開拓重工 (CAT) 2004 Q4 法說會逐字稿

Good morning, ladies and gentlemen.

Welcome to Caterpillar's fourth quarter 2004 earnings conference call.

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

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

Ma'am, you may begin.

Thank you, Jen.

Good morning, and welcome to Caterpillar's fourth quarter and full-year results conference call.

I'm Nancy Snowden, Director of Investor Relations.

With me is Lynn McPheeters, Vice President and Chief Financial Officer, Doug Oberhelman, Group President, and Dave Burritt, who will replace Lynn as CFO when Lynn retires.

This conference call is copyrighted by Caterpillar Inc.

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

If you would like a printed version of the prepared conference call and remarks, you can go to the SEC Filings in the investor section of our web site where they are filed as an 8-K.

This morning, Lynn in his final results conference call prior to retiring, will cover our fourth quarter and full-year results.

Doug will review our outlook.

I'll give some specific guidance for 2005 and then we'll 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 those uncertainties is in a form 8-K filed with the Securities and Exchange Commission today.

Before we get started, I wanted to clarify some confusion that exists relating to a difference between annual consensus in first call for 2004 compared with the fourth quarter consensus plus our September year-to-date results, which would total $5.83.

The difference is due to the recognition of Medicare Part-B subsidy.

When we recognize the benefit for the Medicare subsidy in the third quarter as required by accounting rules, the first and second quarter impact was reflected in September year-to-date results, but not in the third quarter results.

If you add the first and second quarter impact of the Medicare subsidy, of 7 cents per share, this would explain the difference.

Now I'll turn it over to Lynn to talk about the 2004 numbers.

Thank you, Nancy.

Before I discuss the numbers, I'd like to say what a privilege it has been to be Caterpillar's Chief Financial Officer and part of the investor relations team these last six years.

Our mission has been to improve the understanding of our financial results and to communicate as candidly as possible with you.

We recognize and appreciate your interest in Caterpillar and I know the team under Dave Burritt's capable direction will continue this mission.

Now for the results.

As you know, this morning we reported fourth quarter sales and revenues of $8.57 billion and profit per share of $1.55.

For the year, sales and revenues were $30.25 billion and profit per share was $5.75.

Both records by a significant margin.

There were many doubts about the $30 billion sales target when we set it back in 1997 and put a mid-decade time frame on it.

We are very proud of the Caterpillar team for reaching the goal ahead of schedule.

Sales and revenues for the fourth quarter were up $2,106 million from fourth quarter 2003 mainly due to $1,796 million dollars of higher machinery and engine volume, $171 million from price realization and $121 million from the impact of currency.

An increase of $58 million in financial products revenues accounted for the balance.

Profit per share was $1.55 for the quarter, up 60 percent from fourth quarter 2003 profit of 97 cents.

Profit increased by $504 million as a result of additional sales volume and improved price realization.

These favorable items were partly offset by higher core operating costs of $412 million and $45 million of higher retirement benefits as well as $19 million of unfavorable currency impact.

The most significant element of the core operating cost increase was manufacturing costs.

And that increase was primarily related to steel.

Let me remind you this is not a problem unique to Caterpillar.

It has impacted every industry that uses steel.

Market prices of steel increased 54 percent last year with the increases heavier in the second half.

During 2004, our average volume adjusted steel-related cost increase was about 20 percent over 2003, considerably less than general market movements.

The only way to avoid these costs would have been to have quit buying steel and obviously, we couldn't do that.

Of the fourth quarter core operating costs increased $412 million about $200 million of that was for increased material costs predominantly steel related.

Also, as a part of core operating costs, research and development increased about $60 million, well within a reasonable 3 percent of sales.

As we always have, we continue to invest in maintaining and improving our technology leadership by funding research and development.

We will not sacrifice our future for short-term earnings gains.

It's this type of funding that yielded our ground breaking assert technology which provides a platform allowing us to comply with environmental requirements now and in the future while maintaining exceptional value to our customers in terms of engine operating costs, reliability and durability.

SG&A, the final significant factor in core operating costs continues to be impacted by the surge in volume.

However, machinery and engines SG&A as a percent of sales continues to decline from 9 percent in 2003 to 8.7 percent in 2004.

We are focusing 6 Sigma efforts on making our period cost structure so we can react to changes throughout the business cycle.

In addition to core operating costs, results were negatively impacted by currency.

Even though we are largely naturally hedged in our foreign currency positions.

During the year, the British pound and the yen strengthened about 10 percent of the U.S. dollar.

Due to our net short position in these two currencies and especially the British pound, we had a negative currency impact on profit before tax of $19 million for the quarter and $157 million for the year.

This reflects the effect of currency on sales and costs less currency exchange gains reported in other income and expense.

I want to switch to the balance sheet for just a minute. 2004 was a very good year for our cash flow.

We contributed about $680 million to our pension plans, which when combined with asset returns puts the status of our worldwide pension plans at about 90 percent on a projected benefit obligation basis.

Our cash flow allowed funding for capital expenditures of about $900 million, which helped to support our growth.

Dividend payments that reflected two increases in a 12-month period as well as increases in 10 of the last 11 years and the repurchase of shares pursuant to the share repurchase program.

We did all this while improving our balance sheet to its strongest position in many years.

Before we get to the outlook, I'll provide a few comments on North American rental fleets and used equipment.

North American dedicated rental fleet utilization on a 12-month rolling basis through November was up from 66 percent in the same period last year to about 69 percent.

Rental rates for the rolling 12 months through December were up 5 percent from a year ago.

Overall, units in dedicated dealer rental fleets are up 13 percent from a year ago.

Rent to rent units, which currently make up about 55 percent of the total, are up 10 percent from a year ago.

The CAT rental stores which generally rent smaller machines for shorter time periods and currently have about 45 percent of the rental units in dealer fleets, these fleets continue to grow and are up 15 percent from a year ago.

North American dealers added 7 rental stores in 2004 for a total of 395 stores at year end.

And the rest of the world, dealers had about 1400 stores.

We anticipate an increase of about 80 rental outlets in 2005.

North American used equipment prices trended up about 15 percent in the third quarter compared to a year ago for most machines.

We expect continued strengthening in 2005.

As you know, this used equipment reporting lags one-quarter from the current quarter.

And regarding availability of new machines, at the end of the fourth quarter in North America, the majority of our most popular models were under managed distribution.

By managing distribution, we first supply to only those with a confirmed customer order.

This helps ensure that available product is going to the most pressing need.

Producing plants are continuing to hire more employees, add selective production shifts, source from Caterpillar plants supplying lower demand areas such as China and use 6 Sigma teams to identify ways of increasing production capacity.

One final comment.

Dealer inventories at the end of 2004 were up 38 percent, however, inventories compared to month of sales are basically flat with 2003 at three months of sales.

Shipments were up substantially in late fourth quarter, especially outside the United States where dealers did not always have time to convert the shipments into customer deliveries before year end.

Our expectation for full-year 2005 is for dealer new machine inventories to be about flat on a worldwide basis.

We anticipate that in 2005, dealer inventories will increase almost $120 million in North America, largely offset by decline in Asia-Pacific.

Now, I'll turn it over to Doug to discuss the outlook.

Doug.

Thank you, Lynn, and let me lead off by one, congratulating you on your retirement and wishing you the very best to what I hope will be another four years in retirement, and we really appreciate everything you've done for us over your long career and especially the last six years culminating in what is truly a record year for us in outstanding performance in 2004, so thank you.

Let's get down to business now.

We expect 2005 to be another strong year with global economic growth at about 3.5 percent only slightly lower than 4 percent in 2004.

Interest rates, though projected to rise this year, should be favorable to continued economic growth and investment, prolonging construction recoveries particularly in developed countries.

In 2005, commodity prices are expected to remain at levels that continue to make new investments attractive, supporting continued growth in mining activity.

Higher commodity prices also have the secondary effect of boosting incomes and governmental revenues in producing countries resulting in a positive impact on construction spending.

Our worldwide economic scenario anticipate oil prices trading moderately lower than in 2004 but still favorable to increased exploration and development.

This will benefit our petroleum-related engine businesses.

We expect that engine volume will benefit from NAFTA heavy duty class 8 truck industry demand for 2005, which we project at approximately 300,000 units.

Our forecast for NAFTA, mid- range truck, specialty, urban bus, and rv's for '05 is approximately 190,000 units.

In 2004, we were capacity constrained for heavy duty in-line six cylinder engines utilized in on-highway trucks and other commercial applications.

We're adding capacity for heavy duty engines but will be capacity constrained until the new capacity comes on later this year.

The addition of this capacity will improve our supply capability for C-15s, the 15 liter engine in late 2005.

In total, company sales and revenues are expected to increase 12 to 15 percent versus 2004.

Machinery and engine volume is expected to increase about 8 percent.

Improved price realization should add about 3 percent more with the remainder coming from financial products revenues.

This will result in 2005 sales and revenue somewhere between $33.9 billion and $34.8 billion, which will again, be record sales and revenues.

With this volume forecast, we expect 2005 profit per share to be up about 25 percent compared to 2004.

The year will benefit from improved price realization, increased volume, manufacturing efficiencies and an intensified focus on our cost structure.

I really want to focus with you here a minute on price realization.

Frankly, we did not achieve as much price realization in 2004 as we had hoped, and that's why we're putting such a big emphasis on this in 2005.

Two main factors influenced price realization.

And the first is price protection.

In its simplest form, price protection means that if we have a firm customer order before a price increase is announced, we won't harm our customer relationship by raising the price on that order already on hand.

Historically, we've experienced about a six-week lag after the announced effective date of the price increase before we actually began to realize the new price.

With recent long lead times for product delivery attributable to the unprecedented surge in customer demand, the lag between the announced effective date and the actual realization date has been even longer than the typical six-week period.

We're disappointed that this occurred as much as it did in 2004, but you well know our relationship with customers come first and always will.

I guess this is the good news/bad news of booming markets.

The second influence on price realization is that our price increases vary widely across all models and all geographic regions.

We do this to remain competitive for every model and in every market we serve.

In 2004, published price increases ranged from 0 to 6 percent.

In addition to this range of increases, we have to consider any merchandising or discounting that we offer for competitive reasons.

Taking all this into consideration, we achieve $512 million of price realization in 2004, which equated to an overall price realization of 1.8 percent in 2004.

As Jim Owens said, my next goal, it's our plan to more than offset material cost increases with price in 2005 and that's exactly what we intend to do.

We've already announced increases affecting machines, engines, parts and other products that went into effect January 1, 2005.

We announced those increases earlier than ever to minimize the price protection lag time that I mentioned earlier.

Because of the continued strong backlog, and long lead times, we'll still see some lag in 2005, though.

In addition to announced increases, we made a few structural changes our price increases relating to, among other things, work tools and components.

At this time, we expect total price realization of about $1 billion in 2005 from all this pricing activity.

This equates to about a 3 percent overall price realization this year.

Furthermore, as we speak, we're reviewing material costs, especially steel and other commodities to determine if even further price activity is appropriate.

Another significant issue for Caterpillar has been core operating costs and, in particular, costs related to steel.

This has given almost every manufacturer fits since early last year but especially in the fourth quarter.

As we enter 2005, we are not anticipating significant steel price declines until the second half of the year at the earliest.

We expect our costs for the first half of 2005 will appear substantially higher than costs in the first half of 2004 because the comparison will contain the relatively low steel cost experienced at that time.

You can see this is an ongoing challenge we must address.

While Caterpillar utilizes numerous annual and multiyear agreements for the purchase of steel where they make sense, these contracts don't protect us from the imposition of surcharges.

We're continuing to work with our key steel suppliers with whom we have these agreements to assure supply while providing competitive pricing with the goal of jointly managing price volatility.

While this cost pressure will continue into 2005, our plan is to deliver about 25 percent more earnings per share so we can achieve a return on sales of about 7.3 percent.

As Jim Owens also mentioned at my next goal, we're still very much focusing -- focused on delivering at least 9 percent return on sales in the '06-'07 time period.

Our 2005 outlook keeps us on that path.

Also a factor in core operating costs is research and development expense.

We're stepping up our R&D spend to support tier-3 off-highway environmental standards.

The investment we made in our technology continues to pay dividends as the platform for meeting the ever more stringent environmental standards.

2005 will be a record year for new product introduction as we roll out tier-3 compliant machines.

In fact, we'll significantly increase the introduction of new models of construction in mining machines during the year.

This has an impact, not only on R&D expense, but also on support costs associated with new machine introduction.

We're proud to be in the position of leading the way to a better environment with our clean air, tier-3 compliant engines.

I'd like to take just a minute to discuss our business in relation to the overall economy.

After all, our results and our efforts must be competitive against others to remain attractive to investors.

We did very well by that standard last year and expect to do so in the future.

We did increase profit margins over the course of 2004 and in today's environment with low overall inflation, but rising material costs, most companies haven't been able to do that.

As you know, corporate profit margins in the U.S. declined in both the second and third quarters of 2004.

Many of the key industries we serve are just beginning to recover from multiyear declines.

Some in excess of 20 percent such as structures investment in the U.S. and metals mining.

Simply returning to past peaks means years of fast growth for these industries.

Mines underinvested in capacity for years due to unfavorable output prices.

Adding the capacity needed to meet future needs likely will require years of significant investment.

So we're well positioned to gain from increased volume with benefits to sales, profits and profit margins.

Our focus on the customer will ensure we remain the market leader in providing the machines and engines needed by a growing world economy.

In summary, while we're elated, and I mean elated, to achieve the $30 billion sales and revenue milestone were focused on improving our profit pull-through.

In 2005, we'll intensify our efforts by focusing on our core operating costs and price realization.

We remain committed to satisfying customer demand and building on our long-term market position.

At the same time, however, we're focused on improving shareholder value and delivering financial results in line with our expectations.

We're looking forward to another record year in 2005.

And now Nancy will give you some specific guidance related to the outlook.

Thanks, Doug.

In 2004, approximately $450 million in incentive compensation was earned by about 52,000 employees.

We expect our effective tax rate for 2005 to increase approximately 2 percentage points due to the phase out of the extraterritorial income exclusion as provided in the Americans Jobs Creation Act of 2004, along with our expected geographic mix of profits.

The impact of increased retiree pension and healthcare and related costs with a decrease in profits of $139 million in 2004.

This cost increase is due to pension.

We expect retirements benefits costs will increase approximately $200 million in 2005 compared to 2004, $100 million of which is related to the increase in retirement benefits in the recently signed contract with the United Autoworkers.

Capital expenditures for machinery and engines are expected to be about $1.4 billion in 2005 compared with $900 million in 2004.

For machinery and engines depreciation and amortization expense, expectations are about $900 million, which is about $100 million higher than in 2004.

We expect machinery and engines research and development to increase for 2005 and to be about 3.6 percent of sales.

For 2005, we expect machinery and engines SG&A to be about 8.5 percent of sales.

The monthly retail statistics for December are available on voicemail through February 15, by calling (309)675-8000.

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

First question please.

Thank you, ladies and gentlemen.

The floor is now open for questions.

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

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

And lastly, we do ask while posing your questions, that you please pick up your hand-set, if listening on speakerphones, for optimum sound quality.

Please hold while we poll for questions.

Our first question is coming from Alex Blanton.

Please state your affiliation, then pose your question.

Good morning.

It's Ingalls & Snyder.

Just a clarification.

First, the 7 cents that was not in the third quarter, where do we put it to get the quarters to add up to the full year?

We'll let you know.

Hold on.

We have to adjust either the third quarter or the first or the second or all three.

Alex this is Lynn.

Yes.

3 cents in the first quarter.

Okay.

Four cents in the second quarter, which is your seven cents.

Okay.

Thank you.

The second question is, as of January 1 with the new price increase, are your prices then up approximately 9 percent year-over-year; is that what we're hearing?

Alex, Doug Oberhelman here.

Published list prices would total that, yes.

Okay.

Now, how much more do you have to do to recover all of the costs and your forecast for this year, does it include any additional price increases in it?

It does not.

And in a general way, I'll answer your first part of that question, Alex, is that the price realization in our outlook covers our material cost at this point in time.

Okay.

So your going to fully recover with the price increases you have?

Correct.

And make up that $200 million difference.

Okay, that's -- I guess that answers the question.

Thank you.

Okay.

Thank you.

Our next question is coming from Ann Duignan.

Please state your affiliation, then pose your question.

Hi, this is Ann Duignan of Bear Stearns.

Morning, Ann.

Morning.

Just one question and a follow-up.

Now that you've achieved your $30 billion revenue goal, do you intend to issue a new long-term goal in terms of revenue or are you going to wait and see if you can achieve the ROS goal before you add another stretch?

Great question.

We have a group internally working with Jim Owens kind of the next plateau.

We will put something on that later this year.

In the meantime, you can bet, we're working all hands and feet to get our ROS goals as we stated, over 9 by '06 or '07.

So, certainly that's a very near term and day-to-day goal today while our strategic committee looks at $30 billion and beyond.

Okay.

And a follow-up question on your Cap-C banks on the engine side.

I'm a little confused as to how your truck engine business could be capacity constrained given that we're still at least 10 percent below last cycle's peak volume?

What's going on in that business or was it just that you restructured significantly after the last truck cycle?

Well, a couple of things are going on.

The last truck cycle, there's an allocation between our off-highway business, our on-highway business, our on-highway business is booming at the moment.

Our market shares are greater today.

Frankly, the demand on the 15 liter engine, the very large big block or the big block that we offer is through the ceiling.

And I'd say the mix of those three things would lead to the answer to your question.

Okay.

So it's not just a demand for on-highway engines it's a combination of off-highway and on-highway.

Yes.

And greater market shares probably in off and on since the last peak.

Okay.

I'll get back in queue.

Thank you.

Mm-hmm.

Thank you.

Our next question is coming from David Raso.

Please state your affiliation, then pose your question.

Smith Barney.

Good morning.

Good morning.

I don't understand the margins looking out during '04 to get the back half to be strong enough versus the first half to give you a full year, you know, probably a high teens incremental margin needed given your sales guidance and earnings guidance.

The price increases that you're referring to, implicitly in the guidance, it would appear you probably need a July price increase.

CAT typically rarely ever during the year gives a price increase, unique times like this mid-July.

Are you guys open to price increases as need be throughout the year?

I just want to understand the pricing strategy for CAP.

This year clearly, you could have been more aggressive.

Put in price increases on orders in backlog and I can respect the idea of the customer relationship, but if you're struggling again during '05, costs getting well beyond that you planned, are you willing to get the price increase through?

That's the story in '04, you had ever reason to increase price to not let these margins degrade the way they have.

The simple answer is, absolutely, yes.

Okay.

Thank you very much.

Thank you.

Our next question is coming from Joanna Shatney.

Please state your affiliation, then pose your question.

Good morning.

I wanted to break apart the billion dollars of the operating cost change year-over-year.

I know that, somewhat, it sounds huge because it's a billion dollars, but we really need to look at it as percent of revenue so we can just keep it simple.

Look at the billion dollars, Nancy gave us 450 as incentive comp, and you gave us some of the steel cost.

Can you just break it into chunks for us and then talk about how those different buckets move forward into '05?

Well, Joanna, it's Lynn.

As we said, a significant portion of it was in the manufacturing cost area, and the majority of that was material.

Right.

So it was 200 million was steel in the fourth quarter, but can you break up the remaining 664, tell us how much was manufacturing costs and then give us an idea of what the raw material cost hit is so that we can get comfortable that the 3 percent price increase is enough to cover that?

Well, first of all, we got a lot of -- you got a lot of things in your question here.

We've got full year, we've got fourth quarter.

We've got '04 and '05.

Let me just say in general, about half of the core operating costs total increase for the year was manufacturing costs and the majority of that was due to material primarily steel.

The other elements that are in there are the SG&A that we talked about, the R&D spend and the increment in incentive compensation.

Now, as we go forward, as Doug said, it is our plan, certainly, to continually monitor this price situation, and to aggressively work on the cost basis so that in 2005, going forward, as we've stated, we expect to more than offset material cost increases with price increases and we look to the rest of the activities to get us to our bottom line guidance that we gave you of the 25 percent increase in profits.

Okay.

When you say the 25 percent increase in profit, what's the incentive comp change year-over-year assumed in that?

And can you talk about what your assumptions are on the supplier inefficiencies and the production inefficiencies that were really talked about in the third quarter conference call?

Because I'm guessing that if you have the confidence that the raw material cost issue goes away, how are you feeling on the supplier front?

How are you feeling with being able to actually keep up with the production numbers?

Well, let me clarify one thing.

We did not indicate nor suggest that the material cost pressure is going away.

What we said was, and we continue to deal with this issue and we'll have a -- certainly tougher comparison in the first half first or the second half.

We would hope by the second half of the year we begin to see material costs, especially steel costs start to show some relief.

But at this point in time, we are not seeing that occur.

The other part of your question, I believe, was incentive comp.

As you know, we've explained this.

Each year we reset the goal based on our target and, of course in 2004, as the outlook continued to increase during the year, the performance against the original outlook, which was stretched to the target exceeded that.

When you reset, we will see some decrease in the overall incentive comp expense as it's currently forecasted.

Okay, the production inefficiencies and supplier delivery issues?

Let me comment.

I wanted to add a little bit more to Lynn's answer as well.

Mid year last year, I think or first when we first started seeing steel prices escalate as we did, I think there was a feeling at that time among, certainly here and in the industry, that steel prices in late '04 would come down.

In fact, that did not happen.

As we see things right now, the first of February or so, we don't see anything in terms of worldwide demand or steel price supply that's going to affect that materially in the first half.

That's why we've made that statement.

Hopefully we'll be wrong.

We do see it coming down in the second half.

The plants have spent all of 2004 working through -- or most of the plants anyway -- working through supply chain problems.

Inefficiencies, expediting, all kinds of things.

That certainly is coming around as we enter '05 and we'll continue to work on that and gain on that through the year.

But it's not an incremental drag in '05 in your assumptions?

Not materially, no.

Thanks.

Thank you.

Our next question is coming from Gary McManus.

Please state your affiliation, then pose your question.

J.P. Morgan.

Good morning.

Just getting on that 412 million of core operating costs.

You said 200 was material or steel and the other 60 million was R&D.

What's the remaining 162 million again?

I know in previous conference calls you've given detail in SG&A and incentive comp.

Can you do that for the fourth quarter?

ICP was basically flat, Gary, so the majority of the balance of that would be SG&A.

So SG&A was 160 million and if I'm right in the third quarter it was 90 million?

So you had a big tick up?

It was some tick up in the fourth quarter as we had a huge surge in volume and much of that SG&A is tied to just trying to respond to that, and the plants were doing some extraordinary things in the fourth quarter, and there was some tick up in the fourth quarter, yes.

You say incentive comp in the fourth quarter was zero, in terms of what's in that 412, essentially zero?

Flattish.

Flattish.

There was a little increase in the fourth quarter but not much.

Okay.

What's the assumption -- I mean, did you 412 million of core operating costs.

What's the assumption for '05 that's embedded into your forecast?

For core operating costs in total?

Yeah.

Do you expect it to go down as we go through '05?

Do you expect it to go up and then go down?

Just give me a sense of where you see that number going as we progressed through '05 that's embedded in your profit forecast.

We'll have higher core operating costs with volume, of course, Gary.

And there'll be some steel price in there likely on a percentage basis equal to the fourth or second half of '04 as we said.

Then the rate will likely tail -- or hopefully tail off as we put in our outlook for the second half.

So maybe expect a 400 million or so run rate per quarter, maybe a little higher in the first half and coming down in the second half.

I'd say, directionally, that's right.

And just one other thing on the machinery margins in the fourth quarter, you know, 7.4 percent that's the second quarter in a row that they've declined sequentially despite higher revenue growth.

Is it all steel or is there other issues going on that's weighing on machinery margins?

Gary, in the fourth quarter, the majority of that drag was due to the material side, mainly steel.

And this lag in price realization that I referred to.

Those two things really cover it, Gary.

Okay.

Just one thing.

You didn't give a cash flow release as you've done in the past.

Any particular reason for that?

Yeah.

Shortly before the end of the year, a number of companies that have captive finance companies, industrials that have captive finance companies, received a letter of inquiry from the SEC regarding how cash flows are handled in the statement between the finance company and the manufacturing side of the business.

We've been -- all of us have been handling it the same way for a number of years, accepted accounting practice, and it's being questioned.

And until those questions are answered, we're really not in a position to issue a cash flow statement.

We anticipate well have one in with our filing that's coming up in February.

You wouldn't expect any restatements of cash flow, would you?

I don't know the answer to that, Gary.

Okay, thanks.

Just to add a little to that.

We would not expect the enterprise cash flow number to change.

It's a question about the class of how cash flows are classified within the intercompany transfers almost between investing and operational activities but the overall corporate cash flow number is not in question in any way, shape or form.

Thank you.

Our next question is coming from John McGinty.

Please state your affiliation, then pose your question.

Credit Suisse First Boston.

First, a clarification,if I read through your outlook, you are talking about sales gains in North America of 17 percent, 10 percent in EAME, I think 13 in Latin America,10 in Asia-Pacific and yet you're talking about sales in engines being up 8 percent.

Are you assuming you're going to lose pins or what's going on there?

We're not going to lose any pins, no.

This is -- we do have, as you know, the big block capacity constraint won't come on until late in the year which won't help us that much.

It's the mix of everything going on in commercial and electric power and on highway and the way that goes, John.

In other words, the 8 percent's the relevant number not the forecast by region that you give?

Yes.

Yeah.

That would be a much better way to look at it.

Okay.

It's hard --

Why does that -- I mean, if none of the regions are up as little as 8 percent, in other words, if each of the regions are up more than what you're forecasting, there's got to be some kind of a disconnect there.

I'm not sure what it is.

Well, I'll have to study that for a second.

Okay.

Can I ask --

Ask another one while we're studying here, John.

Okay.

I guess one of the points that you made in explaining the difficulties of the third quarter was the fact that the 2 1/2 to 3 percent price increase in July 1 was price protected.

You got very, very little portion of it.

You said basically you'd get it in the third quarter.

As Alex pointed out, you just raised prices last year 4.5 percent in the year.

Forget about what the carryover was, and you only got 1.7 percent.

You raised prices 3 percent in Jan 1 so theoretically, you should have a 6 percent effective price increase in '05 versus '04.

Backing it off, you had said before there wasn't going to be much price protection at all because you gave the thing in August.

What I don't understand is why you're not looking -- in other words, your list price is your average prices.

Forget about the number that you all gave as your average price is up, should be up 6 percent and you are saying it's up 3.

So why are you losing in a market that's going crazy?

Why are you not getting a higher price realization?

It doesn't make sense because you've got so much carry over from what you raised in '04 that you didn't get plus what you put out in January of '05?

Yeah, well, I think the math works out to be 1.8 in '04 and 3 in '05 which would be 4.8 total.

Which is what you raised them cumulatively in '04 let alone nothing for the 3 percent that you raised in '05.

Well, and you're right.

As I mentioned, the price protection and our mix of products around by model impacted getting only the 1.8 versus what we thought was going to be 4.5 total or the published price list announcement of 4.5 total.

And that's what we're working on in 2005.

So we achieved what we published, essentially.

As we work on additional possibilities mid year as I mentioned to somebody earlier.

Even if you don't do the mid year, you're not getting everything that you've put in if you're only getting three this year.

Well, I would accept that to some degree if you look at '05 and '04 because of the slippage in '04.

Hey, John.

This is Lynn.

Let me just to clarify your point about the drinks between the total and the regions.

Yeah.

The region numbers, and this, you bring up a good point that we'll have to watch in the future.

The region numbers are sales increases, which would include price realization.

The total number of 8 percent is volume on machinery and engines, which is not including the price.

So theoretically, 8 plus the three price.

In other words, the comparable number would be 11?

Yes.

Then if you just take North America's half your volume and that's up 17 and the other guys are up on average 11, so even that doesn't quite seem to add up.

Well, you also have to take into account mix --

It's the answer to everything.

It's a good answer.

All I can tell is, is the numbers add up.

If you say so.

Thank you.

Thank you.

Our next question is coming from Andrew Casey.

Please state your affiliation, then pose your question.

Prudential Equity Group.

Good morning.

Hi, Andy.

Hi.

Kind of a detailed question on the finance, the other income line.

Does that translate into what you're talking about in the press release about return on the assets because it's kind of been bouncing around quarter by quarter.

This quarter was pretty good.

I'm just trying to ascertain what the sustainability of that other income benefit in finance is going to be in the future.

Well, the other income -- you're specifically talking about financial products?

Correct.

You know that is a detailed question and frankly I'm going to suggest that we get back to you on that because I don't want to make a guess on it, and I don't have the information right at my fingertips to answer that question.

Okay, fine.

If I could do a -- I'll follow up with Nancy later.

Okay.

On the material cost pressure comment, if you could clarify it, I'm a little confused about the second half of '05 about it coming down and there's some relief.

Is the relief other than, you know, kind of x-ing out your comments about through the year the comps will get a little bit more easy because you had kind of weaker input costs in the first half than you did in the second half of '04.

If you look at the comment, what is embedded in the guidance?

Is it that the actual input cost is going to be flat or are you inputting into the guidance something to the effect that some of your steel costs will come down in the second half?

If could you provide a little more clarity on that, I'd appreciate it.

Thanks.

Yeah, it's kind of a little bit of all of the above.

Certainly, we're going to have some real wide comparisons.

First half '05 over '04 because we didn't really start to feel the steel pricing into our cost structure until the second half and it really caught up in the fourth quarter.

That's going to be the primary difference.

Secondly, there are anecdotes today about steel price surcharges about steel price reductions, about spot markets, about scrap steel and so on that are favorable.

There's not much empirical evidence but there's a lot of anecdotes.

We fully believe that at some point the steel price is going to break, and it may or may not happen in the second half as we said at the earliest second half, but we really believe we're going to see that at some point in time.

We really baked in steel prices that are on a longer run rates in the second half of '04.

Okay.

Thank you very much.

Thank you.

Our next question is coming from Andrew Oben.

Please state your affiliation, than pose your question.

Good morning, Merrill Lynch.

Just in terms of visibility in the end market, I know that you guys don't comment on back logs specifically, but in particular looking at mining and given that really big mining companies now account for the charcoal world demand for construction equipment or mining equipment, how much visibility do you have in your mining business going forward?

Do you have any idea at this point, what might happen in '07 or is it still too early to say?

Really way too early to say, and I think that the best resource for that would be those that track and predict commodity prices specifically copper.

So -- okay.

And the second question is just in terms of steel prices, I remember the end of the second quarter and end of third quarter, we kept hoping that these nonoperating efficiencies would get better and every quarter they would get, you know, they sort of got worse.

Are you doing anything different with your steel suppliers, with your regular suppliers in '05 or are we just sort of basically hoping that the steel prices will self stabilize and as the increased rates would go down, we're going to grow, whatever, like 12, 15 percent versus 30 things will just get easier?

Or is there something specific operationally going on that gives you confidence that things will get better next year?

Well, I'll be a little flippant to begin with, other than screaming and yelling in sessions with our steel suppliers, we're probably doing everything different.

For example, steel castings, we've commented all along, have been a real pinch point for us because of really the lack of supply, the lack of number -- the low number of suppliers of big steel castings.

These are castings, you know that go into the big tractors, the big wheel loaders and the big trucks.

We've been working with our primary supplier.

A number of our black belts, a number of our manufacturing people have been at their supplier and we've brought on a second supplier now that would be bringing production into place in early as '05.

That within we expect to lesson as we go on.

Again, we've got a huge demand for mining trucks that's over and above anything the industry has ever seen.

So we're trying to catch that every single day but our 6 Sigma process allows us to infiltrate suppliers and work together to get better efficiency.

We have multiple plants that deal with one supplier.

We're able to much more coordinate how we deal with them.

We're working on all of those every day.

I would expect improvement in what we call this manufacturing efficiency all the way through the year as we get better at it.

And you're considering investing in your suppliers or sharing some of -- you know, giving them equipment or giving them money for Cap Ex to operate their capacity or --

I'd say yes to all of those.

Thank you.

Thank you.

Our next question is coming from Joel Tiss.

Please state your affiliation, then pose your question.

Hi, I'm still at Lehman Brothers and I've got a broken calculator too.

Can you guys just help me understand, 3 percent price increase is sort of a billion dollars of extra operating profit but you're going to have say plus or minus $3 billion of incremental revenues in '05 over '04 that seem to carry no margin at all.

Can you tell me what I'm doing wrong there?

Joel, where are --

I'm not clear on your math, either.

I'm not clear on your math of the $3 billion of revenues with no margin.

Well, if the sales are going to go up by, you know, 12 to 15 percent that's about $4 billion of higher sales, roughly, at 3 to 4 billion.

And then say a billion of that is just from the price increase.

So that's 2 1/2 to 3 billion of higher revenues.

But just a 3 percent price increase on 30 billion of revenues is, you know, that's almost your billion dollars of extra operating.

That's a billion dollars of extra operating profit.

So you already get the price increase without the extra sales, you know what I'm saying?

So then it seems like those extra sales don't add anything to the profit increase above what you would have just get from pushing the price increase through.

Well, if you take into account the combination of volume, which we've talked about, the price realization that Doug mentioned and the projected increase of core operating costs, then you come to the 25 percent increase in profitability that is in the guidance.

That's the way our numbers work.

Okay.

And any insight into -- it seems like it's taken a while to ramp up.

The demand has been strong for sort of four or five quarters.

Can you give us a sense of why it's taking so long to be able to ramp up.

Is it, you know, suggested capacity constraints in some area?

Is it just the number of plants or not enough workers or can you give us a little help just so we can sort of figure out how it's going to unfold as we go through 2005 what the pressure points are?

Yeah, Joel.

Let me add to that.

We are extremely proud of what our people did in most of these planted.

We went from a standing start, essentially a year ago but go back to the fourth quarter '03.

And in most of the big high volume plants, they put out 40 to 45 percent more physical volume in under a year's time.

I think that's pretty impressive by any stretch of the imagination.

Did we do it as efficiently as we would have done it had we had that kind of volume four two, three, four years in a row?

Of course not.

If you look at the field population we put out last year and what that will reap down the road, if you look at what we set ourselves up for in 2005 in terms of the way in which we run our business, I think we're poised perfectly for the mid to long term particularly if we really see this economic growth as we think we're going to see for the foreseeable future.

I can't think of too many industries or too many companies or too many businesses that can ramp up 40 to 50 percent in a year's time.

We did deliver $7 billion plus in new revenue and we did deliver 5.75 a share.

We feel good about that in retrospect.

A year ago today, none of us saw that coming, including probably most of you on the phone.

So it's been a wonderful year in that perspective.

Okay, thanks.

Going forward in 2005, we saw the second half ramp up, we saw the fourth quarter with extremely high shipping levels.

You saw our sales to users data.

We're continuing that path and refining and working on our efficiency.

So I expect that'll help us.

Okay.

Thank you very much.

Yes, sir.

Thank you.

Our next question is coming from Mark Koznarek.

Please your affiliation, then pose your question.

It's Midwest Research.

Good Morning.

Hey, Mark.

Just to clarify, the actual raw material incremental cost in 2004 was what?

Of our core operating cost increase of the 1.1 billion, about half of it was manufacturing costs and the predominant majority of that was the material.

Okay.

In the third quarter, you had said that your expectations for the full year was that they would be up 300 million.

And it sounds like here in the fourth quarter this 200 in the quarter alone was more than you thought.

So I'm guessing that for the full year it's like 400 to 450 or something.

Is that about right?

Pretty close, Mark.

Okay.

What you're saying for '05, your price increase is going to fully offset raw materials so a good first guess at raw material increase again in '05 is around a billion.

That's the correct way of thinking about it?

No.

No.

So you're going to get more price than raw material.

Likely, yeah.

That's the outlook.

So we shouldn't take that second half, I mean, if you got the 400 or 450 mostly in the second half, annualize that to around 800 and say, you know, that roughly offsets price.

That's not what we're doing in the outlook, you're right.

Okay.

Thanks for the clarification.

I wanted to ask about maybe it kind of extends Joel's question a little bit more but this issue of capacity constraints.

Should we be looking at the regional revenue outlook, you know, for instance North America up 17 percent as kind of an aspiration if you can debottleneck sufficiently to meet demand or do you guys really think you can deliver North America revenues up 17 percent because if you go out and talk to, you know, the folks in the field, there is still, you know, comments that the delivery lead times are extremely long and, you know, concerned about availability and lost sales opportunities and things like that.

So is that 17 percent really a target but you need to debottleneck to get there?

The 17 percent in the case of North America plays directly into our belief that we can deliver the 12 to 15 percent increase in top line revenue.

And there won't be a hand in this company that won't be trying to do that more in 2005.

So your Cap Ex is going up 500 and I imagine a lot of that is debottlenecking kind of stuff?

Some of that is.

A lot of it's new product introduction as well.

Okay.

So you're saying that it's not a lay up.

You've got work to do to get the capacity increase in order to meet the retail sales?

Yeah.

I wouldn't say anything's a lay up when you're looking a year out.

Be that as it may, we're -- our outlook contemplates being able to deliver and sell what we've put in the numbers.

That would be the 17 percent North America and 12 to 15 percent top line for the company.

We -- in our outlook, we contemplate doing that.

We think we can do it.

Okay.

All right.

Great.

Thank you.

Thank you.

Our next question is coming from Robert McCarthy.

Please state your affiliation, then pose your question.

It's Robert W. Baird.

Good morning, everybody.

Hi, Rob.

I wonder if you can handle a couple of clarifications before I ask my questions.

One being that it occurs to me that as you try to reconcile those growth rates for John with the 8 and the 3, isn't there an embedded little extra piece for currency in some of those foreign markets as well?

Rob, we try not to -- first of all, I think it's impossible to truly forecast currencies so when we do our outlook, you know, we take a position where the rates are and really don't build something in there for currency activity.

But where the rates are would, if they stayed where they are, that would yield a positive impact on reported sales for the coming year.

Yeah, right.

Okay.

Well, and you never answered Joanna's question about '05 incentive costs, I don't believe.

How much is embedded in your forecast?

No, you're right.

What I said was we reset the target at the beginning of each year and because of that, because we, you know, if we meet target --

yeah.

Then you anticipate that the incentive comp number would be lower in '05 than it was in '04 because we definitely beat the target in '04.

And raised the bar for '05.

We raised the bar for '05.

Okay.

Here are my questions.

Thank you.

Those weren't questions?

No, they weren't.

They were clarifications of earlier answers.

Okay.

First one's real simple.

Dollar value of the increase in dealer inventories for the full year, new machine inventories.

Looks to me like it should have been around $800 million.

Is that right?

That's close.

And can you talk a bit about everybody's focused on what the total operating income, total operating costs, all of the totals, but I'm struck by the divergence in fourth quarter performance between the two segments.

Margins down, you know, fairly sharply sequentially in machinery.

Virtually nearly a 0 incremental margin compared with prior year.

Engines goes the other way.

Margins up and actually are respectable incremental margin.

Yet seems to me, both businesses face a lot of the same challenges.

Can you talk about what influenced the fourth quarter difference between the two?

Combination of factors, Rob.

The certainly from the standpoint on the machinery business, the significance of the steel price impact in the fourth quarter had a bigger impact on the machinery business.

Especially in the castings, steel castings area.

There are a lot of big steel castings, especially in track-type tractors and the big mining machinery.

That had a significant impact.

So in other words, costs up more on the machinery side than on the engine side?

That's correct.

Okay.

Did you get maybe better price realization on the engine side?

Yes, I think that's a fair statement that the price realization on the engine side was better.

A little difference in price protection practiced there.

Yeah.

I'll just comment on the engine side.

We took a number of actions late in the year, primarily based on the weakness of the dollar in the way we priced primarily in [Inaudible] and elsewhere.

So that helped the engine division to some degree.

And mix?

Because I'm wondering how you're handling pricing at Solar?

Same way as everywhere else?

I mean, that's a really long lead time business.

Yeah.

It would be the same as everywhere else.

They've got, I would say, in that business and industry they probably have better ways on an ongoing basis toe take care of that.

All right.

Thanks a lot.

Okay.

I think we have time for one more question.

Thank you.

Our last question is it coming from David Bleustein.

Please state your affiliation, then pose your question.

Hi, it's UBS.

Can you discuss where you are in your negotiations with the steel mills aside from the yelling and screaming.

Just basically, how exposed are you to spot changes and hot rolled sheets, much does steel plate matter?

Then just I'll ask a follow-up in advance.

You said last year, your steel prices paid were up 20 percent.

What do you expect that same figure is going to be for 2005?

Well, I'm not going to comment on the price increase for '05 in terms of what we think is going to be.

We have the vast majority of our steel under some kind of contract and still do in 2005.

Some of that came off, though in the fourth quarter in Europe and elsewhere.

That's one of the reasons that we saw some of that happen in the fourth quarter.

The steel industry is in the enviable position of being able to price whatever they want regardless of what their contracts say.

It becomes a negotiation on a day-by-day, per ton basis in terms of what your demand is.

A lot of our activity is trying to find out if we can use more basic grade steel than some of the specialty steel we use and substitute a cheaper priced steel.

We've just got lots of things going on in that area.

It really is a day-by-day, week-by-week thing.

Just like you read in the newspaper.

I mean, you read in the newspaper about the steel people being able to price where they want is exactly what we experience.

I don't think we have much different situation although we do have some long-term relationships that do help us.

So essentially, you're saying the vast majority of your 2005 steel purchases are effectively reliant on spot rates?

No.

Well, --

or some discount to spot rates.

There'll be some surcharging on a lot of the steel we buy in terms of flat, rolled or bar.

I think David, this is Lynn.

I just want to add one thing there on this long-term.

As Doug said, we had some long-term contracts come off.

As you might imagine, the steel producers are in here trying to get us now to sign long-term contracts at these price levels.

So your comment about having more of it subject to spot price in 2005 is correct, but in our opinion, this is not the point in time to start signing long-term contracts, and we're going to take all of the actions we can to try to ride this until we start to see some relief in the spot prices.

Okay, but it's certainly fair to say that hot roll plate prices, if you will, rise another $200 a ton, you may need to adjust your forecast.

If they fall $200 a ton, you also may need to adjust your forecast.

What we're going to do.

As I mentioned, we're going to look at our pricing.

If as the next few weeks and months go, we see continued steel price increases and we think that's going to go on, and I personally think that's going to happen for a while, we'll be, as I said, adjusting prices again to our customer base.

Remember, we're going to recover all of our material costs from price realization, or more, as we said.

Terrific.

Thanks.

Okay.

Thank you very much.

If you did not get your call answered or your question answered today, please give me a call.

So long.

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.