Heavy equipment maker Caterpillar Inc. (CAT) on Friday posted disappointing quarterly results and warned that higher raw material costs and production bottlenecks would crimp profits, sending shares down more than 10 percent.

Caterpillar stock fell $5.58 to $48.45 on the New York Stock Exchange (search), its worst one-day percentage drop since November 1999.

Caterpillar's disappointing outlook weighed on the broader stock market, including the Dow Jones industrial average, which turned lower after an initial gain.

Caterpillar said it is not able to keep up with demand for engines and machines used in mining, a scenario it also struggled with at the end of 2004.

"We have to work through capacity bottlenecks and need more focus on production processes to improve order fulfillment and supply chain efficiencies," said Chief Executive Jim Owens, who added that availability of Caterpillar machines has yet to recover to 2004 levels.

Caterpillar profits rose 34 percent to $667 million, or 94 cents per share, well short of analyst forecasts of $1.06, according to Reuters Estimates.

"The report is lousy but it is much better underneath," said analyst Eli Lustgarten of Longbow Research, adding that a higher tax rate and one-time charges make the numbers look worse than they really are.

Morningstar analyst Scott Burns said the company was trapped in a vicious cycle, as rebounding prices of aluminum, steel and copper increase both the company's costs and demand for its equipment.

"The same reasons they're having more orders are the same reason they're having production problems," he said, adding the raw materials bottlenecks may not be specific to Caterpillar.

Those include shortages of such crucial components as tires, which have dogged the company all year.

Caterpillar said it expected fourth-quarter profits in a range of $1.01 to $1.16, compared with Wall Street forecasts of a $1.20 profit. It said full-year earnings will fall in a range of $3.85 to $4, below analyst forecasts of $4.15.

While the company cut its profit forecast, it raised its 2005 sales outlook. It said revenues will be up 20 percent from 2004, compared to its earlier forecast of an 18 percent to 20 percent sales gain.

The revised outlook includes potential charges of about $100 million for possible changes in dealer software and in Caterpillar's product mix, as well as a higher tax rate. Analysts estimate those charges are equal to 10 cents a share.

Lustgarten said it was unusual for the company to provide a profit forecast for the next year at this point in the calendar, and investors would eventually realize those prospects are still pretty good.

"It's almost an instant replay of last year," he said. "The higher costs impact the short term, but (they) correct over the long term."

CEO Owens said demand had yet to peak in the nonresidential construction industry and in mining, as well as in Europe where an economic recovery is just now taking hold.

"Rebuilding adequate capacity and meeting future growth in demand for metals and energy will require significant further investment," Owens said.

The company expects 2006 earnings per share to be up 15 percent to 25 percent from 2005 levels. Analysts expect 2006 profits of $4.85, up 17 percent from projected 2005 profit.

The company, thanks to its dominant position in many of its markets, has been able to pass on higher prices to customers and plans a 1 percent to 5 percent price hike at the start of 2006.

"The trends at this time are indicating improving price levels," Owens said.

Revenues rose 17 percent to $8.98 billion. Machinery sales increased 20 percent to $5.65 billion, with higher prices accounting for a third of the increase.

Engine sales were up 11 percent to $2.75 billion with higher prices accounting for more than half the increase. And financial products revenues rose 21 percent to $585 million.

With Friday's drop, Caterpillar shares are up less than 1 percent for the year. But they are still outperforming the Dow Jones Industrials (search), which are down almost 5 percent year-to-date.

The stock is still well above its fair value of about $44, Morningstar's Burns said. "To push it to where it was trading, near $60, you'd have to assume the commodity cycle would last forever," he said. "You can't forget it's a cyclical company."