康明斯 (CMI) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Cummins Inc. third quarter 2006 earnings release. At this time, all participants have been placed on a listen-only mode, and we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Dean Cantrell, Director of Investor Relations. Sir, the floor is yours.

Thank you, Kate. Welcome, everyone, to our teleconference today to discuss Cummins' results for the third 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 email 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 statement involves risks and uncertainties. The Company's future results may be affected by changes in general economic conditions and by the actions of customers and competitors. Actual outcomes may differ materially from what is expressed in any forward-looking statement. A more complete disclosure about forward-looking statements begins on page 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 four operating segments, beginning with the Distribution segment.

Sales for the Distribution segment were up 17% compared to the third quarter of last year equaling the record sales of the fourth quarter of 2005. The growth was due primarily to increased sales of Power Generation equipment in the Middle East, Europe, and the South Pacific. Nonresidential construction, driven by telecom investments and petroleum revenue, continues to create strong year-over-year demand for Power Generation equipment.

Revenues from engines, parts, service and filtration also saw year-over-year growth in these same geographic regions. We expect sales for the Distribution segment to remain strong for the rest of 2006, and we'll see continued organic and acquisitive growth next year. Quarterly segment earnings of $38 million were a record, increasing 36% year-over-year.

Earnings from joint ventures were the largest contributor to the increase, as we saw strong performance from our unconsolidated North American distributors due to strength in sales of Power Generation equipment. For the quarter, earnings for this segment were 11% of sales above the targeted range of 8% to 10%.

Our Power Generation segment achieved record sales and record earnings this quarter. Sales were up 24% over the same quarter of last year, with growth coming from increased sales of commercial generator sets and alternator equipment. Sales saw strength in North America, Europe, India, and the Middle East, driven primarily by infrastructure investment. The consumer business fell slightly as growth in the portable generator market was offset by a softness in the North American RV market.

Demand for our Power Generation equipment is expected to remain strong through the rest of 2006 and 2007, powered by the same underlying trends of global investment and infrastructure to meet growing demands for electricity. Power Generation segment earnings were 24% higher than the third quarter of last year. Earnings remained above Power Generation's targeted range of 7% to 9% of sales at a 9.1% of sales. The benefit from higher volume and further price realization led to the improvement in profit.

Total sales for the Engine segment were up 10% compared to the third quarter of last year. Within this segment, revenues from on-highway markets were up 7% and off-highway markets were up 19%. Earnings for the Engine segment grew 20% from last year, remaining at the top end of its targeted range at 9.9% of sales.

Greater price realization and the absorption benefit from higher volumes offset lower joint venture income and higher spend for the recently announced new engine development program and investments in capacity to allow for growth. Global shipments for the heavy-duty truck market were up 23% over the same period last year, driven primarily by strength in the North American heavy-duty truck market and our ability to increase manufacturing throughput of our engines. Demand for heavy-duty trucks will remain strong through the rest of 2006 before falling in 2007 as new emission regulations take effect in North America on the first of January.

While North American heavy-duty Class A truck sales will likely be down 30% to 40% next year, our year-over-year North American heavy-duty truck engine volumes could be down as much as 50%, depending upon the amount of 2006 engine inventory at OEM's at the beginning of next year. The decline will be most severe in the first half of 2007, with industry shipments expected to improve in the second half of 2007.

Our 2007 shipments could recover quicker than the industry, as we believe our new products will be better than the competition, which will result in increased market share toward the end of the year. Worldwide shipments to our medium duty truck and bus markets were flat this quarter compared to last year.

Market share gains in North American medium duty truck were offset by an emission-related downturn in Brazil. Brazil has not completely recovered from the Euro III implementation at the beginning of 2006. We expect the market to strengthen in the fourth quarter, and to remain strong in 2007, while our European sales will benefit from additional sales gains through our new supply relationship with Nissan.

Along with these significant market share gains in North America, that we previously announced, 2007 will be a strong year for our medium duty truck business. Global bus engine shipments were down 10% compared to the same period last year. The decrease was due to a large order from the Beijing Public Transit system in the third quarter of 2005 that was not repeated this quarter. North American volume was up 70% as we continue to benefit from increased market share with OEMs. Worldwide shipments to the bus market will be up next year due to increased penetration and full-year availability with our North American OEM partners.

Global light duty automotive and RV shipments were down 18% as market share gains in the North American RV market were more than offset by lower shipments to the North American heavy-duty pickup truck market. While we will continue to closely monitor this market for changes in demand, we expect shipments to the Global light duty automotive and RV markets will be up slightly for the full year 2006 with positive growth expected in 2007 through new product offerings and increased availability of our product at key OEMs.

Shipments to the global construction equipment market were up 19% compared to the third quarter of 2005. Global construction remained robust, driven by higher nonresidential construction spending, particularly in Korea, India, and the Middle East. Shipments to the light construction market continue to grow faster than the underlying market as our market share gains allowed us to grow 29% over the same period last year.

Construction shipments will continue to grow in 2007, although the growth will be more modest as global nonresidential construction slows slightly. Engine shipments were 53% higher to the oil and gas equipment market, 33% higher to the commercial marine market, and 23% higher to the mining equipment market. Continued strength in commodity prices are driving increased investment in oil and gas, and mining equipment, which drives demand for our engines in these markets.

We expect these conditions to continue into 2007 and provide support for growth in our industrial markets, especially with respect to use of our high horsepower engines.

Revenues for the Components segment were up 17% over the same period last year with strong growth in all four businesses in this segment. Sales growth was evident globally in both aftermarket and OEM sales, especially in our filtration and turbocharger businesses.

We will see strong revenue growth in this segment next year as many of the technologies in which we have invested to meet the next generation of diesel engine emissions regulations will begin full production.

Components segment earnings were 3.4% of sales this quarter [INAUDIBLE] quarter of last year. Profitability was negatively impacted by manufacturing inefficiencies as a result of closing two exhaust facilities and consolidating production into the existing facilities.

As a result of winnings over the last year, a significant amount of non-Cummins components business for 2007 pre-production activity has put additional pressure on margins within each of the four businesses this quarter. While these operational inefficiencies led to lower earnings for the quarter, we remain confident that the manufacturing changes and the new product introductions will generate segment margins at the lower end of the targeted range of 7% to 9% by the end of 2007.

Now I'll turn it over to Jean to comment on our consolidated income statement, cash flow, and guidance.

Good morning. Our earnings before interest and taxes were 10.5% of sales, above our targeted range of 7% to 10%, and better than the third quarter of 2005, which was 9.7% of sales. Net earnings for the quarter were $171 million or $3.37 per share, compared to net earnings of $145 million or $2.90 per share in the third quarter of last year, for an 18% increase in net earnings despite a year-over-year tax rate increase.

Gross margin for the quarter was 23.3% of sales, better than the 22.7% of sales during the third quarter of last year. Included in this number is product coverage expense of 2.9% of sales, slightly higher than the 2.7% of sales last year, but consistent with the second quarter of this year. Gross margin remained high due to a continued focus on cost reduction through our global sourcing and Six Sigma initiatives, along with our commodity hedging programs. These actions position us to continue to maintain a high level of gross margin going forward.

Total selling admin and research and engineering spending in the third quarter was 14.6% of sales, compared to 14.5% of sales last year, an increase of 15%, or $52 million. While some of the increase in spending is volume variable and tied to current levels of production, we are investing heavily in delivering emission compliant products for 2007 and beyond in three of the four operating segments, including on-highway engines in North America and Europe, after treatment systems, such as diesel particulate filters and selective catalytic reduction, high-pressure common rail fuel systems, variable geometry turbochargers, and closed crankcase ventilation systems. We also began investing in profitable growth opportunities such as light duty diesel engines in China and North America, and heavy-duty diesel engines in China.

These investments are a necessary component of our profitable growth strategy. Income from joint ventures and alliances increased 19%, compared to the third quarter of 2005, primarily due to greater income from our North American distributors. We expect JV income in 2006 to finish above the 2005 levels, as strength from our distributor JVs will offset lower income from our joint ventures serving the Chinese truck market.

Income taxes for the third quarter were 33.7% of profit before tax. We have raised our estimate for the full year effective tax rate from 32% to 32.5%. The third quarter includes a $3 million catch-up adjustment to bring our nine-month year-to-date taxes up to 32.5%. The effective tax rate excludes discreet period tax items, which were a net tax benefit of $16 million for the first half of the year.

Other than the catch-up to the higher estimated tax rate for the year, there were no discreet period tax items in the quarter.

Cash flow from operating activities was an inflow of $258 million this quarter, 12% higher than the third quarter of last year. Year-to-date, cash flow from operating activities at $613 million is 60% higher than this time last year and we are on pace for record operating cash flows this year. Our working capital for the quarter increased from 17.8% of sales last year to 18.1% of sales this quarter, above our targeted range of 15.5% to 16.5% of sales.

Some of the growth in inventory was related to production cuts in our light duty automotive business at the end of the quarter. We expect inventory levels to improve in the fourth quarter as has been the seasonal trend over the last several years.

Finally, I would like to take a moment to summarize and update our guidance for 2006. We are maintaining our revenue growth to a range of 11% to 13%, lowering our capital expenditure rate to $225 million, raising our expectations for joint venture earnings to be slightly higher than 2005, increasing our effective tax rate to 32.5%, and raising our global pension funding to a range of $255 million to $260 million, from $230 million to $240 million as we suggested last quarter.

With regard to earnings guidance, we are reaffirming our expectation to make between $14 and $14.20 per share for all of 2006, which includes the impact of the higher effective tax rate for the year. Now I'll turn it over to Tim.

This was the best third quarter in our history. We had $171 million in net earnings, 18% higher than the same period last year, even with the 4 percentage point increase in the effective tax rate. We continued to grow quarterly earnings faster than revenue and once again, we are generating record cash flow from our operations this year, which contributes to a strong balance sheet and gives us financial flexibility regarding future opportunities.

In previous teleconferences, I have shared with you the four reasons why we are a different Cummins. These include product and geographic diversification, profitable growth opportunities, technological leadership, and efficient cash management. Our geographic and end market diversification gives us better balance against the cyclicality of the North American heavy-duty truck market. That was particularly evident this quarter -- excuse me -- as our Power Generation and Distribution segments experienced rapid growth in both revenue and profits. Both business units performed better than their financial targets and we expect this performance to continue in 2007 and beyond.

In previous quarters, I've talked about several global opportunities for profitable growth. The list continues to grow. Last week, we announced the signing of the joint venture agreement with Foton, to build light duty diesels. These engines initially will be built for the Chinese light commercial vehicle market beginning in 2008.

Nissan announced that our ISBe engine will power its light commercial vehicles in Europe and here in Columbus, Indiana, we announced the location for the production of a new light duty diesel engine for DaimlerChrysler and other automotive and industrial customers. I believe Cummins has a significant competitive advantage with our emissions technology.

Confirmation of this is demonstrated by our market share gains in most markets. This emissions capability allows us to partner with OEM customers to meet stringent emission standards around the world while providing them with the best possible products.

I just returned from an American Trucking Association convention in Dallas, where I met with the executives of three of our field test fleet customers. Their feedback was very positive. They commented that our field test engines are meeting their expectations for fuel economy, reliability, engine performance, and driver satisfaction. Recent trade press articles also have documented the performance and dependability of Cummins' '07 engines.

The October cover story of "Fleet Maintenance" highlights the positive experience that Knight Transportation has had with Cummins' '07 ISX engines. The editor of "Heavy-duty Trucking" also shared his experience of test driving a Cummins' '07 ISX engine in a separate article this month.

Our cash management strategy focuses on building a strong balance sheet, investing in profitable growth, and enhancing shareholder returns. We plan to pay off $250 million in debt this December to further reduce our interest expense for next year. We have repurchased $76 million of common stock this year and raised our dividend 20% in the third quarter.

I believe Cummins stock is a good value and will continue to earn good returns for our shareholders in 2007 and beyond.

These strategies, diversification, profitable growth, technological leadership, and cash management will help us to continue our financial success into 2007. At our analyst meeting last year, we said we would deliver no worse than our 2004 EBIT margin of 6.4% which was a record. However, we now have higher expectations. We believe that in 2007, the Company will generate an EBIT margin as a percent of sales within our targeted range of 7% to 10%.

Here's why. The Distribution and Power Generation segments are expected to generate strong EBIT margins again in 2007, higher than we thought a year ago. The Engine and Components businesses will be introducing the next generation of new products while effectively managing the challenges of the U.S. emissions standard change.

Cummins' customers have increased their engine and components business with Cummins in recognition of our technical leadership. Many of our markets will continue this current fast growth next year such as Power Generation in India, the Middle East, and China, Engines to North American medium duty truck, bus, oil and gas, mining, commercial marine, and turbochargers and exhaust after treatment systems to North American and European OEMs.

Power Generation is growing faster than the market. It also has extended into adjacent consumer markets. In addition, it has increased prices by 7% to 10% for 2007 EPA Tier 2 and Tier 3 gensets, and significantly improved its low-cost global sourcing efforts to increase margins.

Distribution will continue to grow its earnings faster than sales, organically, as well, through acquisitions. Many of our distributors are benefiting from the strength of the global Power Generation markets. We also expect to continue our strategy of acquiring equity interest in our distribution channel both internationally and in the U.S.

The Components segment with its four businesses will have a significant opportunity to improve margins next year because of the new emissions standards in Europe and the United States. Included in their new product lines will be nine new exhaust after treatment systems, four new fluid and exhaust filters, three new turbocharger models, and the next generation of extra high-pressure common rail fuel systems. To maximize the return on these new products and increase production efficiency, we have closed two exhaust plants and begun manufacturing at three new facilities.

This has had a negative impact on third quarter margins. However, we expect these changes and the new products to help the Components segment return to the lower end of its target profitability range in 2007.

The Engine business also has an effective cost management strategy in place for 2007, particularly for the heavy-duty business. As a result, the Engine business expects its heavy-duty business to be as profitable next year as it was in 2004, despite a projected 50% decline in North American heavy-duty truck engine volume. Part of that strategy includes keeping its highly skilled work force intact, even as it responds quickly to changes in volume demands.

The Engine business is also investing in the next generation of profitable growth opportunities, including three new engine platforms for light duty diesel in North America and China and light commercial vehicles in industrial markets, and a new 13 liter engine platform for the heavy-duty truck market in China and potentially in North America, and developing recipes for the next on-highway Euro 5 and EPA 2010 and mobile off-highway Tier 3 and 4 emission standards.

Finally, I again want to emphasize Cummins' technical leadership. Our focus on technology has generated increased business from customers and not just in the Engine business. Cummins Turbo Technologies has gained a greater share of the turbocharger business with truck OEM's in the United States and Europe. Cummins' emissions solutions expects to be the leader in after treatment exhaust systems in the U.S. and Europe. And looking beyond this year, Cummins fuel systems will begin supplying Scania with our next generation high-pressure common rail fuel systems. We also expect to benefit from continuing market share gains in most of our engine markets.

As a result of the success of our profitable growth initiatives, the market and product diversity of our businesses, our focus on being the low-cost producer, and our ongoing commitment to delivering superior results, I am very confident about 2007 and beyond. We will now take your questions.

Thank you. Ladies and gentlemen, the floor is now open for questions. [OPERATOR INSTRUCTIONS] Please hold for just a moment, while we poll for questions. Thank you. Our first question today is coming from Andrew Casey. Please note your affiliation and then pose your question.

Wachovia Capital Markets. Good morning.

Good morning, Andy.

Can we talk about the '07 outlook a little bit? I mean, you gave a lot more clarity in your monologue than in the release. But two questions in particular. One is, given the significant downdraft in the quarter for the light commercial vehicle engines and presumably, Dodge Ram, what are you assuming that does or can you further qualify what the new incremental product that you expect to offset maybe continued weakness there in '07 would be?

Are you talking about Chrysler?

Yes.

We expect right now to have a volume -- we think this year will be level with last year, with the second half being lower than the first half of this year. And next year, we think we will be up maybe 5%. And that's due to the fact that we are available in the cab chassis program.

Okay. And if you can kind of give us a little clarity, Tim, on the ATA meeting. I mean, there's been a lot of concern lately about some of the softness that the freight guys are talking about in their demand trends. And what are you assuming that does to the '07 demand for engines?

On ton freight mileage?

Exactly.

I mean I think the general feeling, and I probably talked to, you know, 20 fleets in the last two days, I think the general feeling is that it's still very good, but it softened compared to where it was. And they expect that to be that way through the fourth quarter of this year. And then they think it's going to come back next year, maybe not as robust as it has been, but still the ton miles should be going up.

So with that you're still expecting a bit of a second-half recovery for the heavy-duty portion of your business?

For next year?

Yes.

Yes.

Okay. Thank you.

Thank you. Our next question today is coming from H. Peter Nesvold. Please announce your affiliation, then pose your question.

Hey, it is Peter Nesvold from Bear, Stearns. I've got to tell them to drop that H. That's the second time they've done that to me.

[LAUGHTER] We want to know what it stands for.

It stands for Hanz. I guess I want to talk about Components a little bit here, because it seems like we have talked about this margin deterioration for several quarters now. This quarter was the worst margin report for Components this entire cycle. In the release, you attributed some investments into the '07 technology.

I guess first starting with the engineering and research expense, it was flat quarter-over-quarter on a consolidated basis. So I guess I'm not really seeing it there. If you could elaborate on that, and then also maybe quantify some of the inefficiencies that you incurred during the quarter, and how soon do you think that can reverse out in 2007? Is it by January 1, or is it by the end of the year, or something along those lines?

Well, this is Joe, Peter. Let me make a couple of comments. I think one of the points we're trying to make here is that part of the reason we're seeing what we're seeing is at least compared to the beginning of the year, we've actually won more OEM business, non-Cummins OEM business than we thought we were going to win. And that's put pressure on the nature and rate of our ramp-up for new products in new or reconfigured plants. And so we're not quite on the schedule we were hoping to be on. We're behind plan right now. But feeling very good about how we're going to progress as we, even enter the fourth quarter and go into next year.

Basically, the hit was more to gross margin than it was to SAR, to research expense. There wasn't really any hit to research expense. What happened to us in the third quarter is overwhelmingly related to the fact that we were closing some plants, reconfiguring other plants, and opening new plants for -- with more variety and product than we planned on earlier this year. And that hit us harder in the third quarter than we were predicting earlier this year.

We are still extremely confident that as we make our way through next year, that by the fourth quarter of '07, as we said earlier this year, we will be at or above the low end of our 7% to 9% EBIT target range in this business, and in '08 we will move well within the range.

So our issues are more related to the actual cost of rearranging manufacturing to drive for a lower-cost manufacturing base, and second, the amount of variety we have and the actual ramp-up with a variety of our customers. And overwhelmingly the hit was in gross margin. There was really very little in SAR.

Maybe a further question in that particular business for you, there were no comments about nickel or stainless steel prices as a reason for any of the margin miss. We've seen that with some other component manufacturers for turbos and to some degree some exhaust systems where stainless is a big input. How much of that was an impact here in 3Q for you guys?

It was part of the impact in gross margin, but much, much smaller. Overwhelmingly, our issues were around closing plants, reconfiguring plants, and opening new plants with more variety in new product than we had. A small impact in turbos and in the emission solutions from a material cost point of view.

Got you. And I guess, Tim, just a clarification in your comments. You said the profitability in the engine business would be flat year-over-year 2007. Was that in terms of absolute dollars or was that in margin percent?

Peter, what Tim said was our EBIT as a percent of sales would be no worse than what it was in 2004. We did not say that in 2007 that it was going to be flat with 2006.

You didn't comment specifically about the engine business being -- profitability being flat year-over-year?

In engine business, we did not say that it was going to be flat year-over-year, we said that it was going to be no worse than the profitability we had in 2004 in the engine business.

And I guess just a macro question. I guess I just need to ask you, because it feels like there is still a fair amount of good things that are happening internally, what you guys are seeing. What kind of a U.S. GDP do you generally have discounted into your revenue outlook of flat to up 5% next year?

I think it was 3%.

Yes.

2.5% to 3%.

Thanks for the time, guys.

Thank you.

Thank you. Our next question today is coming from Jamie Cook. Please announce your affiliation, then pose your question.

Hi, good morning, Credit Suisse.

Good morning.

You know, I guess my first question, you mentioned -- I thought you mentioned a couple of times -- or you mentioned once or twice acquisitions within the distribution business. Can you sort of elaborate on that and whether you're assuming acquisitions to make your '07 forecast?

Well, we've been on a path for probably the last three years where we've taken more equity position in our North American distributors when we've consolidated territory. And we will continue to do that over the next couple of years. We've also taken equity positions, or bought completely, distributors in Europe and particularly where we've also opened some new branches. Lately, we've increased our distribution capability in Russia, in Nigeria, in Angola. We're looking at some things in Southeast Asia. These are all small in terms of the amount of money that we're investing, but it's an ability to expand both our ownership position as well as territory.

Okay. And my next question, when you look at your guidance for 2007, is there any way you can help us with the, you know, how earnings should play out sequentially, whether you can say a certain percentage of earnings should come from the first half of the year versus the second half of the year? Can we somehow guide whether or not, you know, you see, when we look at the first and second quarter, whether you seem to be on track for the full year?

I really don't think we can. We're still putting our 2007 operating plans together right now and it would be premature for us to speculate or give that information out. We will be able to talk about that more after the fourth quarter.

Okay, great. Thank you very much.

Thank you. Our next question today is coming from Joel Tiss. Please announce your affiliation, then pose your question.

Hi, I'm still Lehman Brothers. How are you doing, guys?

Hi, Joel.

I wonder if you guys can talk a little bit about, there was a comment in the middle of the preamble about small construction equipment growing faster than larger construction equipment and the overall positive outlook for 2007. Can you just give us some details so we can understand that better?

Our light construction market is coming off of a low base. It's a market that we entered in a couple -- just two or three years ago. So we're seeing some real penetration gains in that business, and expect to see those additional penetration gains as we play forward into 2007.

Okay. Because that whole market seems like it's declining. So that would make sense.

Yes, as Dean said -- this is Joe. We've been benefiting from share gain as a result of having particularly a terrific 3.3-liter engine that's been displacing competition in a variety of installations globally. And now we've begun to also gain business below 3.3-liter at roughly 2.0 liter range, as well. So we're basically benefiting from share gain more so than market growth and size. And expect to continue, based on discussions that we've had with OEMs, to continue to pick up share in that end of the market.

Okay. Thanks very much. And can you clarify a little bit, too, the inventory build that's going on in the Class 8 engine business and the impact on 2007? Is that, is that bigger than you thought it was, it didn't seem like there's a lot of scope for your customers to build a lot of inventory. So can you give us some more detail there? Thank you.

I was hoping you would do that for us. No, I think -- a couple of factors that are a little hard to read. And this is part of our cautiousness in looking at '07 is exactly what size will the stockpiling be, and to what degree will it impact on us? As it relates to our engines, we don't -- there won't be significant stock piling of our engines. A, demand for our engines this year is up. OEMs want every engine they can get this year to ship and -- in heavy-duty trucks.

And the second and really important factor here is, you know, Tim talked about being at the American Trucking Association event. I was also there the next day, and in talking to our customers, our '07 products, the feedback we're getting, genuinely look better than the competition's. And because they're better than the competition's, a number of both end users and OEMs are going to be more comfortable buying our new product earlier in the year than they will for the competition.

So right now, while we do expect a little bit of stockpiling to help OEMs transition to the new trucks on a step-by-step basis, for us most of it will take place within the first eight weeks of the year. And the big question mark for us, though, is how much, where CAT is also offered at the same OEM, how much stockpiling will be going on with CAT engines, which is not clear to us. And what impact might that have on our early share, early in the year, which for the most part, we've actually been assuming will probably go down a little.

Whereas, we think our share in the heavy-duty truck market will come out much stronger at the end of '07 than it was at the end of '06 because of our view of the relative good position of our product versus the competitive offering, which is, of course, to be determined for all of us. But we're feeling very confident coming out of this year and going into next.

Okay, thanks very much, just a last quick one. Can you talk a little bit about your confidence level on price increases sticking, and when do you think you'll have, like, you know a good idea that they are going to stick or not going to stick, timing wise?

Which market in particular, Joel?

Well, in PowerGen and in truck engines, as well.

This is Tom, Joe. I can talk about PowerGen markets. We've been increasing prices now pretty regularly over the course of the last two or two and a half years. And so far, all have stuck. And we have pretty good confidence about new emissions generator sets that they will stick. There are some parts of the world where prices aren't as strong as, particularly in Asia, as they are in the U.S. and in Europe. But overall, we're pretty confident, I guess, is the way I would leave that.

And we're confident the prices we've negotiated with the OEMs in the heavy truck side will also stick next year.

Okay, thank you very much.

Thank you. Our next question is coming from Eli Lustgarten. Please announce your affiliation, then pose your question.

Longbow Securities. Good morning.

Good morning, Eli.

A couple of clarifications. One, can you talk about what tax rate we should assume for '07, the shares outstanding that we should assume for '07 -- it was going to be right around 15.5 or something like that and joint venture income for next year? And then I have two quick questions.

Clearly, on the tax rate, although we will give more clear guidance in our January call, I think you can assume that with the phaseout of the export benefits, that will -- that combined with the phase in of the U.S. manufacturers' tax deduction and the potential -- we'll wait and see whether or not Congress passes a federal research tax credit, but all that together we will obviously probably be higher from an effective tax rate than where we are in 2006, but would be below the 35% U.S. corporate tax rate.

Somewhere, like up a percent is a reasonable assumption from this year to 32.5?

Up from 2006, but below the 35% corporate tax rate.

And the shares outstanding, you're buying back some stock, you bought back $14 million in the quarter, I guess, should we assume that we'll be relatively flat at this level or we're going down a little bit from where we are?

Obviously, we have not communicated an amount of shares that we will be purchasing in any quarter, but we're committed to repurchasing the 2 million shares that we announced in July. You did see us actively in the market during the third quarter reducing the share base for the diluted EPS by 0.10 of a point here in the third quarter. I think you can expect going forward that we will continue, obviously, with our share repurchase activity.

Do you have any comment on JV income for next year, yet, versus this year?

Yes, actually -- actually for the rest of '06 we expect it to be higher than '05. We've not given specifics yet on 2007 other than end markets expectations that we would expect to continue to see strength in Distribution given the Power Generation markets that are helping to support our distributors around the world.

Some segment questions. Have you announced any shutdowns or cuts for the first part of next year in the heavy engine business, as we are starting to see? The inventory numbers we're hearing are much higher than you are giving credit for. The general consensus is 50,000 units at a minimum next year. They wanted the trade rights at 100,000 yesterday. I don't know where they got the number from, but they're talking about very large inventory carryovers into '07. And Volvo announced a cutback, and most other companies have announced shutdowns in the first quarter. Have you done any of that?

I think those inventory numbers you just suggested are extremely exaggerated, and again, I feel like I'm fairly current with what's going on in the marketplace. So I wouldn't put any credence in that.

No, we haven't announced any layoffs or anything like that. But as I think I mentioned a little bit in the last teleconference, we have had for some time both in our union and nonunion plants, something we call a rings of defense. And the plant, particularly Jamestown, which is probably most -- going to be most severely hit by this downturn in heavy-duty engine build in the first part of the year, have kind of worked through for some time a flexible approach to be able to drive costs out. And so they've already taken planned on steps in terms of what it is they're doing, in terms of reducing expense; for instance, we've been using temporaries in the plant. This year haven't hired there for some time in anticipation of what will happen early next year. So those temporaries will go.

The rings of defense we have also give us lots of options in terms of reducing build days, reducing hours per week, giving voluntary layoffs for people to leave for a period of time for a variety of reasons, and we're taking this approach right now in part because, a, we've got good experience with the rings of defense in terms of driving costs out, but B, we also think that there is some chance that our '07 engine build will take a sharper rise up than the rest of the industry relatively early in the year.

And so we want an experienced work force who knows how to build quality ready to deal with the opportunity to take our '07 engine rate up faster than the other guys. So, you know, we'll continue to monitor what's going on. But right now, as I say, we're going to take full advantage of our so-called rings of defense.

One of the other things that we're -- we'll actually be doing is we'll be loaning some of our people from the Jamestown plant, again subject to what kind of demand we have, to help those components plants that will be ramping up quickly with new products. And these will be experienced people who have experience with new products and they'll be working with our components factories to ensure that given the variety and the amount of new product that they're introducing, that, in fact, they have a terrific quality ramp-up. So they, too, are also ready if we have a sharp turn before we even come out of the first quarter.

Okay. And one final question. Your profitability in PowerGen is slightly above your targeted range. Based on your best estimates for '07, do you think you'll be able to hold it close to the top end of the targeted range or does it fall back towards the middle because of mix?

Yes, this is Tom, you know, again, based on what you heard from Tim's comments, we have a lot of confidence about next year. There's a lot of water under the bridge to go, and we're not giving guidance on percentages. But it looks good. Next year looks good. And a lot like this year. So we'll see what the guidance we give out after the fourth quarter. But it should be good.

Okay, thank you.

Thank you. Our next question is coming from David Raso. Please announce your affiliation, then pose your question.

Citigroup. Good morning.

Good morning, David.

Two questions, one, on the engine division, the profitability, trying to think through the pieces of it. When it comes to '07 versus '04, the heavy truck piece of it, it will be down from '04. Do you expect that business to be profitable in isolation, just the heavy truck business, in '07?

Yes.

And regarding the light duty auto, RV line item, let's assume it's not that much higher than '04, it would seem like the offset to the heavy decline '04 to '07 is a material jump in medium duty truck and bus profits versus '04 in the Industrial segment? Is that the right way to think about the moving pieces?

Well, yes. One of the things that we have said before, we expect significant increases in share such that we may even see higher volume next year in our medium duty engine business than we're looking at this year, all right, from a unit point of view. So our share, which not too long ago in medium duty was around 10% has made its way to up around 15% and coming out of next year, we expect to be in the 32% to 34% kind of range in medium duty truck. We're going to see significant gains, we believe, in the bus business which we've talked about already.

We have a great product, and flexibility in product for the bus manufacturers. They're excited about it, and we expect to see share gains also in the RV side of things. So one of the offsetting factors in terms of what's going to happen on the heavy-duty engine sales will be, in fact, medium duty engine sales to a variety of markets. And as we talked earlier, we're also expecting that we'll continue to grow our position in construction, particularly, but not only the lower end, and the other factor in the engine business is we continue to increase capacity in our high horsepower engines.

So our capability capacity has gone up roughly 15% this year versus last, and we have an aggressive program to take it up at least another 15% as we go through the next 12 months. And, you know, in Tim's remarks, he talked about what's happening to us in the oil and gas business which isn't only high horsepower, but it's significantly horsepower, what's happening to us in the mining business, and also, frankly, what's happening to us in the commercial marine business to say nothing of PowerGen, right? So our markets for high horsepower engines have also been growing, and that will also be an offsetting factor for what goes on in heavy truck next year.

So it's fair to say in absolute dollars of profit, the biggest delta '04 to '07 positively is that industrial line item?

I don't think we can be that specific. I mean, Joe answered the question. It's medium duty truck, bus, construction, and high horsepower markets. They all play a role of offsetting the downturn in heavy truck.

And then on the Power Gen, maybe a question more for Tom, maybe I missed it in the prepared remarks, you're North American revenue growth in the quarter for PowerGen? What was that percentage?

We didn't give that number.

Are you talking about year-over-year, though?

Year-over-year growth. When you look at CAT's numbers they were flat in North America in the third quarter, their own sales. Their dealers are even down a little bit, down 5% globally, especially North America. You know, CAT in their release, noted down, basically flat in North America. And clearly they are allocating some of their engines to oil and gas given the better margins there. But just seeing your revenue growth figure, I would be curious if you can give me some color on North America and then maybe speak to what you're seeing in the marketplace relative to your competition?

Yes, I don't have the North America number handy. I would be surprised if it was flat. But, the North American market is good. The points you raised for Caterpillar are also true for us. And Joe talked about it where we're limited on our horsepower capacity compared to demand, and there is a lot of high horsepower demand in North America for infrastructure building and that sort of thing.

So some of that market -- it's a strong market, but some of it is how much you can ship versus how much you have on order. But orders are up and business is strong in North America, let me say that so I have to check to get our number year-over-year. And Dean will check and we can follow up with that and maybe by the time I finish with my answer, he'll have the number.

But North America is a good market, and, you know, there's no reason to think that it's turning down short run. We do need to improve our availability and lead time in North America in order to make sure customers don't get frustrated. But otherwise, good market.

And the lower incremental margin in the business, Tom, this quarter versus last, is that partly some of the larger engines being allocated elsewhere or the consumer piece being pretty profitable?

Our base business is basically the same, you know, second quarter and third quarter are basically the same. We had a couple of issues in a rental project in Saudi, and things here and there, but if you look at kind of commercial gensets the markets you're talking about -- our margins were basically flat quarter-to-quarter. They're both really good.

David, this is Dean. For North America, year-over-year, North American Power Generation was up 21%. And sequentially they were up 2%.

So Tom, not on record as saying taking share, obviously, your revenue growth is a lot stronger North America that CAT's, and, again, it could be allocating engines. Given your consumer exposure, if anything you would lean towards probably getting hit a little bit more than someone who focuses not on consumer, and especially focuses on bigger projects the way CAT does?

I don't have a strong statement to make there about share because one quarter is a bad way to look at it. But what I would say, is, as you well know, we are definitely positioning ourselves to be a leader in the marketplace and we're doing everything we can to serve our customers better than our competition. I'll just leave it at that for now.

Thank you, our next question is a follow-up from Peter Nesvold.

Question on inventories, but I don't want to talk about stockpiling because it sort of is what it is. When I look at Class 8 inventories at the OEM and dealer level, we have roughly 62,000 and we have about 72,000 trucks in inventory at the medium duty level. You are picking up share on some new platforms, [PACAR's] medium duty platform, and then the Dodge commercial vehicle roll out. Would you expect, given that you're going on to some new products, does the industry have to work down the inventory that's already out there at the dealer level before you really start to see demand for those new products, or should I look at this as a whole new channel that you have to fill up, so, therefore, you don't really have to wait for those dealer inventories to start coming down?

It will be a little bit of both, depending upon the OEM and which trucks you're talking about here. Clearly, [PACAR] I think is very excited about the Cummins product, '07 product. And as is Freightliner for that matter. So I think we can expect given how well the work has been going with them on the '07 introductions, that even though, yes, they will be selling off inventory, we can expect that they will begin to fill their pipeline in Q1 with '07 engines. On the medium duty side of things.

Okay. Thanks again for the time.

Okay, I think that's all the time we have for questions today. I appreciate everyone joining us today for our third quarter earnings teleconference, and as always, I will be available after the call for your questions. Thank you.

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