Caterpillar Reports Record Third Quarter -2006
Caterpillar Has Best Third Quarter in the Company's History; Focus Is on Execution of the Company's Strategy in Areas of Quality, Safety and Velocity
PEORIA, Ill., Oct. 20 -- With a strong focus on executing its corporate strategy, today Caterpillar Inc. reported record third quarter 2006 sales and revenues of $10.517 billion and record third-quarter profit of $769 million, or $1.14 per share. Sales and revenues increased 17 percent, and profit per share was up 21 percent compared with the third quarter of 2005. Sales and revenues for the first nine months of 2006 of $30.514 billion and profit of $2.655 billion, or $3.86 per share, were also records.
"We achieved this quarter's results due in great part to the efforts of Caterpillar's employees, dealers and suppliers who continue to work to remove bottlenecks and increase production for a number of products," said Caterpillar Chairman and Chief Executive Officer Jim Owens. "Team Caterpillar remains focused on achieving our 2010 goals and executing our corporate strategy with 6 Sigma -- especially in the areas of quality, safety and velocity."
Sales and revenues increased $1.540 billion -- $1.063 billion from higher sales volume, $290 million from improved price realization, $97 million from the effects of currency and $90 million from higher Financial Products revenues.
Third-quarter profit increased $102 million from third quarter 2005. The increase was largely due to improved price realization and higher sales volume, partially offset by higher costs, including approximately $80 million of expense related to various legal disputes, principally a settlement with Navistar.
"I'm excited about Caterpillar's future and our ability to deliver on the goals we've set," Owens said. "We're into our fourth year of solid growth in many of the key industries we serve -- mining, energy and infrastructure development in particular. Our product line remains the global leader, and our brands are strong and recognized worldwide as the highest in customer value. We're well-positioned to build on these strengths going forward."
(A more complete review of third-quarter results begins on page 4.) 2006 Outlook / 2007 Preliminary Outlook
We expect sales and revenues for 2006 to be about $41 billion, up about 13 percent from 2005, and profit per share to be in a range of $5.05 to $5.30. The previous outlook reflected sales and revenues up 12 to 15 percent and profit per share of $5.25 to $5.50. The decline from the previous outlook was a result of charges related to third-quarter legal disputes, higher core operating costs and slightly lower sales volume.
Our preliminary outlook for 2007 sales and revenues is flat to up 5 percent from 2006, and profit per share is expected to be flat to up 10 percent from the midpoint of the 2006 outlook range.
"We're expecting slightly higher sales and revenues in 2007 despite the prospects of a slowing U.S. economy, a sharp drop in sales of on-highway truck engines and weaker housing construction," Owens said. "It's a testament to the strength and diversity of the industries we serve and the global nature of our products and services that we expect at least modest growth despite a weaker U.S. economy and significant declines in important North American markets. While next year will likely be a year of slower corporate growth, the fundamentals for key global industries we serve are strong, and after the 2007 pause, we expect continued solid growth through the end of the decade."
For more than 80 years, Caterpillar Inc. has been making progress possible and driving positive and sustainable change on every continent. With 2005 sales and revenues of $36.339 billion, Caterpillar is the world's leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and a wide and growing offering of related services. More information is available at http://www.cat.com/ .
Note: Glossary of terms included on pages 23-24; first occurrence of terms shown in bold italics.
Key Points
Third Quarter
-- Third-quarter sales and revenues of $10.517 billion were 17 percent
higher than third quarter 2005.
-- Machinery sales increased 15 percent, Engines sales increased
23 percent and Financial Products revenues rose 15 percent from a year
ago.
-- Third-quarter profit was $769 million, or $1.14 per share --
21 percent higher than third quarter 2005.
-- Shares repurchased totaled 6.6 million during the quarter. With
shares issued to offset employee stock options exercised, the net
reduction of shares outstanding was 5.2 million.
Year to Date
-- Year-to-date sales and revenues were $30.514 billion, up 14 percent
from 2005. Profit was $2.655 billion, or $3.86 per share, up
36 percent from 2005.
-- Machinery and Engines operating profit as a percent of sales
increased -- from 10 percent year to date 2005 to 13 percent in 2006.
-- Machinery and Engines "operating profit pull through" -- the change in
operating profit divided by the change in sales -- was 30 percent.
-- Machinery and Engines operating cash flow year to date 2006 was
$2.774 billion, up $832 million from 2005. This strong cash flow
allowed us to increase capital expenditures to $900 million, acquire
Progress Rail, announce a 20 percent dividend increase and repurchase
39.9 million shares. After issuing shares for stock option exercises
and the acquisition of Progress Rail, the net reduction of shares
outstanding was 20.3 million.
Outlook
-- We expect sales and revenues to be about $41 billion in 2006, up about
13 percent from 2005. The 2006 profit range has been revised to
$5.05 to $5.30 per share from the previous range of $5.25 to $5.50 per
share.
-- Sales and revenues in 2007 are expected to be flat to up 5 percent
from 2006, with profit per share ranging from flat to up 10 percent
from the midpoint of the 2006 range, which is $5.18.
A question and answer section has been included in this release starting on page 16.
DETAILED ANALYSIS Third Quarter 2006 vs. Third Quarter 2005
[Link to see chart for Consolidated Sales and Revenues Comparison Third Quarter 2006 vs. Third Quarter 2005: http://www.cat.com/chart11006.gif ]
Sales and Revenues
Sales and revenues for third quarter 2006 were $10.517 billion, up $1.540 billion, or 17 percent, from third quarter 2005. Machinery volume was up $579 million, Engines volume was up $484 million, price realization improved $290 million and currency had a positive impact on sales of $97 million. In addition, Financial Products revenues increased $90 million.
Sales and Revenues by Geographic Region
(Millions of % North % %
dollars) Total Change America Change EAME Change
Third Quarter 2005
Machinery $5,648 $3,198 $1,199
Engines(1) 2,744 1,299 816
Financial
Products(2) 585 412 85
$8,977 $4,909 $2,100
Third Quarter 2006
Machinery $6,472 15% $3,570 12% $1,510 26%
Engines(1) 3,370 23% 1,561 20% 1,078 32%
Financial
Products(2) 675 15% 471 14% 95 12%
$10,517 17% $5,602 14% $2,683 28%
Latin % Asia/ %
America Change Pacific Change
Third Quarter 2005
Machinery $551 $700
Engines(1) 249 380
Financial Products(2) 39 49
$839 $1,129
Third Quarter 2006
Machinery $650 18% $742 6%
Engines(1) 249 0% 482 27%
Financial Products(2) 49 26% 60 22%
$948 13% $1,284 14%
(1) Does not include internal engines transfers of $564 million and
$549 million in third quarter 2006 and 2005, respectively. Internal
engines transfers are valued at prices comparable to those for
unrelated parties.
(2) Does not include revenues earned from Machinery and Engines of
$126 million and $82 million in third quarter 2006 and 2005,
respectively.
Machinery Sales were $6.472 billion, an increase of $824 million, or
15 percent, from third quarter 2005.
-- Sales volume increased $579 million.
-- Price realization increased $183 million.
-- Currency benefited sales by $62 million.
-- Worldwide, and in most regions, dealers reported higher inventories in
constant dollars compared with third quarter 2005. During the
quarter, dealers reduced inventories, which had a negative impact on
sales volume. Inventories in terms of months of supply were down from
a year earlier for the world and all regions, with the exception of
North America.
-- Sales were up in North America due to the acquisition of Progress
Rail.
-- Sales increased in Europe, Africa, Middle East (EAME); Europe had its
best quarter for growth in six years, and strong economic growth
continued in both Africa/Middle East and the Commonwealth of
Independent States (CIS).
-- Although mining activity continued to be strong, new product
introductions and mine permit delays in the U.S. slowed growth in
large machine sales.
North America -- Sales increased $372 million, or 12 percent.
-- Progress Rail sales were $438 million. Excluding Progress Rail, sales
volume declined $184 million.
-- Price realization increased $118 million.
-- Dealers reported higher inventories in terms of months of supply than
a year earlier.
-- The U.S. economy slowed to a 2.6 percent rate of growth in the second
quarter of 2006, and we project third-quarter growth was even slower,
possibly below 2 percent. The slowdown has been concentrated in
consumer spending and housing. Except for housing, other industries
we serve continued to do well in the third quarter.
-- Sales of smaller machines, which are highly dependent upon general
construction applications, were down.
-- Mine production increased more than 3 percent in the third quarter.
However, new product introductions and mine permit delays led to a
decline in large machine sales.
-- Nonresidential construction did well in the third quarter with
spending up more than 20 percent from a year earlier. Highway
spending increased 19 percent, office construction rose 27 percent and
hotel construction increased 69 percent.
EAME -- Sales increased $311 million, or 26 percent.
-- Sales volume increased $253 million.
-- Price realization increased $8 million.
-- Currency benefited sales by $50 million.
-- Dealers reported the same inventories as a year earlier; in months of
supply, inventories were lower.
-- Sales increased in Europe, the result of continued growth in housing
construction and a rebound in nonresidential construction. Second-
quarter data indicated over a 3 percent increase in construction
compared to a year earlier, the best growth in six years. Surveys of
construction confidence in the third quarter were more favorable than
those taken in the second quarter.
-- Sales increased in Africa/Middle East, particularly in the oil
producing countries as well as Turkey and South Africa. Construction
spending increased more than 5 percent in South Africa, Saudi Arabia,
United Arab Emirates and Turkey when compared to a year earlier.
Energy production also increased, as did investments in new capacity.
-- Sales growth in the CIS occurred mostly in Russia and Ukraine. Russia
increased production of crude oil, natural gas, coal and metals. In
Ukraine, construction increased 7 percent compared to a year earlier,
and mining and quarrying increased 6 percent.
Latin America -- Sales increased $99 million, or 18 percent.
-- Sales volume increased $41 million.
-- Price realization increased $49 million.
-- Currency benefited sales by $9 million.
-- Dealers reported lower inventories than last year, and months of
supply were below a year earlier.
-- Healthy economic growth has led to increases in construction.
Spending is up in the major countries, ranging from 5 percent to over
20 percent.
-- Higher prices for metals caused countries to increase production
between 2 and 5 percent. Brazil was one of the few countries able to
capitalize on higher oil prices by increasing production.
-- Chile, Brazil and Colombia accounted for much of the growth in sales.
Asia/Pacific -- Sales increased $42 million, or 6 percent.
-- Sales volume increased $31 million.
-- Price realization increased $8 million.
-- Currency benefited sales by $3 million.
-- Dealers reported higher inventories than a year earlier but lower
inventories in months of supply.
-- Sales growth occurred in China and India where construction and mining
are increasing. In China, office and commercial construction
completions increased 15 percent from a year earlier, and residential
completions increased 29 percent.
-- Sales also increased in Australia where nonresidential construction
and mining increased.
-- Sales declined in Indonesia. Although sales have been on an improving
path this year, they have yet to return to last year's peak.
Engines Sales were $3.370 billion, an increase of $626 million, or
23 percent, from third quarter 2005.
-- Sales volume increased $484 million.
-- Price realization increased $107 million.
-- Currency impact benefited sales $35 million.
-- Worldwide, and for most geographic regions and industries, dealer
reported inventories in constant dollars were up. Inventories in
months of supply also increased.
-- Strong prices for oil and gas, coupled with limited reserve capacity,
continued to drive strong sales of turbines and reciprocating engines
for petroleum applications.
North America -- Sales increased $262 million, or 20 percent.
-- Sales volume increased $197 million.
-- Price realization increased $65 million.
-- Sales for petroleum applications increased 56 percent, led by strong
demand for large reciprocating engines in gas drilling and compression
as well as strong sales of turbines and turbine-related services for
pipeline compression.
-- Sales for on-highway truck applications increased 13 percent due to
strong truck demand and the impact of truck purchases prior to the
2007 emissions changeover.
-- Sales for industrial applications increased 10 percent with ongoing
investment in various types of industrial Original Equipment
Manufacturer (OEM) equipment.
-- Sales for marine applications increased 7 percent as increased sales
for work boats were partially offset by reduced demand for pleasure
craft.
-- Sales for electric power applications remained about flat as increased
sales for telecommunications and data applications were offset by
lower power plant sales.
EAME -- Sales increased $262 million, or 32 percent.
-- Sales volume increased $207 million.
-- Price realization increased $24 million.
-- Currency impact benefited sales $31 million.
-- Sales for electric power applications increased 42 percent with strong
increases in developing region demand for generator sets supported by
high commodity prices, increased demand for electric power rentals and
higher sales of turbines and turbine-related services for power
plants.
-- Sales for marine applications increased 25 percent from higher demand
for oceangoing vessels.
-- Sales for industrial applications increased 14 percent due partially
to improved demand for agricultural equipment.
-- Sales for petroleum applications increased 21 percent with increased
demand for turbines and turbine-related services for oil production
and gas transmission.
Latin America -- Sales remained flat.
-- Sales volume decreased $9 million.
-- Price realization increased $9 million.
-- While sales overall were flat, sales for on-highway truck and electric
power applications increased but were offset by a decline in petroleum
engines.
Asia/Pacific -- Sales increased $102 million, or 27 percent.
-- Sales volume increased $89 million.
-- Price realization increased $9 million.
-- Currency impact benefited sales $4 million.
-- Sales for petroleum applications increased 58 percent, primarily from
continued growth in demand for turbines and turbine-related services
in Southeast Asia as well as ongoing increased demand for drill rigs.
-- Sales for electric power applications increased 20 percent with
increased shipments of large generator sets to support textile and
other manufacturing industries.
-- Sales for marine applications increased 2 percent as higher deliveries
to oceangoing vessels were mostly offset by lower pleasure craft
demand.
Financial Products Revenues were $675 million, an increase of $90 million,
or 15 percent, from third quarter 2005.
-- Growth in average earning assets increased revenues $43 million.
-- The impact of higher interest rates on new and existing finance
receivables at Cat Financial added $31 million.
[Link to see chart for Consolidated Operating Profit Comparison Third Quarter 2006 vs. Third Quarter 2005: http://www.cat.com/chart21006.gif ]
Operating Profit
Operating profit in third quarter 2006 improved $138 million, or 15 percent, from last year, driven by higher price realization and sales volume, partially offset by higher core operating costs needed to support sales growth.
Core operating costs rose $407 million from third quarter 2005. Of this increase, $225 million was attributable to higher manufacturing costs. The increase in manufacturing costs was split about evenly between period costs to support higher volumes, higher material costs and variable inefficiencies. Non-manufacturing core operating costs were up $182 million as a result of higher Selling, General and Administrative (SG&A) and Research and Development (R&D) expenses to support significant new product programs as well as order fulfillment/velocity initiatives. Third quarter 2006 SG&A expense includes approximately $70 million related to a settlement of various legal disputes with Navistar.
Operating Profit by Principal Line of Business
Third Third
Quarter Quarter $ %
(Millions of dollars) 2005 2006 Change Change
Machinery(1) $615 $626 $11 2%
Engines(1) 265 398 133 50%
Financial Products 123 171 48 39%
Consolidating Adjustments (63) (117) (54)
Consolidated Operating
Profit $940 $1,078 $138 15%
(1) Caterpillar operations are highly integrated; therefore, the company
uses a number of allocations to determine lines of business operating
profit for Machinery and Engines.
Operating Profit by Principal Line of Business
-- Machinery operating profit of $626 million was up $11 million, or
2 percent, from third quarter 2005. The favorable impact of improved
price realization and higher sales volume was largely offset by higher
core operating costs.
-- Engines operating profit of $398 million was up $133 million, or
50 percent, from third quarter 2005. The favorable impact of higher
sales volume and improved price realization was partially offset by
higher core operating costs, which included expense related to a
settlement of various legal disputes with Navistar.
-- Financial Products operating profit of $171 million was up
$48 million, or 39 percent, from third quarter 2005. The increase was
primarily due to a $21 million impact from the continued growth of
average earning assets and a $23 million impact from improved net
yield on average earning assets at Cat Financial.
Other Profit/Loss Items
-- Other income/expense was income of $72 million compared with income of
$80 million in third quarter 2005. The decrease is primarily due to
expense related to legal disputes.
-- The provision for income taxes in the third quarter reflects an
estimated annual tax rate of 31 percent for 2006 compared to
30 percent for the third quarter 2005 and 29.5 percent for the full
year 2005 (excluding discrete items). The increase is primarily due
to a change in our geographic mix of profits as well as the impact of
the phaseout provision of the American Jobs Creation Act permitting
only 60 percent of Extraterritorial Income Exclusion (ETI) benefits in
2006.
The third quarter 2005 provision for income taxes included an
unfavorable adjustment of $18 million resulting from an increase in
the estimated annual tax rate from 29 to 30 percent for the first six
months of 2005.
Employment
Caterpillar's worldwide employment was 93,233 in third quarter 2006, up 9,334 from 83,899 in third quarter 2005. Of the increase, about 5,200 was a result of acquisitions, and about 1,900 hourly and 2,200 salaried and management employees were added to support higher volume and new product introductions. The increase related to acquisitions was for Progress Rail and a logistics business in Europe.
2006 Outlook -- Sales & Revenues
The outlook for 2006 sales and revenues is about $41 billion, an increase of about 13 percent from 2005.
-- The U.S. Federal Reserve (Fed) interest rate actions slowed the U.S.
economy significantly the past two quarters. Fortunately, better
growth in both Europe and Japan is helping fill the void caused by the
U.S., and developing country growth remains strong. We expect world
economic growth of slightly less than 4 percent this year, up from
3.5 percent in 2005.
-- The Fed and the Bank of Canada have held rates constant in recent
policy reviews and are not expected to change for the rest of the
year. In countries outside North America, central banks have raised
interest rates from some of the lowest levels in years, but these
increases should pose only a scattered threat to economic growth.
-- Housing construction dropped sharply in the U.S., and the recent
reversal in mortgage rates is unlikely to revive activity much this
year.
-- Elsewhere, prospects for housing are more favorable, the result of
higher home prices, low interest rates and growing populations. The
supply of new homes outside of the U.S. generally appears short of
demand.
-- Nonresidential building construction should do well in most countries.
Construction has not caught up with needs deferred in the past,
profits are at record highs and most businesses have ready access to
capital.
-- Infrastructure construction should continue to grow as well.
Increased federal funding and improved state budgets have led to a
large increase in highway contracts awarded in the U.S. Developing
countries are using revenue gains from increases in both commodity
prices and production to extend infrastructure development booms.
-- Worldwide, metals mining companies increased exploration and
development budgets 45 percent in 2006, the fourth consecutive year of
double-digit percentage increases. Despite those increases, mining
production capacity continues to struggle to meet demand. Metals
demand is growing rapidly, inventories are nearly depleted and
production problems persist. Mine production in three major producing
countries -- Australia, Canada and South Africa -- declined year to
date.
-- West Texas Intermediate crude oil prices recently dipped below $60 per
barrel, and natural gas prices also declined sharply. However, we do
not expect these lower prices to disrupt the growth in exploration,
drilling, pipeline expenditures and tar sands development that has
benefited both machine and engine sales. Very little surplus
production capacity is available, and the potential for supply
disruptions is high.
-- International spot prices for coal are trading above year earlier
prices; demand continues strong, and many exporters are struggling to
increase output. Continued good economic growth should require
increased electricity production, and coal is often the most cost-
effective energy source.
-- Ocean shipping rates are higher than last year, and shipyards have
healthy order backlogs. A high percent of ships are more than
20 years old, which should keep demand for new ships and ship rebuilds
high. Both should boost engine sales.
North America (United States and Canada) -- Machinery and Engines sales are expected to increase about 14 percent in 2006.
-- The Fed held interest rates at 5.25 percent the past two meetings, and
we expect no rate changes for the rest of the year. Past actions have
already slowed the economy, and growth should average around 2 percent
in the last two quarters.
-- So far, economic weakness has been concentrated in consumer spending
and housing. We expect housing starts to stabilize in the coming
months and average about 1.85 million units this year. Thirty-year
mortgage interest rates reversed the second-quarter increase, and
single-family starts appear to have dropped below a rate consistent
with single-family home sales. Housing construction will be below
year-earlier activity the rest of the year, which will continue to
depress year-over-year sales comparisons for smaller machines.
-- Nonresidential construction should remain strong for the rest of the
year, the result of record corporate profits, increased commercial and
industrial lending and more highway funding. The value of commercial
and industrial construction contracts awarded, net of inflation,
increased 9 percent year to date; highway construction contracts
increased by more than 6 percent.
-- Mining and quarrying operations should continue to do well for the
rest of the year. Sand and gravel prices rose almost 9 percent year
to date, and coal prices were up almost 10 percent. Production
increased 10 percent and 7 percent respectively. Metals mines,
despite sharply higher prices, increased production less than
2 percent, symptomatic of the difficulties mines have had boosting
output this recovery.
-- Production of on-highway trucks should be up about 8 percent this
year, the result of better trucking company profits and ordering in
advance of 2007 emission standards. Truck manufacturers have covered
production slots through year-end with orders.
-- The Bank of Canada appears to be finished raising interest rates, and
economic growth should be near 3 percent this year. Although higher
mortgage rates are slowing housing, record corporate profits and
favorable output prices should allow growth in nonresidential
construction, quarrying and tar sands development. Output from both
coal and metals mines declined, despite favorable prices.
EAME -- Machinery and Engines sales are expected to increase about 11 percent in 2006.
-- The European Union (EU) economy grew at a 3.5 percent annual rate in
the second quarter, the fastest in six years. Leading indicators and
business surveys are positive, and we forecast economic growth
slightly below 2.5 percent in 2006. That growth would be a
significant improvement over the 1.5 percent average rate of the past
five years.
-- Residential building permits increased 8 percent in first half 2006,
and low mortgage interest rates, higher employment and rising home
prices should drive further growth in housing construction.
Nonresidential construction is benefiting from good corporate profits,
high capacity utilization and readily available financing.
-- The European Central Bank recently raised interest rates to
3.25 percent, the fourth hike of the year. Although the preliminary
estimate for August inflation was within target, another rate increase
is possible this year. The Bank of England is expected to hold rates
steady for the rest of the year.
-- The Central European economies successfully reduced inflation and are
maintaining low interest rates. Economic growth should be near
5 percent this year, the fifth consecutive year of good growth.
-- The Africa/Middle East region's best recovery in years continues, with
growth of over 5 percent expected this year. Inflation is the lowest
in over 30 years, and key countries are maintaining low interest
rates. So far this year, oil production is running about a half
percent higher than last year, and mine output in South Africa
declined. A limited production response in the face of much higher
prices suggests a need to increase capacity.
-- Russia surpassed Saudi Arabia as the world's largest oil producer this
year, and mining is attracting foreign investment throughout the CIS.
Increased commodity revenues helped Russia to complete an early
repayment of its debt to official creditors and amass over
$180 billion in foreign exchange reserves. Those positives, along
with a 2 percent short-term interest rate, should allow over 6 percent
economic growth this year.
Latin America -- Machinery and Engines sales are expected to increase about 12 percent in 2006.
-- Second-quarter economic growth ranged between 4 and 9 percent in key
countries, which should push regional growth in 2006 close to
5 percent. Interest rates remain low, with Brazil cutting rates over
400 basis points this year.
-- Most countries responded to higher metals prices by increasing mine
production this year; Brazil and Peru are the leaders with over
6 percent growth. Chile, the world's largest copper producer, was
able to rebound from last year's decline.
-- Good economic growth and higher commodity prices are helping
construction. In the major countries, year-to-date gains in
construction range from almost 5 percent to 27 percent.
Asia/Pacific -- Machinery and Engines are expected to increase about 11 percent in 2006.
-- Inflation in the region increased slightly this year, leading to some
increases in interest rates. However, regional economic growth should
be over 7 percent, a slight improvement from last year.
-- Construction continues to increase, with spending in the major
countries of China, India and Indonesia up 7 percent or more.
Nonresidential construction is booming in Australia, but high interest
rates are causing housing to decline. Overall, construction should
continue to grow in response to good economic growth and low interest
rates.
-- Mining output is increasing in most countries in response to favorable
prices. Both metals and coal prices are trading above year-earlier
prices, which should support production the rest of the year.
-- Australia increased expenditures for mineral exploration 19 percent in
the first half, which should make 2006 the fourth year of significant
growth. Despite those increased investments, mine output declined
more than 6 percent in the first half. We expect mining companies
will continue to increase investments.
Financial Products Revenues
-- We expect continued growth in Financial Products for 2006. Revenues
are expected to increase approximately 14 percent versus 2005,
primarily due to higher average earning assets in 2006.
Sales and Revenues Outlook -- Midpoint of Range(1)
(Millions of dollars) 2005 2006 %
Actual Outlook Change
Machinery and Engines
North America $17,709 $20,250 14%
EAME 8,860 9,800 11%
Latin America 3,024 3,400 12%
Asia/Pacific 4,413 4,900 11%
Total Machinery and Engines 34,006 38,350 13%
Financial Products(2) 2,333 2,650 14%
Total $36,339 $41,000 13%
(1) The Consolidated Operating Profit chart below reflects sales and
revenues at the midpoint of the range.
(2) Does not include revenues earned from Machinery and Engines of
$458 million and $317 million in 2006 and 2005, respectively.
[Link to see chart for Consolidated Operating Profit Comparison 2006 Outlook vs. 2005: http://www.cat.com/chart31006.gif ]
2006 Outlook -- Profit
We expect profit per share to be in the range of $5.05 to $5.30. The year is expected to benefit from improved price realization and higher sales volume, partially offset by core operating cost increases and stock-based compensation expense.
About half of the expected core operating cost increase is from manufacturing costs and about half from SG&A and R&D. Manufacturing costs are expected to be higher due to an increase in period manufacturing costs, about a 1 percent increase in material costs and variable inefficiencies. SG&A and R&D are expected to be higher in support of growth, new product programs needed to execute Caterpillar's long-term strategy and an expense related to a settlement of various legal disputes with Navistar.
Preliminary 2007 Outlook
Our preliminary outlook for 2007 sales and revenues is flat to up 5 percent from 2006, and profit per share is expected to be flat to up 10 percent from the midpoint of the 2006 outlook range.
Economic conditions remain generally favorable, but we expect some slowing in world economic growth to about 3.5 percent in 2007, with the slowdown most pronounced in the U.S. In this economic environment, sales and revenue growth is expected to slow to 0 to 5 percent in 2007. This limited sales growth reflects increasing risks that have developed in the U.S. and an expectation that our dealers will reduce inventories significantly. Our strategy will be to establish a cost base that will allow profit growth, even with limited sales and revenue growth.
We believe 2007 will be a slowdown in the current cycle, not the start of an extended downturn. The historical precedent would be 1996 when sales and revenue growth slowed to 3 percent after three years of double-digit percentage growth. Double-digit sales growth returned in 1997. Our analyses suggest that the worldwide need to improve housing, nonresidential structures, infrastructure and mining and energy capacity, identified at the start of the current business cycle, has not yet been satisfied. Moreover, our growing service businesses and product support for the expanded field population will provide a base of sustained solid growth going forward.
Improved price realization is expected to account for most of the growth in 2007, when comparing the midpoint of the 2007 estimate with that for 2006. Worldwide market demand is expected to be down modestly, with weaker conditions in the U.S. largely offset by continuing strength in other regions. In addition, we expect dealers to reduce their inventories significantly.
-- We believe the slowing U.S. economy will eventually prompt the Fed to
cut interest rates in first half 2007, probably by 50 to 100 basis
points. That policy change should be enough to let the economy escape
with a mid-cycle slowdown, similar to the one that occurred in the mid
1990s. Economic growth should improve in the second half and average
about 2.5 percent for the year.
-- We project a further decrease in U.S. housing starts to about
1.75 million units in 2007; lower starts would continue to depress
sales of smaller machines. However, mortgage interest rates appear to
have peaked, which suggests the decline in housing starts should be
nearing an end.
-- Rising U.S. interest rates over the last two and a half years appear
to be sufficient to have reduced the financial incentives for users to
replace existing machines with new machines. As a result, slower
replacement buying could lead to slower sales growth in some industry
applications despite continued strong activity and a favorable
investment climate in these sectors.
-- New emissions standards in the U.S. and slowing freight activity
should cause heavy-duty on-highway truck production to fall an
estimated 40 percent. Truck engine shipments to OEMs would fall even
further.
-- Interest rates in many countries outside North America should increase
from very low rates. Those increases should slow growth slightly but
not below trend rates. Our forecasts are for almost 3 percent growth
in EAME, over 4 percent in Latin America and about 6.5 percent in
Asia/Pacific.
-- Construction is doing well in most countries outside North America,
and we expect that trend to continue in 2007. Growing populations,
higher home prices and low interest rates should benefit housing
construction. Rapid economic growth, record corporate profits and
higher office rental rates should support nonresidential building
construction. We expect that developing country governments will
continue to use earnings from high commodity prices to develop
infrastructure.
-- Although metals mining companies worldwide increased investments the
past few years, evidence suggests that mine capacity is still not
adequate. Inventories of many metals are near critical lows,
production problems persist and prices remain elevated. Our economic
growth forecasts for 2007 imply further growth in metals demand so
prices should ease only modestly. Prices for most metals should
remain high enough to encourage mines to increase investments further.
The strength in the mining sector continues to drive record demand for
large machines, with our sales prospects limited essentially by our
ability to raise production levels.
-- The coal industry should continue to grow in 2007, requiring more
investment in capacity. Expected growth in the world economy will
require more electricity production, and coal should be a preferred
energy source. The strong recovery in worldwide steel production,
which should continue, will increase demand for metallurgical coal.
-- We project oil prices for West Texas Intermediate oil to be down
slightly from the 2006 average. However, the 2007 price should be
high enough to encourage further investment in exploration and
development. Spare production capacity remains tight, considerable
production occurs in areas vulnerable to supply disruptions and demand
should increase.
The outlook above describes our preliminary expectations for 2007. Economic risks to this outlook are higher than in the past two years, primarily due to developments in the U.S. Future Fed actions and the economy's response are less certain and could require changes to our outlook.
Nonetheless, we remain optimistic for the longer term prospects in the markets we serve. The economic environment outside the U.S. is more positive -- reflecting improving conditions in Europe and Japan and continued robust growth in China, India and the developing world. Moreover, a very favorable investment climate worldwide and pressures to catch up for past underinvestment in infrastructure, energy and mining continue to provide very strong fundamental growth drivers in many of the markets we serve.
QUESTION AND ANSWER
Sales and Revenues / Price Realization / Demand
Q1: Do you expect that 2006 is the peak year in this business cycle for
Caterpillar?
A: We believe 2007 will be a mid-cycle slowdown similar to 1996. In
1996, sales and revenues increased 3 percent, a brief interruption
in five years of double-digit growth in sales. Our outlook reflects
a slowdown in the U.S. and a significant reduction in dealer
inventories. Both should be temporary factors. Expected Fed
interest rate cuts should begin to improve the U.S. economy late in
2007, and once dealers have finished reducing inventories, our sales
should more closely match growth in dealer deliveries to end users.
Q2: What are your expectations for price realization in 2007?
A: We expect price realization to be about 2 percent in 2007. The
improvement is the result of price actions that will take effect in
January 2007, partially offset by higher sales variances to support
extended service coverage programs and the effect of geographic mix
on price realization. In addition, the industries that we serve
remain very competitive, and we intend to defend our market
position.
Q3: We have heard that you have announced some 2008 price increases. Is
this true?
A: Yes. We have announced 2008 price increases to our dealers for
large engine products. Lead times and strong order demand have
driven the need to announce these price increases at this time.
Q4: What are you assuming the U.S. Federal Reserve will do with interest
rates?
A: We expect the Federal Reserve will hold the Fed funds rate at
5.25 percent for the rest of 2006, continuing the policy stance
established at its August meeting. Our outlook assumes that slowing
economic growth will prompt the Fed to cut interest rates 50 to
100 basis points in first half 2007.
The historical precedent for such a policy change would be the
mid-1990s. Economic growth slowed to a rate of about 1 percent in
first half 1995 following a year in which interest rates increased
300 basis points. The Fed made its last rate hike on February 1,
1995, and then made a 25 basis point cut on July 6. Within six
months, the Fed reduced interest rates by 75 basis points, a timely
response that quickly revived the economy.
Q5: What are your expectations for housing in the United States?
A: In our second-quarter release, we projected 2006 U.S. housing starts
at about 1.9 million units. We are revising our estimate to about
1.85 million. For 2007, we expect a further decline to around
1.75 million units.
We expect the decline in housing activity should be nearing an end.
The 30-year mortgage interest rate recently dropped to 6.3 percent,
completely reversing the run-up in the second quarter. Our
expectation of Fed rate cuts in first half 2007 should result in
further declines in mortgage rates.
New home sales appear to be stabilizing, and we estimate that
housing starts over the past five months were lower than needed to
support new home sales. The inventory of unsold new homes is a
record high, but relative to the selling rate is below past peaks.
Multi-family starts are holding up better than single-family starts,
and financial returns for apartments appear to be improving. Mobile
home shipments are running about 100,000 units lower than in the
last downturn, shifting demand to construction starts.
Q6. Can you comment on the strength in nonresidential spending, both
public and private?
A: Nonresidential construction is increasing in many countries
throughout the world, and we expect further growth in 2007. One
reason is that we believe investment has lagged behind economic
growth for years, and significant catch-up needs remain. As an
example, U.S. investment in business structures, net of inflation
and depreciation, has declined since the early 1980s.
Transportation infrastructure throughout the world is inadequate to
meet growing trade, resulting in congestion, delays and wasted fuel.
In many countries, profits are at record highs, allowing businesses
to invest more. In addition, businesses in Europe and the United
States have significantly increased their use of credit. The large
increase in commodity revenues over the past four years is providing
developing countries the funds needed to upgrade infrastructure.
Q7: Mining has been very strong for the past three years. Can you
comment on your expectations going forward from here?
A: The outlook for mining continues to look positive. Worldwide
exploration and development budgets increased 45 percent in 2006,
the fourth consecutive year with increases in excess of 20 percent.
But there is little evidence that capacity has outgrown demand.
Inventories of base metals are low relative to consumption, in some
cases near critical lows, and demand is growing. A unique feature
of this recovery is that the production response has been much
slower to develop than many expected, the result of insufficient
past investment. Year-to-date mine production in three major
producing countries-Australia, Canada and South Africa-declined.
Q8: You mention energy as an industry that's doing very well. From a
Caterpillar perspective, how are you participating?
A: Caterpillar's equipment plays a key role in a number of energy-
related areas, and today's high energy prices indicate a need to
increase output to meet the needs of a growing world economy. The
long-term investments that would be required to develop adequate
energy offer excellent growth opportunities for Caterpillar.
Our machines are important to energy production. We are a key
supplier of machines to coal mining with products like large trucks,
track-type tractors and wheel loaders, and we supply large mining
trucks in the Canadian oil sands where most of the oil is mined. In
addition, we supply pipelayers and other equipment used to build
pipelines for oil and gas.
Our engines -- diesel and gas reciprocating engines and gas
turbines -- are important to producers of oil and gas worldwide.
Solar Turbines Incorporated, a wholly owned subsidiary, is a leader
in industrial gas turbines. Gas compression, transmission and power
for offshore rigs are significant energy-related applications. Our
industry-leading reciprocating engines are used for gas compression,
to pump oil, power drill rigs and service wells to increase output.
In addition, we are a major producer of generator sets for
distributed power, dedicated primary power and for standby
applications.
We expect oil prices to decline from an average $68 per barrel in
2006 to $66 in 2007, using West Texas Intermediate oil prices as the
reference. Prices recently dropped below $60, which likely reflects
less concern about supply disruptions. Worldwide demand, relative
to supply, remains tight, and the potential for supply disruptions
is high.
The outlook for energy development would remain positive even if
lower prices should persist. We believe it unlikely that prices
would decline so low (below $40) as to make new investment
unattractive.
Q9: Are dealer reported inventories for machines and engines at levels
you think are appropriate overall?
A: Overall, dealer reported inventories of machines and engines were
higher than a year ago. In terms of months of supply, dealer
reported machine and engine inventories were near historic averages
at the end of the third quarter. As delivery times improve, we
expect dealer reported inventories to decline during the fourth
quarter of 2006 and in 2007.
Engines
Q10: Many who follow the heavy-duty truck industry expect a significant
drop in demand in 2007 as a result of new emissions requirements.
Do you agree, and what are your expectations?
A: We are seeing indications that fleets are engaging in a pre-buy
prior to the 2007 regulations. The 2007 Class 8 North American
heavy-duty truck industry is anticipated to drop from about
325,000 units in 2006 to about 190,000 to 220,000 units in 2007.
The industry drop is expected to be more concentrated in the first
quarter of the year, with demand increasing somewhat in the
remainder of 2007.
Q11: What actions do you expect to take in your heavy-duty engine
business as you prepare for the likely drop in demand for truck
engines in 2007?
A: We are preparing to implement multiple activities to manage our cost
structure for the short-term decrease in heavy-duty truck engine
demand. These include specific plans related to operating costs,
support costs and sales/marketing costs. In addition, continued
strength in our petroleum, electric power and marine engine
businesses should also help reduce the impact of the lower truck
engine volumes, leading to another strong year for our engine
business.
Q12: What actions do you expect to take in your engine business as a
result of the significant reduction in mid-range engine demand due
to the loss of Freightliner and PACCAR business?
A: We are in the process of implementing actions to adjust our cost
structure as a result of this longer term drop in mid-range engine
volume. Our major action is to transform the Greenville Engine
Center into a marine engine facility. This operation will take core
engines from our U.S. locations and convert them to marine engines
by adding marine specific components, applying specialized paint and
performing marine specific testing. These operations are currently
performed by a third party. The marine facility should be fully
operational in late 2007/early 2008. We are also taking actions to
adjust our cost structure, especially in the first half of 2007.
Q13: Will you be ready with your 2007 emissions-certified truck engines,
and how are your plans going for transitioning your production to
the new engines?
A: Since March of 2005, Caterpillar has been building and validating
the next generation ACERT(R) Technology that meets 2007
requirements. We have tested over 160 2007 engines operating on
ultra low sulfur diesel (ULSD) fuel in a wide spectrum of mid-range
and heavy-duty applications. To date we have accumulated over
10 million miles of validation on these engines plus significant
hours on hundreds of lab engines. Several trucks with early
generation engines were driven more than 250,000 miles prior to
being updated to our latest generation engines.
We are continuing to run 2007 engines in a variety of environments
and applications to validate a full range of operating conditions.
We are currently building 10 heavy-duty 2007 engines per day to meet
our customers' demands.
Product Availability
Q14: We've heard from dealers and customers that delivery times for large
engines for marine, petroleum and electric power applications are
very long. Can you update us on the situation?
A: Delivery times for large engines continue to run at extended levels
and are expected to remain extended through 2007. Demand for our
larger 3500 and 3600 families of engines, assembled in Lafayette,
Indiana, has grown substantially since 2004 in most of our markets
and continues to run at very high levels. Since early 2004, we have
roughly doubled 3500 engine deliveries and increased 3600 engine
output by over 50 percent using 6 Sigma Lean initiatives. We are
investing now to further increase manufacturing line and supply
chain capability to continue increasing engine output during the
latter part of 2007 and early part of 2008.
Q15: How many machine models do you have on managed distribution?
A: Availability of many models has improved. In North America, we had
36 models on managed distribution at the end of the third quarter,
down from 69 models at the end of 2005.
Q16: How will your 2007 on-highway truck engine compare with your current
on-highway product?
A: Building on our current 2004 ACERT Technology engines, we will add
clean gas induction (CGI) and a diesel particulate filter (DPF) to
meet the 2007 on-highway regulations. Our 2007 engines will deliver
equal fuel economy, durability and reliability as today's industry-
leading product.
Q17: Are Caterpillar machines with emissions-compliant ACERT engines at
year-end being released as you had expected, and will all machines
that need to meet new regulations be ready?
A: Yes. Since launch in October 2004, over 55 machine models are in
production using 300-700 horsepower ACERT engines. Over 70 models
using 100-300 horsepower ACERT engines will be going to production
in 2006 and 2007. We have met production dates for all machine
models that require the ACERT Tier 3 engines and are on track to
continue to meet schedules.
Costs
Q18: Can you break down your core operating costs in more detail?
A: The following table summarizes the increase in core operating costs
in third quarter 2006 versus third quarter 2005:
Core Operating Cost Change 3rd Quarter 2006
vs.
(Millions of dollars) 3rd Quarter 2005
Manufacturing Costs $225
SG&A 145
R&D 37
Total $407
Manufacturing costs include both period and variable costs
associated with building our products. The increase in
manufacturing costs was split about evenly between period costs that
tend to increase somewhat with volume, higher material costs and
variable inefficiencies. The increase in period manufacturing costs
includes items such as machine and equipment repair and maintenance
and facility support. The increase also includes costs not directly
related to changes in volume such as depreciation of manufacturing
assets.
The increase in SG&A is due largely to approximately $70 million of
expense related to a settlement of various legal disputes with
Navistar. This settlement was not included in our previous outlook.
Higher employment to support volumes, new product introductions,
order fulfillment/velocity initiatives, growth of our services and
development in China also contributed to the increase in SG&A.
The increase in R&D is due to a significant number of new product
introduction programs.
Machinery and Engines operating margins were 10.4 percent in the
third quarter of 2006 compared to 10.5 percent in the third quarter
of 2005.
Machinery and Engines Operating Profit as a Percent of Sales
Q3 '05 Q4 '05 Q1 '06 Q2 '06 Q3 '06
10.5% 11.1% 12.9% 14.3% 10.4%
Q19: What are your expectations for incentive compensation for 2006?
A: At the midpoint of our revised 2006 outlook, we now expect expenses
related to incentive compensation to be about $450 million compared
to $505 million in 2005.
Q20: Can you update your expectations for stock-based compensation for
2006?
A: Based on the valuation of our 2006 employee grant, we expect our
2006 stock-based compensation expense to be about $135 million
($130 million for Machinery and Engines and $5 million for Financial
Products). The distribution of the expense will be as follows:
Consolidated Stock-Based Compensation Expense
(Millions of dollars)
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr 2006 Full Year
$34 $58 $31 $12 $135
The distribution by quarter is the result of our policy to
immediately vest awards upon retirement for employees who are
55 years old or older, have 10 or more years of service and who have
completed six months of service after the grant date (i.e. the fair
value of awards for employees who have met these age/years of
service requirements is expensed over six months rather than the
normal three year vesting period). As the 2006 award was granted on
February 17, the impact is higher expense in the second and third
quarters.
In addition, expense for the first and second quarters is higher
because expense for the final months of vesting for the 2003 grant
was included in the first two quarters. As a result of prior
decisions that resulted in full vesting of the 2004 and 2005 awards
prior to 2006, a full complement of stock-based compensation expense
will not be recognized until 2009.
Q21: What is the estimated impact on your financial statements from the
adoption of SFAS 158 - Employers' Accounting for Defined Benefit
Pension and Other Postretirement Plans?
A: The standard requires recognition of the overfunded or underfunded
status of pension and other postretirement benefit plans on the
balance sheet. The offset to the additional asset or liability is
recorded to equity. The adoption of FAS 158 is expected to reduce
Caterpillar's stockholders' equity at December 31, 2006, by
approximately $2.6 billion, net of tax. The pronouncement does not
affect the results of operations.
Cash Flow
Q22: Can you comment on third-quarter cash flow?
A: The first three quarters of 2006 were very positive for operating
cash flow. For Machinery and Engines, operating cash flow was
$2,774 million -- $832 million more than the $1,942 million in the
first three quarters of 2005.
The strong cash flow in Machinery and Engines was primarily used
for:
-- Capital Expenditures -- $900 million -- primarily to support new
product programs and additional capacity.
-- Acquisitions -- $512 million, primarily for the Progress Rail
acquisition in the second quarter.
-- Dividends -- $531 million -- the quarterly dividend is currently
30 cents per share.
-- Share repurchase -- $2,858 million -- 39.9 million shares were
repurchased. Basic shares outstanding at the end of the third
quarter were 650.5 million -- approximately 20 million shares
lower than at year-end 2005.