開拓重工 (CAT) 2002 Q3 法說會逐字稿

Good morning, ladies and gentlemen.

Welcome to Caterpillar's 2002 third quarter earnings conference call.

At this time, all participants are in a listen-only mode and we will open the floor for your questions and comments following the presentation.

It's my pleasure to turn the floor over to your host, Mr. Jim Anderson.

Sir, you may begin.

Thank you, Jen.

Good morning.

Welcome to Caterpillar's third quarter 2002 results conference call.

As Jen said, I'm Jim Anderson, Director of Investor Relations.

With me is Lynn McPheeters, as usual, Vice President and Chief Financial Officer.

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

This conference call is copyrighted by Caterpillar Inc., and any use, recording or transmission of any portion of this conference call without the express written consent of Caterpillar Inc. is strictly prohibited.

This morning, I'll cover our third 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 eight K, filed with the Securities and Exchange Commission today.

Let's start with the third quarter results.

As you know, this morning we reported third quarter sales and revenues of %5.08 billion dollars, and profit per share of 61 cents.

These third quarter results were in line with our expectations.

Sales and revenues were up $19 million dollars from third quarter 2001, with machines down $74 million dollars and engines up $75 million dollars.

The impact of lower sales volume for machines was offset by favorable currency changes and slightly positive price realization.

Consolidated revenues of the financial products division were up $18 million.

Profit per share was two cents higher in third quarter 2002 compared with 2001, even though profit before taxes was lower by $12 million.

The lower PVT was mainly due to the impact of lower machine sales volume and manufacturing in efficiencies.

These favorable -- unfavorable items, rather, were partly offset by material cost reductions and improved price realization outside North America.

The net impact of currency was a positive one cent 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.

The improvement in profit per share was due to a year-to-date change in our annual effective tax rate, to 28 percent from a 30 percent rate.

The reduction in the rate to 28 percent occurred because of a shift in the geographic mix of profits.

The rate reduction is a real cash flow benefit, and another positive aspect of our geographic diversification.

SG&A and R&D expenses were flat compared with third quarter 2001 levels.

With the unfavorable impact of currency removed, these items were actually down about $11 million.

As a matter of interest, no longer amortizing goodwill had a favorable impact on third quarter results of $21 million, on a pre-tax basis.

And the combination of pension and owe pem ex pense had a unfavorable impact of $14 million.

Further regarding pensions, we made a voluntary contribution of $90 million to one of our pension funds during the third quarter.

However, as noted in today's release, based on third quarter plan asset values, we would be required to increase the additional minimum liability by approximately $2.8 billion at December 31st, 2002.

This would result in a decrease in accumulated other comprehensive income, which is a component of shareholders equity on on the financial position, of approximately $1.8 billion after tax.

These amounts have increased from those disclosed in the second quarter 10-Q, primarily as a result of a further deterioration in the equity markets.

This further deterioration increased the underfunded position in the pension plans and caused an additional requirement under SFAS 87, to offset a $1 billion pre-paid pension asset position, with an additional minimum liability.

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

North American dedicated rental fleet utilization on a 12-month rolling basis is continuing to run at a strong rate, about 62 percent.

Which is the same as a year ago.

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

But continue to remain under pressure.

Overall, units and dedicated dealer rental fleets are up less than one percent, compared to a year ago.

Dedicated dealer rental fleets consistent of rent to rent units and units in Cat rental stores.

Rent to rent units which currently make up about 60 percent of the units in dealer rental fleets are down about seven percent from a year ago.

The Cat rental stores have about 40 percent of the rental units in dealer fleets, which continue to grow and are up four percent from a year ago.

North American dealers added four rental stores in third quarter 2002 for a total of 373 stores.

About seven more are expected by year end.

In the Europe Africa Middle East region, dealers had 714 rental outlets, 156 of which had the Cat rental store identity as of quarter end.

In Latin America, we had 93 Cat rental stores and 17 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 300 in the rest of the world will have the Cat rental store identity.

North American used equipment prices were down in the second 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.

The company still expects sales and revenues for the year to be down slightly, with full-year profit down about 15 percent from last year, excluding non-recurring charges recorded in 2001.

However, uncertain near-term political and economic conditions make the remainder of the year more difficult than normal to predict.

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

For 2003, we expect moderate, which is on trend, worldwide economic growth.

Based on moderate growth in North and South America, as well as Africa Middle East and CIS, slow to moderate growth in Europe, and good growth in Asia-Pacific, excluding Japan.

In the past, we have used our macro economic forecast to project preliminary industry and company sales.

But traditional top-level indicators such as interest rates and expected GDP economic growth, are no longer reliable indicators.

Also, our continuing diversification of products and industries that we serve make it more difficult to project sales changes based on top-level economic indicators.

One of the key indicators of future sales is direct input from our dealers and marketing field personnel.

Since we will not have specific sales input for the 2003 business plan, from our business units until later in the year, we will not provide any specific guidance on company sales and profits until the fourth quarter results release in January.

Now I'll review dealer retail machine numbers and reciprocating and turbine energy sales to users and OEMs.

Remember, all comparisons are based on constant dollars.

Retail sales of machines for the three months ending September 2002 compared with the same three months of 2001 are as follows: For Asia-Pacific, up more than 24 percent.

Europe Africa Middle East, down eight to 15 percent.

Lan America, up 16 to 24 percent.

Subtotal of those three regions, up less than two percent.

For North America, down eight to 15 percent.

And for the world as a whole, down eight to 15 percent.

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

For the three months ending September 2002 compared with the same three months of 2001, total reciprocating and turbine engine sales to users and OEMs were as follows: For electric power, down over 24 percent.

Industrial engines, up eight to 15 percent.

Marine engines, up eight to 15 percent.

Truck and bus engines, up more than 24 percent.

Oil and gas, down two to seven percent.

And the total: Up two to seven percent.

Now let's turn to dealer machine inventories.

First sequentially, comparing September with August 2002.

For Asia-Pacific, up two to seven percent.

For Europe Africa Middle East, up two to seven percent.

Latin America, down two to seven percent.

Subtotal: Up two to seven percent.

And for North America, down two to seven percent.

And the world as a whole, down less than two percent.

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

For Asia-Pacific, up less than two percent.

Europe Africa Middle East, down two to seven percent.

Latin America, down more than 24 percent.

Subtotal: Down two to seven percent.

For North America, down eight to 15 percent.

And for the world as a whole, down eight to 15 percent.

Dealer inventories of new machines at the end of September compared with year-end 2001 were about flat on a worldwide basis.

At September 30th, 2001, dealer inventories were about a $100 million dollars higher than year-end 2000.

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

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

Asia-Pacific dealer new machine inventories are at 2.2 months of sales, down from 2.8 months a year ago.

Europe Africa Middle East dealers are at 2.6 months, down from 2.9 months a year ago.

Dealer new machine inventories in Latin America are at 2.8 months of sales, down from 3.7 months.

Dealer new machine inventories for the subtotal of these three regions outside North America are at 2.5 months of sales, which is down from 3.0 months a year ago.

North American dealer machine inventories are at 2.6 months of sales, down from 3.0 months.

Overall, on a worldwide basis, dealer machine inventories are at 2.6 months of sales, down from 3.1 months a year ago.

The retail statistics for September are also available on voice mail through November 17th, by calling 309-675-8000.

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

First is a comment on employment reductions and the officer retirements and temporary plant closings announced within the last few days.

Since third quarter 2001, we have reduced employment by nearly 2100, excluding additions from acquisitions of 528 people.

Two Vice Presidents and the Corporate Controller will retire at year end.

One vice presidental position will not be replaced, and will have his responsibility assigned to other VP positions, resulting in elimination of one business unit.

From a facility standpoint, we have suspended operations at our Waco, Texas facility, consolidated production at several U.K. facilities, and announced temporary plant shutdowns and layoffs at several engine facilities during the fourth quarter.

These actions are part of our continuing efforts to manage production schedules and costs in a very challenging economic environment.

Second, an update on SicSigma activities.

Enterprise SicSigma benefits are helping offset the unfavorable economic impacts we are facing around the world.

There are six sigma projects underway in every facet of our business.

One of the more significant areas of focus is inventory management. 115 black belts representing 34 global business units are working on projects to deliver immediate inventory management improvements and maximize cash flow.

The number of employees actively involved in SicSigma continues to grow.

Through September, 1,350 black belts have been trained and were on track to surpass our goal of 2 percent of full-time employees trained as black belts by year-end.

We've also exceeded our target ratio of green belts to black belts.

Currently, there are 6,300 projects in our system.

We continue to engage our suppliers and the Cat dealer network.

This quarter, an additional 22 dealers and 37 suppliers deployed SicSigma.

This brings the total to 40 dealers and 87 suppliers.

This extension of SicSigma will strengthen our entire value chain.

Our SicSigma benefits continue to grow, and have already significantly exceeded the benefits realized in 2001.

Lastly, an update on our engine business.

Caterpillar truck engine sales continued to increase in the third quarter and were nearly double the third quarter '01 sales.

This increase was mostly due to truck pre-buying ahead of the October emissions deadline.

Our expectations for North American heavy-duty truck industry demand in 2002 is about 160,000 units, excluding Mexico.

The mid-range truck industry is expected to be about 135,000 units.

North American heavy-duty truck manufacturers have experienced a sharp drop in orders in the last few months, and we believe industry weakness will continue into the second quarter of 2003.

Consequently, we are making significant adjustments to align our production capabilities with expected customer demand.

The electric power slowdown which began last year in both overall industry demand and Caterpillar sales has continued through the third quarter.

As I mentioned last quarter, we expected financial uncertainties and depressed operating profits within the electric utility and telecommunication industries to continue in the second half of 2002, causing our global electric power industry forecast to decrease significantly from 2001 levels.

We expect Caterpillar sales into the electric power sector in 2002 will be down at the high end of the 16 to 24 percent range, compared to last year.

We have adjusted our schedules to match production with expected near-term customer demand.

As industry financial uncertainties are resolved, surplus electric utility capacity is worked down and Caterpillar dealer inventories return to more normal levels, growth will resume as we move into next year.

In the petroleum sector, demand for large engines was particularly strong in Europe Africa Middle East and Latin America, but sales in North America declined significantly, caused by the sharp drop in drilling activity compared to last year.

Although economic growth has resumed and crude oil and natural gas prices are high enough, to stimulate capital spending by customers, we have not yet seen any appreciable improvement in sales because economic uncertainties still prevail.

It appears North American drilling activity troughed in the third quarter.

But the North American industry will be down significantly for full-year 2002.

Despite this industry downturn, we expect worldwide Caterpillar sales into the petroleum sector will be up slightly this year.

Primarily because of strong turbine engine sales.

Energy markets should benefit from stronger demand for liquid and gaseous fuels as we move into next year.

On new engine emissions technology, a sert, remains on schedule for medium duty launch in January and heavy-duty launch in the second quarter.

Caterpillar has received certification from the EPA for our bridge engines, manufactured after September 30th.

We have begun production of the bridge engines, and they will be offered in more chassis options than competitive engines as the October truck models are being introduced.

We expect the Caterpillar bridge product to be on a preferred, competitive position against cooled engines based upon superior reliability and durability with comparable fuel consumption.

We currently have over 100 assert medium and heavy-duty engines either in the field, being tested with customers or with truck OEMs for test and fit up.

About 50 more will be added to that total during the fourth quarter.

These are all production engines that were or will be built on the production assembly line.

In summary, we are on target with the introduction of our assert engines and fully expect to have our industry leading technology in the trucks of customers beginning in the first quarter next year.

Okay.

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

As always, in the interests of time and fairness to others, please limit yourself to one question and one follow-up okay, Jen, first question, please.

Thank you.

Ladies and gentlemen, the floor is open for questions.

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

Pressing one four a second time will remove you from the cue if your questions is answered.

Please pick up your handset if you're on speaker phone for optimum sound quality.

Please hold while we poll for questions.

Thank you.

Our first question comes from David Bluestein.

Please state your affilliation, then pose your question.

UBS Warburg.

Good morning.

Hi, Dave.

Jim, can you walk me through any changes that you've made to pension assumptions since year end, and how much if anything do you expect to contribute to the fund over the next 12 to 18 months?

We haven't made any changes to our assumptions during the year.

Once those assumptions are set, they remain for the full year, and at the end of this year we will be reviewing with our actuaries the assumption for next year and announce those in the fourth quarter call.

In terms of contributions, there really isn't anything more that I can say, other than the fact that I already mentioned that we made a $90 million contribution during the third quarter, and we'll make further contributions as conditions warrant.

All right.

Follow up, do you still expect to report roughly $80 million of pension income this year and what is your best guess for pension income or expense next year?

Yes, again, the amount of pension income that we report in any given year is set at the beginning of the year, and doesn't change.

And again, I can't give you anything specific on next year until we get to the end of this year.

And we'll be providing that in the fourth quarter call, Dave.

Okay.

Thank you.

Okay.

Thank you.

Our next question comes from David Raso.

Please still your affiliation and question.

Hi, Jim.

Hi, Dave.

One question I have is on machinery, impressive margins on the quarter.

I'm trying to understand the moving parts of retail sales, year over year are down, inventories are down year over year.

The pace that they're reducing inventories seems similar to last year, but the machinery sales for Cat down in the same proportion.

Can you connect that with also the margin that -- margin of third quarter was only 13 percent, when historically second and third quarter it's 30, 40 percent.

Bigger number.

Can you help me work through those moving parts on the sales and also is the mix with coal mining that weak?

Trying to understand how the margins were that strong.

Pull in SicSigma savings, quantify that as well.

Well, obviously, there are cost reduction activities going on, and I cannot quantify specifically how much of that pertains to machine sales.

But I think the biggest factor for the third quarter was in fact the price realization and the currency benefit that we got that positively affected sales during the quarter, and then outside North America the improved price realization that was probably the single biggest factor as far as margin improvement.

And again, keep in mind, as I said, our heavy construction and quarry and aggregates businesses, which are generally bigger product, more complex product, little higher margin product, were continuing strong in the quarter, and the other areas that were predominantly weak, especially general construction, is generally lower margin product. -- those are the biggest factor.

And the disconnect a the sales on the retail level and the inventory level, are retail sales do include product and cat rental as well as any dollars?

That is correct.

As we make the sale, that is considered a sale, whether it goes to an in customer, a retail sale, or whether it goes into the dealer rental fleet.

So again, the question that the disconnect between sales down worldwide retail eight to 15, inventory down year over year eight to 15, but Cat sales down only two and a half?

Yeah, again, I think, Dave, it's a mixed issue and it's a pricing issue that we're seeing, that bit of a disconnect during the third quarter.

Pricing was in the retail data as well as the inventory data?

That's what I'm trying to clarify.

Pricing is in the retail numbers, but we use a constant dollar number for getting the retail numbers and our sales do reflect some price improvement outside of North America during the third quarter.

David Raso: We can follow up off-line, but the pricing in the international retail sales, isn't it.

Those are based on constant dollars, so there is no price engine the retail numbers.

David Raso: Okay.

David Raso: Thank you.

That's probably another factor.

David Raso: Okay.

David Raso: We'll talk later.

David Raso: Thank you, Jim.

Okay.

Thank you.

Our next question comes from Steve Voelkman, please still your affiliation and pose your question.

Morgan Stanley.

Hi, Steve.

How is your lucky tie?

I have it on!

Wanted to follow up on a couple things.

If the price stays where it, it will be luckier.

It goes higher.

That's what you want.

Right.

On the pension issue, have you -- assume you must have talked about this with the rating agencies, I guess the only impact that's this really has is potentially on the equity level of the company and what that might mean for rating agencies.

Steve Voelkman: Have you had any conversations like that?

Yes, we have discussed this with the rating agencies and I think, generally I could summarize that by saying that if you pull out the adjustment for pensions, our debt to cap ratio will be within our normal 30 to 40 percent range, with that adjustment in there it will be a little higher.

But we have in place the plans over the next year or two, given our expected profitability and cash flow, that that will come right back down.

So at this point, that's not an issue with the rating agencies.

Steve Voelkman: Okay.

And then following up on sort of the cash potential cash requirement next year, I calculated something potentially in the four to five hunddred million range.

But pre-funding this year, can keep from tripping some of those levels next year.

And I'm guessing that's what is going on here.

So, in other words, I'm probably too high with the three to 400 million.

You're talking about contributions to the pension plan?

Steve Voelkman: Right.

Well, again, I think the critical thing here is that we will make contributions as we deem conditions warrant to do that.

I believe we are not required to make cash contributions either for the balance of this year or next year.

So it will be a matter of really our call as to whether we want to make contributions or not.

Steve Voelkman: Okay.

You get a tax benefit when do you this?

Yes, normally we do.

Steve Voelkman: Okay.

Thank you.

Okay.

Thank you.

Our next question comes from Michael Harris.

Please state your affilliation then pose your question.

Deutsche bank.

On the sharp drop expected in the truck engine sales, you can quantify sharp drop?

Well, I'm not sure we have a specific number for that.

But I can tell you that it is -- the expectation for the fourth quarter, let me put it this way, is a small fraction of what it was in the third quarter.

Just basically, based on what we see in the industry, it could be down 70 to 80 percent.

Okay.

And just follow-up unrelated, but Cap Ex for the full year, where do you expect that to come in?

Well, our original expectation at the beginning of the year was for that to be about $1.1 billion this year.

And as we have progressed throughout the year, with the economic conditions not recovering the way that we thought they would, and we have focused on cost reduction, another area of focus is capital expenditures, and they will be significantly below our expectation at the beginning of the year.

It's a little tough to say at this point exactly what that number will be.

But it will probably be a couple hundred million dollars or more below our original expectation.

Okay.

I'll get back into cue.

Okay.

Thank you.

Our next question is coming from Joel Tiff.

Please state your affiliation and pose your question.

I'm with Lehman Brothers.

How're you doing Jim and Lynn?

Hi, Joel.

Hi.

I wonder if that $23 million improvement in other income, is that sustainable?

Well, what happened in other income, this quarter, was in fact the sale of fewer receivables and at lower interest rates from our marketing companies to Cat Financial.

So you know, it's really a question of what interest rates do in the future, and what business does in terms of how many receivables the marketing companies do sell, to Cat Financial.

We had somewhat the same situation in the second quarter.

Okay.

And I know you said you're not going to give us any help for '03, but can you give us how anecdotally how things are shaping up in terms of first half versus second half?

At this point, I have an attorney here and he's shaking his head no.

So no, I can't.

All right.

Thank you.

Okay, Joel.

Thank you.

Our next question comes from Anne Dubman.

Please state your affiliation and pose your question.

Hi.

Bernstein.

Hi, Anne.

My question around the engine operating profits at 4.3 percent.

If we back into that, we get margins for the power generation business of -- down in the negative double digit range.

Is that about right?

And what is the -- what are you looking at going forward for -- in terms of margins in further restructuring there or how do you get that back to break even in this environment?

I can't give you a specific number on our margins for the power GEN business, but obviously with the dramatic drop in volume we've seen particularly in our Lafayette, Indiana, facility which makes the large engines for power GEN business, that's had a dramatic impact, just the volume itself.

We have taken some actions there to reduce costs, but when volume drops this much, yes, the margin is negative there.

In terms of the future, really what is going to happen there is that as volume picks up, and it will pick up.

We're indicated during the comments we're expecting the industry to start showing signs of improvement as we move into next year -- just the volume improvement itself is going to bring that margin back to a more normal level.

So it's really a function solely of sales volume in that business.

What do you expect to drive sales volume growth next year for reciprocating engines?

Probably the single biggest factor is going to be improvement in the economy in North America in particular of the United States.

As the excess supply then will be utilized or used up, the excess supply of utility power by both individuals as well as businesses and as that happens, the utilities will start buying more or renting more of our equipment, as will the other commercial users of that type of equipment, whether it be manufacturing or technology or Telecom or whatever it may be.

So probably without question, the single biggest factor is a recovery in the economy, in North America in particular.

I should mention here too that the biggest area, which obviously is very significant, that we're seeing downturn in this business is in our large reciprocating engines.

The turbine engine business on power GEN is still not too bad.

As is the business below one mega-watt is still strong for us.

So it really is that 3500, 3600 series engines that are creating the issue here, and as that turns around, again, from a volume standpoint, we'll be back on track with both our sales growth and our margins, as we were in the past.

We should not expect any more restructuring of that business?

Well, I think you -- we are continuing to do the things that we need to do.

We've had -- my recollection is three one-week shutdowns during the third quarter at the Lafayette facility that affected a number of people.

We've had some temporary employees let go, and some selective layoffs.

Overtime is down.

Those kinds of things.

And we are in fact doing other things throughout our engine business now to offset the impacts of the lower volume in both power GEN and now the lower impacts on the truck engine business.

So in terms of a restructuring of taking period costs out, reducing a lot of the management and salary employees and things like that, no, I don't think you'll see that because our expectation is that business is going to come back, and we'll need that structure in place.

Thank you, I'll get back in line.

Okay, Anne.

Thank you.

Our next question comes from Gary McManis.

J.P. Morgan.

Good morning.

Jim Anderson: Good morning, Gary.

On the truck engine, apparently, there was a price increase put in, on the bridge engine October.

Is that -- I think it was talked about three, four, $5,000 dollars per unit.

Is that pricing sticking?

Are you realizing the price gain?

Yes, the price increase that was announced was approximately $3500 on the heavy-duty engines.

And yes, that is sticking, and we had already announced an additional increase of $1500, when the assert engines become available early next year.

Again, that's a market-based price that compared with what the competitors are doing in the cooled EGR engines, compared to what we have available out there, again, it's market based and it is sticking.

Okay.

Just on your full-year outlook, if I back into the fourth quarter, it's kind of suggesting somewhere around a ten to 12 percent operating profit decline.

If that's what happens, how would you weight that between machines and engines?

I know engines will get hurt with truck, but usually there's seasonal strength in the Solar business.

You can break it down?

Which area you think would be doing relatively well versus relatively poorly.

Gary, say again what you had indicated?

That there -- your expectation is for a deterioration?

Well, in operating income.

I could be wrong.

You're talking about -- a 15 percent drop in full-year earnings is like 220, and if I back into that correctly, that would be about a 70 cent fourth quarter, and that's about a ten percent drop.

Year over year.

From a year ago.

Okay.

Right.

How would that break down between the engine and the machines?

Machinery.

I think it would be predominantly on the engine side of the business, but somewhat offset because as you indicated, Solar is generally very strong in the fourth quarter, and we do expect that again.

But with the -- both electric power and the oil and gas side of our business being very weak, that's primarily Lafayette type product, and then the dropoff significant -- significant dropoff in the truck engine side, just from a guidance standpoint, I'd say it would be on the engine side, Gary.

So the machines could be kind of flatish, basically?

Trucks.

Perhaps.

Okay.

Thanks.

Okay.

Thank you.

Our next question comes from Joannea Shatney.

Please state your affiliation and question.

Good morning.

Goldman Sachs.

Hi, JoAnna.

Hi.

Can you talk a little about what you're seeing in how you think this plays out.

I know the aggregates and the highway stuff is flatish this quarter, but are you seeing any substantial dropoff and the backlogs and those businesses as the 221 funds are being debated in Congress and obviously municipal budgets are shrinking, kind where do you see that trending?

How long do you think it can last?

Well, we're not seeing any dropoffs at this point.

And the reason for that, you need to keep in mind that typically these are longer term projects that -- they're not up two-month or three-month project.

They're generally multiple months or even years, and the funding is there for those.

So at this point, we're not seeing any dropoff.

And under the presumption that we do not have a dropoff in the funding level of the new five-year federal plan next year, I don't think we're going to see any significant dropoff at all in North America in the U.S..

And the other thing to keep in mind is that heavy construction has been stronger outside of North America than it has been inside of North America through most of this year.

The same kind of infrastructure projects that are going on around the world have been very strong outside of North America as well.

So it's a little early to tell based on the political situation of what's going on today, what might happen next year in terms of a funding Bill for transportation to replace T 21, but you've heard me say before that certainly from a standpoint of jobs, job creation, stimulating the economy, and the fact that states want to spend their portion of the money so they can get the federal portion of money, this is a pretty popular thing.

So I guess our expectation is we would not see any significant drop and maybe fairly close to what T 21 is, as far as the replacement.

Okay.

And just a as a follow-up, one the few things that really could weaken from here is residential housing, and our economist at Goldman has between a five and ten percent decline in housing starts into next year.

That's going to have some impact on general construction sales.

Or is it your view it's down so much already, it can't get much worse?

Well, I would characterize it this way: Housing starts have been relatively strong over the last couple years, and even if they do go down a little bit and I would have to say that our projection is that they're not going to go down very much, they're going to be fairly flat, there really isn't going to be much impact on us from that perspective because general construction is probably down, and I don't know the exact number, but similar to everything else and maybe more so over the last three or four years, 35 or 40 percent in terms of sales of our equipment.

And so that equipment has continued to be used over that time frame, and not replaced.

So there could very well be a replacement cycle occurring, even though housing starts don't grow or even deteriorate a little bit.

Thanks, Jim.

Okay.

Thank you.

Our next question comes from Mark Kosneric.

Please state your affiliation then pose your question.

Hi, Jim.

It's Mark Kosneric at Midwest research.

Hi, Mark.

I had a question about your comment on assert when were you describing the engines there.

You mentioned comparable fuel economy, and I thought in the past we were talking about actually some advantages when it came to that, you know, operating costs, advantages.

And it seemed like you at least with that statement backed away.

Could you update us on what kind of data is available on assert performance?

Well, let me clarify what I said.

I was not referring to the assert engine.

I was referring to the bridge engine.

The bridge engine will have comparable fuel economy to the cooled EGR engines, and the reason for it deteriorating from our current engines is because you have to do some things with software to reduce the emissions, and that does impact fuel economy.

Our assert engines, we still expect to be better than the cooled EGR engines and comparable to today's engine.

The pre-October 1st engines.

So really, what I refer to was the bridge engine, not the assert engine.

Is any preliminary test data for the full assert available yet in the marketplace that you can discuss, the level of benefit?

Not that I can discuss.

As I mentioned, we have about 100 units now with another 50 or so to be going out, that will be going out here within the next few weeks.

And most all of those are with customers with confidentiality agreements, so even if you try to track them down, they're not going to give you any information on it.

So yeah, we're getting -- I will say this: That the reports that we are getting back are meeting our expectations in terms of the performance and fuel economy and so forth on the field units.

When do you expect to be able to go more public with this information?

Because as we talked to trucks fleets there's this information gap and even once kind of an obvious statement, once you get the information out there, it will take them sometime to digest it and make purchase decisions.

Yeah, I would expect that in the coming weeks, we're going to be making more and more of that information public because, as you say, we want our customers to know what's going on out there with these engines.

And we'll be making that information available I'm sure over the next few weeks.

So some time before the end of this year?

I'm speculating on that, Mark, but yes, because our C9 engine is expected to be going out sometime in January on a production commercial for-sale basis, so yeah, we'll be having that information out to our customers.

Okay, Jim.

Thank you.

Okay, Mark.

Thank you.

Our next question comes from Andrew Casey.

Please state your affiliation and pose your question.

Prudential Securities.

Good morning, Jim and Lynn.

Hi, Andy.

Couple things.

On the truck, talking about essentially 70 to 80 percent down sequentially, is that implying that order rates for the new engine, the bridge engine, are down at that level, or can you help me with that?

No, what I was referring to was the industry there.

I was not making any specific reference to our orders for the Bridge engine or anything else because, as I mentioned during my comments, we fully expect that we're going to have a competitive advantage during the third quarter with the Bridge engine, so I can't make any comments on orders or anything like that, as far as the Bridge engine is concerned, other than to say as I did that we expect to be in a pretty positive competitive position there.

Okay.

Thanks.

And then on the machinery and engines part of the cash flow statement, there's $43 million positive benefit from the expenditures for equipment, disposals.

Is that -- can I assume the $3 million has something to do with sales from power rent business?

You know, I can't remember exactly what that was.

I think there's -- there are two or three things in there, one was the proceeds from the sale of our AG business, and there was another one -- and I just frankly don't remember specifically what it was.

But there were two or three items like that.

Trying to recall.

There was one other one.

Oh, I know what the other one was, the resell -- resale of our investment in the Pioneer dealership in Southeastern United States to the dealers.

So there were a couple items like that that were -- that made up most of that $43 million, proceeds from those things.

Okay.

Thanks.

I'll get back.

Thank you.

Our next question is coming from Barry Banister.

Please state your affiliation then pose your question.

Doug Mason.

Good morning.

Hi, Barry.

Couple political questions.

Or things coming up.

One, you have a 28 percent tax rate, which is obviously a little below the average of the last few years, and the foreign sales corporation is also under political attack, and it contributes about 550 basis points to the tax rate.

So the first question would be, what is the update on the tax rate outlook, including the the FSC?

And the second political question is, would you talk about the level of Knox emissions in your Bridge engine versus EPA guidelines, and the status of that negotiations right now?

Sure.

Let me address the tax rate first.

I can't really give you an expectation for next year, for example.

We'll do that in the fourth quarter.

But I will say this, that our expectation is generally it's going to be somewhere below 30 percent going forward, because of the mix of geographic mix of the profits.

When you look at things -- and that's just kind of our internal expectation with no other changes, with all of the things being equal.

Obviously, it the benefits that you referred to of the foreign sales go away, and Congress is looking at that right now, that is going to have an impact.

And our expectation is that Congress recognizes the impact that that's going to have on a number of major corporations in the U.S., and that they're going to try to address that in one way or another so that companies like Caterpillar and Boeing and Microsoft and IBM and a host of others don't get really substantially hurt as a result of doing something on the foreign sales corporations.

So you know, notwithstanding what might happen there, our expectation would be that our rate is going to be somewhere in that below 30 percent range.

Going forward.

Now, your other question, Barry, was related to the level of emissions on the Bridge engines, right?

Some gauge of what it means for EPA penalties.

Yeah.

Our expectation at this point in time is that we're going to be -- and these are approximate because they are changing and they will continue to change as we do all the testing that's necessary on production engines to submit to the EPA.

But we'll probably be in the range of 2.9 grams to about three and a half grams.

With the heavy-duty engines being on the lower end and the medium duty engines being on the higher end of that range.

And then from a -- that will translate therefore to non-conformance penalties somewhere in -- again, rough range of about 1500 dollars to about $4,000.

And with the medium duty engines being at the low end of that range, during the fourth quarter, and the heavy-duty engines being at the higher end of that range.

Okay.

And just related follow-up, on the engine prices and the engines for the assert, why announce a price increase of $3500 and then say that you're going to raise the assert %1500, when the $3500 price increase probably dissuaded some purchases and netted against the $1500, which probably pulls some purchases forward where by you'll pay a penalty.

What was the motive for that?

Well, first of all, as I said, our engine -- our truck engine prices are in fact market based.

It's what the market pricing is out there for truck engines, and given what we think is the appropriate premium for our product.

So that is really the basis for the $3500.

On the other hand, we didn't think that we should charge the additional amount for the assert capabilities until the Assert engine was out there.

So that's really the logic behind it, generally, Barry.

Okay.

Thanks.

Okay.

Thank you.

Our next question comes from Robert McCarthy.

Please state your affiliation and pose your question.

Robert W Baird.

Good morning guys.

Hi, Rob.

First question.

Jim, could you review planned fourth quarter shutdown activity and compare it with fourth quarter of a year ago, and discuss the potential for some non-recurring expenses that might be associated with that?

And I'll have a follow-up.

Okay.

Let me take the latter part of your question first.

There will be no non-recurring expenses recorded in the fourth quarter, based on what our expectations are at this point.

We've announced that the several engine facilities will be affected by layoffs and shutdowns during the fourth quarter.

Mostly those are going to be truck engine facilities.

There could also be similar things happening at our other facilities.

I have to be...other engine facilities.

I have to be a little cautious here because I can't talk about anything that hasn't already been discussed and disclosed to our employees.

Of course.

So when you compare it back to a year ago, my recollection is in the fourth quarter of last year, we didn't have any shutdowns.

We may -- in the engine facilities.

I think had a couple of one-week shutdowns in perhaps East Peoria and Decatur, but they were like one week at a time and maybe two different times, and those were not part of the non-recurring adjustment that we had in the fourth quarter of last year.

All of that was related to our U.K. facilities and some of it to early retirement offers for engine people.

Engine division people.

So I don't recall that there's any other -- Robert McCarthy: Okay, you didn't address Waco.

Is that suspension indefinite or --?

Jim Anderson: Waco is a temporary suspension, until market conditions improve to the point where we need that facility to produce articulated trucks for sale in North America.

I will say that frankly, there are 12 people employed at Waco, so that is not -- not a huge dollar amount.

Okay.

And won't be again -- there won't be any non-recurring special kind of provisions for these things in the fourth quarter.

Okay.

I understand.

Thank you.

My other question, goes to cost structure, if you will.

In two pieces.

First, given the sales comparison, compared with last year, and your update not just from this quarter, past quarters on the progress with SicSigma, I'm surprised to not see operating expenses down -- combination of SG&A and R&D down more significantly than the $11 million you indicated excluding the impact of currency.

Could you -- my question there is, could you talk about what is creating upward pressure on those numbers that might be offsetting some of what you're gaining through SicSigma?

The related piece is your release speaks to the inefficiencies created in the engine business by rapidly ramping up and down.

Can we put any kind of bread box on that?

I mean, would a point or two of margin in the segment be an excessive estimate towards impact?

Let me take the latter part of your question here first.

I can't really give you a specific number, other than to say that the inefficiencies were in fact one of the major components of the deterioration in operating profit.

Along with the volume piece of it, the two big items.

So in terms of saying specific that -- specifically that it was 1 percent or 2 percent, no, I can't give you that specific number, other than again to say that it was significant.

Okay.

And just to make sure I understand what you're saying, you're saying it's a significant proportion of the dollar decline, compared with prior year in the segment?

Correct.

Robert McCarthy: Okay.

Robert McCarthy: Go ahead.

Okay.

Then the first part of your question, you're really wondering why are SG&A and R&D was not down more than what it was?

Robert McCarthy: Yes.

And what is causing the pressure?

Robert McCarthy: Right.

I think there are two key factors there.

Number one, has been acquisitions have added some additional costs to that over the last year.

And number two, the money that we are continuing to spend, particularly in the R&D area on our new technologies, especially the Assert technology, so those are two key things that have caused that to be not down any more than what it is.

Does that also mean that there's some Assert driven expenses that are reflected in the SG&A line? -- R&D looks good.

It's more SG&A that didn't come down.

Yeah, and a couple other things in there too.

The pension and owe pep expense obviously gets allocated to the various components of our income statement, whether it be R&D or cost or SG&A.

So that's having an influence in there.

As well as the normal merit increases that were given to employees earlier this year.

So it's those things that are causing the upward pressure, being offset by the SicSigma benefits and the other cost reduction kinds of activities that are going on.

And a lot of that from an SG&A standpoint, in terms of what is being incurred, is really again being incurred for the benefit of the future as well.

Marketing programs for new products, new geographic areas and that type of thing.

Okay.

Thank you, Jim.

That's helpful.

All right, Rob.

We probably have time for just one more question.

Jen, can you go one more?

Yes.

Our next question comes from John McGenthy.

Please state your affiliation then pose your question.

Credit First Boston.

Just got lucky on that one, Jim.

First question is pricing.

You talk about machine sales being down six percent visible volume down two percent in sales.

Which implies four percent combination of price increase and currency.

Could you talk about where you actually got price increase, how much of it was price and how much was currency, because you also said net impact of currency was also a penny a share.

So could you expand on that?

The net impact is a penny a share, John.

And that's the effect of everything.

Sales, costs, and the other income.

And expense category.

But on sales itself, currency is far and away the biggest factor there.

And then the price increases really were as much as anything currency-related in the European area.

So if that -- even though there's a higher volume that really shouldn't since costs go up as much, shouldn't have that much positive benefit in terms of margins, yet you said it was one of major reasons why profitability was up even though sales were down.

So I'm a little confused.

Well, costs were not up as high as the negative effect on costs were not as great as the positive effect on sales, and then in addition to that, you had the impact of better price realization.

Could you say price realizations were one percent or two percent, not currency but just pure price.

Jim Anderson: It's less than one percent.

Okay.

And then the other thing I'm surprised you didn't mention and maybe doesn't mean anything, but the article in the Peoria Journal Star about the $100 million cost reduction that you came up with that said you have to get $100 million out of cost, about 20 cents a share, this was in October 4th, article in the paper. $100 million out of costs by the 4th quarter.

A, is the article accurate?

Did you levy a cost reduction on everybody and if so, are you taking -- is any of this just deferring or borrowing from next year or could you talk to that?

Well, the reason I didn't mention that, John, is because I figured you were the only person on the call that ever read that article in the Peoria Journal Star.

But realistically, the article was generally accurate.

We have in place a $100 million reduction and we've had it from the beginning of the year, and as we went into the -- so that was not new news.

This -- that $100 million was in your numbers, all along?

It was.

But then additionally, we have been communicating internally and that's where the Journal Star picked some of that information up from our internal communications, because of the economies around the world not doing what we thought they would do in the second half of the year, we were putting a lot more emphasis on additional cost reduction.

And so the Journal Star article picked up some of these internal communications and kind of wrapped a story around that, but I would say it this way: We had in place the $100 million reduction from our business plan with all business units from the beginning of the year, and then we put additional emphasis on additional cost reduction in the fourth quarter because of the economy not responding the way we thought it was going to respond.

Can you quantify how much you have asked for in the additional cost reduction?

Not specifically.

But it is a sizable number, again, because what is happening from a sales standpoint.

We're not getting the kind of sales that we had expected in the second half of the year.

So we're -- in order to meet our business plan, we're putting more emphasis on the cost side.

Great.

Thank you very much.

Okay, John.

Is there just one more call left?

Jen?

A couple more questions in the cue but do you want me to take the next person in the cue?

Take one more, and then that's it.

And I have to wrap up.

Just one moment.

Our next question comes from Carl Meganthaller.

Please state your affiliation then pose your question.

Hi.

Good morning.

It's Carl Meganthaller, Bank of America Securities.

Hi, Carl.

Can you help me understand how I should be thinking about working capital for modeling purposes next year?

I have, how close are you to your working capital targets and do you still expect that to be a source of cash going forward?

And then secondly, where are you on share buybacks?

Should we expect shares to go down, looking forward?

On working capital, yes.

We do expect that to be a source of cash going forward, particularly as we -- I mentioned we have a lot of emphasis on inventory right now, and on SicSigma teams working on that.

So we expect that to be a source of cash going forward, as inventory and some of the other components of working capital turn around for us.

Second part of your question was related to what, Carl?

Quickly on share buybacks.

Share buybacks.

I'm sorry.

Obviously, we have not been buying shares back this year.

That's a direct function of our profitability, and our cash flow.

I think many of you have heard us say before that our priorities for cash flow are to fund the ongoing -- ongoing growth of the business, pay dividends, and then lastly use our residual cash to buy back shares.

There hasn't been significant residual cash, so this year we have not bought back any shares.

Going forward, we fully expect as profitability and cash flow improves, that we're going to be back on track buying shares back, in accordance with the current plan that we're operating under, which is to take our shares down to $320 million, that we instituted a couple years -- about three years ago, after we completed the first plan, which was about $45 million shares or so.

So we expect to be back on track on that as profitability and cash flow improve.

Thank you very much.

Okay, Carl.

Jen, that's the last one, then.

Okay, sir.

Do you have any closing comments you'd like to make?

Just thank everyone for their interest in Caterpillar.

And if you didn't get your questions answered, please give me a call, and I'll respond individually to you.

Thank you again for your interest in Caterpillar.

Good-bye.

Thank you, ladies and gentlemen.

This does conclude today's teleconference you may disconnect your lines at this time.

And have a great day.