開拓重工 (CAT) 2002 Q4 法說會逐字稿

Good morning, ladies and gentlemen and welcome to Caterpillar's fourth quarter 2002 earnings results conference call.

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

It is now my pleasure to turn the floor over to your host, Mr. Jim Anderson.

Sir, you may begin.

Thank you, Jen.

Well, good morning and welcome to Caterpillar's fourth quarter 2002 results conference call.

As Jen said, I'm Jim Anderson, Director of investor relations.

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

Also with us is Nancy Snowdon, who will become the Direct for Investor Relations.

I think most of you are aware that I am retiring, and this will be my last conference call.

I'm be around for a few more days to help Nancy with your follow-up calls.

I want to thank those of you who have expressed your kind thoughts to me on my retirement.

It has sincerely been a rewarding and an enjoyable four years in this position.

This conference call is copyrighted by Caterpillar Inc..

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

If you would like a printed version of my prepared conference call remarks, you can go to the S.E.C. filings in the investor section of our website since the prepared remarks are filed as an 8 K.

This morning I'll cover our fourth quarter results, review our outlook, go over the usual dealer retail numbers, discuss two special topics, and 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.

One last comment before getting into the results.

You probably know first in our press release today that we have begun providing more detailed explanatory information.

We also changed the format of the financial statements and eliminated the use of ranges in the dealer retail numbers.

We been contemplating these changes in light of the financial reporting and oversight concerns surrounding corporate America and decided to make the changes this quarter.

Caterpillar has always had an outstanding reputation for integrity in everything we do.

These changes reflect another step that we have taken as a leader in corporate governance to provide additional information to our shareholders.

Let's start now with the 4th quarter results.

As you know, this morning we reported fourth quarter sales and revenues of $5.38 billion and profit per share of 88 cents.

For the year sales and revenues were $20.15 billion and profit per share was $2.30.

Sales and revenues were up $280 million from fourth quarter 2001, mainly due to improved price realization of $180 million, about half of which was due to the favorable impact of currency.

Higher sales volume and a 4% increase in revenues of the financial products division accounted for the balance of the increase.

Excluding the effects of currency, worldwide machine and engine price realization was nearly 2% positive for the fourth quarter and about seven-tenths of a percent for the full year compared with 2001.

The fourth quarter price realization impact was mostly attributable to better truck engine pricing and price increases in Europe, Africa, Middle East and North America.

Profit per share was 88 cents per share for the fourth quarter, up from fourth quarter 2001 profit per share of 76 cents, which excludes the unusual charge recorded in 4 Q '01 of $97 million after tax for the sale of our agricultural equipment business and announced personnel reductions.

Excluding this unusual charge, profit increased as a result of higher price realization excluding currency of $90 million pretax and a reduction in SG&A and R&D expenses of $86 million pretax.

These favorable items were partly offset by continuing manufacturing inefficiencies related to volume changes at most U.S. engine manufacturing facilities.

The net impact of currency was positive 6 cents per share for the quarter.

The full year impact was a positive 21 cents per share.

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.

As a matter of interest, no longer amortizing goodwill had a favorable impact on fourth quarter results of $21 million on a pretax basis and $85 million for the full year.

The combination of pension and OpEx expense had an unfavorable pretax impact of $12 million on fourth quarter results and $93 million on full year results.

Further regarding pensions, we made a voluntary contribution of $40 million to the U.S. defined benefit plans in the fourth quarter.

We also contributed $90 million to these plans in the third quarter.

However, as noted in today's release, based on November 30 plan asset values, we were required to increase the additional minimum liability by $892 million in the fourth quarter.

This resulted in a decrease of $610 million after tax in accumulated other comprehensive income, which is a component of shareholders' equity in the financial position.

These amounts decreased from those estimated in the third quarter as a result of an improvement in the equity markets and our cash contributions.

Net free cash flow improved $645 million in 2002 compared with last year mainly as a result of managing capital expenditures and inventory down.

Over 100 6 Sigma projects were focused on improved inventory management in 2002.

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 basis is continuing to run at a very strong rate, about 65%, which is unchanged from a year ago.

Rental rates for the rolling 12 months through December are unchanged from a year ago but continue to remain under pressure.

Overall units in dedicated dealer rental fleets are down 2% from a year ago.

Dedicated dealer rental fleets consist of units in rent-to-rent fleets and in Cat rental storms.

Rent-to-rent units, which currently make up 57% of the units in the dealer rental fleets, are down 7% from a year ago.

The Cat rental stores which generally rent smaller machines for shorter time periods currently have 43% of the rental units in dealer fleets.

These fleets continue to grow and are up 6% from a year ago.

North American dealers added 28 rental stores in 2002 for a total of 373 stores at year-end.

About 15 more are expected in 2003.

In the Europe-Africa-Middle East region dealers have 720 rental outlets, 191 of which were converted to the Cat rental store identity at year-end 2002.

In Latin America we had 93 stores and 21 in Asia-Pacific.

At year-end 2003 we are expecting about 1280 rental outlets throughout the world.

Of these all stores in North American America and about 480 in the rest of the world will have the Cat rental store identity.

North American used equipment prices trended down about 5% in the third quarter compared to a year ago for most machines.

We expect continued weakness in early 2003.

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

Now let's move to the outlook.

Worldwide economic and geopolitical uncertainties remain at relatively elevated levels in the early weeks of 2003.

We expect this will dampen the economic recovery in the first half of 2003.

But growth is expected to accelerate in the second half, leading to worldwide growth of about 3% for the year as a whole.

In this environment industry opportunity is expected to be about the same as 2002.

Company sales and revenues are also expected to be about the same as 2002.

We anticipate improved operational results will offset most of the $300 million, or approximately 60 cents per share of higher post-retirement costs.

Therefore, despite these increased costs, profit should be down only about 5% compared to 2002.

Full details of the outlook for 2003, including other assumptions, are contained in the company's press release issued today.

Guidance with respect to selected items for machinery and engines in 2003 is as follows: for SG&A expense, between 11.50 and 12% of sales and between 3.5 and 4% of sales for R&D expense.

Those two items were 11.7% and 3.5% of sales respectively in 2002.

Overall any spending increases will be more than offset by cost reduction in 2003 as the benefits of continue to accelerate.

The 2003 estimated annual tax rate is 28%, the same as for 2002.

The estimated impact in 2003 from the SFAS 142 change to no longer amortize goodwill is an increase in pretax profit of $85 million, the same as 2002.

Therefore, we will no longer need to discuss this item in 2003.

As I indicated, the estimated impact of increased pension and post-retirement benefit costs is a decrease in profit per share of about 60 cents in 2003.

About 90% of this cost increase is for pensions.

For 2003 our pension gentleman contribution for the long-term rate of return is 9% and 7% for the discount factor.

Capital expenditures for machinery and engines are expected to be about $800 million in 2003 compared with $693 million in 2002.

For depreciation and amortization expense, expectations are about $800 million, which is about $35 million lower than 2002.

Average retail price increases that have been announced for 2003 are about two to two and one-half percent for machines and parts.

Heavy duty truck engine industry prices increased in the 3,000 to 5,000 range.

And we will be at the top end of that range.

Excluding truck engines, the average engine retail price increase will be less than one-half percent.

Again, these are average price increases since the actual price change will vary by model and graphic region.

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

Again, please remember that all comparisons are based on constant dollars.

Dealer retail sales of machines on to end uses for the three months ending December 2002 compared with the same three months of 2001 were as follows: Asia-Pacific flat.

Europe-Africa-Middle East down 1%.

Latin America down 29%.

Subtotal of those three regions down 6%.

North America down 3%.

And worldwide down 4%.

For the full year total worldwide dealer machine sales to end users were down 8%.

However, the month of December was the second highest month of the year for dealer retail machine sales.

For the three months ending December 2002 compared with the same three months of 2001, total reciprocating and turbine engine sales to users and OEMs were as follows: electric power up 3%.

Industrial engines up 6%.

Marine engines down 11%.

Truck and bus engines up 3%.

Petroleum down 15%.

And total engines down 4%.

Now let's turn to dealer machine inventories.

First sequentially comparing December with November 2002: Asia-Pacific up 16%.

Europe-Africa-Middle East down 22%.

Latin America down 10%.

Subtotal of those three regions down 11% -- three regions down 11%.

North America up 2%.

And the world as a whole down 5%.

Next year-over-year comparing December 2002 with December 2001: Asia-Pacific up 9%.

Europe-Africa-Middle East up 4%.

Latin America down 20%.

Subtotal up 1%.

North America up 6%.

And the world as a whole up 3%.

Dealer inventories of new machines at year-end compared with 2001 year-end were up on a worldwide basis about $70 million, most of which occurred in north America.

Although dealer machine inventories did not decrease as we had expected in 2002, they are about $1.5 billion below their peak in 1999 and continue to be at historically low levels.

A increase in retail demand should translate to increased sales by caterpillar.

Our expectation for full year 2003 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 3.2 months of sales, which is down from 3.3 months a year ago.

Europe-Africa-Middle East dealers are at 3.3 months of sales, down from 3.4 months a year ago.

Dealer new machine inventories in Latin America are at 3.5 months, down from 3.8 months a year ago.

Dealer new machine inventories for the subtotal of these three regions outside North America are at 3.3 months of sales, which is down from 3.5 months a year ago.

North American Diemer machine inventories are at 3.4 months of sales, down from 3.5 months a year ago.

Overall on a worldwide basis dealer machine inventories are at 3.4 months of sales, down from 3.5 months a year ago.

These retail statistics for December are also available on voice mail through February 17 by calling 309-675-8000.

Now I'll comment on two special topics.

First is an update on 6 Sigma activities. 6 Sigma results have exceeded our expectations and contributed in excess of $500 million in benefits, the majority of which drastically impacted the bottom line.

In 2002 we completed nearly three times as many projects as in 2001.

More than 15,000 employees are involved in various roles as 6 Sigma project sponsors, black belts, green belts, team members and subject matter experts.

More than 40 dealers and 100 suppliers are in the process of deploying 6 Sigma for their businesses.

Secondly, I normally provide an update on our engine business, but with the additional information we are providing in our release, that is no longer needed.

So, I'll just give you a brief update on our advanced combustion emissions reduction technology.

The big news is last week's EPA certification for our C-9 ACERT engine that we are now shipping to OEMs.

The ACERT program remains right on the schedule we have been discussing throughout 2002 for medium duty engine launch in first quarter 2003 and heavy duty launch in the second quarter.

By fourth quarter 2003 all Caterpillar on-highway truck and bus engines produced will be ACERT engines.

Over 100 field test engines are operating and emission targets have been achieved.

Cat has begun supplying ACERT engines for chassis engineering work at OEMs.

A number of OEMs will have ACERT engines in their trucks at the Mid-America truck show in Louisville in March.

Market acceptance of our bridge engines has been strong.

The unfavorable impact of nonconformance penalties for our bridge engines during the fourth quarter net of price increases was about 5 cents per share.

We expect the net unfavorable impact on 2003 to be no more than the 2002 impact.

Another major development for us is that off-highway customers are gaining their first experience with ACERT engines as we've recently begun Cat machine field testings.

These engines will be a derivative of the on-highway engines.

The off-highway engines must meet tier 3 emissions regulations in 2005 and European noise direct initiatives 2006.

We've tailored the ACERT technology to meet those requirements and offer superior customer value in very demanding off-highway applications.

ACERT will provide a technology platform for our engines through the end of the decade.

We have research and development programs directed towards meeting 2007 and 2010 diesel emissions regulations.

The anticipated 2010 emissions requirement will represent a 98% reduction in emissions relative to consent decree requirements effective in October 2002.

As we've said before, this technology will provide us with a significant competitive advantage well into the future.

Okay, Jen.

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

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

First question, please, Jen.

Thank you.

Ladies and gentlemen, the floor is now open for questions.

If you have any questions or comments, please press the numbers 1 followed by 4 on your touch tone phone at this time.

Pressing 1, 4 a second time will remove you from the queue should your question be answered.

Lastly, we do ask while posing your question that you do pick up your handset if listening on speakerphone for optimum sounds quality.

Please hold while we poll for questions.

Thank you.

Our first question is coming from Anne Deignan.

Please state your affiliation and then pose your question.

It's Anne Deignan from Sanford Bernstein.

My question revolves around the petroleum sector.

Can you explain to us what exactly is going on in that sector, both from a turbine engine standpoint and a reciprocating engine standpoint?

And in particular in light of Schlumberger's announcement yesterday that they were going to further cut capex going into '03 by about 30%.

Just knowing what an important customer Schlumberger is to you in that space, will this have further ramifications for caterpillar in '03?

And can you explain just, you know, what your outlook is for that space?

Sure.

In terms of 2002, basically the turbine engine business has been extremely strong this year, most of which has been outside of North America.

Within North America, which is predominantly served by our reciprocating engine business, that has been especially weak in 2002.

Now, as we move into 2003, obviously the impacts of the worldwide economy and the confidence that consumers and our customers have is expected to have an influence on this.

We are expecting given the oil prices where they are that demand in the petroleum sector will pick up just a little bit in 2003.

All of the things are in place for improved sales there, but it's still this economy and confidence issue that is holding it back.

So, you don't see Schlumberger's reduction in capital expenditures for '03 to be a signal for what's going to happen in that space?

We don't think so.

Now, I mean, obviously, doing what they're doing is perhaps going to have some impact on sales because, as you said, they are a major customer of ours.

But we think the environment that's there in the petroleum market will be sufficient that certainly as we move towards the middle of the year and beyond will generate more capital spending in the industry as a whole.

That's our outlook for petroleum next year.

Okay.

Thanks, Jim.

I'll get back in line.

All right, Anne.

Thank you.

Our next question is coming from David Raso.

Please state your affiliation, then pose your question.

Salomon Smith Barney.

Hi, Jim.

I had a question on the '03 guidance regarding if we stripped out the pension, the health care, it implies roughly 279, 279 EPS from the 230 base on flat sales.

Correct.

Can you help us understand, I assume there must be some mixed issues there?

And also give us some help on the 6 Sigma?

If everything was flat it would probably take north of 250 million of 6 Sigma on flat sales unless there's a material mix issue.

Can you help us with that?

Yeah.

It is predominantly, as we indicated in the release, improvements in our operations.

And 6 Sigma is a substantial part of that.

Given flat sales, typically we would not see -- in the past, historically we would not see profit improvement at caterpillar.

And in fact, you go back a few years with flat sales, we generally would have had a decrease in profitability.

How, this now with 6 Sigma in place and with the things that we are doing from an operations' standpoint, we would have had, as you indicated, somewhere in that range of 275 to 280 in our outlook for 2003 excluding the impacts of those pension and OpEx costs.

And that truly comes from the operating improvements and the 6 Sigma benefits that will continue to accelerate in 2003.

How about the mix issue, though, too?

Is there a little color you can provide on that?

You already gave a little color on oil and gas.

There really isn't a significant mix issue compared to 2002.

You know, across the board in engines or machines we would anticipate mix to be pretty much the same as it has been this year.

So, it truly is all just cost savings, and that's implying you need cost savings roughly about half of what you put up already on 6 Sigma?

Just working through the numbers, you put flat sales, whatever your assumptions are in interest finance will have an impact, but roughly it's needing about 250-plus of cost savings?

I'm not saying if it is do-able or not.

I'm just asking am I looking at if the right way?

You are looking at it the right way, except recall that I said the 6 Sigma benefits were about $500 million this year, the majority of which, meaning more than half, went directly to the bottom line.

So, we are getting other benefits through 6 Sigma through cost avoidance and things of that nature.

But more than half of that went to the bottom line.

And we would expect that to accelerate next year, that's correct.

Thank you much.

Okay, Dave.

Thank you.

Our next question is coming from Alexander Blanton.

Please state your affiliation, then pose your question.

Hi, Jim.

Ingalls and Snyder.

On the question of the 300 million of costs, what could change that as the year goes on?

I mean, are there things that could happen in the -- in the financial markets that might change that number?

No.

Nothing in the financial markets that would change that number because that number is set by our actuaries with us and our outside accountants at the beginning of the year in terms of what that's going to be and the assumptions and so forth, and then it doesn't change.

What could change, Alex, as we go throughout the year, obviously, is the return on the plan assets could obviously get better if the markets were to turn around.

But in terms of that specific number, that won't change for 2003.

The only thing that could change might be on the medical side if you made changes in the plan.

Okay.

And secondly, could you give us an idea, Jim, of what kind of quarterly pattern you expect?

I mean, last year the first quarter was very weak.

Things -- earnings about doubled sequentially in the second and third quarter, more than doubled, and then you had a very strong fourth quarter.

What should we look for this year in the quarterly pattern?

Well, you may recall, Alex, a couple of years ago we made the decision that we were not going to give quarterly guidance.

Now, what I can say, based on our economic outlook, obviously from a macroeconomic standpoint we expect the second half to accelerate a little bit around the world.

So, the only thing I could say is I would not expect it in 2003 to be much different from our historical pattern or even what we saw in 2002.

Okay.

Thanks, Jim.

Okay, Alex.

Thank you.

Our next question is coming from Andrew Casey.

Please state your affiliation, then pose your question.

Prudential Securities.

Good morning, Jim.

Hi, Andy.

I guess a follow-up on Alex's question.

In terms of North American machines, given all the uncertainty that you talked about in the press release, you know, kind of a federal and then the implied state level, and then given that you have kind of more difficult comparisons in terms of what the dealers did for their inventory levels, is it kind of a correct read to think that 1 Q '03 might be more of a difficult quarter than 4Q for North American machines?

Well, again, as I just said, Andy, yeah, I think that's reasonable because that's kind of the pattern we had in 2002.

And again our expectations are for a stronger half of '03 compared to the first half.

So, yeah, I think weaker first half than second half.

Okay.

Again, I'm trying to very much avoid giving you any specific guidance on the quarters, which we don't want to do.

Sure.

Kind of if we could phase it a different way, you have the uncertainty in front of you.

Are you seeing a change in the buying behavior of your end market customers in the U.S. in terms of moving from outright purchases to more of your revenue mix from machines going to more of the long-term lease with option to buy?

No, we have not seen that.

Okay.

Thanks, Jim.

Good luck, Andy.

Thank you.

Our next question is coming from Barry Banister.

Please state your affiliation, then pose your question.

Good morning.

Hi, Barry.

Just to follow-up on this issue of the guidance, if you start from a base of 1.1 billion for machinery and engine operating income and you've got a 300 million hit from pension and OpEx, and your price increases, and I missed what you said about the geographic scope, but it seems to me the applies increases pretty much offset all of the OpEx and the medical.

Then with 6 Sigma kicking in and seal what seeing what it did to the delta on your free cash flow, I don't believe it's not going to continue.

It's hard to see your earnings being down.

You didn't give Salomon any reason to believe there was a mix issue.

So, with the conservative guidance given the sales projection being flat?

Well, the conservative guidance, I'm not sure I would characterize it exactly that way, Barry.

As I indicated, with flat sales and with this, as you indicated, this $300 million dollar cost increase, we are in fact offsetting most all of that increase through the things that I mentioned, 6 Sigma and other things.

And there are no significant mix issues out there, but we are continuing.

I indicated we're increasing our capital expenditures a little bit this year.

So, we are continuing to work on those things that are going to generate some benefit for us in the future.

But nothing that's having any significant impact.

So, it really is just that $300 million in pension and OpEx expenses that's causing it to be where it is in our forecast.

When you talk about flat sales, though, could you give us an update on the dealer's destocking trends on a full year '02 basis, and also what sort of potential there is in 'O3 since you do have a fairly conservative O 3 forecast for the end markets?

Well, in terms of dealer inventory reductions?

Yes.

Yeah, they took down machine inventories in '02 about $70 million on a worldwide -- I'm sorry -- went up about $70 million in '02.

And our expectation is for '03 to be down about $100 million.

Okay.

That helps.

Thanks.

That's a piece of what you're looking for there in the sense that sales -- retail sales, could be a little bit higher than our shipments to dealers.

That helps.

Thanks.

Thank you.

Our next question is coming from Gary McManus.

Please state your affiliation, then pose your question.

J. P. Morgan.

Hi, Jim.

Hi, Gary.

How are you?

Okay.

With the 300 million increase in the pension and other benefit costs, what would it have been if you didn't change -- I assume you changed the assumptions on the returns and the discount rate.

I'm not sure if you changed assumptions on, like, healthcare inflation.

But what would the increase be if you didn't change any of the assumptions?

Gary, I don't have an answer to that.

All I hoe is what it is based on the assumptions that we've used.

So, I don't know that our actuaries or anybody internally even did that.

Okay.

But you don't even have a sense on how big a factor was changing the assumptions on that increase?

You can't even --

Well, I guess, what I've been saying before, if you look at our plan assets of about 6.5 billion dollars, somewhere around there, I don't know the exact number, but somewhere in that range, and adjust the change in the return, the long-term rate of return times that number will give you some indication.

Right.

But that's not a complete answer because you also changed the discount rate.

Again, did you change the healthcare inflation rate?

No, we did not.

Okay.

And secondly, you know, in your outlook you have Europe growing faster, or your sales in Europe for '03 up 4%, Asia 2%.

That seems to me to be a little bit kind of not obvious on why you expect Europe to be faster growth than Asia.

Can you just explain that?

Well, I think we're looking at a little better recovery in Europe and Africa-Middle East because we had growth in Asia-Pacific through most of this year.

It was, in fact, the only region of the wormed that really had much growth in it throughout 2002.

So, I think it's more a matter of Asia-Pacific was kind of preceding what we're expecting in Europe for next year.

All right.

Thanks.

Thank you.

Our next question is coming from Joel Tiff.

Please state your affiliation, then pose your question.

Lehman Brothers.

How are you doing, guys?

Two things: one, you talked about strong cash flow generation.

But when I looked through the balance sheet you provided us, your manufacturing debt is basically flat.

I wonder if you could square where did that free cash flow go?

I'll let Lynn respond to that one.

Hi, Joel.

Your observation is correct, the debt that we have on the manufacturing books -- first of all, we had very little short-term debt going into the end of the year, and the long-term debt that we have is basically not economical to buy back in.

So, at the end of the year we did some intercompany lending to Cat financial to supplement some of their borrowing requirements so they didn't have to go to the market.

Okay.

And then another question.

Can you give us a little bit of an outlook on the electric power gen business?

It seems like that's gotten cut in half in the last two or three years, and it does than seem obvious the rate of decline is going to stay at the same rate.

We should see some flattening maybe.

Yes.

For '03 we're expecting that business to actually start improving a little bit as we move towards the middle of the year, and certainly in the second half growing so that we will have a moderately small increase.

Our expectation is that we will have a relatively small increase in that sector in 2003 with continued expansion moving forward into 2004.

You know, we've had a long-term growth target there somewhere in the range of 20% growth, which we had or have had for three or four years now.

And there's no question that that is too high, but we still think it's going to be significantly into the double digits in terms of the long-term growth in that business.

Much of it is going to depend on what happens with the economies around the world and how quickly business confidence starts coming back.

And as that does, it's going to directly impact this business.

But we are looking at growth this year and significant growth beyond this year, but not quite up to that 20% level.

Okay.

Thank you.

All right, Joel.

Thank you.

Our next question is coming from John McGinty.

Please state your affiliation, then pose your question.

Credit Suisse First Boston.

Good morning, Jim.

Hi, John.

First question, I'm impressed, surprised that your price increase that you got in the fourth quarter excluding currency was, I think, 2% positive for the fourth quarter and .7 for the year, because the .7, less than 1% ex-currencies that you have been running.

How much of that 2% in the fourth quarter was what you raised the truck engines prices, you know, to offset the penalty?

Roughly half of that increase, John, was for truck engines.

Okay.

Then the other, the 1% was more or less kind of in line with what you had been running?

In line with what we had been running throughout the year on the rest of it, yes.

Okay.

And the 2 to 2.5% price increase, I think that was your -- is that the right number, the January 2nd on machines?

Machines and parts.

Machines and parts.

That is a worlds wide price increase, right?

That's a worldwide average price increase, yes.

And a couple of your competitors have already followed that.

You know, that's much higher than what you have gotten.

Are you -- I mean, what's the initial read on that?

On what our competitors are doing?

No, on whether or not you guys think you're going to get the -- I mean, because that's a fair chunk of price increase, a fairly healthy number.

And I mean, you know, it's certainly higher than you've raised price in the last three or four years in January.

Yes.

And our initial read, if you will, or what we're seeing so far in the market is that those are generally sticking.

Okay.

And then as the follow-up to that, and I'm not trying to be too picky, but if I read your outlook statement, you say in North America industry sales are going to be flat and industry demands for engines would be down 5%.

So, if you do a waited on that, that would be down 1 or 2%.

You're forecasting North American sales to be down 3%.

Are you assuming you're going to lose pens?

You had record pens last year across the United States.

Do you just think you can't hold that?

Or is there some trade-off of lower pens for higher prices?

Could you just talk to that issue?

I think probably the single biggest issue in is our expectations for truck engines in 2003.

The industry was considerably higher than we thought it would be going into 2002.

I think the heavy duty industry ended up somewhere in the range of about 165,000.

Rights.

At this point we are looking at a substantial drop off in that industry in 2004.

So, that's --

In '03, you mean.

I'm sorry.

In '03, yeah.

So, that's probably the single biggest factor, John.

So, you're not expecting -- in machines and non-truck engines, you're not expecting a pens deterioration?

Well, you know we don't talk about pins, anyway, so I really can't comment on that.

Thanks very much.

Our next question is coming from Mark Kazmerek.

Please state your affiliation, then pose your question.

Midwest Research.

Hi, Mark.

Hey, Jim.

Hey, can you help me out a little bit with this outlook because I'm struggling with reconciling the performance this year with the 2003 outlook.

And that is I observed that on a very modest decline in sales, you know, 1%, operating income is down, you know, approximately 250 million.

And that's after you just told us that 6 Sigma generated 500 million of savings.

So, I'm calculating, you know, very naively that there was some sort of extra expense of 750 million, you know, that is probably pricing or, you know, inefficiencies.

So, I imagine that most of that is still in place next year.

And then you have this extra 300 on top of that.

I don't see how we get -- you know, that's a big hole to dig out of.

And so, I'm having a hard time seeing how 6 Sigma alone can generate that level of savings in '03.

Well, yeah.

A good question, Mark.

But it is not 6 Sigma alone.

We've kind of put all of these activities that we have going on from an operating perspective under the umbrella of 6 Sigma, including material cost decreases, which will continue on next year, and then further acceleration of the 6 Sigma benefits beyond even what we got in 2002.

So, it's really, given the kind of economic environment that we're facing around the world and flat sales, basically, as we indicated.

It's really much more of a focus on the operations side of the business to really keep costs under control and reduce costs going forward so that we can, in fact, deliver at least some sort of a reasonable level of profitability on the kind of sales that we're seeing based on the economic environments.

That's the key thing, is really the focus on the cost side.

And it's not -- you can't just take 250 million, for example, and say that will be the benefit of 6 Sigma next year.

It's probably going to accelerate beyond what we achieved this year and be even higher next year.

I can't give you a specific number on that, but that's certainly our expectation.

And we are getting a little bit of price increase benefit going forward in the next year.

I guess -- you know, talking about 2002, our gross margin was down -- percentage was down in '02 about 1.5% or so.

And that is a reflection of the mix and selling price in '02.

So, the implication is that this 0.7% net price increase last year, you really do expect to keep this 2% increase or the vast majority of it?

That is our expectation, yes, Mark.

Okay.

Thanks very much.

Thank you.

Our next question is coming from Michael Harris.

Please state your affiliation, then pose your question.

Deutsche Bank.

Good morning, Jim.

Hi, Mike.

At one time I recall you spending about having a goal to get your shares outstanding to that 320, maybe 325 million level.

Can you give us an idea of where you are and if that's still a goal?

Yes, that -- maybe just to give you a bit of background on that.

Back in '95 we initiated our first share buyback room and bought back somewhere in the range of 45 million shares, which was completed by '98.

Then we -- our board authorized another one at the ends of '98, and that's the one we're in right now, to take the shares from about 360, which is where they were at that time, or a little over 360 million shares, down to the 320 million.

Now, obviously what has happened in terms of the market and our profitability over the last year and a half or two years has had a significant influence on that, in that we've used cash flow for operating needs rather than buying back shares.

So, we really have not purchased any shares under that program for the last year or so.

But the program is still there.

As our profit ability and cash flow improves, we will resume buying back those shares with that 320 million target still in place.

And there's no time limit on that, right?

Well, when the board established it originally, there was a five-year time limit, or a five-year program, if you will.

But at that time obviously nobody foresaw the profit levels that we've experienced here the last couple of years.

So, you know, to say that there is no time limit, yeah, there is, but we obviously will not achieve it by the end of this year.

So, I'm sure -- I can't speak for the board, but it will continue on.

Okay.

Thanks, Jim.

All right.

Thank you.

Our next question is coming from Robert McCarthy.

Please state your affiliation, then pose your question.

Robert W. Baird.

Hi Jim, Nancy, Lynn.

Hi, Rob.

I want to ask you first about your outlook for North America in the coming year.

It includes what I thought was sort of a surprising statement, that you expect construction activity to be flat.

And I recognize imbedded in there you have expectations for federal stimulus and the explicit comment that it would more than offset pressure on state budgets.

But traditionally states have to generate matching funding to be able to qualify for the ability to spend federal funding, spend Federal funds.

In addition, you know, the housing market looks peaky and private nonresidential has been in pretty much of a freefall.

And to get to flat for overall construction activity, I guess -- I'm assuming that you're thinking residential won't come off very much and that because of the improved insurance environment, nonresidential activity would pick up by mid-year or something like that?

Can you help a little bit here?

Yeah, that's exactly right, Rob.

We are expecting that residential construction is going to continue at fairly strong levels about flat, and that we are going to see a pickup in the commercial side going forward into 2003 as, again, confidence gets a little better, economic growth improves, and some of these other stimulus packages, or stimulus items that very well could come into place this year.

Okay.

Let me -- all right.

So, I understood generally correctly.

I also want to ask you about dealer inventory levels.

You know, you're all very good about providing information about the estimated level of inventories relative to selling rates.

And of course, the numbers have been sort of stuck persistently above three months, reflecting a weak retail environment.

And this is balanced against, of course, your desire to push inventory levels down to more like a two-month level, a goal that you announced a few years ago.

So, can you help me understand where you think you're at relative to normal levels of retail demand?

In other words, where these inventory levels might be?

Because it seems like a $100 million reduction in dealer inventories in the coming year, it really doesn't sound like a whole lot of incremental progress towards that two-month level.

So, I'm confused.

Can you help?

Yeah.

Let me say it this way, Rob.

The target that we have is to be between the two and two and a half months of sales range. and cyclicly -- I'll say it this way: from a cyclical standpoint the number of months of sales and inventory always rises in the latter half, or the last few months of the year and maybe the first month or so of the new year just because sales projections and forecasts are lower at that point in time.

So, from a cyclical standpoint we should start seeing -- and I believe we've gotten as low as 2.4 months.

Right.

Right.

During that, say, march through July or August time frame.

And as demand -- I can't give you a specific answer as to what is normal, but as demand starts coming back, we will be back down we below 3 and approaching that 2.5 number without really having to take a lot more out of inventory because we're getting very close, within, like, another couple hundred million dollars of where we want to be in terms of absolute inventory dollars at the dealers.

And then the hope would be that you'd be able to keep those levels close to that level as retail demand came back?

Absolutely.

Okay.

All right.

Thanks.

Okay.

Thank you.

Our next question is coming from Joanna Shottney.

Please state your affiliation, then pose your question.

Goldman Sachs.

Good morning.

Hi, Joanna.

I'm just trying to think about what cushions you have in terms of cost reduction, and if we go back a couple of years, you guys were spending a big chunk on new product launches.

Can you just give us a feel for what the function is for a billion dollars of cost reduction?

Are we at the $500 million dollar run right now and we're going to get to the billion by '04?

And then, what kind of opportunity might there be in terms of either getting that R&D number to a lower level or some of the new product spends to go a lower level?

Is there any room on new product stuff?

Yeah.

Let me answer that in reverse order, Joanna.

R & D did drop off just a little bit as a percent of sales in 2002 as some of the ACERT spending started tailing off a little bit.

However, going forward it's not going to fall off completely because -- just talking ACERT right now, because we've got these 2007 and 2010 additional reductions that we'll be working on.

And so, I would say as a general rule we have historically spent in the 3.5 to 4% range on R&D and we will continue to spend 3.5 to 4% just from regulatory things, whether that be engines or otherwise, as well as new product development.

So, we would not expect to see much change in that.

Some years it might be closer to 3.5 and other years closer to 4, but it's generally going to be in that range.

In terms of the other part of your question as far as what we might expect from 6 Sigma and where we're headed, the billion dollar reduction is by the end of '04, yes.

And we believe we're pretty much on track there.

As I said, we got $500 million in benefits this year of which more than half went to the bottom line.

I think the combination of this year and next year's benefits, we're going to be there.

Let me ask it a different way.

I think it was Doug on the strategic conference call said with really high conviction level that $2.00 is the bottom.

What if volume is not the flattest scenario?

What if we do attack Iraq?

What if some of the assumptions behind the forecast fall apart, what kind of cushion is there?

Can we pull forward some of the 6 Sigma projects?

What kind of stuff can you do to offset that to make us have such confidence in the $2.00 number?

Well, repeating what Doug said, he did say that for with conviction, and that's been our goal and target for some time now.

And we've done that.

If in fact our outlook for the year ends up being substantially lower or the reality ends up being substantially lower than our outlook, we would start taking other actions to reduce other costs over and above the things that we have going on and probably start getting into more structural changes if that were the long-term outlook in terms of sales for us.

But you can do those things on a short-term basis from time to time, but as you start having to reduce structure in your costs, you can't react when the market comes back.

And that's part of the issue that we're trying to deal with right now, is what is that balancing point between taking out the costs that we can take out and yet keeping the ability there to react when the market turns around.

Okay.

I'm going to follow up on Cat here.

It sounds like you guys are really cautious on the first half, and you walked through some of the functions on knowledge you're cautious in the first half and what might happen in the second half.

But is the scenario in the second half so strong that we actually see any quarter with year-over-year growth?

Well, again, I really can't respond to that.

I don't want to get into giving any outlooks on the quarters.

I'm just trying to think, you know, how back end loaded is your outlook?

If we take that 3% overall, are we down a lot in the first half and then up significantly in the second half, or are we, you know, low single digit and then we ramp up to something 3 to 5 in the second half?

No, from a macroeconomic standpoint, I think our outlook in the first half of the year would be in the 2 to 2.5% growth range, and then a little above 3% in the second half of the year to get to that overall roughly 3% growth for the year.

Okay.

Great.

Thanks.

Thank you.

Our next question is coming from Steve Haggerty.

Please state your affiliation, then pose your question.

Merrill Lynch.

Good morning, Jim.

Hi, Steve.

When I look at your outlook for the regional industries and then when I look at the outlook for Cat in those industries, it seems as though with the exception of had EAME, you're expecting Cat's dollar performance to be equal to or less than the local industries.

Am I comparing those two numbers correctly, that you're not expecting to sort of gain share regionally on a dollar basis based on this outlook?

No, that's correct, because in generally speaking we talk about the industry and then our outlook is fairly much in line with that industry, yes.

And then just real quickly, on your cash flow, which was strong in the quarter, it looks like you took out your own inventories fairly significantly.

What was going on there in the fourth quarter.

Well, we had a, as I mentioned earlier, a lot of emphasis on inventory reduction in the second half of the year and had something in the neighborhood in excess of a hundred 6 Sigma projects around the company working very specifically on that, because that was something we recognized needed some work.

And we did that, and that was the primary driver for the change.

So, can we believe or expect that the changes we're seeing in the fourth quarter inventory, that that's a structural change and you'll be running at these lower inventories going for word and the impact on your cash flow should be sustained?

That is's our expectation, yes.

Our next question is coming from David Blustein.

Please state your affiliation, then pose your question.

UBS Warburg.

Jim, what were the price increases that you expect for engines in 2003?

I said excluding truck engines, everything else the average increase is less than one-half percent.

Okay.

I know both Barry and Mark have tried this, but given the two to two 1/2% percent increase in machine and parts prices, those increases alone should just about offset the higher pension and OpEx costs, right?

So, if in fact you're generating 250 dush plus million in cost savings from 6 Sigma gains on top of the benefit from prices in 2003, what are the offsetting cost increases that keep your earnings flat to down?

Well, we are going to continue having increases in the R&D and SG&A area, and we probably will have -- I think I indicated to Barry earlier that there probably wouldn't be much of a mix impact, but there could be a little mix impact on the machine side as there's a bit more of a shift towards smaller to mid-size machines.

But I will also tell you the two to two and a half percent are average prices around the world.

And as I think John McGinty pointed out, those are significantly higher than what we've done recently.

And there's probably not a lot of probability that all of that is going to fall through to the bottom line.

We are seeing at this point in time those prices are holding.

But whether they'll hold for the whole year is probably not likely.

All right.

So, that's another piece of it.

You can't take -- what I'm saying is you can't just take the two to two and a half percent and add that in and say, okay.

That offsets the 300 million, because in reality we're not going to -- in our outlook we do not assume that we're growing to get all of that price increase.

What do you assume in the outlook?

How much of it are we assuming?

Mm-hmm.

Some portion of it.

Most of it, but not all of it.

Okay, Jim.

Thanks a lot.

I can't give you the specific answer on that, Dave.

Fair enough.

Thank you.

All right.

Jen, we've probably got time for two more questions.

Your next question is coming from Robert Schanofsky.

Please state your affiliation followed by your question.

CIBC.

Good morning.

Just two quick questions.

One, I want to clarify on the price increase you've announced.

The global increase excludes all currency, correct?

That is correct.

That assumes currency is flat with where it was at the beginning of the year.

And then the second component, can you discuss any specific end markets or geographic regions where you think you'll have greater success in pricing than maybe some others?

Well, part of the reason for -- a big part of the reason for the price increases that we've seen flow through to the bottom line this year has really been currency-related.

They were put in place when the dollar was stronger.

And then as the dollar has weakened, obviously we've been able to hold those prices.

So, that's been a big piece of it.

So, my expectation would be going forward that it's probably going to be not unlike what we saw in '02.

And that would be predominantly in the Europe-Africa-Middle East region.

Again, as much as anything currency-related as well as on the truck engine side and a little bit in North America.

If I could, finally, just one thing.

Given that used product prices are coming down, are there any of your markets that you're concerned where you may actually begin to lose some price because of that differential?

We're not seeing that.

But yeah, that could be a problem if the economy obviously doesn't turn around as we're expecting and see the kind of growth that we're expecting and used equipment prices continue to fall, obviously that will put pressure on those prices of new products, yes.

Okay.

Thanks, Jim.

Thank you.

Our last question is coming from Ben Chernofsky.

Please state your affiliation then pose your question.

Good morning.

Raymond James, Limited.

Hi, Ben.

Hi.

Just a question, if you can add some further clarification for the outlook on your truck engine sales in North America.

Can you add any color as to how you see that breaking down between on-highway trucks and vocational off-highway trucks?

Well, generally speaking I can break it for you into the category of medium duty and heavy duty.

With the heavy duty being predominantly the on-highway long distance haulers.

That industry was, I think I mentioned, 165,000 in '02.

We are expecting a rather dramatic drop in that.

It could be as low as, in our view, on the very low ends maybe dropping to as much as a hundred thousand and on the upper end at this point given the uncertainties that are out there may be 130,000.

So, still a significant dropoff from that compared to '02.

Then on the medium duties, which more go in the buses and the vocational trucks, somewhere in the range of 135,000 units, industry again, which would be about flat with '02.

Okay.

Great.

Thanks very much.

Okay.

Very good.

Well, it's been a pleasure sharing our results with all of you this morning.

If you didn't get your questions asked, please call us.

And as I indicated, I'll be around for a few more days to help Nancy answer your questions.

So, thank you again for your interest in Caterpillar, and good-bye.

Thank you, ladies and gentlemen.

This does conclude today's teleconference.

You may disconnect your phone lines at this time.

And have a great day.