開拓重工 (CAT) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Caterpillar's second-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, Mike DeWalt.

Sir, you may begin.

Good morning, and welcome to Caterpillar's second-quarter 2005 results conference call.

I'm Mike DeWalt, the Director of Investor Relations for Caterpillar, and with me today on the call are Jim Owens, Chairman and Chief Executive Officer of Caterpillar; and Dave Burritt, Vice President and Chief Financial Officer.

This call is copyrighted by Caterpillar, Inc. and use, reporting, transmission of any portion of this call without the express written consent of Caterpillar 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 that are filed as an 8-K.

To leave more time for the Q&A today, I don't intend to reiterate everything that was in the release other than a few key points from the second quarter and the upwardly revised outlook for 2005.

Speaking of the outlook, certain information we will be discussing today 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 SEC today.

Okay, let's start with second-quarter results.

I am very pleased this morning to report record sales and revenues and record profits for the second quarter.

Sales and revenues were $9,360,000,000, and profit was $760,000,000 or $1.08 a share.

Just a reminder here, I am sure you all know that the two-for-one stock split became effective last week, and the per-share amounts in our release all reflect the split.

Sales and revenues were 23% higher than the same quarter a year ago, and profit was 34% higher.

As you read our release and the Q&A included in the release, you'll likely come to the conclusion that in some areas of our business, supply and production capacity are still very key issues, and they certainly are.

To put the situation in context, though, I think it is worth noting that sales and revenues have been on a pretty significant upward trend for over two years.

While sales and revenues are up 23% from last year, they are up 58% from the second quarter of 2003.

Meeting customer demand is a key issue for us, and we have numerous Six Sigma projects working throughout the company related to improving our order fulfillment.

Considering the level of growth we've seen, our suppliers, our dealers and employees have done a great job in responding to this substantial increase in demand over the last two years.

Let's turn from the second quarter for a moment to the outlook. 2005 continues to shape up as a great year, and we are today raising the outlook for sales and revenues and profits.

We now expect our 2005 sales and revenues to be up 18 to 20% versus 2004, and profits to be between $4 and $4.20 per share.

That's an increase from the prior outlook; 2% in sales and revenues and an improvement to our profit of $0.11 to $0.17 per share.

In dollar terms that puts the outlook for sales and revenues in the range of $35.8 to $36.4 billion, again another record year.

Before we move on to the Q&A, I would just like to mention that full details of the outlook for 2005, including other assumptions, retail sales, rental statistics, are contained -- and other details of the outlook are contained in the press release, and monthly statistics for retail and rental and other supplemental information can be found on our website at www.cat.com in the About Cat tab under Investor Relations.

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

In the interest of time and fairness to others, please limit yourself to one call and one follow-up, and we are ready for the first question.

(OPERATOR INSTRUCTIONS) Alex Blanton.

Please state your affiliation, then pose your question.

Good morning.

Mike, just a comment.

I'm getting a lot of static on the call here.

So you might ask the moderator to check the connections.

Could you give us some idea of how the second-half earnings might divide up between the quarters?

If I take the full-year midpoint, subtract the first half, I am left with about $2.21 for the second half.

How would that divide up?

Are we okay now?

Hello?

Moderator, can you hear me?

Your line is very fainted.

Did you want to maybe pull it closer?

Is that better?

Yes, that's a lot better.

Alex, you're correct on the math for the second half of the year.

We have never really given any kind of guidance by quarter, but you probably will note from prior years there tends to be a difference between the third and fourth quarter.

I don't know of anything significant (technical difficulty).

I'm sorry, you're fading again.

Your view of the second half of the year from the press release compared with the first half is accurate, but we are not providing any quarterly guidance on the break.

We can't help you on the breakdown between the third and the fourth quarter.

Okay.

I want to ask a question about the incremental margins.

Year-over-year in the second quarter, the gross profit line, you were at 21.2% which is quite a bit below what they normally are, which is around 30 to 40%.

And indeed from the first quarter, the incremental margins on that line was 32.2%.

But, of course, the incremental year-over-year was low in the first quarter as well.

So we are suffering from the high material cost increases, I would guess, in the second quarter, which are depressing those incrementals.

The question really is, when do you expect to get rid of that effect?

When do you expect to offset most or all of these material cost increases through price?

I wouldn't count cost reductions in that because you're going to get those anyway, whether or not the deal costs went up.

But when do you expect to get rid of these effects on the incremental margins?

You are also right about incremental margins for the first through the second quarter.

We kind of talked about this a little bit in the first quarter.

We said the entire first half, including the second quarter, was going to be a pretty tough comparison, and that is because costs really started rising in the second half of last year.

We've been operating at a pretty high level of costs since then.

So I think if you look at our outlook, you will find that the incremental margins in the second half of the year would be a lot better than the first half of the year.

And if you switch to core operating costs and price realization just for a moment and you look at the actual results of last year -- I'm going back to the full year of '04 for a minute, because when you are talking about cost increases, I think that's when they really started and you kind of need to go back to '04.

If you look at the relationship between core operating costs and price, between the two years they should come pretty close to offsetting each other and material costs are only a portion of the core operating costs.

So I think if you look at all of '04 and all of '05 you will find that price realization will well more than exceed the material cost increase.

Okay, thank you.

Gary McManus.

J.P. Morgan.

I am just looking -- your guidance for earnings suggest $0.70 improving in the second half of the year.

And if I look at what you expect in pricing net of core operating costs, that gets you to $0.70 cents as well.

So it seems like you're saying in the second half just the benefit of pricing less core operating costs, gets you that $0.70 increase, and I am just wondering you still expect revenues to be up.

I think it is around 12% or so in the second half of the year.

Why wouldn't you get additional benefit from higher revenue growth?

Gary, a part of that increase in sales and revenues is the price realization.

So if we are just thinking about volume you would actually need to pull the price realization out.

We don't want to comment twice.

Then if you look at the back half of the year we do have a benefit from price realization.

We will have some volume improvement.

But core operating costs overall in the second half are not likely to decline from the first half.

Material costs overall we're starting to see some positive signs in some of the areas but not all, and we do expect in the back half of the year that we will have a little bit higher SG&A and R&D costs to support volume and product programs.

So overall first half to second half, costs are overall not declining in our outlook.

I'm sorry, Mike, you were kind of fading in and out again but again you expect kind of sequentially this second half operating cost not to be the same as they were in the first half but the year-over-year numbers go down because of easier comps.

Is that right?

And with the steel costs coming down -- what is the assumption you're making for steel costs because they have come off a little bit?

Should that start to help you -- help benefit core operating costs in the second half of the year versus the first half?

Yes, Gary.

There are some signs that material costs are starting to come down in some of the commodities, but others like heat treated plate for example aren't coming down.

Copper prices and the effect on our costs are going up.

Higher costs continue to go up.

And so overall at this point we are not forecasting significant decline in material costs for the back half of the year.

Okay, thank you.

Joel Tiss.

I'm still with Lehman Brothers.

Two questions.

One, can you talk a little bit about the outlook for free cash flow, and why it has been a little bit hard to squeeze free cash flow out of the company so far this cycle?

We don't actually report free cash flow; it is a non-GAAP measure.

So I will kind of bypass specifically talking about free cash flow.

Overall all we have had positive operating cash flow this year, profit has been a big positive factor.

We have had inventory growth over the course of this year, order magnitude I think about 700 million over the first half of the year.

That is a number we would like to see some improvement in.

We have a number of Six Sigma programs in place right now trying to improve order procurement overall.

But I think overall this year we will likely stack up to a pretty good year for operating cash flow out of the machine and engine business.

On a follow-up and unrelated follow-up, Komatsu said that Chinese demand has been up about 40%.

Can you give us a little bit of an update on what is going on in China and maybe any sort of handset at the divergence between Caterpillar and Komatsu?

Thank you.

Joel, Jim Owens, I will respond to that one.

Last year was a pretty strange year in terms of demand in China, with a very strong first half and then a precipitous drop particularly in excavators, some of the core products we sell there in the second half year.

We are in fact seeing a very strong rebound in domestic sales in China, also.

In fact, we've increased our schedule substantially at Cat Zhejiang, and they will be up significantly over the very depressed levels of last year's and are already ramping up.

So, we also are quite encouraged about rebound in demand in China.

Andrew Obin.

Merrill Lynch.

The question just for the second half just to confirm what you guys are saying, in the first half of the year we have close to one billion of extra core operating costs.

And in the second half of the year we are expecting something around 300 million of extra core operating costs, and all you're saying is that its just the delta year-over-year, its just comps are getting easier and you are not really modeling in any improvement in operating costs.

Is that the right way of understanding it?

Yes.

I think that is the right way to look at it.

Costs again started really going up in the second quarter, into the second quarter last year so second (indiscernible) costs were high.

We are not forecasting significant increases in operating costs for the back half of this year relative to the first half, but we are not forecasting significant decreases over -- I think overall if you think about first half, second half you would want to think relatively flat.

So the big driver if you're looking at the first half waterfall charts and outlook waterfall charts and you're looking at the difference before operating costs, its mainly driven by second half comps.

So do you think that going into '06 and just not in terms of guidance but could we expect actual core operating costs declining in absolute terms, sometime in '06?

Or do you think it is just we are going to get stuck here and unless raw material prices going to go down this is just a running level of core operating costs?

Without getting too speculative, and trying to give you any guidance for '06 there are a lot of factors that play into that.

If, for example, volume continues to go up, a chunk of our manufacturing costs and our support costs are affected by volume.

We call them period costs, but they do end up in (inaudible) volume and will likely go up.

You would hope that the signs that you are seeing on fuel prices might slide some costs down, and the longer we operate at these relatively high levels and the more likely it is I think that we would generate additional cost reduction.

So you would hope that the cost rate would come down, but volume does drive a lot of cost.

So on an absolute basis kind of at this point it would be tough to say.

Just an unrelated follow-up question, we've been hearing that there are some delays with getting '07 engines into the field with testing.

And these were not specific to any manufacturer, but I was just wondering if you could comment on the timing of your own experience, how the engines are running in the field and what you are seeing with the results with Asia engines for 2007.

I spent a fair bit of time talking to some of our lead OEM customers, and the biggest challenge quite frankly for '07 engines is getting fuel with 15 parts per million sulfur available to do all the testing work that we needed to do.

But we got a number of engines in the field running now.

We are confident that the OEMs will be comfortable with our engine, engine technology, and they are meeting those compliance levels on a timely basis.

Thank you very much.

David Bleustein.

I am with UBS.

Jim if I could trouble you to answer the question because we can hear you a whole heck of a lot better.

Your comments on price utilization in the front of the release, where are you most concerned about pricing?

Where are the soft spots?

Let me comment on that -- we are looking for about a 5, 5.5% improvement in price realization for the year 2005.

The May increase we announced was 1 to 5%.

It depends on the product and the market.

Obviously we are market sensitive.

I would say we have pockets of concern where competitors haven't followed our price and our dealers feel some pressure.

So we will be pretty selective in where we respond to those pockets of competitive pressure.

But we are confident that the price utilization overall will be north of 5% and greater than material cost increases.

All right, and then the follow-up in terms of timing of increases or reductions in these core operating costs, if you assume flat revenues in 2006, how much of the non raw material related core operating costs would you expect to recapture?

If you just hold your revenues constant?

We haven't made that assumption, again, but a couple of things are going on.

First off, keep in mind our physical volume increased about 60% from the second quarter of '03 to the second quarter of '04.

So we have been on a very, very steep ramp up with a lot of expediting costs.

And about half our core operating cost increases have come on the materials side.

We do think commodity prices in general are going to ease from recent high levels.

And there will be some I think easing in material costs.

Certainly the rate of increase will slow dramatically next year and maybe some declines in selected areas, particularly steel.

But on a core operating basis we are also driving the largest new product introduction I guess portfolio that we've had in the history of the Company by a substantial margin as we particularly, as we roll out all of the machines we are rolling out with new ACERT engines, low emission engines and getting other upgrades in the process.

That coupled with the fact that we are making selective investments in increasing our capacity pretty much across the board in anticipation of the volume opportunities that are before us for the next several years.

So those things are driving some period costs.

We think they are being done very prudently, and will yield good results going forward.

What I'm trying to get at is what are the inefficiencies, what is the number for the inefficiencies that will just get worked out over time, just as the supply chain corrects?

We've already seen quite an improvement I think in for example expediting costs are going down significantly.

Of course overall transportation costs are up due to higher energy costs.

And just some of the bottlenecks that have been in the transport infrastructure.

So those costs are there, but overall I think we will continue.

We are up on a much higher plateau of production.

Our plants have rearranged and adjusted to that.

And I think we are going to see steady improvement in our overall operating performance.

We are already forecasting an improvement in our profitability, our profit rate in the second half versus what we realized in the first half of this year.

And we certainly have targets for further improvement in that next year.

Terrific.

Thanks for the help.

Ann Duignan.

Bear Stearns.

I guess my first question is in the outlook, particularly for machinery volumes, you've talked previously about under producing retail sales as you go through the transition to new products going into next year.

Can you talk just a little bit about what we should -- how we should think about that as we put our forecast together for the back half of the year?

Should we not get too carried away with retail sales in the back of the year in that you will probably under produce in retail sales?

Let me comment on that briefly, Mike.

This is Jim Owens again.

We are working closely with our marketing companies, dealers, product managers to try to be sure we manage I think would be the operative word -- dealer inventory levels.

We would like to manage them down somewhat from current levels, although they are currently at historic lows in terms of months of sales.

We are still very focused on improving our delivery performance, build to customer order and use customer order and minimizing the amount of dealer inventory required in the pipeline.

But having said that, to me the ultimate where the rubber meets the road is the retail sales from the dealer to the customer.

And we monitor that.

I look at that every day.

Is there a magic number in terms of months of sales of inventory that you would like to end the year at, Jim?

No, I would like it to be lower.

And I want it to be, it needs to be specific to the product and the geographic region.

And we are working at that granular level.

So is my assumption right, though, that you will try a little bit in the back half of the year to under produce retail sales as you transition into new products?

For 2006?

I wouldn't relate it to transitioning into new products but we will try to have our shipments be lower than our sales to users in order to manage dealer inventories down somewhat.

Okay, so it is more related with the goal to manage inventories rather than transition into new products?

Correct.

Okay, and a follow-up question.

Last quarter you had talked a lot about strengthening the nonresidential building in the U.S. and also you were expecting some pretty strong growth or growth in Europe to accelerate.

Both of those seem to be tempered a little bit in this press release.

Could you talk about what has changed in your outlook in both of those markets and if there are any other regions that you're nervous about now as you look forward to the rest of the year and '06?

Or likewise where you think there might be upsides from a macroeconomic standpoint?

I think what we said is the nonresidential construction has been relatively slow to respond to the up cycle in the United States, and we think there is more opportunity for growth in that sector going forward.

It is showing signs and certainly all of the macroeconomic stars are aligned for growth in that segment.

We have been concerned about Europe for a while, the overall macroeconomy there is probably going to grow less than 2% this year.

Pleasantly surprising is we are seeing some growth in our industry sales due to very low interest rates and the fact that it has been depressed for a very long time.

Overall in the EMEA region, Africa, Middle East and Eastern Europe, Russia of course are doing quite well, so we are looking for pretty strong sales growth in the overall region.

We haven't changed materially our outlook I don't think since the outlook we issued in the second quarter.

Maybe the one thing we need to watch closely here is the interest rates there in Europe, they might actually be coming down.

So we will have to see how that plays out.

And given that nonresidential has been soft and if rates do come down it gives us an opportunity to have some more spend in that area.

Okay, thank you.

Mark Koznarek.

FTN Midwest.

Let's see, kind of the broad question about outlook here in North America, it kind of struck me a little bit puzzling that the GDP growth assumption moderated a little bit, but yet your revenue assumption went up.

And I'm assuming that most of that is improved price realization expectations.

Can you confirm that or is there any other dynamic going on like better pins or something like that?

Our price realization between the two outlooks is actually pretty similar.

It was 1.7 billion in the last outlook, and its 1.7 billion in this outlook.

The primary increase in the sales outlook is volumes.

And I think it is -- and this is a point I think tends to get lost when people talk about a slowing economy.

We are coming off of world growth last year to this year that was like at a historic high over the last twenty years or so in terms of overall world growth a year ago.

So while this year is slowing down a bit, it is still a very attractive level for growth for us.

And you're right, it might seem a little puzzling that our outlook actually went up at a time when it looks like the GDP numbers are being revised down a little bit, but then again, this is an outlook.

It is forward-looking and we do our best to put together how things look over the next year and the further you get into the year the more actually you have behind you and the better view you have for the rest of the year.

So I don't think I would read anything other significant into that, and it is a closer in refinement of what we see for the current year.

Okay, and if I could follow-up with the specific end market; petroleum related when you look at the supplemental info on the engine side is surprisingly soft given that commodity price and demand momentum and all that.

And it is even deteriorated from the first-quarter level in terms of rate of growth.

And what would be a reasonable expectation then for the second half?

It seems like there is some pretty sizable pent-up growth potential there.

A lot of that is driven by our gas turbine division which is sales in large increments.

But we see the petroleum sector as very strong, probably record all-time record (indiscernible) in backlogs.

And if anything it has been strengthening all year long for both the gas turbines and large reciprocating engines, and will be shipping both of those at near capacity for the last half of the year.

So the second half is going to look sharply better than this first half so far?

I think we don't look at it half necessarily, but it is going to be very strong in that sector, and that sector looks very strong, and it's one of our strongest in terms of market leadership of sectors.

If you look in our release as we kind of talk about engine sales in those segments we've made a couple of references just following up on Jim, that Solar turbine sales are kind of the result of timing of projects when they hit last year and this year.

So I don't think I would play that into an overall view for how petroleum is doing.

I think overall petroleum is actually a pretty hot market at the moment.

Okay.

Thank you.

Mercedes Garcia.

From Goldman Sachs.

The last quarter you were expecting that dealer inventories at the end of the year would be about 75 million higher than in '04.

Was is that number now?

Mercedes, I don't know what our current prediction is for dealer inventories at the end of the year and I don't recall actually making a prediction last quarter.

Dealer inventories are currently up versus last year, and as Jim said a minute ago, on a month of sale basis looking forward they are actually at historic lows.

Although I think the machine number is up versus last year, I think 34% is the number that strikes me.

But I don't think we have a prediction for year end.

Can you give us some sense about where your U.S. allocation is now?

We like to call it managed distribution rather than allocation --

Let's call it managed distribution, then.

We have a little science behind how we try and fill the orders.

Currently for machines we have 58 models that are on managed distribution; that is down a little bit from the end of the first quarter, and we do have a few engine lines that we also have on managed distribution.

I think some of the big engines out of Lafayette and the heavy-duty truck engines.

Let me ask you the last question, what are you seeing now in power gen in North America on a sequential basis?

I don't actually have the sequential numbers in front of me, but power gen in North America is, as I recall from the release was favorable and up.

I don't have the percent in front of me, Mercedes, but I can check on that and we can -- I can get back to you later.

Perfect.

Thank you.

Andrew Casey.

Prudential Equity Group.

Cash on a cash flow question, the operating cash flow from manufacturing improved very nicely in the second quarter, both year-over-year and sequentially from 1Q.

Given that working capital took a hit last year due to production disruption, would you expect cash flow from operations to benefit from more stable condition in the second half?

And then on a follow-on to that, would you expect to be as aggressive or more aggressive in pursuing share repurchase in the second half?

Thanks.

In terms of kind of stability of the things that drove operating cash flow, I think up to this point over the last year, year and a half inventory has been a pretty significant driver.

And if you think about another main component of working capital, our sales are up a lot, and that drives receivables up as well.

I think if you look at the back half of the year from where we are right now, we kind of talked about this a little while ago.

If you take out the volume component for the back half of the year or excuse me --the price component for the back half of the year, volume growth second half to first half is up but certainly not as dramatically as it has been.

So I think we would sure hope that inventory growth would slow down or reverse, and I think you are not going to -- we are not going to see based on our outlook significant increases in sales, second half versus first half, so receivables probably should moderate some.

Also, if you go profit outlook profit is up a fair bit second half to first half.

So that is another positive for operating cash flow.

In terms of your question on share buyback, that is something that we don't telegraph.

We do have board approval to go down to -- I think its 640 million shares now.

And we have been actively repurchasing shares this year.

I think we purchased 18.4 million so far at about an average cost of around $45 a share.

So we have been pretty active so far this year.

But I guess I wouldn't make a prediction about how many we will be buying back in the second half.

Thanks, if I could do a quick follow on, could you give me the diluted share count at the end of 2Q?

I'll tell you what we will get that for you in just a second, and then I will come back with it when we get a break.

Thanks a lot.

That short answers your question, Andy, it might have been just yes, and in particular we are going to work hard on managing our inventories down in the second half and I think that will augment our cash flow.

John McGinty.

Credit Suisse First Boston.

When we look at the change in the outlook with regard to the operating profit looking at the waterfall charts, in the end of the first quarter the sales volume, the increment was 700 to 850 million.

It has gone up to one billion now as there are higher sales, the price is still the same 1.7 billion.

Does this mean that the incremental sales volume is coming through with no price?

Is this the beginning of having to give some price back in order to hold pins?

I'm surprised that price doesn't go up more with volume.

Could you talk about that?

Are you starting to give some price back?

I know the dealers are complaining, but on the other hand it does look like those increases are sticking so I am a little bit confused as to why price isn't going up more.

Basically we've been very encouraged that this year the price increases we announced last year have flowed through into the marketplace (inaudible) the beginning of the year price increase.

We've had some pushback, but we've certainly held the line on that and I think by and large competitors have moved their prices in line with ours.

Selectively we think that might not be the case, and we will look at that.

But by and large our price realization assumption, in terms of rate of price increases is about the same now as we had at the end of the first quarter.

Shouldn't it go up with more volume?

In other words on each volume, aren't you getting some more price on that.

We are, and we just can't slice it that finely.

These are nice round numbers.

Okay, fair enough.

And the follow-up question on the whole issue of basically of output you all have been talking about -- you finally found the second casting supplier.

You've got them qualified.

You've been saying all along that you were going to have particularly the larger machines in for your supplies as we moved into the fourth quarter.

And yet when you talk to the dealers you talk about the allocations they are getting on the orders that they are putting in.

It doesn't seem to be that there is anything really freeing up on the large type of equipment.

Is there any reason?

Is there something else that has come in that is really stopped you all from being able to increase output more?

Why haven't we -- not on mining trucks.

That is a different animal, but on the larger excavators, the larger wheel loaders, the larger crawlers -- why aren't we able to get some of those lead-times down and get more of that stuff out the door as we move through '05 into '06?

The biggest single constraint for the year is certainly going to be tires for the larger machines.

We've gotten some improvement there just in the last few months with a significant supply coming out of China, that is helping our articulated dump trucks but that was kind of in our plan anyway.

Tires are going to be a limiting constraint for most of the year.

You're right, the steel castings we think by August we think will be pretty much increased supply, and will be less disruption.

Every time you get through one set of bottlenecks you find another one.

As I have been around visiting our plant this summer we've been doing our strategic reviews, we are making a significant investment -- not significant in terms of billions of dollars or anything -- but significant investments in selected machine tools, rearranging factories, improving line flows to increase our capacity.

And these things just take some time.

We have had a tremendous ramp up, and I think we still have quite a bit of capability to ship more towards the end of the year and certainly in '06, but we're making investments to get that job done now.

Would you say that in '06 demand -- let's not worry about demand.

Do you think supply, assuming that demand is there, that you all will be in freer supply in '06 than you are in '05?

Generally speaking, guess.

Thank you very much.

Also just to remind you probably saw the announcements where Bridgestone and Michelin are also increasing capacity in large, ultra large tires, so longer term that will also help us as we move to 2006 2007.

So we are working closely with our suppliers, finding alternatives to make sure that this biggest pinch point that we have in the supply chain is solved.

Robert McCarthy.

Robert W. Baird.

To follow-up on the tire question, recognizing that incremental capacity takes some time to bring on, and a lot of the easiest solutions like recapping tires that weren't previously being recapped, etc. have been done, do we run the possibility that the situation actually and with activity -- and end markets continuing to grow -- do we run the possibility of the situation actually getting worse in the intermediate term, say through the middle of next year or something like that before it gets better?

I think that is a risk particularly for some of the very largest tires, but we are continuing to work very closely with the global mining customers that we have as well as with our dealers.

I think we are turning about every stone and competitively we are in a better position than virtually anybody else to get access from the tires that are out there.

We're doing everything we can to work with our customers again to be sure that they have not only tires for new machines, but tires for replacement.

Given your vantage point, Jim, when should we be thinking in terms of seeing some real easing of the situation?

Are we talking '07?

I think for large mining truck buyers we are probably talking very end of '06, '07.

For mid-range tires, mid-range, mid to large range articulated trucks, the smaller trucks, I think we'll see that supply situation easing up by early '06.

My unrelated follow-up question has to do with dealer inventory.

Actually, Mike, you may not be aware that you historically -- cat that is -- has provided information about the -- a rough estimate, anyway, of the dollar change in dealer inventory levels.

I'm going to come at it a different way than Mercedes did.

With the higher outlook for volume now for the year is it -- and given the dealer inventories half way through the year are one-third higher or better than that than they were a year ago, is it your expectation that dealer inventories will finish this year at a higher level than they did last year?

I think given the fact that they are up 34% so far this year and we are not looking for declining volume, I think it would be a pretty safe bet to say they are going to finish the year up.

And probably by a material amount?

I would say probably by a material amount.

Okay.

Thank you.

Up from last year's end.

I understand.

That is a subject that we are giving increasing management attention to focusing on and being sure that we don't let the dealer inventory swings drive our manufacturing cycle this time around.

And I think we are going to do substantially better on that score than we've ever done in the past.

That is certainly what we're looking for you to do.

Thanks.

David Raso.

Citigroup.

On the second half implied volume guidance, just so I am making sure I am running my numbers properly are we implying second-half volumes are up only about 4%, 3%?

Given we've done about 19% year-to-date and your guiding full-year volumes up 10 to 12?

Am I reading that properly?

I think the answer is yes, volume growth in the back half of the year is definitely going to be slower than the volume growth during the first half of the year.

Keep in mind last year during the course of the year, volume increased by 35% to a 50% in real terms in almost every major manufacturing facility.

So that ramp last year was very, very steep.

When you get to the second half the comparisons are much different.

When you look at your employment trends, though, you took 5000 temp employees, made them full -- I am sorry -- you hired 5000 more hourly, you made 2000 from temp to full.

That is adding a decent amount of fixed costs to handle higher volumes.

Why such a low-volume growth in the second half?

I know it is a tough comp but why we go ahead and hire that many people to have flattish year-over-year growth in the next six months?

Those aren't all people we hired in the last month.

That is the increase versus --.

For the last 12 months, but --.

Our volume, I mean right now in the first quarter our sales are up 29%, second quarter 23%.

So actually the rate of growth of the employees has been lower than our total rate of growth for sales.

The 2000 people are people that we had.

They were here working.

We just switched them from essentially supplemental that weren't on our actual headcount to full-time employees as a result of our agreement with the UAW that we settled earlier this year.

Another point there as Mike points out, they were already here so that is just a classification change for that 2000.

And the cost is about the same as they switched over to our regular payroll from the supplemental payroll under the new contract.

And thirdly, I don't consider this fixed cost.

We have been able to hire and ramp up our hourly workforce to mean higher production levels, but if volumes turn down because the market turned down, we'd have the ability to adjust our workforce appropriately.

It's debatable how flexible labor costs are, but I know what you're saying.

These are not guaranteed because we hire someone, they're on our payroll indefinitely.

And I think to that point, we still have supplemental people on our payroll right now that aren't in our headcount but that are working and that could come down.

The fact that you talk about the confidence for the future, we are confident for the future.

And as we've said for quite some time now, we believe this cycle has legs.

So certainly putting in these people we are planning for the future to be flexible and be able to take them off should we need to.

But with robust economic circumstance we are now with the increases, again, we think it will continue.

That's a good point, David.

We are bringing in a lot of new hourly employees, a fair number of retirements coming up in the next several years, and we need to get our new employees trained and fully integrated into our team Caterpillar.

The related follow-up, just trying to work through the second half, we spoke at the first quarter that core operating costs were up about 490 million.

And the impression I got, about 100 to 150 of that was just simply higher fixed costs to serve the higher volumes.

Assuming those fixed costs don't get pulled back in the next six months -- I mean they're fixed for a reason;

I mean they're going to be there at least this year -- the way I'm running my numbers, the material costs on a year-over-year basis have to become a net positive in the fourth quarter.

Am I reading that improperly where costs, material costs will be a net positive year-over-year in the fourth quarter?

We have not provided any quarterly guidance, and it's kind of tough to comment on your model directly.

But I think overall in the back half of the year, we are not forecasting overall any kind of significant declines in core operating costs.

And I think for material costs overall, our predictions are at this point relatively flat.

Okay.

Thank you very much.

Flat to positive year-on-year fourth quarter to fourth quarter.

Ben Cherniavsky.

Raymond James.

Wondering if you -- you didn't make any mention this time around of used prices.

Can you give some kind of update as to how those are unfolding for the first half of this year and what your outlook is for the rest?

Yes, I think historically in the beginning of the call we've commented on used prices and rental, and those are stacks that we are going to post to the supplemental info on our website after the call.

So I can find those on the website later today?

Yes, but generally speaking, used equipment prices are very strong, and in fact they are up substantially more than new equipment prices.

Okay, great.

And as a follow-up, could I try to get you to comment on something that happened earlier this year where you took your -- you consolidated your dealers in the pipeline business to a global franchise.

And I'm just wondering what your thinking was behind that and if you see other markets where you might apply that kind of model?

I think it somewhat to me looks like it is similar to what happened with Energist and power rental in Europe, as well.

Well, I think it's a little bit different in that the pipeline industry is a very unique application.

It tends to occur sporadically in different dealer territories.

There's a lot of specialized expertise required.

We form this small group of dealers into a joint venture that have expertise in this area that can kind of follow the industry on a global scale.

I think we've had very good support from dealers around the world that this was the logical way to pursue business in this particular segment and best serve our customers (indiscernible), but I don't think there are very many segments that this would be a logical approach.

Wouldn't you say mining and other areas of power systems would be equally sophisticated and global?

I think there's a sufficient mining presence in a number of dealer territories, but that presence stays there over time.

Dealers put in significant investment to cover support for the mining industry that is in their coverage territory.

We do work closely with and share best practices across our key dealers who support the mining industry.

Certainly it's not all dealers, but we think that's best served through our current dealer model.

Thanks very much.

Gary McManus.

J.P. Morgan.

Just a couple mop-up.

I know you don't want to talk about how much stock you're going to buy back, but what is embedded in your earnings per share forecast in terms of what the average '05 share count will be?

Share count at the end of the quarter, we are not forecasting any change.

So you are not -- in your earnings forecast you're not assuming any further share buyback?

In the earnings forecast.

In your earnings forecast, right.

Right.

Okay, and secondly capital spending, I think we're going to have a big ramp-up this year, but it hasn't really come up thus far.

Do you still -- I think you were predicting, what was it, 1.4 billion.

Can you just kind of review what your capital spending plans are for 2005?

The number is 1.4, and we haven't changed that in this outlook.

You know, if you look historically at the pattern for Caterpillar, capital expenditures do tend to get back-end loaded.

We have projects that get (technical difficulty) on and capitalized in the back-half of the year.

So I think if you look at our historical pattern, you'll see a back-end loading of CapEx.

So we're talking $1 billion in capital spending in the second half of the year?

Yes.

And you don't think there is any risk to that being too high?

Well, that's what's in our outlook.

I think like any outlook, there are risks that it could be more or less, but that's what's in our forecast at the moment.

Okay, great.

Thanks.

We traditionally spend about 50% in the fourth quarter of that, and a good chance that we will be somewhat short of that just because we won't get all the projects completed.

But clearly that is the direction, and a lot of that is directed to addressing some of the capacity increases that we see the need for going forward.

David Bleustein.

Good morning.

Can you talk a little bit about China's announcement this morning about its changes in exchange rate regime?

Just remind us what your revenue and profitability in China is and talk about any shifts you now expect.

Actually, we've never disclosed what our actual revenues or profitability are in China, so I'll pass up on that piece of it.

But overall, it looks like the change in the rate is going to be about 2%, and in general that is not going to have a very significant effect at all on our results, very, very small.

Overall, we think the action that they take was good and we are supportive.

We're encouraged by the fact they're moving to more of a market-based exchange rate.

Hopefully, that will take off some of the political pressures.

Again, it won't have big material impact on us, and we still are encouraged about our opportunities in China going forward.

If somebody had to guess, would somebody guess that Australia and Japan were two-thirds of Asia and China was a big chunk of the bulk of the rest of it for you?

Yes, you can guess that.

Don't forget Indonesia is kind of important, too.

All right, fair enough.

Pretty large mining opportunity there -- India.

So maybe China is less than 20%?

A wonderful hemisphere over there.

I think one of the things that we have said in the past but not gotten specific, but we have said in the past the our sales in China are approaching $1 billion.

Terrific.

Thanks.

Robert McCarthy.

Thanks.

I wanted to point out that your machine retail comparisons are not appearing on your website, probably for some kind of a mechanical problem, Mike.

Can you read us those?

Yes, that's true.

We had a technical glitch this morning.

We will get them back up here shortly.

Okay.

Thank you.

I will pitch in with earlier we had the question on diluted shares outstanding, and I will give you the answer to that now.

It is 705.1 million shares at the end of the three months, June 30.

Alex Blanton.

My affiliation is Ingalls & Snyder;

I forgot to mention it earlier.

Going back to a question that was asked before on the second-half volume, I get different numbers.

If you assume up 20% for the year in the total sales and revenues, you will be up almost 15% in the second half.

I think someone mentioned 4%, but I don't think that is correct.

But Mike, you indicated that it was correct, so --.

No, I think -- I can't remember who it was, but when we said 4% he was referring to taking the total and taking out price realization.

And I didn't actually confirm the 4% number because we are not actually disclosing that exactly for the second half.

But I think it is fair to say of the sales growth in the back-half of the year, quite a bit of it is coming from price realization.

Right, but not 10%.

Not 10%, no.

No.

So I just wanted the answer to that earlier question.

Thank you.

Ann Duignan.

Just a quick question of the repatriation of funds.

Is there an expectation that you will use these funds to create jobs or for acquisitions?

Or could you just give a little more color on what that money might be used for?

Ann, the board approved the repatriation to fund this year's R&D and capital plan.

And that is consistent with what is in our outlook.

So it doesn't reflect any change to what is in our outlook.

Okay, and then just one quick follow-up.

Can you give us color on what is going on in the logistics business, how that business is performing; is it growing?

You used to kind of highlight it and it's now kind of buried in machinery, so if you could just give us a little bit of color on that business.

It is continuing to grow very nicely and meet all of our not only business plan but growth expectations in terms of finding new clients going forward.

So I would say at the present time we are very encouraged by the intermediate-term opportunities in our logistics business.

And it still has lower return on sales than the average machinery business, but higher return on assets?

Is that the right way to look at that business?

No, I have higher return on sales and little lower return on assets, but it does exceed our total rate return on assets.

Thank you.

We are at the end of our allotted time today.

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

If you didn't get your questions in today, please feel free to call me.

Thanks for your interest in Caterpillar, and have a good day.

Thank you, ladies and gentlemen.

This does conclude today's teleconference.

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

Thank you for your participation.