開拓重工 (CAT) 2010 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Caterpillar second-quarter 2010 earnings results conference call. At this time, all lines have been placed on a listen-only mode and we will open the floor for your questions and comments following the presentation.

It is now my pleasure to turn the floor over to your host, Mr. Mike DeWalt. Sir, the floor is yours.

Thank you very much. Good morning and welcome, everyone, to Caterpillar's second-quarter earnings conference call. I am Mike DeWalt, the Director of Investor Relations. I am pleased to have our CEO and Chairman-elect, Doug Oberhelman, and our Group President and CFO, Ed Rapp, with me on the call today.

This call is 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 copy of today's call transcript, we will be posting it in the investor section of our cat.com website and it will be labeled in the section results webcast.

In addition, we will be discussing forward-looking information today that involves risks, uncertainties, and assumptions that could cause our actual results to differ materially from the forward-looking information. A discussion of some of the factors that individually or in the aggregate we believe could make actual results differ materially from our projections can be found in our cautionary statements under item 1a, risk factors, of our Form 10-K for the year ended 2009 and part two of our first-quarter 2010 Form 10-Q, and also in the forward-looking statements language contained in today's release.

Okay, earlier this morning we reported results for the second quarter and we increased our outlook for the full year of 2010. To start this morning, I will summarize the quarter and the new outlook and then Doug and Ed and I will take your questions.

So let's start with the second-quarter top line. Sales and revenues were $10.409 billion and that's up from $7.975 billion in the second quarter of 2009. And that's an increase of about $2.4 billion or 31%. The increase in the topline was primarily driven by the absence of 2009 steel inventory reductions coupled with improvement in end-user demand. And in terms of dealer inventory, our dealers cut their new machine inventories by about 1.2 billion during the second quarter of 2009 and as a result, Caterpillar essentially undersold end-user demand in last year's second quarter.

During the second quarter of 2010 this year, dealers held inventory about flat, meaning that our machine sales were about in line with end-user demand. We frequently hear comments and get questions about dealer restocking. To be clear, overall dealers have collectively not increased machine inventories yet. They've just stopped reducing them. In fact, that comment goes for the first half of 2010, not just the second quarter. Inventories have remained relatively flat all year long.

Dealer inventories in terms of months of supply are below historic averages. That's a good thing and it is in keeping with our lane strategy that includes Caterpillar holding finished inventory in regional distribution centers to serve our dealers and customers. That said, inventories are getting tight in some parts of the world and the higher sales are in our outlook range, the more likely it is that dealers will want to add some inventory. Okay, that's the situation with dealer inventory.

The second major reason for the sales increase in the second quarter was better end-user demand. Demand has picked up substantially from the very depressed levels of last year. And that is because most of the world's economies are in recovery after last year's severe economic decline.

World growth is being led by the developing countries of Asia, Latin America, the Middle East, and Africa. And we are seeing continuing strong growth in our businesses in the developing world. That economic growth is also driving demand for commodities like iron ore, copper, coal, and oil. And that is helping our mining and energy-related businesses around the world.

The developed countries of the world like the United States and Europe and Japan are also growing, but more slowly. And while economic growth in developed countries has helped, we still have a very long way to go. Sales in North America and Europe, while better than the very low levels of 2009, are still depressed.

So the 31% increase in our top line was primarily due to the absence of last year's dealer inventory declines and improving end-user demand.

Just one more point about the sales increase. The vast majority was related to machinery. Compared with the second quarter of 2009, machinery sales were up 55% while engine sales were up 3%.

Now let's turn to profit. Profit in the quarter was $707 million, a 91% increase from $371 million in the second quarter of 2009. Profit per share was $1.09, up $0.49 from $0.60 in the same quarter of 2009.

Consolidating operating profit as a percent of sales was 9.4%, and that's up from 4.4% in the second quarter of last year. In machinery and engines, gross margin continued to improve and was 24.2% in the quarter.

Higher sales volume was a significant positive factor driving the improvement in profit. That said, that positive impact was mitigated somewhat by a very negative sales mix. Our mix of sales in the second quarter as compared with the second quarter a year ago was negative because machinery sales -- remember at 55% up, increased at a much higher pace than engine sales, which were up 3%. That is a negative because machinery margins are lower than engine margins.

In addition, the production and sale of smaller lower margin machines increased faster than large machines. And that is primarily because smaller machines were more depressed than large machines by the impact of the dealer inventory reductions in 2009. And also the mix of engines that we sold was also somewhat negative. So that's volume, a major positive but mitigated somewhat by a negative sales mix.

In addition to higher sales volume, price realization also improved and was favorable to profit $187 million. Manufacturing costs were also favorable by $316 million. And if you exclude the LIFO inventory decrement benefit that we realized in the second quarter of 2009, the cost improvement was more. It was $426 million and that was a result of better labor and overhead efficiency, lower warranty cost, and favorable material costs.

Another positive in the quarter was the absence of $85 million of employee redundancy costs from the second quarter of 2009. Partially offsetting these positive items were higher income taxes. As a percent of profit before tax, rates went up in the second quarter of 2009, and that's primarily due to the geographic mix of where profits were earned.

SG&A and R&D costs were also higher and that was due to provisions for employee incentive compensation and some increase in R&D spending related to Tier 4 missions. Overall, currency impacts were also negative. The impact of currency was $77 million unfavorable to operating profit and currency impacts were the principal reason that the other income line which is below operating profit declined from the second quarter of 2009.

Before I move onto the full-year outlook, I would like to cover two items, employee incentive compensation and income taxes in just a little more depth. As you may be aware, a portion of the compensation for our support and management and some production employees is variable and based on the financial performance of the Company. And financial performance in 2010 has continued to improve and based on the new outlook for 2010, we expect incentive compensation of about $600 million for the year. We provided about $90 million in the first quarter and that was based on the full-year outlook at that time and we provided $210 million in the second quarter of 2010 and that was based on the new outlook that we released this morning.

That means through the first half of the year, we provided for half of the full-year estimate of about $600 million. So the provision in the second quarter at $210 million was $120 million higher than the provision from the first quarter. And again, that was based on the improvement in the full-year outlook.

The second thing I wanted to add color on was the provision for income taxes. As I mentioned a few minutes ago, taxes and the tax rate were unfavorable compared with the second quarter of 2009, so year-over-year unfavorable. However, our previous outlook for 2010 expected a 30% tax rate excluding the Medicare-related adjustment in the first quarter. Taxes in the second quarter were below that 30% estimate.

We had favorable discrete tax adjustments in the quarter and we lowered our estimated annual tax rate for 2010 from 30% to 29%. As a result, taxes in the second quarter were favorable versus the 30% rate from the previous outlook.

I hope you followed that discussion on incentive compensation and taxes. I know it is a bit complicated, but the punch line is incentive compensation expense in the quarter was probably higher than you might have thought because of the increase in our outlook, but taxes were probably more favorable than you expected.

In addition to profit, we have been very focused on cash flow this year. Through the first half of the year, our Machinery and Engines operating cash flow improved substantially from about $600 million during the first half of 2009 to about $2.4 billion through the first half of 2010.

Our Machinery and Engines debt to capital ratio improved as well and at the end of June 2010, it stood at 41.9%. That is an improvement from 53.1% at the end of June 2009 and an improvement from 45.2% just three months ago at the end of the first quarter.

Okay, let's move onto the outlook. This morning we raised guidance for sales and revenue and profit. Our previous outlook range for 2010 sales and revenues was $38 billion to $42 billion, and that was a midpoint of about $40 billion. The outlook we provided this morning is a range of $39 billion to $42 billion with a midpoint of $40.5 billion. And in that it's probably worth noting that the US dollar has strengthened since the end of the first quarter and that has had a negative impact on our sales forecast as sales and other currencies translate into fewer dollars.

The full-year impact on sales compared with the previous outlook is negative about $0.5 billion. So what that means is the underlying and volume improvement in the sales and revenues outlook is a little better then the headline numbers would indicate.

We also raised our profit outlook this morning. We are expecting profit per share in the range of $3.15 to $3.85 with a midpoint of $3.50 a share. That is up from the previous outlook range, which was $2.50 to $3.25 a share with a $2.88 midpoint. Okay, that's the outlook.

In summary, the second quarter reflected continuing improvement. Dealer sales to end users continued to strengthen and thanks to our suppliers and a lot of hard work in our factories, we were able to raise production significantly in the second quarter and do it with reasonable efficiency. Sales and profit were up. We raised the outlook for the year.

And with that, we are ready to take your questions.

(Operator Instructions) Robert Wertheimer.

It's Morgan Stanley. Good morning, everybody. My question is on basically lane strategy progress in the dealer inventories. Obviously it's easy to read 10-year low dealer inventories as a positive for future production, but there's also the offset where you're trying to work them lower. So I wonder if you can fill that out with some metrics on whether they are below your sort of new target with the lane strategy? Maybe if they are getting the order fill rates that they're looking for, and it's just that it is working or whether there's a surge coming. Thanks.

Hi, Rob, this is Mike. I will start that out and say to some degree it really depends -- it's dealer by dealer. It is not the same story everywhere in the world. In some places, dealer inventory is actually probably a little too tight right now.

I think in general, we are moving along pretty well with lane strategy. At the end of the quarter, we had about 25% coming out of lane one. I think it's probably fair to say that our fill rate out of lane one is not where we would like it to be. It's a little bit below that, although we have been working on it pretty hard. Sales to end-users, end-user demand has just continued to be good and in some parts of the world, it has outpaced what we thought and it has made it a little tough to get the fill rates out of lane one maybe as high as we would like.

I think overall dealer inventories right now, they've come down a lot. They are below the historical averages, as you said. It's not in our plan to take them down from here, but on kind of the increases in volume that we have seen for this year, the plan is actually to hold them kind of steady where they are right now.

Okay, so they are in aggregate -- I know it could be pockets at the right level. The follow-up if I could would be are you production-constrained at all either in the quarter or on the outlook? Your profit outlook was very healthy so you would assume you're not seeing any production problems but you touched on this, Mike, in your comments. There is a currency effect. But nonetheless, the revenue increase wasn't all that huge given low dealer inventories and sort of accelerating markets. So the question is are you production-constrained in that outlook?

Again, it's not a one size all answer. If you were to look at excavators in China, we are capacity-constrained there. The ramp up in mining is about -- I wouldn't say it's capacity-constrained. It's more supply chain, capability, ramp up-constrained. So I think in some product areas in some regions of the world, yes, it's capability-constrained for the year. But in other areas, I will say small machines in the US for example, we could do more. So it's a bit of a mixed answer.

Okay, so there is a little bit -- okay, perfect, thank you.

Meredith Taylor.

Barclays Capital. I'm hoping you can talk a little bit more about some of the puts and takes in terms of the change in guidance. Mike, I know that you indicated that there is about an incremental $500 million of production that doesn't really show up in the increase to the midpoint of the revenue range. But clearly it would seem that there are some other puts and takes there beyond just the increase in the revenue numbers.

So can you talk about some of the other puts and takes there? Particularly I'm interested in has there been a change in point of view around how mix could impact the balance of the year? And then in terms of change in point of view around some of the other cost-saving efforts, lane strategy, etc.

Yes, no problem. If you look at kind of the change in the forecast, the one thing I think that was probably pretty clear in the release was that the tax rate dropped from 30 to 29 and we did have $60 million of discrete items in the quarter. So that helped a little bit, but most of the improvement was really three things with a partial offset.

Volume was -- sales volume was up and again, the volume number is better than the outlook would appear because of the translation on the sale. So that was a positive. It might have been a subtlety in the language, but on price realization we have moved the estimate from about 1% to above 1%. So price realization for the full year looks to be a little bit better than the prior forecast.

And our manufacturing costs are better. We improved -- our efficiency levels look better and we've reflected that in the forecast as well. The one thing that is an offset to all those improvements was incentive compensation. We increased the full-year estimate from about $350 million to about $600 million. So that had a mitigating impact.

But no change in point of view around mix for example as you continue to see some of the (multiple speakers) margin businesses like mining strengthen?

Yes, I think when we look at mix, we are actually looking at it year-over-year. In reality, the mix in the current year is not all that bad. The issue was the mix last year was particularly rich. It was a higher percentage of service in aftermarket, the small equipment really dropped off because dealers were selling it out of inventory.

I think relative to our forecast, I don't see a big shift in the mix between the two outlooks, but for the year again, it's going to be pretty negative. That really has more to do with last year being a particularly good mix rather than this year being a particularly bad mix.

Okay, great, then just a bit of a follow-on to Rob's question. Could you give us a little more detail on how lead times have trended over the course of the quarter and maybe if you could parse lane one versus the rest of the business?

Yes, I will do that and then we'll move on to another caller. But in general, it's a mixed -- it's again, a little bit of a mixed bag. You know, we have I think roughly 40% of our machine sales are coming out of -- about 40% of what's coming out of lane one dealers or customers are getting in a few weeks. A good portion of that they are getting within 10 days. So for a lot of our customers and dealers, particularly those that are able to utilize lane one, delivery times are actually very -- they're not where we would like them to be, but compared to the past before the lane strategy, pretty good.

Then if you look at lead times for the rest of the product, I would say in general lead times, as just a generalization, have moved out. But again, it's little bit of a mixed bag story. If you are a dealer and the product that you order from us is for your inventory, lead times are going out further. If it's for a customer, it gets priority.

So again, as a generalization, I would say as a result of pretty strong demand, lead times are going out a bit. But in the scheme of things, particularly considering lane one, the average delivery time is not too bad.

Thanks much.

Jerry Revich.

Good morning, it's Goldman Sachs. Mike, can you please give us an update on lead times in your mining and turbine business? How far out are you fully booked at this point and what was your book to bill in the quarter for each business? Thank you.

Okay. Thanks, Jerry. I don't know if we can be quite that specific for you, but I can tell you the forecast for those two big product categories for the year has gone up. For mining, they are pretty full for the year in terms of, say, truck production for example and the orders that -- most of the orders that they are taking would be for delivery beyond this year.

In terms of specific sort of book to bill numbers for mining and solar, we don't disclose separately. But what I would tell you is this. The combined total company Machinery and Engines order backlog has gone up substantially from year-end. It was under $10 billion at year-end. It went up to roughly $13 billion at the end of the first quarter and it's gone up another $2 billion in the second quarter. That's overall. That's not specific to mining and solar.

Mike, can you comment on the lead-time question for solar or no?

You know, I don't -- if I actually knew the answer, Jerry, I would, but I don't know. In general, Solar has fairly long times just as a normal premise. I mean, in other words, if they are taking orders today for the most part, it's not for delivery this year. It would be for delivery next year. But -- and it would vary a lot based on kind of the size of the product and the project. So I don't really have any more color on that.

Mike, of the $426 million in improved operating costs this quarter, can you help us with the rough size of the buckets you have identified, material costs versus warranty versus improved productivity on CPS? And also what does your new guidance imbed for material costs assumptions for the year now? Thank you.

Yes, and then we will -- after this one, we will move on to the next caller, Jerry. But in general, if you look at the way that we write our release when we list items, we tend to list them in order of importance. And so labor and overhead efficiency was number one, so that would've been the most significant contributor to the $426 million. Warranty second, lower warranty costs, and then material costs third.

Just -- I mean, they weren't hugely disproportionate. In other words, material costs were still favorable in the quarter, I think close to $100 million. I will say this, we still expect material costs for the full year to be positive. I think our estimate of that has actually declined a little bit since the last forecast, as the steel prices in the sort of first and early second quarter remained pretty high, although thankfully they've moderated a bit.

Thank you.

Alex Blanton.

It's Inglalls and Snyder. Mike, can you fill us in on what the dealer inventory changes are by region? You mentioned the Company as a whole was up 1.2 billion last year and flat this year. But could you break that down by region?

Yes, I can a little bit. Let me give you the second quarter of a year ago. The impact, North America about 300 million, [EMEA], 400 million, Latin America, a couple hundred million, Asia 300 million. So that's the 1.2 billion from last year.

This year it has been remarkably flat and for the most part by region. In the second quarter of this year, North America was down still a little bit, probably order of magnitude 100 million.

Down 100 million?

Yes, roughly, and Latin America was up a little bit. If you look at the -- overall, we were about flat. We had a small change down in North America and a change up in Latin America.

Now the good point about this is in Latin America because the inventory levels are smaller, the increase in Latin America was a bigger portion of the sales increase quarter to quarter. That's one of the reasons why Latin America had that 100% increase in machine sales.

Okay, so it was up in Latin America. Asia was flat then or --?

You know, down but just very, very slightly, well less than $100 million.

Okay, thanks on that. Good detail. The dealer statistics are not up for June yet. When do you expect that --?

Yes, we will be putting those up here at the conclusion of this call. But what I can tell you is the numbers are favorable. They are up again. In fact, dealer sales in North America, I've heard a lot of comments today about North America not helping at all. Sales to end users in North America were actually for machines were up 26% in the quarter. Now --

For the quarter?

For the quarter. So that's a positive (multiple speakers) but since it's at the end of the quarter, it is -- the three-month trailing is the quarter. And the world, the total world is up 22%.

So on a year-over-year increase basis, North America is doing okay. I think you almost have to look at that, though, and realize just how depressed sales were a year ago. They are up, but the dollar amount is actually relatively small. It was just so depressed, it's making the percentage look good.

So I think the comment that I would make on retail demand for machines is that it's up. That's good. It's up in every region, Asia Pacific, North America, Latin America, Europe, Africa, Middle East. And it's up for the world. But, you know, we are coming off a pretty low base. There's still a lot of room for improvement particularly in the US, Europe, and Japan.

It looks like a hockey stick.

Well, I think it was a hockey stick down last year.

Yes, okay.

Ann Duignan.

Good morning, guys. JPMorgan. My first question, Mike or whoever wants to take it, is around your incremental profits. By our calculation, incrementals were about 27% in machinery. I'm just curious whether you were pleased with a kind of an incremental profit given again how bad the trough has been.

And then could you -- would you care to comment on how sustainable that those -- this incremental is given the increase in incentive comp, etc., etc.?

You know, that's a good question. I think that the numbers -- I think the underlying numbers were actually pretty good. Remember, when you're looking at quarter over quarter, we had $110 million of LIFO decrement benefits a year ago, which in the quarter is kind of nonoperational per se.

And then with that incentive comp catch-up, the increase of $120 million, effectively half of that is putting the first quarter on the same rate as the full-year outlook. So you had $90 million in the first quarter, $210 million in the second quarter and then based on the outlook, it would be $150 million in each of the next two.

So the second quarter got a little extra hit from incentive comp just above and beyond the impact of the outlook because we had to catch up to one. And there was LIFO decrement benefits from last year and as I said earlier, sales mix was fairly negative. We had a very significant ramp up in small machines.

So I think the underlying kind of rate is probably better than the headline numbers suggest. Manufacturing efficiency continued along at a very good pace. Price realization was decent, I think, considering the environment. So yes, I think overall we were pleased.

I think the rest of the year particularly when you look year-over-year is going to be constrained a bit by incentive comp and it's going to be constrained by the sales mix. Last year, it was a really tough year. We set pretty tough targets. We didn't have any incentive comp last year, so everything this year is incremental.

So I think between that and sales mix, it will keep the number probably lower than a lot of people would like, but I think the underlying performance on cost, sort of the blocking and tackling in the factories is going pretty well.

Let me just chime in, Mike. Doug Oberhelman here on this point, which is the centerpiece I think of -- one of the centerpieces of us going forward in our new strategy, which we will outline to you all next month. But we have a really tight focus on cost both inside the plants and outside. But what we have seen so far this year as our facilities have brought people back, ramped up, worked with the supply chain is a pull through that we are pretty happy with.

The question is can we sustain that? And the answer to that is that is our goal. If you look now at where Cat Production System is really paying off, the facilities where that's implemented, institutionalized, and working so well and really pushed by our leadership, the benefits are obvious. Virtually every month in 2010, as schedules have been more ordinary than they were in '09, which as you know were chaos, we have seen continued benefits.

And we are, I would say not where we want to be yet enterprisewide on CAT production system, but it's certainly coming along and these operating profit pull rates that the absolute rates this year are evidence of that and we have high expectations that this is what our team can do.

And I guess that's our concern from an investor standpoint is here we are sitting kind of the first quarter, we are kind of normal pickup in volume and only 27% incremental coupled with what you guys said earlier in the call that your lane one strategy is not -- you know, you're not really where you want to be or need to be at this point. So I am just wondering if there is -- if we should be worrying about execution again already in the cycle?

Ann, again -- this is Mike. I will just say if all you take out is the LIFO decrement benefit from last quarter, the real underlying operational performance, even if you leave incentive comp in is still better than 27%.

And we shouldn't be concerned that the lane strategy is not going (multiple speakers)

Well, I will talk about lane strategy and availability generally. We went from a full speed sprint at the end of '08 and into '09 in a lot of facilities, certainly the bigger plants to a dead stop in late '09. And then in early '10, we started to see demand pick up albeit some inventory, absence of inventory build, as Mike described earlier. And now coupled with some retail demand, we have seen some of our facilities go from zero to up 50%, 60%, 70% this year in a supply chain that had zero notice.

So I think as we work that through the system here this year and if retail demand continues to grow relatively modestly as it has, our availability in lane strategy ought to work just perfectly. We're just in this kind of middle of the year where we have had to digest all of this supply-chain ramp up from a standing -- really a dead stop in the last part of '09. So individually at our facilities, we're pretty happy with it.

Overall, we are not happy with our availability in lane one performance, but given what we've been through historically here to now, we think it's done pretty well to get, as Mike said, about a quarter of our products through lane one. It's going to work. We just have to keep it coming here.

Yes, and I would add to this -- Ed. If you think about it, one of the issues with the lane and availability is the fact that take rate from dealers has been higher than we anticipated. In other words, they like it. We get 14 -- the product distribution centers up and running, we're going to continue to expand that.

The other key thing is if you look at the first half of the year, we had no growth in dealer inventory, which means through lane, we are actually able to feed product directly to end-user demand, whereas in the old days of a run-up, you would have seen dealer inventory build and we would've had the wrong product in the wrong place. So we had a lot of work to do, as Doug pointed out, but it is moving us in the right direction.

This is a glass half full at this point in time and certainly the ball is in our court. It's inside our four walls and we are going to get it done. We're going to execute but we are in far, far better shape than we have been in past recoveries at this point in the process.

Ann, this is Mike. I am going to just make one more comment and then we are going to move on to another caller. And that comment is, we said this in a release this morning, but I don't think it has probably gotten enough attention. This hits right to the heart of execution. Going from the first to the second quarter of 2010 was the largest, most significant quarterly increase we have ever had. And again, we did that with pretty decent efficiency. And it was very much sort of Cat Production System, supplier, factory coordinated effort to do that.

And it was -- that's total sales and remember the service revenues don't increase that dramatically, so if you just look at the increase in new machine production, new engine production, it was just up very significantly quarter over quarter and it came off pretty well.

David Raso.

ISI. My question relates to mix and price for 2011. Given your backlog comments, Mike, it looks like at least my calculation, orders were up a little more than 100% year-over-year in the quarter and your backlog is up around 75% year-over-year. Just thinking about the long lead times at mining and solar, the bulk of the order increase this quarter, can you characterize it at all between how much is that -- the big margin -- Decaturs of the world and San Diego for solar?

All I would have would be anecdotal. I've not really looked at it in that kind of detail. But I would say just anecdotally orders have continued to be pretty strong pretty well across the board. Now realize, though, for products like Solar and like mining, kind of the normal thought process, the way we work with those customers, they just have embedded in them a much longer lead time.

So those backlogs tends to go out further on purpose. For most other machines and engines, it's not our intent to have a big backlog. It's our intent that a dealer will order and we will satisfy the order in short order. So we're not actually trying to build inventory of the small stuff.

David, Doug here. I think it's fair to say that it's pretty much across the board. We had good backlogs at the end of the first quarter in mining and solar. They have continued and everything else is kind of catching up. So it would be hard to quantify too much, but we are really seeing it up to down.

In that same vein, again, just trying to think about mix for '11, your customer advances bottomed a couple quarters ago, so they are climbing sequentially. They are still well below that third-quarter '08 peak, but we already speak of solar kind of getting back to the peak levels pretty much this year already. And then obviously, Decatur, you are adding capacity.

So just trying to calibrate customer advances, doesn't seem to be as robust a number as what we are talking about in mining and solar versus prior peak. Can you just give me a little bit better understanding of why that customer advance number is so far below where we were?

I can't do that because I just have not studied the customer advance number, so unfortunately, David, I don't know. Some of it might be timing, but I couldn't tell you.

Then the last -- the question of price increase. We are obviously getting a little bit closer to '11 above 175 horsepower emissions for US and Europe. Want percent of your sales are you -- just roughing right now -- you think will be impacted by that price increase? I mean, you can do it by obviously just a rough idea of the geographic mix and try and get a feel for what do you sell above 175?

I'm just kind of curious what percent do you think is going to be impacted and how should we be thinking about the price increases as a percentage basis year-over-year for '11 for those products?

You know, this is probably going to be an unsatisfactory answer for you, but I think we will divert 2011 questions for a little later in the year.

Okay, thank you very much.

Eli Lustgarten.

Longbow Securities. Good morning, everyone. It's nice to see good execution for a change. Can we talk a little bit about the engine business first? Which -- sales numbers probably were strong, I thought, and your guidance has been staying relatively flat for the year. Ordinarily, I should be able to suggest that the shipment level will stay pretty close to the second quarter. Now, profitably stepped up in the first quarter, still well below last year.

Give me some sense of what's going on there where the profitability can sustain itself with the current second-quarter levels, because there's a big difference between first and second quarter and a big difference between the quarterly year-over-year comparisons and what's going on there.

Eli, are you talking about engines specifically?

Engines specifically, correct.

Okay, I will start it off a little bit. If you look at quarter-over-quarter, the sales were actually fairly flat on engines, but the operating profit was down. Essentially, what happens there is we had continuing cost reduction, which was a positive. We had a little bit of price. That was essentially offset by incentive compensation. And so on balance, pricing costs overall were fairly neutral, but sales mix was negative for engines quarter-over-quarter.

What we had a year ago is sort of continuing strong sales of the big engines out of a little bit longer of a backlog. They didn't really fall off significantly until the second half of the year. So what we have here now in the second quarter is some of the smaller engines have picked up faster. Those that got hurt earlier last year have picked up quicker, like small industrial engines, for example. We've had a lot of strength there.

So product mix, I touched on product mix earlier. So I think that's the primary reason it's down sort of versus the second quarter a year ago. You know, I think versus the first quarter of this year, operating margins for engines were up and sequentially, we had a volume increase. And that was I think a principal driver of the improvement, in both operating profit and we had incremental margins on engines between the two quarters that were certainly higher than the operating profit level. So that's what helped it.

Volume really first to second was a positive and that helped. Quarter-over-quarter, though, mix was negative.

The question I was asking was the current profit level in the second quarter sustainable for the rest of the year, given volumes to be very similar?

Yes, we have volumes -- we don't parse our outlook between machines and engines, but I think it's safe to say that if you look at the midpoint of our outlook range, we have profitability for the second half of the year if you were to take out the favorable tax in the second quarter, roughly in line with what we delivered in the second quarter. So we have sales going up a little bit. I think we're going to have probably a bit more R&D expense in the second half of the year. But by and large I would say the second half of the year just looking at our outlook and subtracting the first half is relatively in line with the second quarter.

And one question on North American machines were up 43%. Was the bulk of the shipment there, there's a little bit of inventory difference, the bulk of it in machines that were slated for export and then I guess have been quoted --

No, no, if it's export, that's not US. It's not based on production. It's based on where sold. So when we show North America, that's where we sold it, not where we produced it.

And most of that was not inventory? It was mostly --?

No, it was a split. Machine sales to users in the quarter I think -- and again, we will post this up here in a few minutes, I think were up 26%. So it was partly a result of dealer inventory absence of reductions or less reductions than last year, but demand is up as well.

All right, thank you.

Eli, I just wanted to chime in a little bit about the operating profit performance of both machines and engines, if I could. I am just really happy with both at this stage. The turnaround, we're starting to see in the machine operating profit and engine operating profit particularly if you adjust for the incentive pay and the items Mike talked about, redundancy and so on, at this stage are gratifying.

We did not see, as you know, well know, that the big tail off in engines it has come back nicely as we just showed you and that is with a really weak marine segment. I just returned from Europe last night and visited with a lot of dealers and customers across the board including the engine people and the marine business in Europe, which is a big piece of it of course, is really weak. It's vastly overbuilt the last few years in terms of new ships almost across the board in both segments anyway. And we're going to be seeing that for a while I think.

But if you look at the smaller engines, our smaller machine businesses and look at those operating profit at this point in time, I'm pretty happy with that. But you have to adjust outlook beyond, as Mike has talked about, where we were. I think we're coming along and I really feel good about that. It's kind of I think a reaffirmation of how well Cat Production System can serve us.

Thank you.

Henry Kirn

Good morning, guys, it's UBS. Can you talk a little bit about where the dealers are with the rental fleets? How much of a replenishment opportunity do you see?

Henry, this is Ed. You know, on the rental fleets, what I would say is dealers have not got into a mode of what I would call replenishment. You know, we have seen some signs of improvement relative to utilization. But with the increase in end-user demand that we have seen for the most part the availability has been going to feed that end-user demand. So I would say moving forward, it is one of the -- in addition to what we talked about on dealer inventory not increasing and rental fleets not increasing, it is something out there in the future that offers some upside opportunity.

Thanks, and what was the impact of the Australian resource tax on mining orders as you went through the quarter?

You know, I don't know how to parse that either, but I think mining orders have been very strong. Australia is continuing to be pretty good. You know, I think it would probably be too strong to say it was a non-event, but I think it would be hard to measure.

All right, thanks a lot.

Stephen Volkmann.

Good morning, it's Jefferies & Co. Can I just go back to the incremental margin question for a quick second? It just sounds to me like in the second half that incremental compensation expense will be a little lower than it was in the second quarter since you had to catch up and then you don't have the tougher comp with the LIFO gain. So we should expect these incrementals to actually get better in the second half. Is there anything wrong with that logic?

I would say there is nothing wrong with that logic, although in the second half of last year, we still had LIFO benefits last year that did help the numbers. But probably not as much as in the second quarter. And you are right on the incentive comp. Unless of course the outlook changes again, which we certainly don't know at this juncture.

But you know, with the outlook where we have it at the midpoint, that would reflect about $150 million a quarter for Q3 and Q4 versus $210 million in Q2. So in general your logic makes sense, although remember we still did book some LIFO in the second half last year.

Okay. Fair enough and then maybe just a quick follow-up for Doug, I guess. You guys have been fairly active in sort of redeploying cash here with the EMD agreement and the mining, the new mining programs and so forth. I just wonder how you feel about where the balance sheet is right now in terms of the capital structure? And then should we be looking for more acquisition activity or new product development going forward or sort of maybe rank the uses of cash?

Thanks, Steve. A couple of things. The priorities for the use of our cash have not changed and won't change. First and foremost is growth of the Company, where we can find those growth pieces that add to our business, and certainly Electro-Motive Diesel was a great one. I'm very happy about that -- and that is going to put us in a big way in the rail market that we are already in around the world, and I'm thrilled to be able to do that.

We talked about mining shovels. You know we were interested and have been interested in mining shovels off and on over the years. We have decided that given the industry aspects over the last six months, it's time to go again. We announced that along with a fairly sizable mining truck increase in both India and the US that should help us well as that market continues to grow.

We've quadrupled our excavator production in China and made that announcement in the last few weeks and I think that really with the state of the industry as well-positioned as we are around the world today, it's time to be looking at growth in a different way because valuations are different than they've ever been in a long time. There are aspects of geographies that are growing like they never have and as we talked about in our strategy announcement, we will talk in great detail with all of you next month. We intend to be a leader in every way, everywhere in the world. And that means China and India and elsewhere and a leader in a very profitable way as we also have talked about.

So I would say that the use of cash, priority number one being to grow the business has not changed and we may have more opportunities based on one just the playing field that is out there today. And two, some valuations. So we are looking in every corner and all of our businesses are concentrating on that today, where we can do that.

Secondly, our pension plans; thirdly, our capital; and then finally, dividends and share buybacks, which has been our priority for a long time. Strength of the balance sheet is improving. Mike talked about the debt to capital ratio. We have a hard and fast -- I'm going to say -- rule. Certainly it's a goal, but it's going to be a rule to maintain that mid A credit rating with the agencies. We think we are pretty close to that today. I don't know.

I don't have any intention of changing it that much, but we certainly intend to stay mid-A for as long as we can. Even in the downturn last year we did pretty well with that. And as cash generation comes back, we would intend to stay in that range. I think I got all your questions, Steve.

I think he did. That was very helpful. We'll see you next month.

Mark Koznarek.

Cleveland Research. I had a question on the parts business and wondering if you can quantify a bit more the extent of increase that you are experiencing in parts given that gives us some visibility into activity of the current machine base and might provide some help into what retail sales activity might be as we go through the remainder of the year.

Yes, this is Mike. Just a couple of comments. Obviously, we don't disclose that separately. So I am not going to give you a number, but what I will try and do is add a little color. Parts activity has been very good this year. It's actually improved in every single region. Of course as you might expect, the developing world regions have outpaced the US and Europe. It has been very good. If we look at the outlook to outlook change, you know the last outlook to this outlook, the parts number went up again, but so did machines. So did engines. It was fairly across the board.

I will say that the parts increase has been -- I would say has been very good, but then again, we were coming out of a pretty deep hole last year.

Let me pile on a little bit, Mike. And I am going to whet I hope your appetite for our meeting next month again here. We set up the parts business, as you know, and our organization structure and strategy as a very big growth opportunity for this Company. We will talk about it in detail, but what we see down the road is a real positive both sales and profit opportunity over the next five years.

We've concentrated our resources. We've put it in one business. We're going to monitor it around the world, work with our dealers and customers to get after parts and products -- parts and aftermarket product support like we haven't in a long time. It's a key piece for us. Again, operating off the fill population we have out there, which is more than double everybody else.

So great opportunity coming and I hope when you leave our meeting next month, you will see where we are with that and I think you will really like it.

Okay, then just one follow up on the new outlook. Is there any expectation of a pre-buy based on the Tier 4 price increase built into the outlook?

Mark, this is Ed. I would say that we in our outlook, we have got very limited pre-buy in there for Tier 4. I think there is a couple factors related to that. One is back to some of the issues we talked to earlier in terms of availability and where we are at today.

And I think the second one is, that's primarily going into the developed parts of the world, where the outlook is a little more uncertain from a customer perspective and the amount of work they are going to have in 2011. So I'd say the outlook has a very limited amount of pre-buy in it.

Okay, thank you.

Andrew Obin.

Yes, hi, it's Andrew Obin with B of A Merrill Lynch. Question on pricing and I apologize if I missed your answer, but the guidance for the year seems to state that the pricing is going to be over 1%. If I look at where we are for the first half of the year, it implies that pricing will deteriorate quite meaningfully into the second half of the year. Are we simply being conservative or is there something going on?

Andrew, this is Mike. A couple of things. One, the price plan for the full year was not aggressive. I mean, when we came into the year we were expecting overall something less than 1%. We've known all year long that when you look year-over-year, it was going to look weaker in the second half because we did selectively do some midyear increases last year particularly on big engines. So I think if you look year-over-year, it will probably look a little bit weaker, whereas it probably won't be quite as weak if you look at it sequentially.

That said, we are out there actively seeking volume. We want to be the leader everywhere we do business. We had a modest price plan this year and I think if you look at the year-over-year change, our expectation in the outlook is that the second half will be less than the first half. So yes.

And just the comment you made about more aggressive or being aggressive on growing market share, has there been a shift in focus where the Company is more focused on '10 versus the previous cycle? Or is it just where we are on -- how should I be thinking about pricing in this cycle versus the previous cycle and Cat's willingness to take the lead on price increases?

I will just start out on this. And I think if you look at -- I'm going to go back to 2009 for a minute. The industry had -- came into 2009 on the back of high material costs. Prices went up the beginning of '09 and for the most part the industry had pretty good pricing discipline. There was not much business to be had. Volumes were down a lot and frankly there wasn't a lot of business to go after, if you will.

Now I think our philosophy for 2010 has been there's going to be more business out there, volume is going up and end-user demand is better and we want as much of that as we can get. So to some degree I think, yes, we're taking a pretty active and as aggressive as we can be approach to getting more volume. Whether or not there's a giant philosophical change between now and five or eight years ago, I will let that one go.

I will too. But I will say that as we were capacity constrained the last five years, we couldn't do all the things we wanted to do. Today we've got capacity. We're going after market share and we are going to continue to do that and juggle all the priorities as we go forward. But remember, market share drives that aftermarket and that aftermarket drives many good things around here. So we get that balance right, we all win and that is what we are after.

Andrew, this is Ed. I think you've also got to think through the other levers coming out of a downturn that we have to pull. Dealer strength is a key one and if you think about the tough times that kind of machinery-only dealers had throughout '09 versus the more diversified portfolio and services that a Cat dealer has, I think in relative position we come out of '09 into '10 from a dealer perspective very strong.

In addition to that, if you look at financing, capital markets in some cases for our customers continue to be a bit difficult and in the strength and positioning of Cat finance is another lever we have to pull that we think can assist in terms of our desire to grow the market.

We are at the end of our time and need to wrap up the call. I just want to say thank you very much, everybody, for joining us today.

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.