開拓重工 (CAT) 2011 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the first-quarter 2011 earnings conference call. At this time all participants have been placed on a listen-only mode and we will open up the floor for your questions and comments after the presentation.

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

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

This call is copyrighted by Caterpillar Inc. Any use, recording, or transmission of any portion of the call without the expressed 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 Caterpillar.com website. It will be in the area labeled Results Webcast.

This morning we will be discussing forward-looking information 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 those 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 on February 22, 2011, and also in the forward-looking statements language contained in today's release.

This morning we were pleased to report financial results for the first quarter of 2011 that were significantly better than last year's first quarter. Sales and revenues were over $12.9 billion and profit was $1.84 a share in the quarter. Sales and revenues were up 57% and profit was up over 400%. It was the best quarter for profit in our history.

You will also see in this morning's release that we raised the full-year outlook for 2011 sales and revenues and profit. To start this morning, I will summarize the results; then Doug, Ed, and I will take your questions.

Also in this morning's release, you may have noticed that we have made changes in our reporting format, including revised segment disclosures. As a part of the strategy update that Doug rolled out last year, the Company was reorganized around end-to-end businesses managed by our Group Presidents. That is how we are managing the Company and that is now how we are reporting.

This morning's release is structured around those new segments. We are reporting sales and revenues by segment and geography and operating profit by segment. And, we are providing sales and operating profit commentary by segment.

The segments that make up our Machinery and Power Systems businesses include both the sales of new equipment and aftermarket support for the businesses they serve. While there is a more complete description of each of the segments in the glossary in today's release, and I encourage you to read them, in a nutshell, the segments are Construction Industries, which are essentially the businesses at Cat that support customers in most types of construction all around the world. Everything from compact machines for a landscaper to larger machines to build a highway.

Then there is Resource Industries where we serve customers in areas such as mining, quarrying and forestry. Next there is Power Systems, which encompasses reciprocating engines and turbines across industries serving oil and gas, electric power, marine and industrial engines and our rail-related businesses, including new locomotives from EMD and rail services from Progress Rail.

We are reporting Financial Products in a segment and there is an All Other segment. The largest sales contributor to the All Other segment is External Logistics and Remanufacturing. Again, I would encourage you to read through the glossary in this morning's release to better understand what is in each segment.

Okay, let's get to the numbers. Again, sales and revenues were up 57%. Now, in that number, Financial Products revenues were nearly flat and Machinery and Power Systems sales were up 63% or $4.7 billion. Now, in that 63% increase in sales, Construction Industries were up 71%, Resource Industries up 84%, and Power Systems sales were up 51%.

Another way to look at the $4.7 billion increase in sales, $4.1 billion of it was from higher sales volume and most of the sales volume increase was driven by customer demand with first-quarter dealer machine sales to end users up 61%.

In addition, during the first quarter dealers did increase new machine inventory about $800 million from year-end 2010. And dealers commonly increase their inventories during the first quarter of the year to support higher end-user sales levels that usually occur during the spring and summer selling season. We do not expect to see this level of increase during the rest of the year. In the first quarter of 2010, by comparison, dealer machine inventories were about flat with year-end 2009.

Now, in addition to the higher volume, $295 million of today's sales increase was from improved price realization, $264 million was from the acquisition of EMD that was not included in the first quarter of 2010, and currency impacts were positive to sales by $94 million. Sales improved in all four major geographic regions -- North America up 72%, Latin America up 90%, Europe Africa Middle East up 67%, and Asia/Pacific up 35%.

Now, the increase in North America may seem surprising with the continuing depressed level of construction activity in the United States. Housing starts are at historic lows, commercial construction is still very weak, but in the face of weak construction activity, sales from our Construction Industries segment were up 92% in North America.

While the growth rate is dramatic, remember it's coming off of a very low base in 2010 and sales of new construction equipment in North America remain well below the 2006 peak. In fact, new machine volume is still only about half of the 2006 peak levels.

Now most of the machines sold in North America we think are likely replacing aging machines in customer fleets and in dealer rental fleets. During the recession, customers cut machine purchases much more rapidly and deeply than overall construction spending declined. As a result, their fleets both shrunk in size and age, and we are seeing that in customer fleets and we are seeing it in dealer rental fleets.

We believe customers are beginning to buy enough machines now to slow or stop their fleets from continuing to degrade. But let's be clear though, we do not think this is any kind of a bubble. It's not that customers are buying more than they need and, judging by what we are seeing in dealer rental fleets, we are not seeing increases in either fleet size or a reduction in fleet age. We believe they are essentially buying enough to keep their fleets from continuing to degrade.

Let me give you a few statistics about North American dealer rental fleets that illustrate that point. Let's start with BCP products and rental fleets, and that would be small and compact machines.

Rental fleet sizes are still very close to the recession lows and the fleet is older than it has ever been. In fact, the rental fleet for BCP-sized product is even smaller than it was in the 2002 recession and about 50% older than it was then.

It's a similar story for earthmoving products in rental fleets. Despite higher sales to dealers for rental, the size of their fleets continued to decline during the quarter and remains both smaller and older than even the 2002 recession.

Dealer rental fleets for excavation products also declined in unit volume in the first quarter, despite much higher sales to dealers, and fleets were at their lowest levels since we have been tracking it. The average age of the fleet is the oldest on record.

Now when actual construction activities, like housing starts, commercial building, and road construction, begin to improve it will likely place additional pressure on customers and dealer rental fleets to both improve fleet age and increase fleet sizes. In short, new machine sales in the United States, while better, are still depressed and far below the peaks of 2006. When construction activity begins to improve, we expect sales will continue to improve.

Now in addition to construction activity, mining and power systems also improved in North America, but again from low levels in the first quarter of 2010. Mining activity and higher commodity prices, including coal, have encouraged customers to invest in large mining equipment. And higher sales to oil and gas and electric power customers, along with the acquisition of EMD, drove the increase in Power Systems sales.

Outside of North America, sales continued to improve in the developing countries around the world. Machinery and Power Systems sales increased in the developing countries of Africa, the Middle East, and the CIS. Sales were up 90% in Latin America and 35% in Asia/Pacific.

Economic growth in developing countries has been good and is driving investments in infrastructure and increased demand for commodities, and that continues to be good for our business. A wise man at Caterpillar once said, the road to progress begins with the road, period. And that is what we are seeing in emerging markets.

In Europe, sales improved as well and the reasons were similar to those in North America -- to slow or stop the deterioration in age and the size of customer machine fleets and dealer rental fleets.

Okay, let's turn to first-quarter profit for a moment. It was a record at $1.225 billion and that was almost $1 billion higher than the $233 million from the first quarter of 2010. Profit per share was $1.84, more than 5 times the $0.36 a share from the first quarter of 2010. Higher sales volume was the primary reason that profit improved in the first quarter of 2010.

Price realization was also a positive at $295 million. Now, partially offsetting the higher volume and improved price realization, manufacturing costs were $219 million higher. Most of that increase was a result of higher period costs to support the large volume increases and from higher incentive compensation.

Material and freight costs were also slightly higher. Considering the size of the volume increase, the scale of capacity increase projects we are working on, and commodity-related pressures on material costs, cost control in the first quarter was good. SG&A and R&D costs were also up $219 million and driven by higher incentive compensation, costs to support new product development programs, and the impact of the much higher sales volume.

While costs were up some, as a percent of sales in our Machinery and Power Systems businesses, the combined SG&A and R&D went from about 15.9% of sales a year ago, down to about 12% of sales this year. And that reflects our continued focus on controlling period costs.

Now currency at an operating profit level was also negative. It was positive to sales $94 million, but the impact on operating costs was negative $118 million. In total then, it was negative to operating profit $24 million.

Below the operating profit line, Other income was $17 million and that was down $46 million from the first quarter of 2010. Most of that reduction was mark to market losses on interest rate swaps that we put in place in preparation for the Bucyrus acquisition and costs for bridge financing related to the Bucyrus acquisition.

Moving down the income statement to taxes, there are two points of interest to note on income taxes. First, the quarter reflects an estimated annual rate of 29%. That is a point lower than the 30% rate from the first quarter of 2010, but it's a point higher than the 28% level that was in our full-year outlook that we released back in January.

Now, the second point on taxes is that the first quarter of 2010, that is a year ago, included a discrete charge of $90 million and that was in addition to the taxes at the estimated annual rate. And that charge was related to the enactment of US healthcare legislation last year.

I will cover one final point and then move on to the outlook and that point is incremental margin, a subject I know many of you are interested in. Now we put a Q&A on incremental margins in our release this morning; it's question 14 on page 17 of this morning's release.

And consolidated sales and revenues were up $4.7 billion, consolidated operating profit -- these are off the face of the statements -- were up $1.325 billion. That is an incremental margin rate of about 28%. But to do it apples-to-apples, you need to exclude the acquisition of the EMD. If you do that it was more than 29%.

Incremental margins were good in Construction Industries, Resource Industries, and in Power Systems segments. We executed well in the quarter and did a good job of controlling costs. As a result, consolidated operating profit as a percent of sales was 14.2%.

Okay, that is a quick review of the quarter. Let's move on to the outlook. To start, I would like to clarify what is in the outlook and what is not.

In 2010, we announced three acquisitions that were large by Cat standards -- EMD, MWM, and Bucyrus. We closed EMD in the third quarter of 2010. It's in our results today and it's in our full-year outlook. Because we have not closed either the MWM or Bucyrus transactions, neither is included in our outlook and that is our long-standing policy. We don't include acquisitions until after they close.

With that in mind, this morning we raised the outlook for 2011. We now expect sales and revenues to be between $52 billion and $54 billion and our previous outlook expected sales and revenues to exceed $50 billion. In our new outlook, we expect profit in a range of $6.25 to $6.75 a share, and that is up from our previous outlook that expected profit near $6.00 a share.

While our 2011 outlook is improved, the increase would have been greater if not for the impact of the disaster in Japan. Our facilities in Japan were not damaged by the earthquake and tsunami, but many of our suppliers in Japan were. As a result, we are experiencing sporadic production disruptions at many of our facilities around the world. These disruptions are having a negative impact on sales, factory efficiency, and costs like premium freight.

While the situation has steadily improved in the aftermath of the disaster, it will likely have a negative impact on 2011 sales of about $300 million and negatively impact operating profit by about $100 million. And the most significant impact is expected to be in the second quarter.

In terms of the improvement in the profit outlook, higher sales volume was by far the main driver. Overall, the net of price realization and operating costs isn't much different than our original outlook for 2011. Price realization will likely be a little bit better, but material and freight costs a little worse. On balance, though, the big driver in the profit outlook is sales volume.

Below operating profit in the outlook, we do expect more headwind on the tax rate. Again, we raised our full-year estimate from 28% to 29%.

Okay, that is it for the outlook and sales and profit in the quarter. Before we take your questions I would like to quickly touch on three additional points. They are employment, cash flow, and investment in capacity.

Since the end of the first quarter of 2010 we have added almost 21,000 people to our global workforce, about half are full-time Caterpillar employees and about half are in our flexible workforce. In total that represents an increase of over 19% in the total global workforce. That is very positive news for employees and the communities they are located in.

In terms of cash flow, Machinery and Power Systems operating cash flow improved over 50% from the first quarter of 2010 and was over $1.6 billion in the quarter. Our Machinery and Power Systems debt-to-capital ratio dropped from over 47% at year-end 2009 to 34.8% at year-end 2010, down to 30.4% at the end of the first quarter of 2011. That is a drop of almost 4.5 points from year-end.

Cash and short-term investments on the balance sheet were almost $4.9 billion at the end of March as we are accumulating cash in our effort to minimize or eliminate the need for new equity to fund the acquisition of Bucyrus. All-in-all, very good cash flow for the quarter.

Finally, investment in additional capacity is very high on our list of priorities. In fact, our current outlook for 2011 is capacity constrained for some products, such as excavators and many of our large mining products. We are investing in capacity increases around the world to be prepared for 2012 and beyond, including substantial investment in the United States. In fact, more than half of the $3 billion that we expect to spend on capital expenditures in 2011 is being invested in the United States.

Expansions that have been announced around the world include capacity expansion for mining trucks in Decatur, Illinois, a new lower powertrain facility in the US, expansion of our BCP products in North Carolina, a new engineering design center in the United States, a new excavator facility in Texas, a new factory to manufacture locomotives in Muncie, Indiana, capacity expansion for mining trucks in India, significant increases in excavator capacity in China, a new factory for small wheel loaders and backhoe loaders in Brazil, a new mini excavator factory in China, a new internal logistics center in China, and a new factory to produce 3500 Series engines in Tianjin, China.

As we move forward we will continue to evaluate capacity needs based on our expectation of future demand. Okay, that summarizes this morning's release. And with that, Doug, Ed, and I are ready to take your questions.

(Operator Instructions) Stephen Volkmann.

Good morning, it's Jefferies & Co. I am wondering, I guess if I could just start with a little bit of a philosophical question. Mike, you talked about how sales is being driven by some replacement in the fleets and that, as you pointed out, a lot of the fundamental drivers, like construction spending and so forth, haven't really kicked in yet.

How long do we think we can continue to drive these types of strong sales, just based on that type of demand? And when do we need the actual end markets to really start to kick up for us?

Well, I don't know if I give -- put a time on it, but what I would tell you right now is I think we are at a position where dealers would like to increase rental fleet sizes, I think they would like to improve the quality of the fleets. For a lot of product we are producing as much as we can, like excavators, for example, we are capacity constrained.

So I still think there still needs to be more, I think, upgrading of the fleet even before thinking about real, I would say, construction-led demand from construction spending.

Now this is going to sound like maybe an odd comment, but in a lot of ways this has been pretty good for us. I think that had the US roared back with big housing starts, a highway bill, an improvement in commercial construction it would have been very, very tough, given the strength in emerging markets, I think for us to deal with that. That is why at the end of my little intro there that is partly why we have all those investment capacity additions coming.

Okay, great.

I will just add to that, Mike. It's Doug Oberhelman here. And I am not going to put a time frame on it either, but if you really look at what is happening in the US it's a very slow recovery from very low numbers for us, which means all that is in front of us. Rental fleet rebuild, customer aging fleet rebuild, and then construction activity.

So Mike is exactly right; we are in a very good position in this recovery where we can really get our factories in order. We can apply our CPS, Cat Production System, disciplines to get this going so that when that construction activity rebounds in the developed world, call it, the US and certainly Western Europe, we are going to be ready. But I don't know, the economists on the call would have a lot better view of when that is going to happen than I am but that day is coming.

Okay, thanks. And if I could just follow up. Mike, I understand the new segment reporting is closer to the way you guys look at things, but it leaves us a little bit high and dry as we try to think about forecasting and modeling.

And I am wondering, based on the margins that you guys reported for this quarter, are those the right type of margins to think about going forward? Was there anything big seasonally or any other type of special situation that would mean maybe that 29%, for example, in resources isn't what we should think about going forward? Any help you can give us with the segments.

Sure, sure. I will just point out one thing on the segments. The operating profit numbers that we are reporting are -- that is how we are looking at it internally. Now in the sales numbers that we are reporting by segment, they -- that is external sales, sales to outsiders.

The profit numbers include some intercompany sales as well. And you will notice in the sales table we have some footnotes below that, that show the intercompany sales numbers as well. So if you are calculating actual margin numbers to match up the sales to the operating profit number, you probably want to include the intercompany as well. That is why we provided it as a footnote.

In terms of the quarter, anything unusual; I am not sure I would qualify this as unusual or not, but -- and we have said this before. This is not a new comment. Fourth quarter is usually seasonally a high-cost quarter for us and the first quarter is usually seasonally a low-cost quarter for us.

We certainly saw that in the fourth quarter of 2010 and we saw that in the first quarter of this year. So typically it's a pretty light quarter for cost. You have got R&D programs that will ramp up, but in terms of -- there were no redundancy costs that we called out. There were no big, unusual items that we called out.

Okay, thanks. I will pass it on. Appreciate it.

Henry Kirn.

Good morning, guys; it's UBS. Could you talk about inventories at the dealer level? How much room is there to still grow there and how do you expect the wholesale and retail sales to compare as we go through the year?

On dealer inventory there isn't usually -- and when I say usually you kind of have to temper that a little bit depending upon where you are in the cycle. But usually the seasonal pattern is that dealers will build some inventory in the first quarter. Their big selling season, particularly in the Northern Hemisphere, is spring and summer when contractors are out working more.

So generally they will build some inventory in the first quarter. Historically, they might then use some inventory maybe in the -- use from inventory in the second quarter where they have bigger sales. Now for the full year our view is that inventory will probably go up a little bit from where it's at now, but nothing on the order of the quarterly increase that we saw in the first quarter.

On the retail sales numbers, we started to pick-up in the first quarter of last year. In fact, you will see the Asian numbers, percentage-wise, look lighter than maybe North America. And I think that probably surprises people in terms of the thinking that North America is weak and Asia is strong.

I think when you look at the retail numbers you kind of have to step back and look at when recovery started. Recovery in Asia started earlier than it did in the US and Europe, and so they are starting to lap now very good numbers. And I think as we move forward and the impacts of the 2009 recession are -- those low, low levels get behind us, I think the retail comparisons will get tougher as we go forward.

Henry, this is Ed. The only thing I would add is that if left to their own devices dealers would want to take that inventory level up, but in a lot of cases we are allocating product and moving more of that inventory into the PDC's and into the lane configurations. And it is a real effort to make sure we have the right product in the right places. Very different than the way we managed the upturn last time around.

That is helpful. Is it possible to talk a little bit about the supply chain outside of Japan where you may be seeing some tightness?

Yes, this is Mike. We have got a lot of factories around the world, a lot of products and I am sure if we went into any one of our factories, the product manager could rattle off a dozen components that they would like more of. But I think on balance our suppliers have just done a fantastic job of ramping up. If you look where we came from, the depths of say the third and fourth quarter of 2009, production is significantly higher than it was then. We have tried to communicate as far forward as we can with our supply base and I think for the most part, they have reacted. So we don't have anything specific to call out. It is tight in a lot of areas but our suppliers have done a great job.

That is helpful. Thanks a lot. Good quarter.

Robert McCarthy.

It is Robert W. Baird. Congratulations, guys. Isn't stronger execution a beautiful thing? One of the things that -- you were just talking about capacity -- one of the things that I have been concerned about is the time lag and being able to close the Bucyrus acquisition and the fact that they are sold out for at least this year in their hydraulic shovel business, which of course is a very important asset that you are acquiring. And as you know, they are landlocked in Germany.

So from their end capacity is just flat static right now. Are you already in the process of trying to -- is this what, part of what Texas is? Are you in the process of building capacity so that you will be able to quickly add to their existing capacity once you take control of the business?

Doug Oberhelman here, Rob. We are only going to comment on Bucyrus today about the closing that we still expect in mid-2011, but I will tell you the factory that you referred to in Texas has nothing to do with the mining business. That is a construction excavator plant only, call it 25- to 35-ton machines; unrelated entirely to Bucyrus.

And that is just about as far as we will go. That is as far as we will go today with Bucyrus. Everybody is working hard to get it closed; we expect mid-2011 to get it done.

Okay. Then my follow-up has to do with your expectations for dealer inventory growth. I am interested in both the $800 million in the quarter and your expectations for the full year. Can you talk about where that will be concentrated by segment within the new segments? I am guessing most of that would be at BCP, construction in other words.

Yes, I think that is where most of it is. There is not a lot of mining inventory, so that is a pretty easy one to say yes to.

I think geographically -- well, I will just start off the $800 million that we are already up in the first quarter, our expectation is that we are probably not going to end the year a lot higher than that. Somewhat higher, but not a lot higher, than that. So I wouldn't expect big changes from the end of the first quarter by the time we get to year-end.

Now there might be some up and down during the year. Again, the second quarter is usually a big quarter for sales to users in terms of actual volume, and so it's not unusual for dealers to take a little bit -- take inventory down a little bit in the second quarter. But I don't think for the full year, at least our view is that it won't be a lot higher than where we ended the first quarter.

And you were going to say something regionally, Mike?

Regionally, all regions were up in the first quarter except Asia/Pacific. Asia/Pacific actually declined just a touch and I think that reflects the point that Ed made earlier. Dealers would like to take more inventory if they could.

If you take Asia, for example, our excavator production in China is -- we are going full out. I think if we could get more products of some things like excavators we would certainly put more in our lane inventory and I think that dealers could -- even though we are trying to put as much as we can in lane inventory to get it distributed well, you could probably make a good case for some dealers needing a bit more.

Thank you.

Ted Grace.

Thank you very much, Susquehanna. So I think, speaking for myself and then probably for a lot of people trying to calibrate our expectations around the new reporting format, but as it relates to the incremental margins for what historically was the Machines business and now I guess we will call it the Construction Industries and Resource Industries. One more quarter into the recovery it would be great to kind of get your updated sense for how you think the opportunity on the incremental margin side is.

And kind of as a second part, whether it's Doug or anybody else on the call, could you just compare and contrast the opportunity that you see within machines relative to engines when you took over that business and made the dramatic improvements there?

I will start with the first part of that. When we came into 2011, if you go back to our original outlook, we said we expected incremental margins in the neighborhood of 25% this year and for the full year. And if you look at our outlook today, we have revised the sales number up and we have revised the profit number up. I think the incremental margins embedded in that aren't a lot different than what we said before.

We did a little bit better than that in the first quarter. If you look at the year-over-year sales increase, the first quarter of a year ago was still coming off of, let's just call it recession lows, and sales really started to improve through last year. So if you look at first quarter to first quarter it will probably have the most significant year-over-year comparatively increase in volume. The bigger your volume increase, in a lot of ways, the easier it is to get high incremental margins.

So I think it's not surprising that the first quarter is a bit better than what we were expecting for the year. On balance I don't think our expectations for incremental margins for the year are significantly different than how we started out the year.

I am not sure -- Doug Oberhelman here. I got the backend of that question vis-a-vis engines, but what I will tell you is that we have the entire leadership team of the Company and we communicate with employees constantly on this idea of incremental margins and profit pull-through. It's a big deal inside our company and it's a motivator to many.

The segmentation presentation that we provide this quarter is what our leaders use internally as well. That is the document we all are motivated by; what you see is what we see and how we manage.

Now, having said that, Mike is exactly right, the 25% incremental margin we want for the rest of the year in our outlook is what we expect to deliver. And that is one of the better years in the last many in terms of year-over-year improvement, which we are pretty happy with. But it's something that is a key core metric of ours internally.

The Executive Office, that is all the Group Presidents and myself, look at this continually and that is how we do our business planning and so on, and will into the future, because the history of 2006, 2007, 2008 is still pretty fresh. The success we had -- I think your point on the engine business is the one we modeled the machine business after and we are seeing that here in the last couple quarters as well. Certainly first quarter is very rewarding to that.

Yes, exactly. So that is -- I am sorry to interrupt.

That is okay, go ahead.

What I was going to ask is when you think about the longer-term opportunity, not as much just 2011, if you were to look at the Engine segment between 2002 and 2009, sales growth was similar to your peer group and yet your margin expansion was 1,200 basis points. Peer average was 200.

And so if we try to apply that kind of construct to the opportunity within what was historically the machines business, I am just curious to get a sense how you think about the increased opportunity from here longer-term, say over 3 to 5 years.

Sure and I am not going to -- we don't really -- I am not going to talk about that 5 years out, but we certainly have talked about it internally and where we want to be. And that is one of our metrics.

As we talked to all of you in New York at the Exchange last year, at 2015 the goals we laid out for that really get us to this kind of a profit pull-through. So, yes, I think you can -- I don't know what it is vis-a-vis the peer group, but certainly in terms of where we want to be by the end of 2015 that is a key piece of getting us there.

Okay, thank you.

Eli Lustgarten.

Longbow Securities. Good morning, everyone, and wow (inaudible). Can we go back and talk a little bit more about the profitability you gave us one quarter in comparison? And I hope you will give us restated quarters quickly for last year. Resource is the one that sticks out when you show a 28.8% margin I guess, even if you add back sales of 26.

That doesn't seem to be like a normalized profitability as some of these -- and I think it's a question we are trying to get a sense of what is the normalized profitability. And can you put it in the context with the guidance that you gave us?

Because what you effectively set for the rest of the year, assuming that you are not being ultraconservative, is that the sales number for the rest of the year doesn't change a lot but your quarterly profit report goes down 10% to 20% on average from this huge first quarter. So I am just trying to reconcile the two.

It has to be -- at some point it suggests that the operating profitability would be lower in the segments versus what we saw in the first quarter. So I am trying to get an idea of what more normalized numbers would be.

Okay, a couple of things. It is our intention to restate the quarters of last year and we will do that as quickly as we can. I would expect that it's likely that we will have that done before we talk and disclose it before next quarter. I think we will be able to do that. So that might give you at least some quarterly perspective from a year ago.

Resource Industries includes mining, which is, shall we say, more profitable than the total. One thing you need to remember, though, when you are thinking about the numbers in total, there is a line within our segments that has corporate costs and there are some costs in our business, things like -- I will give you some examples -- our corporate treasury group, our tax group, part of our human resources group, part of our legal group, some of the pension costs that aren't related to service costs -- they are not included in the individual segments. So you will see those as a negative when we sum up the segments plus that to get to the total.

So if you were looking at machinery, for example, before as we reported it we would have allocated all that to machinery and engines, and now we are not. So I think it probably will help you when we can give you a little bit more historic data. But again Resource Industries is a more profitable than average segment, no doubt about it.

Now in terms of the first quarter versus the rest of the year, I kind of touched on this. The first quarter is usually a pretty light cost quarter. Fourth quarter is pretty heavy, first quarter is pretty light, and we saw that.

Now in addition to that I think what we are going to see as we move through the year is probably a little bit more headwind on material costs. On the first quarter we didn't say much about it in the release because it was just slightly negative. It was not a big deal in the first quarter. But as we go through the year, that will likely be more of a headwind as we go forward, and things like R&D costs, for example, I think that will probably go up.

Then, of course, in the second quarter, that is where we would expect to see the vast majority of the impacts from the disaster in Japan. So that is having a little bit of a negative on the rest of the year, particularly the second quarter as well.

I guess what I am driving at is when volume goes up a little bit from the first quarter and we are looking at somewhat lower quarterly report, can we get some calibration of where the decline is coming from in profitability? Is it in the segment stuff or is it in that cost -- the consolidated corporate cost numbers? Can you give us some idea of how to handle that as we go through the year?

I think it would be in the segments. Material costs would be in the segments, the impact from Japan would be in the segments, so, yes, it would be most likely in the segments.

And a follow-up, can you give us some idea of how much capacity space you have left for increased volume and unit reporting? Are we pretty full out at this point in resources, because you can't expect much change in volume from the first quarter and the rest of it comes from construction? Give us some sense of where the volume changes that we are seeing for the rest of the year can come from.

That is a little bit of a hard question to answer, partly because some of the ramp-up issues that one would have, particularly in the short term, aren't necessarily capacity driven. I will just give you an example.

If you look at big diesel engines, we are definitely not at capacity. Lafayette could do more. But there is a fairly long supply chain on some of the big key components and you can't change that production on a dime. So for that we couldn't take up production rapidly within a month, but that doesn't mean that we are at capacity.

For things like excavators and much of the large products -- trucks, big bulldozers -- we are running pretty well flat out right now. We are actually doing better. We have been able to get out more I think in both of those kind of product areas than we did last year. We got more investment going in place to try and get that up.

So I don't know how to quantify, because you have to look it product by product and then figure out what that meant for the supply chain to get it back to a number this year.

All right, thank you. Terrific quarter.

Jerry Revich.

Good morning, it's Goldman Sachs. Mike, the high end of your sales guidance implies low production increases from your seasonally weakest sales quarter. Is that a contingency for Japan and broader supply chain tightness? And I am wondering if you can touch on where your supplier on-time deliveries were in the quarter. Thanks.

I think it does reflect, again, for a lot of products we are producing all we can today. Again, the big products, a lot of the big products, underground mining trucks and excavators, which are pretty key products. It also reflects fairly long lead-times for some of the other products and it also reflects Japan. We expect the second quarter to be negative there.

A lot of that is in products that we effectively don't have capacity to make up later on in the year. Again, like excavators, for example. So we do have the increases built into the rest of the year in our sales outlook, at the midpoint, and at the top end, but they are limited somewhat by our ability to produce. And I mention this in my lead-in. Our sales forecast, if it weren't somewhat capacity constrained, from a demand standpoint, could be higher.

And it looks like your inventories were up nicely in the quarter. Can you give us an update on your lane strategy fill rates and what are your updated targets for this year? Thanks.

Yes, Jerry, this is Ed. If you look at lane performance at the end of the first quarter, I think 70% of the volume went out within 10 days and so we are seeing good performance in that area.

As I said earlier, dealers would take more inventory but we continue to herd it into lane to make sure we have the right product in the right place. In fact, we actually increased lane inventory during the quarter as we continue this commitment that we made and this ramp-up of making sure we have the right product in the right place.

There is more buildout of the PDCs to come in second quarter and we have got product diverted into the lanes to make sure we have good product availability and we can maximize those end-users sales. And I think you are seeing the benefits of that with the rolling three-month data we have been providing on end-user sales.

So I would say the lane strategy is moving ahead. The strong demand puts that under pressure, but we remain committed to it. It is one of the things that is going to help us manage this upturn far better than we did the last one.

And, Ed, just to clarify, what proportion of your lane 1 target products are you stocking within that 10-day period? Is that that 70% number or are we talking about out of the products that you stock 70% is within 10 days? Thanks.

That would be -- the 70% would be across the spectrum of our product line versus that target.

Thank you.

David Raso.

ISI. Good morning. Quick question on the rest of the year implied guidance; essentially it looks like you are implying incremental margins of only 10% year-over-year for the rest of the year. Can you give us a little more granularity on what -- you went through roughly some of the cost issues, but it just seems like a very low incremental margin for the rest of the year. Can you detail that?

Yes, I am not going to go through the math, but I don't think it's quite that low. And remember, you need to deal with EMD in whatever calculations you are doing, because that is adding to sales, at least for the second and third quarter, without adding much to profit. Then remember we have got Cat Japan in the second quarter.

But I think there is no doubt, at least in my mind, that we had the most significant volume increase in the first quarter. Just on a quarterly basis that gives you the most opportunity I think to show really good incremental margins. In quarters where there is less volume increase I think it's tougher.

But I think that 10% number is pretty -- it's too low. I mean we are looking for about 25% for the year. We had 28% to 29% in the first quarter.

I definitely appreciate that but the math is implying the equipment company EBIT is around $5.9 billion for the year.

Yes. We do profit per share but I don't think that math works.

Okay, we will talk off-line. Then on the cash flow, saw something I don't think I have ever seen Cat do. On the equipment company first quarter working capital actually a source of funds. That hasn't happened since '98 and '98 was even an anomaly because that is when you were first selling receivables in the equipment company over to Cat Financial.

So maybe it has never happened, at least from my data. Obviously very impressive. Can you give us some thoughts then on how you are viewing cash flow for the year on equipment company? Because again it's a unique start to the year to have working capital as a source of funds.

David, I am going to let Ed answer that, but you are seeing the increasing number of nevers-before in front of your eyes and this is one of them. We like that part and that is where we are headed as we talked to all of you last year. That we are going to be in the territory here the next couple years where we have never been before and we are starting to see the results.

David, it ties into a number of things. One, when we rolled out the strategy we talked a lot about the balance of the focus on the P&L and also on cash flow and moving it to a top-tier metric. As we have really driven this and cascaded it down the organization I would say, number one, we are getting good traction on that.

Secondly, we have talked about our desire to minimize the need for equity related to Bucyrus and we have got the organization clearly focused on what it has -- what we collectively have to do as a group to make that happen. In fact, if you look at the measure from a debt-to-cap perspective, we finished the first quarter with the strongest balance sheet we have had in more than 20 years.

So I think you are seeing the traction come from the deployment of the strategy, the focus on cash flow, and really driving it down through the organization. It came through with good numbers in the first quarter. And if you think about the opportunities that we have ahead of us in terms of the industries we serve, the capacity increases we have talked about, we have got the organization clearly understanding that generating strong cash flow is where we are going to fund that growth going forward.

I know, obviously, there is a lot of positives this print but that was probably the most impressive. Are you willing to at least give us some kind of range in how you are thinking about operating cash flow for the year?

David, we have historically not given guidance on that. What I would say is that based on what we clearly articulated relative to the top-tier metrics when we rolled out the strategy, the balance of our focus, zero equity in terms of a target, if you would, on Bucyrus, we are going to be all over cash flow.

Thank you very much. I appreciate it.

Thanks, David. I might just chime in here a little bit that in one metric that we watch -- that is working capital to sales -- we are benchmarking the best in the capital goods industries. And that is our target here over time. Granted it's going to take maybe to 2015 to get there, but we are seeing a down payment on that.

So I would just generally think about that and the best in capital goods is where we intend to be no later than 2015.

Ann Duignan.

JPMorgan. I would like to just follow up on David's question and ask it a little bit differently. Doug, would you be disappointed in the businesses if they did not deliver 25% incrementals in each quarter going forward, other than maybe construction next quarter because of Japan?

Well, I am really focused on 2012 and 2015. I would expect the Group Presidents in charge of those businesses, in this case Rich -- Rich Lavin and Steve Wunning, to use those. And they are as their top-tier metrics.

That is a question that they would have for their teams. I know they are concentrating highly on it, but in terms of quarter-to-quarter stuff there is so much -- so many variables and change I am really trying to get us to 2012 and 2015 in a big way and they handle the day to day quarterlies and everything in their business, Ann. That is the way I look at it.

Okay, that is good color. I appreciate that. And then a separate kind of question, kind of a tough question to ask, but, Japan is a headwind right now. At some point I think we would all anticipate that that could turn and could become a tailwind.

The way we look at it is we would likely see demand for power generation for the engine business to pick up first and then later, perhaps much later, demand for rebuilding equipment may pick up. Is that the right way to think about it and how do you guys think about it internally?

I will comment here. Ann, you are right, this is a tough one to talk about. This will profoundly change the country of Japan for decades. It will profoundly change the way that industry is viewed inside Japan for a long time as well. And while there will be rebuilding opportunities down the road, and certainly we have seen power as we would typically do after a disaster of this kind, lead the way, it's hard for us to really talk about that.

We are still making sure our supply chain is right. We were so fortunate that our own Japanese employees and facilities were not hurt, but having said that every one of our Japanese families have either a relative, friend, or something that has been touched very deeply with this. So we are not pushing that too hard and I am going to shy away from that answer, Ann, except that generally, and in all other disasters, that is kind of the flow in which we have seen recoveries.

Okay, I appreciate that. I will get back in line. Thanks.

Jamie Cook.

Good morning, Credit Suisse and congratulations. Two questions, Mike. I am going to try the guidance one more time.

Your first quarter you came in at $1.84, Q1 seasonally a weaker quarter which implies at the midpoint we are only going to do on average about $1.55 a quarter. I get we have high volumes; Japan is only $0.10, your R&D was up 30% in the quarter, you are seeing 20% for the year. I understand the dollars get bigger, but is material costs that material or is it we are only in the first quarter? So why set the bar high?

Then the second question, just broader commentary on Tier 4. Tier 3 was a big issue for Caterpillar last cycle, I am just wondered how that has gone relative to expectations.

You know, you are right normally first quarter is a pretty seasonally low quarter for our sales. I think that trend is probably a little bit muted in situations where you are constrained on production. So I think, again, if there weren't any production constraint, there weren't any capacity issues, I think our sales number, as we said, would have been higher and you might have seen more of a seasonal pattern.

But I think probably because of production constraints on excavators and large product, our expectation is the seasonal variation won't be quite so much. And it is early in the year; there is a lot you don't know. We do expect that material costs will go up somewhat from here.

We expect -- you are right, year-over-year R&D was up, but if you look at it sequentially as we go through the year it's going to go up from the first quarter as it did last year.

Jamie, I will cover Tier 4. I would say at this point in time it's in the early innings, but I would say we are cautiously optimistic. If you think back to when we first got into it, a lot of people were talking about Tier 4 being a sacrifice on fuel economy. I think almost across the board our Tier 4 machines are actually going to offer improved fuel economy.

There was a lot of fear about the need for operator intervention. We have almost completely removed that from the equation so I think customer feedback on that has been positive. I think the team has done a good job of using technology in terms of getting immediate feedback back in terms of any issues in the product development cycle. And we have leveraged our supply base in a number of areas across the platforms of our machines.

So I would say early days, but I am much more confident in terms of where we are at in Tier 4 versus where we were at with Tier 3.

All right. Congratulations again.

I think we have time for one more.

Robert Wertheimer.

It's Morgan Stanley. Good morning, everybody. My question is from the outside the margins obviously look extraordinary this quarter and really impressive. I wanted to ask, from the inside, when you look at your internal metrics, whether it be rework, quality or early hour quality, all the things that you talked about in 2009, whether it feels just as good, better, or whether you are seeing some of the signs of strain that you saw at last peak in 2007, 2008.

I will be happy to take that one, Rob. It's Doug Oberhelman here. Generally, across the board on internal metrics that we use, those that you mentioned and others, but the biggest one is the external metric and that is incremental profit pull-through, which in my mind is the culmination of all those things that have to happen internally. We are seeing vast improvements from 2006, 2007, 2008, and 2009.

Now, having said that, we are running more and more of our plants at capacity. As we go up that chain we are working through those. We have a far different, and I am going to say far better, global purchasing and supply chain management team around the globe that learned from the prior experience and have put in processes that have changed.

So without question our CPS metrics are better. Every single metric that we would use that you would see on our -- inside our factories as you go through that we put up on our metric boards than they were, say, 3, 4, 5 years ago. We are not where we want to be. Our goals are still down the road for us from where we want to be, but we are getting there.

I think I have often said that it's probably going to be late 2011, 2012 before we really see a lot of those internal metrics get to the goals that we want as we continue investments to make the changes that we have to, to get them where we want to be. So there is some of that improvement in front of us, but there is no question we are moving up the scale operationally internally. I am very, very pleased with our team on that.

Wonderful. I will stop there, thank you.

Thank you, Rob.

Okay, with that I would like to thank you all for joining us on the call 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.