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Caterpillar Recovery Draws Worrywarts

As Caterpillar sees growing global demand -- as evinced by strong second-quarter results -- the company again faces concerns about manufacturing execution.
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(Caterpillar story updated with further commentary on the company's incremental margins.)

PEORIA, Ill. (


) --


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appeared to confirm Thursday that the heretofore recession-bound bellwether had turned the corner, but some investors and company watchers remain worried about whether the company can fully take advantage of an upturn as it strives to ramp-up manufacturing plants it had idled during the downturn.

In reporting

second-quarter results

that bulldozed through Wall Street forecasts,

Caterpillar (as expected)

lifted its earnings-per-share target range for 2010 and tweaked its revenue projections for the same period. And a bevy of data appeared to offer more detailed evidence of Caterpillar's return. Machine sales, for instance, the industrial bellwether's core rolling yellow heavy equipment, jumped 55% year-over-year in the company's core region, North America (a number helped by extremely easy comparisons with an epochally bad year-earlier period for Caterpillar.)

The news gave the company's stock a modest boost in Thursday trading. More importantly, combined with strong quarterly results from other corporate giants --


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chief among them -- CAT's sanguine outlook lit a fire under U.S. equities, with the Dow Jones Industrial Average surging by more than 200 points.

But you wouldn't quite describe the company's conference call with analysts Thursday morning as celebratory. At issue for some sell siders was Caterpillar's "incremental margins," or the profit the company takes from each additional dollar of revenue it turns. Essentially, the figure is a measure of how well the company is executing as it brings idled capacity online and speeds the process of manufacture to meet rising customer demand. (That demand has come largely from the mining industry; construction, long Caterpillar's bread-and-butter, remains in the doldrums.)

In the past, Caterpillar has struggled with this -- indeed, the company was highly criticized for just such production inefficiencies at the outset of the last boom, when it went through prodigious growth, and growing pains.

Company executives are hyper-aware of the issue; they've spent the last few years attempting to retool Caterpillar's production systems, along the lines of the so-called "lean manufacturing" methods pioneered long ago by


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, so that it might be better prepared to take advantage of an upcycle. The company also instituted something called a "lane-one strategy," a new sales process by which Caterpillar aims to speed the delivery of equipment sporting its most popular features, pushing those kinds of machines into customers hands without delays.



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is often held up as a teacher's-pet example of manufacturing prowess, in contrast to Caterpillar's sometime clumsiness.)

Already, though, Caterpillar is facing some familiar critiques. At least one analyst on the call, Ann Duignan of


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, was disappointed with the incremental margins -- 26% -- that Caterpillar registered in the quarter. Because the company posted revenue growth in the second period of about 30%, many observers felt its incremental margins should have surmounted 30% as well.

"Should we be worried about execution, again, this early in the cycle?" Duignan asked the Caterpillar executives on the call.

Managers (including the company's new head man, CEO Douglas Oberhelman) admitted that the lane-one strategy hadn't yet reached its full potential. "Delivery times aren't where we'd like them to be," said one executive on the call.

Executives also blamed the incremental margin shortfall on higher incentive compensation paid to its employees, and on a less-than-great "product mix." That is, Caterpillar sold more lower-margin gear during the quarter than the year-earlier period, hurting profit comparisons.

Oberhelman added, "We went from a full-speed sprint at the end of '08 ... to a dead stop in '09." Now, he said, the company's plants are going from a dead stop to something close to top pace. "We've seen some facilities go from zero to 50, 60, 70 percent," he said. "We're not happy with where we are, but given what we've been through historically ... we think we've done pretty well."

The new CEO, who took over from long-time chief Jim Owens on July 1, said CAT's management would detail the company's global strategy as demand continues to recover at a meeting with analysts and investors in New York in August.

Part of those plans will likely include further acquisitions, Oberhelman hinted on the conference call, after discussing

Caterpillar's $800 million purchase

of an electric railroad engine manufacturer in May.

"I think really with state of the industry, and as well positioned as we are around world today, it's time to look at growth in different way," Oberhelman said, pledging to use the company's cash horde "to grow the business."

-- Written by Scott Eden in New York


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Scott Eden has covered business -- both large and small -- for more than a decade. Prior to joining, he worked as a features reporter for Dealmaker and Trader Monthly magazines. Before that, he wrote for the Chicago Reader, that city's weekly paper. Early in his career, he was a staff reporter at the Dow Jones News Service. His reporting has appeared in The Wall Street Journal, Men's Journal, the St. Petersburg (Fla.) Times, and the Believer magazine, among other publications. He's also the author of Touchdown Jesus (Simon & Schuster, 2005), a nonfiction book about Notre Dame football fans and the business and politics of big-time college sports. He has degrees from Notre Dame and Washington University in St. Louis.