開拓重工 (CAT) 2002 Q2 法說會逐字稿

Good morning, ladies and gentlemen.

And welcome to Caterpillar's 2002 second quarter earnings release conference call.

At this time all participants have been placed on the listen only mode and we will open the floor for questions and comments following the presentation.

It is my pleasure to open the floor to your host Mr. Jim Anderson.

Sir, you may begin.

Thank you, Jen.

Good morning and welcome to Caterpillar's second quarter 2002 results conference call.

As Jen said, I'm Jim Anderson, Director of Investor Relations with me as usual is Lynn McPheeters, Vice President and Chief Financial Officer.

We will address your questions during the Q and A portion of today's call.

This morning I'll cover our second quarter results, review our outlook, go over the usual dealer retail numbers, discuss a couple of special topics, and then wrap up with the Q & A. Certain information we will be discussing is forward looking and involves uncertainties that could impact expected results.

A discussion of those uncertainties is in a form 8K filed with the Securities and Exchange Commission today.

Let's start with the second quarter results.

As you know, this morning we reported second quarter sales and revenues of $5.29 billion and profit per share of 58 cents.

The second quarter results coupled with our first quarter results were in line with our expectations for a relatively weak first half of 2002.

Sales and revenues were down $197 million from second quarter 2001 with machines down $171 million and engines down $46 million.

The decrease was nearly all related to volume reductions as price realization was about flat net of currency changes.

Consolidated revenues of the financial products division were up 3%.

Profit was 20 cents lower in the second quarter 2002 compared with 2001.

As a result of the lower sales volume and related manufacturing inefficiencies including absorption of fixed cost as production in our larger facilities were down about 20%.

Additionally, the recognition of a $40 million decrease in the market value of securities in the investment portfolio of CAT Insurance unfavorably affected profit.

These declines in market value had been previously marked to market on a monthly basis and reported in other comprehensive income.

But in accordance with conservative application of FAS 115 now have to be taken to income because they are considered other than temporary.

As a matter of interest, when the market reverses and starts to grow, any increase in value of these securities must continue to be recorded in other comprehensive income.

These items that unfavorably affected profit were partly offset by a net favorable impact of [INAUDIBLE] of 5 cents per share for the quarter.

This includes the net effect of currency on sales and costs and currency exchange gains or losses reported in the other income and expense category.

SG and A expenses were down $30 million and R&D expenses primarily related to emissions were up $14 million compared with second quarter 2001 levels.

As a matter of interest, again, no longer amortorizing good will had a favorable impact on second quarter results of $20 million on a pretax basis and the combination of pension and OPEP expense had an unfavorable pofit before tax impact of $24 million.

Reduction from the first quarter level of the unfavorable impact of pension and OPEP expense is the result of recent changes in our benefit plans.

We now expect the unfavorable impact of this benefit expense to be about 20 cents per share for the year rather than 35 cents projected earlier in the year.

Now I'll provide some comments on North American rental fleets and used equipment.

North American dedicated rental fleet utilization on a 12-month rolling base is continuing to run at a very strong rate.

About 64%.

Which is about one point higher than a year ago.

Rental rates for the rolling 12 months through June are basically unchanged from a year ago.

And continue to remain under pressure.

Overall, units in dedicated dealer rental fleets are up less than 1% compared to a year ago.

Dedicated dealer rental fleets consist of rent-to-rent units and units in CAT rental stores.

Rent-to-rent units which currently make up about 60% of the units in dealer rental fleets, are down 5% from a year ago.

The CAT rental stores which generally rent the smaller machines for shorter time periods currently have about 40% of the rental units in dealer fleets.

These fleets continue to grow.

They are up 9% from a year ago.

North American dealers added four rental stores in second quarter 2002 for a total of 369 stores. 11 more are expected by year end.

In the Europe, Africa, Middle East region, dealers had 684 rental outlets. 168 of which had the CAT rental store identity as of quarter end.

In Latin America we had 89 CAT rental stores, and 16 in Asia Pacific.

At year end we are expecting about 1,220 rental outlets throughout the world.

Of these, 380 stores in North America, and about 390 in the rest of the world will have the CAT rental store identity.

North American used equipment prices continue to be down moderately.

In the first quarter, compared to a year ago, for most machines.

We expect continued weakness in the near term.

This used equipment reporting lags one quarter from the current quarter.

Now for the outlook.

Worldwide economic growth is unfolding along the lines of our previous outlook which anticipated a gradual recovery in global production over the course of 2002.

However, most industrialized markets continue to operate at relatively low levels of capacity utilization and capital spending in North America is recovering much more slowly than anticipated.

Therefore, the second half economic recovery is not expected to be as robust as anticipated in the first quarter outlook.

In this economic environment worldwide industry opportunity is expected to be down slightly in 2002. [INAUDIBLE] sales and revenues are also projected to be down slightly for the year.

Sales in the geographic regions outside north America are expected to be about flat or up slightly.

While sales in North America are expected to be down moderately.

With this change in the economic outlook and resulting impact on our full year sales and revenues projection, full-year profit is projected to be down about 15% from last year's profit, excluding the nonrecurring charges reported in 2001.

Full details of the outlook for 2002 are contained in the company's press release issued today.

Now I'll review dealer retail machine numbers and reciprocating and turbin engine to users and OEM'S.

All comparisons are based on constant dollars.

Retail sales of machines for the three months ending June 2002 compared with the same three months of 2001 are as follows.

For Asia Pacific, down 2-7%.

For Europe, Africa, Middle East, down 8-15%.

Latin America, up more than 24%.

The subtotal of those three regions down less than 2%.

For North America, down 2-7%.

And for the world as a whole, down 2-7%.

Retail machine sales were down for the quarter due primarily to weakness in the coal mining and general construction sectors which were partly offset by improvement in the heavy construction sector.

For the three months ending June 2002 compared with the same three months of 2001 total reciprocating and turbin engine sales to users and OEM'S were as follows.

For electronic power down over 24%.

Industrial engines, flat.

Marine engines, down 8-15%.

Truck engines, up more than 24%.

Oil and gas, up 8-15%.

Total engines, down less than 2%.

Now let's turn to dealer machine inventories.

First sequentially comparing June with May 2002.

For Asia Pacific, up 2-7%.

For Europe, Africa, Middle East, flat.

Latin America, down 8-15%.

The subtotal of those three regions, flat.

For North America, down 2-7%.

And for the world as a whole, down 2-7%.

Next, year over year comparing June 2002 with June 2001.

For Asia Pacific, up 8-15%.

Europe, Africa, Middle East, down 2-7%.

For Latin America, down more than 24%.

Subtotal of those three regions, down 2-7%.

For North America, down 8-15%.

And for the world, down 8-15%.

Dealer inventories of new machines at the end of June compared with year end were up on a worldwide basis about $150 million.

Most of which occurred in North America as dealers were preparing for the selling season.

This seasonal increase was about 50% less than the increase in second quarter 2001.

As dealers are getting more comfortable with our ability to reduce lead times on products from our factories.

Since dealer inventories are at historically low levels, an increase in retail demand should translate to increased sales by Caterpillar.

Our expectation for full year 2002 is for dealer new machine inventories to decrease in the $100-200 million range on a worldwide basis.

Asia Pacific dealer new machine inventories are at 2.3 months of sales, down from 3.2 months a year ago.

Europe, Africa, Middle East dealers are at 2.6 months of sales.

Down from 3.1 months a year ago.

Dealer new machine inventories in Latin America are at 2.7 months of sales.

Down from 3.7 months a year ago.

Dealer new machine inventories for the subtotal of these three regions outside North America are at 2.6 months of sales, which is down from 3.3 months a year ago.

North American dealer machine inventories are at 2.7 months of sales.

Down from 2.9 months.

Overall on a worldwide basis, dealer machine inventories are at 2.7 months of sales, down from 3.2 months a year ago.

The retail statistics for June are also available on voice mail through August 15, by calling 309-675-8000.

Before I get into the Q & A, I want to just comment on three special topics I think will be of interest.

First is an update on SicSigma activities.

Our commitment to SicSigma continues to strengthen.

And the resulting benefits continue to grow.

Providing a clear line of sight to deliver results that will significantly exceed the benefits realized in 2001.

Additionally, by year end we will have about 1,400 train blackbelts, nearly double of 2001.

We currently have about 5,000 projects in the system.

We're also extremely pleased with the engagement of our suppliers in the CAT dealer network.

This quarter our pilot dealers and suppliers graduate their first 114 blackbelts this extension will strengthen our entire value chain.

Secondly, a brief update on major sectors of the machinery business in North America and Europe, Africa, Middle East, our two largest geographic sales regions.

North American sales to users continue to be adversely impacted by significant reductions in sales for the coal mining sector, directly related to the price of coal.

Although housing starts remain strong, the commercial side of the general construction sector is weak.

Sales-to-users in the heavy construction and quarry and aggrogate sectors continue to be positive.

Customer confidence in the timing of economic recovery is a key factor across most business sectors.

Many contractors are keeping equipment longer during this period of economic uncertainty.

In Europe, Africa, Middle East, sales-to-user trends are mixed.

Sales into the mining and general construction sectors have weakened during the first half.

Heavy construction is weaker in Europe but remains strong in Africa, Middle East.

Sales into the quarry and agrogate sector improved.

There are a number of large projects throughout the region.

But funding may become a problem in some areas.

Lastly, an update on our engine business.

Caterpillar truck engine sales continue to increase in the second quarter and were up significantly from second quarter last year.

We are now projecting North American heavy duty truck industry demand for 2002 at 158,000 units, excluding Mexico.

Up from the 125,000 units previously projected.

This increase is due to a stronger-than-expected first half of 2002 as improved housing and consumer spending spurred increase freight tonage benefiting the truck industry.

Truck prebuying ahead of the October omissions deadline is also occurring.

The slowdown in overall industry demand and Caterpillar sales into the electric power industry has continued throughout the second quarter.

The economic slowdown resumed hydroelectric production in Southwestern United States and mild weather in North America, as well as substantial growth in new power plants have all caused a current surplus in electric utility plant capacity compared to widespread energy shortages last year.

Consequently, Caterpillar's second quarter EPG engine sales were down compared to second quarter last year when demand for large CAT engines used to provide distributive power to the electric utility and telecommunications industries surged.

Because economic recovery is not occurring as quickly as had been anticipated earlier in the year, we now expect Caterpillar sales into the electric power sector in 2002 will be down in the 16-24% range compared to last year.

As industry financial uncertainties are resolved, surplus electric utility capacity is worked down and dealer inventory stabilize, we expect Caterpillar sales into the electric power sector to resume growth later in the year with stronger growth continuing into 2003.

Caterpillar sales into the Petroleum sector rose in the 8-15% range in the second quarter.

Led by robust sales gains in Latin America and Asia Pacific where demand for turbo machinery was particularly strong.

Second quarter Petroleum sales in North America declined significantly, caused by the sharp drop in drilling activity compared to last year.

Due to the deteriorating investment climate faced by the oil and gas companies, we now expect Caterpillar sales into the Petroleum sector to be up only slightly this year.

There is not much new information on the status of assert, our new engine emissions technology.

We have begun to ship heavy duty bridge engines to OEM's to assure production readiness.

These bridge engines will be in EPA certified, low emissions version of our current engines with changes to software and the addition of an oxidation catalyst.

We have submitted our application for certification to the EPA and Carb for the October heavy duty bridge engines and our mid-range engines.

Since there is minimal new content, Caterpillar engines will be as reliable and durable as ever and continue to out perform the competition.

We continue to pursue resolution of issues with the EPA through the dispute resolution process under the consent decree.

Recently filed on May 31 a petition with the U.S. court of appeals for the District of Columbia, challenging EPA certification of a competitor's engine that may utilize defeat devices.

We strongly believe Caterpillar is the industry leader in technology and emissions reductions.

We have completed the invention or developmental stage of assert.

We will be in full field testing stage on both medium and heavy-duty engines within a few weeks and plan to begin shipping the first assert production medium duty engines in the first quarter of next year.

The first assert production heavy duty engines will begin shipping shortly there after during the second quarter.

Ok.

Now it's time to move to the Q & A portion of the call.

In the interest of time and fairness to others please limit yourself, as always to one question and one follow-up.

Jen, first question, please.

Thank you, ladies and gentlemen.

The floor is now open for questions.

If if you have any questions or comments, please press numbers one, followed by four on your touchtone phone at this time.

Pressing one for a second time will remove you from the queue should your question be answered.

We do ask that you please pick up your hand set if listening on speaker phone for optimum sound quality.

Please hold while we poll for questions.

Our first question from David Rosso.

Please state your affiliation.

Solomon Smith Barney.

Hi.

My question is more on mix and the pricing comment and incorporating the comment that the large facility saw about 20% less manufacturing hours.

What I'm trying to figure is that the decline in the operating margin of the machinery business, a little bit larger than the mix would suggest your comments about heavy versus general in coal mining.

Last year coal mining was very strong.

For example, the second quarter.

Total machine sales were up.

Coal mining was very strong.

And the margins still were down significantly, second quarter 2001 versus second quarter 2000.

We're now seeing sales down 5 percent, margins collapse.

The decline, more than I thought.

It can't all be coal mining because coal mining didn't dry the second quarter last year when it was strong.

I'm just trying to understand the comment of price realization flat which is contrary to what channel check suggests.

And it can give us caller on a larger facility comment.

Obviously East Peoria is getting hit with the dozers and cater facility for the mining truck.

Can you give us more on what's going on there in the price realization and the mix and what's your view of production going forward on the mix?

Sure.

That was perhaps more than one question, Dave.

But let me try to address it in general.

Then you come back and tell me if there are other areas that you want me to talk about.

First of all, in terms of the margins, it was in fact, really volume which caused our margins on the machinery side to be lower compared to a year ago.

Because as I said, and as you said, price realization was essentially flat.

And I mean essentially flat.

It's within a couple million dollars of being ZERO compared to a year ago.

So it really was that.

We did have some reductions in SGNA that benefited the margin a little bit.

They were down on the machine side from about 9.5% last year to 7.8% this year.

But when you consider the impact of volume reduction at about 35-40% incremental margin, that's essentially the difference.

And the same thing basically happened on the engine side of the business.

We had volume, a little bit of an unfavorable mix effect, obviously, with the truck engines improving and with EPG engines deteriorating.

And then we also had increased R&D on the engine side.

So that's what caused it on the engine side where they declined from about 6.5% to a little over 5% this year.

Now, from the standpoint of production hours, you mentioned the primary facilities on the machine side.

It is, in fact, Decatur which produced our mining equipment, track type tractors, which is East Peoria.

They produce obviously the large track type tractors that are used in the mining industry.

And those two facilities have probably been hurt the worst.

To a lesser extent our Aurorat facility which also produces excavators used in the mining business, was affected as well.

On the engine side, it is predominantly our Lafayette, Indiana, facility that produces the 3500 and 3600 series engines used in power generation and oil and gas.

Going forward I can't really give you any specifics in terms of production volume.

These averaged about 20%.

Some of our facilities were down more than that.

And some of them obviously less than that.

And we do have some facilities that are up.

Such as our [Moscow] facility that's producing the truck engines.

So it's a little difficult to say exactly what may happen to those facilities in the second half.

It's simply going to depend on the recovery and the economy.

I guess I can talk off line.

It's a full mouthful question.

But it doesn't square up that pricing flat mix saying it's coal mining when coal mining didn't have the opposite effect.

A very big positive effect on margin last year when full machines were up and coal mining was up a lot.

Even the first quarter that coal mining was the real reason the mix got hurt, driving the margins down.

You can't have it both ways.

There's got to be something else going on price or something else going on the production mix.

To suggest the margin should be down that much.

Well, last year as well there were some mix issues.

And we can talk some more about that.

But you may recall that we did have some other mix issues as well.

And particularly geographic mix where products sold in certain geographic regions, generate a little higher margin than they do in other regions.

Yeah, we can talk further about this off-line.

Thank you very much.

Ok, Dave.

Next question?

Our next question comes from Steve Logan.

Please state your affiliation.

It's Morgan Stanley.

Hi, Steve.

Just a couple of sort of drilldowns on some of these end markets guidance that you've given us, which is very helpful, by the way.

In terms of the engine business is it safe to say that it was the powergen and perhaps some of the oil and gas was the real driver of the decline there?

Yes.

And I think --

On the reciprocating side for oil and gas.

Because turbo machinery continued to be pretty strong.

Ok.

And you had -- I think you said something about how you expected it to be up again next year.

I'm wondering what you base that on.

On oil and gas?

I think it was more EPG.

With EPG, when I was talking about that.

What we're basing that on is really, again, predominantly recovery in the economy later in this year.

We were expecting EPG to start growing in the third quarter.

And because of what I talked about and what's in our outlook for the year, the recovery isn't occurring as we anticipated.

It's being moved out, obviously.

And so as the economic recovery occurs, the surplus inventory that we have in the field of electric power units gets taken down.

Then we do expect to see some recovery starting to occur in that business.

Late this year and probably really moving more into stronger more into next year.

And are there orders or contracts or quoting activity?

Or is this just kind of the way the business works from a historical perspective?

It's kind of all of the above.

It's input we're getting from the field.

It's a recovery in the economy.

It's the level of, quote, activity that we have and inquiries going on.

It's really a little bit surprising.

The quote activity has been reasonably strong for several months now.

But the fact is it's not translating to orders yet.

I think you've heard both Lynn and I talk about this before, that it's really a confidence issue out there right now as to when the economy is going to turn and when capital spending then is going to start picking up.

So we think the underlying demand is there.

There's just a confidence issue more than anything else.

Great.

Thanks.

Ok, Steve.

The next question from Michael Harris.

Please state your affiliation.

Deutsche Bank.

Hi, Mike.

Hi, Jim.

Clarification question.

If historically you define slight 2-7%, how would you define moderate?

Is that 7 to what percent?

Well traditionally what we have used in the way of our modifiers as slightly as 2-7% and moderately is the next category, the 8-15%.

Yes.

Ok.

And just a little bit on SicSigma -- can you give a little more color on the contribution in the second quarter from that effort and what you have in terms of projections for the second half.

I was wondering if someone was going to ask that question.

As we said in the first quarter call, we're not going to disclose what our contribution is on a quarterly basis.

What our intent is that we will discuss that at the end of the year and report what we did for the full year.

You may recall that we said last year that our expenses related to SicSigma were about $30 million and our benefit was substantially above that, nearly double that, quite honestly, and that we expect the number this year to be substantially above that.

So that will give you a feel for the year.

It certainly -- our feeling, it will be well above $100 million.

That's about the extent of what I can give you for this year.

We will give you the actual at the end of the year, however.

Ok.

But from what you can see so far, you are on plan?

We are absolutely on track for that, yes.

Ok.

I'll give back in the queue.

Ok.

Thank you.

Our next question from John Inch.

Please state your affiliation.

It's Merrill lynch.

Hi, John.

Let me ask you.

Other than in North America, other than EPG, based on what you're seeing today in the current trends, do you expect any of your end markets to be up next year?

And if so, what do you base that on?

Next year?

Yeah.

Well, we're not going give any projections, John, on next year until we get into the third quarter release.

Which is traditionally when we would give you our preliminary outlook on sales for the next year and then following up in the fourth quarter with sales and profits.

So I really can't comment on next year at this point.

Let me try a couple of housekeeping questions then.

The 40 million pretax charge in accordance FAS 115, can you remind us how much gains you've taken historically -- as a result of that pronouncement?

Yes, I can.

That's very easy.

The answer is ZERO.

So this is the first time this has come?

This is a loss though.

I understand.

Yeah.

In the past -- following 115 what we have historically done is record -- or mark to market those changes in the securities and take that to other comprehensive income.

Now, because of the concerted interpretation of 115, as I said, not to take those losses or declines in the value of those securities directly to income.

And that's what we did.

I don't understand.

You're saying that the benefits before didn't flow to the bottom line or they did?

No, they did not.

They go to other comprehensive income which is not part of net income on the results.

That was according to the standard.

So any increases or decreases in the value of those securities never hit the bottom line until now.

And the reason, again, is because the market doing what it's done here over the last year or two years, according to the standard and the conservative interpretation of that, those are considered other than temporary declines.

And that's the reason we had to take it to net income.

Final question.

Currency benefited you by 5 cents, yet the U.S. dollar versus other currencies around the world declined more sharply than that.

Does that imply that you're going to see a currency benefit growing later in the year?

Why didn't currency with half of your income overseas benefit you more?

Well, keep in mind the rates were declining throughout the quarter.

And we actually translate the rates at the end of the quarter.

Translate the balance sheet at the end of the quarter.

And generally I guess the other factor is when you look at where we are in terms of manufacturing locations around the world, we're pretty well balanced.

We are on a net currency basis around the world.

So we don't get the same kind of impacts perhaps that other companies would have that are focused primarily in one or two geographic areas.

So it's a combination of those two things.

Thank you.

Ok, John.

Thank you.

Our next question comes from Jamie Cook.

Please state your affiliation.

Your line is live.

It's John Mcginty.

I was expecting Jamie.

What can I say?

Just a couple of questions.

Getting back to this whole issue of confidence and sales and people not buying.

Is there any way you can talk to us about either the age of equipment or hours on the machines or in any way to kind of give us a handle or help us to understand where we are in had terms of people buying or not buying or really what's going on out there?

Well, really all I can give you, John is some anecdotal comments that come from our field and the work that we do to determine the age of the fleet that's out there and that type of thing.

As you well know, the buildup in equipment during the mid-to-late 1990s was pretty significant.

That equipment -- from that level, let's say the 1998 level of demand, particularly in North America, it's been down 30-35%.

Since that point.

So what is happening is the equipment has continued to be used.

There was this big buildup back in the mid-to-late 1990s.

The equipment is continuing to be used because the work is actually basically stayed pretty much the same over this time frame.

Customers or contractors are renting more equipment and are keeping their equipment longer.

Some of the information that we have would indicate that the hours on equipment and the length of time that contractors in fact, are keeping the equipment is expanding.

And therefore at some point in time from a productivity standpoint and from a cost to maintain the product standpoint there will be a replacement buying.

It's just again back to this confidence issue of knowing when that's going to occur.

Then on the EPG side can you talk to us about what we have to work our way through?

In other words to what extent -- how many idle two-megawatt power modules do the dealers have?

How many does Caterpillar have?

And what's the status of any tenders, major tenders out there that might, in Venezuela, Indonesia as Brazil did in the fourth quarter of last year, give us any kind of relief?

Yeah.

The status today in terms of the power modules and for those of you that don't know, these are typically our 3516 engines about two megawatt capacity, is about as best we can tell at this point in the field and at our dealers, there's probably about 300 units which are not being utilized right now.

Let's put it that way.

As opposed to excess or whatever.

This include Caterpillar?

Yes.

Although we have very few -- we don't have much inventory there.

Most of it would either be unused at a customer location or at a dealer.

Ok.

Sorry.

So there's roughly 3 hundred of those.

These will dissipate as the utilization begins to pick up.

To speculate on how much -- or how quickly that will be is a little difficult right now.

It's really going to be tied in with the recovery of the economy.

However, we do expect that to start moving down.

In terms of where we can utilize that excess inventory, if you will, or idle inventory, yes there are some tenders that are still being worked, particularly in South America.

To my knowledge, as of a couple of days ago, none of those have come to fruition yet.

So there is a possibility that some of those idled units, because they are essentially new units, can be used in those large projects.

But they're still open at this point in time.

Thank you very much.

Ok, John.

Thank you.

Our next question comes from Joanna Chapman.

Please state your affiliation.

Goldman Sachs.

Hi, Joanna.

Hi can you talk about what you're seeing for the fourth quarter for truck production.

And I know you said in your press release you didn't expect the emissions to have a material impact on results for the year, but can you talk about what your assumptions are on the penalties that you'll be paying as of October 1 and what you can regain on price?

Let me kind of summarize all of that.

I can't give you a specific number for the fourth quarter downturn.

Estimates out there range anywhere from the fourth quarter being 20% to 50% of what the third quarter will be.

Your forecast is 158 what are you assuming for production for 4q?

I can't give you our production assumption for the fourth quarter other than to tell you that it will be substantially below the second and third quarters.

Ok.

In terms of the impact of truck engines and prebuy that's going on or the whole emissions issue here on us this year we have said it will be very insignificant.

Less than 10 cents a share is the specific number we have been using for this year.

And the reason for that is because when the penalties start, assuming there will be penalties, in the fourth quarter, the production volume will be substantially below where it is today.

And secondly, our prices will be roughly $3,000 to $3,500 higher.

We've already announced that to all of our customers.

So any potential penalty will at least be partially offset by the price increase.

And then you have the much lower volume effect in the fourth quarter so putting all of those together it really doesn't matter what the penalty is.

Whether it's under the current consent summary or whether it's under the current proposal or back to something similar to the original consent decree.

It won't matter it will still be a relatively immaterial impact this year.

Thanks, Jim.

Ok.

Thank you.

Our next question comes from Mark Hadley.

Please state your affiliation.

It's Midwest Research.

Good morning, Jim.

Hi, Mark.

Could you discuss some of the credit quality in loss ratio issues at the credit subsidiary.

Whether they are further deteriorating from the first quarter where things stand there?

Well, I can say that in CAT financial's release they mentioned a couple of points here.

Past dues over 30 days were 4.5%.

Which is a little above where they were a year ago.

But my recollection we're either right in line or maybe even slightly below where they were in the first quarter.

They're certainly no worse than they were in the first quarter of this year.

They're very much in line.

Write-offs of net of recoveries were 12 million during the quarter.

Second quarter of this year compared with 13 million in the second quarter of last year.

So from that perspective, mark, I think CAT financial is pretty much kind of just hanging right in there with where they had been running for the last couple of quarters.

Jim, let me just add one comment on that. -- Mark, this is Lynn.

This is also very much in line with what we saw in the last recession at CAT financial from a past due perspective.

So we dealt with this before in recessionary times.

Credit conditions, the credit procedures and practices at the finance company have been in place from the beginning and continue to serve us well there.

One of the ratios we continue to watch and they continue to watch closely is their reserve to write-off ratio.

And that continues to run about two and a half times reserve-to-write-off so a very sound underlying practice for the portfolio.

Ok.

As a followup to the prior question on power generation.

Jim, you mentioned there's about 300 idle units and at year end there's only about 100 to 200 you described at the end of the fourth quarter.

So I'm a little puzzled about that this is supposed to be peak utilization time.

With peaking and all of that.

I'm wondering if you guys -- is this kind of a sign there was overbuilding in the first half of the year that needs to be corrected here in the second half.

Overbuilding of our units or of utility plant capacity?

Your own power units.

No.

Because we're -- frankly not building very many of them.

These are units that were out there that had become idle or never were used either by the end customer or by our dealers where at the end of last quarter we thought that number was in it fact, in the 150 to 200 range.

And as it turns out, the number is higher than that because utilization continues to be pretty low on that.

So it's not a matter of us shipping more to dealers because dealers aren't really ordering those right now because of the surplus.

It's just an identification issue that there really are more idle units today than there were a quarter ago.

Ok, Jim.

Thanks.

Ok, Mark.

Thank you.

Our next question comes from Andy Casey.

Please state your affiliation.

Prudential Securities, good morning.

Hi, Andy.

Just a clarification on what you just said with Mark's question on EPG and a quick other question.

Do you know mean that utilization has gone down for the units out there?

No.

I mean that our identification of idle or excess units is -- I guess you would maybe even say better today than what it was at the end of the first quarter.

Because at that point in time based on input from our dealers and from the field we felt there were only 150 to 200 units out there.

Now it does appear that there's closer to 300 units out there.

I guess I would make one other comment on that, Mark.

Both for you and, Andy, for your question.

Utilization rates typically peak during the summer months.

That's when utilities and commercial operations typically would be renting these units for peak shaving purposes during the hot summer months.

We have seen a pickup that's starting to occur.

But it's not anywhere near what it normally would be at this time of the year.

Typically we would be seeing somewhere in the range of 80% utilization of those units right now.

It's not anywhere near that.

Now.

So that's, again, part of the reason why back three months ago when we were looking out to see what the units were that would be excess, the expectation is that utilization would be higher than what it is right now.

So that's really the rationale behind it.

Ok.

Thanks.

And then on R and D, given that the assert -- I think I should put it out of the invent stage.

Will that continue at the current run rate or do you expect that to be pulled in a little bit?

Well, probably for the balance of this year it's going to be pretty much continuing at the current run rate.

As we get into next year, it should start to pull back a little bit.

But again, it won't pull back a lot because we'll be working on the new level of standards.

And those coming from offhighway vehicles as well as the 2007 on-highway standards so it won't come back a lot.

But it should moderate somewhat, yes.

Thanks, Jim.

Ok, Andy.

Thank you.

Our next question comes from Anne Dugian.

Sanford Bernstein.

Hi, Anne.

Hi, Jim.

One quick follow-up question on foreign exchange.

You mentioned that foreign exchange had a total 5 cent impact on your earnings.

Can you break that out between the currency conversion portion that would have been reflected in the operating earnings versus the other income would have been a result of your hedging activities?

Yeah.

Basically the impact on our sales and costs was about half of that.

The balance of it, the other half of it, would have been reflected in the other income and expense line which would have been where the translation impact as well as the hedging impact is reported.

And a follow-up question.

Your inventory levels were up significantly verse as a year ago.

Both as measured by days on hand and actual dollars.

As also were your payables.

Of should we take from that that the operations continue to purchase raw materials even as sales declined?

And how do you intend to get those inventory levels back down in line with your goals or where they were a year ago?

First of all, let me say that the asset utilization and asset management is a key focus right now throughout the company.

We have a number of both SicSigma projects as well as other projects going on to address the issue of asset management.

Quite frankly, I don't know the specific numbers in terms of the increase.

Lynn is looking at it right now.

Is there anything that you want to add to that, Lynn?

I really can't tell you anything specific on the actual numbers compared to the previous quarter a year ago.

Except to tell you that that is an intense area of focus within the company right now.

Should we be looking at the inventories then that these are work in process inventories or raw material inventories?

Can you give us any guidance of where those inventories are sitting in your operations?

It's a combination of both.

But it's heavily weighted towards in process.

We carried very little prime product inventory.

Most of our mean finished product.

Most of our inventory is going to be raw material and work in process.

This would be predominantly work in process.

My only concern is that as you implement, you take inventories out of work in process.

That's exactly right I guess the one other comment I should add to this -- I'm look at our statement here now.

Our inventories were up a couple hundred million dollars.

And as the dealer inventories of new equipment, new machines, goes down, we have, in fact, added a little bit of inventory here to compensate for that so that as we're working through -- as I mentioned the projects and so forth to better manage assets and bring values down, in the near term we are to have some excess inventory over and above what we've had in the past.

Simply to support those kinds of lead times to the dealers and support their reduction in inventories.

Ok.

Thanks.

Ok.

Thank you.

Our next question comes from Gary [INAUDIBLE].

Please state your affiliation.

JP Morgan.

Good morning Jim and Lynn.

Hi, Gary.

My question is just relates to the truck engine business.

I'm assuming that Caterpillar's experiencing quite a bit of inefficiencies relating to -- you're trying to get your bridge engine as close as possible to the EPA standards, I assume.

You're also trying to ramp out the assert next year.

I assume again there's a lot of incremental costs there.

Plus you have a ramp up production.

It's the second and third quarter.

Then drop in the fourth.

So you have to deal with that.

Can you talk a little bit about how engine performance or profitability is going thus far and what you expect in the second half relating to these issues.

Well, again, I can't give you any projection or outlook for engine profitability in the second half.

But what I can say, Gary, is as you indicated, we are ramping up production in our Mossville facility for truck engines right now.

And have been for the last two or three months and we'll continue that.

And then through the third quarter.

And then there will obviously be some sort of a reduction.

Again, the magnitude of which we're not exactly sure of at this point.

But some reduction, probably significant, in the fourth quarter.

So as you're ramping up production, we do run into inefficiencies associated primarily with suppliers.

We deal with it internally here.

Primarily through the use of what's called supplemental employees, where we can add temporary employees to those facilities, and with overtime.

So we're able to deal with it I think much easier than some of our suppliers.

So that is a little bit of a problem, obviously, in a big ramp up.

And it's a;sp little bit of a problem in a big ramp down.

So we will have some inefficiencies that will continue in the engine business.

And obviously, I'm talking here about truck engines.

But obviously we've got the same issue at our Lafayette facility with our large engines, our large reciprocating engines there where the ramp down has been pretty significant compared to where they were at the beginning of last year, for example.

So we've run into a lot of inefficiencies.

And the absorption of period costs or fixed costs is an issue for us.

And frankly, we'll continue -- it will continue to be somewhat of an issue for us going forward.

My follow-up is I've heard from a lot of people that the constraint on building trucks here in front of the October deadline is engine capacity.

And one of your truck customers, lower guidance here -- I guess yesterday -- talking about a shortfall of getting CAT engines.

Can you comment on your ability to meet demand here in the second and third quarter?

Any inefficiencies, allocations?

Whether you're treating the customers in the same way and so forth.

Well, as you well know, there are some outstanding lawsuits.

So I have to be a little cautious here.

In what I say.

I'm not going to comment on any of those things.

But what I can say is that, yes, we are basically producing everything we can produce from an engine perspective.

We have notified all of our OEM's, our customers that engines are on allocation.

And we have notified them of the process and how many engines that they typically could expect to receive.

So all of our customers had been notified of that.

And we are on allocation, producing everything that we can produce.

Thank you.

Ok.

Thank you.

Our next question.

Please state your affiliation.

Lehman Brothers.

How are you doing, guys?

Hi, Joel.

On your construction business, can you give a little more specifics on where it was weak and the outlook on the commercial?

Can you give us a sense of what you're thinking there beyond economic recovery?

Well, the commercial side was essentially weak in most areas around the world.

Certainly in our two major markets -- North America, and Europe and Africa-Middle East.

It was extremely weak.

We don't see any sign of that turning until there is an economic recovery.

That's going to be tied pretty closely with an economic recovery on the commercial side.

And as I said, that's in both geographic areas.

In terms of some of the other areas, heavy construction, as I mentioned, continued to be really very good for us good business around the world in all geographic regions of the world.

That is continuing to grow.

Housing starts in North America in particular, have been strong.

I mentioned that.

And that business has been reasonably good.

It's really on the commercial side.

And mining and some of these other areas that I didn't specifically address.

But obviously coal mine and even metals mining is relatively weak.

Certainly on an historic basis as well.

And what I'm trying to get at is the potential for pent up demand throughout on the commercial side it seems like it's been slightly weak.

But like you said before, it's running along.

It's still reasonably high levels.

Can you give us any pieces of information to give us a sense of what pent up demand might look like in that business so we can see how it unfolds over the next couple of years?

Just on the commercial side you mean?

Yeah.

Well, commercial is part of general construction.

Housing continues to be pretty good.

So I wouldn't say that there's necessarily anything in the way of pent up demand on the housing side.

On the commercial side, because that has been fairly weak over the last two or three years I think -- just our feeling from the field and from our dealers is that there is some pent up demand there.

Part of that is taken care of by rental.

More and more customers are utilizing rental.

I don't know that I can give you much in the way of when we would expect anything this year until probably moving into next year for a recovery in commercial.

So not a lot of specifics there.

Lynn wants to add a comment here.

Let me just add a comment.

We're all familiar with the buildup of rental fleets that took place in the mid to late 1990s, peaking about 1998, mainly in the commercial rental houses.

Then our rental stores started to kick in at that point in time.

Those fleets have basically -- at least on the commercial side -- have gone without significant replacement.

In fact, have been downsized over these last two or three years.

Our fleets, as they were building in this that late 1990s time frame are reaching the age, the three to four-year range where you begin to see normal replacement of rental fleets.With the continued construction activity that has occurred in these last few years and without replacement, I think it's safe to say that at least over the last two years we are building to a point where equipment is reaching from a maintenance standpoint and a productivity standpoint is reaching the point where it needs to go into secondary applications and needs to be replaced.

So I think there is demand building.

Thank you.

Ok, Joel.

Jen, we probably have time for one more question here.

And then we should wrap up.

Ok.

Your next question does come from Steven Fisher.

Please state your affiliation.

It's David Boosky.

Just a couple of cleanup questions.

How many weeks of downtime were taken at Lafayette in the second quarter?

In the second quarter there was just one week.

And there are two more scheduled in the third quarter.

All righty.

How much was your pension income in the first quarter and then again in the second quarter?

Dave, I don't know the specific answer to that.

Our estimate for the year was about half of what we had last year.

And that was roughly 80 million for the year, which is our estimate for this year which would put it at about 20 million per quarter.

So I don't know the exact number, but it's somewhere in that range.

It seemed like you moved it around on us a little bit.

The comments I made earlier?

Mm-hmm.

Yeah.

That was related to other post retirement benefits.

Primarily retiree health care benefits not pensions.

Terrific.

And Lynn, what is your philosophy on maintaining the dividend?

Well, our general philosophy has been that we want to consistently increase the dividend in a sustainable fashion.

Our cash flow uses and order of priority, number one, continue to vest in the business.

Number two, have a consistent and sustainable increase in dividend policy.

And number three, the residual cash would go to share buyback.

So we definitely -- and we have a range of payout over the cycle that we monitor in Maine.

But as you see your outlook today, you envision maintaining the dividend?

Maintaining the dividend?

You mean verse as a cut?

Right.

Oh, absolutely.

Terrific.

That's what I needed.

Thank you.

Thanks, Dave.

Again, thanks to all of you for participating in the call.

If you didn't get your questions answered, please give me a call and we'll address them off-line.

Thanks again.

Thank you, ladies and gentlemen.

This does conclude today's teleconference.

You may disconnect your phone lines that time being and have a great day.