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EXHIBIT 99.1
Conference
Call Transcript
CAT
- Q1 2010 Caterpillar Inc. Earnings Conference Call
EVENT
DATE/TIME: APR 26, 2010 / 11:00AM EDT
CORPORATE
PARTICIPANTS
Mike
DeWalt
Caterpillar
Inc. - Director, IR
Doug
Oberhelman
Caterpillar
Inc. - Vice Chairman & CEO elect
Jim
Owens
Caterpillar
Inc. - Chairman & CEO
Dave
Burritt
Caterpillar
Inc. - CFO
CONFERENCE
CALL PARTICIPANTS
Alexander
Blanton
Ingalls
& Snyder - Analyst
Mark
Koznarek
Cleveland
Research Company - Analyst
Seth
Weber
RBC
Capital Markets - Analyst
Ann
Duignan
JPMorgan
Securities - Analyst
David
Raso
ISI
Group - Analyst
Henry
Kirn
UBS
Securities - Analyst
Eli
Lustgarten
Longbow
Research - Analyst
Joel
Tiss
Buckingham
Research Group - Analyst
Jamie
Cook
Credit
Suisse - Analyst
Ted
Grace
Avondale
Partners - Analyst
Andrew
Casey
Wells
Fargo Securities - Analyst
Barry
Bannister
Stifel
Nicolaus - Analyst
Andrew
Obin
BofA
Merrill Lynch - Analyst
PRESENTATION
Operator
Good morning,
ladies and gentlemen, and welcome to the Caterpillar first-quarter 2010 earnings
results.
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, Director of
Investor Relations. Sir, the floor is yours.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Thank you very
much. Good morning, everyone, and welcome to Caterpillar's first-quarter
earnings conference call. I'm Mike DeWalt, the Director of Investor Relations,
and I am pleased to have our Chairman and CEO, Jim Owens; our Vice Chairman and
Chairman-Elect, Doug Oberhelman; and our CFO, Dave Burritt, with me on the call
today.
This call is
copyrighted by Caterpillar Inc. and any use, recording, or transmission of any
portion of the call without the express written consent of Caterpillar is
strictly prohibited. If you would like a copy of today's call transcript, you
can go to the SEC filings area of the Investor section of our cat.com website or
to the SEC's website where it will be furnished as a Form 8-K
today.
In addition, what
we will be discussing today is forward-looking and involves risks,
uncertainties, and assumptions that could cause 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 on
February 19, 2010, and also in our Forward-Looking Statements language contained
in today's release.
Earlier this
morning we reported results for the first quarter and we updated our outlook for
the full year of 2010. To start this morning I will quickly summarize the
quarter and updated outlook, then we will take your questions.
Let's start with
the quarter and what a difference a year makes. In the first quarter last
year we were seeing rapidly declining demand, order cancellations, turmoil in
credit markets, and declining economies across much of the world. At Caterpillar
we were busy cutting production, costs, employment, and working capital.
Our
major focus was on three goals -- maintaining profitability, holding the
dividend, and maintaining our mid-A credit rating -- and we were successful at
all three.
This year's first
quarter saw a very different picture. Capital markets are in much better shape
than last year, demand for our products is rising, and we are seeing it in most
geographic regions, although it's much more robust in the developing countries
of Asia, Latin America, Africa/Middle East and the CIS.
We are also seeing
a significant pickup in mining globally. In fact, we have already filled our
available 2010 production slots for some of our large truck models and are
taking orders for 2011. Demand for aftermarket service parts in our Machinery
and Engine businesses is very strong and gained steam as we moved through the
quarter. This is usually a good indicator of how much work is getting done in
the field and the strength we have seen is encouraging.
We are working with
our suppliers and within our own factories to ramp up production and in some
cases to accelerate planned capacity additions.
In terms of
employment, we are able to absorb a portion of the production improvement with
the existing workforce by winding down the rolling plant shutdowns that we used
last year to manage production declines. However, we are also selectively adding
to employment to support increasing demand. We are seeing employment increases
in our factories in Asia and Latin America where the demand improvement is the
strongest, and also in key US facilities that are seeing strong export
demand. Employees in those factories certainly understand the importance of
free trade.
I think the
contrast between last year and this year can be summed up by saying last year we
were rapidly ramping down and faced a very negative economic climate. This year
we are rapidly ramping up and are seeing much better prospects for the world
economy.
Sales and revenues
in the first quarter were $8.2 billion, and that was down about $1 billion from
the first quarter of last year. Now given my positive comments about the
economic environment, you may be asking why are sales and revenues lower than
the first quarter last year when demand is improving and we are ramping up
production. Well, there are two main reasons:
-
First, we ended 2008 with a strong order book for mining products and large engines. And while we saw cancellations and very few new orders, we did continue to produce and ship mining products, large engines, and turbines at relatively good levels throughout the first quarter of 2009.
-
The second reason is that it does take some time to ramp up and not just in our factories. Our suppliers are seeing, in many cases, dramatically higher demand from us. We have increased production schedules throughout the quarter and March was our best month for sales and revenues since the end of 2008.
One other point
about sales and that is throughout 2009 we talked a lot about the impact of
dealer inventory changes and the very negative impact that had on our full-year
2009 sales as dealers shed inventory. This year we are expecting relatively flat
dealer inventory and for the most part that is what happened in the first
quarter. Overall, dealers held new machine inventories about flat, but took
engine inventories down about $200 million.
While the midpoint
of our outlook reflects relatively flat dealer inventories in 2010, in some
regions inventories are becoming lean. And the higher we are this year in our
outlook range, the more likely it is that collectively dealers may add some to
their inventories later in the year.
Okay, let's turn to
the first-quarter profit. Profit in the quarter was $0.36 a share and during the
quarter we recorded a $90 million after-tax charge related to Medicare subsidy
tax changes in the recently signed U.S. healthcare legislation. Excluding that
charge, profit was $0.50 a share.
That compares with
the first quarter of 2009 when we had a loss of $0.19 a share including
redundancy costs of $558 million. Excluding the
impact of redundancy, we earned a profit of $0.39 a share in the first quarter
last year. Now again that is $0.50 a share in the first quarter this year
excluding the Medicare charge and $0.39 a share in the first quarter last year
excluding redundancy.
Okay, just a few
key points about the quarter. Profit was higher despite lower sales volume and a
negative product mix. Manufacturing costs were favorable $566 million, and
included in that, labor and overhead costs, warranty, and material costs were
all favorable.
SG&A and
R&D costs were close to being neutral despite added costs for incentive
compensation and pension expense.
Our machinery line
of business was profitable for the first time since the third quarter of 2008
and Engine operating profit as a percent of sales improved sequentially from the
fourth quarter of 2009. Cash flow was a positive and our Machinery and Engines
debt to capital ratio improved from year-end 2009.
All-in-all it was a
good quarter. Demand and order rates have picked up, we are ramping up
production, efficiency is improving, costs were down, and the balance sheet
continues to improve.
Okay, that was a
quick look at the quarter. Now let's turn to the outlook. This morning we raised
guidance for sales and revenues and for profit. Our original outlook reflected
sales and revenues up 10% to 25% from 2009 and in dollars that was a range of
$35.6 to $40.5 billion with a midpoint of about $38 billion. The revised
outlook we provided this morning has a top-line range of $38 to $42 billion
with a midpoint at $40 billion.
In terms of profit,
the original outlook expected $2.50 a share at the midpoint of the sales and
revenues range and our revised outlook this morning reflects a range of $2.50 to
$3.25 per share with a midpoint of $2.88. And a point of clarification, that
outlook does include the negative impact of the first-quarter tax charge related
to the U.S. healthcare legislation. In other words, our profit expectation for
the year would have been higher if the bill had not been enacted.
Now there are four
main reasons for the improvement in our outlook this morning. First, while our
original outlook for 2010 did expect growth in developing countries, it's now
looking even stronger. Engine sales, particularly for gas turbines, are looking
better than we expected. Sales of aftermarket parts, which are integral to and
included in our Machinery and Engine businesses, are growing faster than
expected. And, finally, mining is increasing more than in our original
outlook.
Now in terms of
costs in the outlook, in general what we said in our original outlook looks to
be about on track and some key elements include favorable material costs for the
full year; favorable manufacturing, labor, and overhead costs driven by
improving factory efficiency; SG&A costs should be up slightly, excluding
short-term incentive pay; and, as we said in our original outlook, we do expect
higher R&D expense.
As a reminder,
pension costs are up as well and included in manufacturing, SG&A, and the
R&D lines.
Also, one other
point. With profit improving we do expect increased short-term incentive pay and
that is linked to improving financial results and is, as a result, highly
aligned with shareholder interests. Okay, that is the outlook.
In summary, the
first quarter was a very good start to the year. We are seeing positive
increases in demand, our machine production is increasing and we raised the
outlook for 2010.
Just one more
comment before we move on to the Q&A section, and that is we are going to
hold our annual analyst meeting this year in New York City on August 19 in the
afternoon, so mark your calendars. We will provide you more details on that over
the next couple of weeks.
And with that, we
are ready to take your questions.
Doug
Oberhelman - Caterpillar Inc.
- Vice Chairman & CEO-Elect
And, Mike, maybe
before we do that I would like to interject here a little bit. It's Doug
Oberhelman speaking. As you all know, I will become CEO in about two months time
and I thought given that this is Jim Owens last quarterly call I would mention a
few key statistics of Jim's time in office here, what has happened during what
will no doubt be one of the most interesting runs as CEO in our history where
sales mushroomed and then sales tanked. And I will get into that in just a
little bit.
Jim has done a --
we all think here -- a wonderful job for our company, and let me tell you some
of that. Jim became our CEO on February 1, 2004. That seems like many lifetimes
ago, Jim, but it went fast and here we are in 2010 already. That is six years
and 24 quarters, for the record.
2003 earnings per
share before Jim came in as CEO were $1.56 a share, and I know as I look back at
some of these statistics I was -- I had forgotten a lot of this history. Of
course, we peaked at $5.66 a share in 2008, which was a record of any time in
our history.
2003 sales were $23
billion and I can remember so well a couple of studies we did at that time
wondering how we were ever going to break above $20 billion where we had been
stuck for six or seven years or so at that number. Sure enough, in 2008 we
ballooned up to $51 billion and exceeded our -- Jim's strategic goal of $50
billion by 2010. Unfortunately, in 2009 we cut that back by almost 40% and now,
as you see from our outlook for 2010, we are back up to $40 billion
This really gets
interesting. During this period of time when Jim was our CEO and Chairman, our
stock has risen almost 80%, even with the ups and downs of 2009; a tremendously
successful run as CEO and Chairman. When Jim took over our quarterly dividend
was $0.185. Today it's $0.42. That is a 125% increase.
And I will tell you
that Jim was the main cheerleader, main arm-twister of our Board, and main
driver of maintaining that dividend last year when everybody else was looking to
cut around our industry in so many other companies. He was forthright in his
determination that we were going to make it through it. We were going to be
profitable in 2009, which we were; maintained our dividend and our cash flow,
which we did; and it paid off very well for shareholders.
Employment is up
about 25,000 during this period of time. It certainly was up more than that, but
in the end we are still up over where he started. And I think what he really
will be remembered for -- and all of you as shareholders and the sell-side
probably don't know a lot of this -- but the internal things we changed on
Vision 2020, which was his strategy plan that we are working on revising now
again.
It brought us the
growth in China and emerging markets. It brought us the Cat Production System.
It brought us the improvements in quality we are seeing. It brought us
efficiencies in our factories, set us up for the next few years which will
really see these things pay off. And we are all pretty excited about
that.
He set us up for
the Tier 4-Stage 3b in Europe-emissions regulations. He brought us the
acquisition of Progress Rail, which has turned out to be a real winner and one
we are extremely happy with. And I know Jim is very proud of his attendance and
membership in the Economic Advisory Council under President Obama.
Another final cap
on this, market cap when Jim took over was about $27 billion. Today I noticed
it's right at $45 billion. Just a great run with this giant roller coaster in
the middle, but he got us through all of that. So, Jim, with that -- and this
will be the first of many -- not the first but the first of many farewells
between now and November 1. But congratulations to you and these statistics you
can hold up with anybody anywhere in industry anytime.
Jim
Owens - Caterpillar Inc. -
Chairman & CEO
Thank you,
Doug. I am speechless.
Doug
Oberhelman - Caterpillar Inc.
- Vice Chairman & CEO-Elect
It is true,
those are all facts. So Mike, we will go back to you and our Q&A
session.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Okay, we are
ready for Q&A. Thank you.
QUESTION AND
ANSWER
Operator
(Operator
Instructions) Alexander Blanton.
Alexander
Blanton - Ingalls & Snyder
- Analyst
Good morning. My
finger must have moved very quickly. I am with Ingalls & Snyder and my
question is -- and I hope I have time answer for a second one, ask a second
one. Last year you reduced dealer inventory by $3.9 billion so that if sales
were $36.3 billion this year, for you they would be flat at the dealer
level.
Now your low end of
your sales guidance is really only a couple billion less than $2 billion above
that, $36.3 billion, so that is really only about a 5% increase at the low end.
If the dealer inventories are flat this year, dealers would be up 5% at the low
end of your sales range. That doesn't seem like a lot considering what is going
on in Asia, as you mentioned. So can you sort of elaborate as to why you have
got such a low sales increase at the dealer level at the low end of the
range?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Alex, this is
Mike. I will start that off. Just as a reminder, we did raise sales guidance
today. The midpoint went up about $2 billion.
Alexander
Blanton - Ingalls & Snyder
- Analyst
I understand
that.
Mike
DeWalt - Caterpillar Inc. - Director,
IR
The midpoint of our
guidance is $40 billion. I think we provide a range around that because there
are uncertainties in terms of what is going forward. And not everything in the
year is positive. There are some parts of the business that -- Engines, for
example, we see as being flat this year, not a big increase at least at the
midpoint.
I think if you were
to look at new machine production and look at the percentages around that, that
would look better than the total overall. I think you would find dealer
sales to users are up more than what total sales are. Again, partly because
engines are flat and the service-related businesses that were in the high 40's
in terms of a percent of our total sales and revenues are much more stable
than the Machine and Engine business.
So the bottom line
to that is I think if you are just looking at new machine sales, percentage
wise, that is where more of the increase is, new machine sales.
Jim Owens - Caterpillar Inc. - Chairman &
CEO
Maybe just one
touch of color to that, too. As you know the recovery in machines sales,
particularly in the United States, Europe, and Japan, the traditional OECD
countries, is pretty anemic at this point. So we have very robust growth
occurring across the Asia-Pacific theater, Latin America, and selected parts of
Europe, Africa/ Middle East, but very anemic growth in the OECD world, which is
a substantial percentage of the total industry globally.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Alex, if you
would like to get back in the queue to do another question that would be fine,
but we are going to try to keep everybody to one so we can get more people
in.
Operator
Thank
you.
Operator
Mark
Koznarek.
Mark
Koznarek - Cleveland Research
Company - Analyst
Hi, Cleveland
Research, good morning. I would like to ask a question around the turbine
business because 90 days ago we thought that would be down pretty significantly.
I guess at the meeting that you hosted out there last year there was --
people got the sense it was going to be down double digits and, you know, the
guidance now seems to be flat.
First of all, I am
wondering if those are reasonable suppositions in terms of the change and then
if you can talk about where the demand improvement is coming from.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Well, the second
part of it being relatively flat, that is a pretty good supposition. The
piece before that about it being down significantly, we never used those words.
We said it would be off of the peaks of 2008 and 2009. We never really did give
a percentage range, but I would have never called it significant.
And the improvement
that we have seen is primarily for Solar in Latin America, both oil and gas
and electric power.
Doug
Oberhelman - Caterpillar Inc.
- Vice Chairman & CEO-Elect
Let me just add a
little bit to that, Mike. And Mark, you are right; we were definitely more
bearish last August about Solar's 2010 than we are today. Several things have
happened; Mike alluded to most of those.
I would say the
biggest surprise we had was -- that is new since we talked to you last was a
couple of very big orders in Latin America that are coming through in 2010 that
we did not expect -- to surface. They did, and that really helped out the
year for 2010.
Then, secondly, the
phenomenon around shale gas in the US, which is growing everywhere and you can
read about that constantly. But that is driving lots of new investment in
drilling and that is full compression of course into the mainline gas lines in
the United States. So those two things have been -- one, in the case of Latin
America, a very positive outcome we did not know about at that time and shale
gas has held up a lot more briskly than we thought.
So those two are
the broader things that I would answer that with.
Mark
Koznarek - Cleveland Research
Company - Analyst
Just to follow up
on this turbine business, what roughly is the manufacturing cycle time? Are
these two and three-quarter kind of production schedules or could we potentially
even see further upward revision? If orders come in, could they still impact
revenues later this year?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
I would say on the
short end Solar would probably be six -- it depends a lot, Mark, on the product.
But in my last discussions with them I think on the short end it's about a
six-month lead time and on the longer end maybe a year or more, for some of
the big, more complicated stuff.
Jim
Owens - Caterpillar Inc. -
Chairman & CEO
That would be
for new packages. For their customer services side of the business, which is
very substantial for them, they can react in shorter time frames.
Mark
Koznarek - Cleveland Research
Company - Analyst
Thank
you.
Operator
Seth
Weber.
Seth
Weber - RBC Capital Markets -
Analyst
RBC. Wondering if
you could just -- you mentioned a couple of times how the mix was a negative
drag on margins. I am wondering if you could -- if it's possible just to
quantify that a little bit more, give us some more detail whether that was more
on the Machinery or the Engine side.
And then as we look
forward, is it possible to frame that with the guidance? If you see the revenue
numbers coming in more towards the top end of the guidance, would that be more
of a headwind or less of a headwind? Thank you.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Generally speaking,
the sales mix -- I will give you just a couple of points around the first
quarter, then we can kind of talk about the year.
Now if you think
back to last year, we had really high engine margins in the first quarter,
relatively weak machine margins. If you look at the sales change quarter over
quarter, machines held up pretty well; most of the decline was in engines. So in
the first quarter a bigger decline in higher-margin engine business than
machines.
Then if you get
within machines and within engines, you see even more of it. We were producing
large engines, turbines, mining product out of a backlog to a higher degree,
let's say, in the first quarter of a year ago. So we had a pretty good engine
mix, we had a pretty good machine mix, and engines were relatively stronger than
machines. All of that kind of turned around here during the first
quarter.
So those are the
negatives. The positives -- there were some positives -- on balance it was
negative for the quarter. There were a few positives, though. We talked a little
bit ago about aftermarket. That has seen good improvement and that helped offset
some of the other declines. If you -- as you look out through the full year,
partly because of the inventory declines, the dealer inventory declines last
year, we are going to have probably quite a rebound for much of the smaller
product because it has more of an impact from the dealer inventory
changes.
So our small BCP
product production and sales on that is just going to be up substantially this
year and a lot of it is from a dealer inventory impact. So I think as we
progress through the year and the machine sales are up, we will continue to see
this negative mix throughout the year. And it's -- we didn't quantify it in the
release separately, but it's fairly significant.
Seth
Weber - RBC Capital Markets -
Analyst
Okay. So just
to clarify, if you hit the top end of your revenue guidance do you think that
would be a function of selling more of the lower margin
product?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Well, you know, I
think in all things there is a range for all sorts of the product. In other
words, there is a range for mining, there is a range for oil and gas. Jim made a
point a bit ago about Solar service business, for example, being able to react.
So I think there is plus and minus potential for probably each part of the
business so it depends which part of the business drove us towards the top
end.
Seth
Weber - RBC Capital Markets -
Analyst
Okay. All
right, thanks very much, guys.
Operator
Ann
Duignan.
Ann
Duignan - JPMorgan Securities
- Analyst
Good morning, guys,
JPMorgan. My question is around seasonality. Maybe you could help us understand
given that you are talking about ramping up production from here on out versus
we normally would model Q2 being stronger and then Q3 weaker. How should we
think about seasonality, particularly in machines, Mike, as we go through 2010?
Because it's not a normal year.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Seasonality is much
more difficult to play in when you are at kind of an inflection point, I think,
like we are now. Where we have moved from things getting worse to flattening
out to moving up. So I think the way I would think about it is production
will probably ramp as we go through the year.
Ann
Duignan - JPMorgan Securities
- Analyst
Okay, and
then just a quick follow-up. Since you raised the midpoint of your revenues, how
comfortable are you still that input costs will not now be a net
negative?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
You mean
material costs?
Ann
Duignan - JPMorgan Securities
- Analyst
Yes.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Yes. Well, material
costs were actually favorable in the first quarter and part of that $566 million
of manufacturing costs that we reported. So we are off to a pretty good start
but in all things, you know, the outlook is a forecast and certainly things
could change.
Based on where
commodity prices are, our discussions with suppliers, the cost-reduction actions
that we have enacted, the purchasing forward that we have done that, I think we
are reasonably comfortable that we will have favorable material costs this
year.
Ann
Duignan - JPMorgan Securities
- Analyst
Okay, I will
get back in line. Thanks.
Operator
David
Raso.
David
Raso - ISI Group -
Analyst
ISI, good morning.
Just thinking about the implied incremental margins for the rest of the year.
Year-over-year incrementals are implied around 18% and even if I want to add
back $400 million of higher R&D in the rest of the year, incentive comp say
around $250 million, it's still only implying 26%
incrementals.
And I appreciate
the mix, but I know we have discussed at times -- incrementals are different
than absolute. I know BCP is not a good margin business on an absolute level,
but year-over-year we spoke of BCP could get to breakeven this summer. That is a
big incremental in that business, so what am I missing why even with the R&D
and the incentive comp, 26% incremental margins? I mean, Machines revenues are
going to be up 55% year over year the rest of the year as per guidance. Is there
some thing I am missing about the incremental margins?
Mike DeWalt - Caterpillar Inc. - Director,
IR
Just a couple of
things, David. Our variable margin rate would be in the sort of mid-30's
normally, so with that as a starting point we do have negative mix, like we have
talked about, going forward. We do have a little bit higher R&D
costs.
When you have big
increases in volume that does drive a little bit of period cost in the factory.
Incentive compensation is higher, that is related to higher profit. So I think
those are all things that would take our variable margin rate and kind of
mitigate it.
Again, I think it's
R&D, I think it's incentive comp, I think it's product mix. And that is what
would take our kind of mid-30's variable margin rate down into the
mid-20's.
David
Raso - ISI Group -
Analyst
But again, the
mid-20's I had added it back to the R&D in the short term. If you want to go
all-in, you are saying the normal mid-30's so I guess it would be cut in half to
18%. And I am just trying to be clear, is there something unique? I would have
figured initially price versus cost. You are still guiding in a way that price
versus cost maybe is not quite as robust as three months ago, but it's not a
potential negative.
Mike DeWalt - Caterpillar Inc. - Director,
IR
If I -- it's
hard for me to guess what is in your model, but I would suspect probably that
maybe you are not factoring in enough for sales mix. I don't know.
David
Raso - ISI Group -
Analyst
Okay, and real
quick what it implies for 2011. If dealer inventory is flat, and I know Cat with
the lane strategy is trying to keep the dealer inventory tight. I am just
curious, what is management's view of a comfortable level for the dealer
inventory? Because whatever you want to assume about retail growth in 2011, the
dealers did take out $3.3 billion of inventory in 2009.
I know it's hard to
handicap it, but what is the thought, either it be you, Mike, or Doug or Jim on
in 2011 would it be logical that you can get half of the $3.3 billion back? What
are you comfortable with and obviously it depends on how effective the lane
strategy is, but what is the comfort level?
Doug
Oberhelman - Caterpillar Inc.
- Vice Chairman & CEO-Elect
You have got it,
David, and I would say at this stage it's going to be hard to judge 2011 for
lots of reasons. But we are about -- we are just over halfway through
implementation of our lane strategy right now, which we have got a long ways to
go with that. Where it has -- where it is working, the dealers love it, we love
it, and it's really going to pay off. But how that sorts out with the ramp up
here in the rest of 2010 and how fast we can get that fully implemented is going
to be part of the answer to 2011, as is the economic environment in
2011.
But we have got a
view that between rentals, between dealer inventory, and between our finished
goods inventory in lane one, that entire -- the aggregate of that mix is what we
are aiming to improve on any prior cycle we have had. So it's a bit -- even
if we wanted to comment about 2011, which we don't, we would not be in a
position just yet to talk about the full impact of the lane
strategy.
But it's coming and
I think by the time we see you in August we will have a lot better, I think,
idea of where that is going to end up. But we are still in the growth stage and
formative stage of that as we go and many of you have heard that through you
dealer surveys as well.
David
Raso - ISI Group -
Analyst
But is it
fair to say that unlikely flat inventory in 2011 versus 2010?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
David, this
is Mike. I am going to interject. I think we will pass on talking about 2011 and
we need to move on to the next question.
David
Raso - ISI Group -
Analyst
I appreciate
it, thank you.
Operator
Henry
Kirn.
Henry
Kirn - UBS Securities -
Analyst
Good morning, it's
UBS. First off, congratulations to Jim and congratulations for a good quarter.
Could you talk a little bit about how demand by end-market applications will
shift in 2010 versus the last few years?
Mike DeWalt - Caterpillar Inc. - Director,
IR
Well, definitely --
if we take Machines, definitely we are seeing increasing end-user demand in
mining. Actually, if you look worldwide, things actually look slightly positive
for residential, although North America is certainly down. Infrastructure
spending around the world looks pretty good.
I think, generally
speaking, if you look worldwide, again driven by the emerging market countries,
I think most all of the end markets look from slightly to moderately positive.
But mining is -- from a Machine standpoint is definitely looking
best.
I think for Marine
things are looking up right now in oil and gas. We talked about Solar a little
bit ago and Doug touched on the shale gas. Electric power is looking a little
bit better. Marine still weak and the MaK business is probably likely to
decline. Marine is probably a weaker one.
Actually in the
first quarter we had good sales from industrial. That piece of it I think turns
a little quicker, so that is looking more positive. I think maybe with the
exception of big Marine, I think most of the end markets are looking a little
bit better.
Henry
Kirn - UBS Securities -
Analyst
Thanks a
lot.
Operator
Eli
Lustgarten.
Eli
Lustgarten - Longbow Research
- Analyst
Longbow Securities,
good morning. We are going to miss you, Jim, but I hope you will help out your
economics department a little bit.
Anyway, can we talk
a little bit more about the cost side of it? With material costs going up this
year, how far out are you hedged this year? Am I to assume that you are
basically hedged for almost the entire year in most of your major steel
costs?
As part of it, with
emissions coming next year, you have higher material costs, you are going to
have to face at one point or another emissions. What is the probability of
seeing some sort of pre-buy both in the Engine and particularly in the Machinery
side as you get toward the end of the year because of the potential for higher
prices next year?
Mike DeWalt - Caterpillar Inc. - Director,
IR
That is one
complicated question.
Doug
Oberhelman - Caterpillar Inc.
- Vice Chairman & CEO-Elect
Great question,
Eli. Wow.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
I will start out
the first part on material costs. We don't actually do a lot of hedging per se.
There is a little bit, but not a lot.
What we have done a
little bit more of this year is do some pre-buys. I guess you might call that a
form of hedging. But we have gone out to some of our suppliers and done a little
bit of pre-buying, both to lock in some supply and some price. And I think
those mostly just go out through a couple of quarters so it's not massively
extensive.
I think the biggest
positive for us on material costs this year -- I think commodity costs will be
up -- but we have done a lot of work to drive cost reduction, design and
sourcing-related cost reduction. And our view is that is going to likely
offset the commodity-related increases this year and keep us slightly
favorable.
Doug
Oberhelman - Caterpillar Inc.
- Vice Chairman & CEO-Elect
Let me talk about
Tier 4 a little bit, Eli, and you will be seeing our strategy on Tier 4 here
rollout in the next few weeks and month or two in terms of what we intend to do
with our models that we offer and our pricing strategy.
As you know, the
off-road business really has never seen a pre-buy phenomenon like the on-road
business has. Depending on the strength of the economy, when all of us in
the industry announce 2011 strategies, I would expect some pressure from
customers on some pre-buy. But, again, it's going to be spotty and
dependent.
You have got to
remember too Tier 4/3b only applies to Western Europe, Japan, and America
and then it's a phase-in. The rest of the world has nothing to do with Tier 4 at
the moment, which would be two-thirds of the business if not a little more.
But I would expect in some models, in some zones geographically, we would see
some heightened order activity mid-year, third quarter after they see how we are
all going to come at this for 2011.
As it rolls on out
through 2012 and 2013, as more and more of the horsepower ratings and ranges
come in, and depending on what happens with the January 2011 early-model
adopters, you could see some of that. I think we would expect something around
that, but it's really difficult to predict at the moment with so much
uncertainty in exactly the places where Tier 4 and 3b is going to occur, Western
Europe and the US.
Jim
Owens - Caterpillar Inc. -
Chairman & CEO
And it might
not be that material, Eli, because of just sheer capacity in the fourth quarter
given how fast things are ramping up.
Eli
Lustgarten - Longbow Research
- Analyst
Thank
you.
Operator
Joel
Tiss.
Joel
Tiss - Buckingham Research
Group - Analyst
Buckingham
Research. Of the $4 billion of underproduction in 2009, about how much came back
in the first quarter?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Well, in the first
quarter machine inventory was about flat. So in the first quarter a year ago, I
think machine inventory declined about $300 million. So we said this year would
be flat and for machines that's what happened actually in the first quarter.
Dealers actually took a couple hundred million out for
engines.
Joel
Tiss - Buckingham Research
Group - Analyst
That's on the
production side?
Mike DeWalt - Caterpillar Inc. - Director,
IR
Right. Plus
production is essentially, for the most part, sales.
Joel
Tiss - Buckingham Research
Group - Analyst
Okay, thank
you.
Operator
Jamie
Cook.
Jamie
Cook - Credit Suisse -
Analyst
Good morning. I
guess a quick question. Can you sort of comment internally how -- I guess the
concern is if this recovery happens how you think Caterpillar is doing so far.
I'm hearing surprising statistics in the channel already about sort of lead time
issues on the machinery side. So if you could sort of comment where you are,
where lead times are today for machinery relative to where we were sort of three
or six months ago and your ability to -- what you are assuming if any in your
forecast in terms of potential market share gains.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
I'll start that
question out and then I will let Jim and Doug chime in as they want to. But I
think basically with the lane strategy, you almost have to look at this in
pieces. It's not as simple as just what are lead times, because it really
depends upon what channel they come out of. With lane one, for example, our
target is about a 10-day lead time.
And except for a
couple of products that are coming out of Japan and we actually underestimated
demand, except for those couple of products, generally speaking that's about
where we're at. So delivery time for the roughly 24% of machine sales that came
out of lane in March, lead times are very, very short.
Now for a product
that's just -- the dealers place on the factory and don't get out of lane one,
we have moved in terms of quoted delivery time from sort of 11, 12 weeks to
around 15 weeks. So it has moved out, and I think that is really a function of
again being at an inflection point where we are in process of moving production
up to a higher level.
I would point out,
though, as a part of that we are giving preferential treatment to dealer orders
that have a customer attached. So if there is a customer involved, those orders
generally get shipped three or four weeks earlier than an inventory order, if a
dealer is ordering to add to his inventory. So I think in the scheme of things,
delivery times are going out but really aren't too bad.
Jim
Owens - Caterpillar Inc. -
Chairman & CEO
Jim Owens. Just a
brief comment. Capital goods are notoriously difficult to forecast. Three to six
months ago, most of you, all of our dealers, and many of our customers were very
pessimistic about the global economy and I don't think they saw the V-shaped
recovery, particularly in a lot of commodity sectors and emerging markets, that
was unfolding even at that time.
So we have had a
very sharp bounce back in enthusiasm here and, quite frankly, our economics
group was well ahead of most marketing groups, as well as even customers, in
forecasting the upturn in the strength of commodity markets. So as early as
October last year we have been out working with suppliers, not only our direct
suppliers but our second tier suppliers, and helping them understand this
inventory cycle and how it's going to impact their sales.
I think we are more
ahead of it, if you will, certainly than we were coming into the 2004 cycle. Our
ability to ramp up now is really a function of how fast we can bring the supply
chain along. Our ability -- we are kind of capacitized for $55 billion or so
top-line sales and revenue, but you have got to bring a supply base up to get to
that kind of level and that is going to take some time.
We are working that
issue very hard. Again, we had a roadshow in October helping them get prepared
for this eventuality. We weren't certain it would happen, but we thought there
was a high probability. So I think we are out in front of this to a reasonable
extent compared to where we were back in 2004.
Jamie
Cook - Credit Suisse -
Analyst
All right.
Thanks, and best of luck, Jim.
Operator
Ted
Grace.
Ted
Grace - Avondale Partners -
Analyst
Good morning, it's
Ted Grace from Avondale Partners. I had a quick question on integrated services.
In the press release we could see that it was about 47% of 1Q revenue. Just
wondering if you could give us a year-ago comp and then if you could also speak
to kind of the key elements.
I know you
mentioned that aftermarket parts was looking better on the outlook side. I am
just wondering if you might be able to give us some more color on machines
versus engines. And then if you could give us any color on some of the other big
parts, logistics, and Progress Rail would be terrific. Thank you.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Yes, I am going
from memory here, Ted, but I think last year was around 40% in terms of
integrated services so this year is little bit above that. So in other words,
last year we did $9.2 million and 40% of that would have been integrated
service-related.
Ted
Grace - Avondale Partners -
Analyst
Okay. And
then any specific color on Machines versus Engines and logistics versus Progress
Rail? We can already see what happened with Financial Services.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Yes, yes. The only
place where it actually made any specific comments is around the aftermarket
piece of that, and that is definitely improving. Again, the rest of the -- or in
general the integrated services businesses, they don't go up and down as
dramatically as certainly new machine and new engine sales.
So I'll sort of
leave it at that. We have never really broken them out and shown them
separately.
Doug
Oberhelman - Caterpillar Inc.
- Vice Chairman & CEO-Elect
And I would just
add a couple things. The manufacturing business and our Progress Rail element
have performed well in 2009, as we expected them to do, and they are enjoying a
bit of an uptick as well, not dissimilar to the rest. So it's kind of across the
board, but the big driver is those aftermarket parts, as we have said many
times. And that is important to us.
Ted
Grace - Avondale Partners -
Analyst
Okay, thank
you very much.
Operator
Andrew
Casey.
Andrew
Casey - Wells Fargo Securities
- Analyst
Wells Fargo
Securities. Thanks and good morning. Clarification on the gas turbine comments.
Should we expect production to flip positive when compared to the
prior year as you get to the end of 2010? And then lastly is the $55
billion capacity size for the Company at today's pricing levels?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
The answer the
first question is if you look at Solar, just a couple of observations. One, we
said full-year could be close to last year, but last year they had a really big
first quarter and second quarter. And already in the first quarter their
deliveries were below the first quarter of a year ago. So the last three
quarters ought to be better.
They had a really
big second quarter, so I would suspect that year-over-year they will probably
see a bigger increase in the second half of the year.
I am sorry, Andy,
what was the second part of your question?
Doug
Oberhelman - Caterpillar Inc.
- Vice Chairman & CEO-Elect
But having said
that, Mike, we are still cautionary beyond in terms of where we are going to be
in 2010. We were surprised by a couple of big orders we did not anticipate. We
will see how it goes after that. So I would say that is a fair comment of
Mike's, but we would go no further.
Andrew
Casey - Wells Fargo Securities
- Analyst
Okay. Thanks,
Doug. The second part --?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
On the capacity
issue, that is a rough number. Again, we actually did over $51 billion at 2008
prices in 2008 with only one quarter of Cat Japan in the number. So
basically the $55 million is an observation based off where we were in
2008.
Andrew
Casey - Wells Fargo Securities
- Analyst
Okay. I just
wanted to clarify that in front of whatever the strategies are for Tier
4.
Jim
Owens - Caterpillar Inc. -
Chairman & CEO
That does not
include Tier 4 pricing.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Right. No,
that would be, let's say, where we are at today. Tier 4 pricing would definitely
go up.
Andrew
Casey - Wells Fargo Securities
- Analyst
Okay. Thank
you very much.
Operator
Barry
Bannister.
Barry
Bannister - Stifel Nicolaus -
Analyst
Barry Bannister,
Stifel Nicolaus. I was looking at an Engineering News Record article on February
22 and it said that CAT construction equipment prices will rise about 12% over
the next four years as the Company rolls out Tier 4. Then it goes on to say that
about a third of the increase or 4% would start in 2010, said CAT officials at
the Peoria headquarters.
Pricing in the
quarter was 2%. Are you planning on trying to do 4% this year or was the article
out of context? And does 12% over several years sound about right?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
The 12% was really
starting in 2011, not 2010, when Tier 4 starts. And that is not necessarily an
overall machine number. We have adjusted in those places where you are going to
get Tier 4. For the product that goes to emerging markets that is not Tier 4
that certainly wouldn't apply.
The point of the
article, Barry, was that on average over the Tier 4 implementation, we
are seeing a cost increase and we felt the need to get about 4% for Tier 4. And
the thought was that we would try to do it uniformly over a few years rather
than just one lump sum at introduction, say, in 2011.
So it really wasn't
so much a 2010 comment.
Doug
Oberhelman - Caterpillar Inc.
- Vice Chairman & CEO-Elect
Let me come back to
this little bit, Barry, in terms of Tier 4 phase-in, and Tier 4 is not a big
bang by any stretch. In fact there is some fairly narrow horsepower band ratings
that phase-in beginning January 1, 2011. That is the very first pricing activity
that we would take for Tier 4 emissions. Then over the next four years
culminating with the big high horsepower stuff in locomotives and barges, Tier 4
is done.
But nothing happens
in 2010 and then it's really a building wave in 2011, 2012, 2013, 2014, and 2015
as those new products come in. There are lots of ways to use the
regulations to the industry's benefit in there as well. So we will be talking a
lot more about that probably in August and you will see as we go what our
strategy will be as the year rolls on.
Barry
Bannister - Stifel Nicolaus -
Analyst
Okay. Thanks,
guys.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
I think we
have time for one or two more, and then Jim will wrap up. Next
question.
Operator
Alexander
Blanton.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Next
question? Alex, you got back in the queue.
Alexander
Blanton - Ingalls & Snyder
- Analyst
Yes, I did. Thank
you very much. Listen, I just wanted to say one thing. Thanks for allowing a
dialogue on our questions this time, because it really didn't work too well last
time cutting us off right at the beginning of the answer. So I think that worked
a lot better and you got everybody in it looks like.
Just could you
clarify what that 12% is on the last question from Barry? Is it 4% a year for
three years? Is that --?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Yes, I think
what we talked about is increases of up to 12% on Tier 4 product and we were
going to phase it in.
Doug
Oberhelman - Caterpillar Inc.
- Vice Chairman & CEO-Elect
Remember Tier 4 is
machines, engines, locomotives, every single product off-road we make across our
300 product families and beyond, so it's a very broad statement that applies to
a lot of things. The specifics -- we will be dealing with the specifics as we
introduce these products going forward. It's a very -- almost technical review
of pricing as well as competitive environment at that time.
Alexander
Blanton - Ingalls & Snyder
- Analyst
But it sounds like
it's because you are phasing in various products each year. Because if the cost
-- if it's just a cost catch up, picking up the cost of this, and you only do 4%
the first year, would there be a negative impact on your costs that year in tune
--?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
We
will talk about that more when it happens in 2011, but remember all the sales
don't phase-in the first year either.
Alexander
Blanton - Ingalls & Snyder
- Analyst
All right, so
it phases in along with the sales. Thank you.
Operator
Andrew
Obin.
Andrew
Obin - BofA Merrill Lynch -
Analyst
Yes, BofA Merrill
Lynch. I guess I have to learn how to punch numbers in better. The question I
have is on phasing in of the manufacturing costs throughout the
year.
Could you just give
us some guidance as to -- this is the number you disclosed in your [water flow]
chart. How should we be thinking about it throughout the year and if it can
actually become a drag by the end of the year?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Well, again
manufacturing costs are material, labor and overhead, warranty, and we expect
all of those to be favorable for the full year. They were actually pretty
favorable in the first quarter.
You know, I think
for material costs, it's probably a little bit easier in the first quarter
because we were coming out of the first quarter of 2009 and it was coming off of
maybe a higher cost level coming out of 2008. So I would say probably for
material costs with -- commodity prices is up and I think the comps will get
increasingly difficult. So I think material costs will get harder as we go
through the year.
I think in terms of
labor and overhead we got a lot of programs in place. I think we are doing a
pretty good job. Now the first quarter of last year we did -- that is when we
started the ramp down, but I think it will probably be favorable as we go
through the year.
I think with
further implementation of CAT Production System, we got higher volumes, and all
that ought to be pretty good for manufacturing costs.
Andrew
Obin - BofA Merrill Lynch -
Analyst
So by Q4 it
would still be better than nothing, right?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Again, I
would --
Andrew
Obin - BofA Merrill Lynch -
Analyst
I understand
it's hard to forecast the future, but generally that is the direction I should
be thinking of?
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Yes, I think that
is correct. Again, though, I think the comps get harder as you go through the
year on material costs. So that is one where I would guess the gap would be
shrinking.
Andrew
Obin - BofA Merrill Lynch -
Analyst
Terrific,
thank you very much.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Okay, with
that we will let Jim wrap up and --
Jim
Owens - Caterpillar Inc. -
Chairman & CEO
Well, thanks, Mike,
and thanks to all of you. I have -- let me just start by saying I have enjoyed
the opportunity over the last 6 and one-half years to work with the analyst
community. You have been very understanding. We have had good working rapport, I
would say, and I appreciate the work that you all do.
Secondly, of
course, the greatest honor for me has been to play quarterback for what I think
is one of the finer companies on the global stage, great people the world over.
And in terms of accomplishments, the people side of the equation, what we
have done on the safety and engagement side, I think bodes very well for the
future of our company and is just indicative of the kind of very positive change
that we have made on a continuous and steady basis.
We are very much
focused on managing through the cycle. I think we were challenged certainly to
get the pull-through we would have liked with explosive growth from 2003 through
2008. I think we demonstrated a lot of capability, maybe surprising some of you,
on our ability to manage a very troublesome and horrific recession in 2009. I
think it was one of our finest hours.
We showed a lot of
nimbleness in taking costs out in a hurry and did achieve what we considered the
hat trick of sustaining profitability, sustaining our credit rating, and our
dividend. And I think we continued to invest in key capacity bottlenecks and in
research and engineering that bode very well for our future.
We are very much
focused on delivering results for long-term shareholders. Sometimes I know that
doesn't square with the image of CEOs that are focused on just quarterly
pennies, but we are very much focused on the long-term shareholder. I think we
have our company exceptionally well-positioned for growth on a global
scale.
I can't tell you --
I was honored with Doug's opening comments, but I think the transition that we
have planned has been well laid out. It's going exceptionally well. I am
confident you are going to hear a strategy rollout in August which shows you
exactly how the team is going to take our company to another level going forward
for the next five to ten years.
So, again, it has
been an exciting time. I, again, appreciate all the work and rapport we have
had. Good luck on these forecasts for the coming year.
Mike
DeWalt - Caterpillar Inc. -
Director, IR
Okay, with
that we are at the end of our hour. Thank you very much and we will be talking
to you over the next quarter.
Operator
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.