開拓重工 (CAT) 2003 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Caterpillar's second quarter 2003 earnings results conference call.

At this time all participants have been placed on 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, Nancy Snowden.

Ma'am, you may begin.

Thanks.

Good morning and welcome to Caterpillar's second quarter 2003 results conference call.

I'm Nancy Snowden, Director of Investor Relations.

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

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

This morning I'll go over our second 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 form 8-K filed with the Securities and Exchange Commission today.

Okay.

Let's start with the second quarter results.

As you know, this morning we reported second quarter sales and revenues of $5.93 billion, and profit of $399 million.

Sales and revenues for the first half of 2003 were $10.75 billion dollars and profit was $528 million.

Sales and revenues were up 12% from second quarter 2002, with machinery up $418 million and engines up $168 million.

The increase was primarily due to favorable currency impact of $221 million, higher machinery and engine volume of $213 million, and improved revenue yield of $107 million.

Revenue yield is the impact of net price changes excluding emissions price increases.

Revenues of financial products were up $55 million or about 15%, the favorable impact of approximately $48 million due to the continued growth of finance receivables and leases at CAT Financial were partially offset by the approximately $25 million impact of generally lower interest rates on existing finance receivables and new finance receivables.

Also, there was a $25 million increase in earned premiums on extended service contracts at CAT Insurance.

Profit was $199 million higher the second quarter of 2003 compared with second quarter of 2002, as a result of the favorable impact of improved revenue yield of $107 million.

Lower core operating costs of $138 million and a favorable net currency impact of $44 million.

These items, which favorably affected profit, were partially offset by higher retiree pension, healthcare and related benefit cost of $69 million, and unfavorable impact of changes in emissions standards of $22 million.

We also experienced unfavorable sales mix, which more than offset the favorable profit impact of additional machinery and engine sales volume, resulting in a net unfavorable profit impact of $10 million.

SG&A expenses, excluding retiree pension, healthcare and related benefits and excluding currency, were up approximately $35 million, and R&D expenses, primarily due to timing were down about $25 million compared to second quarter 2002 levels.

Year to date retiree benefit expense is $126 million.

As you may recall, we changed our benefit plan design in the second quarter of 2002, which resulted in lower benefit cost for the remainder of 2002.

Therefore, as we move throughout 2003, the year over year increase will widen.

We continue to expect higher retiree pension, healthcare, and related benefit costs of approximately $300 million in 2003.

Although we have no mandatory U.S. employment retirement income security act, funding requirements during 2003, we are choosing to fund $563 million into our U.S. pension plans.

We are required to make nominal contributions to certain non U.S. pension plans during 2003.

We have adequate liquidity to fund both U.S. and non U.S. pension plans.

We announced worldwide machinery and parts price increases to dealers averaging 2 to 2 1/2% effective January 2nd, 2003.

Caterpillar continues to be resolute in holding to the price increase and has been invoicing dealers at the increased price.

Caterpillar has made no significant changes to price or discount level through the end of the second quarter.

We continue to work with dealers and product groups to evaluate response to specific competitive pressures as dealers pass these increases onto the retail marketplace.

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 64%, which was about the same as a year ago.

Rental rates for the rolling 12 months through June were down 2% from a year ago and continue to remain under pressure.

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

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

Rent to rent units, which currently make up about 55% of the units in dealer rental fleets are down 3% from a year ago.

The CAT rental stores, which generally rent smaller machines for shorter time periods, currently have about 45% of the rental units in dealer fleets.

These fleets continue to grow, and are up 7% from a year ago.

North American dealers have a total of 382 rental stores, 13 more are expected by year end.

In the Europe, Africa, Middle East region, dealers have 769 rental outlets, 297 of which had the CAT Rental Store identity as of quarter end.

In Latin America, we had 130 CAT Rental Stores and 97 in Asia Pacific.

At year end, we're expecting about 1430 rental outlets throughout the world.

Of these, 370 stores in North America, and about 500 in the rest of the world will have the cat rental store identity.

North American used equipment prices declined 3% in the first quarter compared to a year ago for most machines.

We expect continued weakness in the near term.

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

At the end of the year -- I'm sorry, at the end of the second quarter, there are three product groups under managed distribution, track type loaders, skid steer loaders and multi-terrain loaders.

Most of the models under managed distribution are going through the normal transition from a current to an updated model.

We are managing our distribution through a combination of increased production and alternate sourcing.

Dealers frequently manage the shortfall by providing low hour machines from their rental fleets.

Now, for the outlook, we expect worldwide economic growth will improve only slightly in the second half of 2003 and full year growth will be only marginally better than 2002.

Modest economic growth, low interest rates, and continued replacement buying for an aging construction equipment fleet in North America should lead to increase volume of machinery and engine sales for 2003.

We expect the U.S. dollar to continue to trade weaker than a year ago, resulting in a favorable currency impact on company sales in the last half.

For 2003, we expect 5 to 10% higher machinery and engine sales in North America as a result of an improving economy and very low interest rates.

The currency affect of the strong Euro in Europe, Africa, and the Middle East is expected to boost machinery and engine sales by about 10%.

Led by China, we expect 15 to 20% higher machinery and engine sales in Asia Pacific for 2003.

Machinery and engine sales are expected to decline by approximately 10% in Latin America as a result of continuing economic growth well below trend.

In total, we now expect 2003 machinery and engine sales to be up about 10%.

The favorable affect of volume is expected to contribute about half of this sales increase with the third coming from the impact of currency and the balance coming from revenue yield including emissions.

We are continuing to project NAFTA heavy duty truck industry demand for 2003 at 140,000 units to 160,000 units, with increasing confidence that industry demand will be at the high end of this range.

Our forecast for NAFTA mid range truck and specialty and urban bus industry is 145,000 units.

Profits should be in the range of $2.75 to $2.90 per share.

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

Included in the outlook is a pre-tax charge of $55 million, $40 million after tax, for early retirement of our $250 million, 6% debentures due in 2007.

We will call these debentures, which were issued at a significant original issue discount, and have an effective annual interest rate of 13.3% during the third quarter.

The charge reflects accelerated recognition of the unamortized original issued discount.

The redemption allows Caterpillar to retire high interest outstanding debt using available cash or low interest commercial paper, or both.

Future years' earnings will benefit by the cessation of the original issue discount amortization expense and the 6% coupon interest rate.

We are providing supplemental information including deliveries to users and dealer inventory level.

We sell the majority of our machines and engines to dealers and OEMs to meet the demands of their customers, the end users.

Due to time lags between our sales and the deliveries to end users, we believe this information will help readers better understand our business.

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

All comparisons are based on constant dollars.

Retail deliveries of machines for the three months ending June, 2003 compared with the same three months of 2002 are as follows: Asia Pacific up 54%, Europe, Africa, the Middle East, up 3%.

Latin America down 51%.

Subtotal, up 3%.

North America, up 3%.

World, up 3%.

Retail machine deliveries were up for the quarter, due primarily to strength in the general construction, mining, industrial and forestry sectors, which was partially offset by the decrease in the heavy construction sector outside North America and Asia Pacific.

For the three months ending June 2003, compared to the same three months of 2002, total reciprocating and turbine engine deliveries to users and OEMs were as follows: Electric power, up 6%.

Industrial engine, up 8%.

Marine engines, up 8%.

Truck engines down 12%.

Oil and gas up 15%.

Total up 3%.

Now, let's turn to dealer machine inventory.

First sequentially comparing June 2003 with May 2003.

Asia Pacific up 5%.

Europe, Africa, Middle East, down 4%.

Latin America up 20%.

Subtotal is up 1%.

North America down 2% and the world flat.

Next year over year comparing June 2003 with June 2002.

Asia Pacific up 16%, Europe, Africa, and Middle East up 1%.

Latin America, up 20%, and the subtotal is up 8%.

North America down 1% and world up 2%.

Dealer inventories of new machines at the end of June compared with year end were up on a worldwide basis about $150 million, the majority of which occurred in North America as dealers were preparing for the selling season.

This seasonal increase was about the same as the increase in second quarter 2002 showing that dealers continued to be comfortable with our ablility to reduce lead times on products from our factories.

Inventories compared to expected delivery rates were lower than year earlier levels in all regions.

Our expectations for full year 2003 is for dealer new machine inventories to decrease $150 million on a worldwide basis with inventories increasing about $50 million in North America and decreasing about $200 million spread over the rest of the world.

Asia Pacific dealer new machine inventories are at 2.3 months of deliveries, down from 2.6 months a year ago.

Europe, Africa, Middle East dealers are at 2.8 months of deliveries, down from 3.3 months a year ago.

Dealer new machine inventories in Latin America are at 2.7 months of deliveries, down from 3.3 months a year ago.

Dealer new machine inventories for the subtotal of these three regions outside North America are at 2.7 months of deliveries, which is down from 3.2 months a year ago.

North American dealer machine inventories are at 2.5 months of delivery, down from 2.9 months.

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

The retail statistics for June are also available on voice mail until August 17th at 309-675-8000.

The June engine retail percentages have been calculated using constant dollars.

Previously these percentages were calculated using net invoice value of engines sold.

We will provide these percentages going forward using constant dollars.

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

First is an update on Six Sigma activities.

Six Sigma benefits have exceeded our expectations and played a key role in our improved financial performance this year.

We are creating significant sustainable benefits from Six Sigma projects companywide.

A Six Sigma benefit is the difference between our as is performance and an improved performance less implementation cost.

Six Sigma impacted manufacturing costs, sales and general administration processes and expense, healthcare cost, product quality and volume.

The greatest advantage is in manufacturing cost, which includes all variable manufacturing expenses, the most significant being material costs.

We're approaching material costs from two fronts, improved supplier management and leveraging the design process.

One of the guiding Six Sigma principals is sustainable process, service and product improvement.

With over 22,000 employees involved, Six Sigma has become part of the corporate culture.

Six Sigma isn't about one large project delivering significant benefits, it's about thousands of small projects adding up to enterprise wide improvement.

Thus, the sustainability is on the ongoing use of Six Sigma to approach our business challenges.

The expected benefits are reflected in our outlook.

One of the drivers behind deploying Six Sigma was the need to deliver the shareholder value out lined in our corporate strategy.

The combined demonstration of growth and cost management.

Six Sigma is how we're delivering our strategy and shareholder value.

You've heard us talk about the goal of reducing costs by $1 billion from our 2000 base.

Six Sigma projects play a large role in accomplishing that goal.

Lastly, a brief update on our advanced combustion emissions reduction technology, or ACERT.

The ACERT program remains right on schedule.

We have received certification by the EPA for a third engine equipped with ACERT technology, the C15 engine.

Earlier this year we received certification for the C7 on highway and C9 urban bus engines.

With this latest certification, we are the first engine manufacturer to offer 2004 model year clean diesel engines that are fully EPA compliant in both the heavy and medium duty truck categories.

Our mid range ACERT engines began production during the first quarter and are ramping up to full production.

We have begun shipping C15 ACERT truck engines and we'll be in full supply on all on highway models by year end.

Customer acceptance of first ACERT engines has been quite positive.

ACERT engines will have accumulated 10.2 million miles by October 2003.

Customer feedback indicates we are on track to deliver the reliability and fuel economy we have promised.

Market acceptance of our bridge engines continues to be strong.

Our expectation for ACERT units this year is about 15% higher than we had originally expected.

The increase in bridge demand will create an increase in nonconformance penalties that will only partially be offset with our price increases on this new product.

We now expect the unfavorable impact of emissions standard changes to be about $40 million after tax.

Complete details will be provided in the second quarter 10-Q.

ACERT is truly breakthrough technology that will meet the clean air goals we support while maintaining superior engine reliability and performance our customers have come to expect from Caterpillar products.

We are confident this technology will provide us with significant advantages providing bottom line savings for our heavy-duty customers of over $10,000 per engine over competitive technologies.

Before we get to the Q&A, I wanted to mention that Caterpillar will be holding an analyst conference on September 4th, 2003, featuring presentations by Glen Barton, Chairman and CEO, Jerry Shaheen, group president responsible for core machinery business unit, and each of the vice presidents for the core machinery business units.

The conference will be webcast.

Information for accessing the webcast will be available on the investor information portion of our website at cat.com in advance of the meeting.

Okay.

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

In the interest of time and fairness to others, please limit yourself 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 one followed by four on your touchtone phone at this time.

Pressing one four a second time will remove you from you queue so your question be answered.

Lastly we ask while posing your question that you pick up your handset if you're on speakerphone for optimum sound quality.

Please hold while we poll for questions.

Our first question is coming from Alex Blanton.

Please state your affiliation and then pose your question.

I'm with Ingalls and Schneider.

Congratulations on the quarter and also a terrific graphic in the press release showing the different changes in sales and profit from last year.

Thank you, Alex.

We're glad you like the new graphic.

Yeah, it's terrific.

In the revenue yield part, does that exclude all currency affects?

Is that just price?

Yes, it does.

Okay.

So that's a separate -- currency is a separate item.

We've extracted that from revenue yield.

That relates to the price increase that you talked about?

That's correct.

Okay.

Now, on the sales for the quarter, you mentioned replacement demand dealer rental fleets replenishing.

It didn't look like there was a lot of sales based on the retail sales ending June for the world up 3%.

Could you discuss that?

There seems to be a little disconnect between your sales strength and the retail sales strength, but I didn't really see it in the inventory figures, either.

It didn't look like the inventories were up a lot.

I'm sorry, Alex.

We missed the word that you said?

You said that there didn't seem to be a lot of.

Sell through.

Sell through.

You were selling machines, but the retail sales pickup wasn't nearly as large in the figures you gave.

And the inventories didn't expand either, so I'm just wondering, have they started to scrap more machines and replace them that way?

Is that what's going on?

What explains the strength in your sales versus the retail being less?

The replacement cycle largely in the rental fleet I think is where a significant portion of the increase is being absorbed.

Okay.

And the so the inventory figures don't reflect the rental fleet.

No, the rental fleet is not included in inventory.

Is rental fleet up or is it just being replaced at a constant level?

Well, there's a combination of both.

We continue to increase our rent to rent, as we -- our rent to rent is down a bit, but the rental stores are up 7%, as we mentioned in the commentary.

Okay.

That would, I believe, be the explanation.

There's also a significant replacement going on.

And apparently you expect this to continue for the year, because you've raised your estimate for sales for the year substantially, so you don't think this is a one-shot thing for the second quarter?

The rental fleet will logicly replace over a period of time.

Yes.

The average age of equipment in the rental fleet is approximately 31 months.

This includes the rent to rent and rental services equipment.

So logically this replaces on that timeframe.

And finally, when did you see this strength?

When did you first notice it?

Was it a sudden fly up in June or across the quarter?

I think it's been spread across the time period.

Not a sudden?

Alex, you probably have been listening to our retail sales figures, and, you know, there's been a gradual increase over each month.

They didn't reflect this sales increase which went into the dealer rental fleets.

Yes, it would.

It would include that.

Okay.

Thanks.

Thank you.

Thank you.

Our next question is coming from David Raso.

Please state your affiliation and then pose your question.

Smith Barney.

These are really two questions but very interrelated.

On the second half guidance, the first half we just put up earnings growth of 88%, $1.52 versus 81 cents in the first half last year.

The rest of the year is implied at $1.31 to reach the midpoint of your guidance versus $1.49 second half of last year.

The $1.31, though, I can see how you add back about 33 cents or so incremental tension, about 11 cents with early debt retirement.

Maybe the real analysis should be about $1.75 versus $1.49.

Given the strong EPS growth in the first half, what's driving you to assume growth of only 17%, assuming those numbers are correct in the second half?

That kind of relates to my follow-up.

Sure.

David, I think there are a number of factors that come into play in the second half.

There is some negative impact from sales mix.

We've got increased quantities of compact construction equipment and lower sales of higher margin fuel system components.

A third of our increase in sales is attributable to currency, which has a minimal impact on profit.

Also, research and development costs, as well as pension and other post retirement benefits are more heavily weighted in the second half of the year.

As you know --

Can you help us with that number?

I'm sorry?

I was already kind of waiting the second half, $170 million of the $300 million full year.

What's the second half of the $300 million, for the pension post retirement?

Of the full year $300 million, how much in the second half?

I think we've already had $126 million.

I missed that number.

In the first half.

That's about right, $175 second half is about 35 cents.

Okay.

Then if you keep thinking through some of the factors, you know, as you identified, the bond redemption.

Last year in the fourth quarter, we took some significant actions to contain costs that we will not be repeating in the fourth quarter of this year.

And, of course, as we project increased volumes, we'll drive some increase on cost.

So if you add up all these factors, I think that drives you to the outlook that we have stated.

So related to that, the issue on the machinery sales, the first half of the year you've put up, you know, roughly about 12% or so growth for the year, the first half.

And the retail sales, I know part of that 12% is -- but the retail sales, yes, the sales that go into CAT Rental Stores are not showing in the inventory, so I can see why the inventory numbers aren't reflecting stronger CAT sales than at retail.

But in fact, when you put a machine into CAT rental, it does get reflected in your retail sales number that you give us each month.

So the relationship is still there that's hard to see your sales are up 12% and the retail activity up low single digits.

Can you help me understand, then, how much must be going into the rental?

It still should show up in the retail sales number.

I am correct, you do report in your retail sales equipment that goes to your dealer who then puts into his CAT Rental Store.

David, I think over time we've given you a good deal of information about rental stores, number of stores, average volume in stores.

And you know, giving you an idea of sort of the replacement cycle on this.

I think taking all those factors together, you can kind of derive what amount is in rental stores and rental fleet.

We'll follow up off line, it still seems as if retail sales data, if that much is going to rental stores should be reflecting it.

I think there may be some time delay in the reflex in the retail sales.

We'll follow up, but thank you very much.

Thank you.

Thank you.

Our next question is coming from Gary McManus.

Please state your affiliation, then pose your question.

JP.

Morgan.

Hi, Nancy, great quarter.

Hi, Gary, thanks.

I'm a little bit -- I'm wondering about this second half as well.

I think you're suggesting, if my math is right a much lower operating margin in the second half of the year than you had in the second quarter.

I know there's probably some seasonality there.

You talked about the higher retiree expense, pension, and medical.

But with 10% year over year revenue growth, why wouldn't there be continued margin improvement from volumes?

Gary, I think some of the answer is in sales mix, definitely.

And like we said, currency and the other aspects.

Maybe one other factor that we might mention is the securitization that occurred at CAT Financial occurred in the second quarter and had an impact in the first half of this year when you compare it to what happened in the third quarter in 2002.

But those are really pretty much the factors that should identify this change that we've indicated.

Okay.

Just to follow up on the sales mix, you said it was negative in the second quarter as well.

I mean, can you talk to what degree did you see a negative sales mix in the second quarter and to what extent do you see it getting more negative presumably in the second half of the year?

I'm not that we can disclose that level of detail on the mix.

Okay.

And just finally, can you go through some of your major segments and talk about pins, how you do versus the industry.

I see in the truck industry how well you're doing there, but just talk in some of the other key areas like construction, power GEN, so forth, petroleum, how you think you're doing relative to the industry.

Gary, we never talk about pins.

So I'm sorry I can't help you with that.

You can't talk generally how you're doing -- what areas you think you're gaining share?

You can't give me some description of that?

No.

Sorry, I can't help you out.

Okay.

Thank you.

Thank you.

Our next question is coming from David Bleustein, please state your affiliation and then pose your question.

It's UBS.

Good morning Nancy.

Truly sorry to beat a dead horse.

Retail sales in the quarter were up about 3% for machinery and engines, wholesale sales up 12%, and I thought you said that units in dealer rental fleets were up 1% year over year.

Do I have those facts right?

The amount of being up, that doesn't identify the replacement in the rental fleets, Dave.

Okay.

So are the units -- did fleet age come down?

You said it was 31 months today.

Was it younger -- was it older a year ago?

Actually, I think it's increased a little bit, the aging of the fleet.

Let's definitely follow up off line.

Then following up on Alex's question, would you now expect dealer inventories to remain at historically low levels due to the growth in dealer rental fleets?

Are we seeing a substitution of inventory kept, you know, in that -- from one measure and moving it over to the rental fleet?

I think there are a number of things that impact the level of inventory.

One of the things that will impact is the low interest rate, which would tend to make the inventory increase; availability, a little tightening as we mentioned in some availability may drive a little bit higher inventory level.

But I think you focused on the correct fact that the rental fleet can be used as something of a cushion against having a higher inventory level.

All right.

And final question, switching gears, on ACERT, how many more engines do you expect to have certified this year and give us a rough timetable?

I'm sorry, would you repeat your question?

Sure.

On ACERT, how many more engines do you expect to have certified this year and give us a rough timetable.

The expectation is the C13 will be certified very shortly, and we will be in full ACERT certification by the end of the year.

And we have one more, the 600 horsepower, which will be certified in January, our expectation is.

January of next year.

Okay.

Terrific.

Thank you so much.

Thank you.

Thank you.

Our next question is coming from John McGinty.

Please state your affiliation and then pose your question.

Credit Suisse First Boston.

I wanted to go and look at the guidance for a second and compare to the guidance a quarter ago.

The total sales are up 10%.

The guidance last quarter was 0 to up 4%.

There was currency in that.

What I'm trying to understand is if there's currency in this.

Is any of the increase from the 0 to 4% to the 10% more currency than you had before or is whatever currency is assumed in the 0 to 4% the same currency that's in the 10%?

I think we're using the same protocol to determine those.

So it would be similar.

Okay.

Then if we come over to the guidance in North America, which is up 5 to 10% versus flat to off last quarter, without any real increase in the economic -- again, it's hard to read through what you were saying then versus what you are saying now.

Is all of the incremental difference between that -- because there's no currency in the North America, the difference between the flat to off to up 5 to 10%, is that all essentially replacement -- increase in replacement in.

I think a significant portion is the increase in replacement.

As you look at these low interest rates, I think that drives the replacement point closer in, because of the lowered interest rate.

I wanted to add another statement.

With a little help from my friends, I've got a better answer for you.

Retail sales are in constant dollars, our sales reflect the increased currency impact and revenue yield.

So that's where the disconnect may be occurring.

Hopefully that helps.

There's no currency in the U.S.?

In other words, the U.S. up 3% and machines.

I'm sorry, I wasn't answering your question.

No, I understand.

Absolutely.

It's U.S. dollar to U.S. dollar.

Okay.

And then as a follow up, the -- your dealers seem to be much more concerned about availability.

They are talking about stretchouts and lead times, maybe we're not into whatever the term we're using instead of allocation.

I know we don't say the A word anymore, it's managed distribution, the MD word.

There seems to be a lot longer lead times on machines stretching out, other than just these three groups.

I guess the question I have is why?

Is it that you don't have enough confidence in the sustainability of demand that you're not raising schedules more?

Is it that you can't raise schedules more given all of the stuff about, you know, just in time management or whatever we're calling all of these things?

In other words, why are lead times stretching as much as they are and you guys not responding with schedules, schedule increases, sorry.

John, it's Lynn.

Hey, Lynn.

How are you doing this morning?

Good, thanks.

John, as a general statement, I'll make a general statement first.

There are some isolated situations where product lead times have stretched out a little bit, and in some cases a little further than we will like.

We'll catch up to those.

What we call S& OP, the sales and operations planning process, that we instituted about 18 months ago where the marketing company and production units get together at the beginning of every month and decide on the forecast and the production schedules.

It takes a little bit of time for that to catch up.

We do have a few models where that process is lagging just a little bit, but we're not concerned about being able to meet demand.

And I don't think as a general rule, I don't think the dealers are either.

Like I said, John.

They are managing some of this shortfall by using low hour machines out of their rental fleets.

And then just one final question.

The average age of the equipment and the rental fleet is 31 months.

That is -- clarification, that's both the rent to rent fleet and the rental service?

That's correct, John.

If you took just the rental services, that would be 24 months.

And the rent to rent would therefore be whatever, 38 --

Doing the math, yeah.

All right.

Thanks very much.

Sure.

Thank you.

Our next question is coming from Andrew Casey.

Please state your affiliation and then pose your question.

Prudential Equity Group.

Good morning.

Good morning, Andy.

Question on the machine side.

With the perceived reduction in the age of the fleet going forward, not this quarter but going forward, would you expect the rental rates to improve in.

The reduction in the age of the rental fleet going forward, would we expect the rental rates to improve?

That's right.

Well, as we noted, they have actually decreased a little bit with continued pressure.

I think as you have a younger piece of equipment, typically you would expect to be able to command a higher rental rate.

So I would think especially our equipment versus others, we could do that.

Okay.

And then would that, then, imply for incremental revenue contribution at the dealer level that this replacement demand, if you will, of the rental fleet would continue?

And how long do you think it could continue without any improvement in the underlying market?

The replacement cycle as these -- as this equipment ages and as we maintain the utilization at about 65%, which is really the sweet spot in the rental services business, we would anticipate that you would see a replacement.

How you normally configure your fleet would be to have a third, a third, and a third being replaced, so you don't have to replace the entire fleet at one time, and we would expect that that should go forward.

May I add something here, Andy.

It's Lynn.

One of the things that distinguishes us from our competition is the fact that five years ago when we started this rental services strategy in conjunction with our dealers, it puts us and them in the position to command a leadership role in rental services.

And, in fact, if you just look at the number of outlets, we are the leader worldwide in rental services today.

Our dealers have never varied from the replacement cycle.

The replacement of a rental unit is based on two or three things, one being the maintenance curve, the other being the number of hours that accumulate on it.

If you look at the age of the fleet of most of our competitors in this business, "It is stretching out.

They don't have the re-marketing capability that our dealer network has, and that's something that is significantly distinguishing us from the rest of the pack.

The rate question is really one of, you know, market clutter right at the moment.

Until there's some consolidation, it's doubtful, I would think, that rates will firm significantly, although we are seeing in some pockets and some models a little bit of firming in the rates.

Okay.

Thanks.

Thanks, Lynn.

Just one other question on power generation.

It was up, I believe, the number you gave Nancy was up 6% at the retail level.

Did that show any change through the quarter on a sequential basis in and is there any special thing like Iraq shipments, or whatever, that helped that?

Thanks.

The electric power was largely concentrated in Europe, Africa, and the Middle East and Asia Pacific.

I think there were some sales into the Middle East, and I think that's been the main focus of the electric power.

Thanks a lot.

Sure.

Thank you.

Thank you, our next question is coming from Ann Dougman.

Please state your affiliation and then pose your question.

Bear, Stearns.

Hi, guys.

Hi, Ann.

My question is around oil and gas.

You stated that global sales were up 20% versus the retail numbers that we've been getting.

May is the last number I'm looking at, and that was down 19%.

Is all of that difference the difference in one being constant dollars and not including pricing?

Or is there something else going on there?

Secondly, just what is your outlook for oil and gas?

We're beginning to see rig tons improve, that has to drive processing further down the road.

What are you thinking about in terms of oil and gas for the remainder of '03 and going into '04.

Ann, I think the most significant factor was a significant uptick in solar sales in North America.

That was very significantly increased.

Going forward, I think you pointed out some of the major factors.

Rig counts up 29%.

The price of natural gas is extremely high as you know.

And we are beginning to see orders increase.

These haven't been full sales, but we're beginning to see orders increase in the reciprocating engines as well.

So I think our outlook is that we will see some firming and increases in this particular sector.

What kind of lead times do you have between, you know, rig tons increasing and you receive an order for reciprocating engines, then you ship a reciprocating engine versus the solar products which will be more tied to processing of oil or gas.

Solar has longer lead times, typically, than -- depends on the size of the reciprocating engine.

Solar lead times, Lynn, what would you say?

About six months on average versus about 8 to 12 weeks on the reciprocating.

Okay.

And a second question that's somewhat related.

Can you talk to us a little bit about mining also, where you might be seeing some uptick and also give us a little bit of color on the recent Terex announcement.

Any ideas how much impact that might have on revenues or earnings going forward?

I'll take your second question first.

The Terex announcement is a very preliminary point.

As you probably noticed it's a nonbinding agreement.

We're in the process of doing due diligence.

I think the positive impact for Caterpillar is we have an electric drive -- if this deal is consummated we have an electrical drive and mechanical drive mining truck, which will give us a complete range in mining trucks.

I think that's a big positive and should have a positive impact on sales.

It's hard to quantify the amount, but would have a positive impact.

Taking your first question, the upturn in mining is largely driven again by the replacement cycle.

We're starting to see some commodity price improvement in iron ore, gold, oil sand.

They are leading the improvement.

Copper and coal demand lags largely due to commodity prices.

One of the things I think we can focus on in mining is the alliances that Caterpillar has been forming during these past months.

One we announced was the BHP alliance.

I think that will stand us in good stead as the economy turns around.

Okay.

Thanks, Nancy.

Thanks, Ann.

Thank you.

Our next question is coming from Joanna Shatney.

Please state your affiliation and then pose your question.

Goldman Sachs.

Hi Joanna.

Hi.

In the press release you guys talked about how Six Sigma is running faster than you expected and you highlighted in your comment.

Can you just talk about what's coming faster?

Are the pieces that you highlighted in the commentary, does that mean maybe there's more than Glen hinted about or talked about and how quickly do we get to that goal, what is it a billion in cost reduction?

We do have the goal of a billion in cost reduction.

As I said, a significant piece of this is being driven by the Six Sigma culture here at Caterpillar.

Joanna we're probably not going to give you any dollar figures.

We'll give you a sense of this at year end, as we did at year end last year.

But we're having terrific results from our Six Sigma efforts.

Many projects are in process here at Caterpillar and driving significant sustainable benefits.

Like I said, we'll give you a better sense of that at the year end.

And the goal was to get there by 2005, right?

So is there a chance that we can get there somewhere earlier than that?

Actually, Joanna, the goal was 2004, and I feel -- we feel that we're very much on track to doing that and have a high level of confidence that we will accomplish that.

The number has not changed?

It's not a bigger number?

No.

Okay.

Thanks.

Thank you.

Thank you.

Our next question is coming from Mark Koznarek please state your affiliation and then pose your question.

Hi.

It's Midwest Research.

Nancy, just one clarification.

When you were answering John McGinty's question, you were talk being North America and what led to the increase in the outlook, and the answer was increased replacement demand, do you mean solely the CAT rental channel, or do you mean across all end users?

No.

Mark, it's across all end users.

Okay.

So it's not solely just the dealers.

No.

There's a significant role in to the rental fleet replacement, but there's also replacement demand separate and apart from the rental fleets.

Okay.

Now the question I had had to do with the performance of the engine segment on the profit line, because if you look at the loss from the first quarter to the 5% margin in the second quarter, that's like verging on 50% incremental margin, very high.

I'm wondering what was going on there?

Is it the impact of these solar shipments that dropped into the quarter, can you characterize some of the strength there and whether that profit strength will continue in the second half?

I think there are three different things that we cite, lower cost, increased volume, and this is -- solar has a piece of this, indeed -- and currency.

Those are contributed to the profitability.

Negative to that were some negative on mix emissions and retirement and OPEC costs.

I'm looking at versus the first quarter, OPEC and emission would be sort of neutral wouldn't it?

It is an increasing amount as we progress through the year on pension and OPEC.

First quarter versus second.

Second quarter was higher.

Okay.

But is there any major deltas in that oil and gas was up so much as that part of the profit driver, is there mix as a big part of that?

Actually mix was negative on profit in the second quarter.

I'm not sure if it was versus first quarter.

That's hard to say.

Mark, maybe one of the factors was we are beginning to ramp up on the engine sales of ACERT engines, which don't have nonconformance penalties.

Therefore you have that positive impact of selling engines without NCPs, and revenue yields also, there's the positive revenue yield on the ACERT engines.

Then just a final clarification on ACERT.

You mentioned that ACERT shipments would be up 15% from prior expectations.

When you say ACERT, do you include include the bridge engine or is this just true ACERT.

It's just true ACERT.

You actually think 15% more.

We anticipate at the start of the year.

Okay.

But it certainly would be that ACERT will be a small fraction of medium and heavy sales for the full year.

I think small fraction may be too light.

As ACERT ramps up, you know, there's a ramp up period and a ramp down on the bridge.

So, I mean, there will be some ACERT engines and small fractions probably too light.

Thank you.

Our next question is coming from Robert McCarthy.

Please state your affiliation and then pose your question.

Robert W. Baird, good morning.

Hi, rob.

Hi.

I'm having -- Mark actually touched on where I wanted to go.

I'm having a little trouble understanding why a higher forecast for ACERT engine sales within the context of an unchanged of NAFTA build would result in a higher estimate for noncompliance penalties?

Say that again?

Well, in your remarks you told that you had raised your expectations for ACERT shipments for the year by 15% and then proceeded to tell us that you also then consequently expect noncompliance penalties to be a larger drag on results than estimated in last quarter's Q. And I don't understand

The whole amount has gone up.

It isn't -- we didn't increase our industry estimate, but our sales in general have gone up, including the bridge engines.

And as the bridge engines go up, of course the NCPs increase.

So that means you've also raised your forecast for bridge?

That's correct.

Okay.

All right.

That makes better sense?

I understand that.

I'm having a little trouble with the NAFTA forecast.

I guess what I really want to ask you is how tightly it's tied to your overall outlook, because a quarter ago you told us that you were 140 to 160 for NAFTA build, first half of this year was in excess of 80 for the industry, and with rising build rates.

So if all you're looking for is 160, you're implicitly assuming that there will be cuts in production rates later this year by the industry, so consequently it's very important to understand how tightly that forecast is tied to your overall forecast for the company's result.

As we said, we have confidence it will be at the higher end of it, rather than somewhere in the middle.

Lynn, do you want to add to that?

Well, rob, 140 to 160, if we're at the high end, whether that's 150 to 165 or 168, you know, we can't get that precise with that kind a forecast.

But certainly we think it's closer to the 160, and if that takes us a little over that level for the full industry, you know, --

You're aware build rates are running around 200,000 unit rate in the second quarter, right?

Yeah.

We are aware of that.

You have questions about its sustainability?

Yeah, because frankly if you look at the underlying economy, we're not seeing -- I mean, we're seeing certainly better growth, and this kind of goes back to John's earlier question.

He said we weren't projecting any growth in North America.

We are suggesting that growth will be higher in the second half than the first half.

We're talking about a 3% economic growth in the second half versus I'm not sure where the total first half is going to be but probably around 1 1/2, under 2, certainly.

But how much of this is getting in in anticipation of that and if it will, in fact, be sustainable, right now our best look is something around that 160,000 unit level.

An element, Lynn, would be uncertainty about at what -- once you've switched over to almost 100% ACERT, there's naturally questions about whether they will be purchased in the short-term at the same rate bridge engines have been bought.

That's not a question in our mind, rob.

Not at all.

All right the.

The ACERT engine is performing exactly as we said it would be and the feedback is excellent.

Nancy, can I just get you to clarify something for all of us, I think.

As I look at the outlook by region in the earnings release, in the press release, and it sounded like you were also describing it this way in your own remarks, it sounds like the regional outlooks are being characterized in terms of expectations for Caterpillar machinery and engine sales as invoiced as opposed to expectations for industry volume which has been the traditional method.

Am I picking up a change here?

You're correct in stating that it is an outlook for Caterpillar sales.

By North America.

Yeah, by geographic area.

All right.

Thank you.

Thank you.

We have time for one more call.

Okay.

Our last question is coming from Stephen Haggerty.

Please state your affiliation, then pose your question.

Merrill Lynch Hi, Nancy, hi, Lynn.

Hi, Steve.

A couple of housekeeping questions in terms of timing of R&D spending, that's why R&D was low this quarter can you give us an idea what it should be for the remainder of the year, more anticipated levels.

That's our anticipation, about on par with last year's.

Any particular product in development that you're ramping up to that's going to bring it become to normal levels?

I guess the question is why was it abnormally low this quarter?

I think you're seeing some of the tailing off of the ACERT spend, but there will be other product endeavors that will demand additional R&D.

That's why our anticipation is as it is.

Just two other real quick questions.

On currency, I think, Nancy, when you ran through the chart you talked about the impact of currency being $44 million.

On the chart that's $31 million.

Are you including currency impact that's buried in the other income line?

Well, the differential is the $44 million net favorable impact of currency on profit includes the $31 million net favorable impact on operating profit as well as the $22 million favorable impact of translation, which is partially offset by the unfavorable currency impact of conversion.

The $22 million in terms of your P&L, the $22 million is buried in your other income line?

That's correct.

That's contained in the other income.

This will be my last one.

On pricing sounds like you're pretty confident that the price increases are sticking.

I want to understand from a distributor's perspective if I bought a product you've invoiced me on the higher price is it up to me to get that price in the marketplace because I've ordered the product and it hasn't arrived yet or should I be confident that I can pass that 2% along to -- along to my customer, too.

The dealer, it is up to him to pass that on to the retail marketplace.

You said you're working with them.

Do you have any sense what the feedback is from the dealers.

I think the feedback has been pretty positive that they are able to pass it along.

Thanks a lot, guys.

I see by the list we have one, Barry Bannister is waiting.

We'll take one more.

The next question is coming from Barry Bannister.

State your affiliation and pose your question.

Leg Mason.

I realized that SCM is more a source of technology than a source of profits, but when I see Japan possibly on the mend and I see 66% sales export growth into China, I'm wondering if $6 million swing to break even is all I can expect in the future?

Is SCM a multi-billion dollar company that's a potential source of profit surprise, or is that a company that has pretty much not been part of all the changes that CAT has done since the last cycle began?

Barry, I think SCM has focused very strongly on cost cutting and made every to weather this storm that has been taking place in Japan for so many years.

As to the future, Lynn, can you comment on that?

I would certainly echo what Nancy said.

They have done a tremendous job managing through this period.

They are certainly in position to take advantage of upturns, and the Asian -- and we're seeing the benefits.

Keep in mind that is a 50-50 joint venture, what you see coming through our equity line is 50%.

Where it goes in the future in terms of profitability, you know, I think we are certainly in position to to take advantage of the future upturn and would certainly hope for higher returns there.

In a related sense, the margin targets at SCM in terms of other international operations and then secondly on pricing, could you talk about whether or not the pricing on a month by month basis seem to be fading as we went out of the second quarter given the weakness in public construction, for example?

When -- you're referring to pricing are you still referring to SCM?

I skipped tunes on you, I was talking about worldwide.

I was going to say I don't know what's going on with SCM pricing.

No I don't think we're seeing anything tail off.

Certainly at the end of the first quarter it was too early to tell what was going to happen from the retail level with the pricing action.

We're now through two quarters and as Nancy pointed out, we have held the line here in terms of any kinds of actions to the increased discounts and we have not.

So I think what we're seeing is that it is moving through into the retail marketplace.

And I tell you, you know, for five years we have been -- we have continued to increase the value of Caterpillar products through development, research, higher productivity, and we haven't had price realization.

What we're seeing, in my belief, what we're seeing is the customer recognition of that higher value that we've been putting into the product, that it does command at this point in time some return to Caterpillar for that value that we've provided to the customer.

So despite some increase in short-term financing cost, you're not seeing that much pushback from the dealers in the last month or so.

Not that I'm aware of.

Thank you.

All right.

It has been a pleasure sharing Caterpillar's results with all of you this morning.

If you didn't get your questions answered, please give me a call.

Thank you for your interest in Caterpillar.

Thank you, ladies and gentlemen.

This does conclude today's teleconference.

You may disconnect your telephone lines at this time and have a great day.

Thank you for your participation.