開拓重工 (CAT) 2010 Q3 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Caterpillar third-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 and good morning and welcome, everyone, to Caterpillar's third-quarter earnings call. I am Mike DeWalt, the Director of Investor Relations. I am pleased to have our CEO, Doug Oberhelman and our Group President and CFO, Ed Rapp, with me on the call today.

Just a reminder, 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 Investors section of our Cat.com website and it will be in the section labeled 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 filed with the SEC back on February 19 and our Form 10-Q filed with the SEC on May 3 of 2010. And it is also in our forward-looking statements language contained in today's release.

Okay, earlier this morning, we reported results for the third quarter. We increased our full year outlook for 2010 and we provided a preliminary outlook for 2011 sales and revenues. To start this morning, I will summarize the quarter and the outlook. Then Doug and Ed and I will take your questions.

Let's start with the third-quarter top line. Sales and revenues were $11.134 billion and that is up from $7.298 billion in the third quarter of 2009 and that is an increase of about $3.8 billion, or 53%. Now that includes about two months of sales at Electro-Motive Diesel and we will be referring to that as EMD here today, which we acquired in the third quarter and added about $216 million in sales to the quarter. Excluding EMD, sales and revenues were up about 50%.

The increase in sales was primarily a result of improving end-user demand and the absence of 2009's dealer machine inventory reductions and I will cover both of those this morning.

First, in terms of end-user demand, good economic growth in the developing world has been positive for sales in Asia, Latin America, the CIS and Africa/Middle East. In addition, the growth in those developing countries has improved demand for commodities and that has been good and positive for our mining business worldwide.

In addition, we are seeing growth in the developed countries of North America and Europe, albeit off depressed levels from 2009. With weak economic recoveries in the US and Europe and with depressed construction activity, I know it is tough to understand why sales of Cat machines are up so much. And new machine sales in the United States are a good example that illustrates the point.

Here is what is happening -

First, sales to users peaked in 2006, then declined in 2007, declined again in 2008 and then declined even more significantly in 2009. From the peak quarter in 2006 to the bottom in late 2009, dealer machine sales to end users in the US declined nearly 80%.

Today, we are seeing improvement from those low levels as customers are buying some machines to slow the aging of their fleets. In addition, dealers have increased machine purchases for rental fleets. That said, rental fleet size hasn't improved much. The average age of dealer rental fleets hasn't improved and it remains elevated. And rental inventory utilization rates have increased and are now higher than in 2007, 2008 and 2009.

In addition to better end-user demand, dealer inventory changes also affected the sales comparison with the third quarter of 2009. Last year, dealers reduced new machine inventories by about $1.1 billion in the third quarter. So far in 2010, dealers have held machine inventories relatively flat. They were actually up about $100 million so far this year and that was in the third quarter.

Speaking of inventory levels though, we frequently hear comments and get questions about dealer restocking. And just to be clear, other than the very small increase this quarter, that has not happened. Overall, dealer machine inventories are within a few percent of the year-end 2009 levels.

Dealer machine inventories in terms of months of supply continue to decline and are below historic averages. That is a good thing and 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, dealer inventories are very tight in many parts of the world and dealers will probably need to add some inventory next year.

In summary on the top-line, sales and revenues were up in all regions. North America was up 55%; Latin America, 95%; Europe/Africa/Middle East, 31%; and Asia Pacific was up 51%.

Okay, let's turn to profit. Profit in the quarter was $792 million. That was a 96% increase from $404 million in the third quarter of 2009. Profit per share was $1.22 and that was up $0.58 from the $0.64 a share we earned in the third quarter of last year. Consolidated operating profit rose from $277 million in the third quarter of last year to $1.187 billion in the third quarter of 2010 and that is a 329% increase in operating profit. As a percent of sales, and this is on a consolidated basis, operating profit was 10.7% and that was up from 3.8% a year ago. In addition, Machinery and Engines gross margin continued to improve and was 25.8% in the quarter.

The increase in sales volume was the most significant factor driving the improvement in profit. That said, that positive impact was mitigated somewhat by a very negative sales mix compared with the third quarter of 2009.

In addition to the higher volume, price realization improved and was favorable to profit $262 million. Manufacturing costs were favorable by $142 million and if you exclude the $120 million of LIFO inventory decrement benefits that we realized in the third quarter of last year, the cost improvement was $262 million. And that was a result of better labor and overhead efficiency, lower warranty costs and favorable material costs.

Just one point on the material costs. While we have been favorable compared with 2009 in every quarter this year, the degree to which material costs were favorable has been declining as material costs have been trending up.

Okay, partially offsetting those positive items in terms of profit, income taxes were very unfavorable. In the third quarter of 2009, income taxes actually benefited profit $139 million, of which $129 million was related to the settlement of tax returns for years prior to 2009.

The third quarter of 2010 reflects tax expense at an estimated annual effective tax rate of 28%, less $14 million from a year-to-date adjustment and that was related to moving the estimated rate from 29% down to 28% in the quarter. SG&A and R&D costs were also higher and that was primarily due to provisions for employee incentive compensation and increased R&D spending, primarily related to US and European emissions regulations that apply beginning in 2011.

Overall, currency impacts were also negative. The impact on currency in operating profit was a negative $46 million and currency was the principal reason that "other income," which is below the operating profit line, declined $65 million from the third quarter of 2009.

Before I move on to the full-year outlook, I would like to cover employee incentive compensation in just a little more depth. As you may be aware, a portion of the compensation for management support and some of our hourly employees is at risk and it varies based on the financial performance of the Company. Given the economic environment in 2009, the profit target related to our short-term incentive plan was aggressive and it did not trigger. As a result, there was no incentive-related expense in 2009.

Financial performance in 2010 has been much better and based on the newly-revised and higher profit outlook for 2010, we expect incentive compensation to be higher. Our practice is to accrue the expense as we go through the year based on our full-year expectations. That means when we change the outlook, we have a year-to-date catch-up in the provision. And that happened this quarter.

The outlook we provided with our second-quarter release included $600 million in incentive compensation. $300 million of that was in the first half and we had an expectation of about $150 million in each of the third and fourth quarters.

Because we raised the outlook in the third quarter, the full-year estimate for incentive compensation rose from $600 million to $700 million, an increase of $100 million from our prior estimate. Since we are three quarters of the way through the year, we provided for three quarters of the change in the full-year estimate in the third quarter. As a result, we provided for about $225 million of incentive compensation in the quarter compared with the $150 million that was in our previous outlook.

The punch line here is incentive compensation expense was probably higher than you would have expected. It was higher than our previous outlook and that is because we took guidance up and needed to reflect the change in the third quarter.

One last thing before I move onto the outlook and that is incremental profit. For Machines and Engines, sales were up $3.869 billion and operating profit was up $900 million. That is a 23% incremental margin rate. However, our results in the third quarter of 2010 included the acquisition of EMD and the third quarter last year included $120 million of LIFO decrement benefits. Excluding those two items, incremental profit was about 27% and that, by the way, does include the negative impacts of product mix, the $225 million in incentive compensation and the negative currency impacts. So, all in all, it was a pretty good quarter operationally.

Okay, let's move onto the outlook. This morning, we raised 2010 guidance for sales and revenues and for profit. Our previous outlook range for sales and revenues was $39 billion to $42 billion with a midpoint of $40.5 billion. The outlook we have provided this morning is a range of $41 billion to $42 billion with a midpoint of $41.5 billion. So at the midpoint of the range, sales and revenues are up about $1 billion for the year and about half of that improvement is related to the acquisition of EMD, again, which we completed in August.

We also raised the profit outlook this morning. We are expecting profit per share in the range of $3.80 to $4.00 a share with a midpoint of $3.90. That is up from the previous outlook range of $3.15 to $3.85 with a $3.50 midpoint. While EMD is having a positive impact on sales, for the remainder of this year, it is not expected to have much impact on profit.

In addition to the 2010 outlook, we provided a preliminary top-line look at 2011 and we expect sales and revenues to approach $50 billion next year. That would reflect our current run rate for the second half of the year, which is about $46 billion, plus the full-year impact of the acquisition of EMD, continued improvement in end-user demand, including some additions to dealer rental fleets, some dealer machine inventory additions and modest price realization.

This morning, we did not provide profit guidance and we don't plan to do that in the call today. As usual, we are in the part of our planning process where we start with sales and we are working on our profit plan for next year. That has been the case for the last couple of years and that is where we are this year.

Okay, that's the outlook. In summary, the third quarter reflected continuing improvement in our financial results. We raised the sales and profit outlook for 2010 and provided a first look at 2011 sales and revenues that approaches $50 billion. With that, we are ready to take your questions.

(Operator Instructions). Jamie Cook.

Good morning and congratulations. Two questions. One, when I think about your 2011 top-line guidance of $50 billion, I guess I am struggling with that number because, if we take the back half of the year and you say you are annualizing $46 billion in revenues and imply sort of 8% top-line growth for 2011, why so conservative, especially with the North America market down so much? So if you could give me some of your assumptions there.

And then is there any reason to believe that, for 2011, incrementals shouldn't be at least within your targeted range of 25% to 27% with some of the headwinds you laid out in the press release?

Jamie, this is Mike. I will start and then I will let Ed and Doug chime in if they would like to. I will just start with your second question first. We are going to really try -- since we didn't provide profit guidance this morning, we are really in the process right now of working on our plans. So we are going to try to avoid giving profit guidance here this morning for next year.

In terms of the first part of your question, if you look at the sales increase next year, we still have a pretty weak recovery going in the developed world. I mean it is improving, but those percentage increases are off pretty low levels.

Also, I would say most of the increase next year is more heavily skewed to Machines. Engines have been a little bit later cycle. Oil and gas had been good, but it has slowed down. You can see our retail statistics for today. Oil and gas has flattened out. The Engine increase over the last few months, even versus last year, is up 5%. Marine is continuing on the downside. So I think most of the increase next year is going to be probably related to Machines and again, we have modest economic growth built in to the US.

Okay. But Mike, I know you don't want to give incremental margins, but is there anything -- I mean we can make our own assumptions on pension. On R&D or even on product mix, is there anything unusual that we should be aware of as we think about 2011?

Probably the only thing that you can glean from what we have said already is that it will probably be a bit more Machine-centric than Engine-centric and you can see that in the way the retail numbers are shaping up now.

Okay, thanks. I will get back in queue.

Robert McCarthy.

Thank you. It's Robert W. Baird. Morning, guys. I am also going to do, in a sense, the same thing. I want to try and dissect the $50 billion number a little bit. You talked about $46 billion as a run rate. We pick up a half a billion dollars at EMD. By annualizing a couple points on price would be $1 billion. That leaves me with, if I am doing my math correctly, $2.5 billion or less. What kind of dealer inventory build are you assuming in your outlook? I assume you wouldn't mention it if it wasn't at least a half a billion dollars.

I will give you a comment and a correction. We did say in the release that we expected price realization less than 1% next year.

Oh, I am sorry.

It was a little bit high. I know it is a long release to get through. And on dealer inventory, it is a little bit, at this point, tough to be exactly precise. We are ramping up lane inventory. We are a little bit out of the historic patterns now that we are using the lane inventory. We added the lane inventory in the quarter actually by about 50%. Performance out of lane improved.

So I think a little more time needs to pass before we are actually ready to talk about a forecast for dealer inventory next year because we are in a little bit of uncharted territory. Again, that said, it did go up about $100 million in the third quarter. The months of supply is pretty weak. So I think there is no doubt that it is going to go up; it is just I think to what degree.

Thanks, Mike. And then my other question I think probably is best directed to Mr. Oberhelman. While we understand the drags on incremental profitability or contribution margins, and you guys have been very transparent in predicting what they would be, can you talk about how satisfied you are specifically with the 22% number on the Machinery side and the progress overall, especially in the context of your recent remarks on supply chain and how you wish you were a little further advanced there?

Yes, it is Doug Oberhelman here and you are right, we are in the early stages, I think, of the maturation of the supply chain efficiency. We have restructured, reorganized internally in recent months and I am pretty happy with the way that is off to a start. I think that is before us. You have seen some improvement in variable labor and efficiency that we have talked about in the past. But overall, we ought to be seeing incremental margins as we have seen so far this year. And I am, on one hand, happy we have seen those and, on the other hand, my challenge to the team is to deliver them in the future.

Okay, thank you, Doug.

Barry Bannister.

Hi. It's Barry Bannister at Stifel Nicolaus. I apologize for maybe being a little accounting-challenged here, but if I look at the reduction of equity of $1.8 billion on the pension change, and I consider that your US/non-US and OPEB charges were about $1.120 billion in '10 and $1.243 billion in '09, that is an average savings of about $1.2 billion. So will we get back in cash what we are losing in book value this year on a fairly quick payback?

Barry, I apologize, but I did not follow all that.

Okay. Well, I will probably end up following up with you later, but can you talk about the savings from going from a defined benefit to a defined contribution on an annual run rate starting in 2011 and beyond?

Okay. Hey, Barry, this is Ed. What I would -- in terms of the move from defined benefit to defined contribution, that is going to play out over a number of years as we phase out of it. I wouldn't look at it as, if you would, a savings on a year-over-year basis as you do your numbers.

Okay. And then lastly, I reread the transcript from the August analyst meeting and Cat Financial was never mentioned, even though it was about 18% of the last dozen years' profit and about 16% year-to-date. Does Cat Financial play a role in your multi-year plan?

Cat Financial plays a huge role in our multiyear plans. I mean if you think back, Barry, to 2009, which was the all-time stress test in terms of financial markets, I think you have seen from the numbers Cat Financial performed very well through that downturn. It is tied very much to our business model, being able to go to customers and provide them not only great products, but great services. Cat Financial continues to not only grow in what historically has been the developed parts of the world, but is playing a key role in the developing markets as well such as China, Russia and other parts of the world that are growing. So Cat Financial remains a central part of our overall strategy.

And is there a risk, before I get off, that you are expanding and becoming the largest lender in places like China, yet you have never had a downturn to deal with and that the finance company is going to overreach?

No, I think it is our job to manage that risk and if there was ever going to be a stress test to do your overreaching on, it would have been '09 and I think if you look at how well we performed during that period of time, we managed it well. We are taking the very same principles that we applied in other parts of the world as we have expanded with a captive finance company and used them there. I mean we are financing product that we know. We are working with dealers that we partner with, iron that we understand, we know how to redistribute. We understand the residual values. It is a business model that we have exercised around the world and we stay very close to it.

Thanks, Barry.

Alexander Blanton.

Thank you. It's Ingalls & Snyder. I would like to just ask a question about your Caterpillar Production System. It clearly is getting great results because if you look at the gross margin line and look at the incremental gross margin year-over-year, with the LIFO in last year it was 36%, which is in the middle of your historic range of 30% to 40%.

But if you take out the LIFO gain last year, it was a 39% incremental margin year-over-year on the gross margin line, and that is with the very negative mix change that you mentioned. So clearly, there are great things going on in the manufacturing. Could you just elaborate on what some of those are?

Yes, this is Mike. We only have 30 minutes left for this call, so I'll try to be brief with that. Cat Production System is pervasive throughout the factory. It is all about building to schedule, for example, and our ability to actually build to our schedule has just improved dramatically.

I saw statistics over the last couple of days where our performance has gone -- the amount that we have missed, the performance has gone down by about three-fourths in terms of missing builds. So working with the supply chain, all the discipline around standard work, has helped a lot in meeting production schedules and that helps efficiency.

Lane strategy has helped as well. We are producing -- a higher percentage of what we are doing -- are more standard products, which helps efficiency. So I think it is not just one thing. It is a combination of all the work on the supply chain, the standard work in the factory, lane strategy, all kind of working together to simplify. I would also be remiss if I didn't say a healthy increase in volume helps as well.

Well, those are interesting metrics because it is like inventory reduction. In order to get an inventory reduction or in order to get a better improvement on deliveries or cycle time you mentioned, you have to reduce the costs, correct? I mean you haven't really told us where those cost reductions are. You just told us about the results, which is good. Okay, thank you.

Just let me add this from a little different take - Doug Oberhelman here. If you look at our forecast for next year approaching 50, coming off the bottom of 31 two years ago, and we have done that increase over -- call it a two-year period arguably, but call it two. The last time we did that it was four years, more or less, and we are doing it this time with better quality, better pull through, almost every metric inside our factory.

So that is kind of the big picture that I look at in terms of are we doing it better than we ever have in the past? We certainly are. And then you see things like you mentioned there, Alex, in some of the numbers with gross margin, etc. And we also like the internal metrics around committed shipped dates, around our quality numbers and so on. So that is coming our way and the CPS dividend is starting to pay and be evident.

And did these improved manufacturing results have to do with your decision to build factories in the United States now instead of abroad? Was that a factor in being able to get your costs down to the point where you can create the jobs here rather than abroad? Is that correct?

Hey, Alex, this is Ed. Our manufacturing strategy is really driven by serving on the high-volume product in kind of those three hemispheric zones like we have always done historically. We are seeing great traction on CPS in the US. We are seeing great traction on CPS in Europe, great traction on CPS in Asia. So our manufacturing strategy is really more driven by serving local markets with local manufacturing.

Okay, thank you.

Ann Duignan.

Hi. Good morning, JPMorgan. Could you talk a little bit about -- you were very clear about laying out some of the headwinds that you are facing going into 2011. Could you talk about any tailwinds that might be out there going into 2011, for example, mix or maybe one region being stronger or Engines are recovering? Could you just give us any examples of where there might be a tailwind?

Yes, I will just talk about some of the things that we have already talked about. I mean we did put in this morning's release that we do expect some, although modest, price increase next year. The sales volume is pretty good. Mix though, as I kind of talked about a little earlier, the growth in sales has been more centered around Machines than Engines.

So I think from a mix standpoint, you would have to say that does not look very positive for next year. The flipside of that, though, is Machine margins have been improving a lot. They are well below where we were in the last cycle, so I think there is certainly a lot more room for improvement there.

Beyond that, Ann, we have not talked yet about efficiency or cost reduction or material cost. That is not because we are trying to send a negative signal. We are just still in the process of working all those resource plans.

So, volume is a wonderful thing really. Is that the key takeaway?

Yes, that is probably a good takeaway. And I think the other one, Ann, that Mike mentioned in his opening comments is just what has happened -- in the US, we have been through an extended downturn. Fleets are aging, rental fleets are down versus historical numbers and that is another thing, as Mike mentioned earlier, that should bode us well going forward.

Okay, and that leads me to my follow-up question. Could you just talk a little bit about how much of your revenues to dealers, particularly on the rental side, are even end users that are coming with trade-ins and therefore, you now maybe have a build-up of used equipment that has to be liquidated at some point?

Ann, on that one, what I would say is, if you look at the US in particular and the extended downturn dating back to the first quarter '06, I would say the used equipment fleets had been run down during that period of time because for most of that duration, markets in the emerging markets were actually fairly good and so you had quite a bit of used inventory that went abroad. So I would say in addition to the rundown of rental fleets, you have also seen a decline in used fleets as well. So we don't see anything in terms of really a build-up of used equipment.

Yes, on rental, I kind of read off a few of these stats earlier, but rental utilization is up. Dealer fleet size for rental is still very, very low. I mean if you look at a graph of it, it looks like you can take a sled down the hill and then just take a little tiny jump off the bottom. And ages have gone up dramatically over the past three or four years and remained elevated. So I think there is still a lot of work to do with rental fleets.

Okay, I will leave it there and get back in line. Thanks, guys.

Jerry Revich.

Hi, good morning. It's Goldman Sachs. Mike, you had excellent Machine pricing this quarter, particularly in North America. Can you step us through the drivers and perhaps touch on why price increases have been lower in Engines where capacity utilization in most of your markets is tighter?

Well, I think one of the things with Engines that has really changed in price realization really from the first half of the year is last year, in the middle of the year, particularly on the bigger engines, despite the fact that it was a tough year, we did a midyear price increase. So we have lapped that now. So it is in the "base period" comparison, if you will. So the Machine price realization doesn't -- isn't maybe as high as it was earlier.

In terms of Machine price realization, I think honestly we have been pleasantly surprised as we have gone through the year. As you know, we started out the year with an outlook of Machine -- or of price realization being up less than a point. Then at the end of the second quarter, we said about 1% and it has been more than that all year long.

Effectively, the merchandising programs required to sell the product, I mean of all kinds, have been less than we thought. We have not taken any price increases per se. Generally, we do that most of the time just in January. Every once in a while, we do a mid-year. We didn't do that this year. So I think just in general we have been, I would say, positively surprised on price all year long.

Thanks, Mike. And Doug, thinking about cycle-over-cycle dealer inventories, the changes because of the lane strategy, I guess would we be off the mark if we thought of the 40% ship out of lane one as translating to about a 30% reduction in dealer inventories versus prior cycle? Is that the type of payout we should be thinking about?

Jerry, I am going to jump in on that. We are new at lane this year really and I think that we need to get a little bit more history under our belt. And I think with dealer inventory, that will probably play out over the next year or so as the program becomes more mature. So, probably about a year from now would be a better time to talk about that.

And Mike, just a quick follow-up. It looks like your dealer inventories are down about 40% from '07 when you had very similar sales levels to which you are going to have for Machines in 2010. I guess just trying to understand the magnitude of inventory restock we should be thinking about, any color you can provide there would be helpful.

Well, I guess I would say this. If you look at where we came off of '08, dealer inventory declined almost, not quite, let's say close to 50% from the end of '08 to the end of '09. Actually the high 40%'s. And it has stayed pretty flat this year. That was a $3.5 billion inventory decline between '08 and '09.

I can tell you that our approaching $50 billion next year does not have us back to '08 volume levels for Machine units. Remember, it has things like EMD in it, so it is not the same. Also, if you go back to the 51 that we had in '08, we only had Cat Japan in for a quarter that year. So kind of the real underlying number with the companies that we have now was higher.

So we are not back to that '08 level yet. We don't expect in this preliminary outlook this morning to be back to that '08 Machine level in 2011. So we have not given any numbers on dealer inventory, but I would certainly think that we are not going to be back to the '08 volumes, plus we have lane. So we are not looking for that magnitude of an increase.

And Mike, I think the point that we can emphasize here -- year over year, we are talking about an 84% growth in Machinery sales and we are talking about virtually flat dealer inventory. And that means that through working with our dealers, the lane strategy, that we have been able to flow that increase directly to end-user demand instead of having it sit in inventory around the world. We are going to continue to partner with our dealers on how we do that going forward.

Thank you.

Robert Wertheimer.

It's Morgan Stanley. Good morning, everybody. My first question is on capacity and your comfort level with getting to next year's revenue guided range at the current capacity levels you have got. I mean I guess last cycle, as it worked out, you ended up being short capacity and then tried to add in '06 to '08 and I think you commented at the time it is tough to order a machine tool with a long lead time to get it in. And so you ended up with some production issues that were capacity-related.

And I think, Doug, when you took over the reins, you have ended up announcing a lot of capacity and I kind of wondered how much of that was just pure growth above that $50 billion level versus you weren't completely comfortable with the capacity you had put in from '06 to '08. So that is my first question, whether you feel like you can get to the $50 billion with what you have got?

I will start with that one. Capacity, unfortunately, is not fungible. It kind of depends upon what products you are selling. If you look at big engines, for example, right now out of Lafayette, they have improved a lot since the depth of the recession. But as we talked about earlier, and if you look in today's retail sales, oil and gas has flattened out. So, for products like that, we probably have a lot more capacity than we would need for next year.

For mining product, on the other hand, we will be capacity-constrained probably throughout 2011. I mean business there is very good. To the point that you made earlier, we are investing in capacity increases. We talked about that for mining trucks in India and mining trucks in the US. We talked about investing in shovels, although that is not, from a sales standpoint, next year.

So I think the answer is we wouldn't have put out guidance for next year approaching $50 billion -- in sort of a summary answer -- we wouldn't have said that if we didn't think we could make it, number one, and number two, how much capacity we have and how much more we can do, I think it really depends a lot on what we are actually selling. There are a lot of products right now where volumes are still very depressed. If you look at compact product, very small stuff, it has improved, but still way off the peak. So we have a lot of capacity there. So, it just really depends a lot on the product. I know that sounds like a bit of a non-answer, but it is just not -- we are not like a refinery; it is not uniform capacity.

All right. Let me see if I can ask it in a different way and ask an employment question. So is the de-bottlenecking you have gotten from adding some of the machine tools and adding some of the capacity -- I guess I believe you can get to the $50 billion. I guess I wonder if you can get to it smoothly without the kind of strain you had in '07 and '08 and whether the de-bottlenecking more than offsets the kind of increased depreciation or increased costs.

And the second would be just in terms of people and capacity, I think your employment is around 10% down from peak. Is that enough to get you back to where you were given the improvements to the production system? Thank you.

Just one more comment on that. In terms of going from the middle of this year's guidance, $41.5 billion, to something approaching $50 billion, the point that we made earlier -- we are already -- our second half of the year is operating at around $46 billion. We have announced capacity increases that should help next year. We talked about being able to produce more excavators in China, more mining product, for example. So, some of the things that we did announce earlier this year should help next year and we are currently doing better than the full-year average. So as was brought up earlier, the increase isn't maybe as dramatic as looking at $50 billion versus $41.5 billion.

In terms of employment, even there, and again, I'm sorry if this sounds like a non-answer, but when you are looking at the production capability of employment, you have got to look at not only our full times -- we have a very large, flexible workforce that we had actually going into the last downturn, which really allowed us to shed costs quickly. So you really have to add that to the employment number. There are also things like overtime that impact your kind of productive capacity out of people. So it, in and of itself, is also not a perfect indicator.

What I would tell you is, and we have said this a couple of times today, our labor productivity has improved a lot this year and that has been very good. We expected that from CPS and frankly, we would expect that -- we would expect improvements to continue.

Thanks.

David Raso.

Yes, ISI. Good morning. The question relates to '11 mining and also oil and gas. You mentioned the capacity-constraint principle at Decatur more than anywhere else, but thinking about the comment in the release about a 25% increase you have seen sequentially 2Q to 3Q, is there further, the way it exists now before India ramps up and so forth, do we have much increase left -- current capacity -- to increase sequentially? And if not, where is the current level of mining if we run this out through '11 on a year-over-year basis, '11 versus '10?

Yes, I will try and answer as much of that as I can with what we are public with. Next year, we have invested and are investing in both Decatur and India. We do expect production levels for mining to be up next year. I would say that between the third and the fourth quarter, we are kind of running up against it, so I don't think you will see much dramatic change in mining between Q3 and Q4. If you look at our total top-line, excluding EMD -- in total top-line, not mining-specific -- but it is not all that dissimilar than the third quarter. I would say mining probably fits in that boat.

Just so I am clear on the last comment, Mike. If I kept mining production today, run it out the next four or five quarters, what is that year-over-year increase in mining, '11 versus '10?

Yes, we didn't give that. All I was really trying to say is I think the fourth quarter is probably not going to be dramatically different than the third quarter, but based on the improvements that we have put in place, the investment that we are making, we would expect that production levels as we go through next year would improve.

Okay. And on Solar, just want to get a little update on how you are seeing that order book develop for '11.

Yes, we weren't specific at all with that in the release, but what I would call you back to is, this year, for I think all of us as we got into 2010 surprised a little on the upside. Solar took in some big orders very early in the year that helped them and those were from a couple of customers. Those they were able to do because they had capacity.

Remember, they have been at capacity on the back of a very strong oil and gas business for the last four years and the last three have been records. So I wouldn't look for more increases in Solar or at least I wouldn't -- I'm being careful -- trying to be careful here because we haven't provided specific guidance on it. But yes, I wouldn't look for a big change in Solar up next year.

Well, the customer advances are now 21% off the trough a few quarters ago back in 4Q '09. Quite often that is Solar. So just trying to square up your comment of not expecting much growth in Solar in '11 versus customer advances. Can you touch on that?

Customer advances would not just be Solar, but they are certainly a big piece of that. And again, we didn't provide any specific guidance this morning around Solar, so I am going to not push that one any further.

All right. Then last, the geographic mix of where you see dealers need to increase their inventory. Would you highlight any particular geographies where the dealers would like to and you think you will be able to serve it?

Well, the second part of your question is, in some ways, probably the more important part, as we have been ramping up production. Where we have seen a little bit of inventory increase this year has been in Latin America and Asia, but again, it has been pretty small even there. And again, I think it is related to production, it is related to lane strategy. I think probably, truth be told, next year, if it plays out the way we think, dealers in all regions will probably want to add more. I think if you look at the historic averages, the months of supply are below in all regions today. So I think it will be fairly pervasive.

Okay, thank you very much.

Meredith Taylor.

Hi, good morning. It's Barclays Capital. I just wanted to, I guess, build off the last couple of questions on mining and Solar. Mike, you have addressed the mix looking ahead to 2011 between Machinery and Engines. Can you talk a little bit about the mix within Machinery and Engines?

I will talk a little bit in broad trends, kind of things that we have already talked about. Electric power and industrial are probably doing the best of the four Engine end markets. And you can see from the retail sales today, marine is very late cycle and that is going down. And that will probably be a negative next year.

Oil and gas is actually pretty flat. If memory serves me, I think it was around 1% over the last few months. So I think in Engines, the trend that you are seeing is relative strength in electric power, industrial, late-cycle weakness in marine, particularly the really big oceangoing kind of marine and a more neutral oil and gas business. That is the trends that you are seeing right now.

In terms of Machines, again, we didn't provide a lot of detail. I think probably most types of Machines will be up. Next year, the parts of the business that are probably the least capacity-constrained and the lowest in terms of how they are doing versus the last cycle would be the smaller equipment. So I think, to some degree, there is probably the biggest scope for improvement there. They were very depressed. As you can see in a lot of the residential and commercial construction markets, there is not a lot of business there right now.

I know I wasn't very helpful probably with that answer, but, again, we have not provided a lot of detail on the breakdown of 2011. It is a preliminary guidance. Again, we are not trying to be overly cagey with it. We are still a few months from next year. We are still working on our plan and we don't normally provide a lot of detail at this time.

Okay, but it sounds like within Machinery at least, you are looking for somewhat of an adverse mix, putting those pieces together.

Well, you can use your own judgment.

Okay. Just as a follow-up, could you address lead times for products both coming out of lane one, how that has changed over the last couple of months and then products not coming out of lane one?

This is Ed. Let me cover that. I mean in lane one, what we have seen -- we kind of track service within 10 days and we have seen that jump about 20 points over the last quarter. And so we are seeing improved service out of lane one. Corporately, in percent of sales, about 25% coming out. In terms of lane one inventory, we have doubled it since the beginning of the year and we are looking for additional lane one inventory build as we get into the fourth quarter.

And it is really focused on what we talked about earlier. We are looking at -- you saw across US, Europe, Latin America, Asia pretty strong year-over-year growth in Machinery sales and through using lane and working closely with our dealers, we have been able to flow that product through to end users instead of some of the things we had back in that '07 and '08 timeframe when a lot of it flowed to inventory.

So, I think the lane is continuing to mature. As Mike said, we are relatively new at it, but I think some of the results are starting to bear fruit.

Okay, thanks.

Eli Lustgarten.

Good morning. It's nice to see good results with solid foundation underneath it. We don't have to worry about it for a change. Can we talk a little bit about profitability, particularly it is not hard to understand why Machine profitability will step up at this point with the higher volume, but can Solar profitability, which went up in the quarter, can Solar profitability hold these levels and Engine profitability hold these levels with the more sluggish kind of environment here, particularly not only this year, but into next year or can we still improve operating profitability?

Yes, and I'm probably going to disappoint you on this answer as well, but again, we've not talked about profitability much at all related to next year. Again, we are still --.

I'd even settle for fourth quarter at this point too.

Well, if you look at what is implied for the fourth quarter, we have -- in the $3.90 we're $2.68 year to date. So that would imply $1.22 or similar profit in the fourth quarter to what we had in the third quarter. And again, we have never really provided that separate guidance by product category. So I will let you estimate what's going to happen there in little more detail.

All right. Could we talk a little bit about interim Tier 4 introductions? You haven't talked much about it. I guess the pricing is going to be up more like 4%, but there is not a lot of product being introduced. Can you talk about the impact of what can we expect to see over the next year and the year after? What to expect with this emissions change beginning to flow and even though I guess it's not -- when most of the sales are outside the US, it is not all that big. Can you give me some indication of what we are going to affect and costs?

Yes, yes. For people listening on the call too, I will make a comment. We do have a Q&A in the back of our release that talks a little bit more about Tier 4. But essentially, it is in the US Tier 4, Europe stage 3B. It is for product, for the most part, in those regions above 165 horsepower this year, below 165 horsepower in 2012. So you are right. A lot of the product, particularly the smaller product, is not going to be affected this year; it will be next year.

From an Engines standpoint, it would affect also product in those kind of size ranges in the US and Europe except for emergency power or backup power. And emergency and backup power is most of what we do.

So you are right to say that a lot of the product will be affected in the year and the larger product in the US and Europe, but you won't see it all change on January 1. You have the ability to take some flex credits and delay some of the introductions. So I think it is probably going to be a little bit less of a giant January 1 shotgun start. It will be more of a phase-in I think as you go through the year.

And to your point, it doesn't affect all our service-related businesses. It doesn't affect most of our Engine business. It doesn't affect small machines, it doesn't affect Latin America or Asia or Middle East or the CIS. So it is probably a bit more of a muted impact on the total Company than most people might think.

Eli, the only thing I would add to that is the other thing we haven't really seen much of is any significant type of pre-buy. Some of that is driven by the fact that availability has moved out as we have seen the strong increase in demand. I think the other factor that is really out there is a certain degree -- especially in the US -- of uncertainty amongst our customer base. We still don't have a highway bill. We still have got uncertainty in terms of where we are going with tax legislation and as you know, a lot of these are small businesses. And so we really haven't had any of what I would consider noticeable pre-buy on Tier 4 either.

All right, thank you.

Henry Kirn.

Thank you, it's UBS. Good morning, guys. Just wanted to ask about the spare parts business. I saw the piece on the integrated services businesses within the release, but how has spare parts within that been trending and what can you glean about new equipment demand trends from that?

That's a great question. As you look for leading indicators on new equipment demand, you look at rental fleet utilization, you look at used equipment prices. You can look at service parts business and actually all of those indicators right now look pretty positive. Again, we don't have a spare parts business per se. Parts are integral to each of our businesses, but certainly demand has been very good this year. Used equipment prices have gone up and rental utilization has gone up. So that should actually be a very positive forward-looking group of indicators.

Thank you. And one follow-up. Is there anything you can share about how market shares in Asia, particularly China, have been trending given all the focus on the region?

I would say market share is not something that we disclose, so I won't be all that specific. But particularly in China, we have been capacity-constrained and that is one of the reasons why we announced fairly large capacity expansions, really starting in next year, for China excavators because we think if we can produce more, we can sell more.

So I would say particularly in that part of the business, we don't have the capacity all online yet, so that will take a little bit more. Our business model is really based on field population and field population is based on the strength of the industry and the share that we get. So it is a big deal to us. To your point, we are really focused on it. Where we need to add capacity, we are trying to do that. So yes, I would say it is a big deal, but I won't quote numbers.

Thank you. Good quarter.

Okay, thanks. I think we have time maybe for one more quick one.

Stephen Volkmann.

It's Jefferies & Company. Thanks, guys. I just squeezed it in. I am wondering if you can just comment -- we haven't really talked about the 2012 goals that you have had for quite some time now. And I guess it just strikes me that things are going to have to accelerate from your preliminary 2011 guidance fairly markedly to still get us up into that 2012 level. I don't know if maybe you wouldn't even agree with that, but are we still sticking with our 2012 goals and do we feel like this is a fairly pro rata movement through the next couple of years or is there an uptick in 2012 that really gets us over that goal line?

Steve, this is Ed. I would say our 2012 goals are as we laid out in the analyst meeting in New York recently. If you think of the story that we laid out there, we laid out a path that said we could get to $55 billion in that 2012 timeline and I think the $50 billion, approaching $50 billion is a good step in that direction. And I think it really gets back to what are -- from the earlier discussions -- some of the tailwinds that may be out there. And while we have seen some good growth in the developed parts of the world, as you know, they are still way off the peaks.

We talked earlier about rental inventory being down, dealer inventory being well below historical levels. Engine business, kind of a later cycle, hasn't really started to pick up recently. So as I look out to that 2012 timeline and the goal that we established, I think there is still -- the underlying principles and fundamentals are still there.

Okay, great.

I think that's a good one to conclude on and I will end it on that, but Ed is exactly right. We went over with everyone in some detail in August our 2012 numbers and how we constructed the path to get there. That is still our plan. We are still expecting that on out and beyond as we talked about in August and there is no change to that.

If you look at the economic GDP growth next year, which is anemic worldwide and maybe a little bit more anemic than we said in August, I view that as upside because the world cannot grow very long at these low rates. It's just untenable. Something will happen at some point and we will go and pick up and that is ahead of us and turns into a tailwind. But we are absolutely still in the ballpark from what we said in August.

Thanks, Doug.

Yes and just while I have got the floor, I am going to maybe just comment a bit. Ed Rapp, of course, is our new CFO in the executive office and he is doing a great job. And you may not see me on every one of these calls because he and Mike are doing so well. So just before I got too far out on that and if I am not here, it's not because I don't want to be, Ed certainly can handle it and is doing great and is a great representative for us and he and Mike do a super job. So you wouldn't expect to see that at some calls on the quarterlies in the future and we thank you all for joining us today. Mike?

Okay. Thanks a lot and you guys have a good day.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.