開拓重工 (CAT) 2004 Q2 法說會逐字稿

Good morning ladies and gentlemen and welcome to Caterpillar's second quarter 2004 and 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.

Thank you, Jan.

Good morning and welcome to Caterpillar's second-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 go over I was second quarter results, review our outlook, go over the usual dealer retail numbers, discuss two special topics and wrap up with the Q&A.

Certain information we will be discussing is forward-looking and involve uncertainties that could impact expected results.

A discussion of those uncertainties is in our form 8-K filed with the Securities and Exchange Commission today.

Let's start with the second quarter results.

As you know, this morning, we reported second quarter sales and revenue of $7.56 billion and profit of $552 million.

Sales and revenues for the first half of 2004 were $14.03 billion and profit was $964 million.

Sales and revenues were up 27 percent from second quarter 2003 with machinery up $1.17 billion and engines up $429 million.

The increase in sales and revenues was largely due to a $1.35 billion of higher machinery and engines volume, $131 million of increased price realization, a $116 million favorable impact of currency on sales due primarily to the strengthening euro and $33 million of higher financial products revenues.

Revenues of financial products were $464 million, up $33 million, or about 8 percent from second quarter 2003.

The favorable impact of approximately $54 million due to the continued growth of earning assets at Cat Financial were partially offset by a $26 million impact of lower interest rates on new and existing finance receivables.

Profit of $552 million was up 38 percent and was $153 million higher in second quarter 2004, compared with second quarter of 2003.

The main contributors to the profit increase were higher sales volumes of $356 million, higher price realization of $131 million and the absence of $47 million in nonconformance penalties recorded in the second quarter of 2003.

Partially offsetting these favorable items were $254 million of higher core operating costs, the net unfavorable impact of currency of $63 million and higher retirement benefits of $37 million.

The increase in core operating costs reflects higher manufacturing costs due to surging volumes, general support costs to support our growth, planned spending on product development programs and higher incentive compensation due to our increased outlook.

I will provide more information on the higher core operating costs in the special topics section.

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

North American dedicated rental fleet utilization on 12-month rolling basis is continuing to run at a very strong rate, about 69 percent, up 3 percent from a year ago.

Rental rates for the rolling 12 months through June were up about 4 percent from a year ago and are forecasted to improve over the next six months.

Overall units in dedicated dealer rentals fleets are up about 6 percent compared to about 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 up 2 percent from a year ago.

The Cat Rental Stores, which generally read smaller machines for shorter time periods, currently have about 45 percent of the rental units in dealer fleets.

These fleets continue to grow and are up 11 percent from a year ago.

North American dealers have a total of 392 rental stores.

Five more are expected by year end.

In the Europe, Africa, Middle East region, dealers have 793 rental outlets, 368 of which have the Cat rental store identity as of quarter end.

In Latin America, we had 106 Cat Rental Stores and 132 in Asia-Pacific.

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

Of these, 380 stores in North America and over 550 in the rest of the world will have the Cat Rental Store identity.

North American used equipment prices improved about 14 percent in the first quarter compared to a year ago for most machines.

We expect used equipment prices to remain strong in the near-term.

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

Machine availability.

The North American commercial division and the products group continue to work closely together to develop plans to improve availability on key machine models.

Unfortunately, due to critical problems with suppliers, material shortages and an unprecedented level of the late machine orders to support very strong demand, overall availability has worsened.

Currently, all models with minor exceptions are on managed distribution in North America.

Managed distribution is Caterpillar's method to equitably distribute equipment to dealers to meet critical customer needs.

To respond to this unprecedented surge in volume, Caterpillar is well positioned to work in cooperation with its worldwide dealer network to share models, which may be in short supply.

In addition, many dealers are able to prevent lost sales on these models by providing customers with slightly used machines from their rental fleets as loners until new machines are received.

Now for the outlook.

We expect the world economy to grow 4 percent in 2004.

General economic recovery, along with strong demand for housing and high raw materials and energy prices should lead to continued strength of Company sales and revenues in the second half of 2004.

Sales and revenues strengthened significantly in the last half of 2003, so the future base for comparisons will be higher than what it was in the first half.

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

Our industry forecasts for NAFTA mid-range trucks, urban and specialty buses and RVs for 2004 continues to be approximately 180,000 units, up from a comparable figure of approximately 159,000 for 2003.

We project Company sales and revenues will increase about 25 percent in 2004, up from the previous forecast of about 20 percent growth.

Machinery and engines volume is expected to increase about 20 percent and the favorable impact of currency is expected to contribute about 2 percent with the remainder coming from improved price realization and financial products revenues.

We now expect profits per share to be up 80 to 85 percent compared to 2003, up from the previous forecast of 65 to 70 percent.

We expect to deliver about 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 $200 million, pressure on core operating costs associated with supporting higher than anticipated volumes and increased product development costs as we invest in our future.

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

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

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

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

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

All comparisons are based on constant dollars.

Retail delivery machines for the three months ending June 2004 compared with the same three months of 2003 are as follows.

Asia-Pacific is flat, Europe, Africa, Middle East, up 10 percent;

Latin America, up 76 percent; subtotal of the three, up 13 percent.

North America, up about 33 percent; the world up 24 percent.

Retail machine deliveries were up for the quarter due to strength across all sectors, with the exception of Asia-Pacific, which was flat because of decreased deliveries in China.

Higher coal and metals prices contributed to increased deliveries into mining.

Economic recoveries, along with low interest rates, boosted deliveries into construction and construction-related activities.

For the three months ending June 2004, compared with the same three months of 2003, total reciprocating and turbine engine deliveries to users and OEMs were as follows -- electric power up 27 percent, industrial engines up 12 percent, marine engines up 22 percent, truck engines up 28 percent, petroleum down 3 percent, total up 17 percent.

Now let's turn to dealer machine inventories, first sequentially comparing June 2004 with May 2004.

Asia-Pacific up 5 percent, Europe, Africa, Middle East down 4 percent, Latin America up 11 percent, subtotal of the three up 1 percent, North America down 1 percent, world flat.

Next, year-over-year comparing June 2004 with to 2003.

Asia-Pacific up 55 percent, Europe, Africa, Middle East up 1 percent, Latin America up 43 percent, subtotal of the three up 21 percent, North America up 24 percent, world up 22 percent.

Dealer inventories of new machines at the end of June compared with year-end were up on a worldwide basis about $530 million, the majority of which occurred in North America as dealers were preparing for the selling season.

This seasonal increase was substantially larger than the increase in second quarter 2003 as a result of dealers' anticipation of increasing sales.

Inventories compared to projected delivery rates were lower than year-earlier level in all regions.

Our expectation for full-year 2004 is for dealer new machine inventories to increase about $150 million on a worldwide basis with most of the increase in North America.

Asia-Pacific dealer new machine inventories are at 2.0 months of deliveries, down from 2.9 months a year ago.

Europe, Africa, Middle East dealers are at 2.6 months of deliveries, down from 3.2 months a year ago.

Dealer and new machine inventories in Latin America are at 1.9 months of deliveries, down from 3.5 months a year ago.

Dealer new machine inventories for the subtotal of these three regions outside of North America are at 2.3 months of deliveries, which is down from 3.1 months a year ago.

North American dealer machine inventories are at 2.2 months of deliveries, down from 2.6 months.

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

The retail statistics for June are also available on voicemail through August 16th by calling 309-675-8000.

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

As you know, Caterpillar achieved record sales and profits this quarter.

For the year, our outlook forecasts about a 25 percent increase in sales on revenues with an 80-85 percent increase in profits over 2003.

The breadth of this recovery is unprecedented in our history.

Our entire value chain, including suppliers and dealers, are taking extraordinary steps to meet this surging customer demand, which because of our global network, we believe that Caterpillar is best position to meet.

Of course, meeting this dramatic upturn comes with a cost.

We have chosen to incur that costs to satisfy our customers.

The costs include higher material costs resulting from steel surcharges, higher freight and expediting costs to ensure timely delivery of material, premiums due to supplier capacity constraints and manufacturing inefficiencies due to the steep ramp-up of production.

As the world economy has improved, demand for various materials has skyrocketed.

By focusing global purchasing teams on particular materials and supply chain bottlenecks, we have leveraged our worldwide presence to maximize Caterpillar's acquisition of scarce materials.

Where others may have failed to get materials, Caterpillar has, in most cases, exceeded.

Of course, basic supply and demand applies.

Prices for materials have increased in the face of robust demand and limited supply.

The sheer volume of requirements have forced us in some cases to deviate from our sourcing plans and acquire materials from significantly more expensive suppliers.

Also, we are seeing the effect of outsourcing of certain items from others which are normally produced in our own factories; again, adding incremental expense.

When we face limited or delayed material availability, manufacturing inefficiencies occur as we await materials, adding further to expense.

Overtime and expanding costs increase as we strive to meet significantly higher production schedules.

To mitigate as much of the cost impact as possible, we're focused on eliminating supply chain bottlenecks and inefficiencies.

We are currently using over 50 Six Sigma teams working at and with various suppliers to improve availability and material flows.

We are committed to improving our cost structure, even during this period of strong growth.

Costs related to supply chain bottlenecks are not dissipating as fast as we had anticipated.

Scrap metal costs again have risen.

There currently are steel capacity shutdowns.

Supplies are being conscious about increasing capacity because of concerns about the durability of the economic recovery.

As a result, we do not foresee significant cost relief for materials for the remainder of 2004.

On a positive note, rising material and energy prices are not all negative for Caterpillar as many of our key markets, especially mining, are greatly strengthened by these price increases.

This is resulting in the increased demand which requires the extraordinary steps outlined above.

Machinery and engine's SG&A was 9.0 percent of sales for the second quarter.

Excluding the increase due to retirement benefits, incentive compensation expense and the impact of currency, SG&A was 8.5 percent of sales, or up approximately $100 million from the second quarter of 2003.

The increase is in line with planned spending programs to support our growth and includes an increase of about $10 million due to consolidation of new entities.

Another element of higher core operating costs was incentive compensation, which was about $60 million higher than second quarter of 2003.

We still expect full-year incentive compensation to be up approximately $100 million, compared to 2003 as a result of our improved outlook.

Due to the timing of our outlook revisions, this increase has been essentially recorded in the first half of 2004.

Based on our current outlook, we do not anticipate second half incentive compensations to be higher than 2003.

As profitability has improved, we are now ramping up our product development investments to maintain and improve our product technology leadership position.

Machinery and engine research and development was 3.0 percent of sales for the second quarter.

Excluding the increase due to retirement benefits, incentive compensation expense and the impact of currency, research and development was up approximately $35 million from the second quarter of 2003.

Research and development is projected at 3.6 percent of sales for 2004 in our current outlook, which has not changed from the previous outlook, but is up from last year when it was 3.2 percent of sales.

Currency negatively impacted operating profits by the net amount of $62 million, largely the result of the stronger British pound and Japanese yen on our manufacturing costs in the UK and Japan, respectively.

Higher retirement benefits offset profitability this quarter by $37 million.

Going forward, assuming rising interest rates and that our long-term return assumptions remain the same, this expense should in future years level off and possibly turn lower.

We expect higher retirement benefits of approximately $200 million in 2004.

Although we have no mandatory U.S. employment retirement income security act funding requirements during 2004, we chose to fund about $500 million into our U.S. pension plans in April.

Despite the significant pressures on various costs, we continue to forecast that we will be able to deliver about 7 percent return on sales and revenues, up nearly 50 percent from 4.8 percent return on sales and revenues we achieved in 2003.

Our final topic is China.

The recent actions of the Chinese government to slow the economy have affected the industry for the short-term.

We can certainly expect these cyclical variations in the industry from time to time.

However, we remain quite optimistic on long-term growth opportunities in China.

We will continue to build our product portfolio and invest and implement our global business model.

We are long-term investors in this market and expect to achieve industry leadership.

The China market represents tremendous infrastructure and development opportunities.

The short-term softening of the industry in China has resulted in a reduction of dealer deliveries in the country by 38 percent in this quarter, compared to the second quarter of 2003.

We have, however, been able to successfully leverage our global capabilities and are using this opportunity to redirect some of our China and Asian production capability to the very strong markets in North America and Asia.

Our global diversity allows us to make up the drop in sales in China with sales in other parts of Asia, thereby avoiding a drop in sales quarter-over-quarter for the region.

The access to the global markets through the Caterpillar Distribution Network is an advantage no other competitor can duplicate.

We have a long-term strategy to establish a solid manufacturing presence in China and to be one of the least cost producers in China serving the Chinese market.

We will supplement that with imported product and some imported content for product we assemble in-country.

This strategy is for the long haul and will not change as a result of short-term variances in the economy.

One last thing before the Q&A.

If you are planning on attending Mine Expo in Las Vegas, be sure to save September 28, 2004.

Hotel rooms are getting tight, so book your reservations soon.

This can be done via the official Mine Expo web site at www.mineexpo.com.

We will be holding a luncheon for security analysts.

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

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

Jim's comments will be webcast.

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

Okay, now it's time to move to the Q&A portion of the call.

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

The first question please, Jan (ph).

(Operator Instructions).

Alex Blanton.

It's Ingalls & Snyder.

Good morning.

I would like to ask a question about the guidance for the second half.

If we subtract the first half earnings and take the midpoint of the range for the year, which would be $5.71, we're looking at $3 a share of earnings in the second half against $1.59 last year about, or about an 89 percent increase in the second half against the 35 percent increase we just saw in the second quarter.

And it implies that the quarterly rate in the second half would be approximately the same as the second quarter, or about $1.50 (ph) a quarter.

Now typically, you have a decline in the third quarter from the second.

How should we think about dividing the $3 between these two quarters?

Are we going to get that dip and then we're going to be fourth quarter above the second quarter, third quarter below the second quarter?

Is that how we should look at it?

You know, Alex, I think you need to count on your own view of Caterpillar's cycle over the past, because as you know, we do not give quarterly guidance.

So I think we're going to have you look at your own resources and make that determination.

Well, this is an unprecedented year, so it may not apply, but let me ask it this way.

Do you expect any mitigation of the factors that affected the second quarter and caused it to be 20 cents or so below the consensus.

Do you expect mitigation of that in the third quarter?

As to quarterly guidance, again, what the consensus was, we did not give guidance for this quarter.

We are increasing kind of substantially what the outlook is for the full year.

As I said in my comments, at this point, we don't anticipate material costs reducing over the remainder of the year.

We have teams here working very hard on availability; that's a big issue.

With the robust economy, everyone is working hard to get those materials that are somewhat scarce and we have teams working on availability, as well as costs; that's an important issue as well.

But at this time, we don't see a real mitigation of those costs during the second half.

Follow-up.

This is a broader question, but I am getting questions from people asking -- things are so good, how can it possibly continue, couldn't this be a peak year for Caterpillar.

And of course, the things that Jim Owens have said in the past would indicate not since he is looking for $30 billion in annual sales in 2006.

So how do you -- when you are looking forward here beyond 2004, do you expect this unprecedented rate of equipment replacement to continue?

I mean, you have a whole population of equipment out there that you have to replace with new, more efficient equipment, so it would seem to be reasonable.

Alex, I think we're seeing a combination of replacement, as you have identified.

We had such a long lag between -- of a downturn.

We did see a real surge in replacement, but we're also seeing expansion of the markets as all of the economies as you look across the world are expanding.

It goes to your view on where we are on the economic upturn.

We saw metals starting to improve and mining impacted of course and coal has just recently begun to improve.

As you look at any of the markets that we serve, it's a fairly recent upturn in the economic fundamentals.

So hard to say.

Of course, we have a view and we have given a very positive outlook based on that positive economic outlook, at least for the remainder of 2004, and we anticipate some further activity as we go forward.

Thank you.

Thank you.

David Raso.

Smith Barney, good morning.

If you look at just price and volume, the second quarter had incremental margins of 33 percent year-over-year.

I'm just trying to think through your waterfall slides and the moving parts.

I'm pricing against that, alright, we have the July 1 price increase.

I will qualify it a little bit.

The price goes into effect, but there are some current sales that have to cycle through at the old price, so that may be having a little bit of a delayed impact of that July price increase.

That's cool, I'm just trying to think through 4, 5, 6 months from now.

I'm just trying to (indiscernible) -- price should get better, your FX hit probably goes away largely by the fourth quarter -- .

I'm sorry, David, our what hits?

I'm sorry, at that currency.

Currency hit between the fourth quarter.

The incentive comp hit year-over-year, you said it will basically go away this quarter but you lose the benefit of the noncompliance, the absence of those in the fourth quarter?

I think that is correct.

The retirement benefit -- the hit, the retirement benefit -- the hit (indiscernible) doesn't go away, but it doesn't ramp up.

It appears you have more profits than negatives.

The biggest issue is we're now three weeks into July.

The kind of product you make, you don't just buy components and turn it out in a day.

You must have some visibility into either improving or not improving availability of your components, which was a big problem in the second quarter to have the guidance that you have now for the back half.

Why should we have confidence that it has improved?

You must be seeing something already in July for three weeks to think through the rest of your third quarter and even fourth quarter.

Is it true you've seen any improvement in availability because the price is not getting better when it comes to the end-of-the-line materials and you seem to agree with that.

Are you seeing anything at all to believe this guidance?

David, what we base our guidance in the outlook on is what we believe we have sales for -- sales, as well as what we can actually produce.

And the production forecast is based upon availability of materials.

It goes into that equation.

So when we say our outlook, we are saying it is based on all of those factors.

I'm not sure if Lynn wants to chime in on anything.

Clearly, your factory operators must be passing on to you something has gotten better, because if it repeats the second quarter, isn't going to work.

You must be seeing better availability, and if you are not, the guidance is simply too optimistic.

I will only echo what Nancy said.

Our outlook is based on what the people in the factory believe.

They can produce and ship against the orders that we have.

Is that better than they would have answered a month ago?

I don't know what -- I'm not going to answer on how our monthly outlook's going to go into play.

This is our outlook for the year and we don't put outlooks out unless we believe they have support and that we can make them.

I appreciate it.

Thank you.

Thank you David.

Gary McManus.

J.P. Morgan.

Good morning.

Another question on the core operating costs.

With 77 million in the first quarter, 254 million in the second, so obviously, worse performance here.

What is your assumption for core operating costs in the second half of the year that's baked into your earnings guidance?

I don't know that we're going to break that out as a factor.

Just give me a ballpark.

Is it 250, is it -- there was a big increase between the first and second quarters, and obviously, it seems like a lot of these inefficiencies got worse.

So I'm just wondering, the question I think I was asking is what kind of improvement, if any, are you expecting in the second half of the year?

Hang on for a second, I think we'll have something for you.

Gary, it is pretty similar in the second half as it has been in the first.

So that would be -- there was roughly 331 million I think that is right in the first -- you expect a similar number in the second half.

So the quarterly run rate declines in the second half versus the 254 you showed in the second quarter?

Is that right?

That's correct.

You mentioned a number of different factors that are in these numbers.

What improves?

Obviously, you're saying you expect material costs to stay high.

Is it freight costs, is it premiums due to supplier capacity constraints, is it manufacturing efficiencies?

What do you anticipate getting better?

I'm not sure that I can break it down specifically.

There are opportunities of course in freight and expediting.

As the suppliers get more up to speed and availability improves, of course freight could improve over time and basic SG&A could improve as well.

On all of these inefficiencies, did it get worse as the second quarter progressed, or did you think it was worse earlier in the quarter and you've already made some progress?

I don't have that kind of information, Gary.

Sorry I can't help you.

Mark Koznarek.

Midwest Research.

Nancy, just a clarification on that last question.

Core operating costs contain your incentive compensation accrual, right?

The appropriate portion -- all of it, I'm sorry.

That's right.

So you said that comparison becomes even in the second half, so that is one reason why those core operating costs drop down in the second half?

Mark, as you recall, last year, we ramped up the accrual for incentive comp pretty significantly.

As you compare year-over-year and the second half, that helps to mitigate that expense.

Okay, so it sounds like sort of the operational expenses really don't drop in the second half, you know, raw materials and expediting and efficiencies.

Yes, that is correct.

I just wanted to clarify that.

The question I really had is if you could get into some more detail with regard to China and what sort of the near-term outlook is there?

It seems like that is a pretty sharp swing from recent trend.

Do you expect that to continue through the third quarter?

Can you kind of give us any sense of what that is going on and what some reasonable expectations are for China demand?

Sure, Mark, I would be glad to.

Our view is that the Chinese economy has not really slowed significantly.

What they have done is taken governmental action to curtail activity in particular sectors.

They were concerned about certain sectors experiencing too rapid a growth and inflationary pressures.

As a result, construction equipment fell pretty severely.

And I think you have seen that played out from our competitors' standpoint as well.

One bright spot for Caterpillar in China is the engine business.

That has been strong in China as a result of a couple of things.

We have not seen a curtailment in the activity in the marine business.

They are building ships very strongly requiring marine engines.

And as you know, there are brownouts and blackouts in China as a result of failures of hydroelectric and transmission and that business continues to be strong.

So we see that as a positive opportunity.

As for projecting what is going to happen in China, we don't think on the near-term construction will turn up necessarily, but we do believe that the engine business will continue to be strong.

So, you have said in the past, though, your machine sales are a lot larger than your engine sales.

So it sounds like, overall, we should expect China's sales to be perhaps flat or even down a bit for the year.

Mark, there's another possibility too for the production out of China that we can redirect it to other stronger markets.

It takes a little bit of time to do that, because this was a pretty abrupt decline in their sales opportunities.

So we are beginning to redirect that to North America and other parts of Asia.

There is a bit of time required as regional environmental requirements vary and we need to ramp up for those.

Great, Nancy, thank you.

Thank you Mark.

John McGinty.

Credit Suisse First Boston.

Good morning, Nancy.

Let me just try this one other way.

Can you, in looking at the 254, the incremental negative hit from core operating costs -- can you talk to what portion of that was represented by the higher steel costs, the surcharges, the inefficiencies, the whole litany of things that had to do with just the sudden ramp-up, much stronger than expected ramp-up in demand and your moving through to meet that demand?

In other words, you did mention that the incentive comp costs were 60 million in that and I think R&D was up 35 million.

Should we subtract those and say that it's 160 or 170, or can you quantify the special costs any further than just what you've done?

We've given you an unusually large number of about information, as you know John.

And I know that you can, as you sit down, figure out exactly what the manufacturing cost increase was.

But I would say it's in the ballpark of $60 million.

For the inefficiencies?

Well, it's sort of all-in -- surcharges, expediting, inefficiencies -- all of these things that have been affecting our costs.

That number does not go away from what you were saying.

In other words, you are not expecting in the second half, those numbers to go away?

At this point in time, we don't expect that.

And the follow-up -- as the only thing that changes, because you've given the volume and to come back, it has got to be the 2.5 percent, 2 to 2.5 percent price that you went through on July 1st, even though there was some price protection in there.

I assume that you're getting no pushback from that.

Can you, A, talk to the pushback and, B, talk to whether or not we are going to need more price increases because we're talking about -- you were talking about scrap prices going back up and some of the other material costs pushes?

Are you contemplating any -- A, is this price increase going through and, B, are you contemplating any further need for any price increases.

Well, as you know, it just came into play on July 1st, so it is a little bit early to make much of a comment on its acceptance.

But I don't believe we've had very much pushback at this point.

And, John, as we go forward, of course you look at what your underlying costs are, and that is an opportunity in pricing of course because this kind of cost increase is applicable to everyone in the marketplace.

So it's a factor when you are looking at competitive pricing.

But you don't have built into your forecast another price increase?

We have built into our forecast the announced price increases.

Exactly, thank you very much.

Thank you.

David Bleustein.

UBS.

The question is really a follow-up to John McGinty's.

You've mentioned that you don't expect any letup in the material costs over the course of the balance of 2004.

Can you touch on 2005?

And specifically the question is -- how much of your 2004 steel costs, if you will, were covered by contracts?

And what do you have contracted out so far for 2005 and what kind of cost increase are you paying over your 2004 contract levels?

David, I wish I had a better crystal ball.

But it is hard to see what's going to happen in 2005.

I have an overall manufacturing cost increase, which I gave to John, but I don't have it broken down into the various underlining segments, so I'm afraid I will not be of much help do you.

How about just a specific question?

When you entered 2004, what percentage of your steel costs were covered by contract?

And as we sit here today, what percentage of your steel is contracted out so far for 2005, and what is the average percentage increase?

I don't have that information.

Okay, thanks.

Thank you.

Joanna Shatney.

Goldman, Sachs.

Can you just go through what's going on with the petroleum market, why that was down?

And then also talk about what the Medicare bill has done, in terms of your outlook.

And we talked a lot about the core operating costs going up.

But are there any other pluses that we are missing on the margin here besides the price improvement and maybe some of the Medicare benefits that are helping to preserve the 7 percent ROS?

Sure.

I will take what's going on in petroleum first.

Basically what we have seen is a bit of a shift in petroleum.

Reciprocating engines are remaining very strong in the petroleum market with a good growth rate.

We have had a negative impact of Solar (ph) sales into gas compression this quarter.

What has happened is they are being offset by -- the increased sales of reciprocating engines are being partially offset by substantial reductions in sales of a large gas turbines used for high-capacity compression in transmission, primarily in larger pipelines.

So you see that offset and that is why --- and this is typically in North America.

So that's why you're seeing a negative 3 percent in petroleum sales.

Your next question -- I've forgotten what the next question is -- why don't you repeat it.

Sure.

Medicare bill -- I guess is that in your outlook now?

If it is, it is probably a plus.

Are there any other pluses besides that?

Medicare part D (ph) is in our retirement benefit outlook and that is why, as you noticed Joanna, at the beginning of the year, we said 250 million and now we're saying around 200 million, if that gives you a sense of the size.

And is that the only difference on the positive side of things besides the price increase from the first quarter?

There is an impact of the contribution we made into the pension plan that has a positive impact as well.

Okay, thanks.

Andrew Oben (ph).

Merrill Lynch.

What kind of visibility right now do you have into your production schedule in 2005, in terms of what kind of orderbook are you seeing?

How far does it extend right now into '05?

You know, Andrew, we don't really talk about backlog or orderbook.

But let us say it's robust.

Would it be fair to say that it extends into 2005 right now?

We don't really like to talk about 2005.

Let's say we're not worried about 2004.

Just going back to trying to understand a little bit more of the steel cost increases.

Last quarter, you commented that in the previous quarter, your steel costs were sort of in the range of 550 to 600 million range, if you do the math.

What kind of sequential increase did you see in your steel prices?

Because average steel price was up 28 percent quarter-over-quarter.

What kind of price increases have you guys seen?

We have not seen that high a price increase, but Andrew, I'm not going to be able to give you the actual number.

Was it significantly lower, or you just don't have the number?

I have it, but I cannot give it.

It's lower.

It's lower than what you said.

Joel Tiss.

I'm still at Lehman Brothers.

I wonder if you are allowed to share with us, you have shared with us in the past a $1 billion target on Chinese revenues.

Can you share with us an updated number on that at this point?

Well, as we said, our sales decreased.

Usually, we don't give a country-by-country estimate.

But as we mentioned in the release, they are down 38 percent from what we had projected for the year in machines, but that is the machines only.

So that's not really enough to extrapolate.

On a different topic, can you give us the size of your rental fleet and maybe the original purchase price of the rental fleet, just so we can get an idea how big it is?

I think we have given you a lot of information over time.

I will try to pull it together of what we have said.

As you know, by the end of the year, we are expecting 1480 rental stores.

And as we have said in the past, a typical inventory for a rental store would be about $5 million on average.

About half of that would be for Caterpillar equipment, the rest would be for affiliated type of equipment.

So doing the math, I cannot do it in my head, but I am sure you can -- about 3.5 million.

Lynn can -- 3.5 billion.

That gives you a feel.

And as we said in the past also, Joel, what you typically will see is a replacement over about a three-year period, typically a third, a third and a third.

Now, that's ballpark of course, but hopefully that gives you some help in your question.

Thank you very much.

Robert McCarthy.

Robert W. Baird.

Good morning, Nancy and Lynn.

I'm having a little trouble understanding -- this is a small detail -- but your expectation for the change in incentive comp is still 100 million as it was a quarter ago, despite the fact that you raised your outlook this quarter.

How does that work?

it works that, as you said, we are continuing to believe that incentive comp will be 100 million.

Now the payout in incentive comp is based on financial performance -- earnings-per-share.

That has increased in our outlook.

But it is also based on other factors as well which are non-financial measures.

And at this point in time, as we look at the earnings-per-share outlook and the nonfinancial measures, we are still maintaining at that increment of 100 million year-over-year.

Thanks, that helps.

And if I'm doing my math right, if we're talking about something like a $60 million per quarter increment in, call them excessive manufacturing costs, that is coming really close to the difference between a 7 percent and an 8 percent return on sales, which leads me to the conclusion that at current revenue levels in a more stable marketplace, you likely would be able to generate close to 8 percent, which has been your long-term target to return back to 8 percent on sales this year, while sales and revenues are still well below the $30 billion dollar target.

Am I missing something?

As usual, you're right on.

Thanks Nancy.

Thanks Rob.

Ann Duignan.

This is Ann Duignan, Bear Stearns.

Hi, guys.

I just wanted to ask a question on the financial services business.

SG&A was up significantly, about 253 (ph) million versus a year ago about 140 million.

Did we miss anything in terms of what happened there?

Is it leasing, a change in mix, or was it just a once-off?

Yes, it's an unusual situation.

You're seeing a -- I have the explanation, because we anticipated that you might see that as an issue.

If you look at the financial set or what you're talking, about approximately 100 million of this increase was the result of an intercompany transaction between the machinery and engines groups and financial projects, specifically Cat Insurance.

If you look at the consolidating adjustments column, there was a corresponding increase in the elimination entry.

In addition, there was a similar increase in financial products revenue, so it was also eliminated in this consolidating and adjustments column.

This transaction had no impact on consolidated profit.

So what should we look for going forward with this, just a Q2 event?

Yes, you should look for nothing going forward.

So we should go back to a run rate like we (multiple speakers) in Q1?

Absolutely.

And you're not seeing any negative impact on profit before tax because of a change in mix towards higher leasing?

No.

This had no impact on consolidated profits.

Real quick -- on the 60 million of inefficiencies, etc., etc.;

I guess being cynical, why wouldn't I ask -- what are these 50 Six Sigma teams doing?

Why won't they be able to reduce those extraordinary costs through the remainder of the year?

That is a net number with the assumption of the efforts of the Six Sigma teams.

So it could have been higher.

Lynn, did you want to add something?

It's a very good question, because we've talked an awful lot about Six Sigma and the benefits we're getting out of it.

As Nancy pointed out, that is a net number and reflects some positive impacts of the Six Sigma teams that are working.

So we are climbing the hill, but it's a big hill to climb and we're making progress.

But over time, wouldn't we expect that with 50 teams working on this, that they ought to be able to make a dent even into the 60 million?

Over time, we certainly hope that we will be able to mitigate all of these costs.

This ramp-up, if you look at the size of it and the short time frame in which it has occurred, is unprecedented.

And from a supply chain standpoint, it takes some time to get on top of it.

So yes, you're absolutely right.

We want to get there, it's just not going to happen as quickly as we had earlier anticipated.

We see some of these Six Sigma teams helping with finding hidden capacity as we've seen in our own plants, locating other sources.

There are many aspects of this that they're working on.

So over time, we will see results from the Six Sigma team.

Okay, thank you.

I think we have time for one final question.

Andy Casey.

Prudential Equity Group, good morning.

Hi, Andy.

If we could step back from the quarter for a second, you have talked pretty well about the demand surge against long-term a goal to carry lower field inventories at the distribution channel.

Your guidance in the call and the answer to Ann's last question suggests really no near-term improvement in efficiency issues at a strength manufacturing base.

Are you currently questioning, or is anybody questioning, your ability to supply the distributors, given all of the work that you have done?

As you know, Andy, this is a record sales quarter and a record sales year.

So although we're not quite chinning the bar of the total upturn in sales requests, we have made substantial progress and we will continue to do so.

But as you know, this was a pretty sharp upsurge in sales and I think we're doing a pretty good job of meeting that upsurge.

Okay, so you're not concerned about increased inventory in the field going forward?

At the dealers, are you talking about?

Yes.

The dealers order what they believe they will need for sales going forward.

Lynn, did you have something you'd like to add?

Andy, I think you've heard us speak about our long-term goal to bring total chain inventory down, and we have certainly been working on that.

And at the dealer level, you heard Nancy's statistics on where dealer inventories are now.

Worldwide, 2.3 months of sales.

Right.

So we're coming down to that level where we anticipated we wanted to be.

We're dealing right now with, as she pointed out, an extremely strong upsurge in demand.

But through the network of dealers, through managed distribution, through the work that all of our teams are doing with suppliers to eliminate bottlenecks, we believe that we can satisfactorily address it.

It takes a little more time, but you asked -- are we concerned?

Concerned is not the right word.

Are we active?

Absolutely.

We're actively pursuing every alternative we can to satisfy the demand of our customers.

And as Jim pointed out in his comment in the release, we did that very consciously, even though it did add to our costs.

So we're actively pursuing every avenue and it just takes a little more time to respond to a 25 percent of turn in sales and revenues in a very short period of time.

Okay, thank you.

Thank you all very much for your interest in Caterpillar.

If you didn't get your question asked today, please give me a call and I will be happy to speak with you.

So long.

Thank you, ladies and gentlemen.

This does concludes today's teleconference.