開拓重工 (CAT) 2006 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Caterpillar first-quarter earnings conference call for 2006.

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 the floor over to your host, Mike DeWalt.

Sir, the floor is yours.

Good morning, everybody, and welcome to Caterpillar's first-quarter conference call.

I'm Mike DeWalt, the Director of Investor Relations.

With me on the call today are Caterpillar Group President, Doug Oberhelman, and CFO Dave Burritt.

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

If you would like a printed copy of my prepared remarks, you can go to the SEC filings section of our website under investor relations, where they are filed as an 8-K today.

They are also available on the SEC's website.

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

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

This morning, we reported a great first quarter, and we announced an improvement in the profit outlook for the full year.

The first quarter was an excellent start to the year, and compared with a year ago sales and revenues were up 13% at $9.4 billion, and profit per share was $1.20, up 48% from a year ago.

Of the increase in sales and revenues, price realization was $587 million, physical sales volume increased $511 million, and Financial Products revenues were $99 million higher.

The effect of currency in the quarter was negative $144 million, primarily due to a weaker euro versus a year ago.

If you look at the $511 million volume increase, about $324 million was machinery and $187 million was engines.

While profit per share was up 48%, consolidating operating profit was up 61% versus a year ago.

I think is worth a reminder at this point that the quarter's results included $34 million of expense for stock-based compensation.

That is new for 2006, and a breakdown of our expectations for the year is included in the Q&A section of our release.

In addition to higher profit, the rate of profitability improved as well.

On a consolidated return on sales basis, we were at 8.9%.

That is up from 7% in the first quarter a year ago.

I know many of you follow our Machinery and Engines operating profit as a percent of sales; and it climbed to 12.9% in the first quarter.

That is up from 8.7% a year ago, and it is 1.8 percentage points higher than the fourth quarter of 2005.

In fact you would have to go back to the second quarter of 1997 to find a better rate.

And, the Machinery and Engines profit pull-through was 47%.

That is the change in operating profit from the first quarter a year ago divided by the change in sales.

It was a great quarter, but that doesn't mean we don't have work to do.

Delivery times for many of the machines and engines we sell are longer than we and our customers and dealers would like.

We're working to increase production.

Core operating costs increased $303 million in the first quarter, and I'm sure you have questions about that, so I will address it now.

To put it in context, over the past couple of years, we have talked a lot about the job that we have had to do in ramping up production in our own factories.

In fact if you go back just three years ago to the first quarter of 2003, you would see that sales and revenues in this first quarter are up 95%. that is almost double, versus the first quarter of 2003.

It is been a big challenge ramping up production, and 6 Sigma was a key driver in making it happen.

Now, if we look at the $303 million cost increase, about $170 million of it in the quarter was manufacturing costs.

That was largely a result of higher period and variable labor and overhead costs.

Material costs were not a significant factor in the quarter and were about flat versus the first quarter a year ago.

The increase in period manufacturing cost was to support higher sales; spending in our factories to help increase our production capacity; support for new product programs; labor inflation; higher depreciation; and higher energy costs.

The increase in the variable costs was a result of inefficiencies related to operating at or near capacity in a number of our facilities and from cost inflation.

SG&A costs were up $71 million, and increased at a lower rate than sales.

R&D expenses were up substantially compared with the first quarter a year ago.

We have significant product programs in the pipeline; and, as we expected and mentioned in the last quarter's conference call, R&D expenses are expected to be up for the year.

Let's turn to cash flow for a moment.

Machinery and Engines operating cash flow was 527 -- or excuse me, consolidated cash flow was $527 million in the quarter, which was up $348 million compared with the first quarter a year ago.

On the plus side, the increase in profit was a big positive for cash flow, and the primary reason for the increase versus the first quarter a year ago.

But cash flow in both quarters was affected by higher inventory, which was up over $600 million in the first quarter of 2006.

It is not unusual to build some inventory in the first quarter in preparation for the second quarter, which historically is a seasonally strong quarter for end-user deliveries.

In addition, some of the inventory build in this quarter was the result of a high level of new product introductions.

In other words, we had material in our factory, but were somewhat slow in ramping up deliveries on some of the new products.

Bottom-line, operating cash flow was better than a year ago, and we expect it to continue to improve as 2006 unfolds.

Okay, let's touch on the outlook for a minute before we move on to the Q&A.

We have raised our profit outlook for 2006.

We expect profit for the year to be in the range of $4.85 to $5.20 a share.

That is an increase of $0.20 per share at both ends of the range.

We have a positive view of the overall world economy and for the industries we serve and continue to expect sales and revenues of about $40 billion for the year.

That is up about 10% from 2005.

Inflation remains low in most countries, and should help keep interest rates worldwide at relatively low levels, and should support continued growth in the world economy, with overall growth in 2006 similar to that of 2005.

We expect continued strength from most of the industries we serve; notably, mining, road building and paving, infrastructure development, nonresidential construction, and engines for petroleum, electric power, marine, and on-highway applications.

Overall, the fundamental for the industries we serve look good.

That said, we know there a number of uncertainties and risks that face Caterpillar and the economy as a whole.

Internally, in 2006 we're focused on execution, improving operating consistency and excellence throughout our factories to drive better quality, asset utilization, shorter lead-times for our dealers and customers, and lower costs.

We need to continue to increase production at a number of our factories, particularly those producing large machines and engines.

We are introducing a number of new products in 2006, and we are preparing now for new machine and engine introductions in 2007 and 2008, including the next generation of ACERT engines.

Today, we have a great quarter to talk about and to celebrate.

Tomorrow we have a lot of work to do, because as good as the quarter was, we have plenty of room to improve our execution, and we are all about improvement through 6 Sigma.

Okay, that is the end of the prepared remarks.

Let's move on to the Q&A portion of the call.

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

We're ready for the first question, please.

(OPERATOR INSTRUCTIONS) Alex Blanton.

Ingalls & Snyder.

The margins were very good in the quarter.

The net margin was, as you pointed out, almost 9%, 8.94%, and at the high end of your range for the full year.

It would be 9.1% using the $5.20 and the $40 billion.

A couple years ago, Jim Owens said 9% margins were his target, 9% net margins.

Then he modified that later and said, no, that is his target for the average margin over a cycle, 9%.

So that is where we are right now, 9% net margins.

How high can they go at the peak?

What is your target for the peak?

Alex, it's Doug Oberhelman speaking.

You know, I could add some humor and say they can go as high as they want to go.

But realistically, we modified the 9% a couple of years ago for the stock option expense as well as the tax rate at that time.

I think internally, we're still shooting and they have a goal that we would like to see it above 8.5%.

I think that is what we signaled maybe the last time.

But we certainly don't have a cap on it.

I would tell you that all of us would like to see that 9% come through at some point in time.

But it is more of an aspirational thing than anything.

We are quite happy with what we saw in the first quarter in terms of the 8.9%, though.

Well, you will be at 9% for the year if you make the top end of your range.

That is what I am pointing out. 9.1%.

Yes, that is correct.

So what I am saying is, how high can they go at the peak of the cycle?

That's at $50 billion in sales, which is what you're forecasting for 2010, what will the margins be then?

What is your target?

Well, we're not -- we do not have a target for that, but certainly everybody is kind of cheering for where we are or greater.

That is about all I would say on that point, Alex.

Okay.

Second, follow-up question is this.

If I take the amount by which your real sales were up in the quarter, volumes, sales volume of 511; and I add the negative currency to that, which gives me 655; that is an increase of 8.4% without the price.

Then if I do the same thing for the machinery portion, on page 5 of the press release, it is 7.6%.

But your retail machine sales for the quarter were up a lot more than that.

Could you remind us of what that figure was?

But it was a lot more than that.

So where is the disconnect here?

Are you building inventory at the retail level here?

Or is it just that last year something odd happened and so you get a different comparison?

Alex, this is Mike.

If you look at the retail statistics that we post up on the website, there are actually quite a few things that that does not include.

That would be new machine sales and new engine sales.

It does not include parts and service and some of the other things like that.

So it is not exactly a match for match.

Also, too, it is dealers; it is not our deliveries to dealers.

It is dealers' sales to end customers.

So it is not an exact match for match.

We'd did build, there was a little bit of inventory build in the first quarter at dealers.

That is again not unexpected.

The second quarter is usually a pretty strong seasonal quarter for deliveries to end-users.

What was that figure for the three months?

Can you remind us?

You know, Alex, we have stopped actually publishing the actual numbers.

The percentage increase?

We're talking about whether they are up or down or the rate, the monthly -- the per month rate was up or down.

You know, and the reason we have done that is because, you know, it is built on a lot of averages.

It is inventory that they have.

It looks back a few months; it looks forward a few months.

There is a lot of opportunity in there for estimates, and we're just trying not to try and imply a significant precision there.

Okay, thank you.

David Raso.

Citigroup.

A quick question on the revenue outlook.

You kept it the same; that is the second straight quarter we kept it at 10%.

But the pricing went up from -- basically 3% was how you used to [cite] the mix, or it's 7% unit, 3% price.

But now we're looking for closer to 4% on pricing, essentially implying that the unit volume growth has come down a bit.

Is that the correct read?

Or are you taking down the price increase because maybe currency is more of a drag?

I'm just trying to think through the issue of pricing versus your ability to get units out the door.

Yes, I think, I would not read anything into that, David.

The pricing for the year, we took up about $200 million.

In the context of the way we try to describe it, we have never tried to be that precise.

We never said it is 40.0.

We have said it is about 40.

For us, that implies that it is around 40; and I think a $200 million change in price was not enough for us to change our idea of about 40.

That does not mean that we have taken down our volume view for the year.

Okay, great.

Thank you very much.

Gary McManus.

JPMorgan.

If I look at your implied guidance for the rest of the year, if you look at the incremental margins, or you call it I guess profit pull-through, it was 47% in the first quarter.

You expect only 29% for the rest of the year.

You actually, I think, if I calculate it right, your first-quarter operating margin of 12.9, you're actually suggesting a slightly lower operating margin for the rest of the year.

You give pricing and core operating costs; so they are not really much of an influence on these numbers.

So what is it that is causing you to have much lower incremental margins and overall operating margins for the balance of the year?

That is a great question, Gary, and I think we really want to hit that head on here.

When we talk about incremental margins, they're a comparison versus a period in the prior year.

If you look at our outlook, there is absolutely no doubt that in terms of the year-over-year change in price realization, it had a much bigger effect on the first quarter and, as a result, the first-quarter incremental margins or pull-through as compared with the first quarter a year ago.

That is the most significant reason for the change.

On a year-over-year basis, our outlook does not reflect that same rate of improvement.

Now let me just follow-up on that, and kind of talk about it a little bit, and get that out on the table.

Last year, we had two price increases during the year, January and in midyear.

We did parts in April; and we did Machines and Engines in May.

Then this year, we have a price increase that was effective in January.

The first-quarter price realization then has the midyear of last year and it has the first quarter this year in the comparison.

In addition to that, this year's first-quarter price increase we announced earlier than we historically had, and one of the effects of that is a lower price protection.

So, not only did we have the price increase, we had lower price protection in the first quarter than we did the first quarter a year ago.

So again, first quarter impacted, two price increases, and lower impact from price protection.

In the second quarter, the comparisons start to get tougher, because a year ago we would not have had significant price protection in the second quarter anyway.

So that piece of the equation would, in terms of a comparison, largely go away.

And in the second quarter of last year we did have some effect from the price increases that we took, albeit not a full quarter.

Then when we get to Q3 and Q4, essentially from top-line price change, the major impact is just this January's price increase.

So I think it's the case where, because we took a midyear last year, and when we get into the second half of this year and the second quarter to some degree, the comparisons get a lot tougher; and that means that the year-over-year change from pricing is not as dramatic.

So bottom line, that is the story on pricing and the reason that the pull-through, or the incrementals as you call it, get a little tougher as we go through the year.

So you're basically saying it's related to when you announce price increases.

But I assume at the time you were announcing price increases last year you had fairly high backlog in fairly important product categories.

I would not think you're getting that price increase right away.

So I am just -- it is just so confusing on me why the announced price increases would have as much of an impact; because you price protect products that have already been ordered in your backlog.

This is Doug Oberhelman again.

I think Mike's answer was right on.

If you look, if you go back a little further even, when we announced the first price increase this round, we announced it and didn't really get much out of it until many, many months later because of the backlog.

At that time it was growing and we were way behind on shipments.

As we have done this now through January '06, every one of those price increases we have announced, we have announced earlier and earlier and earlier and earlier.

That essentially has led to the compounding that Mike was referring to, that now -- that we saw in the first quarter.

We have not planned a general price increase for the middle of '07.

We're looking at this almost on a daily basis.

There may be a selective few parts general -- or not general but specific increases here and there in some machines and engines.

But overall, we won't be doing anything midyear '07.

Therefore we would not have the benefit of that as we have seen in the past years as well.

That is a midyear price increase.

Okay, thank you.

Ann Duignan.

Bear Stearns.

I just wanted to build a little bit on the pricing versus input costs idea, following up on Gary's questions.

How comfortable are you that price -- that input costs are only now going to rise 1% for the full year?

It does seem like a lot of the base commodities are beginning to reaccelerate.

Then when we track pricing across a number of key end markets, we are beginning to see pricing decelerate a little bit.

Not turn negative, but just decelerate from kind of the lofty levels of last year.

So going forward, how are you thinking about your ability to offset any further acceleration in input costs with pricing?

I know you just said you're not anticipating any price increases midyear this year.

But how are you watching that?

How are you tracking that?

When will you know it's time to move again?

And will the market accept further price increases?

Yes, Doug Oberhelman here.

All great questions.

I can tell you that we are monitoring this on a daily basis.

Between our global purchasing group and all of our marketing companies around the world, we are tracking both of those.

Both the material cost inputs as well as our marketplace position.

Right now, I would tell you we're feeling pretty good about material cost inputs for the full year.

We projected a 1% increase and so far that is holding very, very well.

Now, this recent run-up in commodity prices that you referred to, which is very recent -- in the last few weeks as a matter of fact -- we have not heard anything out of that.

So given that continues, which we expect it will, given oil prices not going through the roof any further than where they are, we think we are operating in a pretty good sweet spot and feel pretty good about that through the rest of the year.

Now there's a couple of big givens in there and ifs, which I would leave on the table; that is, oil and commodity prices zooming out of control.

But nobody here is expecting that, and as you can see, they're pretty volatile from day-to-day.

Do you think, though, that you will be able to push even greater price increases through to the marketplace without suffering market share loss if necessary?

Or -- I mean I know it is always a very tight balance to tread, giving up share versus pushing through prices.

Is there still room for price increases out there if commodity prices go up again?

You're right, it is a very tough balance.

That is one of the reasons we chose not to announce a general at the middle of '07.

But if things start to get out of hand again, as they have seen, we would be looking at that.

I'm not going to comment on whether we would or not.

I think right now we're in a position that we like.

We will track it and see what we do, and go from there.

If prices keep moving on up or costs keep moving on up on us, we will take a look at it.

Okay.

Just to [really] follow-up on that very point, it looks like from our industry data that, number one, Europe remains quite weak.

That is reported in your numbers, obviously.

But it looks from the '05 data that you may have lost market share in Europe across a number of different applications.

Could you just comment on that, and tell us what is going on over there in Europe?

Is it just cyclical or is there something fundamentally different that we need to be concerned about?

It's Mike.

Just a couple of comments on Europe.

One, economically, actually we are encouraged by what we see there.

Economic sentiment has improved.

Some of the survey data has improved on the economy overall.

Now that said, that is improving to a growth rate that is below the rest of the world.

So, it has not been robust gross there.

In fact continental Europe has probably had the weakest growth of about any region that we do business in.

So I think one, it has been weak; the expectations for '06 are for a better economy, but still weak.

In terms of our first-quarter sales there, our sales were lower than you would expect, I think, based on the economic activity.

For us, a lot of that had to do with slow shipments on a couple of product lines related to NPI.

You know, new product changeover and not getting as much of the new product out when we expected we would or thought we would.

So we were a little bit behind on medium wheel loaders and a little bit behind on shipments for backhoe loaders.

In terms of specific market share comments about regions, you know we have a history of tending to not talk about the numbers of market share.

Overall I would have to say we are doing pretty well; but in terms of specific products or regions or individual markets, we just tend not to talk about that.

Okay, thank you.

I'm sure I will get it out of your team when hat I go over to the INTERMAT show.

We will let them know you're coming and prep them well.

You do that.

Okay, I will get back into line.

Thanks, guys.

Joel Tiss.

Still at Lehman Brothers.

I'm trying to get a little bit of -- trying to dig a little bit into what is going on with supply and demand.

It sounds like demand is still very strong, but supply in some markets is catching up a little bit with demand.

Can you maybe give us a sense of where the inventories are growing?

Like smaller machines versus larger machines; and maybe that will give us some insight into mix later in the year, etc.

Yes, I think overall, Joel, your comment on demand and supply is pretty right on.

If you look at the number of models we have on managed distribution, it remained at what is a reasonably high level, 69 that we had at the end of last year.

It is kind of buried back in one of the Q&As, but our expectation is it will remain high, particularly for the larger machines as the year goes on.

I think by implication there, I think what we're saying is that generally speaking for smaller machines supply is certainly a lot better than the big machines and the big engines.

So I don't have in front of the detail of the dealer inventory of what they have.

But at the risk of doing a little speculation here, I would say they would have proportionately more of the small machines than the large and medium machines because they have been in such tight supply.

Yes, I think that is exactly right, Joel.

Our core product has been in very high demand for a very long time.

While we are inching up on our supply capabilities with that, as you know, we're not piling a lot of money into new brick and mortar.

We're trying to get there through a more deliberate way of using our throughput advantages.

But certainly if you go and look at dealers around the world you will see an awful lot of inventory out there, and they're high numbers.

But it's kind of across the board in different things.

Mike is right, it would be higher numbers in units of the smaller equipment.

Just a follow-up, can you give us any signs -- you keep hinting, sort of, in your press release that there -- I don't know.

You're not saying that there are signs.

But are there any signs you're seeing that the higher interest rates are going to slow things down at all?

No, not at the moment.

We are contemplating a couple of more short-term increases before this period is over.

But right now, we are not contemplating any of that.

So it is just a forecast.

You're not seeing it in the results at all.

Not yet.

Okay, thank you.

John McGinty.

Credit Suisse.

Let me start out on this pricing issue one other way.

You guys raised prices; you knew what the pricing was; you knew what the price protection was.

How could you miss the estimated price realization by $200 million?

In other words, what was it that caused the increased price realization from $1.1 billion up to $1.3 billion between the January and the April forecast?

John, the 200 million, first, is full year.

All right?

Right, but it was full year in January as well.

Absolutely.

I think a couple things in there.

One is you're right, we know overall what price increase we have taken.

We know the kinds of programs that we have out there.

But I will tell you that we don't have a crystal ball in terms of the specifics of what the takeup of each of those programs is going to be, and how much of it we will have to actually use to get the business that we're looking for.

So, I think realistically, since we have not talked about any different levels of list price changes, the changes in product mix, what we're selling where, and in the level of discounting that we had in the first quarter, and our expectations for the full year.

So in other words it was the programs were less -- just to make sure I understand it.

You are saying that the programs were less than you thought they might be?

For the full year, our forecast of what they will cost us is less than we thought at the last outlook.

Okay.

Then the follow-up question I have is, in answer to Gary's question, I understand perfectly about the timing in terms of why the incrementals.

But if I can come back to your forecast of 3% price, when that is essentially what you raised prices in January, you were up substantially more than that in the first quarter.

But the fact that since the first quarter was up so much more than 3%, the second, third, and fourth quarter are going to be up the 3% that you raised in January, if nothing more.

Forget about the fact that you actually should get a little bit more because they did not come in all when they were supposed to a year ago.

The fact that you are assuming 3% price when in fact the magnitude of price, given the first quarter, is going to be substantially greater than that -- is that because you are assuming you're going to go back to discounting?

If I come back to the answer, the last line of your question 1 in the Q&A is kind of scary.

Industries we serve are very competitive.

We intend to defend our market position.

Are you losing [pins]?

Are you going back after the domestic discounters?

Is that what the implication is?

If not, then I don't see why the price realizations would not be higher than the 3%, given what you had in the first quarter and what happens over the balance of the year.

Again, John, we tend not to talk about any specifics of pins overall or by region.

I think the last comment in the Q&A section really means that if you look at the rest of the year for us, we are prepared with additional discounting to protect our market position.

Is that why we're only assuming a 3% price increase, when you're so much higher than that in the first quarter and you have got that on a sequential basis?

The answer to that is yes.

That is a factor for the back-half of the year and our forecast going forward.

Okay, thank you.

John, it's great to hear from you by the way.

I have not talked to you for a while.

Doug Oberhelman.

Thanks, Doug.

Andrew Casey.

Prudential Equity Group.

Back to a couple questions ago, I think you reaffirmed that you are not looking to spend a lot in brick and mortar to increase your production capability.

When you bring out the new engines and the filtration products, is that a point where we can see better debottlenecking within the engine area?

Or could you help us understand how you are going to address increasing your production capability?

Thanks.

Doug Oberhelman here.

Certainly, the new after-treatment business, which is I think what you're talking about, isn't expansion of capacity; but it is a new business for us.

So I don't put that in the same category as I would the large engines, where we have been on managed distribution for some time and will continue to be for some time.

We're looking to expand after-treatment.

We are investing.

We think there's a lot of opportunity there down the road.

That is going to add hopefully both top line and bottom line as we go forward.

In the case of large engines, which I think is really where you are aiming that, we are inching up capacity and have.

As Mike said a minute ago, '06 versus '03 is up 100%.

We've seen the same kind of things in the large engine business and basically, with the same amount of physical plant and capacity, have addressed that and have plans to inch that up as we can go on from there.

We are looking at where that demand is.

Of course, it is related to lots of commodity price things.

Petroleum is huge; the marine business is huge, with that primarily driven off off-shore work boats in the oil and gas arena.

Electric power is again strong, and we don't know how cyclical that is over the long period of time.

We have seen boom and bust there.

So what we're trying to do is juggle what is long-term demand there versus what capacity we have.

We feel with what we're planning to do over the next year or so, in inching that capacity up, we will be able to address that across the board.

The new engine I think you referred to is the C175, which will really gain full production status late '07, early '08.

So that is a ways away.

Thank you.

Andrew Obin.

Merrill Lynch.

Just to shift the topic a little bit away from pricing, we have been hearing from some of the industry sources that truck OEMs are thinking about stockpiling engines in the first quarter.

Well, stockpiling engines throughout '05 to limit the number of trucks with new engines being shipped in first quarter of '06.

A, I'm just wondering if this is feasible under the EPA guidelines; and B, if you are seeing any of this going on.

I think you are referring to first part of '07 versus '06.

Yes, sorry.

That's okay.

There is a tremendous amount of medium and heavy truck volume right now.

We think the heavy truck industry this year is going to be around 315,000.

We I think put in the Q&A that we anticipate that dropping to around 200,000.

Certainly that is driven by January '07 new emissions regulations here in the U.S. for the EPA.

I'm not going to comment, as I don't know today if our OEM customers will stockpile engines early in '06 -- or this year in '06 to use and build into '07.

I do know that right now virtually everything that we are producing is going into some kind of a truck chassis for ultimate destination with their customers.

So I think you would have to ask them about what they plan to do with their demand on us.

But we know January 1, '07, we have got to be in full production with the new engine, which we will be ready to do.

Just another follow-up question.

Given the decision that Freightliner made on their medium duty engines for '07, are you willing to share any plans for us for the production capacity at this facility, where I assume there will be more incremental capacity going into '07?

I am not willing to share, but obviously we have known of this for some time.

We have what I think is a superb way -- and I'm not going to use the word restructuring, but it isn't -- but some rearranging of facilities and capacities to really take advantage of that.

So I feel pretty good about where we are going to end up on that in early '07.

Thanks.

I know I am not supposed to say that anymore, but great quarter.

Thanks a lot.

It's okay, Andrew.

You can say it as much as you like.

Yes, we like to hear that, actually.

They told us not to.

Have a good day.

Who is they?

David Bleustein.

UBS.

Quick question.

You mentioned in the low sulfur diesel fuel discussion you thought, or at least alluded to the potential that the EPA would delay implementation of the '07 standards.

Is that just kind of a throwaway comment, or does that really have a chance of happening?

Doug Oberhelman here.

As of today as I sit here, there is no -- I don't think there is a chance at all, really, that those ultra low sulfur content rules will be delayed past October-November of this year.

The only footnote we have put in there is you will recall a year ago, when the hurricanes hit, the whole gasoline and diesel octane subjects were thrown in the air as the Gulf was thrown into chaos for supply.

At that time the oil companies did get a 45-day delay for their ultra low sulfur fuel.

Given what we see today, though, I just don't think that is going to happen.

We are very confident at the moment there will ultra low sulfur fuel in the truck stops according to the EPA regulations they put forward later this year.

My related follow-up is Cat-speak, how much is inching?

In other words, can you discuss the capacity constraints and -- just pick a business like mining truck; have the suppliers caught up?

As you think about inching capacity up in 2007, should we think about an inch as 1% to 5%, 5% to 10%, 10% to 20%?

How much is an inch?

Well, I probably should have said, in deference to all of my international friends, millimeters or centimeters, but I won't quantify that either.

When I say inching, I don't mean doubling, but here and there we find ways to do it.

Getting back to mining trucks and some of the large products we make, the bottlenecks in mining trucks are still heavily influenced by tires, and I think everybody knows that.

We're struggling with getting enough tires for what we make.

Everything else is coming around pretty well, and we are working through, have worked through the bottlenecks to some degree.

But we are not going to see the ability to double capacities from where we are today with the physical structure we have in place.

The last question is you mentioned that there is not a mid '07 price increase planned.

Do you mean mid '06 or are you really looking out as far as '07?

If I said mid '07, I made a mistake.

It is mid '06, I'm sorry.

Terrific, thank you.

Eli Lustgarten.

Longbow Securities. (indiscernible) just a clarification (inaudible).

When you talked about material prices, and 1%, and they're not going up, and you have looked at it, has any been hedging done, either on material prices or currency for the rest of the year?

You know, I think first on material costs, when you say hedging, we have a certain amount of product that we have in the normal course of events with suppliers.

You have contracts for the rest of the year in materials, basically?

Yes, I mean it depends upon the products.

There are some that we have long-term agreements with.

Certainly that would vary supplier by supplier.

But certainly, some of what we buy for material cost is under long-term agreement.

In terms of currency, I kind of want to put that in just a couple of buckets; you know?

One, over the past two years, '04 and '05, we had the big hedges on the pound.

Those are done and we don't have anything in place that is kind of like that right now.

Now that said, I would not say that we don't have any hedging going on.

If you have a big capital project that is going in, you might hedge that.

So I would not want to give you the impression that we don't have anything going on.

But we don't have kind of the strategic hedge like we had with the pound a couple years ago.

Let me just add to that, Eli, a little bit.

That British pound hedge came about because the British pound dollar was so way out of whack, I want to say back in '02, and we enjoyed the fruits of that all the way through last year.

If you look at the trade weighted value of the dollar today, it is not really out of whack against anything.

I suppose you could argue maybe China and maybe a couple of others.

But if you look at the individual currencies and the overall trade weighted value, it is on a long-term basis kind of in the trading range.

So there's not a lot of opportunity for us to hedge.

Now we are in and out of the market every day as you know, hedging short-term, what we consider 12 month or less, both our transaction amounts and our translation balance sheet amounts.

But nothing extraordinary there.

Your forecast doesn't have any material changing currency in it?

I guess that is where it [becomes active].

No, not going forward, but again versus a year ago, we have absence of the hedges.

Okay. (inaudible) Follow-up, can we talk about truck engine demand?

It was down again in the first quarter; it was down in the fourth quarter a lot.

You blame it on inventory issues at customers, and it is sort of strange with what is going on in the marketplace.

As part of that can you talk about what you're increasing prices on medium engines for?

I guess the heavy engines are up $7,500 to $10,000 full year.

What do price increases for the medium engines look like for '07?

Okay, we did see an inventory reduction from our major OEMs the last few months.

I think for the most part that is behind us.

What we're seeing now is demand pick up based on what they are seeing from there fleets.

I don't think there is any question there is some degree of prebuy.

I have no idea knowing how much there is prebuy going into January.

That is, you would have to ask them.

In terms of the midyear price increase or the mid-range price increase, we have not announced that publicly; and in fact in some of the chassis we're still working through that, Eli.

It is on a percentage basis similar to the heavy engines?

I'm not going to make any comment.

I think you could probably draw that conclusion and be safe in some general calculations, though.

Okay, thank you.

Mark Koznarek.

FTN Midwest Securities.

I have a question on the cash flow outlook.

You know, now that the earnings outlook is up, that implies $140 million or so more to the operating cash flow line.

Can you review what the new operating cash flow outlook is?

Is working capital going to be a use or a source of cash.

Then remind us of the capital spending outlook, please.

This is Dave.

Good observation on the cash flow.

Our operating cash flow for M&E is some $650 million greater than 2005.

Just to kind of remind everybody in terms of our priorities for cash, it is first, of course, grow the business and keep the healthy pension and benefit plans; consistent moderately increasing dividends for (inaudible) [forever]; and then the stock buyback.

As far as CapEx goes, we spent $226 million; we expect to spend $1.75 billion for the year.

We have at any one time 30 to 40 acquisitions going on.

The logistics space, the remand space, the China space, but we're going to make sure that we go into businesses that we are going to make good profits.

This is a 16% hurdle rate, 10-year discounted cash flow basis.

As far as the pension and benefit plans, we spent about $20 million so far.

We might go a couple hundred million more.

But our pension and benefits -- our pensions are essentially fully funded with the PBO at about 88%, and ABO at about 93%.

So we're in great shape there.

As far as dividends go, we have spent $168 million in the quarter.

As I said, we will expect to take that up a bit more later this year.

Then of course, the stock buyback, the $738 million that we spent on stock buyback, about $10.5 million, $8 million a year ago.

If you look at last year, as far as the repurchase, we had about $34 million last year at less than $50.

This year we have spent the $10.5 million at about $72.

So that kind of gives you a dimension on how we are spending that.

And we have got some issues as far as the working capital that we are working through, in terms of our inventories and trying to put additional focus on that as we move forward with our [Cat] production system in order to delivery.

Does that latter comment, Dave, mean that you are shooting for a neutral for working capital for the year?

Mark, this is Mike.

You know, we don't really put out an outlook for cash flow and we don't have a balance sheet outlook.

But I think it is safe to say we're not looking for the kind of increase in inventory for example that we had in the first quarter.

In fact, that is why in my prepared comments I tried to explain it a little bit.

Some seasonal build, and some effect of the NPI.

Okay.

Then kind of a follow-up on the tax rate, up 150 basis points; and we have got that ETI thing phasing in.

What is the expected increase for next year, just based on the regulatory?

You know, our tax rate is a function of several things, geographic, profits, as well as the change in the ETI.

I think we will say that comment when we talk about the '07 outlook maybe later in the year.

But it is being phased out.

Definitely there will be upward pressure.

Upward pressure on the number, on the rate.

So the U.S. side will go up, and then from there on it is a mix of where the profit is coming from?

Certainly.

That's correct.

And the U.S. goes up -- is it 100 more?

We're not going to comment on that.

We will cover that in the outlook when we get to '07.

Okay, great.

Thank you.

Robert McCarthy.

Robert W. Baird.

The other income and expense for Machinery and Engines swung from a $54 million positive item a year ago to a $51 million negative item.

So about a $105 million swing year-to-year.

In the release, in comparing the consolidated numbers, I believe $49 million is indicated in terms of the absence of foreign currency gains.

Can you talk about how much of that is attributable to M&E?

I assume most of it.

And then what is the rest of this?

In the first quarter, the major item, you are right, was the lack of the hedge.

For the full year, the difference between operating profit and the bottom line I think we covered pretty well in question 8 of the Q&A.

The remainder of what the detail is in the other income line, I don't have in front of me at the moment.

But the major item was lack of the gain on the hedge.

Okay, you will have to pursue it off-line.

I don't know what higher oil prices have to do with it.

Oil prices?

What now?

I was looking at question 8.

18.

I'm sorry.

Okay, we can catch that later.

Clarification, the 1% increase forecast in materials costs, is that a change from a quarter ago?

No, we have been saying that really since about the third quarter of last year when we came out with sort of the preliminary outlook.

We have been around 1%, I think, since then; and our view has not changed.

The $1.75 billion CapEx number that Dave just mentioned, that is, I assume, a consolidated?

Yes.

What would an M&E number be?

I don't have the breakdown, but I can get that later.

Okay, thank you.

Dana Richardson.

Argus Research.

I just wanted to have another crack at that tax question.

I know you may not want to elaborate on it, the 2007 tax.

But you indicated that the tax rate has gone up 150 to 200 basis points as a result of the phaseout of the ETI going down from 80% to 60%; and it's going to go down to zero.

So I was just wondering if it would be correct to think about it as that your tax rate could go up say 4% to 5%; or is that just way out of line and too high?

We will cover the tax rate for '07 when we do the outlook for '07, but again, the phaseout will take it up.

What it does ultimately will depend upon where we're earning profits and what profit is in the U.S. versus other countries.

Okay, thank you.

One other comment.

Rob, just a minute ago, when we talked about the 1.75, that is M&E.

My mistake.

That is the number for M&E.

Next question.

Ben Cherniavsky.

Raymond James.

Just a quick question.

I am wondering if you can shed any light on what is happening to used prices.

I don't know if you want to go so far as to make a projection for them.

But if you are not -- if you're planning to hold your pricing steady for new, do you think the used equipment market for pricing is leveling off or will level off later this year?

Well, the used equipment price -- and of course we are, other then Cat Financial, where they have a significant number of machines that come off lease, and they put into the used equipment market -- used equipment prices have been very robust over the last couple of years.

In fact, that is one of the positive factors that have helped Cat Financial's results in the current quarter.

No, I don't really have forward visibility of that.

I don't know whether it will cool off going forward or not.

All I know is over the last couple of years it has continued to strengthen.

In fact, there have been some quarters when it's been up double-digits.

I would just say used equipment prices are very, very strong, really around the world, particularly in North America.

Retail activity is high, ongoing demand is high as we have mentioned, and that all feeds back to used.

We are not going to comment about where that is going.

But I suspect if you watch retail sales by dealers, that would give you some kind of correlation back to used prices.

But, boy, that market is really good right now.

A lot of our customers are smiling because their machines are really holding their value well.

But just I suppose intuitively, they will follow the new price market, right?

Well, there is a correlation to new and used, certainly.

Just because we don't take one midyear '06 price increase I don't think will be relevant on used equipment prices.

They are a bit more of a longer trend.

Right, and your decision not to -- at this point to implement an '06 price increase, is just a wait-and-see approach, rather than a sign that you think prices are leveling off themselves?

I would say that is right.

I don't -- at this point, used would not have entered into that.

Used prices would not have entered into that midyear decision.

Thanks a lot.

Okay, we are at about 1 minute or 1.5, 2 minutes left to go here.

So we have time for I think one more quick question.

Stephen Strong.

Mr. Strong?

Okay, I think, in light that we are down into our last minute, I doubt that we can get one more question in now and back out, so we will close.

I just want to thank everybody for participating in the call today.

We had a great quarter to talk about, and it was a pleasure sharing our results with you.

Thanks for your interest in Caterpillar.

Goodbye.

Thank you.

Ladies and gentlemen, this does conclude today's conference call.

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

Thank you for your participation.