Caterpillar Inc. (CAT) Q3 2010 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Caterpillar Third Quarter 2010 Earnings Results Conference Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Mr. Mike DeWalt. Sir, the floor is yours.

Thank you, and good morning, and welcome, everyone, to Caterpillar's Third Quarter Earnings Call. I'm Mike DeWalt, the Director of Investor Relations. I'm pleased to have our CEO, Doug Oberhelman, and our Group President and CFO, Ed Rapp, with me on the call today. Just a reminder, this call is copyrighted by Caterpillar Inc., and any use, recording or transmission of any portion of this call without the expressed written consent of Caterpillar is strictly prohibited. If you'd like a copy of today's call transcript, we'll be posting it in the Investor section of our cat.com website, and it'll be in the section labeled, Results Webcast. In addition, we'll be discussing forward-looking information today that involves risks, uncertainties and assumptions that could cause our actual results to differ materially from the forward-looking information. A discussion of some of the factors that individually or in the aggregate, we believe could make actual results differ materially from our projections can be found in our cautionary statements under Item 1A - Risk Factors of our Form 10-K filed with the SEC back on February 19, and our Form 10-Q filed with the SEC on May 3, 2010. And it's also on our forward-looking statements language contained in today's release. Okay, earlier this morning, we reported results for the third quarter. We increased our full year outlook for 2010 and we provided a preliminary outlook for 2011 sales and revenues. To start this morning, I'll summarize the quarter and the outlook, then Doug and Ed and I will take your questions. Let's start with the third quarter top line. Sales and revenues were $11,134,000,000 and that's up from $7,298,000,000 in the third quarter of 2009. And that's an increase of about $3.8 billion or 53%. Now that includes about two months of sales at Electro-Motive Diesel and we'll be referring to that as EMD here today, which we acquired in the third quarter and added about $216 million in sales for the quarter. Excluding EMD, sales and revenues were up about 50%. The increase in sales was primarily a result of improving end-user demand and the absence of 2009's dealer-machine inventory reductions, and I'll cover both of those this morning. First, in terms of end-user demand, good economic growth in the developing world has been positive for sales in Asia, Latin America, the CIS, and Africa/Middle East. In addition, the growth in those developing countries have improved demand for commodities and that's been good and positive for our Mining business worldwide. In addition, we are seeing growth in the developed countries of North America and Europe, albeit off depressed levels from 2009. With weak economic recoveries in the U.S. and Europe and with depressed construction activity, I know it's tough to understand why sales of CAT machines are up so much. And new machine sales in the United States are a good example that illustrates the point. Here's what's happening. First, sales to users peaked in 2006, then declined in 2007, declined again in 2008 and then declined even more significantly in 2009. From the peak quarter in 2006 to the bottom in late 2009, dealer-machine sales to end users in the U.S. declined nearly 80%. Today, we're seeing improvement from those low levels as customers are buying some machines to slow the aging of their fleets. In addition, dealers have increased machine purchases for rental fleets. That said, rental fleets size hasn't improved much, the average age of dealer rental fleets haven't improved and it remains elevated. And rental inventory utilization rates have increased and are now higher than in 2007, 2008 and 2009. In addition to better end-user demand, dealer inventory changes also affected the sales comparison with the third quarter of 2009. Last year, dealers reduced new machine inventories by about $1.1 billion in the third quarter. So far in 2010, dealers have held the machine inventories relatively flat. They were actually up about $100 million so far this year and that was in the third quarter. Speaking of inventory levels, though, we frequently hear comments and get questions about dealer restocking. And just to be clear, other than the very small increase this quarter, that's not happened. Overall, dealer-machine inventories are within a few percent of the year end 2009 levels. Dealer-machine inventories in terms of months of supply continued to decline and are below historic averages. That's a good thing, and it's in keeping with our Lane strategy that includes Caterpillar holding finished inventory and regional distribution centers to serve our dealers and customers. That said, dealer inventories are very tight in many parts of the world and dealers will probably need to add some inventory next year. In summary on the topline, sales and revenues were up in all regions. North America was up 55%, Latin America, 95%; Europe, Africa/Middle East, 31%; and Asia/Pacific was up 51%. Okay, let's turn to profit. Profit in the quarter was $792 million and that was a 96% increase from $404 million in the third quarter of 2009. Profit per share was $1.22, and that was up $0.58 from the $0.64 a share we earned in the third quarter last year. Consolidated operating profit rose from $277 million in the third quarter last year to $1,187,000,000 in the third quarter of 2010, and that's a 329% increase in operating profit. As a percent of sales, and this is on a consolidated basis, operating profit was 10.7% and that was up from 3.8% a year ago. In addition, Machinery and Engines gross margin continued to improve and was 25.8% in the quarter. The increase in sales volume was the most significant factor driving the improvement in profit. That said, that positive impact was mitigated somewhat by a very negative sales mix compared with the third quarter of 2009. In addition to the higher volume, price realization improved and was favorable to profit, $262 million. Manufacturing costs were favorable by $142 million. And if you exclude the $120 million of LIFO inventory decrement benefits that we realized in the third quarter last year, the cost improvement was $262 million. And that was a result of better labor and overhead efficiency, lower warranty costs and favorable material costs. Just one point on the material costs, while we've been favorable compared with 2009 in every quarter this year, the degree to which material costs were favorable has been declining as material costs have been trending up. Okay, partially offsetting those positive items in terms of profit, income taxes were very unfavorable. In the third quarter of 2009, income taxes actually benefited profit $139 million, of which $129 million was related to the settlement of tax returns for years prior to 2009. The third quarter of 2010 reflects tax expense at an estimated annual effective tax rate of 28%, less $14 million from a year-to-date adjustment and that was related to moving the estimated rate from 29% down to 28% in the quarter. SG&A and R&D costs were also higher and that was primarily due to provisions for employee incentive compensation and increased R&D spending, primarily related to U.S. and European emissions regulations that applied beginning in 2011. Overall, currency impacts were also negative. The impact on currency in operating profit was a negative $46 million. And currency was the principal reason that other income, which is below the operating profit line, declined $65 million from the third quarter of 2009. Before I move on to the full year outlook, I'd like to cover employee incentive compensation in just a little more depth. As you may be aware, a portion of the compensation for management, support and some of our hourly employees is at risk and it varies based on the financial performance of the company. Given the economic environment in 2009, the profit target related to our short-term incentive plan was aggressive and it did not trigger. And as a result, there was no incentive-related expense in 2009. Financial performance in 2010 has been much better. And based on the newly revised and higher profit outlook for 2010, we expect incentive compensation to be higher. Our practice is to accrue the expense as we go through the year based on our full year expectations. That means when we changed the outlook, we had a year-to-date catch-up in the provision and that happened this quarter. The outlook we provided with our second quarter release included $600 million in incentive compensation; $300 million of that was in the first half and we had an expectation of about $150 million in each of the third and fourth quarters. Because we raised the outlook in the third quarter, the full-year estimate for incentive compensation rose from $600 million to $700 million, an increase of $100 million from our prior estimate. Since we are three quarters of the way through the year, we've provided for three quarters of the change in the full year estimate in the third quarter. As a result, we provided for about $225 million of incentive compensation in the quarter, compared with $150 million that was in our previous outlook. The punchline here is, incentive compensation expense was probably higher than you would have expected. It was higher than our previous outlook and that's because we took guidance up and needed to reflect the change in the third quarter. One last thing before I move on to the outlook and that's incremental profit. For machines and engines sales were up $3,869,000,000 and operating profit was up $900 million. That's a 23% incremental margin rate. However, our results in the third quarter of 2010 included the acquisition of EMD. And the third quarter of last year included $120 million of LIFO decrement benefits. Excluding those two items, incremental profit was about 27%, and that by the way, does include the negative impacts of product mix, the $225 million in incentive compensation and the negative currency impacts. So all in all, it was a pretty good quarter operationally. Okay, let's move on to the outlook. This morning, we raised 2010 guidance for sales and revenues and for profit. Our previous outlook range for sales and revenues was $39 billion to $42 billion, with a midpoint of $40.5 billion. The outlook we provided this morning is a range of $41 billion to $42 billion, with the midpoint of $41.5 billion. So at the midpoint of the range, sales and revenues are up about $1 billion for the year and about half of that improvement is related to the acquisition of EMD, again, which we completed in August. We also raised the profit outlook this morning. We're expecting profits per share in the range of $3.80 to $4 a share, with a midpoint of $3.90. That's up from the previous outlook range of $3.15 to $3.85, with a $3.50 midpoint. While EMD is having a positive impact on sales, for the remainder of this year it's not expected to have much impact on profit. In addition to the 2010 outlook, we provided a preliminary top line look at 2011 and we expect sales and revenues to approach $50 billion next year. That would reflect our current run rate for the second half of the year, which is about $46 billion, plus the full year impact of the acquisition of EMD, continued improvement in end-user demand, including some additions to the new rental fleets, some dealer-machine inventory additions and modest price realization. This morning, we did not provide profit guidance and we don't plan to do that in the call today. As usual, we're in the part of our planning process where we start with sales and we're working on our profit plan for next year. That's been the case for the last couple of years and that's where we are this year. Okay, that's the outlook. In summary, the third quarter reflected continuing improvement in our financial results. We raised the sales and profit outlook for 2010 and provided a first look at 2011 sales and revenues, that approaches $50 billion. With that, we're ready to take your questions.

[Operator Instructions] Our first question today is coming from Jamie Cook. [Crédit Suisse] Jamie Cook - Crédit Suisse AG: Two questions. One, when I think about your 2011 top line guidance of $50 billion, I guess I'm struggling with that number because if we take the back half of the year and you say you're annualizing $46 billion in revenue as an implied sort of 8% top line growth for 2011. So, why so conservative especially with the North America market down so much, so if you can give me some of your assumptions there? And then, is there any reason to believe that for 2011, incrementals shouldn't be at least within your targeted range of 25% to 27% with some of the headwinds you laid out in the press release?

Jamie, this is Mike. I'll start then I'll let Ed and Doug chime in if they'd like to. Well, I'll just start with your second question first. We're going to really try, since we didn't provide profit guidance this morning, we're really in the process right now of working on our plans, so we're going to try to avoid giving profit guidance here this morning for next year. In terms of the first part of your question, if you look at the sales increase next year, we still have a pretty weak recovery going in the developed world. I mean, it's improving but those percentage increases are off pretty low levels. Also, I would say most of the increase next year is more heavily skewed to machines. Engines have been a little bit later cycle. Oil and gas had been good, but it's slowed down. You can see our retail statistics for today, oil and gas has flattened out. The engine increase over the last few months even versus last year is up 5%. Marine is continuing on the downside. So I think most of the increase next year is going to be probably related to machines, and again, we have modest economic growth built in to the U.S. Jamie Cook - Crédit Suisse AG: But Mike, I mean, I know you don't want to give incremental margins, but is there anything, I mean we can make our own assumptions on pension, on R&D or even on product mix, is there anything unusual that we should be aware of as we think about 2011?

Probably the only thing that you can glean from what we've said already is, that it'll be probably be a bit more machine-centric than engine-centric. And you can see that in the way the retail numbers are shaping up now.

Our next question today is coming from Robert McCarthy. [Robert W. Baird] Robert McCarthy - Robert W. Baird & Co. Incorporated: I'm also going to do in a sense, the same thing. I'm want to try and dissect the $50 billion number a little bit. You talked about $46 billion as a run rate. We pick up $500 million at EMD by annualizing; a couple of points on price would be a $1 billion. That leaves me with, if I'm doing my math correctly, $2.5 billion or less. What kind of dealer inventory build are you assuming in your outlook? I assume you wouldn't mention it if it wasn't at least $500 million.

I'll give you a comment and a correction. We did say in the release that we expected price realization less than a 1% next year. So it was a little bit high. Yes and I know it's a long release to get through. And on dealer inventory, it's a little bit at this point tough to be exactly precise. We are ramping up Lane inventory. We're a little bit out of the historic patterns now that we're using the Lane inventory. We added the Lane inventory in the quarter actually by about 50% performance out of Lane improved. So I think, a little more time needs to pass before we're actually ready to talk about a forecast for dealer inventory next year, because we're in a little bit of uncharted territory. Again, that said, it did go up about $100 million in the third quarter. The months of supply is pretty weak. So I think there's no doubt that it's going to go up it's just I think to what degree. Robert McCarthy - Robert W. Baird & Co. Incorporated: And then my other question, I think, probably is best directed to Mr. Oberhelman. While we understand the drags on incremental profitability or contribution margins and you guys have been very transparent in predicting what they would be, can you talk about how satisfied you are, specifically with the 22% number on the Machinery side and the progress overall? Especially in the context of your recent remarks on supply chain and how you wish you were a little further advanced there?

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

Our next question today is coming from Barry Bannister. [Stifel, Nicolaus] Barry Bannister - Stifel, Nicolaus & Co., Inc.: I apologize for maybe being a little accounting challenged here, but if I look at the reduction of equity of $1.8 billion on the pension change and I consider that your U.S., non-U.S. and OPEC charges were about $1,120,000,000 in '10 and $1,243,000,000 million in '09, that's an average savings of about $1.2 billion. So what we get back in cash, what we're losing in book value this year in a fairly quick payback.

Barry, I apologize but I did not follow all that. Barry Bannister - Stifel, Nicolaus & Co., Inc.: Well, I'll probably end up following it up with you later. But can you talk about the savings from going from a defined benefit to a defined contribution on an annual run rate starting in 2011 and beyond?

Barry, this is Ed. In terms of the move from defined benefit with defined contribution, that's going to play out over a number of years as we phase out of it. I wouldn't look at it, as if you would, a savings on a year-over-year basis, as you do your numbers. Barry Bannister - Stifel, Nicolaus & Co., Inc.: And then lastly, I reread the transcript from the August analysts meeting and Cat Financial was never mentioned, even though it was about 18% of the last dozen years profit and about 16% year-to-date. Does Cat Financial play a role in your multi-year plan?

Cat Finance plays a huge role on our multi-year plans. I mean, if you think back, Barry, to 2009, which was the all-time stress test in terms of financial markets, and you've seen from the numbers Cat Finance performed very well through that downturn. It's tied very much to our business model, being able to go to customers and provide them not only great products but great services. Cat Finance continues to not only grow in what historically has been the developed parts of the world, but is playing a key role in the developing markets as well, such as China, Russia and other parts of the world that are growing. So Cat Finance remains a central part of our overall strategy. Barry Bannister - Stifel, Nicolaus & Co., Inc.: And is there a risk, before I get off, that you're expanding and becoming the largest lender in places like China, yet you've never had a downturn to deal with and that the finance company is going to overreach?

No, think it's our job to manage that risk and if there was ever going to be a stress test to do you overreach or not, it would have been '09. And I think, if you look at how well we performed during that period of time, we managed it well. We're taking the very same principles that we applied in other parts of the world, as we've expanded with the Cat Finance company and used them there. I mean, we're financing product that we know, we're working with dealers that we partner with, iron that we understand, we know how to redistribute, we understand the residual values. It's a business model that we've exercised around the world and we stay very close to it.

Our next question today is coming from Alexander Blanton. [Ingalls & Snyder] Alexander Blanton - Ingalls & Snyder: I'd like to just ask a question about your Caterpillar Production System. It clearly is getting great results because if you look at the gross margin line and look at the incremental gross margin year-over-year, with the LIFO in last year, it was 36%, which is in the middle of your historic range of 30% to 40%. But if you take out the LIFO gain last year, it was a 39% incremental margin year-over-year on the gross margin line, and that's with a very negative mix change that you mentioned. So clearly, there are great things going on in the manufacturing, could you just elaborate on what some of those are?

Yes, this is Mike. I mean, we only have 30 minutes left for this call so I'll try to be brief with that. But Cat Production System is pervasive throughout the factory. It's all about building to schedule, for example, and our ability to actually build to our schedule has just improved dramatically. I saw the statistics over the last couple of days where our performance has gone -- of the amount that we've missed, the performance has gone down by about 3/4 in terms of missing builds. So working with the supply chain, all the discipline around standard work has helped a lot in meeting production schedules and that helps efficiency. Lane strategy has helped as well. We're producing a higher percentage of what we're doing are more standard products, which helps efficiency. So I think it's not just one thing, it's a combination of all the work on the supply chain, the standard work in the factory, Lane strategy, all kind of working together, to simplify. I would also be remiss if I didn't say a healthy increase in volume helps as well. Alexander Blanton - Ingalls & Snyder: Those are interesting metrics because it's like inventory reduction. In order to get an inventory reduction or in order to get a better improvement on deliveries or cycle time you mentioned, you have to reduce the costs, correct? I mean, you haven't really told us where those costs reductions are. You just told us about the results, which is good.

Just let me add this from a little different take. Oberhelman here. If you look at our forecast for next year approaching $50 billion, coming off the bottom of $31 billion 2 years ago, and we've done that increase over, call it a two-year period arguably, but ought to, the last time we did that it was four years more or less. And we're doing it this time with better quality, better pullthrough, almost every metric inside our factory. So that's the kind of the big picture that I look at in terms of are we doing this better than we ever have in the past, we certainly are. And then you see things like you've mentioned there, Alex, in some of the numbers with the gross margin et cetera. And we also like the internal metrics around committed ship dates around our quality numbers and so on. So that is coming our way and the CPS dividend is starting to pay and be evident. Alexander Blanton - Ingalls & Snyder: And did these improved manufacturing results have to do with your decision to build factories in the United States now instead of abroad? Was that a factor and will you be able to get your costs down to the point where you can create the jobs here rather than abroad, is that correct?

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

Our next question today is coming from Ann Duignan. [JP Morgan] Ann Duignan - JP Morgan Chase & Co: Could you talk a little bit about -- you are very sure about laying out some of the headwinds that you're facing going into 2011. Could you talk about any tailwinds that might be out there going into 2011, for example, mix, or maybe one region being stronger or Engines are recovering. Could you just give us any examples of where there might be a tailwind?

Yes, I'll just talk about some of the things that we've already talked about. I mean, we did put in this morning's release that we do expect some, although modest to our price increase next year. The sales volume is pretty good. The mix, though, I kind of talked about a little earlier, the growth in sales has been more centered around machines than Engines, so I think from a mix standpoint, you'd have to say that does not look very positive for next year. The flipside of that though is machine margins have been improving a lot. They're well below where we were in the last cycle, and so there's, I think, there's certainly a lot more room for improvement there. Beyond that and we've not talked yet about efficiency or cost reduction, material costs, and that's not because we're trying to send a negative signal, we're just still in the process of working all those resource plans. Ann Duignan - JP Morgan Chase & Co: So volume is a wonderful thing really, is that the key take away?

It's probably a good take away. And I think the other one, Ann, Mike mentioned in his opening comments is just what's happened, in the U.S. we've been through an extended downturn. Fleets are aging, and rental fleets are down versus historical numbers, and that's another thing, as Mike mentioned earlier, that should bode us well going forward. Ann Duignan - JP Morgan Chase & Co: Could you just talk a little bit about how much of your revenues to dealers, particularly on the rental side are -- or even end users, are coming with trade-ins and therefore, you would now maybe have a build up of used equipment that has to be liquidated at some point?

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

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

Our next question today is coming from Jerry Revich. [Goldman Sachs]

Mike, you had excellent machine pricing this quarter particularly in North America. Can you step us through the drivers, and perhaps touch on why price increases had been lower in engines where capacity utilization in most of your markets is tighter?

Well, I think one of the things with engines that's really changed in price realization, really from the first half of the year is, last year, in the middle of the year, particularly on the bigger engines, despite the fact that it was a tough year, we did a mid-year price increase so we've lapped that now. So it's in sort of the base period in comparison, if you will. So the machine price realization isn't maybe as high as it was earlier. In terms of machine price realization, I think honestly we've been pleasantly surprised as we've gone through the year. As you know, we started out the year with an outlook of machine – of price realization being up less than a point. Then at the end of the second quarter, we said about 1%, and it's been more than that all year long. Effectively, the merchandising programs required to sell the product, I mean, of all kinds, have been less than we thought. We've not taken any price increases per se. Generally, we do that most of the time just in January. Every once in a while, we do a mid-year. We didn't do that this year. So I think just in general, we've been, I'd say positively surprised on price all year long.

And Doug, thinking about cycle over cycle dealer inventories, the change is because of the Lane strategy, I guess, would we be off the mark if we thought of the 40% ship out of Lane 1 as translating to about a 30% reduction in dealer inventories versus prior cycle? Is that the type of payout we should be thinking about?

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

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

Well, I guess I would say this, if you look at where we came off of '08, dealer inventory declined almost, not quite, close to 50% from the end of '08 to the end of '09, actually, the high-40s. And it's stayed pretty flat to this year. That was a $3.5 billion inventory decline between '08 and '09. I can tell you that our approaching $50 billion next year does not have us back to '08 volume levels for kind of machine units. Remember, it has things like EMD in it, so it's not the same. Also, if you go back to the $51 billion that we had in '08, we only had Cat in Japan in for a quarter that year. So kind of the real underlying number with the companies that we have now was higher. So we're not back to that '08 level yet. We don't expect in this preliminary outlook this morning to be back to that '08 machine level in 2008 as yet. So with not giving any numbers on dealer inventory, but I would certainly think that we're not going to be back to the '08 volumes, plus we have Lane so we're not looking for that magnitude of an increase.

And Mike, I think the point that we can emphasize here, you look at like year-over-year, we're talking about an 84% growth in Machinery sales and we're talking about virtually flat dealer inventory. And that means that through working with our dealers, the Lane strategy that we've been able to flow that increase directly to end users and demand instead of having it set in inventory around the world. We're going to continue to partner with our dealers on how we do that going forward.

Our next question today is coming from Robert Wertheimer. [Morgan Stanley]

My first question is on capacity and your comfort level with getting to next year's revenue guided range at the current capacity levels you've got. I mean, I guess last cycle as it worked out, you ended being short capacity and then tried to add '06 to '08 -- I think you commented at that time that it's tough to order a machine to a long lead time and get it in. And so you ended up with some production issues that were capacity related. And I think, Doug, when you took over the range, you've ended up announcing a lot of capacity and I kind of wondered how much of that was just pure growth above that $50 billion level versus you weren't completely comfortable with the capacity you had put in from '06 to '08. So that's my first question, whether you feel like you can get to the $50 billion with what you've got.

I'll start with that one. Capacity, unfortunately, is not fungible. It kind of depends upon what product you're selling. If you look at big engines, for example, right now, out of Lafayette, it improved a lot since the depth of the recession. But as we talked about earlier, and if you look in today's retail sales, oil and gas is flattened out. So for products like that, we probably have a lot more capacity than we would need for next year. For mining product, on the other hand, we'll be capacity constrained probably throughout 2011. I mean, business there is very good to the point that you made earlier, we are investing in capacity increases. We talked about that for mining trucks in India and mining trucks in the U.S. We talked about investing in shovels, although that's not from a sales standpoint next year. So I think the answer is, we wouldn't have put out a guidance for next year approaching $50 billion and sort of a summary answer, we wouldn't have said that if we didn't think we could make it, number one; and number 2, how much capacity we have and how much more we can do, I think, it really depends a lot on what we're actually selling. There are a lot of products right now where volumes are still very depressed. You look at compact products, really small stuff, it's improved, but still way off the peak. So we have a lot of capacity there. So it just really depends a lot on the product. I know that sounds like a bit of a non-answer, but it's just not -- we're not like a refinery, it's not uniform capacity.

So is the debottlenecking you've gotten from adding some of the machine tools and adding some of the capacity, I guess, I believe you can get the $50 billion. I guess, I wonder if you can get to it smoothly without the kind of strain you had in '07 and '08. And whether the debottlenecking more than offset the kind of increased depreciation or increased costs? And the second would be just in terms of people and capacity, I think your employment is around 10% down from peak. Is that enough to get you back to where you were giving improvements to the Production System?

Just one more comment on that. In terms of going from sort of middle of this year's guidance $41.5 billion, something approaching $50 billion, the point that we made earlier, we're already -- our second half of the year is operating at around $46 billion. We have announced capacity increases that should help next year. We talked about being able to produce more excavators in China, more mining product, for example, so some of the things that we did announce earlier this year should help next year and we are currently doing better than the full year average. So the -- as was brought up earlier, the increase isn't maybe as dramatic as looking at $50 billion versus $41.5 billion. In terms of employment, even there, and again, I'm sorry if this sounds like a non-answer, but when you're looking at the production capability of employment, you got to look at not only our full times, we have a very large flexible workforce that we had actually going into the last downturn, which really allowed us to shed costs quickly. So you really have to add that to the employment number. There are also things like overtime that impact your kind of productive capacity out of people. So it in of itself is also not a perfect indicator. What I would tell you is, and we've said this a couple of times today, our labor productivity has improved a lot this year and that's been very good. We expected that from CPS and frankly, we would expect improvements to continue.

Our next question today is coming from David Raso. [ISI]

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

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

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

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

And on Solar, I just want to get a little update on how you're seeing that order book develop for '11?

Yes, we weren't specific at all with that in the release, but what I would call back to is, this year, for I think all of us as we got into 2010, surprised a little on the upside. Solar took in some big orders very early in the year that helped them and those were from a couple of customers. And those they were able to do because they had capacity. Remember, they've been at capacity on the back of a very strong oil and gas business for the last four years, and the last three have been records. So I wouldn't look for more increases in Solar or at least I wouldn't -- I'm trying to be careful here because we haven't provided specific guidance on it. But yes, I wouldn't look for a big change in Solar up next year.

The customer advances are now 21% off the trough a few quarters ago back in 4Q '09, quite often that is Solar, so just trying to square with your comment, not expecting much growth in Solar in '11 versus customer advances, can you touch on that?

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

And lastly, the geographic mix of where you see dealers need to increase their inventory, would you highlight any particular geographies where the dealers would like to and you think you'll be able to serve it?

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

Our next question today is coming from Meredith Taylor. [Barclays Capital]

I just wanted to, I guess, build off the last couple of questions on mining and Solar. Mike, you've addressed the mix looking ahead to 2011 between Machinery and Engines. Can you talk a little about the mix within Machinery and Engines?

I'll talk a little bit in broad trends, kind of things that we've already talked about. Electric power is probably doing -- and industrial -- are probably doing the best of the four engine end markets. Then you can see from the retail sales today, the Marine is very late cycle and that's going down. That will probably be a negative next year. Oil and gas is actually pretty flat, if memory serves me, I think it was around 1% over the last few months. So I think in engines, the trend that you're seeing is relative strength in electric power, industrial, late cycle weakness in marine, particularly the really big ocean going kind of marine, in a more neutral oil and gas kind of business. That's what the trend that you're seeing right now. In terms of machines, again we didn't provide a lot of detail. I think probably most types of machines will be up next year. The parts of the business that are probably the least capacity constrained and the lowest in terms of how they're doing versus the last cycle would be the smaller equipment. So I think to some degree, there's probably the biggest scope for improvement there, they're very depressed as you can see in a lot of the residential and commercial construction markets, there's not a lot of business there right now. I know I wasn't very helpful, probably with that answer, but again, we've not provided a lot of detail on the kind of the breakdown of 2011. It's a preliminary guidance, again we're not trying to be overly cagey with it. We're still a few months from next year, we're still working on our plan and we don't normally provide a lot of detail at this time.

But it sounds like within machinery, at least you're looking for somewhat of an adverse mix, putting those pieces together?

Well, you can use your own judgment.

Just as a follow-up, could you address lead times for products both coming out of Lane 1? How that's changed over the last couple of months? And then products not coming out of Lane 1?

Meredith, this is Ed. Let me [ph]] I mean in Lane 1, what we've seen, we kind of track service within 10 days and we've seen that jump about 20 points over the last quarter. And so we're seeing improved service out of Lane 1. Corporately in percent of sales, about 25% coming out. In terms of Lane 1 inventory, we doubled it since the beginning of the year, and we are looking for additional Lane 1 inventory build as we get into the fourth quarter. And it's really focused on what we talked about earlier. We're looking at -- you saw across U.S., Europe, Latin America, Asia, pretty strong year-over-year growth in the Machinery sales. And through using Lane and working closer with our dealers, we've been able to flow that product through to the end-users. Instead of some of the things we had back in that '07, '08 timeframe when a lot of it flowed to inventory. I think the Lane is continuing to mature, as Mike said we're relatively new at it, but I think some of the results are starting to bear fruit.

Our next question today is coming from Eli Lustgarten. [Longbow Research]

Can we talk a little bit about profitability, particularly it's not hard to understand why machine profitability will step up at this point with a higher volume but can Solar profitability, which went up in the quarter, can Solar profitability hold these levels and engine profitability hold these levels with the more sluggish kind of environment here particularly, not only this year but into next year or can we still improve operating profitability?

I'm probably going to disappoint you on this answer as well but again we can't talk about profitability much at all related to next year. Yes again, we're still –

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

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

Can we talk about interim Tier 4 introduction, you haven't talked much about it. I guess, the pricing`s going to be up more like 4%, but there`s not a lot of product being introduced. Can you talk about the impact of what can we expect to see over the next year and the year after? And what to expect with this emissions change being to flow and even though , I guess, with most of the sales outside the U.S. is not all that big. Can you give us some indication of what we're going to effect in…

For people listening on the call too, I'll make a comment. We do have a Q&A in the back of our release that talks a little bit more about Tier 4. But essentially, it's in the U.S. Tier 4, Europe Stage IIIB; it's for product for the most part in those regions above 165-horsepower this year, below 165-horsepower in 2012. So you're right, a lot of the product, particularly the smaller product's not going to be affected this year, it will be next year. From an engine standpoint, it would affect also product in those kind of size ranges in the U.S. and Europe, except for emergency power or backup power and emergency and backup power is most of what we do. So you're right to say that a lot of the product will be affected in the year and the larger product in the U.S., in Europe, but you won't see it all change on January 1. You have the ability to take some flex credits and delay some of the introductions. So I think it's probably going to be a little bit less of a giant January 1 shotgun start. It'll be more of a phase in I think as you go through the year. And to your point, it doesn't affect all our service related businesses. It doesn't affect most of our engine business, it doesn't affect small machines, it doesn't affect Latin America or Asia or Middle East or the CIS. So it is probably a bit more of a muted impact from the total company than most people might think.

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

Our next question today is coming from Henry Kirn. [UBS]

I just wanted to ask about the spare parts business. I saw the piece on Integrated Services business is within the release, but how is spare parts within that been trending and what can you glean about new equipment demand trends from that?

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

Is there anything you can share about how market shares in Asia, particularly China, have been trending, given all the focus on the region?

Yes, I would say market share is not something that we disclose, so I won't be all that specific. But particularly in China, we've been capacity constrained and that's one of the reasons why we announced fairly large capacity expansions, really starting in next year for China excavators because we think, if we can produce more, we can sell more. So I would say, particularly in that part of the business, we don't have the capacity all online yet so that will take a little bit more. Our business model is really based on field population, and field population is based on the strength of the industry and the share that we get. So it's a big deal to us to your point, we're really focused on it. Where we need to add capacity, we're trying to do that so yes, I'd say it's a big deal. But I won't quote numbers.

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

Steve, this is Ed. I'd say our 2012 goals are as we laid out in the analyst meeting in New York recently, if you kind of think about the story that we laid out there, kind of laid a path that that said we could get to $55 billion in that 2012 timeline. And I think the $50 billion, approaching $50 billion is a good step in that direction. And I think it really gets back to one of the earlier discussions some of the tailwinds that may be out there. While we have seen some good growth in the developed parts of the world, as you know, they are still way off the peaks. We talked earlier about rental inventory being down, dealer inventory being well below historical levels, engine business kind of a later cycle hasn't really started to pick up recently. So as I look out to that 2012 timeline and the goal that we established, I think there's still -- the underlying principles and fundamentals are still there.

I think that's a good one to conclude and I'll end it on that but Ed is exactly right. We went over with everyone in some detail in August, 2012 numbers and how we constructed the path to get there. That's still our plan. We're still expecting that on out and beyond and as we talked about in August, and there's no change to that. If you look at the economic GDP growth next year, which is anemic worldwide, and maybe a little bit more anemic than we said in August, I view that as upside because the world cannot grow very long at these low rates, it's just untenable; something will happen at some point and it will go and pickup and that's ahead of us and turns into a tailwind. But we are absolutely still on the ballpark from what we said in August. And just while I've got the floor, I'm going to may be just comment a bit. Ed Rapp, of course is our new CFO in the executive office, and he's doing a great job. You may not see me on every one of these calls because he and Mike are doing so well, so before I get too far on that and I`m not here, it`s not because I don't want to be. Ed certainly can handle it and is doing great and is a great representative for us. And he and Mike do a super job, so you would expect to see them at some calls on the quarterlies in the future. And we thank you all for joining us today. Mike?

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

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