The power generation business also contributed healthy margin increases this quarter and achieved record revenue and operating margins. The company expects these results to continue. As further evidence of Cummins diversification, all of its businesses experienced sales increase over last year except for some of the North American automotive markets. While the firm continues to diversify its participation in global heavy-duty truck engine markets, the more important story this quarter is the benefits it is receiving as a result of the cost structure improvements in all of its businesses since 2001.

The firm has benefited from engines that were emission compliant and ready to build on January 1st.

Cummins shipped nearly 40,000, 2007 emission compliant on highway engines during this quarter, and gained market share because its customers asked for additional volume when other manufacturers in the industry were unable to meet their needs. As part of the 2007 launch, the firm did extensive preparation work for its distributors and OEM dealers to properly support its new products.

The firm has currently more than 1500 distributor and dealer locations and over 3200 service technicians qualified to service Cummins 2007 products. Last year, the firm completed 146 customer-focused Six Sigma projects resulting in savings of more than $20 million for its customers and another $20 million for Cummins. The firm will do significantly more customer focused Six Sigma projects in 2007 with even better results. Six Sigma is enabling the firm to drive out variation in product design, manufacturing, and in supply base.

Given the early positive response of customers, Cummins is expanding its manufacturing capacity to support future demand.

The firm produced nearly 850,000 engines last year across all of its operations. By 2010, the firm expects to produce more than 1.3 million engines with 25% of that production coming from engine platforms not manufactured today. The good news is that the company will have the engine capacity and the component capacity in place to support this growth. The company is investing nearly two-thirds of its capital budget or $210 million this year to support growth in current and new products. The company is also directing its joint ventures to increase capital spending an additional $275 million to $350 million of which nearly 75% will be to expand the manufacturing capacity through existing and future products.

Some of these growth projects include:
- Expansion of after-treatment assembly capacity in the United States to triple the daily production rates this year.
- Expansion of fuel system machining and assembly capacity in the United States and Mexico by over 50% this year and a new plan in China by the end of the 2008
- Expansion of turbo charger assembly capacity in the United States, China, and India by 60% by the end of this year.
- Increase in high horsepower engine machining and assembly capacity by 15% in 2008 in the U.K. and India. The firm has already raised the capacity by 30% since the beginning of 2005.
- 36% increase in mid-range engine assembly in the United States this year and nearly doubling a block in head machining capacity in Brazil by 2008.
- Machining and assembly capacity of nearly 150,000 light duty diesel engines is coming online beginning in 2010 in the United States.
- Acquisition of company-owned distributors in Spain and Turkey and formation of joint ventures in the south eastern United States, Nigeria, Thailand and Latin America, and a 50% more genset assembly capacity by 2008 to serve the specifically the Power Generation market in India.

Performance Analysis of Segments

Power Generation segment

Segment revenue and earnings were both records for power generation. Each line of business experienced growth especially the commercial generator and alternator businesses. Excluding sale of SEG segment revenue in the fourth quarter of last year, segment revenue in the first quarter increased 29% over last year. The firm expects segment sales to grow 15% to 18% in 2007. Demand for commercial generator equipment, including alternators remains strong due to construction spending on data centers in North America and India and on general infrastructure development in the Middle East. Consumer sales are projected to increase as a result of growth in portable genset sales and the launch of auxiliary power units for commercial trucks.

Segment earnings increased 71% benefiting from significant price realization and continued focus on cost. Price increases on new emission complaint product in North America and on commercial and alternator products in international markets are remaining ahead of new product costs and the commodity cost pressures. Combined with the robust demand outlook and the usual seasonality of the consumer business, earnings for this segment are forecasted to strengthen for the year and remain above the top end of its targeted range of 7% to 9% of sales.

Engine Segment

The growth in international on highway markets and global industrial markets offset nearly the entire decline in North America on highway markets, demonstrating the end market diversity of the business. As expected, revenue for the segment was down slightly compared to the first quarter of 2006 due to new on highway diesel emission regulations in North America despite significantly lower heavy-duty volumes, earnings were within the segment’s targeted range demonstrating the effectiveness of the firm’s actions to lower the cost structure of this business. Gross margins were lower because of higher initial cost for the new 2007 products.

For the full year, the firm expects increased shipments in the off highway and medium duty truck and bus markets to balance decreased shipments in the North American heavy duty truck market. Segments earnings for the full year are expected to be slightly below or equal to the bottom end of the targeted range of 7% to 10% of sales.

First quarter volumes of heavy duty truck engines benefited from strong export markets and market share gains in North America. International shipments were up 54% this quarter, while North American market share improved to nearly 28% from 26% a year ago. The firm’s market outlook for NAFTA Class 8 Group 2 truck sales remains essentially the same as it expects the truck market to be down 40% to 45% this year. Engine shipments are likely to be down more than 50% due to stockpiling in 2006. However, the firm believes those industry stockpiles are depleted at this point.

The firm still expects its volumes to improve in the second half of the year as demand increases in North America and it maintains current market share. While global shipments medium duty truck and bus markets were down this quarter compared to last year, volumes rebounded in Brazil as recovery drove demand for medium duty trucks to transport produce. The firm still expects global medium duty truck and bus shipments to be up approximately 25% this year due to market share gains in North America and new supply relationship with Nissan in Europe.

Global light duty automotive and RV shipments decreased 29% due to lower shipments in North America. Shipments to the recreational vehicle market will grow solidly this year due to increased availability at key OEMs. Light duty automotive shipments will be flat in 2007 as increased availability of the company’s product in a new class of commercial vehicles will offset softness in shipments to the heavy duty pick-up truck market. Shipments to the global off-highway markets were up 19% on strength and construction, primarily outside of North America. Global non-residential construction, high commodity prices and sustained prices for oil and natural gas continue to be positive drivers for global off-highway markets. The company will continue to grow in these markets as it increases its high horsepower manufacturing capacity by 15% over the next 18 months.

Distribution Segment

The revenue was up 12% excluding the impact of the reporting change of the North American distributor. Global investments in non-residential construction and overall economic expansion drove revenue growth in power generation and off highway Engine Markets especially in Eastern and Western Europe. Joint venture income nearly doubled driven primarily by orders for Power Generation equipment in North America. The firm still expects the distribution segment to grow this year between 7% and 10% excluding the reporting change.

In the first quarter, Cummins added joint ventures in Southeastern United States, Nigeria, and Thailand. Later this year, it will add joint ventures in Brazil and Columbia. These new joint ventures plus strong performance from consolidated entities will keep segment earnings above the top end of distributions targeted range of 8% to 10% of sales.