as opposed to all the same day or week. So you can assume from that, there'll be some level of stockpiling. As I think is clear, we're not really interested in doing much stockpiling. Because A, it takes away from sales opportunities in '06, which we think we have, and we're real confident in our 2007 product. It's going to do a good job for the OEMs, and for the end users. So it's still very early days on that question. I don't think there's very much going on right now. But all the OEMs are thinking it through. And we'll work with our partner OEMs on reasonable requests. But I don't think we're seeing, in fact, very much of it happening right now. I think it will be something we'll all see and learn a little bit more of, as we go through the course of the year.

Great. And I'll ask 1 other quick one, and then I'll get back in queue. The EBIT eliminations in first quarter, it looked like it was substantially higher than it's been in the past. What's changed at that line?

Nothing from a reporting perspective has changed in that line. I think what we have seen is obviously, higher gross margins, higher level of shipments, and all of that is kind of left with a little bit higher inventory in the channel, that has resulted in us having to eliminate that profit that is essentially on our balance sheet, and will be released in later quarters, as those shipments are made.

I don't quite understand. So it's a buildup of inventory in the balance sheet?

It is, as we are producing -- producing product within the 4 walls of the Company and moving it inter-company that we are creating -- .

Oh, I see. Okay. So where's the biggest overlap? Is it Power Gen and Engines?

They're definitely 1 of the issues. But it is also as we are moving product into the distribution channel as well, that we're seeing inventory -- .

All the Components groups have a lot of inter-company sales, also.

That makes sense. Okay, terrific. Thanks for the time.

Gary McManus.

JPMorgan. Great quarter. Looking at your guidance, I assume in your full-year guidance, you're using the 270 number in the first quarter. You're not adding back the $0.23 for the tax, is that right?

That's correct.

Okay. So you did 270, you expect 340 midpoint in this second quarter. So that's 610 for the first half, which means about 640 in the second half. And that's $6.40 in the second half, is only about 3% up year-over-year. And I know you've been kind of ridiculously conservative in your guidance in the last few years. It's been way too low in terms of what actually happened. But do you see any kind of meaningful slowdown in growth, or is this just conservatism?

Our guidance is what it is. You can make your judgments about what you want. But I think I've said before, is that we're going to give guidance that we think we can meet or exceed. And we're not going to put numbers out there that are at risk. And we are confident with the guidance that we put out. And it's up to you to determine whether you think it's conservative or not.

So you truly believe you're only going to have roughly 3% earnings growth in the second half, year-over-year? Even though, you talk about very good conditions, and joint venture income, which was pretty weak in the first quarter, is going to get better I guess, as the year progresses. You're buying back stock, which is going to reduce your share count. You're generating cash, which will help lower -- or increase interest income. All the things you can point to, I assume you're going to get good pricing. So it just seems very low. And I'm just trying to understand what is -- in your mind, what is causing the slowdown in earnings growth in the second half of the year?

I'm not going to comment any more on our guidance. We think it's the right guidance, and we're not, you know -- it's up to you to whether you want to make those kind of judgments.

Okay, okay. Fair enough. If I'm looking at the segment income, you are including interest income in the segment numbers. Is that correct when I look at that? And I'm just wondering, is there interest income in each of the 4 segments?

No.

Okay. Well, I'll have to talk offline on that, because it looks like it's in that -- when you look at the -- it looks like interest income is being added to the segment income. But you're saying no. One last thing, the 31% full year tax rate assumptions. I just want to make sure, is that $12 million adjustment in the first quarter, is that in there or not in there?

No, the 31% is our effective tax rate. That would exclude the discreet items.

So I should use 32% you did in the second -- I'm sorry, in the first quarter, taking out the $12 million, I should do it that way?

What we have said is, going forward -- first, we have the discreet item in the first quarter. But then going forward, we're still operating under the assumption that Congress will pass the research credit. That's why we've used a 31% for the rest of the quarters. If they don't do that, it would be closer to 32%.

Okay, great. Thanks.

Andrew Casey.

Prudential Equity Group. First, a clarification. The tax adjustment that Gary was just talking about, was that in your original 1Q guidance?

No.

Okay. And then, what was the product coverage cost in the quarter?

3.1%.

Okay, thanks. Now the question, as Dean, as you were detailing the results, I was struck by how many businesses are already in the business cycle EBIT margin target range. Can you kind of comment, truck aside, how the rest of the businesses, how high can those get? Should we just use your guidance, in terms of the target range for the business cycle, because some of them are bumping up against the top end?

Yes, some of those targets, we raised in the last year. And most of the businesses are performing very well, and we're comfortable with the ranges that we have for each of the businesses. On the Components business, we saw improvement in the first quarter. We expected some. They did better than what our expectations were. And we're still saying, they'll get into the 7 to 9% by the end of next year at the bottom end. And we'll get higher in 2008. But some of the operating issues that we've had in the Components businesses are either fixed, or close to being fixed. So we're seeing some improvement there. The other businesses should be operating at the same levels that you saw in the first quarter.

And just as a reminder, those targeted ranges are, on average, across the cycle, too. So I think that you would probably be comfortable on modeling those going forward, because many of them are operating pretty flat out at this point. And so I think I'd use those ranges.

Okay. Thanks.

John McGinty.

Credit Suisse. Just on the Components group, I think you -- the comment was 3 out of the 4 businesses were strong. And you mentioned them, and could you just remind me which is the fourth business, and what is the issue there?

Yes. The fourth business is what we call the Components group, which includes our turbocharger business, our fuel systems business -- .

No, no, no. In Components, you said filtration, turbo, and fuel systems were strong. What's the fourth one, what's the one that isn't strong within Components?

Emission Solutions. And within -- Emission Solutions is very much in an investment stage. And introducing a whole series of new products for the '07 -- '07 and also in Europe. And so they're down this year, relative to target, right? So we're expecting -- . Relative to the -- to the target we have set for the group, and we expect significant improvements in performance next year. Let me add though, as we said in the last conference, we also have had some issues in terms of performance in our exhaust business, which is part of the Fleetguard organization. And that's where we've been -- have playing focused attention on making improvements in that business in order to improve earnings.

But the implication -- I mean, when you talked about the Filtration being strong, that included the Exhaust business, I assume?

It was stronger. It is still not within -- the whole group is not within their targeted range.

No -- but, let me ask it slightly differently. If -- and I'm not saying you ever would , but if you were to break out the old Fleetguard turbo and fuel cell business, I would assume the margin would be substantially higher than the reported margin that you have so far?

The Fuel Systems business was not in the old filtration and other. So it's a little hard to do that kind of a breakout.

Yes. Without using numbers, though, John, I think the simple answer to your question is yes.

Okay. And you have, in the past said that the exhaust issue was a price -- cost-price issue. Has that been resolved?

We've made a lot of -- it's not totally resolved. We've made a lot of progress on the issue. And we'll make more progress as we go through the next 2 quarters.

And is that why you don't hit 7% until -- if I heard you correctly, until the end of '07? Until like the third or fourth quarter of '07?

Yes, what we've said is that we'll be at the lower end of that range by the end of '07. So we think at this point, as Q4. We have a shot, obviously, if everything comes together, of doing a little bit better than that. But the first half of '07, we have a significant number of new product introductions. And so we're being a little bit cautious, in terms of how things will actually go as we work our way through the new product introductions from Fuel Systems, from Emission Solutions, and some from Turbochargers.

Okay. And then, if I come back -- when Jean was giving the comments on the gross margin improvement, one of the points, Tim, that you made, is that heavy duty trucks are only -- which is where you have the long-term sales agreements, are only 14% of sales. So in the other 86% of sales, how important was price? What you've seen in some of your competitors is that they've been very aggressive in getting fairly substantial price increases. And was that a major factor in your gross margin?

I would say it was significant. But the increase in production and increase in efficiencies of our plants is probably the biggest contributor to the improvement in gross margin.

Okay.

We've also -- our global sourcing efforts, where we have buying offices in India and China and Brazil and in Europe and the Czech Republic, that's starting to bear some fruit right now, too. And we were able to also keep in check some of the commodity pricing issues that several businesses are experiencing. So it really was a combination of all of those things, as opposed to 1 item. I will say that we have priced aggressively in Power Generation, and there may be some opportunities to continue to do that. And we continue to look for other pricing opportunities in our other markets.

And on the heavy duty side, as it affects everything from the large Power Generation modules over to mining trucks and so on, where are you on lead times? One of your major competitors is out to 11 months on the thousand and up horsepower engines. Are you guys in that same ballpark, or are you able to pick up share in that regard?

On our very high horsepower, we're somewhere between 100 days to 250 days.

It's a range by market, because a lot of it has to do with how much we had forecasted for the market versus how much the demand is. So it's not 1 number, and it won't be for our competitors either, by the way, because they're global. And when you go to different markets, you'll get very different numbers.

Sure.

But my point is, I don't think we're substantially advantaged on lead times to our competitors, though we'd sure like to continue to make improvement against that. That's why I mentioned the point about us increasing capacity in our engine and generator set capabilities is really helping us, both from a sales point of view, but also make our customers happy. Because the lead times are longer than our customers really require today.

John, I want to come back to just 1 more comment on the Components business. Because I'm not sure we've been as clear. But all 4 of those businesses right now have a disproportionate amount of investment in technology around bringing out new products. And as those products are introduced, some of the costs associated with that will be reduced. And that's another reason why we're confident that we can get into that 7 to 9% profit target. So it's not just fixing the exhaust business, for example. There's a real shift. And also, especially, with Emission Solutions, when you look at '07 here and Europe, you're going to see a significant increase in sales. And as that happens, we'll get production efficiencies, and so forth. So we like where we are with the Components business. It's the only general business we have that isn't operating at the higher end of our targets. But we have a path that we're pretty confident that we'll get to where we need to be.

Okay. And then just the final question I have is, and I think it's important to come back to, Tim, the point you made, that North American heavy duty truck business, where we've got issues about tougher comps, slowing growth and everything else, is 14% of your sales. We have the other 86%, your sales were up 21% in the first quarter. You've raised your sales guidance, but you're only up to 8 to 10%. So you can do what you want with 14%. But the other 86%, why -- where are we seeing as we look at the Power Gen, as we look at the international distribution, as we look at the industrial and medium and the Dodge, where are we seeing such a dramatic slowdown?

Well, I think that -- what we're saying, it's going to stay flat as opposed to continue to grow at 20%. It will stay flat at the current levels. And one of the reasons is that we're producing at capacity levels. And rather than bring in large chunks of new capacity, we're incrementally doing that. So the growth will slow, just based on our availability to produce. And also, by staying at these levels, we think that we maximize our efficiency at production. So, that's what's going on.

And I would also comment, remember this is full year to full year, as opposed to just first quarter last year to first quarter this year. So, remember, we had pretty rapid growth last year.

But the markets, except for the heavy truck market, there's not evidence that the markets are slowing or declining. Maybe the rates have gained -- diminished, but what you're saying is that the capacity is your issue?

It's one of the issues.

And the other issues, you don't want to raise them?

John, I think it's not declining. The word declining doesn't make sense to me. The point is, the growth rate from last year is not as high, as you look quarter-over-quarter. But nothing is declining.

Or there's a sense of conservatism in the numbers, as Gary pointed out.

Well, you and Gary often have agreed.

Thank you.

Peter Nesvold.

It's Bear Stearns. In Jean's comments, you mentioned that she expects China truck to improve towards the second half of this year. Can you give us some more color why you expect that to rebound?

I think, basically, we're expecting it to rebound at least somewhat in the second half, as the government gets clearer on how it's dealing with enforcement of the overloading regulations, which has been probably the single biggest factor which has deflated demand since the peak back in sort of 2004.

Okay. And then I guess a question about Jamestown. I was out there a few years ago, but I don't remember, is that only Class 8 engines, or do you make medium duty engines there, too?

We make only, basically 11 and 15 liter engines for all markets.

Are there any of the engines that you're making for Freightliner or BlueBird starting in '07, would that be made out of Jamestown?

No. Well, a few. But most of the engines that we make for Freightliner and for BlueBird will be coming from our CDC plant in North Carolina.

How do you think about capacity for that plant, then in '07? Is there a point -- some point late this year you have to make a decision? Or is it really variable cost oriented, so you could scale down very quickly, cut overhead? I mean, the OEMs and the suppliers seem to think demand comes back pretty quickly in the back half of '07 so -- ?

We're in good shape on capacity for these markets going forward.

But for '07, how do you treat '07? If you think it's only maybe a 2 quarter downturn, do you cut overhead and scale it back up again? Or do you just leave it as it is in anticipation of a rebound in the second half of the year? How do you think through that?

Well, it's a good question. And I guess all I'll say, is this is a question we've been working on answering for some time. We are lucky enough, in that with our workforces, we have a very flexible approach to work hours. So, and in all cases, we have what we call a "rings of defense" approach that enables us to reduce cost as volumes go down, without having to go through lots of [massinations] that might threaten quality on the way back up. So we have a plan plant by plant, depending upon what actually happens, as to how we'll deal with it. And so we can cut costs in the down quarters, and deal very quickly, if the turn is steep. And I think I'll leave it at that.

Okay. Thanks, again.

Okay, I think that's all of our time for this morning. Appreciate your participation in our earnings call today. And if you have further questions, you can reach me in the office today. Thank you.

Thank you, ladies and gentlemen. That does conclude today's teleconference. You may disconnect your phone lines at this time, and enjoy the rest of your day.