開拓重工 (CAT) 2004 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Caterpillar's first-quarter 2004 earnings conference call. (OPERATOR INSTRUCTIONS).

It is now my pleasure to turn the floor over to your host, Nancy Snowden.

Ma'am, you may begin.

Good morning and welcome to Caterpillar's first-quarter 2004 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 morning I will cover our first-quarter results, discuss three special topics, review our outlook, go over the usual dealer retail numbers, 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 first-quarter results.

As you know, this morning we reported record first-quarter sales and revenues of $6.47 billion and record first-quarter profit per share of $1.16.

Sales and revenues were up $1.65 billion from first quarter 2003.

The increase was due to higher machinery and engine volume of $1,033,000,000; a favorable currency impact on sales of $176 million, which was due mainly to the stronger Euro; favorable price realization of $74 million, and higher financial products revenues of $68 million.

Profit was $412 million, $283 million higher than first quarter of 2003.

The increase in profit was due primarily to a $405 million favorable profit impact of higher sales volumes, higher price realization of $74 million and the absence of $49 million in nonconformance penalties paid in the first quarter of 2003.

These favorable items were partially offset by higher core operating costs of $77 million, higher retirement benefits of $55 million, and the net unfavorable impact of currency of $15 million.

Machinery & Engines core operating costs were $77 million higher than first quarter 2003 levels as a result of higher spending to support volume growth, including higher steel prices, production ramp up, material expediting costs and general support costs to meet the current higher than anticipated demand.

In addition, higher incentive compensation due to increasing our outlook above what was originally anticipated and increased spending on product development programs also contributed to higher core operating costs.

These unfavorable items were partially offset by the positive impact of continued material cost reductions.

As communicated in the release, the total negative impact of currency on operating profit was $68 million.

However, as a result of currency hedging gains included in other income and expense, the net unfavorable profit before tax impact of currency was reduced to $50 million.

The main reason for the negative impact was our significant short position in the Pound Sterling and Japanese Yen due to sizable manufacturing operations in the UK and Japan.

Hedges are in place, which at today's rates, should mitigate more of this risk during the remainder of the year.

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

North American dedicated rental fleet utilization on a twelve-month rolling basis is continuing to run at a very strong rate, about 67 percent, which is 3 percent higher than the same same period last year.

Rental rates for the rolling twelve-months through February were up 2 percent from a year ago.

Rental rates are forecasted to improve 2 to 4 percent over the next six months.

Overall units in dedicated dealer rental fleets are up about 3 percent from a year ago.

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

Rent to rent units, which currently make up about 55 percent of the units and dealer rental fleets, are down 2 percent from a year ago.

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

These fleets continue to grow and are up about 10 percent from a year ago.

North American dealers added three rental stores in first quarter 2004 for a total of 391 stores.

About five more are expected by year-end 2004.

In the Europe, Africa, Middle East region, dealers had 793 rental outlets, 306 of which were converted to the CAT rental store identity as of quarter-end.

In Latin America, we had 103 stores and 118 in Asia-Pacific,, including Japan.

At year-end 2004, we are expecting about 1480 rental outlets throughout the world.

Of these 380 stores in the United States and Canada and about 480 in the rest of the world will have the CAT rental store identity.

North American used equipment prices trended up more than 6 percent in the fourth quarter of 2003 compared to fourth quarter of 2002 for most machines.

We expect continued strengthening in the near-term.

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

The Company continues to yield benefits from our focus on sales and operations planning and order fulfillment for processes.

These processes combined with the flexibility realized through our alternative sourcing strategy has allowed us to provide dealers with improved and stable availability on a majority of our products.

We are, however, experiencing isolated availability problems on selected models where very strong demand has exceeded our forecast.

At the end of the first quarter, the following models were being managed under the North American commercial division managed distribution program -- hydraulic excavators, the 330 and 325; articulated trucks, the 740, 735, 730, and 725, and medium track type tractors, the D6N and D5N.

Plans have been developed to improve availability on these models.

Many dealers continue to provide low hour machines from their rental fleets to fill customer demand.

We announced worldwide machine and parts price increases to dealers averaging 1.5 percent effective January 2, 2004.

Caterpillar is holding to the price increase and has been invoicing dealers at the increased price.

Earlier this week we announced to the dealers additional worldwide price increases of 2 to 3 percent on machines effective on shipments from the factory on or after July 1st, 2004.

Actual price changes may vary by model and geographic region.

Now for the outlook.

The world economy is in a bigger recovery and global economic growth should be about 4 percent this year, up from 2.5 percent last year.

All regions are improving, although the recovery in the Eurozone economy is still weak.

The world economy should provide a favorable climate for our businesses.

We expect continued low interest rates will encourage more replacement buying, as well as drive recoveries in housing and nonresidential construction.

Recent increases in coal and metals prices have prompted mining sectors in most countries to increase investments.

We expect the mining recovery to strengthen further.

Included in the outlook is a revision of our expectation of industry sales of heavy-duty truck engines in North America including Mexico to 240,000 units in 2004.

For midrange engines, Caterpillar sells not only into the midrange truck and urban bus market, but also has growing sales into the RV market.

For this reason, we include an estimate for the bus and RV market in our overall projections of the midrange engine market.

Our industry forecast for NAFTA midrange trucks, urban and specialty buses and RVs for 2004 is approximately 180,000 units, up from a comparable figure of approximately 150,000 units for 2003.

We project Company sales and revenues will increase about 20 percent in 2004, up from the previous forecast of about 12 percent growth.

Machinery & Engines volume is expected to increase about 16 percent, and the favorable impact of currency is expected to contribute about 2 percent with the remainder coming from improved price realization and from financial products revenues.

We now expect profit per share to be up 65 to 70 percent compared to 2003, up from the previous forecast of about 40 percent.

We expect to deliver 6.5 to 7 percent return on sales and revenues in 2004 as compared to 4.8 percent in 2003 despite an increase in retirement benefits of about $250 million and pressure on core operating costs associated with supporting higher than anticipated volumes.

Full details of the outlook for 2004 including other assumptions are contained in the Company's press release issued today.

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

All comparisons are based on constant dollars.

Retail sales of machines for the three months ending March 2004 compared with the same three months of 2003 are -- Asia-Pacific up 39 percent;

Europe/Africa/Middle East, up 19 percent;

Latin America, up 49 percent; a subtotal of the three, up 30 percent;

North America, up 43 percent; world, up 37.

Retail machine sales were up in all marketing regions.

North American sales benefited from continued replacement buying, upgrading of rental fleets and increased construction activity.

The depressed North American coal mining sector recovered sharply.

Strength in dealer deliveries to end-users in Asia-Pacific was pervasive, covering most countries and most industries. 19 percent higher sales in Europe resulted primarily from deliveries into rental fleets.

Sales into countries with sizable energy and commodity sectors accounted for the growth in Africa/Middle East.

The 49 percent gain in Latin America was due to the mining sector.

For the three months ending March 2004 compared with the same three months of 2003, total reciprocating and turbine engine sales to users and OEMs were as follows -- electric power, up 37 percent; industrial engines, down 8 percent; marine engines, down 3 percent; truck and bus engines, up 28 percent; petroleum, up 17 percent, and total, up 20 percent.

Now let's turn to dealer machine inventories.

First, sequentially comparing March with February 2004.

Asia-Pacific, down 1 percent;

Europe/Africa/Middle East, up 10 percent;

Latin America, down 8 percent; and a subtotal of the three, up 3 percent;

North America, up 6 percent; world, up 4 percent.

Next, year-over-year comparing March 2004 with March 2003.

Asia-Pacific, up 20 percent;

Europe/Africa/Middle East, down 1 percent;

Latin America, up 54 percent; a subtotal of the three, up 12 percent;

North America, up 24 percent; world, up 18 percent.

Dealer inventories of new machines at the end of March compared with the year-end were up on a worldwide basis about $500 million, most of which incurred in North America as dealers are preparing for the upcoming selling season.

Dealer inventories related to sales are still lower than a year ago, so that an increase in retail demand should translate to increased sales by Caterpillar.

Our expectation for full-year 2004 is for dealer new machine inventories to increase in the $140 million range on a worldwide basis.

Asia-Pacific dealer new machine inventories are at 1.7 months of sales, down from 2.6 a year ago.

Europe/Africa/Middle East dealers are at 2.5 months of sales, down from 3.1 months a year ago.

Dealer new machine inventories in Latin America are at 2.3 months of sales, down from 3.4 months a year ago.

Dealing new machine inventories for the subtotal of these three regions outside North America are at 2.2 months of sales, which is down from 3.0 months a year ago.

North American dealer machine inventories are at 2.2 months of sales, up from 2.4 months.

Overall on a worldwide basis dealer machine inventories are at 2.2 months of sales, down from 2.7 months a year ago.

The retail specifics for March are also available on voicemail through May 17th by calling 309-675-8000.

Now I want to comment on three special topics that I think will be of interest.

First, with the change in our profit outlook, a topic of interest may be the anticipated 2004 payout under Caterpillar's short-term incentive compensation plan.

In our proxy statement, we stated that approximately $335 million in short-term incentive compensation was earned by approximately 52,000 employees in 2003.

The compensation committee of the Board of Directors bases the incentive compensation target on a significant stretch above the Company's performance outlook for the year as stated in January.

As stated today, our profit outlook has increased from the outlook stated in January.

Naturally we expect you will be interested in how incentive compensation will be impacted as a result of the improved outlook.

Incentive compensation expense in Q1 2004 is an increase of approximately $60 million.

Based on our current outlook, we expect full-year incentive compensation to be up approximately $100 million compared to 2003.

The combination of base pay plus incentive compensation at target allows Caterpillar to pay at competitive salary levels.

Over the past 13 years, Caterpillar's short-term incentive compensation plan has paid out at about 105 percent of target with some years above and some years below target.

Incentive compensation allows us to vary pay to employees in accordance with the performance of the Company, thus assuring close alignment with shareholder interests.

Second, I will give an update on material cost and steel prices in particular and their impact on Caterpillar.

Approximately 10 percent of Caterpillar's direct material cost is for steel purchased directly by Caterpillar and another 10 percent for steel purchased by our suppliers.

Approximately 60 percent of our cost of goods sold is attributable to direct purchases.

We are continuing to work with our suppliers to contain prices.

We have numerous projects underway using Six Sigma to help our steel suppliers contain their own internal costs.

From an macroeconomic perspective, we are seeing increasing availability of scrap steel.

As a result, the price for scrap has decreased approximately 20 percent since February and appears to be on a continuing downward trend.

As scrap prices decline, we are seeing steel surcharges ease.

As a result of our cost reduction efforts using Six Sigma and the easing of steel surcharges, we continue to anticipate that steel prices at Caterpillar will increase in the range of 4 to 5 percent for the year of 2004.

Even including this anticipated steel price increase, we believe that our total direct material costs per unit will be reduced in 2004 relative to 2003, reflecting other material cost reductions efforts.

However, the reduction in our material cost per unit will not be as great as we had originally anticipated because of the steel prices increases.

Our final topic today is operating profits on our engine line of business.

Our engine operating results have gone from a loss of $54 million in the first quarter of 2003 to a profit of $40 million in the first quarter of 2004.

This turnaround indicates that the introduction of our groundbreaking ACERT technology in our on-highway truck market, severe cost restructuring efforts, and selective pricing actions over the last two years are beginning to reap benefits in the engine business.

Our current level of operating margin is forecasted to continue to improve throughout the year.

In the first quarter, our volumes improved due primarily to stronger industry demand.

Core operating costs improved despite spending to support the surge in volume, which includes some selective utilization of suppliers to meet peak volumes needs.

However, at an operating profit level, this net improvement in core operating costs was offset by the impact of a stronger Pound Sterling on our manufacturing costs in the UK.

As mentioned before, at a profit before tax level, hedges are in place which reduce this currency loss and should mitigate some of the Pound Sterling risk for the remainder of the year.

We have transitioned to selling all ACERT engines to the on-highway truck market.

We are still experiencing ramp-up costs with our ACERT product, which causes us to not realize our full operating margin.

We anticipate the ramp-up costs will be phased out in the second quarter of this year.

As mentioned in the release, we saw growth in deliveries into the electric power market in the first quarter.

However, the industry levels are still significantly below the pre-2002 volume level.

We have taken actions to adjust our cost structures to this lower level of volumes in the marketplace.

While price levels have begun to recover from the impact of the industry downturn and resulting inventory overhang, they are still below the pre-2002 level, thus impacting our margins in this business.

We expect to see stronger industry growth for the remainder of the year in our on-highway truck, petroleum and electric power businesses.

This industry growth, coupled with the full impact of improved margins on ACERT engines in the on-highway truck market, continued cost improvement, and selective price actions, will improve our margins throughout the year.

One last thing before the Q&A.

If you were planning on attending Mine Expo (ph) in Las Vegas, be sure to save September 28, 2004.

We will be holding a luncheon for security analyst.

You will have an opportunity to hear Chairman and CEO Jim Owens speak and answer questions.

We also will be giving a tour of the Caterpillar booth at that time.

Further details will be coming out in the second quarter.

Okay.

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

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

First question, please.

(OPERATOR INSTRUCTIONS).

Alex Blanton.

It is Ingalls & Snyder.

First question relates to the price increases you announced -- 1.5 percent in January, 2 to 3 percent effective July 1 -- and yet you have said that material costs you expect overall to decline.

So my question is, how are you justifying -- I am not complaining understood -- but how are you justifying these kind of price increases to your dealers and your customers when, in fact, your costs seem to be going down?

Good morning, Alex.

It is a matter of a number of years we had taken no price actions at all.

And as the economy improves and we have over that period of time, of course, continued to invest in our products and improve them, and the timing is such that it looks that it is appropriate to have this sort of price increase.

Okay.

So the market will bear it is what your same basically, and you are recovering the value-added to the product in terms of new technology?

That is right.

Okay.

Second part of the question relates to the forecast.

Again, I am not really complaining, but I am just wondering how you react (multiple speakers) to this.

If you take the first quarter sales, the year sales back to first quarter, the rest of the year is going to be up 16 percent versus your 20 percent forecast for the year as a whole.

But if you take the quarterly rate for the rest of the year then, it is 7.5 percent higher than the first quarter you have just reported, which seems awfully conservative in terms of the usual -- first quarter is usually weak.

And the same kind of calculation you can do for the earnings, although it is not as questionable.

But I am just wondering, was there something about having a really weak first quarter last year in comparison with the rest of the year and then a very strong quarter this year?

And in relation to that, you said dealer inventories were up 500 million I think in the first quarter?

Yes.

Has there been a lot of dealer inventory buildup because of strong demand that is skewing the first-quarter numbers a little bit, and that is why you are seeing the seasonal increase for the rest of the year being only an average of 7.5 percent for the first quarter?

Well, I think you asked a couple of questions, and you have also helped me by answering the first one probably for me.

Alex, you are right on.

As we progress through 2004, we will be comparing sales quarters in 2003 when the recovery was underway.

While there will continue to be solid improvement in 2004, the fact that percentage comparisons will be against that improving base year will cause some slowing in the year-on-year percentage increases.

And as to your inventory question, you know it is very typical that you would see a buildup in inventory in preparation for a major selling season in the Northern Hemisphere.

What my question is really, is that more than usual because you are only forecasting about an 8 percent average in sales figure for the rest of the year versus the first quarter just reported?

I think it is in line with the sales projections.

You know as you look at it, months of sales in inventory have decreased from a year ago.

So I think that gives you an indication.

David Raso.

Smith Barney.

One clarification before my question.

Second quarter last year you raised guidance a great deal, but it appears we didn't take the hit on the higher short-term incentive until the third quarter.

The way you laid down the full-year increase in incentive compensation this year, 100 million, and you already took 60 million of the hit in the first quarter, is it fair to say that you captured the increase in the EPS guidance better this time around, or you captured it in the current quarter, the first quarter already?

Yes.

We have captured that in the first quarter, and as you see, the 60 million was in the first quarter, and we have captured it earlier.

My question is really more on the mix.

If you look at your waterfall chart and just look at sales volume and then the operating profit benefits and volumes, exclude price, currency, everything, it looks like the margin on that incremental sales volume was 30 percent.

In the fourth quarter, same analysis says 14 percent.

The mix alone then by being 30 percent margin, not 14, added 38 cents to the quarter, of course, tax effecting it.

The mix the way it is playing out, is there anything abnormal about the first quarter?

Obviously we do our own work and do it through the mix is getting stronger, is there anything about the first quarter that we should not extrapolate on mix for the next two or three or four quarters?

There is a positive impact on mix in machines definitely.

As we see larger equipment, mining trunks, etc. come back, but there is a negative impact on engines as well because we are seeing less sales by solar into the old oilpatch.

We are also seeing some increased electric power sales, and the negative impact of that mix is that that has been priced so low that we are at a low base on electric power.

We also see additional sales of the compact electric sets from Perkins.

So the year -- it should not really change very much.

From what we saw in the first quarter?

No.

It should not.

In answer to your overall question, no, it should not change much.

So in summary, the incremental benefit we saw in the quarter from mix versus just the fourth quarter, that momentum should not really change dramatically?

No, it should not.

Gary McManus.

J.P. Morgan.

Hi, Nancy, and congratulations.

Just looking at two items in the P&L -- SG&A and R&D.

I mean SG&A was only up 2 percent on a 36 percent sales gain, so you did very well there.

But R&D was up 47 percent.

Can you talk a bit about what was going on in those two categories, and what kind of assumptions we should use for the rest of the year?

Okay.

The assumption you ought to use on R&D for the rest of the year is 3.6 percent, which is exactly what the percentage was in the first quarter, and I think that is pretty historically the average that we have seen.

So I think that is a good estimate for R&D.

SG&A, it should be about the same going forward.

So I think you can look at that and use those as your percentage.

Same in terms of the -- it was about 9.9 percent of revenue -- the same in percentage terms or year-over-year increases?

I would say 9 to 10 as a percent would be in the ballpark.

Okay.

Even though the first quarter year ago was like -- per user, your SG&A as a percent of sales is high in the first quarter because it is a weaker quarter seasonally.

Well, this was, as you know, it was a good quarter.

The second question.

It looks like you might be generating very good free cash flow this year.

I assume there is no real changes in the D&A or CapEx.

So can we assume that the 250 million of cash used to repurchase stock, is that a good guide for the run-rate for the year, or what is the potential of acquisitions?

Yes.

I really cannot speculate on that one.

You can't even assume that we can't use the 250 million run-rate for the first quarter and for the rest of the year?

No, I do not think we should.

Lynn, do you want to talk to that?

Let me just add a little color to that.

The reason we cannot we have talked to you before, as you know, about our priority of cash uses, and the share buyback program is what we identify as residual cash.

In other words, cash that is available after we have satisfied growth, done the CapEx, done our R&D, and paid whatever dividends the board decides should be paid to shareholders.

So those amounts could vary, and as you also know, we do not speculate on acquisitions.

So we really cannot address that.

Sorry.

Just to clarify the 65 to 70 percent earnings per share growth does not assuming any share buyback beyond the first quarter?

Is that it?

There is some, but like we said, we are not ready to disclose that.

Ann Duignan.

Bear Stearns.

I would like a little bit of color on both the electric power business and the petroleum business just in terms of building on Raso's question on mix.

Can you tell us a little bit about the mix between reciprocating engine demand versus solar products by region?

And then the outlook.

Do you expect the profit side of petroleum to pick up through the year?

Do you expect distributed generation to pick up versus backup?

Can you just give us some color on both of those end markets?

Sure, I would be glad to.

As you know, first let's look at petroleum.

Energy prices are somewhat volatile, but there still very high with oil at $28 a barrel plus and gas at over $5.00 per BTU.

We are seeing the drill rig count increase by about 11 percent, but like I said, price volatility is still something of a concern.

As you note from our release, the Caterpillar sales of engines into the petroleum sector were up 15 percent in the first quarter of 2004 from fairly depressed levels in 2003.

This increase was powered by stronger gas compression in the United States.

However, activity for North American gas transmission and offshore production are at reduced levels after several years of very high activity.

That impacts solar sales.

We expect Caterpillar sales into the petroleum sector to be up for 2004, but not by quite as large a percentage as we are seeing in this first quarter since the comparisons get more difficult as the year progresses.

Now that is the story on petroleum.

And as to what is going on in electric power, again we see clear evidence that growth has resumed in electric power.

You would expect this with the global economic growth.

We are also seeing stronger sales into the Middle East and Europe for engines and stronger sales of turbines in Latin America and in the cogeneration applications in North America.

Now, as you know, it was a 51 percent increase year-on-year, and I think we need to get a little prospective on that number.

It was a very low quarter, first quarter last year for electric power sales.

So although again we expect the electric power to increase year-over-year, it won't increase in nearly that percentage.

I hope that answers your question.

So just in summary, if I am hearing you correctly, petroleum will be up but not as significantly as in Q1, and the mix will probably be leveraged more to the reciprocating engine side than turbines? (multiple speakers)

That may not be the correct assumption because, as you know, that is what happened in the Q1.

But, as you know, turbines are a bit of a lumpy business, and they may not have been as strong, showed great strength in the first quarter, that does not mean the year will not be strong.

And then on the electric power side, this is really driven by global GDP and coming off a very low base?

That is a huge help.

Just as a follow-up question.

Some figures (inaudible) any discussion of the logistics business, except that employment increased in that business.

Can you give us an update on how that business is progressing and what is driving the hiring?

The business continues to grow.

We did not make a comment on it, but that does not mean that it is not still a significant part of our growth story.

As you can extrapolate from the increases in employment, there is significant growth going on in CAT logistics.

Can you give us any color on that where or what customer is a part of the Bombardier deal, or is it in anticipation of new business?

I think it is both, Ann.

Lynn, did you want to jump in?

Yes.

It is not -- you used the comment anticipation of new business.

The employment additions were for new warehouses, new customers that were opened in the first quarter, so it is not anticipated.

It is actually business that has been contracted.

Joel Tiss.

Still at Lehman Brothers.

I wonder if you guys could -- there have been a couple of questions about this -- can you give us a sense if you just run down through the different segments of which areas you would expect to grow faster than your 20 percent Company average and which one is slower?

Just to give us a little bit of a sense and then we can figure out the mix from there?

You know we do not like to go on an outlook on a segment, but I think we have given you some information like, we expect mining to strengthen.

I would say that -- hang on here;

I will try to give you a -- I can run down this getting to the right place in my release here.

Okay.

What we are expecting is -- are you looking for industrial segment, or are you looking for geographic area?

The industrial segments.

Okay.

We can give you by geographic, but we cannot give you by industrial segment.

Well, whatever you can I guess would be helpful.

I think some of the things we have told you already are that mining will continue -- I think it is an across the board strength that we are expecting for the year.

And I think of particular note is the mining segment.

All right.

Can you talk a little bit then about share gains?

Your sense on if you have been gaining share and which areas we should be focusing on?

Another question that we do not like to talk to, of course, is market share.

So I am afraid we cannot really help you out there either.

Andrew Casey.

Prudential.

A question I guess back to David Raso maybe answered it, but on the incentive accrual, you projected somewhere around 100 million hit this year because of the higher level of earnings.

Presumably that hits in Q2.

Would that potentially turn a positive variance in the second half of the year?

Let me clarify.

It is a 100 million for the entire year. 60 million is already in Q1.

So I think you are thinking back, Andy, as you should be, about what the shape of the accrual was in 2003.

As you remember, we increased the accrual toward the end of 2003, and now we are increasing it more toward the front.

I would say the vast majority of the increase will show up in the first half.

Okay.

And you potentially get pricing going into the second half.

So some of that should year-over-year -- okay.

In terms of the mining, you gave some regional breakout in the quarter.

Can you give us a sense of what it did overall year-over-year?

It came from such a low base.

As you can imagine, with gold at over $417 an ounce and copper greater than $1.38 a pound, Appalachian coals around $50, this has been an area for significant growth.

We expect that -- we had strong activity in mining in Asia-Pacific and Latin America, and of course, with coal prices going up, we are seeing increased activity in North America.

The utilization on the fleets are very high, and that continues to be reflected in the tight supply of used mining equipment.

Our expectation for 2004 mining sales will show marked improvement over 2003.

Sorry I cannot give you an exact number.

But it is pretty significant coming especially from a very low base.

Okay.

A follow-up on that last mining.

Did the strength that you saw in mining contribute to some of the managed distribution that you noted on some of the products?

No.

Those were not mining related pieces of equipment.

The basis of the question is some of the equipment comes from the same plant, though.

No -- well, no, that is not correct.

None of those -- I don't think there is any overlap between decayer (ph) mining and the big track type tractors, which would be some of the most significant segments.

Wouldn't you agree, Lynn?

Yes, there are different plants.

Joanna Shatney.

Goldman Sachs.

You changed the expected destocking of which you had an actual inventory increase.

The change is about $190 million better for CAT.

How does that rationalize with your whole theme that the dealers are going to carry lower inventories long-term?

Does this inventory increase just because the sales base has gotten much stronger, or is it because they are worried about product availability?

You all are helping me a lot today in answering your own questions.

It still continues to be a low month of sales in inventory.

We are maintaining that as we had indicated we would.

So there is no change in the fact that the inventories that the dealers hold are trending lower over time?

That was always our intent to have them trend lower over time and keep less in inventory.

It is a sensible business approach I think.

Just on the finance stuff.

The revenues were up only 14 percent compared to the overall Machinery & Engines business being up over 35.

Why are we not seeing a higher revenue growth rate out of the finance subsidiary, and will that business catch up through the year?

That is a factor of the low interest rate impact on those revenues.

You want to take that, Lynn?

Let me add a little color to that.

There are two things at work, and Nancy has already answered one of them.

The lower interest rates on new contracts obviously have some impact on the dollars or revenue, but it also reduces the cost of funding for the finance company so the spreads are maintained.

But the other thing you have to think about their revenue increases will not necessarily be lockstep with our sales because the contracts they put on their books average somewhere between four and five years.

So the revenue generated over the life of the contract is spread out over a longer period of time.

They had a record first quarter in terms of retail volume, almost $2 billion of retail volume.

So they are doing quite well.

So if we were to think about the net pricing, does that include any special deals that you are doing in the finance subsidiary?

When you talk about having the 74 million of price realization, that is a net number?

If there are special interest deals, that is reduced from price realization as sales variance.

John McGinty.

Credit Suisse First Boston.

I am curious about the price increase.

When you went through the steel prices and the fact that you are able, in fact, to not have the price increases, really there is some effect, but it is nowhere near the amount of price increase that you put in.

You had raised prices 4 percent coming up to January in the last two Januaries.

Historically you got into trouble in the late '70s because you had the price umbrella.

Competition came in underneath it.

You guys have been fighting for pins and gaining pins dramatically for the last three or four years.

Now admittedly all of your competition has raised prices.

So was this an opportunistic thing, or does this, in fact, reflect the lack of availability?

You can't increase production anyway, so you are just going to go out to price?

It just seems this is so out of character with where you all have been in terms of pushing four pins for the last four years, getting costs down.

Was this opportunistic, or does this reflect the absence of availability?

John, it is a whole strategy of getting the price that we think is appropriate for our products in the marketplace.

Of course, we will keep our eye on pins, and working those two things together, it is a balance.

Well, I guess the question is, what is the availability?

In other words, the leadtimes are out.

You mentioned only six machines on allocation.

Your dealers talk about it -- I am sorry.

On managed distribution, we don't have allocation anymore.

Your dealers talk about leadtimes being way much longer than they want.

They cannot get anything.

Things are way stretched out.

Is this just a UAW-related issue, or when are you going to increase schedules more?

There are a number of things that we are doing in order to deal with this managed distribution situation.

We are hiring more people.

Managed distribution is really where we limit the orders to only those with confirmed customer orders.

Some of the way we managed some of these limitations are that the dealers have been sharing inventory among themselves, and like I said, good thing we are ramping up some of the production in the critical plants.

And global purchasing is working on increasing supplies from our suppliers.

So putting all that together, that is the approach we are taking to deal with the managed distribution or the extended availability that you have noted.

And final question then in that same regard.

What, if anything, can you talk to the UAW vote on Sunday?

Basically from either what the union said or what has been in the paper -- in other words, I know you all are not commenting on it other than to say it exists, but can you give us any color on that from a local area?

No.

It has been a very positive atmosphere around the UAW negotiations.

As you know, we had a confidentiality agreement which was signed at the beginning of the negotiations.

We have not broken from that and neither has the UAW.

Of course, we are hopeful that there will be a ratification, but we really cannot say anything else, John.

Barry Bannister.

Legg Mason.

I am just a little bit disturbed by something I am seeing.

I was going back and doing some calculations.

The midpoint return on sales guidance is 6.8 percent.

I went back and looked at the second year of recovery in the last cycle, which was '94, and your actual net margin that year, your ROS, was 955 million of earnings on 14.33 billion of sales and revenues.

So that was exactly the same.

It was about 6.7 percent, and you are saying 6.8 this year.

At the end of '93, you had 29 goals on allocation like excavators, (inaudible) and wheel loaders.

And I don't think you call it allocation anymore.

But I see in here that there are quite a few things on, let's just call it, backlogs, or it takes a long time to get delivery.

So it seems to me that the only real bottom-line change at CAT in exactly 10 years is that the management has probably taken about 120 basis points off the ROS from incentive pay, and that disturbs me a little bit.

I would like some information on why this is just a typical cycle for CAT thus far, even if you do 5.25 this year?

And why you are not paying yourself maybe on ROS other than off the bottom versus past cycles so we can see what the trajectory is?

I think you have asked a couple of questions.

From the standpoint in this quarter and this year, it is pretty severe ramp-up on volume.

So we are seeing some inefficiencies due to the degree of the ramp-up.

We have expediting cost.

We have out some additional sourcing from suppliers.

Kind of talks to some of the experience in this quarter and perhaps even on the year.

As to the incentive comp end of your question, as I said in my remarks, our incentive comp plus target allows Caterpillar to pay people at a market price.

If you think about our outlook and you look at what the results will be if we perform at that level, it will be about $1 billion more in profits.

The impact of incentive comp is, as I said, $100 million.

So on $1 billion, it would be about 10 percent.

Now that is a very market-based typical incentive comp plan, and that in combination with our base pay puts us at a very competitive level with other industries in our segment.

So I guess the implication that you are trying to give is not really appropriate.

It is a market-based pay, and that would be our bottom-line on it.

I agree with you.

I am just saying that in 10 years, your ROS is flat. '94 and '04 look like they are going to be the same and the differential of 120 basis points in incentive pay.

So I feel like it is a rich program.

We would be at 8 percent where it not for the program.

Obviously some is reasonable, but perhaps this level is excessive.

So I just was -- I will follow up with you off-line, but I would like to go through the long-term plan because I don't have clarity on that now.

We have stated at our $30 billion milestone, our anticipation is that we would be at 8.8 percent or better return on sales.

So I think we are going in that direction, and we are working toward a structure that would allow us to have that.

In this year, we are seeing some pretty severe expediting and ramp-up costs, but overall I think our cost structure is getting in line so that we can perform as we have indicated at around the 9 percent return on sales level at the $30 billion revenue.

You did 8.8 in '97, so that is not an improvement either.

But we will follow up later.

I will call later.

Thanks.

Andrew Oben (ph).

Merrill Lynch.

As Caterpillar is getting more comfortable with the ramp-up in the second half and mining activity has started picking up, should we see the incremental margin start to approach 30 percent, and I mean incremental margin off of the company as a whole as we have seen in the previous cycles, or will the mix and headwind just keep it around the 20, 21 percent range that we saw in this quarter?

Andrew, we do not really make a projection on incremental margin.

I guess it is even a little unusual for us to make one on return on sales, although, of course, you could extrapolate that.

But I think you will have to make your own assumptions on incremental.

But we are convinced that we will have a bottom-line return as was indicated.

Let me rephrase my question just a little bit.

Should I see improvement in mix towards the second half of the year as mining picks up?

It is about the same; that is the anticipation.

So mix will remain constant for the year.

That is right.

Just a follow-up question.

We have hearing that there are issues with suppliers in the mining business.

I think you have difficulty -- we have heard people have difficulty getting mining hires.

Does that limit how fast you guys can ramp up in mining this year?

You know the economic upturn is impacting lots of industries in lots of countries.

As you point out, Andrew, tire is a bit look of a bottleneck, but we have plans in place to deal with that situation.

We have given you an outlook that anticipates what we believe we can build and deliver.

I know.

It is a terrific outlook.

I am just trying to understand what is going to happen to the mix.

Thank you very much.

Mark Koznarek.

Midwest Research.

You went through three topics after your normal presentation of information and the third one was engines.

You said something that I am wondering if you could clarify, which I thought you said something along the lines of limited use of suppliers being used to meet peak levels of demand.

And by that statement, are you saying that you guys are outsourcing production of certain products to third parties that capital remarket?

What is that statement all about?

Well, instead of internalizing some of the capital expenditures at the peak, we are buying those certain components from external suppliers.

What would be a "for instance" just to give me a better idea of what you're talking about here?

Hang on.

I am going to pool people because I don't know that I know that off the top of my head.

Cylinder heads.

We make them and we also buy them, and we are trying to use outside supply to bridge peaks rather than put ourselves in a capacity position that at the peak because then we would have excess capacity if the market turned down.

Okay.

So we are talking about components rather than complete engines?

That is absolutely right.

Okay.

And is this sort of a widespread thing that you are undertaking?

Is it the new strategy here?

Is it -- would you characterize it as normal production planning?

I would characterize it as normal production planning.

All right.

So we do not have to worry about you folks necessarily giving up a lot of margin as you shift production to outsiders?

It would be minor.

Robert McCarthy.

Robert W. Baird.

First, a follow-up on a question that you had earlier on managed distribution.

I am wondering if managed distribution of really what looks like the entire articulated truck productline is a function of demand, or is it more a function of being careful about managing your currency exposure because the product is produced in the UK?

It is managing demand and not currency.

Okay.

We talked a little bit earlier about incentive compensation expense.

I just want to clarify a couple of things.

Number one, that $60 million year-to-year increase would be included in the $77 million increase in core operating costs; is that right?

Yes, it would.

Okay.

And when you talk about a $100 million incremental hit for the year, that would, of course, be the net amount.

I understood what you said about first half, second half.

Can we go a little bit further and say it is probably -- there is probably a negative year-to-year impact in all of the quarters except the third quarter?

In the third quarter, actually it might decline because of the large catch-up accrual last year?

I think you ought to look at the fourth quarter too as not being negative.

As would likely be up some in the quarter?

Yes.

Okay.

That is what I was driving at.

So my takeaway here is that despite --

Rob, I want to make sure you got it.

It would be a positive rather than a negative in the fourth quarter.

All right.

Okay.

No, that was not the way I took it.

Sorry.

I wanted to make sure.

So in the first quarter, your core operating cost only went up by about $17 million outside of this one particular item.

You had apparently the largest concentration of ACERT ramp-up cost that you expect.

I would assume the highest level of supplier expediting expenses that you hope to face for the year.

At least some of the steel increase.

I mean, it seems to me that if we take out the $100 million number for the full year, you are not looking at much of an increase in this core operating expense number for a full-year basis?

There is some.

There is some increase in core operating expenses for the full-year.

But a --

Because of the expedited ramp-up.

That is the main reason.

So you think that will be an ongoing issue in the second quarter?

And R&D also will have some impact on this.

Yes, I think you can look at it probably for most of the year.

Okay.

Well, we can talk more later.

I think this will have to be our last question.

Charlie Renchlyer (ph).

Landenberg & Co..

I wondered if you could give a little bit more explanation as to what you mean by ramp-up costs for ACERT and then segue into how ACERT is doing in the heavy-duty truck engine market?

I would be glad to do that, Charlie.

Ramp-up costs for ACERT -- there are some residual costs as we are completing the last year full introduction of ACERT.

So there is a certain aspect of completing those ramp-up costs.

Also as we see the increasing demand and sales of ACERT, we are having some increased cost in that area as well.

Your question on how ACERT is performing, it is performing exactly as we had promised.

With the 3 to 5 percent fuel economy gain, with the oil changes and maintenance schedule as we had expected, it is showing the value that we anticipated, and we are seeing that from actual experience in the field of numerous large fleets.

Thank you.

Thank you.

This comes to the end of our first-quarter conference call.

Thank you for your interest in Caterpillar and have a good day.

Thank you, ladies and gentlemen.

This does conclude today's teleconference.

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

Thank you for your participation.