開拓重工 (CAT) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Caterpillar year-end 2005 earnings results conference call. (OPERATOR INSTRUCTIONS).

It is now my pleasure to turn the floor over to your host, Mr. Mike DeWalt, Director of Investor Relations for Caterpillar.

Sir, the floor is yours.

Thank you.

Good morning and welcome to Caterpillar's year-end results conference call.

I am Mike DeWalt, the Director of Investor Relations, and with me on the call today are Jim Owens, Chairman and CEO, and Dave Burritt, Caterpillar's CFO.

This call was copyrighted by Caterpillar Inc., and any use, recording or transmission of any portion of this call without the express written consent of Caterpillar is strictly prohibited.

If you would like a printed copy of our prepared remarks, you can go to the SEC filings in the Investor section of our website where they are filed in an 8-K.

They are also available on the SEC's website.

In addition, certain information we will be discussing today is forward-looking and involves certainties that could impact expected results.

A discussion of those uncertainties is included in the Safe Harbor statement included in the Form 8-K filed with the SEC today as well.

To start off this morning, I will just take a few minutes to walk you through the past year and the fourth quarter. 2005 was certainly a great year for Caterpillar.

Sales and revenues were up $6 billion to 36.3 billion for the year.

That is 20% higher than 2004 and right on the outlook we provided at the end of the third quarter.

Profit per share for the year was $4.04.

That is 40% above last year's $2.88 a share.

That is $0.04 above the top end of the outlook we issued with the third-quarter release and $0.11 per share above the midpoint of the outlook range.

For Machinery and Engines, the operating profit pull-through for the year was 20%.

That is the increase in operating profit divided by the increase in sales.

For the year operating cash flow was $3.1 billion, and that included over 900 million of pension funding.

We used 1.7 billion of the cash to buy back 33.9 million shares, 1.2 billion to fund capital expenditures for capacity, growth and to support new product introduction programs, and in addition over 600 million was spent on dividends.

And speaking of dividends, we raised the rate again in 2005.

The dividends paid in the third quarter were up 22%.

During the fourth quarter, it was the best in our history in terms of sales and revenues and profit.

Sales and revenues were $9.7 billion, a 13% increase from the fourth quarter of 2004, and profit per share was $1.20, up 56% from last year.

For the quarter, operating profit pull-through for Machinery and Engines, that is the increase in operating profit divided by the increase in sales, was 40%.

And that 40% included about 70 million of charges in the fourth quarter related to our dealer distribution support software and the product realignment that we have highlighted in the outlook at the end of the third quarter.

We will spend much of our time today talking about how 2005 compared with 2004, the fourth-quarter comparison and the 2006 outlook.

But I think it's appropriate to go back a couple of years and put 2005 into perspective in terms of where we have come from.

2005 sales and revenues were up for the third year in a row, and a year ago we were talking about the extraordinary growth of 2004 when our top-line was up $7.5 billion.

In dollar terms, the 2005 improvement was up 6 billion, almost as dramatic as the 7.5 increase last year. 2005 sales and revenues were up 60% versus 2003.

When you consider that some parts of Caterpillar have not grown that fast, you realize that there are areas of the Company that have more than doubled over the past two years, mining trucks for example.

Supply chain issues, expediting of material, our efficiency in dealing with rapid growth and the production capacity of some of our factories have all been key discussion points for many of you and for us internally over the past two years.

We did not have a crystal ball.

And if you look back at our original outlooks for both 2004 and 2005, you will see that we did not anticipate the demand for our products was going to be as significantly higher in both years as it turned out to be.

As a result, supply chain has been an issue, and in some areas it still is, like very large tires for mining trucks.

However, on the whole, our suppliers rose to the challenge and have done an excellent job of supporting Caterpillar.

Even though in each of the past two years, we ended up being up quite a bit higher than we had predicted.

We have also talked a lot about factory efficiency and the tough job we have had in ramping up our production in our own factories.

It has been a very significant challenge, considering the size of a production increases we have seen over the past two years.

The bottom line is our employees have done an exceptional job.

One of our top priorities has been responding to the needs of our customers, and in an environment with the kind of growth we have experienced, it was tough.

But our employees have responded, and Six Sigma was a key driver in making it happen.

Core operating costs, a subject that many of you have talked to us about, and it is a subject that is extremely important and we have worked hard to manage, in an environment of rising material costs, significant volume increases and substantial new product introductions.

That said, costs have risen sharply over the past couple of years.

Even so, the increase also needs to be viewed in perspective.

Internally we categorize our costs as period or variable, and you can get a feel for the distinction between period and variable by looking at the glossary at the end of our release.

But the point is we volume adjust variable cost when we do our analysis.

So the core operating cost bar in our release includes the rate increase in variable costs, and material content has been the major variable cost factor over the past two years.

For period costs things like SG&A and R&D and a sizable chunk of our manufacturing costs, we don't volume adjust.

In all analysis, we show dollar for dollar the increase in period costs.

Given a 60% increase in sales and revenues over the past two years, it is not surprising that period costs have gone up.

However, as a percent of sales, period costs are lower.

For example, if you look at the combination of Machinery and Engines, SG&A and R&D, they were 12.7% of sales and revenues in 2003, 12.3% in '04, and 11.4% in 2005.

That is a 1.3% drop from 2003 at a time when R&D investment and absolute dollars had been increasing substantially to support the development and introduction of a significant number of new products.

Finally, profit before tax as a percent of sales and revenues has risen 4.2% over the past two years, from 6.5% in '03 to 8.9% in '04 to 10.7% in 2005.

Now I would like to turn it over to Jim Owens who will take you through some of the highlights of the year and our expectations for 2006.

Good morning, everyone, and thank you for joining us today.

It is, you can imagine, a pretty satisfying day here in Peoria in terms of the financial results with records across the board.

Perhaps as important, we have very strong demand across virtually all of the industries we serve on a global basis -- our global mining, electric power, oil and gas, heavy and general construction.

And we closed the year with very strong retail sales, dealer reported sales, as well as new orders.

Probably -- not probably -- certainly the strongest order backlog typically for our large machines and engines in my memory.

We also during the year continued to successfully pursue selected acquisition activity to strengthen our service businesses and grow in China.

As Mike indicated, we introduced actually a record number of new products in the year.

We did not do it ourselves, but of course, the U.S. highway bill and energy bills were signed during the year.

We were strongly support of those.

We think these measures are important for our country and certainly for the intermediate-term future of our industries that we serve.

We increased our dividends last year, as Mike indicated, for the 11th time in the last 12 years.

One of the more important events for the year is the rollout of our Vision 20/20 strategy with very definitive targets for 2010, which I had discussed with you in New York in the fourth quarter.

We also recorded our fifth consecutive year of being on the Dow Jones Sustainability Index and substantially increased our focus on developing sustainable business as we move forward.

With all this activity, very strong demand, big ramp-ups in production, I was also very proud of the way our Company, our employees and dealers responded to global traumas around the world -- the tsunami in Southeast Asia early in the year, the Gulf Coast hurricanes, the South Asian earthquakes.

We responded with getting machinery and engines to those sites promptly and with a tremendous humanitarian effort on the part of our employees and dealer employees, as well as a great contribution.

So I could not be more proud of our organization and how we responded there.

So all in all, just a terrific year for Caterpillar.

I'm very satisfied.

Before I start with the outlook, I would just like to reiterate a point that Mike has made.

From a financial perspective, I think 2005 was really a spectacular year for our Company -- record sales, record profit, generating $3.1 billion in operating cash flow.

Again, a tremendous team effort on our employees, supplier and dealers' parts.

We have worked hard together to meet the needs of our customers, and these exceptional financial results were a tribute to that effort.

As we look at the 2006 outlook, you probably read this morning that we are maintaining our previous outlook for sales and revenue of $40 billion, up about 10% from 2005, and we have increased our estimated profit range from 4.65 to 5 per share.

That is up slightly from our previous outlook.

We continue to have a very positive view of the overall world economy for the industries we serve, not only in 2006 but for the next few years.

Inflation remains low in most countries and should keep interest rates worldwide at relatively low levels.

Our expectation is that the Fed is about finished raising interest rates in this country, suggesting a Fed Funds rate of just under 5%.

This should support continued growth in the world economy.

Our forecast for worldwide economic growth is about 3.5% in 2006, which is about the same as the pretty strong growth we recorded in 2005.

In particular, we expect continued strength from most of the industries we serve, and we have even more confidence here.

Global mining.

Major infrastructure development.

Road building and paving.

Infrastructure development in this country.

Some of that reconstruction globally.

Nonresidential construction, which is picking up smartly.

Engines for petroleum, electric power, marine applications and on highways staying at a very high level.

Overall the fundamentals look very good.

That said, there is still a number of challenges and risks that face both Caterpillar and the economy as a whole.

But internally we're staying very focused on executing our strategy, our Vision 20/20 that we laid out for you.

As you know, we have a new officer-led group that is very focused on implementation and rollout of the Caterpillar production system.

They are focused very much on operating consistency and excellence throughout all of our factories to drive better quality, asset utilization, shorter leadtimes for our dealers and customers and, of course, lower cost.

We are introducing a number of new products again in '06.

It will be another record year of new product rollouts, and we're preparing now for new machine and engine introductions in 2007 and 2008, which will include the next generation of ACERT engines. 2006 will be another heavy year for R&D, but again I think it's positioning us well competitively going forward.

We will be focused on continuing to grow our service businesses also.

To provide additional focus here, we have created a new officer position late last year to grow our remanufacturing business.

The emphasis here is remanufacturing for others, and we see substantial growth in that field of play.

We are working hard to increase production at a number of our factories, particularly those producing larger machines and engines, and that will be an ongoing effort throughout the year that we will be pursuing in vigor with our supply base.

In summary, there are a number of things that we need to do and work on in '06 and get them right.

And while we are at it, we are certainly working to improve our flexibility of our cost structure and preparing to have improved profitability, substantially improved from our last cycle whenever that cycle load might occur.

What impresses me about team Caterpillar at this point is that none of us are satisfied to rest on our laurels.

Everywhere I look employees, dealers and suppliers, we are striving to improve our performance.

So 2005 was a great year. 2006 looks better, and the near-term future looks very positive.

We have a lot of work to do, but I'm confident we are well positioned for the challenges ahead, and we will benefit from having some macroeconomic wind at our back while we pursue these initiatives.

With that, Mike, let me turn it back to you.

Yes, okay.

I think we are ready for the Q&A portion of the call.

As always, in the interest of time and fairness to others, please limit yourself to one question and a follow-up.

And we're ready for our first question.

(OPERATOR INSTRUCTIONS).

David Raso.

Citigroup.

Just bigger picture, I'm trying to understand where we are relative to serving the demand that is out there?

I'm just trying to think through a couple of items really coming to mind on back in the Q&A you mentioned that the number of machines that are on managed allocation or managed distribution has actually gone up since the third quarter.

It went from 60 models up to 69.

I would also like to track how much profit you are dropping down incrementally just from sales volume?

And that incremental margin really exploded this quarter.

It went from like 44% to tracking around 30.

I'm just trying to understand, how we are trying to handle demand -- we're not that close to serving the level of demand that is out there.

Are we falling further behind?

And I know, say, the cycle is obviously a good problem to have, but how would you characterize where you are on serving demand versus, say, even a quarter ago?

David, Jim Owens.

I would say for a lot of our products there is extended delivery availability.

But a lot of the extended availability goes back to supplier capacity and for some larger items like tires, large steel casting, some of the things we've talked about all year long.

We think we're getting our fair share.

We have probably given up very little marketshare but a little in some of the larger ends of our lines where we have very extended delivery and customers just have to have product.

We're doing everything we can to meet those needs, and a lot of our customers are waiting for us.

But understandably we're losing a little bit of share.

Overall across the whole machine product line we held steady with our overall (inaudible), gaining in some areas where we have better availability, lost a little where we -- and those reasons we lost were not price but availability-related issues.

So we are continuing to work that equation very hard.

I think we're as well positioned as anyone in our industry to continue to grow our production, and it is just a very very strong global industry situation at the present time.

The reason I brought up the incremental margins on just sales volume alone, is it possible to somewhat cherry-pick which orders you are filling the sense of profitability?

Price utilization came in a little stronger than I thought.

The incremental margin I spoke of on sales volume alone hopefully is mixed.

I'm just trying to think through in this environment, often being sensitive to customers I understand, is there a way to serve the demand where margins are highest, and is that what we're starting to see?

I'm trying to get a feel are we about to see a pretty significant shift mix and also the profitability of what we're choosing to sell given we are still so far behind demand?

There is a little bit of that.

Within reason we have met business plan requirements for all the marketing companies and dealers around the world.

Where we had incremental demand in some additional capacity, obviously we sold it in places that had better margin opportunity in some cases.

And then a related follow-up, if you are keeping the revenues at 10% growth for '06, and it just sounds like demand at the moment is fairly inelastic, I mean your ability to raise price on top of what you're getting from mix, what are you thinking now of that 10% is volume versus price?

I assume maybe now there is a little negative currency in that as well.

Can you help us break out that 10%?

Roughly 7/3 -- 7 volume and 3 price.

And flat currency?

Yes.

Alexander Blanton.

Ingalls & Snyder.

The first question is, and I had to jump off the call for a minute, so it might have been asked already.

The charge that you had estimated for the fourth quarter was $100 million, and I believe it says that it turned out to be 70 million.

Is that correct?

Yes, that is correct.

Okay.

What is that per share?

70 I think would be roughly about $0.07.

And how did that break down between the two items?

I don't know that we have broken that down before, but they were both a factor and both a little bit lower than we thought.

Distribution and support software and global telehandler alliance?

Right, right.

And I think as long as we are on the subject I think it is probably worth noting that we had estimated 100.

We had about 70 in the fourth quarter.

That does not mean that we are expecting more later.

It just means that our estimate for it was lower than what we thought.

Our estimate was higher than the way it came out, sorry.

And that was in SG&A, so it did not affect incremental?

It was in other operating costs.

Yes, it was not in the cost of goods sold, right?

No.

Because you had an excellent incremental profit, it looks to me like 57% in the fourth quarter.

Is that in line with your calculation?

Yes, it was incremental operating profit --

No, incremental gross profit.

Gross profit went up from -- I did not calculate the incremental, but it went from 19.5 to 23.6.

So a 4.1 percentage point improvement in Q4 to Q4.

Right.

So that was your I think best in a long while.

It was great, yes.

Now for this year what are you expecting on the line?

Do you expect to continue to get that kind of incremental profit over last year for the next few quarters as we go through the year, or was there something unusual in that quarter?

I mean I assume that the increased supply that you talked about and the lesser problems and inefficiencies would contribute to an incremental, a large incremental profit on the line.

So can we look forward to that?

I will answer around that question in a few ways, Alex.

If you look at our outlook, you know from the outlook we provide a bucket for operating profit.

Operating profit is going from 3.8 billion in '05 to 4.8 billion in '06.

And if you take the financial products out and just look at the M&E operating profit related to the M&E sales change, that would give you an incremental operating profit here at midpoint of the range of I think around 29%.

So we are looking at pretty strong incremental operating profit for next year again.

We don't have a gross margin on the page there.

I don't have that in front of me, but (multiple speakers) operating profit level has gone up pretty well.

I think when we model that out, it is going to show that.

That is absolutely right.

Okay.

Thank you very much.

Ann Duignan.

Bear Stearns.

A quick question on your supply constraints.

You are insinuating I think in where you have articulated your fall behind retail sales that it is primarily being driven by supply constraints.

At what point do you see that changing and it becoming a kind of bottleneck within Caterpillar's own factories, or are you at that point right now?

And if so, what should we expect in terms of -- I know you are investing in some of your -- to eliminate some of your bottlenecks, but at what point would you consider investing in brick and mortar?

Well, maybe one quick point -- Jim Owens -- is we have been really working with our marketing groups and encouraging better management of dealer inventories.

I was quite encouraged to see them come down somewhat towards the end of the year.

That is very much in our plans and our hopes.

We want to do a better job of delivering directly from the factory and taking total inventory levels down and despite the fact that there are supply constraints out there.

So we're working to increase capacity of suppliers in our assembly capacity.

We are selectively investing in additional bricks and mortar where needed.

We had a lot of excess square footage going into this substantial upturn, so we are using that square footage a lot more effectively now, and we have a lot of assembly capacity.

So selective machining, heat treat capacity investments underway, gradually coming to fruition.

But again, I think we're doing and will do over the next couple of years as well or better than most of our competitors at capturing available supply from the supply network.

We are certainly a global player, and we are working very hard to bring on new suppliers in addition to the existing suppliers to satisfy our needs.

So I guess stating it another way, if you had no supply constraints, if you could purchase all the components you needed today, would you be able to meet demand, or would you still have internal bottlenecks?

We would be able to meet demand.

You would be able to meet demand?

And the areas where you are selectively adding capacity, that is primarily on the engine side?

Is that correct?

Well, we are gradually increasing our ability to assemble more product, both machine and engine side.

The biggest bottlenecks in terms of absolute capacity constraints would be large engines.

That is 3500, 3600 Series MaK Series engines, and there is -- the grey iron castings, blocks, machining, etc. more than assembly is a constraint there.

Test sales become a constraint at some point.

And very large mining equipment.

And there is the availability of large steel castings and large tires are the biggest constraint.

I guess if we had absolute free supply of those, the next bottleneck we would hit would be just sheer fabrications capacity of, say, 797 truck bodies.

But we are not in danger of hitting that because we still don't have enough of the other key components.

So, so long as tires are in short supply, fabrication is okay?

Yes, and we are adding additional -- we have added additional fabrication capacity in Mexico.

We had a (inaudible) facility which was not fully utilized.

We had another manufacturing facility, which is in mothball which we reactivated last year.

So we're continuing to tap into the resources that corporately we had available improving our efficiency and increasing our capacity along the way.

So, as you add this capacity, I guess what I'm getting at on the bottom line is I'm trying to figure out whether your revenue forecast or your volume forecast of 7%, whether that is still a little bit conservative if you can address some of these bottlenecks?

I sincerely hope it turns out that way.

Okay.

I will get back in line and ask my other questions later.

Gary McManus.

J.P. Morgan.

With the 3% pricing assumption for 2006, if my math is right, you did 6% in '05, including 7.5% in the fourth quarter.

So is this just being conservative, especially since you have got greater demand than your ability to produce and long leadtimes.

Why wouldn't pricing be up more than what you have been recording recently?

A couple of comments about that, Gary.

I think your math kind of depends -- we will talk about the math for a minute now, and I will try and answer your question.

When we look at the improvement in price realization, you need to make sure that you are calculating that on last year's sales, plus the increase in volume because we have price on the increase in volume as well, and that is in our price bucket.

I think we looked at overall price realization for the year I think on a percentage basis to be around 5.5 if you adjusted -- if you do it on the volume on the full-year volume.

And what would it have been in the fourth quarter?

I think in the fourth quarter it would have been just under 7.

Okay.

And why would it slow down to 3% for the year?

These percentages, remember, those are versus 2004.

We have had pretty strong price realization throughout 2006.

I mean the full-year number is around 1.7 billion.

So what we're really looking at when we are going forward is kind of building off of the strong 2006 that we're coming off of.

In general, we're looking for about a 1% increase kind of coming out of 2006.

So, in other words, if we had no price increases in 2005 or excuse me in 2006 built in, we would be looking at kind of a carryover of around a point.

Okay.

And then we announced a price increase last fall for January, and kind of net net out of that right now, we are expecting a couple of points.

Now is that conservative?

Is that not conservative?

There's still a lot of the year to play out in terms of what the marketplace is going to do and how competitors are going to react, and certainly we watch we have a revenue management group, and we watch the competitive landscape carefully, and we will do what is appropriate.

It is fair to say you have pretty good visibility on pricing given you have long leadtimes and a relatively large backlog, is that fair?

Yes, for a lot of product we have relatively long leadtimes, now particularly, as Jim said, the really big product.

One of the things that we did is our price increase for this year was announced a little bit earlier than historically we had, so that will cut down a little bit on the effect of the backlog.

My follow-up, just a couple of kind of forecasts in '06 versus '05.

One is pension and health care, and the other is R&D and the third is capital spending '06 versus '05?

First, CapEx.

I think we have a CapEx number in the -- let me just see which question it is -- in the Q&A, we have a question that talks about CapEx.

I think it's 1 billion 7 roughly, 1 billion 75 for next year.

I'm sorry, Gary, what was the first part of your question?

Pension and health care costs '06 versus '05.

Yes, we're looking at it being fairly flat, and in fact, if you look at our outlook, we raised our outlook for profit per share a little bit.

We're up to 4.65 to $5.00 a share.

That is a little bit of an increase before.

And one of the things that has changed is we made a pension contribution in the fourth quarter of last year 2005, and that is going to help lower our cost a little bit next year.

So year-over-year we're looking for it to be about flat, and that pension contribution was a help in terms of next year's cost versus the outlook.

Ana Recinos.

In your outlook you focused on a $750 million increase in core operating costs for next year.

I guess the question is, at what stage of the game do you expect some of those manufacturing -- do you expect to see manufacturing efficiencies start to offset those costs?

When does the supply chain get so caught up that the expediting goes down and you start to see true manufacturing efficiencies or the recapture of the inefficiencies?

I will make a couple of comments about that.

First, in some ways, I think it will depend upon what really happens with volume.

In my kind of preamble, I said that over the last two years we had planned for one level of volume and what actually happened was quite a bit more, and we were in a bit of reacting mode.

This year we are going into the year.

We're looking, as Jim said, at about a 7% increase.

If it turns out to be something quite a bit higher than that, and I'm not suggesting it is, it might be as it was in the last couple of years, something we have to react to.

But overall if we look at the year going forward in our 750, the big factor in the 750 are about a 1% increase in material costs, an increase that is really kind of in-line with inflation for SG&A.

No big seat change in terms of SG&A expense.

Our relative operating efficiencies next year, sort of our factory efficiency, we don't have a huge change built in.

We are introducing the Cat Production System, and that should be a positive.

This is Dave.

We are mobilizing the masses here on the Cat Production System.

You heard Jim comment about a new Vice President heading up this group, focused on the operating system, the management system, the cultural system.

We have applied Six Sigma at the individual business unit level, and now we're going to apply it horizontally across the entire company -- same method, same process, same system, same everywhere.

This is some heavy lifting.

The global finance people are going to get the process started with these guys, working hand in glove to make sure that we have the breakthrough.

But don't expect big improvements here in 2006.

We are getting ourselves aligned globally, and a lot of great work is getting underway.

Okay.

Terrific.

Let me just recap Gary McManus' question.

Could you just talk through what the carryover price is from 2005 to 2006 and then add to that what you have announced in terms of new price increases for '06?

The carryover is about 1 point the net net for what we have announced, and realize when we make a price increase that there are other things that are not included in that.

For example, truck engines or sales to major OEMs, they happen based on individual contracts with those customers.

But to answer your question, specifically about 1 point carryover and about 2 points net net based on what we have announced so far.

Yes, Mike makes a great point here.

This is not just a simple calculation of when the price announcement or the price action comps to pass.

There's a lag to the price realization.

A lot depends also when the new product is going to be introduced, and that is staggered throughout the whole year.

So you have to kind of be careful with just trying to do it mathematically because it depends upon a lot of factors.

Robert McCarthy.

Robert W. Baird.

Mike, can we assign the -- can we take the 70 million and allocate it between Machinery and Engines?

Yes, roughly about two-thirds was machinery and about one-third was engines.

Okay.

Nothing would go to Financial Products then?

No, no.

I have forgotten the other one, so I will have to call you later.

Okay.

No problem.

Andrew Obin.

Merrill Lynch.

The first question, you had very significant CapEx increases.

Could you give some comment by geography where we are spending the CapEx?

And I apologize if I missed that.

You know, Andrew, by geography I don't have the number I'm afraid.

The total is up (multiple speakers)

In general, I guess what I mean is, is most of it spent outside of the U.S., or are we spending where we have the sales?

Are we spending proportionately to where the existing capacity is?

Just very sort of broad flavor of what is going on.

Broadly speaking, it is in line with our global manufacturing footprint.

This would not include acquisitions, so we're looking for about a 40% increase.

It is tied heavily to our new product introduction programs and a very heavy agenda for NPI.

But selective capacity expansion addressing bottleneck areas and increasing capacity, almost across the board in our manufacturing operations, and that would be in Japan, China, Australia across the Americas, North and South and Europe.

So it is pretty broad-based.

The second question is just a follow-up.

In your incremental cost operating -- if you will quantify them, I guess operating costs, could you quantify of that how much is higher labor costs?

Because we have been hearing more and more from companies that labor costs are now becoming an issue.

And Ingersoll just talked about them an hour ago in our small cap serving sort of shows the same thing.

Could you expand on that a little bit?

Well, let's just kind of break it down in a couple of sections.

First, there was a question earlier on employee benefit costs, and our comment on that was that employee benefit cost relative to the bucket that we had before is fairly neutral '06 over versus '05.

I don't think we have announced yet what a merit program or sort of the normal pay increase program is, but I don't think it is out of line or would likely be out of line with our history.

I think if you look at overall labor cost increases, I think we frequently use a 4% kind of number to quantify it.

But I don't think there is anything really out of line.

We agreed with the UAW on a new contract about a year ago, which reflects very competitive wage structure and kind of appropriate for the markets that we are in.

So there is nothing really out of line there.

I don't think we have anything that I'm aware of that is sort of out of the norm.

The one thing point that I would make, though, that is different and it is in compensation, it is the new accounting standard related to stock options, and that is an incremental 125, 125 million, in the year.

And I think we called that out in our Q&A.

We give you kind of a split for how we see it coming in in '06.

Absolutely.

Thank you very much and I love new disclosure.

Thank you.

Joel Tiss.

Still at Lehman Brothers.

I wonder, two areas.

One, I see the engine operating margins are up quarter-over-quarter in every quarter -- just about every quarter in 2005.

Can you talk a little bit about what is underlying that progression?

You know, volume, utilization, price, mix, productivity, whatever is in there just to give us a sense of what to look out for for 2006?

Yes, I guess the short answer is all of the above.

Yes, the operating profit pull-through for engines in the fourth quarter and actually machines as well, it is very coincidental they were both 40%.

For engines it was a similar number in a prior quarter and has been strong all year.

If you look at the material cost increase that we had in 2005 over 2004, it was more heavily weighted towards machines.

I think if you look at engines, some of the industries that they serve like truck, it tends to be or has tended to be fairly extreme in cyclicality.

And I think the supply base around maybe the engine business maybe is a bit more used to the kind of swings that we have seen.

So material costs have not been as big an issue with engines.

Now that said, I think everywhere in the Company we have worked pretty hard on getting price through, and price for engines for the year was also pretty good and for the quarter it was pretty good, and the factories have worked on efficiency.

I think the biggest difference between machines and engines for the year and the change in operating profit was not as much of the material content affected engines as it did machines.

Let me see if I can add briefly to that, Mike.

The mix has also been pretty positive.

We are kind of running relatively flat up in the truck engines side, which tends to be a high-volume piece.

But very strong growth in the petroleum oil and gas related sector, which is strong for us, both the large (inaudible) engines and gas turbines, and good volume leverage across our asset base for large engines and turbines.

That is the highest margin engine segment of our engine business, and that is very strong.

Okay.

And since I have only got one more, I'm going to glue two together.

I wondered if, Jim, you can talk just a little bit about sort of maybe giving us a sense of where we are in the cycle on a couple of the factors you're looking at over the next three years?

And also what kind of ideas do you have for your new found balance sheet capacity?

Well, we still think we are really about three years into this cycle.

It has been a little more robust than previous cycles.

But, as we look at the global economy and particularly we look at global mining, the strength of demand and how long it is going to take to bring new capacity online, we are very optimistic about that industry having a few more years of great strength.

Global energy markets, oil, gas, tar sands, a very important piece for us, and coal all look very strong, under-capacitized.

We think there is legs to that part of the industry.

Power generation on a global scale, there has not been enough capacity put in place to take care of global microeconomic growth.

We think that plays well to distributed power in a lot of our capabilities in our size ranges that look very encouraging.

So and then large infrastructure.

The reconstruction following the devastation last year from hurricanes, earthquakes and tsunamis.

Nonresidential construction being in the very early stages of the business cycle recovery, and major investments in infrastructure, which have gone underinvested in for quite some time.

Not only in the United States but in the emerging markets.

All give us pretty good confidence that this cycle has legs.

And that would not be different than the legs that the cycles had in the '80s and '90s.

If anything, this looks stronger than any of those.

So we are very encouraged about the fundamentals.

The question on cash flow, this was a delightful opportunity, but we certainly -- I know that how we deploy cash is key to building shareholder value.

I think you can look for us to fund our growth, but the (inaudible) of the money and being sure that we're investing in things that fully meet shareholder expectations going forward.

But that will be -- and we talked about 1.7 5 billion in incremental CapEx to support our new product programs, as well as additional capacity.

We will be looking at selected acquisitions again carefully with the focus in China and some of our service business areas there.

I think we will still have ample left to raise dividends, and we will be talking to the board about that around midyear.

And we will do a little funding of benefit plans as needed and as we get a tax deduction going in and tax-free earnings once we're in with those investments.

And then with what is left, I would expect we will have a substantial share buyback going forward.

Great.

Thank you.

Pretty strong position.

Thank you.

Eli Lustgarten.

Longbow Research.

I have got a couple of -- two quick clarifications in the press release.

One, you talk about the tax rate for '06 of 1%.

Does that mean you are talking 30.5, less than 29.5 affecting out all the other gyrations?

Yes.

Okay.

I wanted to make sure because of the other stuff, because you've got a benefit of about $0.09 from the recognition in there.

Yes, that comment would exclude the discrete items which we separated from the rate.

Now, the other clarification.

Originally in your Q, you had talked about stock option expense of 100 million in '06 and 110 million in '07, and now I mean you are showing this 125, so it went up 25 million for this year.

Can you tell me about what happened there and was about '07?

Does it go up a little bit in '07 or how that works?

Well, I don't know about '07, but I think the primary reason for the increase that you're talking about for '06 is the increase in our stockprice.

That is a nice problem to have.

So, of course, it has to happen in '07, come on?

Right?

Well, I mean, you know, we don't have an outlook for '07.

If all the positive things happen in this year, then maybe it would, yes.

Now from an operational standpoint, can you get a discussion on two parts of the business.

One, you talk about the fourth-quarter truck engines being down 26% because of inventory management, you have a better availability.

Can you talk about what is going on in your truck share?

I know you are forecasting this heavy truck market as flat in '06, but was the volatility strictly in inventory management, or was there some share loss, or what is happening there?

And the second question, can you give us some view -- or the second part of that on mining.

You have a very bullish outlook for mining, but it seems like to be a step function, demand will just, say, step up and stay very strong for awhile.

Are you planning to be able to meet at that basis, or do you really need a lot of capacity because mining demand will ramp over the couple of years?

Let me start with engines.

You're right.

The fourth quarter truck was a function of inventory.

We took C13s and C15s off of managed distribution in the fourth quarter, and that allowed, because of the improved delivery, we had been increasing capacity on those products throughout last year.

We were able to take them off managed distribution.

And that I think gave some of our customers the confidence to lower their own inventory.

And because they built trucks and put our engines in them out of their inventory, rather than buying them from us, that had a negative effect on our sales for the fourth quarter.

In terms of our truck share going forward, you know I think we are pretty confident about our product and certainly our ability to supply.

We did increase production last year, and so I think we are pretty bullish about our prospects in terms of share in 2006.

Specifically what was the question again on mining?

On mining there is a very bullish outlook on mining, but it seems that mining runs in big step function often demand stays up there.

And the question, were you looking at demand to be very stable for the next couple of years, and therefore, you would be bottlenecked, or do you really need to increase materially the capacity of your mining equipment shipments over the next couple of years?

Yes, if you go back a few years just to sort of set the stage, you know you're right.

Mining has been just a significant increment over the last few years, particularly for things like trucks up a lot.

Jim kind of mentioned earlier that we are supply constrained right now, certainly on engine or on tires related to big mining vehicles.

And so I think we do have very strong demand.

The mining guys tell me they have taken orders for product for delivery that go out actually in a couple of years.

I think there is one thing that is happening with the mining industry, and we have a very strong strategic partnering relationship with most of the major mining houses in the world, is that they are now getting their capital plans approved further out so that they can schedule major truck deliveries from us even out into '07 and '08.

So we have a -- we are a little supply constrained this year, but we are getting some visibility of demand by going out a couple of years in some cases.

So that is then very encouraging to us.

I think you're right.

It is kind of taking a step function up, but likely sustainable at a pretty high level for quite some time.

Well, that is what I was really asking.

From running the business, are you looking at the sustained step level, or do you have to really ramp your capacity up because of further growth?

It looks to me that you said if tires were available, you can meet most of the demand.

But you really don't want to put too much more capacity in place, while if it stays great for quite a few years, there is volatility as you go out over --

We are painfully aware of the long-term volatility in the industry and are preparing ourselves to meet the demand as best we can at the top, but also to stay attractively profitable through cyclical fluctuations in future years, whenever that might occur.

Jamie Cook.

Credit Suisse.

My first question relates to your guidance for 2006.

You have increased your EPS to 2.65 to $5.00.

You have not changed your sales forecast, and I'm just wondering what the major drivers are?

You mentioned lower pension costs, higher stock option expense.

But I guess my question is, is it priced in lower core operating costs, or is there anything weird or other in that change in forecast?

No, I don't think there is anything weird or other in there, and the forecast has not changed that much between the two periods.

And again, I think probably the one factor that I would mention is that in the fourth quarter of last year, we contributed a little over .5 billion to our pension plan, and that has helped lower our pension cost for '06 below what we had in our previous outlook.

And so that was certainly a factor in changing the outlook.

Okay.

And then my next question, just if you could build a little on your -- I guess your question 13, you talk about how many engines are out in the field and that you will be -- there will be some more engines out there for customers in April of 2006.

I guess can you comment -- I mean are you on schedule with where you thought you would be?

I mean is there anything that you are seeing out there to suggest that we should have less of an impact -- less of a prebuy than we did in a previous cycle?

Well, you know, we would certainly hope that, but I don't think we are predicting that.

It is likely that the industry will be down in '07.

How far it will be down is a result of a number of factors.

In the last emissions changeover, the technology was later into customers' hands than it is now.

We have about 100 engines that are actually running in fleets right now.

They are all using low sulfur fuel, so it is a really good 2007 test.

And we will continue to ship to customers that want to test the engines.

Some of the other factors that can contribute to a prebuy or how big a prebuy would be and how low 2007 could go would be certainly the state of the economy, how strong the overall U.S. economy is as we go into 2007.

How comfortable the industry feels with the technology, you know, is another factor going into it.

I mean there certainly would likely be some prebuy just because there is likely to be a cost increase related to the engine.

If you are a customer, you would probably like to buy one that is a little less expensive.

And then just a follow-up, but are you on track with where you thought you would be with 100 engines out in the field and whatever you're going to put out there in April of 2006?

Yes, I think by and large we feel pretty comfortable with where we are at.

Before you leave, please give our best wishes to John.

Thank you.

I will.

Mercedes Garcia-Ayuso.

Goldman Sachs.

If my math is right, the color plating costs were higher by 120 million versus what you had expected last quarter.

And if we had the variance in between the restructuring costs, that would take the number to 150.

What was different from what you were forecasting only three months ago?

Yes, a couple of comments about that.

First, I'm going to talk in a little bit more of a generality.

The buckets that we put in the release we round to the nearest 50 million, so I don't want to get quite down to the last million in terms of precision.

But one of the factors that resulted in higher fourth-quarter cost was incentive compensation.

In fact, we have a note in the Q&A related to that.

One of the factors that drive incentive compensation for us is level of profitability.

And our actual results were actually higher than the midpoint and even higher than the top end of our outlook.

When we were reviewing the third quarter, we said that short-term incentive comp would be down about 10% year on year.

And in the note that you will see in the Q&A in this release, it is about flat, and that is about $460 million.

So a chunk of it was because our performance was better, our incentive comp was higher.

Another factor -- if you go back and think about our third-quarter release, we had a single profit number.

We said profit for the year was going to be up about 10 -- I am sorry, sales were 10.

Yet we had a range for profitability.

Part of the reason we had a range for profitability is historically for us the timing of expense between fourth quarter and first quarter is always an issue for us.

And it is a tough forecast sometimes for discretionary expenses in the fourth quarter versus what is going to go into the first quarter.

If you kind of go back in history and look at Caterpillar, we frequently have a pretty strong fourth quarter in terms of cost and a pretty light first quarter.

If you look at kind of the categories that were related to that, quite a bit of it was SG&A in the fourth quarter.

SG&A was actually higher than we had expected it would be by a fair bit.

And I think that really gets down to the timing of discretionary expenses.

There is not any one or two items that I would pick out and pick on as a part of the change, other than the increase in incentive comp overall as a result of higher profits.

Perfect.

Let me ask you another question.

Also CapEx for the fourth quarter was lower than you guys were thinking.

Is there any comments there?

I'm sorry, what --

CapEx, fourth-quarter CapEx also was a little bit lower than what we were looking for.

Yes, I think that is also somewhat historic for us.

We do that.

We go out and we look very hard at each of our units on what they think they are going to get in in the current year, and we just underspend it.

That does not mean that we canceled a bunch of programs.

It is primarily a result of time.

It would be timing for the most part.

Let me ask you the last question, what kind of assumptions are you making for dealer inventories in Europe and percent sales growth forecast for '06?

Down slightly.

I think we are at the end of our time.

I would like to thank you all for joining us on the call today.

We are very pleased with this year's and this quarter's results and the outlook for 2006.

Thank you very much and have a good day.

Thank you, ladies and gentlemen.

This does conclude today's conference call.

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

Thank you for your participation.