康明斯 (CMI) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cummins fourth quarter 2006 earnings teleconference. [OPERATOR INSTRUCTIONS]

I would now like to turn the presentation over to your host for today's conference, Mr. Dean Cantrell, Director of Investor Relations.

Welcome, everyone, to our teleconference today to discuss Cummins results for the fourth quarter of 2006. 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 this teleconference. This teleconference will include certain forward-looking information. Any forward-looking statement involves risks 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 of our forward-looking statement 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 the website for the reconciliation of those measures to GAAP financial measures. Our press release with a copy of the financial statement and a copy of today's webcast presentation is available on our website at www.Cummins.Com under the heading of investors and media.

Now, some comments regarding each of our four operating segments, beginning with the Distribution segment. Both quarterly sales and segment earnings for Distribution were a record this quarter. Growth continues to be driven primarily by increased sales of Power Generation equipment in primarily by increased sales of Power Generation equipment in the Middle East, Europe, and the South Pacific. The higher mix of Power Generation equipment sales dampened the incremental return on sales versus the same quarter last year; however the segment did experience higher joint venture earnings driven primarily by organic growth in joint venture revenue but also from the year-over-year addition of three new joint ventures in North America.

Beginning in 2007, we will no longer consolidate one of our North American joint ventures. In addition, an independent distributor in Iraq will now handle the sales of Power Generation equipment in that country rather than through our Company owned distributor in Dubai. Together, the change will subtract $195 million from 2007 segment revenue. Although it will have no impact on Cummins net earnings, it will redue 2007 segment earnings by $13 million. Excluding the impact of these changes, we expect sales to increase between 7 and 10% in 2007, while we are adding two distributors in Europe early in 2007, the majority of this growth will be organic from existing distributors. Non-residential construction spending, outside of the U.S. is expected to continue to drive our revenue growth in Power Generation and the off highway Engine Markets.

Organic growth in both consolidated and unconsolidated distributor earnings is expected to be supplemented by new joint ventures. We announced the formation of joint ventures in Thailand, Nigeria, at the end of 2006, and expect to finalize new joint ventures in Columbia, South America, and the Carolinas here in the U.S. early in 2007, thus, earnings for the segment are forecasted to remain above the top end of its targeted range of 8 to 10% of sales.

The Power Generation segment also set a new record for quarterly sales and earnings. Growth in sales of commercial generator sets and alternator equipment was dampened slightly by continued softness in the North American RV market for the consumer business and the completion of the sale of SEG during the quarter. During the quarter the segment completed the sale of its German subsidiary, SEG as previously announced in September. SEG specialized in the design and manufacture of products primarily for the Wind Power Generation segment. The disposition of SEG which reported nearly $50 million in revenue in 2006, generated a $9 million gain for the segment in Q4.

Earnings from remaining operations were 13% higher than the fourth quarter of 2005 on the higher volume; however supply constraints pushed higher levels of Gen set production later into the quarter combined with higher material costs, freight expense, and overtime to recover the production schedule, this segment experienced a margin deterioration of nearly 0.5 percentage point. Excluding SEG, we expect segment sales to grow 10 to 12% in 2007. Sales of commercial generator sets and alternator equipment continue to be robust in North America, the UK, the Middle East, Eastern and Western Europe, and India. Consumer sales are projected to increase as we ramp up production of portable Gen sets, introduce auxiliary power units for commercial trucks and expect greater penetration in the towable segment of the RV market. Price realization on new products, global sourcing initiatives and manufacturing improvements are expected to produce steady improvement in margins throughout 2007. Earnings for this segment are forecasted to remain near or at the top end of its targeted range of 7 to 9% of sales.

The Engine segment achieved record sales in the fourth quarter, up 6% compared to the fourth quarter of last year. Within the segment, revenues from on highway markets were up 5% primarily on the strength of the North American heavy duty truck market. Off highway markets were up 10% driven by high horsepower industrial markets. Earnings for the segment grew 16% from last year. The favorable volume leverage was softened by a higher frequency of supplier delivery issues during the quarter. Investment in new products drove higher research and engineering spending year-over-year. Sales for this segment are forecasted to be flat in 2007 with increased shipments in the off highway and medium duty truck and bus markets offsetting the decrease in the North American heavy duty truck market. As expected, earnings for this segment will be the lowest in the first quarter of 2007, but will improve throughout the year as volumes increase and we climb the learning curve for new product introduction. New product pricing will be largely offset by new product cost. Full year margins are expected to be slightly below or equal to the bottom end of the targeted range of 7 to 10% of sales.

Global shipments for the heavy duty truck market were up 12% over the same period last year on the strength in North America, while North American heavy duty class A truck sales will likely be down 30 to 40% in 2007. 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 currently at the truck OEM's. The decline will be most severe in the first half of 2007 with industry shipments expected to improve in the second half of 2007. As a result, we expect our market share to drop in the first quarter; however we believe our new products will quickly recover market share in the second half of the year to the levels we were experiencing at the end of 2006 or better.

Worldwide shipments to our medium duty truck and bus markets were down slightly this quarter compared to last year. Market share gains in North America were offset by an emission related downturn in Brazil. We expect the Brazilian market to remain flat in 2007 while our European shipments will benefit from our new supply relationship with Nissan. These markets, together with the significant market share gains in North America that we previously announced, are forecasted to drive global, medium duty truck and bus shipments up approximately 25% in 2007. Global light duty automotive and RV shipments were down in the fourth quarter, although shipments to the LDA market were sequentially higher than the third quarter, they were 13% lower than the record fourth quarter of 2005. We expect shipments to the global light duty automotive and RV markets to increase nearly 5% in 2007 through new product offerings and increased availability of our product at key OE M's.

Shipments to the global off highway markets were up 6% due primarily to higher shipments of mid-range product of the international construction markets. Revenue was up 10% on strength in global markets such as mining, marine, and oil & gas served by our high horsepower engines. Although some commodity prices have retreated at the end of 2006 from their historical highs, we see sustained demand in 2007 for our engines in the oil & gas and mining equipment markets. Growth in these markets will be paced by our incremental 15% capacity expansion planned in our high horsepower plants during the year. Global construction shipments will show modest growth in 2007 with increased availability at OEM's in North America, India, and Japan.

Revenue for the components segment was up 12% over the same period last year, with the strongest growth in emissions solutions and Turbo Technologies. Segment earnings were 3.8% of sales this quarter, down $1 million from the fourth quarter of last year. Two of the businesses, filtration and fuel systems, were able to leverage their incremental volume to the bottom line. Emissions solutions and Turbo Technologies continued to experience manufacturing inefficiencies related to new product introductions and an accelerated volume ramp up. In addition, the margins in the turbocharger business were pressured by higher metal market costs.

Revenue for this segment is forecasted to grow approximately 18 to 22% in 2007, primarily on growth in emissions solutions and Turbo Technologies. The manufacturing changes that we began to implement in the second half of 2006 will correct the operational issues in the emissions solutions business in 2007. The material cost and operational issues in the turbocharger business are expected to yield a slower margin improvement as they ramp up new products; however we remain confident that these challenges are manageable. We expect to see sequential improvement after the first quarter and to achieve 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% of sales at the top end of our targeted range of 7 to 10% and slightly better than the fourth quarter of 2005. Net earnings for the quarter were $189 million or $3.75 per share, 13% higher than the fourth quarter of last year. Gross margin for the quarter was slightly lower than the fourth quarter of last year, though the full year gross margin in 2006 improved by 0.8% from 22% to 22.8%. Price realization and improvements in product coverage expenses were offset by higher material costs, higher freight expenses and inefficiencies caused by supply chain and machining constraints across our operating segments as well as the cost of ramp up for new 2007 products.

Gross margins in 2007 are forecasted to be lower from the loss of volume leverage in the heavy duty engine business. Price realization of nearly 4% is expected to offset higher new product introduction costs and higher product coverage expense related to the new product. We have demonstrated our ability to improve gross margins through global sourcing and Six Sigma and believe our gross margins will improve as we gain manufacturing experience with our new products during the year.

Total selling, admin., and research and engineering spending in the fourth quarter was 13.6% of sales down from 13.9% in the fourth quarter of last year. Although total spending was up $28 million from the same period last year, it grew slower than sales. While some of the increase is tied to higher levels of revenue and the impact of currency, our activities to deliver emission compliant products for 2007 and support profitable growth opportunities globally account for the remaining variance. For example, development expense for the light duty diesel engines in both China and North America as well as the heavy duty diesel engines in China increased in the fourth quarter.

Income from joint ventures and alliances increased 25% compared to the fourth quarter of 2005 primarily from our joint venture in China with Dongfeng, our joint venture in India with Tata, and our distributor joint ventures in North America. Earnings from our distributer joint ventures represented nearly 50% of our total earnings from joint ventures during the fourth quarter 2006. We expect joint venture income in 2007 to increase 5% over 2006. Growth will come from new distributor joint ventures that Dean mentioned earlier. Our joint venture earnings from the engine segment are forecasted to be lower due to the discontinuation of the technology fee from our European engine joint venture and start up expenses in our photon joint venture a modest recovery at our joint venture with Dongfeng will provide some benefit.

During the fourth quarter, legislation was passed that retroactively extended the federal research tax credit to 2006 and 2007. We recorded a benefit of $10 million in the fourth quarter related to this legislation. The impact was $0.20 per share in the quarter and $0.21 per share for the full year. Excluding discrete items, our effective tax rate was 32.3% for the full year. Our estimated effective tax rate for 2007 is 33%, slightly higher than our 2006 rate due to the complete phase out of the export tax benefits in 2007.

Cash flow from operating activities was an in flow of $227 million this quarter, lower than our record setting quarter last year of $375 million. Accelerated pension contributions and a net use of cash for working capital due to the higher proportion of sales at the end of December led to the overall lower cash inflow. For the year, we generated the highest cash flow from operations in our history at $840 million. Excluding pension contributions, cash flow from operations increased 21% for the full year. This allowed us to strengthen our balance sheet, to invest in profitable growth and to return greater value to our shareholders. We reduced debt by $556 million, including $310 million in cash. We contributed $266 million to our global pension plan and invested $249 million in capital expenditures. We also repurchased $121 million of our shares and paid higher dividends than in past years. We will maintain our disciplined approach to cash management in 2007 with plans to contribute between 230 and $240 million to our global pension plans, invest between between 320 million and $350 million in capital expenditures and reduce the amount of cash committed to working capital.

Following the review of our disclosure policy and industry trends, we have modified our earnings guidance practices for 2007 and beyond. We've made some changes this quarter to improve the transparency of our segment reporting and plan to do the same on joint ventures in coming quarters. While we will continue to give annual earnings guidance with details about the business, operations, and trends, we are discontinuing quarterly earnings per share guidance.

Let me summarize our guidance for 2007 for the Company and operating segments on the next two slides. The emission standard change has created greater volatility than normal in the North American on highway markets in the first half of 2007. Because several of our markets and products are interdependent, market dynamics could impact more than one of our operating segments. To help bridge the year-over-year growth in total revenue let me summarize the pluses and minuses.

On one side of the ledger, we expect a reduction in sales of 10 to 12% from the impact of EPA emissions standard change across several markets and segments. In addition the divestiture of SEG and deconsolidation of the distributor joint ventures removes about $230 million in sales. On the other side of the ledger, emissions related new business and greater availability of our product at OEM's adds between 5 and 7% to our sales. Pricing actions for emission related products and other general increases inflate sales another 3 to 4%. Organic and acquisitive growth in all other markets creates between 6 and 7% more sales. The net impact of all of these factors results in our revenue guidance of flat to up 5%. We expect annual earnings per share of between $11 and $11.50. Our guidance suggests that EBIT will be around the mid point of our 7 to 10% targeted range. We believe our guidance represents the appropriate balance of the risks and opportunities we face as we introduce new products this year and as emissions related markets in the U.S. remain volatile. Now I'll turn it over to Tim.

Thanks, Jean. I'm proud to report that 2006 was the best year ever in Cummins 88-year history and we are confident there is more good news to come. We gained share in key businesses around the world. We launched successful new products and announced plans to enter exciting new markets in the near future. We delivered additional value for our shareholders by reducing our debt by by $556 million year-over-year. We are currently operating with a debt-to-capital ratio of 22%. We increased the dividend by 20%. We also purchased more than 1 million shares of Cummins stock at a cost of $121 million as part of our two stock buyback plans. We had record cash flow of $840 million, even after funding our employee and retiree, pensions to well above the required levels. For the year, we paid $266 million into our pension funds. As a result, we are already over 88% funded and well on our way to reaching our target of 90% funding a year early.

Our average total return to shareholders for the last four years was approximately 46% a year, well above the performance of the S&P 500 which had a return of 13% and our peer group average which was 20%. In addition, during 2006, we had record revenue for the Company at each of its businesses. Record operating earnings for the Company at each of its businesses for the full year. The highest net earnings as a percent of sales since 1984 at 6.3%. An increase in return on average net increases from 19% in 2004 to 31% in 2006, and a 25% return on equity making this the third consecutive year we've exceeded our target of 18%. For the fourth quarter, we posted the highest sales ever for the Company in each of our operating segments, and we had record operating profits from our Power Generation and Distribution segments. Along with our financial successes, we had many other business highlights.

Cummins launched its entry into light duty diesel markets with two major product announcements. One in North America and one in China. Our mid range engine plant celebrated the production of 1.5 millionth Dodge RAM Engine and our consolidated diesel joint venture turned out its 2.5 millionth engine. We opened a new turbocharger plant in Charleston, South Carolina, and a new emissions solutions plant in South Africa. The Company unveiled its new brand strategy which has allowed our operations to speak with one voice in a common visual identity. Cummins Six Sigma program saved the Company more than $300 million this year, a record amount. The Company was once again named to the Dow Jones World Sustainability Index and to Business Ethics Top Corporate Citizens List.

Our record breaking performance in 2006 is an example of how we are a different company, a company that is less cyclical, more diversified, more results oriented, and committed to turning a greater share of its sales to profits , but let me further illustrate what I mean by sharing examples that compare where we were in 2000 with where we are today. Over the last six years, our foot print in China has grown dramatically. In 2000, earnings from China were $3 million. In 2006, they had grown to to $65 million. In India, we had earnings of $13 million in 2000, in 2006 , we posted earnings of $52 million. The contribution to earnings from our North American distributor channel has increased from $4 million in 2000 to to $56 million in 2006. At the same time, revenues from our international distributors have more than doubled to $1.4 billion over the same period. Joint venture income has grown by 20 times in the last six years from $7 million in 2000 to $140 million in 2006. Annual engine shipments for the Dodge RAM heavy duty pick up truck in 2000 were less than 120,000 units. In 2006 we shipped more than 160,000 Engines.

Our balance sheet also reflects this transformation. At the end of 2000 we had $41 million in cash and today that number is $840 million. In 2000, we had sales of $6.6 billion, for 2006 we had record revenues of $11.4 billion. EBIT has grown from from $95 million in 2000 to $1.2 billion this past year. As a percent of sales, EBIT was 1.4% 6 years ago and 10.4% in 2006. Our net income has increased more than 50-fold from $14 million to $715 million and earnings per share have increased more than 40-fold during that same period. The numbers reflect the steps we have taken to improve our performance and become a different Company, and we believe they are indicators of our results in 2007 which we expect to be vastly different from past years when we had changes to diesel emission standards.

Let me take a minute to review the three factors that have contributed to our strong performance results and increased our confidence in 2007 and beyond. First, we have changed our business model to increase our focus on diversification and cost cutting. Second, our technology leadership has provided customers with great new products and increased our business in many markets with more to come, and finally, we are aggressively looking for and investing in the next generation of profitable growth opportunities.

Our revamped business model includes a greater focus on diversification, both in geography and markets. For example, ten years ago, Cummins generated 62% of its sales in North America. During the last two years, revenue from our international businesses has equaled or exceeded that of North America. We expect that to happen again in 2007. Much of our international growth will come from our Distribution business. We'll also benefit from our global Power Generation Markets which have doubled since 1996. Both our Distribution and Power Generation Businesses operate on a different cycle from our traditional truck engine business. As important, this new business model relies on a cost structure vastly improved by global sourcing, Six Sigma, technical productivity, and Lean manufacturing. As we've mentioned before, cutting the heavy duty engine business breakeven point by more than half has had a significant impact on our bottom line.

The second reason our technology leadership is helping us create great products for new markets and improving our market share, and because of this technological expertise, tighter, new emissions standards around the world are a competitive advantage for Cummins, not a burden. For example, we are introducing a full range of exciting new products to meet the 2007 EPA emissions standards. Just last week, Cummins and Chrysler unveiled the latest emissions technology for the 2007 Dodge RAM heavy duty pick up truck. The 6.7 liter, Cummins turbo diesel engine goes beyond the 2007 EPA requirements and meets 20/10 truck emissions standards in all 50 states. With the new Cummins engine, this truck is more powerful. The best torque curve across the entire operating range of the truck, has 50% less noise and is cleaner than any other pick up truck on the market, and has the same or better fuel economy. The 2007 RAM with the Cummins engine has raised the bar in the heavy duty pick up market and customers will love it. We are committed to remaining a technical leader in our industry and we'll talk later in the year about our plans in this area for 2010 and beyond.

Finally, our next generation of profitable growth opportunities doesn't need to come from large acquisitions. Instead, we'll focus on four areas related to our technology leadership and global distribution channel. Those areas include an increased share of engines and generator sets in nearly all of our markets, as well as the supply of turbochargers to other engine manufacturers. The introduction of the new engine plans platforms for light duty diesel and heavy duty diesel on and off highway markets in China and North America, increased business in the sale of exhaust after treatment and filtration devices because of changing global emissions standards, and finally, the expansion of our global distribution channel to deliver better service to our customers.

We'll be discussing these growth opportunities in depth in future earnings teleconferences. But as Jean said earlier, we are increasing our capital expenditures in 2007 to support this growth. We'll be spending nearly $100 million on new product development and $110 million for incremental capacity of existing products. We'll also be looking at other options for our capital such as increasing the dividends and repurchasing more shares when it makes sense to do so. Let me conclude by stressing once again that even though our 2007 results will not match Cummins record performance in 2006, we will still operate well within our targeted EBIT range of 7 to 10% and we are confident in 2007 will be among one of the best years in the Company's history. We'll now take your questions.

[OPERATOR INSTRUCTIONS] Our first question will come from the line of David Bleustein of UBS. Please proceed.

Good morning.

Good morning, David.

Tom, could you provide us a sense for business conditions in the Power Gen into year-end and what does your backlog look like?

Yes. Power Gen Markets are still really strong. There's still strong capital spending. I'm sure you read the non revs numbers as much as I do. There's talk about them weakening but so far, I do. There's talk about them weakening but so far, things are really really strong and international markets remain strong , so we still have long backlogs, particularly in the high end of the market where there are supply constraints, but orders are strong, kind of through those same regions that Dean mentioned.

And the follow-on question, you mentioned capacity constraints. Where do you see the big capacity coming online? Which quarters of the year is that starting to have an impact on your ability to price?

There's really no big capacity blocks coming online. Cummins, and competitors, have basically been trying to expand large capacity over the last three years. It's been kind of a steady trend. We've talked about on this call before about our strategy which has been to find incremental capital expenditures we can make to increase capacity steadily and a lot of that work of course is with our suppliers. It's not really assembly capacity, but it's all of the supply components and we've been doing that steadily and that's just going to continue. We mentioned in the call 15% increase. That's actually through a couple of different increases that relieve bottlenecks and I think that's kind of how the rest of the competitors are doing it too just by observation, that's what I'd say. There aren't really any big blocks, so I don't expect it to see a big overhang in the market with big capacity coming online. I expect people to continue to try to solve capacity constraints throughout the year.

Of course. And then let me just switch back to the North American heavy duty truck. Can you walk us through your heavy duty engine build schedule, just help us to understand what, at what point in time in either February or March do you expect the line rate to come up to a sustainable level?

I'm not sure what you mean by sustainable level, but we began producing 2007 product right at the beginning of the year, as we've said in the past, our approach to this year has been to implement what we call our rings of defense and to avoid layoffs wherever possible in order to enable us to respond quickly to any changes in market. On the heavy duty side of things right now, we went into the quarter planning a substantive number of down days, we've had to reduce those down days for two reasons. One, our non-North American heavy duty engine business is better than we guessed, both in the Power Gen sector, in the construction sector, and, frankly, orders in the heavy duty for '07 engines for the heavy duty truck market and the heavy duty side of things are better than we expected, so I don't know exactly what you mean by sustainable levels, but build rates as we said will start low in the first quarter and we think will continue to build as we go through the year and on the heavy duty side, we're starting out a little better than we thought we were going to and needing far fewer down days than we thought we were going to have to take to meet requirements in Q1.

Good color. Thanks a bunch.

Our next question comes from the line of Jamie Cook of Credit Suisse. Please proceed.

Hi, good morning.

Good morning. Jamie.

I guess my first question, you mentioned pricing on I think a 3 or 4% price increase. I guess first of all, is there any, I guess are you giving any incentives to place orders earlier in the year or should we think there will be any difference in pricing in the first half versus the second half?

No. We're not giving any incentives for early orders and the 4% pricing is established.

Okay. And are you, in terms of the 4% price increase, can you just talk about what that is relative to what you're hearing about your competition in terms of pricing for '07?

Well, our pricing is different in different markets, but I would assume that our competition is raising prices in a similar fashion.

Okay. And then my next question, Tim, longer term, I just wanted to sort of hear your thoughts on [Packard's] decision to bring their engine over into the U.S. How do you think about that longer term in your planning process? Are you assuming that at some point Packard tries to move into the 15 liter engine as well?

I think you need to talk to Packard about their product strategy, but basically, the product that they will be building in North America is in the 13 liter range and we don't sell 13 liter engines to Packard. Caterpillar does so I think it will have a bigger impact there. If you look at our most recent success with Packard is that we've earned 100% of their medium duty truck business effective beginning this year and we've raised our market share in the heavy duty market substantially, primarily with the 15 liter engine, and we also are selling them components and we have long term arrangements that give me great confidence that Packard and Cummins will have a supply partnership going well out into the future. So my own view is that their announcement will not affect Cummins either short-term or long term in any significant way and I think Packard will continue to grow our business with them.

Okay, and then just my last question, I understand you're not going to give specific quarterly guidance, but can you help us to some degree with how earnings should ramp throughout the year or give us a percentage of earnings from the first half versus the second half just so we can see where you guys are relative to your internal forecasting?

The only thing I'll say is that we've said consistently that the first quarter will be the worst quarter of the year and I think that you'll see the second half stronger than the first half, but we're not going to give any more information than that.

Okay, great. Thank you.

Our next question will come from the line of Peter Nesvold of Bear Stearns. Please proceed.

Good morning. Jean, I think in your opening comments you talked a little bit about some of the gross margin pressure in the quarter. Gross margin is down 40 basis points on 10% revenue growth. Can can you just elaborate a little bit more on what was driving that lack of operating leverage in the quarter?

Yes. Let me sort of take a step back as I mentioned, year-over-year, gross margins obviously improved from 22% to 22.8% and if you look at year-over-year, we had a lot of favorability in volume, price, mix, manufacturing, improvements, et cetera, And then if you look at the quarter to quarter variation, particularly into Q4, sort of what I would say is our leverage and our manufacturing improvements were offset by some of the end of the year issues we had with high volume at the very end of the year, some freight issues, commodities and all that kind of thing so the real cause of the variation was a bigger increase in lower margin products than higher margin products. So if you look at it, I assume your question is really related to going forward and the way I would say it is earlier in the year, gross margin will be somewhat lower because the volume, because higher product coverage, and because of new product ramp up and that will improve and get, as the year progresses, and so if I think about it, our full year gross margin, we should be getting to that range by the end of 2007.

I guess a follow-up here on the margins, and I guess the guidance, on slide 15 in the packet. You've talked me down a little bit from the ledge on pulling the quarterly guidance and I appreciate the additional detail on the divisions. It's very helpful. When I look at the components guidance on slide 15, revenue up 18 to 20%, JV income up 35, but still, the EBIT below the low end of the target range. So it intuitively suggests to me we still haven't addressed the items that have been an overhang in this business for the last two years, so can you just I guess elaborate a little bit more on what's happening there? I know last quarter you talked about repositioning the capacity footprint. Where are you in that and how soon as the year progresses do you expect the margin recovery to pick up?

This is Joe. Yes, I mean, bottom line is we're disappointed about where we are in the segment as a whole emissions solutions where we planned to lose money last year, in fact last a little more money than we planned and CTT, Cummins Turbo Technologies did make money last year but not as much as we planned. The issues were around there were -- both of them are looking at huge increases in sales going through '06 and into '07, and both of them have had more issues in terms of their ramp up to going after those huge sales than we anticipated and have put a lot more money into it than we planned; however, even though we're behind plan in terms of where we thought we would be right now, we're still pretty confident that as we get into quarter four this year, we're going to essentially enter into at that point, the lower end of our target range. So we're behind where we wanted to be in terms of the ramp up, but confident that still by Q4 of this year, we'll be in the lower end of our range and well into the range in 2008.

And I would add that the fuel systems business and the filtration business are performing -- they're meeting our expectations right now, so in the components group as Joe said, the issue is really with emissions solutions which you should view as a start up company, and the turbocharger business which again, has got a massive new product introduction. It has a new plant that it's breaking in, and it's developing several new customers right now, but I agree with Joe is that by the end of this year, I think that they will be performing at the bottom end of the range with an opportunity to get even better in 2008.

And the biggest difference there is just increased experience with the new emissions solutions products; is that correct?

Yes. It's the ramp up, primarily the ramp up of essentially new plants. We have several new plants in the equation, either refitted or new plants in the equation, and it's getting through the experience there. Just a little more technicolor, CTT's business grew by roughly in '06 versus '05 18% and we're going to grow close to, not quite, another 30% next year in sales, and emissions solutions essentially is a 3X factor, in sales from this year to next year. And the size of these increases are because in the Turbo Technology business, we've won significant share over the last couple years particularly in Europe but also in North America on the heavy duty side and on the emissions solutions side, we're going to be the number one packager of heavy and medium duty after treatment systems in the world in Europe and in the U.S. next year, and the business came our way a lot harder and stronger and faster than we anticipated, and orders and volumes increased at a higher level than we anticipated so we struggled quite honestly, but are confident that given the plan we have in place, again, we will get into the lower end of our target range come the fourth quarter of this year.

Great and if I could explore one more item here. Dongfeng Engine Corporation has been a wonderful success for Cummins. Going forward, are you contractually the exclusive supplier of heavy truck engines to Dongfeng and is there a period at which that exclusivity ends or can you just give me a little more sense on what the ownership structure looks like there? Is there a point at which that comes up for renewal?

Well, first of all, the Dongfeng Cummins Engine Company is a 50/50 JV between essentially Dongfeng Motors and Cummins. We have never been the exclusive supplier of diesel engines to the heavy duty or medium duty engines for that matter, right? So we compete with other local suppliers for the business and compete very well, and our engines made at DCEC are also sold to competitors of Dongfeng Motors on the Chinese Market as well. So I don't know if that's getting at your question, but.

Well I guess what I'm getting at is Volvo recently acquired a pretty sizeable stake in Nissan diesel which has an affiliation with Dongfeng and Volvo announced earlier this week that they were looking at deepening their relationship with Dongfeng and I'm trying to understand the competitive dynamic with what you supply currently to Dongfeng as a corporation, which again, has been again a really terrific success and whether or not the competition ramps up there at some point from Volvo entering that market?

Yes. Volvo doesn't have a product today that competes with the product we sell to Dongfeng. Okay? We have opportunities in the future for larger product and in fact as we've announced, are in a joint venture with Dongfeng joint development partnership with Dongfeng to design and manufacture a 13 liter engine for application in China, but we're quite aware of the discussions that are going on between Dongfeng and Volvo. I've talked to both parties about it. I feel confident about our position at the end of the day when the discussions conclude, and as I said, where our business is strong and growing, Volvo doesn't have a competitive engine and are pretty excited about the opportunity to work with Cummins in that regard.

In fact we're making a huge increase in capacity at Dongfeng for our medium duty engines in addition to what Joe talked about the development of a 13 liter engine and remind you that Volvo, as they go in there, are displacing Nissan and Nissan makes their own engine as well, so there's absolutely no change in terms of concern about us losing our position at Dongfeng. It's just not going to happen.

Thank you. I'll jump back in queue.

Our next question will come from the line of Andy Casey of Wachovia Securities.

Good morning.

Good morning, Andy.

A clarification on the quarter, Jean, if you could. What were the product coverage costs?

I think it was 2.4.

Hold on, Andy.

It's on -- Andy, it's on slide ten.

Okay, thanks. And then if you go back to the Cummins--?

2.3%.

Okay, thanks, Tim. When you go back to the end of quarter discussion about the high end, the significant increase in production to meet some commitments, did that carry through into the first quarter? I mean, is it a short-term catch up to what you wanted or is it just reflective of the demand?

Andy, this is Tom. From a Power Gen point of view which I think is where a fair bit of that happened, it reflects the demand being in excess of supply chain capacity kind of consistently and so we've had some, we've had some periods where we really got the supply chain working pretty well and then we've had bumps in the road now and again because we're kind of up against it all the time, and fourth quarter was -- the end of fourth quarter was not as good because we were behind and we had to catch up. Our view is we're not, we're still tight, but a lot of the freight cost that we're sort of in excess of trend, we don't think will continue. Our expectation is those were kind of one-time or will be short lived and will get back in front of it as we have done before.

Okay, thanks, and then just a question on the outlook today versus what it was at the end of the third quarter. It's sharply more narrow, I'm guessing that's related to Jean's comment about the 11 to 11.50 based around the mid point of the guidance that was in the third quarter release. Is the mid point increase apparent, it's about a quarter. Is that related to the tax rate change or is there something else?

I'm sorry, I'm not following you because I think in the third quarter we said that we would be about the mid point.

No, we said 7 to 10%, we didn't qualify.

Oh, that's right.

So you're right. We've refined it and I don't think it reflects anything to do with the tax rate. It reflects that we have a better view of this year than we had when we talked about it in 2006 at the third quarter.

Okay, so demand is just stronger in several markets?

Yes.

Okay, thank you.

Our next question will come from the line of Eli Lustgarten of Longbow Securities. Please proceed.

Good morning, it's close, right?

Yes.

Can we talk a little bit about kinds of cost impact in the first part of the year or the year that will be materially different? I'm thinking with the contributions that you're making to pension and healthcare cost and what the pension and healthcare cost drop might look like in '07? And then associated with that, in your press release when you announced the 2007 engine certification, you indicated you were keeping your workforce together in the first quarter, further in anticipated ramp up, a faster ramp up in the market and what might the cost impact of that be that we have to absorb?

Well, I can start with the second piece first, and what we said is that we were going to keep our workforce intact particularly in the heavy duty side of our business where we're expecting the biggest drop in production, and that we're going to implement something we called the rings of defense and that rings of defense included reducing all temporaries and reducing all overtime and we had used overtime and temporaries late last year to keep up with production in our heavy duty plants and next is we offered voluntary leaves to employees to be able to take voluntary leaves without pay from Cummins for a certain period of time and we've got a good take on that as well, and then we also scheduled a whole series of shut down days during the course of the quarter and these are things we worked out with employee groups last year through a variety of sessions, planning this. As it's turned out, we're not going to have to use all of the shut down days that we thought. In fact, maybe very few of them, and we will be ramping up during the quarter with fewer shut down days, so the impact on cost is pretty low from just our overall approach. There will be an impact as we're going, ramping up with new products and making sure we've got everything in line getting back to normal cycle times, et cetera. There will be some hit there, but basically, the strategy we put in place enabled us to reduce expenses based on the lower rates and that's working very well for us right now.

And when you look at the -- on the pension and healthcare side, on the pension side, we're planning on funding between 230 and $240 million because as we've said before, we're going to continue to voluntarily fund higher than the required levels because our goal is to get above 90% globally by the end of this year and we're at about 88.5% right now. On the healthcare side, our trends have been lower than most companies because as you know, we've taken a lot of actions to improve our healthcare trends and have been quite a bit lower and our retiree trends are beginning to trend down a little bit, so you'll see similar results in the healthcare side in 2007 as you did in 2006.

I was asking about what the impact on the income statement would be for your expense items in healthcare and pension, but I assume those numbers are going down almost materially in '07 versus '06?

Yes. We're finalizing obviously the valuation of our pension and we did see about a 17% increase in our pension expense in 2006 compared to '05. We will have the final pension number for you later on.

But would it be fair to assume that you expect a drop in '07 versus '06?

We didn't see much in the way of discount rate improvement in the valuation of our pension. Obviously, the excess contributions are contributing and we did see our under funded position decrease at the end of '06, so all of those are obviously pointing in the right direction but we really didn't see a material improvement in the discount rate.

Well, we'll talk about it off line. One follow-up question. Have you announced all the increases in the medium business that will lead to the 25% upturn or is there still more coming, because you gave us a couple of them, but--?

I think so.

With the market down 20%, we're still trying to get to the 25% increase.

It's Packard, Freightliner, Ford, Blue Bird, Nissan.

Those are all of them? And they've all been announced, there's nothing else?

Yes, correct.

Thank you.

Our next question will come from the line of Joel Tiss of Lehman Brothers. Please proceed.

Hi, guys, how are you doing?

Good.

Can you talk a little bit about the -- a little more about the margins outside the U.S. And as that business grows a lot faster so we can have an idea how that plays out?

Well, we don't or haven't talked specifically about margins on the outside of the United States versus inside the United States, and I think you should just assume that from a standpoint of analysis that our margins are standard in both inside and outside the United States. We're not going to start giving margin information by country, for example.

Okay. And then in the third quarter, you mentioned the 5 to 7 business looks like it has 70% growth in 2007 over '06. Is that still a valid range to be thinking about?

I'm sorry, repeat your question. We didn't quite--?

In the third quarter, you talked about your 5 to 7 business because of all of the factors that you just mentioned to Eli being up about 70%. Is that still a reasonable range to be expecting?

Okay, so you're talking about class 5 to 7 truck and you're right. We had disclosed in prior quarters that the North American medium duty truck business, so that's more narrow than the 25% that we gave, the North American medium duty truck is clearly going to be up at least 60%. What we tried to provide you here this quarter was rolling global medium duty truck and bus altogether is how we were arriving at the increase in shipments of 25%. So in prior quarters we were very narrow in talking about a single truck market in a single geography. We gave you guidance this time that was more broad for the entire line item of medium duty truck and bus.

Right, okay. I just wanted to be able to square those two. And then last, can you give us a free cash flow estimate for 2007, even just sort of a ballpark? Thank you.

Well, as you know, we don't give free cash flow guidance. We have chosen to provide you the individual pieces that should allow you to come close to calculating the free cash flow. We've talked about capital expenditures. We gave you our pension contributions and those for us are really the big drivers of our free cash flow.

And working capital needs, is that going to turn into a source of cash in '07 or is that still going to be a use?

I think we are focused on trying to make that less of a use.

Okay, thank you very much.

Obviously, Joel, we still have growth in a lot of markets around the world, so we're focused on making that less of a use of cash.

We have opportunities to reduce inventory.

Okay, thank you.

Our next question will come from the line of Jonathan Steinmetz of Morgan Stanley. Please proceed.

Thanks, good morning, everybody.

Good morning.

A few questions. First of all, are you able to break out the impact from currency translation on revenue and EBIT in the quarter year-over-year?

Yes. That was on the bottom of one of the slides. I'll get you the right one here. Jonathan, if you look at slide ten again--.

I apologize. I'll keep going then, thank you.

Okay.

In terms of the supply chain inefficiencies that you talked about, would you characterize all of them as sort of volume related or is there anything where as volume gets worse these get worse in terms of anything related to some of the bankruptcies among some of the suppliers to the light vehicle industry or anything like that?

It was volume related.

Okay.

It's on the -- volume went up, that was what drove it, not volume going down I think is what you're asking, right? We didn't have issues with bankruptcies or any of that kind of thing.

And then the last one is, within the forecast, do you have an explicit number on the heavy duty Dodge RAM year-over-year that you're expecting in terms of production?

Up 5% off of the 162,000 this year.

Even given some of their sales issues and the high inventory they have in the channel?

We remind you that we also released on their Cat Chassis program so there's some new business there.

Sure, thank you.

I think that's all the time we have for questions today. I appreciate all of your participation and we'll be available for questions after the call. Thank you.

Thank you for your participation, ladies and gentlemen. Have a great day.