開拓重工 (CAT) 2005 Q1 法說會逐字稿

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

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

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

Ma'am, you may begin .

Thank you.

Good morning and welcome to Caterpillar's first quarter 2005 results conference call.

I'm Nancy Snowden, Director of Investor Relations.

With me are Jim Owens, Chairman and Chief Executive Officer and Dave Burritt, Vice President and Chief Financial Officer.

Also with us today is Mike DeWalt, who will become the new Director of Investor Relations.

Unlike all previous directors of investor relations here at Caterpillar, I am not retiring.

But I am moving to new responsibilities at the company.

I'll be available for a few more weeks as Mike transitions into investor relations in early June.

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 remarks, you can go to the SEC filings in the investor section of our website where they are filed as an 8-K.

You've likely noticed that we've changed our results release.

We've moved the presentation of supplemental data to our website, tabularized some of the information, provided additional information on the outlook and added a question and answer section with answers to questions we thought you'd like to know.

We hope you'll find these improvements helpful.

This morning I'll cover our first quarter results and review our outlook.

Jim Owens will comment on our outlook from a broader market context 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 uncertainties is in a form 8-K filed with the Securities & Exchange Commission today.

Okay.

Let's start with the first quarter results.

As you know, this morning we reported record first quarter sales and revenues of $8.34 billion and record quarterly profit per share of $1.63.

Sales and revenues for the first quarter were up $1.86 billion from first quarter 2004.

The increase was due to higher machinery and engine volumes of $1.44 billion, favorable price realization of $250 million, a favorable currency impact on sales of $102 million, and $72 million of higher financial products revenues.

Profit was $581 million, up $161 million or 38% higher than first quarter of 2004.

The increase in profit was due primarily to a $521 million favorable profit impact of higher sales volume and higher price realization of $250 million.

These favorable items were partially offset by higher core operating costs of $489 million and higher retirement benefits of $48 million.

Machinery and engines' core operating costs were $489 million higher than first quarter 2004 levels.

Primarily as a result of higher manufacturing costs.

About two-thirds of the increased manufacturing costs were material and related supply chain inefficiencies, primarily related to steel.

This continues to be a cost impacting every industry that uses steel.

Material costs and volume related manufacturing and supply chain inefficiencies began accelerating more rapidly in the second half of 2004.

As a result, first quarter of 2005 versus the first quarter of 2004 is a tough comparison.

In the new question and answer section of our release, question number three, we have provided a detailed breakdown of core operating cost change.

Machinery and engines SG&A without the impact of retirement benefits and currency was $46 million higher than in the first quarter of 2004.

SG&A continues to decline as a percent of sales from 9.8% in 2004 to 8.3% in the first quarter of 2005 We are focusing Six Sigma efforts on making our period cost structure flexible so we can react to changes throughout the business cycle.

Also, research and development, another part of core operating costs, was basically flat in dollars with the first quarter 2004 and decreased as a percent of sales to 3.1%.

In addition to core operating costs, the total negative impact on-- of currency on operating profit was $37 million.

The main reason for the negative impact of currency on operating profit was our short position in the pound sterling and Japanese yen due to sizable manufacturing operations in the UK and Japan.

However, as a result of currency gains included in other income and expense, the impact of currency on profit before tax became a favorable $4 million.

Retirement benefit costs increased $48 million this quarter, in line with our expectation that retirement benefit costs would increase $200 million in 2005 compared to 2004.

An increase in retirement benefits in the contract signed with the United Auto Workers this year accounts for about $100 million of the increase.

The remaining $100 million of increase is primarily a result of the lower discount rate applied to the pension obligation in 2005 versus 2004.

Before we go into the outlook, I'll provide some comments on North American rental fleets and used equipment.

North American dedicated rental fleet utilization on a 12-month rolling basis through February was up to about 69% from 67% in the same period last year.

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

Rental rates are forecasted to continue to improve over the next six months.

Overall, units and dedicated dealer rental fleets are up about 16% from 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 52% of the units in dealer rental fleets are up 12% from a year ago.

The Cat rental stores which generally rent smaller machines for shorter time periods currently have about 48% of the rental units in dealer fleets.

These fleets continue to grow and are up about 21% from a year ago.

North American dealers in first quarter 2005 had a total of 402 stores.

About 30 more are expected by year end 2005.

In the Europe, Africa, Middle East region dealers had 792 rental outlets, 395 of which were converted to the Cat rental store identity as of quarter end.

In Latin America, we had 105 stores and 154 in Asia Pacific, including Japan.

At year end 2005, we are expecting about 1540 rental outlets throughout the world.

Of these, 420 stores in the United States and Canada and about 600 in the rest of the world will have the Cat rental store identity.

North American used equipment prices trended up about 14% for most machines in the fourth quarter of 2004 compared to the fourth quarter of 2003.

We expect continued strengthening in the near term.

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

Regarding availability of new machines, at the end of the first 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 selected production shifts, source from Caterpillar plants supplying lower demand areas such as China and use Six Sigma teams to identify ways of increasing production capacity.

Dealer inventories at the end of the first quarter of 2005 were up 38%.

However, inventories compared to months of sales are down slightly from the year-end 2000 level of 2.6 months of sales to 2.5 months of sales. with dealer deliveries increasing in all regions, we believe the growth in the inventories reflects dealer preparations for continued strong deliveries.

Over the rest of the year, we expect a decline in inventories from today's level.

We anticipate the dealer inventories at the end of the year will be about $75 million higher than at year-end 2004.

With all of the increase in North America.

Now I'll review the outlook.

First of all, 2005 is shaping up as another very strong year.

We now expect company sales and revenues to increase 16 to 18% this year, up from the previous forecast of 12 to 15% growth.

This should result in 2005 sales and revenues somewhere between 35.2 and $35.8 billion, another record year for sales and revenues.

With this volume forecast, we now expect profit per share to be up 35 to 40% compared to 2004, up from our initial forecast of about 25%.

Continued pressure on core operating costs will persist as these volume levels, but some relief on materials cost is expected in the last half of 2005.

In fact, material cost increases are already showing signs of slowing.

As a result, we expect margins in the last half of 2005 to be stronger than in the first half.

The pricing actions we've taken in the last 15 months resulted in $250 million of price realization in the first quarter of 2005.

We anticipate continued improvement in price realization as the year unfolds and price protection programs are worked through, resulting in about $1.7 billion positive impact for the year.

This includes the price increase announced on March 1, 2005.

Price realization takes into account the projected impact of price protection, product and geographic mix and any merchandising or discounting.

After many years of improving our products without commensurate price increases and last year's subpar realization, we are encouraged to see this level of price realization.

As Jim Owens said at MINExpo and has reinforced over the past few months, it is our plan to more than offset material cost increases with price in 2005.

We have taken concrete steps to do just that.

Turning to our material costs and availability situation, the materials environment continues to be challenging.

Steel castings and specialty bar quality steel have been in short supply, but are now improving.

We now have adequate supplies of specialty steel to meet our production needs.

In the past year, we have more than doubled the daily tonnage of steel castings available from key suppliers, allowing us to address the significant backlog of demand for castings.

We anticipate being completely current with demand for steel castings, by the fourth quarter of the year.

While there is a continuing tire shortage, we are utilizing a variety of alternatives, including bias for radial substitutions, adding new suppliers and considering retreads in some applications to deal with the industrywide tire shortage.

In some cases, we are shipping equipment without tires, where customers provide their own tires.

The tire shortage will take time to resolve, but we are finding creative solutions to work through this problem.

And again, our key suppliers are stepping up their investment in additional equity.

From a cost standpoint, we now expect material costs to be slightly higher than originally expected, but again, the rate of increase is moderating, and we do expect some easing in steel prices in the second half of the year.

Further, we have improved our expediting and work done outside costs from the highs experienced in the last half of 2004 and anticipate continuing improvements throughout the year.

Our new and improved outlook takes all of this into account.

Now I'll turn it over to Jim to comment on our market outlook in a broader context.

Thank you, Nancy.

And it's a pleasure to be back with our analyst community this morning.

And good morning to all.

I haven't had the opportunity to talk with most of you since the MINExpo presentation last September.

And, given recent financial market jitters, I thought a few reassuring words about our outlook might be helpful.

As indicated at MINExpo and in my year end letter to shareholders, we are projecting global economic growth to be relatively robust over the next five years.

Averaging about 4% per annum in real terms.

That's about 1% higher than the average for the decade which ended in 2003.

The case for Caterpillar is that this growth will require relatively high levels of investment in the key markets we serve We developed this outlook over a year ago and developments since then have solidified our confidence in this forecast.

I'd like to take a few minutes to explain the thinking that supports this forecast and why it's so positive for Caterpillar.

A key factor is that inflation is low.

Inflation this decade has been the lowest since the 1960s throughout the world.

And despite some recent concerns, inflation in most countries is well within central bank targets.

With low inflation comes lower interest rates and a positive investment climate.

Today, interest rates around the world are much lower than in the 1990s, and even with the continued expected rate increases by the U.S.

Fed, interest rates in the United States will be lower, or should be lower than they were in the mid-1990s recovery period.

The industries we serve will require significantly higher investment levels over the next several years to accommodate this stronger economic growth.

The impact of China's economic growth on the world economy last year provided an example of the bottlenecks that exist in the global economy.

Look what happened in energy and metal commodity markets, and the economic acceleration exposed a number of choke points in basic materials, energy and infrastructure.

This leads us to the conclusion that investment in the future will have to do more than just match demand growth.

It will also need to correct for a prolonged period of underinvestment.

The examples are compelling.

Worldwide investment in base material -- base materials has basically been flat for over 20 years at a time when demand for most metals has increased by 2 to 3% annually.

Today, capacity is insufficient.

Consumption exceeds production.

Inventories are at critical lows.

Operating drill rigs declined by two-thirds between 1981 and 2004.

Today, the world has only 1 to 2% spare oil production capacity compared to a needed safety margin in the 10 to 15% range.

This comes at a time when some fields are declining and many are located in politically unstable areas.

The world's transportation system is struggling to handle growing trade flows.

Ports, airports, and roads are at capacity creating delays and inefficiencies.

We don't think government leaders or the public will want to continue with these inadequacies.

And we are seeing signs of change.

Widesport-- widespread support for a new highway bill in the United States is one positive sign.

And developing countries are using the gains from exports and higher commodity prices to step up investments in their infrastructures.

This increase in global mining, energy, transportation and construction industries comes at a time when the existing population of machines needed to do the work is aging.

Available data shows an older field population of construction equipment, on-highway trucks and ships.

Low interest rates, more productive machines and a positive outlook for demand should prompt an upgrade in fleets, which will further benefit our sales of machines and engines.

We are likely in the early stages of the growth cycle for many of the key markets we serve.

This is the third year of industry recovery.

The last two recoveries that followed prolonged downturns lasted seven years.

If economic history is any guide, we should be moving from a strong cyclical recovery into a solid expansion phase.

At Caterpillar we intend to seize this growth opportunity by continuing to serve our customer base while improving operating performance.

We will also maintain a focus on improving our cost structure and diversifying into businesses that help stabilize earnings.

This allows attractive profitability in future cyclical downturns.

Last fall at MINExpo, I made the case to you that Caterpillar is better positioned for success than the average company in the S&P 500.

Since then, in our annual report, I outlined the five characteristics that distinguish Caterpillar from the pack.

First, our established strength with products and services.

As you know, essentially number one or number two with every major product line on every continent, a real brand -- global brand strength.

Second, technology leadership in our industry.

Perhaps the best exemplified by our new Acert engine technology but it also spans technology in our machine product line.

Third, a well established global footprint.

That means a fully integrated manufacturing presence on every continent that gives us a natural hedge.

A dealer organization that's the envy of the industrial world and gives us distribution and product support capabilities the world over.

Fourth, governance and financial integrity.

And finally, fifth, the unique set of market strengths which I've highlighted today.

These characteristics, coupled with our intense focus on improving efficiencies through Six Sigma and lean initiatives, our focus on continuing to leverage our global purchasing organization to eliminate supply chain bottlenecks and effectively manage material cost, and finally -- finally streamlining efforts in the order fulfillment area.

All of these should generate bottom line results that exceed our topline sales growth.

In summary, I believe that Caterpillar is better positioned to win in today's global economy than the average company in the S&P 500.

You know what my aspiration is.

To have a valuation that recognizes that fact.

And I think our post-1993 performance merits that type of recognition.

Now I'll turn the floor back over to Nancy before we proceed to our question and answer session.

Full details of the outlook for 2005, including other assumptions, are contained in the Company's press release issued today.

The monthly retail statistics for March, as well as the supplemental information that have previously been included in our quarterly release can now be found on our website at www.cat.com under the "About Cat" tab under investor information.

The retail statistics can also be accessed by voicemail by calling (309)675-8000 through May 16th.

After today, we will no longer be sending e-mail and providing voicemail with retail statistics information because of the website availability.

We will be archiving the retail statistics beginning with the January 2005 information for a period of five years.

While you're on our website, you might check out Jim's interview with Bloomberg television's For the Record.

The program was taped at our Tinaja Hills facility in conjunction with ConExpo and was broadcast nationally on March 19, 2005.

You can access a video of the interview on our website.

Okay.

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

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

First question, please.

[OPERATOR INSTRUCTIONS]

Our first question is coming from Alex Blanton.

Please state your affiliation and then pose your question.

Good morning.

It's Ingalls & Snyder.

Jim, in the -- on page 23 of the press release, it says you expect to have a 10.7% operating margin for the year.

And if I took the first quarter and I plugged in a 10.7% operating margin into that, which I did this morning, I come out with a net margin -- because of other income below the line, of 8.1% which is compared with 7% last year.

So you would have a 110 basis point improvement in net margin if you achieved the operating margin you were talking about.

Is that correct?

Alex, I haven't done that exact math that you just ran through.

But it sounds order of magnitude correct.

I think our forecast for the year does expect some continued improvement in operating efficiencies as the year unfolds and we've got a pretty good line of sight to that and continuing improvement in price realization as reflected in that chart.

So we should see improving operating margins each quarter going through the year.

But this is still below the 9% net margin which is your target for the average over the cycle.

So you expect that to continue to --?

That's our target for -- that was our target for 2006.

And we're still working very hard to --

--for 2006?

to nail that target.

Yes.

-- 9%.

Yes.

Okay.

Good.

Now, secondly, it mentions on page 22 that you expect incentive compensation to be 15 to 20% lower than last year.

Why is that?

I would expect it to be going up if your profits are.

Well, that's a great question.

Last year, of course, we substantially exceeded our business plan expectations.

Every year we set an incentive comp target based on a business plan of about 90% of -- and our stretch target is always to -- is the target that we're working to.

That gets us to a payout factor of 1.

Last year the average payout factor was right around 1.25, 1.3, depending on the business unit.

So this year we'll have to do considerably better than the current outlook to get back to that lofty level.

But we raised -- essentially we raised the target substantially based on the opportunity.

Okay.

So this is based on plan versus target -- I mean actual versus plan.

Well, the comment in the outlook is based on incentive comp payout at the current outlook level of earnings.

Okay.

Thank you.

You're welcome.

Thank you.

Our next question is coming from Anne Duignan.

Please state your affiliation then pose your question.

Good morning, everybody.

Good morning, Anne.

I have a question on the T -- the road bill, the TA-21.

I'm just curious if you could give us a little bit more color on the timing that you're anticipating now for that bill.

And then what kind of a lag should we expect before we see any significant projects that might get released that may be caught in pent up demand right now?

And should we expect significant increase in machinery sales as a result of that in '06?

Anne, I think I can field that one.

As you are probably aware, the total dollar amount of the ongoing highway bill that is before Congress is $284 billion.

Both the house and senate have come up with that number.

There will probably be a conference bill in that there are some dissimilarities between the two bills.

The old highway bill, T-21 was extended through May 31st and allowed for a 6% increase in highway con -- spend contracts up until the passage of the new bill.

So we're expecting -- we're fully hoping that the new bill will be finalized before the ending of the old bill.

As -- these things are phased in over the six-year period.

So, we would anticipate that it will be a fairly smooth payout on -- under the highway bill over the period of time.

I'm not sure what percent we would anticipate of the 284 billion coming to construction equipment sales, but it is definitely a positive factor that will continue to fuel ongoing sales of construction equipment.

Great summary, Nancy.

I think the key thing is with passage of this bill, there will be ongoing pretty solid level of funding at a higher rate than the last five years for highway construction in the United States and restoration.

And we've enjoyed a pretty high level of sales of heavy construction equipment into that sector for some time and it looks like we have a pretty positive outlook for the next few years in that segment.

Have you been able to quantify, though, what the impact of the 35% increase in actual funding will actually translate into higher machinery sales?

Obviously you wouldn't expect a 35% increase in machinery sales.

But historically when the bills have been passed what has it done to demand for heavy equipment?

Well, I think Nancy's right.

I mean there's a lot of work that's underway.

This bill was extended.

A lot of highway construction activity is ongoing.

We think it will be a steady, and slight increase from this level, but sustainable for the next several years.

That's the encouraging thing.

Okay.

So you're not anticipating a huge step function growth.

No, we're not.

Okay.

And then one quick point of clarification on your manufacturing costs.

I didn't see in your release, maybe I missed it, but can you break down what specifically were the material costs impact versus the inefficiencies?

Anne, I can take that one.

You know, we did break down in question three in the release that about two-thirds of the incremental core operating cost was for variable costs.

Right.

Of the variable costs, about 75% of that was for materials.

So pure materials was about 75%.

Okay.

I missed that in question three Thank you.

Thank you, Anne.

Thank you.

Our next question is coming from Gary McManus.

Please state your affiliation.

Then pose your question.

J.P. Morgan.

Hi, Nancy and Jim.

Let me just say, I like the improvements that were made in the press release, especially the Q&A.

My question -- we talk a lot about core operating costs year-over-year.

Can you talk about how it did sequentially, in other words, what was core operating costs first quarter versus fourth quarter, are we seeing improvement, is it still getting worse or just some color there.

Maybe a little color.

Certainly, in the last half of 2004, particularly in the fourth quarter, we experienced a very sharp acceleration in material costs, particularly in the steel area where we ran out of our long-term contracts.

And with the tremendous demand we were trying to satisfy and customer commitments that we had made, we went outside to specialty steel houses, et cetera.

So we had a stronger uptick in material costs, more expense for expediting shipments, material in and material out.

And we're seeing some significant improvements in that already in the first quarter.

So lower expediting costs, better material availability, a lot less usage of nontraditional suppliers for materials.

So better material flow.

And some moderation and easing in some cases in material costs.

So a lot of very positive signs, I'd say, in the first three months of the year.

And in line with our expectations, as we are really plateauing at a much higher volume level than we were building at during the first half of last year.

Okay.

And when I look at your guidance both for the core operating costs for this year, the 1.2 billion, that's actually, obviously the rest of the year is going to be operating at a lower run rate than what we saw in the first quarter.

And then when I look at pricing, which you expected to be -- a price realization of 1.7 billion, you did 250 million in the first quarter.

So that's an increase in the pricing.

I think I have a 6.5% price realization expected for the second -- for the rest of the year.

So I just want to ask -- the confidence in these projections and what could go wrong in terms of not getting that kind of price realization or not seeing the core operating costs decline as we go through the rest of the year.

Well, first of all, the production isn't slowing down significantly.

In fact, it's -- we'll continue to have pretty high bill rates in line with say, the end of the first quarter rate for most of the rest of the year per the current outlook.

And again, I think with improved efficiencies and better material flow we're looking for ongoing improvements in our operating efficiencies as the year unfolds.

We've got the material costs projections built into our outlook statement as Nancy indicated.

We now look for slightly higher material cost increases than we had in our initial business plan.

But we have pretty high confidence in that number at this point in time.

On the pricing side, again, we've -- these are the announced price increases, including our March 1st announcement for another increase in May, which should bring our average net price realization for the year to right at 5% year-on-year.

Now, that compares to 1.8% that we actually realized in 2004.

So, again, I think we have pretty good confidence that that net -- that price realization will be realized and we've factored in all of the anticipated discounting and other delays due to price protection that we give our customers and dealers as we work through the announced price increases.

Okay.

Thank you.

Thank you.

Thank you, Gary.

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.

How you doing?

There's -- Can you talk sort of big picture if there's any reasons why this cycle, that the peak operating margins in the machinery business would be lower, like noticeably lower than they've been in past cycles?

And my memory is sort of 14.5 to 15% in the last two -- the last two recoveries.

12.8

Nancy tells me the number was 12.8.

In 1997.

In '97.

Well, I'd say if you'd go back to '97, I'm more focused on long term return on assets employed in the business, return on equity overall.

And I think we have a slightly less rich mix probably than we had in the 1997 time frame, much larger small machine business, a much small-- large -- larger small engine business than we had at that time.

And more services.

So I think the ROS is probably not the best metric, it's not the one I look at, more return on assets employed and return on equity.

I think we'll do quite well again with this cycle.

And we expect continued improvement as I indicated in my general comments.

I think our bottom line earnings per share growth rate will be significantly higher than our topline growth rate for the next several years.

Okay.

And the follow-up, can you talk a little bit also about the competitive landscape?

Are your competitors giving aggressive deals or trying to gain share or are they capacity constrained?

Can you just give us a little flavor of what the channels in the competitive landscape look like?

Thank you.

We're seeing selective cases of competitors being pretty aggressive in trying to gain some market share.

But overall, my expectation is that most of our competitors are experiencing similar types of material costs, pressures that we have experienced.

The dollar is relatively weak vis-a-vis where our competitors are manufacturing in some cases.

I would guess that most of our competitors will take the opportunity to follow our price leadership.

It remains to be seen.

I don't expect to give up any significant market share, certainly, but I do expect to get the price realization we targeted.

Okay.

Thank you

Thank you.

Our next question is coming from John McGinty.

Please state your affiliation then pose your question.

Credit Suisse First Boston.

I just wanted to first echo Gary's comments.

I thought this was a very, very solid change in the reporting and information.

Also, having the -- Jim on the call and Doug last time was, I think, very, very positive.

Just a -- first question's kind of a picky one, which is, having said that, I'll ask a picky question.

Trying to just make sure I totally understand the difference between the 12 to 15% and the 16 to 18%.

Because if I look at it, price is 5.5% versus 3, so that's 2.5% of it.

You're talking about currency being 1.5%.

And Lynn made the point last time that you had no currency in there.

So you're really, if I get this correctly, the only real increase -- substantive increase other than the price, which is real and important on the margin side, you've got volume going up only 8 to 10% versus 8 previously.

So on the midpoint it's only up 1%.

And, how do you square that with your comments about the first quarter being much stronger than expected and you're being somewhat more optimistic about volume.

In other words is this 8 to 10 still pretty conservative relative to the 8% you had last time given the first quarter and given those comments?

We hope that turns out to be the case.

But I think we did have -- we have a pretty strong first quarter.

We -- keeping a finger on the pulse of global demands and our capacity to ship.

So, it's --

And we're trying to manage some dealer inventory reduction as the year unfolds.

Okay.

So it's not really -- I mean you really don't -- okay.

So if the dealer inventory reduction may be -- may be the new piece of it, because if anything, it's really not much of a -- of a -- of a real volume forecast increase from where you were at least in effect to the low end.

It's nothing.

But you think you can get more out of dealer inventories perhaps which is logical, if you can get-- I guess if you can get your production up a bit.

We're looking to substantially improve availability from factories and in doing that, we'd like to manage, and the key operative word here is "manage" thoughtfully dealer inventories down somewhat in the upturn.

Okay.

The second question, getting back to your comment, Jim, earlier, which is that you want to look at return on assets, you want to look at return on equities, one of the things that you are doing because of supply chain management and everything else is generating tremendous amount of cash as these earnings go up.

It's not being tied up in terms of dealer inventories or any things like that in the past.

And the question -- is where are you?

You said when you initially took the job, you were going to reinstitute the strategic planning function.

Can you talk to us about where you're coming down on what you're going to do with the cash?

Because it's actually piling up at a fairly aggressive rate and where are you on what you want to do?

Buybacks, acquisitions?

Can you share with us where you are?

Is it too early at this point?

Well, thank you for the question, and the comment -- and the observation.

Because our cash flow is very positive and should be a source of corporate strength for the next few years.

I plan to be in Boston, New York with an analyst meeting in the late October, early November time frame right after our third quarter release.

At that time, I will be talking about our -- the rollout of our new vision mission-critical issues and definitive targets for where we hope to be in 2010.

I think back to the cash question, John, we -- first off this year we have stepped up our investment in CapEx quite a bit and we're selectively expanding capacity.

We will entertain ideas from our business units for selective investments, most likely only small acquisitions to further complement our line and increase our business strength.

We have the most aggressive new product program in the history of the Company, rolling our new Acert engine technology into our complete machine lineup.

And that also involves other machine enhancements which we think will strengthen our competitive position over the next two years.

But far and away the most aggressive program in the history of the company.

Having said all that, we'll still have a lot of cash left.

Great.

I would hope that we will be able to consider -- the board thoughtfully -- annual dividend adjustments and certainly with the residual, we'll be reasonably aggressive at share buybacks to maintain our debt structure the way we'd like to see it and focus on return on equity.

Thank you very much.

You're most welcome

Thank you.

Our next question is coming from Mark Koznarek.

Please state your affiliation then pose your question.

Hi.

It's Midwest Research.

Good morning Jim, Nancy and Mike.

Jim, a question for you with regard to your question five -- or answer five in the press release talking about some of the cycle dynamics.

You talk about a normal cycling cycle that Cat revenues roughly double, and it strikes me that if you look back to 1999 versus where you're targeting your revenues to end this year, we're almost at that 100% increase.

And it sounds like earlier you were making the case that this might be unusual cycle, but I'm wondering if you could get into the cycle dynamics a bit more as to how much of the cycle might be left in mining, how much in heavy construction, some of the broad categories such as that?

Okay.

Good question.

Let me just recap a little bit back in the plateau period where we kind of hovered in the $20 billion range for quite a few years there.

This was a very serious global recession in most of the markets we serve.

As you all know, a 12-year recession in Japan, an absolute depression fallout in southeast Asia, recessions in the U.S., sluggish growth in Europe, commodity prices, virtually no investment in mining in the post-Asian crisis out through 2003.

In fact, disinvestment.

So coming out of that period, and during that period of time, we had brand-new acquisitions of MAK, FG Wilson, Perkins, just to sustain our $20 billion.

And all of of these industries were soft in that period of time with virtually no price realization.

So we did a pretty good job of, I think, hunkering down and delivering reasonably attractive trough earnings in that period of time As we come out of this period today, I think I look at our major market segments, global mining, I think, is in the early phases of an expansion.

And as -- a point I made in my prepared comments, it's going to take several years to get mining capacity up to fully meet the needs of a world economy if it grows at about 4% annually, as I think it will.

And we look for a very solid growth across particularly Asia with China now having critical mass, India becoming pretty strong and the whole of the ASEAN group now picking up.

And a lot of interregional trade growing.

So a very strong economic base there, which fuels higher real prices for commodities and oil and gas long term which I think will sustain a lot of investment into those industries over the next several years.

That, coupled with, as I mentioned, transport systems.

If you want a new container shipped now, you're about three years out just to get one, which is changing the dynamics for some of the large engines that we manufacture, which creates, I think, sustainable demand for those.

So we look for very healthy demand opportunity in heavy construction, mining, large power generation for distributive power and marine power.

And those are really sweet spots for Caterpillar over the next several years.

I don't know that my crystal ball goes out more than three or four years.

But I think the next three or four years to me looks like a period of time that we could have pretty sustained high level of opportunity in those key markets.

Great, Jim.

Thank thank you very much.

You're welcome

Thank you.

Our next question is coming from Andrew Obin.

Please state your affiliation.

Then pose your question.

Merrill Lynch.

The question I have is on your supply chain and when you stated that the topline forecast could prove conservative at the end of the year.

From what I remember, in December of 2003, you guys were one of the few companies that had the foresight to go to the suppliers and sort of stress the fact that '04 was going to be a good year.

Yet, at the end of the day, you guys turned out to be quite -- you sort of -- you were too pessimistic about the outlook and things turned out to be much better on the topline, but you guys got hit on the operating line because your suppliers had a really hard time keeping up with you.

What are you guys doing in 2005, given that you are saying that this forecast can prove conservative, to make sure you guys don't run into the second issue the second half of 2005?

Well, Andrew, we gave you our best shot at the forecast.

I said I hope it turns out to be conservative.

Because I -- one of the best set of problems I can think of dealing with is how to get more production.

But I think we've got a reasonable forecast, and we're staying very attuned to sales to users and how that's tracking and our order backlogs, et cetera.

We have stepped up our communication with our suppliers substantially.

Quite frankly, 2004, unprecedented in my 30-plus years in this industry, when we hit on all cylinders in almost every market segment we serve, and keep in mind that our plants did take production up last year for the large iron plants between 35 and 50%.

So I'd say that was spectacularly good performance on the operating side.

In fact, I've got a council meeting going on this very day, and I'm very appreciative of what that team pulled off and our supplier network.

Most of them did Herculean job to ramp up after a prolonged period of very slow growth in the whole industry.

The industries that they are in.

So I think they did a pretty good job.

Now we're adding -- seeing them make investments and adding capacity.

As we said in our release, steel castings, we think we will be -- we will have ample supply of steel castings to meet our needs by, certainly the beginning of the fourth quarter, if not sooner, and a number of our suppliers have really stepped up to the plate and made additional investments in capacity to grow with us.

And we're trying to do a much better job of communicating and coordinating, how all of our plants are communicating through global purchasing with that supply base.

The second question I have is on how you look at cash flow.

You stated that you guys have pretty good levels of cash flow in absolute terms.

Yet, in relative terms, one could argue that you guys are pretty average, probably not the best in category in terms of free cash flow yield.

And, I was wondering as you're focusing on return on assets and return on investment capital, if cash flow is one of the metrics you guys want to improve significantly going forward.

Absolutely.

It is.

And I agree.

We're not nearly as good as I'd like to be.

We do generate a lot of cash compared to our needs.

But I believe our business has the opportunity to generate even more, and we're working very hard on the order fulfillment initiative, which I perceive is a journey over the next several years to get to the world class standards I expect to be at.

But I think we'll get there, and I think it will generate even more cash going forward.

Thank you very much.

Cash flow is an important top (ph) to your metric force.

Thanks a lot.

You're welcome.

Thank you.

Our next question is coming from Andy Casey.

Please state your affiliation.

Then pose your question.

Prudential Equity Group.

Good morning.

Good morning.

Good morning Andy.

I have, I guess a follow-up to Andrew's question and a couple of the earlier questions related to your comment about flat production rates for the rest of the year relative to the first quarter.

First, would you expect the supply chain issues that you kind of identified to go away slowly through the second half to support higher unit throughput?

And then second, given the positive longer term outlook, what sort of additional unit volume throughput, kind of on a ballpark basis, in terms of growth, is really yet to be achieved over the course of the cycle, not looking at a quarter or year?

Thanks.

Well, let's see how to answer.

First of all, the production ramped up quite a bit during the first quarter, March being the considerably higher production levels than we had in January, February.

That's kind of typical pattern for us in terms of our shipment and ramp-ups.

At -- If we sustained March production through the balance of the year, we could, in fact, meet the business plan forecast or the current outlook or level of sales.

So, I guess, what I'm suggesting to you is we've come up a very sharp ramp to get to that March 2005 level of production.

Sustaining that for the rest of the year would yield production levels compatible with our current outlook statement.

We believe we can go higher than that if the business opportunity is there.

But as I indicated in my response to John, we'd like to take this opportunity to manage thoughtfully our dealer inventories down somewhat as product availability out of the factory improves.

So that's part of the equation for the rest of the year.

We are making this year -- we increased our CapEx spend about 40%, a lot of that is directed to, not only new product program initiatives, but also selected bottleneck alleviation and upgrading our factory -- manufacturing operations around the world.

We're also working very closely with our supply base to understand their capacity and to work with them to be sure they're putting investments in place to meet our projected needs out through the year 2010.

We're sharing -- we'll be sharing those kinds of forecasts with them to be sure we have adequate capacity in the supply base.

And quite frankly the constraining factor in our ability to ship more is basically from suppliers.

We think we're getting on top of that.

I would guess by certainly into the third quarter, those bottleneck -- bottlenecks in the supply chains that are constraining will largely be alleviated.

Okay.

Thanks.

And then just one quick clarification on pricing.

When you look at the rent-to-rent fleet growth that you saw in the quarter, do you price protect for units shipped into the rent-to-rent or is that just to invoices with a customer name, outright sales?

Thanks.

If it's already in the order backlog it's protected.

If it's not, it's not protected.

Thank you.

Thank you.

Our next question is coming from Barry Bannister.

Please state your affiliation.

Then pose your question.

Hi.

It's Barry Bannister, Legg Mason.

How are you.

Fine, Barry.

Good morning.

Good morning.

I have a question about proportion in a couple of ways.

Mining equipment, where you sign these global alliance agreements within the global mining concept and perhaps tie long term supply contracts to price escalators that may not be keeping pace with your costs.

Is mining equipment a disproportionate negative effect on your operating margin in the machinery group alone?

I think the short answer to that is no.

We do have long-term alliance agreements that have pricing contracts usually tied to a producer price -- producer price index.

So we get annual adjustments in those prices.

There's a little lag, but I think the price increases we got at the beginning of this year will keep the margins on those products attractive, and they won't be a drag on our performance.

And when you look at the 4.2 price versus 1.7 a year ago that I calculate on the equipment, is engines playing a disproportionate role in that total price increase relative to its fairly small 31% of sales?

No.

In fact, engines get slightly less than machines.

Because we took a fairly large adjustment in engine prices at the time we rolled out our bridge engines preceding Acert.

So -- and again we have some large -- large customers that have long-term contracts.

So -- but they're not -- they're getting slightly less than machines.

So that big jump in engine pricing anniversaried already.

That's right.

Yeah.

Well, Nancy, I just wanted to thank you for doing a great job.

And good luck.

Thanks, Barry.

Before we leave, and I think we're about out of time.

I also wanted to thank Nancy for the really terrific job she's done as our Director of Investor Relations over the last couple of years.

They've been a little prickly here and there.

But by and large, she's -- I think really stepped up our game and as evidenced by the kind of writing you're getting in -- with this release and I'm delighted on top of all that Nancy that you get to leave on a high note, some pretty satisfying results around here.

Well, I hope it's not the highest note.

Oh, no, no.

Certainly not.

Anyway, thank you all very much for being with us today.

We enjoyed the opportunity to share some very good news with you.

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.