開拓重工 (CAT) 2003 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Caterpillar's third-quarter 2003 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.

Good morning, and welcome to Caterpillar's third-quarter 2003 results conference call.

I am 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 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.

This morning, I'll cover our third-quarter results, review our outlook, go over the usual dealer retail numbers, discuss 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 8-K filed with the Securities and Exchange Commission today.

Okay, let's start with the third-quarter results.

As you know, this morning, we reported third-quarter sales and revenues of $5.55 billion, and profit per share of 62 cents, or 73 cents excluding a $40 million or 11 cents per share nonrecurring charge for the early bond retirement.

Profit per share, excluding a bond retirement, is a non-GAAP measure.

A reconciliation of this amount to our GAAP profit will be included in our earnings release in a Form 8-K filed with the Securities and Exchange Commission and posted to our Website today.

Sales and revenues were up $470 million from third quarter 2002, with Machinery up $345 million and Engines up $67 million.

The increase was primarily due to higher machine volume of $226 million, a favorable currency translation impact on sales of $128 million, which was due primarily to the stronger euro.

In addition, Financial Products revenues for the third quarter increased $58 million, or about 15 percent, compared to third quarter 2002.

The profit increase was due to lower core operating costs of $59 million and improved price realization of $34 million.

Core operating costs are defined as Machinery and Engines volume-adjusted operating cost change, excluding currency, retiree benefits and emissions production cost increases, ramp-up production costs and non-conformance penalties.

The favorable impact of sales volume/mix was $15 million, as higher sales volume was partially offset by negative sales mix compared to third quarter 2002.

Partially offsetting the favorable items was $71 million of higher retiree pension, health-care and related benefit costs.

The majority of the increase in volume in both Machinery and Engines into electric power applications was from the small end of the product line.

As you know, a significant amount of management compensation is tied to performance in the form of variable pay.

In 2002, as we were operating in very difficult conditions, we reduced the accruals for variable pay, in line with estimated 2002 full-year results.

In the third quarter of this year, in line with forecasted operating results, we have increased the accruals, resulting in a quarter-to-quarter swing of approximately $75 million.

Machinery and Engines SG&A was higher compared with third-quarter 2002 levels, excluding the impact of currency and higher retiree pension, health-care and related benefit cost.

The higher SG&A includes a portion of the impact of higher accruals for variable pay related to operating results.

We continue to expect higher retiree pension, health-care and related benefit costs of approximately $300 million in 2003, compared to 2002.

Year-to-date retiree benefit expense is $196 million.

Although we have no mandatory U.S. funding requirements during 2003, we made a voluntary contribution of $563 million into our U.S. pension plans in the third quarter of 2003.

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.

As you know, included in our results is a pretax charge of $55 million -- $40 million after-tax -- for early retirement of our $250 million 6 percent debentures with original issue discounts due in 2007, which had an effective annual interest rate of 13.3 percent.

The redemption allowed Caterpillar to retire high-interest outstanding debt using available cash and low-interest commercial paper, which has since been paid off with cash.

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

Now, I will 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 strong rate, about 65 percent, which is 5 percent higher than a year ago.

Rental rates for the rolling 12 months through September are down 2 percent from a year ago, and continue to remain under pressure.

Overall, units in dedicated rental dealer fleets are up 2 percent 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 percent of the units in dealer rental fleets, are down about 3 percent from a year ago.

The CAT rental stores currently have about 45 percent of the rental units in dealer fleets.

These fleets continue to grow, and are up 8 percent from a year ago.

North American dealers have a total of 381 rental stores. 12 more are expected by year end.

In the Europe, Africa and Middle East regions, dealers have 782 rental outlets, 298 of which have the CAT rental store identity as of quarter end.

In Latin America, we had 131 CAT rental stores, and 105 in Asia/Pacific.

At year end, we are expecting about 1,430 rental outlets throughout the world.

Of these, 370 stores in North America and over 450 in the rest of the world will have the CAT rental store identity.

North American used equipment prices were down about 1 percent in the second quarter, compared to a year ago for most machines.

We expect to see used equipment prices improving in the near term.

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

In North America, at the end of the third quarter, there are five products under managed distribution -- two track-type tractors, one excavator and two wheel loaders.

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

We are continuing to manage our distribution through a combination of increased production and alternating sourcing.

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

Now, for the outlook.

The world economy appears to be strengthening in the last half 2003, and full-year growth should be about 2.5 percent.

Low interest rates, increased cash flows for many businesses, and increasing demand for metals are positives for Caterpillar businesses, which should persist through year end.

The Company continues to expect sales and revenues for the year to be up about 10 percent, and now expects full-year profit per share to be about $3 per share, as a result of continued cost control.

Full details of the outlook for 2003 are contained in the Company's press release issued today.

In 2004, economic growth is expected to improve in all regions, raising world growth to 3.5 percent.

We expect the world total machine industry forecast to be up 7 percent, ranging from no change in Japan to 12 percent growth in both North America and Latin America.

In addition, we expect a 6 percent growth in world engine industry demand.

This global economic recovery will benefit both Machinery and Engines, as well as provide opportunities for continued growth in earnings assets at CAT Financial.

Therefore, the preliminary 2004 forecast of Company sales and revenues is anticipated to be about 10 percent higher than 2003.

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

All comparisons are based on constant dollars.

Retail sales and machines for the three months ending September 2003, compared with the same three months of 2002, are as follows.

Asia/Pacific, up 14 percent;

Europe/Africa/the Middle East up 6 percent;

Latin America, up 16 percent; subtotal of those three, up 9 percent.

North America, up 11 percent; world, up 10 percent.

Retail machine sales were up for the quarter, due to strength in all sectors except quarry and aggregates, paving and waste.

For the three months ending September 2003, compared with the same three months of 2002, total reciprocating and turbine engine sales to users and OEMs were as follows.

Electric power, up 42 percent; industrial engines, up 6 percent; marine engines, up 4 percent; truck and bus engines, down 25 percent; petroleum, down 7 percent; total, flat.

Now, let's turn to dealer machine inventories.

First, sequentially, comparing September with August of 2003 -- Asia/Pacific, up 2 percent;

Europe/Africa/Middle East, up 11 percent;

Latin America, up 3 percent; subtotal, up 7 percent.

North America, up 2 percent; world, up 5 percent.

Next, year over year, comparing September 2003 with September 2002 -- Asia/Pacific, up 18 percent;

Europe/Africa/Middle East, down 15 percent;

Latin America, up 8 percent; subtotal, down 5 percent.

North America, up 4 percent; world, down 1 percent.

At September 30, 2003, dealer inventories were about $50 million lower than year-end 2002.

Since dealer inventories continue to be at historically low levels, an 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, with inventories increasing about $75 million in North America and decreasing about $175 million spread over the rest of the world.

Asia/Pacific dealer new machine inventories are at 2.2 months of sales, down from 2.9 months a year ago.

Europe, Africa and Middle East dealers are at 2.5 months of sales, down from 2.9 months a year ago.

Dealer new machine inventories in Latin America are at 1.8 months of sales, down from 3.3 months a year ago.

Dealer new machine inventories for the subtotal of these three regions outside North America are at 2.3 months of sales, which is down from 2.9 months a year ago.

North American dealer machine inventories are at 2.3 months of sales, down from 2.7 months a year ago.

Overall, on a worldwide basis, dealer machine inventories are at 2.3 months of sales, down from 2.9 months a year ago.

The retail statistics for September are also available on voicemail through November 17 by calling 309-675-8000.

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

First, an update on Six Sigma activities.

The major enabler for improved operating profit continues to be our Six Sigma effort.

We have seen significant improvements in manufacturing costs, which include variable manufacturing expenses, the most significant being material costs.

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

Six Sigma has helped Caterpillar to reduce manufacturing costs and improve product performance.

For example, our large engine center demonstrated this when a Six Sigma team sought to use a single-turbocharger technology across the entire 3,600 gas engine products.

The team successfully applied the common turbocharger that has a lower cost, better reliability and performs better in altitude and ambient temperature.

Not only has Six Sigma been a major driver to reduce core operating costs, Six Sigma projects are also helping to create growth for Caterpillar.

As an example, our Europe, Africa and Middle East marketing division used Six Sigma to improve the sales of work tools in Germany.

Specifically, the team addressed the hammers, couplers and demolition tools used on the hydraulic excavators.

The team's efforts improved work tool availability and delivery, which increased work tool sales within the regions.

Aside from the financial gains, Six Sigma is driving a lasting cultural change.

More than 23,000 employees are fully engaged, including more than 2,100 trained black belts.

During this quarter, over 3200 projects delivered benefits.

We continue to engage our suppliers in the CAT dealer network.

This quarter, an additional 24 dealers and 87 suppliers deployed Six Sigma.

This brings the total to 97 dealers and 247 suppliers.

This extension of Six Sigma will strengthen our entire value chain.

One project at a time, we're building a stronger company that is sustainable into the future.

Simply put, Six Sigma is enabling the delivery of our corporate strategy, it's reshaping our company, it's making us more efficient, it's building the Caterpillar of tomorrow today.

With the recent power losses in the Northeast United States and Canada, as well as the potential for power sales in Iraq, electric power is another topic of particular interest.

In response to the Northeast blackout and Hurricane Isabel, the disaster recovery team of Caterpillar and Caterpillar dealer personnel assembled to provide an accelerated response.

When Hurricane Isabel struck, electric power equivalent was immediately mobilized, with the combined response amounting to over 1,500 units and over 750 MW placed on rent, with 30 to 40 dealers responding to customer needs.

When the Northeast blackout occurred, over 400 megawatts were placed online just hours after events occurred.

Units of all sizes were placed on rent, with an average engine output between 300 and 400 kW.

Shortly after the event, small generator set sales increased, along with rekindled interest in large generator set systems.

Incremental large generator system sales may result from these events, following the typical development period of these more complex projects.

As we are all aware, there is a large need for reliable power in Iraq, estimated at several GW.

However, the need is still being defined, as basic infrastructure restoration and existing equipment repair is in process.

As power consumption is restored to the rejuvenated power grid, the need for distributed generation solutions is expected to grow substantially, and longer-term infrastructure investment in distributed generation plants will take place.

In the meantime, bridge power needs are being filled through purchase and rental of mobile diesel generators.

Caterpillar is extremely well-positioned to capture both immediate and mid-term opportunities, and is already participating in this business.

To date, we have sold over 1,400 small units, or approximately 230 MW, in support of restoration of power to Iraq.

Caterpillar and the Caterpillar dealer network have mobilized generator sets from around the world, positioning them in the Middle East.

When called upon, we are ready to provide power units immediately.

Lastly, a brief update on our Advanced Combustion Emissions Reduction Technology, or ACERT.

The ACERT program remains on schedule.

We have received certification by the EPA for four engines equipped with ACERT technology -- the C13 and C15 heavy-duty engines, and C7 and C9 medium-duty engines.

These are all 2004 model year certifications.

We remain the only manufacturer to offer 2004 model year clean diesel engines that are fully EPA compliant in both the heavy- and medium-duty truck category.

We are in full production of the C7 and C15 ACERT engines.

By year end, all Caterpillar on-highway truck and bus engines produced for the U.S. and Canadian market will incorporate ACERT technology.

Field results to date indicate that we are on track to deliver the reliability and fuel economy we have promised.

Market acceptance of our truck engines continues to be strong, with Caterpillar engines continuing to lead the industry in heavy-duty sales and overall on-highway engine sales.

For the fourth consecutive year, Caterpillar has won the prestigious J.D.

Power Award.

Caterpillar's C15 engine ranks highest in customer satisfaction among vocational heavy-duty truck diesel engines, achieving the highest scores in each of three factors.

Caterpillar remains the only truck engine manufacturer to have ever won a J.D.

Power Award.

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

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

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?

(OPERATOR INSTRUCTIONS).

David Raso.

Smith Barney.

First, a clarification, Nancy.

The 75 million of accrual for variable pay -- that was related strictly to pension OPEB, correct?

No, David.

That was related to variable pay such as incentive comps.

So how does that flow into the P&L this quarter?

Is that an incremental 75 million hit for this quarter that did not exist in the second or first quarter?

It's the differential between third quarter 2002 and third quarter 2003.

That would be the difference quarter on quarter.

Just so I can better understand it, what was that differential in the second quarter versus second quarter a year ago?

I'm not sure that I know that off the top of my head.

I have people in the room who will help find that out and we'll get back to it once we have the answer.

I appreciate that, but my question, though, really is on margin, and really it's like two parts -- one on Machinery and one broader, for the whole Company.

The Machinery margins were obviously key here; they are disappointing versus what people are looking for.

The price realization -- the second quarter, you had 3 percent.

This quarter was only plus 1.

Can you help me understand what happened on price?

Is there something on a cost perspective as well that caused the Machinery margins not to put up the same performance it did in the second?

David, if you look at the entire picture, on a gain of 470 million in sales, you are really looking at about 340 in sales that were not currency-related.

So reducing it to 340, I think some of the factors that are probably influencing it most were the bond redemption, 55 million.

The net changes to emissions standards had an $11 million impact.

And quarter on quarter, the timing of the securitization had another $19 million impact.

I think also the variable pay differential had a huge impact, as well.

I apologize; maybe I asked the question too broadly.

The price, though, was to me the biggest obvious --

Oh, I see.

The two -- basically, 200 basis points, on a year-over-year basis, seemed to have been lost, right?

Third quarter is plus 1, second quarter was plus 3.

If you can, first, just what happened to the price increase that you were getting in the second for Machinery that seemed to dissipate --

I'm sorry, David.

Remember, when we announced the price increase, it was a worldwide average price increase.

So therefore, depending on the product and geographic mix, you'll see the price realization fluctuate.

Now, the company has remained resolute in holding to the price increase, and we have been invoicing the dealers at the increased price.

Can you help us a little bit with that geographic comment and product comment that would make the price increase dissipate that much, from plus 3 to plus 1?

I know personally the Asia/Pacific revenues were a little bit less than I would have thought.

Can you give us some more color how the mix would have driven such a difference?

David, I am not sure I can go into any more granularity than that.

But rest assured we are imposing that price increase as we had, it just depends on which products are being purchased, and in which geographic locations.

And the last related question, on the margin question, is if you bring it back to the whole Company, the way you lay out your pension incremental, you had about a 65 million per quarter run rate incremental.

In the fourth quarter, you're going to get hit with 104 million incremental.

So if I look at the numbers, if I try to add back pension for the third quarter, on an equipment basis, the Company's operating margins were 7 percent, up about 100 basis points.

The way you are laying out the fourth quarter, if the pension hit is that much and sales are up 10 percent, if you hit your full-year sales number of plus 10, it means the core operating margins have to be about 9.8, up 220 basis points.

And that's why I'm just driving home -- was something unique in the third quarter that you feel, well, in the fourth quarter, we'll again begin to see core margin improvements of hundreds of basis points?

Well, as we said, our outlook is that we'll make $3 for the year.

To go into any further detail -- I'm not really sure that we're ready to do that.

I'd appreciate if you could follow up on that differential on the variable, accrual variable for variable pay?

Hold on for a second.

I may be able to speak to that right now.

It was around 10 million in the second quarter on that swing, second quarter of 2002 to second quarter of 2003.

Your third quarter, on a year-over-year basis, took a 65 million greater hit than the second-quarter phase (ph), right? 10 versus 75?

Doing the math, that would be correct.

Gary McManus.

JP Morgan.

Just a clarification -- for the $3 number, does that include or exclude the 11 cent hit here we had in the third quarter?

It includes it.

Includes it?

Okay.

On the bonus accrual, was there a catch-up in the third quarter?

In other words, because you were expecting to earn more money, presumably, that there was a bigger hit in the third quarter relative to what you were accruing in the first half of the year?

Or in other words, what was the accrual third quarter versus second quarter, let's say?

I don't think we'll give the actual dollar amount.

I think, Gary, what's going on is what the expectation over the course of the year was.

And in the third quarter, we took them down more significantly, compared to this quarter we're increasing them -- it's the big swing, and looking at what the expectations for 2002 were, versus the expectations for 2003.

And I think third quarter was a pivotal quarter, where the differential has been pretty significant, in the amount of 75 million.

You were willing to give us the delta year over year, both in the second and third quarter.

I'm just asking, sequentially, what was the difference in the third quarter accrual versus the second quarter?

I'm sorry.

Lynn, do you have that?

It was about 40 million.

40 million.

Okay.

And would you expect -- was there a catch-up in the accrual?

In other words, you would expect the fourth-quarter bonus accrual to be less than the third-quarter?

Yes.

By what magnitude?

We can't really say that, what we expect that would be, Gary.

But it would be less?

I'm just wondering -- I mean, everyone's -- obviously, the margins are, I guess, disappointing relative to most people's expectations.

I'm wondering, in your opinion, how much relates to this bonus accrual.

I think it's a significant factor.

Alexander Blanton.

Ingalls & Snyder.

I've got questions along the same lines, but I'm wondering where the 75 million is in the income statement.

Which line -- is that in SG&A?

It's spread among the areas that have people in them, like SG&A, R&D, cost of goods sold -- it aligns with where the people are.

And what about the 55 million?

That's also --

The bond accrual charge?

The bonds;

I'm sorry.

I was thinking you were talking about the OPEB.

The bond accrual is in other income and expense.

And the guidance that you are providing for the year, $3, which includes 62 cents for the third quarter -- would that assume, for the fourth quarter, 86 versus 88, or slightly down on a 10 percent sales increase?

Could you go over the main factors in that?

Why it's flat versus 10 percent sales increase?

I think it's a lot of those factors that we've talked about, like OPEB -- (multiple speakers) -- OPEB and pension, some of the emissions-related factors --

What is the pension contribution part versus last year in the fourth quarter?

This will be your last question, Alex, because we're going to need to move on.

But the pension accrual -- repeat that last question?

How do these factors compare with last year's results in the fourth quarter -- for example, pension?

It will be about the same, quarter to quarter, as the third quarter differential.

Year over year.

The third quarter to the third quarter differential will be similar to the fourth quarter to the fourth quarter differential.

Okay.

We'll have to do this off-line, because I don't know understand what you're saying.

Steve Volkmann.

Morgan Stanley.

Can you hear me?

Yes.

Good morning, Steve.

I guess it's just the final nail in this.

The year-over-year executive comp referrals, I assume, are going to be higher for the next several quarters, until we sort of anniversary this.

Is that accurate?

In other words, the fourth-quarter penalty should be similar to the third-quarter penalty?

No, I don't think that's correct, Steve, because now we have made the accrual in line with what the projection for the year is.

So the main hit on that accrual will have taken place -- that's our anticipation, that it will have taken place in the third quarter.

So this really was a bit of a one-time item here?

That's our anticipation.

On the share count, obviously, it went up, I assume, for kind of the same reasons here.

Should we be looking -- is there more on that to come, I guess, is one question.

And the second -- obviously, you have a repurchase authorization that is either about to or has just expired.

And is there an update on whether a new repurchase authorization might be available?

Steve, it's Lynn.

In the release, we stated that the Board had reauthorized the repurchase program that was expiring in October of this year, with a new expiration date of 2008.

Very good.

My fault -- too many conference calls in one day.

David Bleustein.

Good morning.

It's UBS.

Back to the 75 million for one second -- how many people are in that program?

Everyone in the Company is involved in some sort of variable pay program.

And then to Dave Raso's question -- using back-of-the-envelope figures, it appears that your incremental margins in the quarter, on a consolidated basis, were under 10 percent and are still under 20, even X-ing out price and retiree benefits.

Why was the operating leverage so low?

Dave, I'm not sure that we have -- there's some mix aspect to this, of course, as I mentioned in the commentary.

What we have seen is more significant purchasing in the smaller end of the product lines than in the larger.

And I'll get off, but here's my last one.

That $75 million -- can you just walk us through the mathematical calculations, so that as we build our '04 models, we can sort of model in these bonus accruals?

How do you get to the $75 million?

I think where you are seeing the big impact this quarter is the swing from a declining accrual in the third quarter and, in this case, an increasing accrual because of the increased expectations.

How these variable pay programs work -- it ties employee payouts to the performance of the Company.

And as we see better performance, that's shared, of course, with the employees, who were a significant part of making that performance happening.

Well, I'm struggling.

It would appear, just from your guidance, that the big increments in your expectations for how you are going to perform in the current year occurred in the second quarter, which is why I'm somewhat surprised to be see the big change in the accrual in the third quarter.

What am I missing?

The timing of the accrual is really what you're asking about.

Right

And the accrual differential occurred in the third quarter; it's just how the timing worked.

Excuse me; it's Lynn again.

As Nancy said in the commentary, a year ago, in the third quarter, we were facing conditions that suggested performance by the end of the year was going to be extremely difficult, and we in fact reduced the variable pay accrual.

This year, we are facing a different situation, where we were able to raise the outlook, and we're looking at better results.

And so, when you consider the swing of a year ago, with a declining accrual versus the first two quarters, and this year, with an increasing accrual versus the first two quarters, you get a significant swing in the quarter.

Okay.

Okay, thanks a lot.

John McGinty.

Credit Suisse First Boston.

Good morning, Nancy and Lynn.

A clarification, if I might.

The 75 million -- I assume you won't break it down between Machine and Engines for us?

No.

Really, if you -- as you're thinking about it, John, you break it down where you anticipate, in percentages, where the employees are located.

If I look on your waterfall chart on page 6, is it going to show up in core operating costs?

Yes.

Okay.

So in other words, the difference between going from 138 year over year in the second quarter down to 59 in the third quarter -- there is a $75 million year-over-year hickey that I'm taking in core operating costs this year?

That's the correct bar to put that in.

Okay.

And the related question is, in the second quarter of '03, the third bar over you called revenue yield.

This time, you call it price realization.

Have you changed?

Every other bar is exactly the same.

Is that exactly the same bar, or have you changed your definition?

John, its exactly the same.

I think -- we believe that price realization was a bit more descriptive.

I don't disagree;

I just wanted to make sure.

Then I want to come back, if I could -- my primary question is, why is there a difference?

Why is that one-third in the third quarter?

In other words, you raise prices in January; you raised prices 2.25 percent.

So whatever you would have gotten, that's over a year ago.

So whatever you would have gotten in the first and the second quarter, that same gain should have accrued to you in the third quarter.

So the real mystery to me is why the revenue yield in the third quarter on the waterfall chart is only 34 million, as opposed to 107 in the second quarter.

I think it goes back to the earlier answer that I gave, John.

This is an average price increase, so a lot depends on which products and which geography sales were coming from, because the price variance varied anywhere from 0 to 5 percent.

So the average -- you'll just see a variance and fluctuation in that, depending on which products were purchased and where.

I'll get back in queue.

Andrew Casey.

Prudential Equity Group.

Just, I guess, returning to the core operating costs bar in the waterfall chart for a second, if I understand the issues correctly as you described them to John, should that bump up again, on a year-over-year basis, back closer to what we saw in the second quarter, when we look at it from a fourth-quarter perspective?

Or does fourth quarter have a more difficult comparison?

As we said, Andy, the main differential on the accrual swing, we believe, has happened in the third quarter.

So we don't anticipate that you'll see that sort of change in the fourth.

Joanna Shatney.

Goldman Sachs.

Nancy, can you just talk about the '04 revenue outlook?

And is there a sales mix issue that you can kind of help us with, because it seems like that's part of the margin issue here. [Were you] expecting the gain next year to be a healthy blend between the high-margin stuff and the low-margin stuff?

Or what's the expectation at this point?

Joanna, it will depend, of course, on where the growth in the economy occurs.

As you see electric power as distributed generation, bigger power plants come into play.

That will improve the mix.

If mining comes back, of course, that is an opportunity for improvement, as well.

Overall, we're looking at a fairly similar mix, at this point, to what we currently have.

But later on, as the economy continues to improve, we should see some improvement in mix, as well.

We should be able to see something which is a more normal CAT operating leverage in '04?

On that 10 percent?

Joanna, I think we will go into more detail on the first quarter of what our anticipation is.

In this quarter, we would really like to leave it at these are what we're anticipating revenues and sales to be.

Okay.

Can you just talk about some of the things?

I know that is in '04, but we kind of have some clue of what they'll be, like the MCPs -- how much you anticipate that will cost you?

Well, this is the good news.

We will not have MCPs in 2004.

And the pension OPEB incremental?

We haven't made a statement on that yet.

Our plan year ends in November, and we'll have a better idea after that.

Mark Koznarek.

Midwest Research.

A question on some of the end markets.

Oil and gas is surprisingly weak, even though the recount is still robust and the commodity prices are still strong.

Can you speak to that?

Sure.

I think I can probably put the differential to rest with one comment.

Solar had a very large transaction deliver in third quarter '02.

The same magnitude project was not completed in '03, this quarter, and therefore, the comparable is difficult.

And that's where we see most all of the change.

Was it a timing thing?

Is Solar expect to have a better fourth quarter?

Or you just had a big bubble last year that didn't reoccur?

Well, Mark, you know it's kind of a lumpy business with Solar, very cyclical.

And depending on where projects fall, you will see a big swing in their sales and revenues.

Okay.

And then, if I could ask you about China, because I was kind of surprised to see the Machine revenue in Asia/Pacific drop to only 10 percent.

That sounds funny, saying that; but it's been a lot stronger.

And I'm just wondering if you can sort of characterize the market there for you guys.

Is there timing issue there?

Is there a slow-down, or can you just discuss it a little bit?

No, China is still a very much a growing market, and we continue to do well in China.

Mark, you may be seeing a bit of comparable that Asia/Pacific had improved last year, and the comparison is getting to be more difficult.

So the 10 percent increase is from a higher level than it was last year.

Okay.

But there's apparently no timing issue that you -- because of the distances, you ship it all in the first part of the year and then sell it in the second -- (multiple speakers)?

No.

A lot of the production is in China.

Okay.

Thanks a lot.

Ann Duignan.

It's Ann Duignan at Bear Stearns.

My question is building on the mining activity.

We understand that roughly 50 percent of your mining sales are North American-related, and the remainder to rest of world.

We would expect that the rest of the world mining sales will pick up based on metal commodity prices and global GDP.

Can you give us any outlook for the North American coal industry, and what you might be seeing there, or what you might be expecting going forward?

Ann, are you asking for 2004?

Or just the remainder --?

2004.

I don't think we can get into that level at this point in the year.

We may speak more to it as the year progresses next year.

Can you give us just a general outlook of coal mining activity in North America, even for the rest of this year?

Any inventory replenishment going on at the utilities?

Or are you seeing any pickup in activity there?

Ann, as you know, in 2001, we saw a big replacement cycle in the coal mining activity.

And coal mining -- coal prices continue to be relatively low in North America, so we really haven't seen the replacement.

Joel Tiss.

Still with Lehman Brothers.

Two questions -- one, can you give us a sense of why the truck and bus engine business was down 25 percent?

Is that all from a product transition?

And a sense of what's going on in the fourth quarter?

Gerald, it's all from a difficult comparison with the pre-buy prior to the October 2002 emissions regulations.

Caterpillar continues to hold its market position.

The awards data just recently came out, and we continue to have over one-third of the market for truck engines.

So there isn't any product transition issue for the fourth quarter at all?

We're not seeing that.

And second, can you give us a sense of why the income, the operating profit in the financial division, was up so strong, so we can get a sense of what might be some of the driving factors for 2004?

It's continuing return from earning assets -- I mean, as the release says -- and a favorable change in the gain or loss on sales of equipment.

Those are the main factors.

Robert McCarthy.

Robert W. Baird.

First, can I also beg for just a clarification -- on the pension OPEB 196 year-to-date figure you mentioned, is that the year-to-year change relative to prior-year level, or is that an absolute measure of expense levels?

No, it's the year-to-year change.

I just wanted to make sure.

Yes.

It would help a lot, I think, if -- regarding this question about variable pay and core operating costs, et cetera, if you could give us what the -- as John said, in this waterfall chart.

What would the core operating cost delta be for the nine months, and can you tell us, then, what kind of level of variable pay number is netted into that for the nine months?

We will provide more detail in the 10-Q.

That will give you a good feel for it and allow you to project going forward.

In other words, in the Q, you'll give us what the first-quarter contribution was?

It will be the year to date.

It will be the year to date?

Right.

I'm sorry, was the year to date in the second-quarter Q?

Yes, it was.

I apologize.

I'm sorry; it wasn't the variable pay.

It was the core operating.

Only the core number?

Yes.

And you're going to have something to say about the variable pay in the Q?

We will, because it's material now.

On my not-quite-so-related follow-up, last year, you didn't make an initial revenue forecast for the coming year after the third quarter, like you are doing this year.

Isn't it fair to assume that that means that there is a material improvement in your confidence about the outlook for the coming year, this year relative to (multiple speakers) last year?

Rob, I think the reason we didn't last year is because there was so much political uncertainty in the world.

And this year, we don't have those same factors -- quite those same factors -- so we're making a statement about the outlook.

That has been our policy in prior years, and last year was the exception.

Stephen Haggerty.

Merrill Lynch.

Good morning, Nancy and Lynn.

Nancy, just for clarification, I wanted to make sure.

I think in the last two quarters, you told us the percentage change in the dealer rental, sales to dealer rental operations.

I had here it was up about 27 percent in Q1, and about 25 percent in Q2.

Did you give that number when you ran through your rental discussion this morning?

No, we didn't.

Would you like to?

And, Steve, the reason we don't mention that as a factor is because of its significance relative to other factors.

There is more of a broad-based improvement, and so it didn't rise to a level of note.

But I want to assure you that that rental replacement cycle continues.

On average, the rental fleet replaces on a three-year cycle.

As you can imagine, it's a significant competitive advantage for CAT because of the relative use of our rental fleets compared to other alternatives.

But you are suggesting that as a contribution to the overall unit sales of the Company in the quarter, rental sales were less significant then they were in either the first or second quarter?

That's why you're not mentioning it?

That's correct.

And if that's true, I'm surprised that the mix effect was as negative as it was.

I am just thinking I thought maybe that was one of the reasons why you had this negative mix effect, because you kept seeing sales of smaller equipment to some of the rental operations, and if it was a more broad-based sales pattern, what's accounting for the relatively weak -- or drag from mix?

The compact construction is increasing, and the smaller end of the electric power business has been increasing, as well.

Fuel systems in Engines have decreased, and those were more profitable than the current mix.

Those are a few of the elements that have impacted this.

So mix was not -- I guess I'll stop here.

Mix was not just in Machinery; it was also in Engines (multiple speakers)?

No, it was across the product lines.

Barry Bannister.

Legg Mason; this is Barry Bannister.

A quick question.

Last year in the fourth quarter '02, just looking at the press release, it talks about sales and revenues up 5 percent.

Then it says that was largely due to a 180 million improvement in price realization, about half of which was due to the favorable impact of currency, and higher sales volume.

So it seems to be setting off a tough comparison in fourth-quarter '03 pricing, given that we had the step down in the waterfall from the second to the third quarter, from 107 to 34.

So would you tell me what the comparable year-ago fourth-quarter price realization was, so I will know what to expect as we go into the new quarter?

Barry, I'm going to have to get back to you on that one.

I don't have that information.

Well, if it says about 180 million in price realization, about half of which was due to favorable currency and higher sales volume, can we imply (sic) that the net was 90 million of price, or what?

You know, I'm going to have to get back to you, Barry.

Okay.

And just on the related pricing question, is the truck engine pricing netted against the fines in the year-ago period?

And has it done so in this quarter, and could you give us a little breakdown on that?

It depends on what you're looking at.

If you're looking at sales and revenues, then it is simply the price increase is included in the emissions bar.

If you look at the graph in the release, you'll see it in the emissions bar.

As a profit item, it is netted against -- there's a net impact.

I'll refer you to the glossary and the definitions of change in emissions standards, and it is netted -- you take the price increase, and you take out production and manufacturing cost increases, minus the NCPs, and that's what's contained in the bar on profit.

I get it.

The chart on page 3 and page 6 have a different presentation mode.

Thanks a lot.

That's right.

I think we have time for one more question.

Corey Gilcrest.

I'm trying to try to triangulate the margin variable comp, et cetera, with the incremental margin comments that everybody has had.

As we look at Engines' last third quarter for the Company, and margins flat year-over-year, despite the fact that there were a lot of engines produced in third quarter '02 for pre-buy, and the economies of scale you get with that, and the fact that you're paying NCPs in the third quarter of '03 that fall away, as I look at that operating profit bar chart, the netted emissions, my guess is in the fourth quarter and in 2004, that's going to be a significant positive, as the NCPs fall away and we get the price increase on the ACERT platform.

And related to that, I'm wondering if that 75 million variable comp accrual is related to your forward look of what happens in the fourth quarter as we move to 100 percent ACERT, as well as 04?

Corey, let me address the first part of the question first, which is that I think next year at this time, we will be talking about a variation as a result of the NCPs falling away, that's definitely true.

And then the second part -- I'm not sure I understood.

Could you repeat the second part?

Corey Gilcrest As we move from the third quarter of '03, with NCPs being paid, and you are looking to the fourth quarter, is a portion of that variable compensation accrual due to the fact that we have an operating profit swing per engine of the price increase with NCP fall-away, let's say $5,000 a unit, is that part of the reason for the variable comp, and is it the timing, looking into that fourth-quarter profitability swing?

Corey, it's Lynn.

For the group, let me just say something about this variable pay question.

We thought -- and obviously, because of the magnitude of the quarter-to-quarter shift, it's something we needed to disclose here, and thought this would be a fairly simple explanation, I guess.

But the accrual that we make that goes into the expense for variable pay is based on a formula that is tied to our forecast for our operating results.

And because of the fact that our outlook has improved from the beginning of the year to the $3 a share right now, we have increased the accrual for variable pay, which impacts, as Nancy pointed out, virtually every employee of the Company.

What the accrual represents is our outlook, at this point in time, of $3 a share, which will drive, then, the payout of various programs around the Company that are based on performance.

So, in answer to your question, what the expense or the accrual is based on is the $3 outlook.

Great.

And as a follow-up, the 2004 guidance that you have given of 10 percent revenues with the 30 to 35 percent incremental margin comments that have been made -- does that lead to the significant margin improvement that we're expecting after the NCPs fall away?

We will certainly talk more about the 2004 margin and profit outlook in the first quarter, when we make our fourth-quarter release.

Okay.

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

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

Thank you for your interest in Caterpillar.

Thank you, ladies and gentlemen.

This does conclude today's teleconference with Caterpillar.

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

Thank you for your participation.