Q3 2020 Caterpillar Inc Earnings Call
Thanks, Jason.
Morning, everyone and welcome to Caterpillar's third quarter 2020 earnings call today, I'm joined by Jim Umpleby Chairman of the Board and CEO, Andrew Bond deal Chief Financial Officer, Kyle I believe Vice President of Global Finance Services Division and Rob Frankel Senior IR manager.
On the call, we're expanding on our earnings news release and sales to users, which we issued earlier this morning our.
Our slide some today in the news release, all in the investors section of Caterpillar Dot com under events and presentations.
The floor forward looking statements, we make today are subject to risks and uncertainties as you.
Too often make assumptions that could cause our actual results to be different than the information we're sharing with you on this call.
Please refer to our recent SEC filings and the forward looking statements your mind or in the news release for details on factors that individually or combined could cause our actual results to vary materially from our forecast.
[music] Caterpillar is copyrighted this call and we prohibit use of any portion of it without her prior written approval.
So in a moment Andrew will update you on our third quarter results and our financial position. The first please turn to slide three as I hand, you over to our chairman and CEO Jim Umpleby.
Thank you Jennifer thanks, everyone for joining the call.
I'm proud of how our global team has performed in a challenging environment.
But in the essential products and services that enable our customers to support world in need.
We continue to leverage our strong safety culture.
Raining boxaban productive in this pandemic altered work environment.
We remain committed to our strategy launched in 2017, which is based on operational excellence expanded offerings and services.
The operational excellence element of our strategy has served us well, resulting in disciplined management of structural cost.
As a result, we went into the pandemic with a strong balance sheet and have continued to invest in expanded offerings and services to make our customers more successful.
Introducing several new products and are enhancing our digital capabilities.
Now I'll briefly cover third quarter results, starting with slide four.
While earnings while sales earnings and profit per share a decline versus the prior years quarter. Our performance in the quarter was better than we expected third.
Third quarter sales and revenues of $9.9 billion decreased by 23%.
Lower sales volume drove the decline primarily due to lower end user demand.
In addition dealers decreased inventory by $600 million this quarter versus a decrease of $400 million in the third quarter of 2019.
It was more of a decrease than we anticipated.
With dealers, having to reduce their inventories by $1.8 billion year to date, we now estimate they will reduce their inventories by about two and a half billion dollars by year end.
This morning, we also reported three months sales to users, which decreased by 22% versus the previous year.
This was similar to the second quarter's trend and about in line with our assumptions.
Machine sales to users decreased by 20% driven by a 31% decline in North America.
Asia Pacific overall was flat, reflecting higher demand from China offset by declines in other countries in the region.
Energy and transportation sales to users decreased by 27% with declines primarily driven by oil and gas and industrial applications.
Profit per share in the third quarter of 2020 was $1.22 cents versus $2.56 in the third quarter 2019.
Turning to slide five we believe it is helpful to also compared the third quarter against the second as both periods were impacted by COVID-19.
The second the third and second quarters of this year, we are roughly similar.
Sales were only slightly lower in the third quarter compared to the second down about $100 million or 1%.
Sales are typically lower seasonally in the third quarter versus the second.
Sales were essentially flat across our three main segments.
While sales came in largely in line with our expectations, our operating margin performance was better than we anticipated.
Third quarter margins were 10% 220 basis point improvement from the 7.8% we reported in the second quarter.
The margin improvement came from a combination of cost control favorable geographic mix and better factory efficiencies than we anticipated.
Looking at sequential margins for the segments construction industries March.
Margins led the way with favorable price due to less of an impact from geographic mix and operating efficiencies.
The higher margins in resource industries reflected favorable favorable manufacturing costs that more than offset unfavorable price.
Energy and transportation margins declined relative to the second quarter.
Ian T hit unfavorable mix, including reduced sales from oil and gas mainly in solar turbines.
As you know so worst business tends to be lumpy.
In addition margins in N.T. were impacted by some nonrecurring items.
Next I'll comment on the third quarter 2020 sales to users data released today versus the data from the second quarter of this year the.
The 20% decline in the third quarter of 2020 machine sales was a three percentage point improvement over the decline in the second quarter of 2020.
That was about what we expected.
For construction industries, most regions reported less of a decline in year over year sales to users in the third quarter when compared to the second quarter year over year sales year over year performance.
Stronger residential construction benefited our construction industry segment.
Asia Pacific remain positive driven by continued strong demand in China.
Sales to users in resource industries declined sequentially as North America remained low, particularly in heavy construction quarry and aggregates, while other regions continued to see lumpiness across the segment.
Energy and transportation sales to users declined by 27% during the third quarter of 2020, compared with an 18% decrease reported in this years second quarter.
As expected reduced demand in oil and gas contributed to the decline.
Power generation continue to fluctuate while industrial remained weak.
Exportation improved as reported declines moderated in the third quarter versus the second quarter of 2020.
Turning to slide six as we look ahead for the end markets. We serve a caterpillar much still depends on the pandemic and its impact on the global economy.
While the situation remains fluid overall, we are cautiously optimistic.
We continue to work closely with our suppliers to be well positioned to meet changes in market demand.
We're maintaining good product availability levels for the vast majority of our products.
Availability of our aftermarket parts is solid as well.
I will share some thoughts on demand trends for the fourth quarter in each of our end markets based on what we see today.
Overall, we expect sales and end user demand to improve in the fourth quarter compared to the third.
This follows our typical seasonal trends.
End user demand should improve going into next year as well.
For construction industries, we expect stronger sales and end user demand in the fourth quarter compared to the third quarter.
The percentage reduction in year over year sales to use your should also improve in the fourth quarter compared to what we saw in the third.
Recovery in North America provides a boost as low interest rates homebuilder confidence in growth in housing starts support demand for our smaller machines, which are built by our building construction products Division.
In China, we expect our construction business to continue to be strong due to government spending on infrastructure and building activity.
Based on what we see today the strength in China should continue going into next year.
We anticipate nonresidential construction will remain subdued in North America in the fourth quarter as well machine sales for oil and gas related activity.
Overall based on what we see today, we expect end markets for construction industries to continue to improve.
As I mentioned earlier the situation remains fluid.
Turning to resource industries, we expect higher sales in the fourth quarter compared to the third with sales to users improving versus the third quarter as well all down although down slightly year over year in a business that tends to be lumpy.
We're encouraged by continued continued solid quoting activity in mining and orders picked up in the third quarter compared to the second.
We have some large large tenders pending for deliveries that will be spread over the next few years.
The tender activity is particularly strong in large mining trucks and large tractors.
Demand for base metal commodities is expected to remain strong.
Aftermarket part sales are expected to improve his machine utilization overall is high men.
Many miners have deferred rebuilds and some maintenance into next year.
Mining Capex is expected to increase over the next 12 months based.
Based on everything we're seeing we remain optimistic about improving conditions in mining.
We expect heavy construction inquiry and aggregates in resource industries to remain weak in the near term, particularly in North America.
In addition, our economists mining trucks continue to gain traction with customers continuing to report improvements in efficiencies and safety autonomous mining sites.
We have over 340 autonomous trucks running now and expect to approach 400 by year end.
Sales in energy and transportation are typically higher in the fourth quarter, including stronger sales to users compared to the third quarter.
We expect that trend to continue this year.
We see continued challenges for reciprocating engines in North American oil and gas during the fourth quarter. However, we are encouraged by recent comments made by industry participants in well servicing.
For power generation, we expect to increase data center activity to create higher demand in reciprocating engines.
As is typical solar should have its best best sales quarter of the year in the fourth quarter. However, solar sales will likely be lower than in previous years. As we are seeing some customers delay maintenance into next year, which will also impact NTS mix in the fourth quarter.
In addition in the fourth quarter, we expect the timing of product development investments to have a negative margin impact on the empty miles.
Meanwhile, demand for industrial engines, and transportation is expected to show some improvement, but continue to reflect the dynamics in the markets. They serve.
Before moving on to energy and transportation, Let me comment on the agreement we signed earlier this month to acquire where is oil and gas business.
We see a strong strategic fit between the where oil and gas in our current offerings in oil and gas it.
It comes with a strong services business and would expand our product portfolio to one of the broadest in the well service industry.
Our goal is to make our customers more successful with us than with the competitors and upon closing this acquisition would give us a more complete solution in this space we.
We view this as an opportunistic time to strengthen our lineup of oil and gas products and services and importantly, we believe the transaction economics will prove attractive even if oil prices remain low.
Andrew will share the details on the fourth quarter assumptions in a few moments overall versus the third quarter were looking for stronger volume performance improved operating margins in additional dealer inventory reductions.
We expect to be well positioned as we move into 2021.
Turning to slide seven we said that our 2019 Investor day that we intend to return substantially all of our M. N T free cash flow to shareholders through the cycle.
Year to date, we have returned $2.8 billion to shareholders via dividends and share repurchases.
As we said last quarter, our share repurchase plan will remain suspended through calendar year end.
In the third quarter, we returned about $560 million to shareholders through our quarterly dividend. We are proud of our aristocrat status, where for 27 consecutive years, including 2020, we paid higher annual dividends to shareholders. The dividend remains a high priority through all economic cycles.
All decisions concerning the dividend are made by our board of directors, but we anticipate increasing our dividend again next year.
Before closing, let me mention two other important things the retirements at year end of billions worth group President of energy and transportation and revenue Nessie group President of construction industries, We think billion Rahman for their significant contributions to caterpillar and wish them all the best in retirement.
We also welcome Tony Casino in Joe Accrete to the executive office.
I'd also like to mentioned that the caterpillar team is proud to have been recently recognized by the Wall Street Journal as number 19 on its list of the most sustainably managed companies in the world the new ranking assessed more than 5500 publicly traded companies around the world.
In summary, as we continue to execute our strategy for profitable growth.
We're investing in services and expanded offerings to better serve our customers.
Or improving operational excellence, which includes working more slate safely than ever and making our cost structure more flexible and competitive.
We'll be able to react quickly and are well positioned for changes in market demand.
We will emerge from the pandemic as an even stronger company.
Now, let me turn it over to Andrew.
Thank you Jim and good morning, everyone.
I'll start on slide eight with a recap of our third quarter results.
Then I'll walk you through the segment results and free cash flow.
Touch on the fourth quarter outlook, I'm finished with that cash and liquidity position.
To summarize sales and revenues declined by 23% to $9.9 billion.
Operating profit decreased by 51% to $995 million.
Third quarter 2020 profit per share was $1.22 cents.
This included a pre tax remeasurement losses of $77 million or 12 cents per share, resulting from the settlements of pension obligations.
Adjusted profit per share was $1.34 cents.
I'm not you 3 million or 17 cents per share discrete tax benefit is included in both our profit per share and adjusted profit per share figures.
Last year's profit per share for the quarter was $2.66.
Overall sales and revenues finished fairly close to what we thought in July with the operating margin being better than we anticipated. Although this was partially offset by negative foreign exchange impacts and lower investment income.
As shown on slide nine the topline declined by $2.9 billion of which $2.6 billion were due to lower volume.
A 200 million dollar a year on year improvement in dealer inventory also contributed to the decrease.
As Jim mentioned sales to users overall decreased by 22% for the quarter.
Sales are sales to users for construction industries to come by 15%.
Within that number Asia Pacific was a bright spot.
It rose, 4% benefiting from stimulus spending in China, where the industry is actually up year to date.
North America, while down 27% improved from the second quarter trend.
Resource industries, which does tend to be lumpy had some unfavorable timing and a 31% year over year decline, mainly due to weakness in North America and Latin America.
Energy and transportation sales to use has decreased by 27%.
This reflected lower levels of activity for reciprocating oil and gas engines, particularly in North America.
We also had unfavorable timing in our southern Autobots business I know the sales to users in industrial applications.
As you would expect both revenue resource industries and energy transportation sales to users have been impacted more significantly this quarter. As these print products tend to have a longer lead time between when the orders received and when delivery of the final product is made to the customer bought the diva.
Telus decrease inventory by $600 million this quarter.
That compares with a decrease of $400 million in the third quarter of last year.
The slight improvement in machine sales to use us quarter over quarter enable dealers to reduce inventory more than we anticipated.
Do you guys have reduced inventory by $1.8 billion year to date.
Our comments and my expectations for fourth quarter movements in the dealer inventory in a few moments.
Sales decreases versus versus the prior year were fairly consistent among the three prongs segments.
Sales declined and construction industries by 23%, while sales in resource industries, and energy and transportation to come by 21% and 24% respectively.
Looking at the geographic region region sales were most resilient in Asia Pacific driven by healthy demand in China.
While sales in North America, and Latin America were fairly challenged the percentage decline was less pronounced than we saw in the second quarter of 2020.
This was driven by better relative performance and construction industries.
Unfavorable price realization of $121 million was less of an issue than last quarter and were affected many changes in geographic mix within construction industries and resource industries.
Machine orders increased by double digits percent, comparing the third quarter versus the second quarter.
This is one reason we believe that despite the de stocking dealers are seemingly more confident about the future.
We still do those become more positive about demand and construction industries.
We also saw solid so the solar turbines backlog increased slightly compared to the second quarter of 2020.
Now on slide 10 operating profit for the third quarter fell by 51% to $995 million.
Volume declines with the probably drive drive it the decrease.
Favorable short term incentive compensation helped partially offset that.
Lower manufacturing costs also help mitigate the effects of lower volume.
We delivered an operating margin of 10.0%, a 220 basis point improvement compared with the 7.8% operating margin in the second quarter trench of trenching.
As I mentioned this was better than we expected and primarily reflected good cost control.
And more favorable geographic mix and better factory efficiency.
Restructuring expense for the quarter was $112 million compared with $24 million in the third quarter of 2019.
We continue to make progress addressing certain chums products as we committed to doing so at the beginning of the year.
This quarter, we completed the contemplation process related to closing the Dolan facility in Germany.
This facility manufactures a productivity costs of hydraulic mining struggles.
Well considering locations closer to end customer and supply base. This.
This will help us to improve our competitiveness in this market segment.
Pre tax profit was impacted by foreign exchange losses, and lower investment income due to lower interest rates.
As I mentioned earlier profit per share was $1.22 cents and adjusted profit per share was $1.34 cents.
Now I'll discuss the individual segments results for the third quarter beginning on slide 11.
For construction industry sales decreased by 23% to $4.1 billion.
Volume declined due to low end user demand and changes in dealer inventories.
End user demand decrease in North America fueled by declines in pipeline and road construction related sales.
Dealers also reduce the inventories principally in North America with the most significant decrease during the third quarter 2020 compared to the prior years quarter.
The segment's third quarter operating profit decreased by 38% to $595 million, reflecting the volume decrease and unfavorable price realization impacted by geographic mix of sales.
Lower manufacturing costs and favorable short term incentive compensation expense provide an offset offset.
The margin declined by 340 basis points to 14.4%.
As shown on slide 12 resource industry sales decreased by 21% in the third quarter to $1.8 billion. We saw a lower end user demand for equipment supporting heavy construction quarry and aggregates a modeling.
We also saw lower aftermarket parts sales impart due to customers deferring maintenance rebuilds.
In addition, unfavorable price realization contributed to the reduction in revenue.
Specific to mining the timing of deliveries in this lumpy business impacted sales.
But as Jim mentioned, we expect fourth quarter sales were mining applications to improve versus third quarter.
The park truck percentage has stayed low as activity and production continues to improve.
We saw lower machine sales across all markets, but it was primarily in North America and Latin America.
Third quarter profit decreased to $167 million.
The segment's operating margin declined by 430 basis points to 9.2% due to the volume decrease and unfavorable price, partially offset by favorable manufacturing costs as well as short term incentive compensation expense.
Turning to slide 13, third quarter sales of energy and transportation declined by 24% to $4.2 billion.
That included a 41% to comp sales decline in oil and gas.
Demand slowed in North America for reciprocating engines using gas compression.
Power generation sales decreased as well down 8%.
This was primarily due to lower sales volumes in engine aftermarket parts and small reciprocating engines as well as turbans and turban related services.
An increase in large reciprocating engines, partially helped partially offset those declines.
Industrial and transportation sales decreased by 26%, 19% respectively.
Rail sales declined on lower locomotive deliveries and related services revenues, primarily in North America.
Profit for the segment decreased by 52% to $492 million driven by lower volume.
The segment's operating margin declined by 690 basis points to 11.8%.
As well as the negative volume impacts margins were also affected by positive onetime items in 2019 and negative one time items and 2020.
Moving to slide 14 to wrap up our segment commentary.
Financial products revenue decreased by 16% to $724 million. This.
This was due to lower average financing rates across all regions and lower average earning assets.
The latter reflected lower purchase receivables from catch caterpillar and associated with the volume declines.
Profitability decreased by 35% in the third quarter to $142 million led by higher provision for credit losses are lower yet net yield and a lower asset base.
The increase in provision expense was primarily due to lower valuations on collateral that has helped to support marine vessel financing finance receivables and certain oil and gas assets.
Caf financial continues to support our dealers and customers during this challenging time.
Overall, our customers are in good shape.
Credit applications are at healthy levels about flat with last quarter about 15% year over year.
Postures were 3.81% in third quarter up seven basis points from the second quarter.
Customer care programs were successful as request was second modifications have been very limited.
In the United States second request only represent about 1% of our customer retail portfolio.
While the global percentage remains in the low single digits percent range.
Over 90% of customers, who loans were modified have now exited the first modification period and the vast majority have resumed Tommy payments.
As is always the case confidential what I can say, we'll continue to work closely with their customers as they manage the COVID-19 impacts on their businesses and cash flow.
Now on slide 15.
Free cash flow for machinery energy and transportation was about $900 million in the quarter, a decrease of about $200 million versus the third quarter of 2019, but up about 400 million goes versus the second quarter of this year.
Lower profit was partially offset by favorable cash impacts from working capital as accounts payable improved.
We continue to hold a high level of inventory, including components and other work in process to ensure that customers will not be impacted by potential supply disruptions and to make sure. We are able to respond quickly to improve demand.
Whilst we are not providing annual guidance, we do have a few sort from the fourth quarter that may be helpful. For your modeling purposes as shown on slide 16.
Overall, we expect to see less of a decline in end user demand in the fourth quarter compared with the third based on what we hear from dealers and see an orders.
Seasonally the fourth quarter is also typically large in the third.
So some services are expected to continue to outperform original equipment for both the fourth quarter and the full year.
We now expect strategy this will reduce the inventories by about $2.5 billion by year end versus our prior assumption of more than $2 billion.
For the fourth quarter that would translate to a reduction of around $700 million, which is similar to the reduction we saw in the fourth quarter of 2019.
The important point is we expect this reduction will enable us to begin 2020, one with positive momentum as we'd expect to be producing much closer to demand.
I remind you, though that ddas, our independent businesses and they manage their own inventories.
Overall, we expect an improvement in operating margins versus the third quarter.
Keep in mind, we continue to that some of the benefits of the material cost reductions, which began in the second half of 2019.
And we also do normally see a seasonable reduction in gross margins in the fourth quarter.
The fourth quarter will benefit from savings on incentive compensation.
Overall overall, we do therefore expect an improvement in operating margins quarter on quarter.
We currently expect about $400 million in total restructuring expenses for the year.
This implies restructuring expense of around $100 million in the fourth quarter 2020 compared with only about $50 million in the fourth quarter of 2019.
More importantly, we continue to make progress addressing challenge products, including the Dolan facility action I mentioned earlier.
These efforts will continue to increase our efficiency and competitiveness as we move forward.
In total we expect about $300 million of the 400 million go spend to relate to these challenge products.
We also expect the tax charge to increase in the fourth quarter as we do not expect any discrete tax items at this time.
Now turning to slide 17, and our financial position.
Earlier this month, we declared our normal quarterly dividend to one dollar and three cents per share, which translates to around $560 million per quarter.
Including share repurchases made early this year, we've returned $2.8 billion to shareholders year to date.
In April we suspended our share repurchase program to turn so certainties associated with coded non team and then extended that through to the end of the calendar year.
At commitment from Investor Day in May 2019 is unchanged and we intend to return substantially all of the immune T free cash flow to shareholders through the cycles.
We continue to maintain a strong balance sheet, which we can use for compelling M&A opportunities.
As Jim mentioned earlier this month, we announced an agreement to purchase the weird groups oil and gas business for $405 million in cash.
It's a financially attractive transaction, even without a recovery in oil prices.
Combining we established pressure pumping and pressure control portfolio with our own engines and transmissions enables us to create additional value for customers.
The proposed to also enhances our ability to provide services to oil and gas customers.
Its results will be included within our energy and transportation segment upon closing.
This acquisition comes at a time when some valuations are compelling is consistent with our strategy of investing for long term profitable growth.
We ended the third quarter with a strong financial profile, including non point $3 billion in enterprise cash and over $14 billion in enterprise liquidity.
Our credit ratings remain strong.
We've shown our residents in the current environment, and we will emerge an even stronger company.
So finally, let's turn to slide 18, let me recap today's key points.
We continue to we continue to execute our strategy for profitable growth, we're investing in services and expanding overdone offerings, while improving operational excellence.
In the third quarter, we improved operating margins versus the second quarter.
We see improved margins and stronger volumes in the fourth quarter.
With dealer inventory coming down by two and a half billion dollars was thought 2020, one well positioned for changes in market demand.
And we will emerge from the pandemic as an even stronger company.
With that I'll hand, it back to Jason to prepare for the Q and a session.
Operator, we're ready for our first question, we'd like you to limit yourself to a single question. Please.
Certainly your first question comes from the line of Jamie Cook from Credit Suisse. Your line is open.
Hi, good morning.
I guess im just trying to read between the lines here just your comments on dealer inventory it sounds like you think.
We've seen the bottom of declines in end user sales on your commentary just on orders or backlog I mean do you have a more positive view 2021 in terms of the possibility of end user demand growth and if so can you sort of comment on which areas you're more constructive on versus last without understanding you're not going to want to quantify.
A revenue growth opportunity for next year. Thanks.
Good morning, Jamie and yes, you are correct I'm not going to give 2021 guidance, but I will try to make some comments just to provide some color. So certainly as we sit here today I feel better today than I did a quarter ago. We've.
We've talked about the fact that we are quite constructive on what we see in mining so mining quoting activity is quite high.
Mentioned in my earlier remarks, we're tendering for some large projects that we feel good about that would involve multiyear deliveries of large tractors and large mining trucks.
Again mining really is is continues to improve we've talked about.
Housing starts in the U.S to driving.
Activity on the smaller end of our construction industries business as well and we believe that strength will continue going into next year as well.
So again, we're not going to give a guidance here for 2021.
Better today than we did a quarter ago.
Your next question comes from a lot.
David Raso from Evercore ISI your line is open.
Hi, good morning sort of in the same spirit I'm, just trying to get a sense of you speak now a lotta revenues and so the sequential historical terms and now that we have a bit of a baseline for how you're thinking about fourth quarter to extrapolate that into early 21, I'm just trying to appreciate the commentary about the improvement you're saying.
Under production and see eye to back in line with retail.
The way the year is going to start in 2001, just for some perspective.
Should we still just think of it as normal sequential starting the year or is what you're seeing on the order book you mentioned, maybe some timing issues with solar and mining.
Give us a little baseline and I think Andrew said positive momentum into 21, I think we're just all trying to sanity check.
When can the company returned to positive revenue growth I mean to choose and a relatively easy comp.
People, just trying to figure out how much momentum to start 21, just some perspective I appreciate it.
Yes, David it's Andrew and good morning, obviously, if you remember in the first quarter, we did see some inventory build although lower than normal by dealers.
As a result of getting ready for the buying season.
Obviously as we hit that the pandemic hit.
As well.
Couple of thoughts on on Q1, so that will be an impact. So obviously year on year comp as you say is a little bit more challenging we did see the big dealer inventory into your reduction occurred in Q2.
We would expect will so busy in.
For example in China, China is a later Chinese new year this year.
So that means that may be some inventory build in Q1.
Chinese new year's sort of middle of February this year.
So that may impact Q1 comps and I think generally as we say we think that.
The underlying momentum in end user sales will start to have an impact will positively, but obviously first quarter had less of an impact so it's going to be a little bit challenging as we go through the year I think as we get to January we'll be able to give you a little bit more feel for exactly how that pans out for the year.
Thank you.
Your next question comes from the line of Chad Dillard from Bernstein. Your line is open.
Hi, good morning, guys.
Morning, you guys could comment on cats.
I guess right.
Sales.
Okay.
How should we think about the magnitude of the stock in there.
Yes.
Sure.
What would you consider to be helpful level.
Yes, Hi, this Andrew good morning.
As we said, we all holding more inventory than we would normally hold at the cat end for couple of reasons for that one which is obviously, we had a little bit of extra safety inventory.
As we go in through the year.
Partly because obviously, we have been concerned about supply disruption.
So as safety inventory levels are a little bit higher.
Second thing is actually this is one of those audio is well actually we have a downturn and potentially getting ready for an upturn in demand in the same time historically you would always have seen in a down cycle, obviously, a reduction in cash caterpillar owned inventory.
Given the dealers are reducing the inventory levels given that we are expecting to underlying demand to tick back up as we move into the next fund financial year.
We believe is right for us to hold a little bit more inventory than we would normally have handheld getting ready for that so the we aren't in a position where the bullwhip effect catches us out as we move into 2021.
I mean, obviously normally if we were in a situation where we did didn't see that we obviously would be continued to reduce inventory levels. Obviously again, we are we have plenty of cash on hand, we all in a low interest rate environment. So financially, it's not a big drag on us to hold a little bit more inventory than we would normally do.
Your next question comes from the line of Joe O'dea from vertical research. Your line is open.
Hi, good morning, everyone.
And Joe Jonas.
Morning questions related to services and we saw end user demand trends the decline rates pretty similar between Twoq and Threeq you. It it looks like the decline rates on the services side of the business might have accelerated from Twoq to Threeq, you think you've talked about some deferrals, but.
[music].
If you could just comment on what you saw a little bit on on the year over year trends. If in fact, it was getting a little bit tougher sequentially and then in the recent announcements around the leadership changes a clear focus on services there.
What you see in terms of opportunities in the near term to.
Control, what you can control and drive those revenue is higher.
Yes, certainly and thanks for your question and certainly we are continue to be very focused on on on services is an important element of our strategy and as you would expect.
Services did decline by a lesser extent than OE in this in this declining market.
Having said that again, we are we continue to invest to to increase services and I did make some comments I believe him and about.
What we expect in mining in terms of just given that utilization is high we expect moving into next year to see higher higher aftermarket sales, but to again continue to.
To invest in that part of the business and it's something that we're very excited about the opportunity.
Your next question comes from the line of and Doug NIM from JP Morgan Your line is open.
Yes, good morning, if.
If we could just focus on the comments you made on inquiry in aggregates being weaker and then well construction also I think you noted in construction equipment being weaker can you talk a little bit about the importance of a new fast Act, our new Highway Highway Bill Gross's.
Anything we get.
Hello, Ginormous infrastructure.
So important is it to get to and new four year Highway Bill going into 2021, particularly part of your customers.
Who may not be able to invest with that long term comp.
Contract.
Yeah. The recent one year extension of the surface Highway Bill does provide some certainty for state and local governments. So they can plan for projects.
As we think about.
And of course, we continue to advocate for long term reauthorization of the Federal Highway Bill.
We think would be very appropriate in terms of economic stimulus and of course, the overall infrastructure bill that seems to have.
Very broad bipartisan support certainly would be a positive for our customers and for us.
Timing of all that in fact of course is uncertain. It all depends on politics and when it gets when it gets passed but again.
And everything we see Thats, the one thing that the two sides tend to.
Agree on at this point.
Your next question comes from the line of Tim theme from Citigroup. Your line is open.
Great. Thanks. Good morning, So that question relates to the interplay of price and material costs as we as we look into 21, just given the recent moves are you still seeing most grades of steel and what looks to be a bit more of an inflationary environment.
Which of course, we coming down the Pike for Cat, how should we think about the opportunity.
For pricing actions into 21.
Just given that the state of the markets globally, and then catch ability to stay in the plus widens of price versus material cost and 21. Thank you.
Yes, Thanks, Tim It's Andrew Yes, just some and from that perspective, I mean, obviously, we do buy forward a little bit of a steel. So we are still seeing the benefits of price reductions at this stage.
As we are thinking about price actions in 2021, yes, you are completely correct, we are taking into account.
The demand side of the equation.
To see if demand is.
In a softer demand environment, you, obviously do not want to push price too hard.
And we all reflecting the fact, obviously at the moment, we are still seeing favorable material costs in the events, obviously that that does change as we go through the year, we always have the option of thinking about that later.
But at the moment, we win a reasonably good position as we move into 2021.
Your next question comes from the line of Rob Wertheimer from various research your line is open.
Our young.
I am so sorry, I'm, so sorry, good morning.
You saw a transition to present this quarter, which is a little bit unusual and I wonder if you could talk about that for a second perhaps what was accomplished at theres a different focus on the future for Joe and Tony or whatever direction, you want to take it.
Thank you.
You bet well certainly as I mentioned, we think Billy and Rahman for their their many contributions during their careers and wish him well in retirement and we're very excited also about having Joe and Tony joined Executive office. It doesn't not signal any kind of change in strategy. You know, we're going to continue to.
To execute the strategy that we introduced in 2017 expanded offerings expanded offerings and services and operational excellence. So we went to very strong bench and our board expenses considered.
A considerable amount of time on succession planning so again.
That's again, we wish billion Raman all the best.
Your next question comes from the line of Courtney components from Morgan Stanley. Your line is open.
Hi, guys. Thanks for the question.
Good comment you commented before the housing and Brazil.
Parts of the business that seems to be driving activity on the small business that it sounded like you're expecting more muted nonresidential activity in the fourth quarter.
If you can just comment maybe on those relative sizes of your business and the margin profile between the two and.
And.
Acknowledging that you kind of talked about rising heading into next year. If there is any comments.
Okay. Thanks.
Yes, Thanks, Colin is Andrew.
Obviously.
With a broad portfolio like Caterpillar you have different margin structures within different parts of the business and that varies across the portfolio.
Obviously as we have been clear obviously, the smaller machines tend to have a slightly lower margin than the large machines, but.
But overall, we think that the portfolio mix as you've seen even.
Even this year is relatively small and manageable within the context of the broader caterpillar So I think overall.
We are not.
Too worried about that having a drag impact on gross margins also the other thing to remember is obviously, if you get very favorable leverage.
From some of these products.
It does help actually improve your margin structure. So that has been the the way the way, we manage which is why it's been very manageable and we expect it to be manageable going forward.
Your next question comes from the line of Ross Gilardi from Bank of America. Your line is open.
Yes. Thank you.
Good morning had a question for Jim.
Kim the industrial economy seems to be getting better I mean, thus far you're not really seeing it in your retail sales growth in both.
Mining in a in a I mean, maybe some of that as you guys, Scott Lumpiness and delivery timing, but not a lot of that got to be due to a pretty anemic capital spending outlook in the energy sector pressures in market like coal.
It seemed to be flagging ongoing at least near term headwinds for solar which has been very resilient. The last few cycles. I know you are buying the we are out but the company, giving any thoughts that you think 9 billion dollar cash or to diversify away from the fossil fuel industry, given the structural headwinds in the energy market.
And in markets like coal and if not why not.
Well Ross certainly appreciate your question I do believe we signal any headwinds for personal alarm, but probably the best way to start is by her but it's quite an expensive question. You've asked so I'll give you a bit of an expansive answer.
I will start by reminding me were large diversified business. Both in terms of end markets and geography as I mentioned earlier, we're proud had been named 19th at a 5500 companies around the world than to Wall Street journals.
Top sustained we managed companies we build the world's infrastructure and that would include investments in future energy infrastructure around the world and I'm confident our products will play a part in that.
I believe that we're well positioned to benefit from both the period of transition and after the transition has occurred.
And we'll continue to support our customers during the period of transition no matter how long that is but we're also very well positioned to succeed in the future in terms of how we're we're supporting our customers today, we have world class products and services to support oil and gas customers, but we're helping them with their SSG goals as well, helping them to reduce their carbon carbon footprint.
Whether its methane abatement by reducing flaring, we're providing battery storage solutions and efficiency improvement and we've introduced to them a gas blending engine that allows our oil and gas customers to substitute up to 85% of diesel fuel with natural gas and we continue to support all of our mining customers as well and by the way our exposure you mentioned coal arcs.
Closure to coal is low it's generally between three and 5% of company revenues, including both machines and parts and when our mining business looking to the future we see future opportunities due to the growing electric vehicle market that is expected to increase demand for essential minerals in particular copper and nickel are expected to see sustained growth.
And we're very excited about some of the opportunities in energy and transportation, we have significant experience burn in a wide variety of fuels in our with our Recip engines, and our turbines, including natural gas Coke oven gas landfill gas and other bio gases.
We are well positioned to run our equipment on a variety of blended fuels, including hydrogen already are so large gas turbine generator sets can burn a 100% hydrogen to produce electricity.
Our turbines and Recip engines can be paired with advanced technologies, whether it's electric drive batteries hybrid configurations to reduce overall fuel consumption and carbon emissions and we have battery electric powered and electric drive machines.
Enable customers to take advantage of available electricity as as a renewable alternative traditional fuels. We've done things like we have a and all switch battery locomotive, we develop and in conjunction with volley one of our rail customers. So you think about distributed generation, which many believe will be a large part of the future we're already selling.
Given engines and gas turbines to backup wind farms in so far as well.
Our engines provide.
A variety of distributed generation solutions as hydrogen blends in or out of the gas networks and so again, we think we're very well positioned for the future as as that transition occurs but we are going to continue to support the customers that we have.
Your next question comes from the line of Larry de Maria from William Blair. Your line is open.
Thank you good morning, everybody.
Fair environment.
For Q1 next year.
Can you talk maybe.
Profit side.
Apples.
Taken profits example.
Good.
Other items on an apples to apples.
Profit from this year and next year.
Okay.
Good morning.
Hi, Larry It's Andrew Yes, obviously the.
From a top line perspective, if we produce COSA demand, obviously that means we wont have the negative impact of dealer inventory reductions so that will be a positive flowing through to profit assuming no other.
Obviously, it changes from an operating leverage perspective.
On the sort of cost side.
We did see obviously step normal step runs at about $800 million per year on the basis of a stand a payout.
We will have that as a headwind as we move into 2021, we did see some delays in discretionary spending.
Some of that May not come back some of that may come back, but it is relatively very minor overall for.
For example, things like travel has been less obviously there have been other projects, which haven't really got sausages was such a big.
Because they have been delayed while people onto in the office together, so we'll see how that pans out as we get in and obviously, we'll be able to give you a better guide to that as we get into January when we talk about 2021.
Restructuring.
Restructuring.
At this stage, we are still putting our plans together for 2021, obviously, we assume normally on average about $200 million of base restructuring and then obviously, we've seen some incremental relay.
Relating to these challenged products some of the challenge products restructurings will recur in 2021, but.
But we're spending about $400 million of ship probably wouldn't be that much significant at this stage different next year will and maybe even slightly less we'll need to see how.
As we finish our planning process.
Thanks, Craig.
Your next question comes from the line of Nicole Deblase from Deutsche Bank. Your line is open.
Yeah. Thanks, good morning, guys.
Good morning, the going in there.
Just wanted to spend a little bit more time on T. I was a bit surprised by the retail sales deterioration. There that you guys reported for the three months ending September if you could just elaborate a little bit on that and then also with respect to that segment decremental margins were a bit higher this quarter anything special going on there and how to think about that into Fourq Hill.
So I'll start with the Nicole with the margins piece as I said in my comments, we did have a small one.
Onetime credit loss to income.
And he and see this year, we had a number of negative one time as I equated to about $70 million.
That related to some asset write downs and also some inventory impairments. So that was actually the big driver of the the margin change quarter on quarter.
And in terms of sales in.
Both any MTN in resource industries industries, particularly in tea.
Really a lumpy business. So you can see deviations quarter to quarter in terms of a retail sales so.
At that drives a lot of it.
Okay.
Your next question comes from the line of Steven.
Jefferies. Your line is open.
Hey, good morning, everybody. Thanks for taking my question.
On the return of cash to shareholders and understandable to sort of pause the repo. This year I'm. Just curious how you think about next year, assuming it restarts at some point do you over return of cash to sort of make up the difference and get to where you want to be or do you restart at.
Kind of the.
The operating cash flow level and.
Proceed that way thanks.
Overseas.
Good morning, Steve It's Andrew obviously any decision around that will be a board decision, which will take an update as we move into 2021 remind you that.
Actual policy is to return substantially all of immune T free cash flow. This year, we will already have over return based on that free cash flow year to date and the amount of buyback we've done probably we will be over.
So probably would just rebase back to two to what the number is but again, we'll have a conversation.
And just a discussion around that probably back in debt in January to on Prem with you.
Your next question comes from the line of Jerry Revich from Goldman Sachs. Your line is open.
Yes, hi, good morning, everyone.
Good morning, good morning Gerry.
We've seen across the board strong digital engagement in this environment for a lot of folks and I'm wondering if you could just quantify for your business out of your connected machines, what proportion of your customers.
Digital ordering.
Connected to dealers via that channel I know you are putting a lot of work there I'm wondering if you could just quantify for us how much traction you're building in that way.
Where you're comfortable talking about it thanks you.
You bet, Jerry we certainly are going to qualify quantify a number but thats something that were very focused on and we're seeing improvement over time. So you know as we continue to invest in and our dealers investing as well and their capabilities were seen improvement and what we expect that to continue but I really can't quantify it for you. This morning.
Your next question.
Comes from the line of.
Steven Fisher from UBS. Your line is open.
Great. Thanks, Good morning wondering Steve how much visit.
Barry how much visibility you guys have.
Construction and it looks like the retail sales activity is maybe moderating, but Jim you noted you expect continued strength in the next year. So can you just talk a little bit about the visibility there and maybe the drivers in terms of some of the policy shifts versus.
Versus market share in any other key factors. Thank you.
As I mentioned earlier, we Steve we do see continued strength in China. It's it's been it's been quite strong and we do expect that strength to continue into next year.
Based on what obviously weve done a crystal ball, but based on everything we see today, we expect the business to continue to be strong.
Again hard to elaborate much more than that frankly.
Okay. Thank you.
Thanks.
Your next question comes from the line of Seth Weber from RBC capital markets. Your line is open.
Hey, good morning, everybody.
Just kind of along the lines of a prior question. Your R&D spend has been down here for a couple of years I mean in a scenario where revenue starts to come back up would you expect a material pick up in R&D spend next year. Thanks.
Yes, I mean, I think one of the things. That's obviously one of the biggest factors. This year on R&D spend actually has been no short term incentive compensation reductions that has a year on year one of the most significant impact yes, there have been some project delays obviously.
As we've gone through the year.
Inevitably not having all the engine is in the room together.
It does mean that some of the the R&D projects all going slightly slower.
As a percentage of sales actually.
R&D was actually up year over year, because obviously you spend has held up slightly better than the the rate of decline in revenues. So obviously you will see we will see an absolute dollar increase.
But obviously, maybe not quite as.
A big maybe slightly lower percentage as a percentage of revenue.
But again, we are we are we are confident that we are investing in the most important R&D projects and continue to build out that expanded those expanded products continue to invest in digital so again, we're very committed to continue.
Developing new products and investing in the most important R&D programs.
Take our last question.
Your final question comes from the line of Bill.
From Baird. Your line is open.
Thanks, Good morning, Thanks for squeezing me in.
Want to go back to mining, if we could and maybe Jim a question for you here.
If we're kind of looking at the current environment.
Sounds constructive on mining it sounds like there are some things in the pipeline and the customers are starting to move on deploying a little bit of capital how would you how would you compare the discussion and the pipeline that you have now versus where you were in say 2016 going into 2017 and I ask because the fleet.
We all know it we all know its older. So I'm presuming that the decision making.
For your customers is a little bit different today than it was say in 2016.
Yes. It is the conversations are very different indeed, I mean by the end of 2016, frankly, our customers were shellshock, just giving them what they had gone through between 2012 and 2016, a very very tough time for them and all the discussions were about continued cost reduction about.
Finding ways they could squeeze more cost out of everything you're doing the conversations are quite different today conversations around autonomy. How we can help our customers be more successful, they're talking about greenfield projects, expanding brownfield projects retrofits of autonomy on existing fleets. The conversations are very very different and I'd say the mood couldn't.
Be more different I mean on that im not expecting a wild spike up as I've said previously you know I think the best thing for both the industry and for US is more of a moderated the increase overtime, but the comment that the mood is very very different than it was in 16.
Thanks.
That concludes Q.
Back to the presenters for closing remarks, well thank you Jason.
Thank you everyone for your time. This morning, just to kind of summarize here you know we're pleased with our performance in the quarter and the company is performing well. We believe are very well positioned for next year and the longer term future as well and we look forward to discussing.
Our fourth quarter results with you in January.
Thank you thanks, Jim Thanks, Andrew and everybody, who joined US today before we close let me point out find 20, where we're providing a preliminary data for quarterly earnings in 2021 January 29th April 29th July Thirtyth in October 28, 2021.
A replay of our call will be available on line. Later. This morning, we'll also post the transcript on our Investor Relations website later today I click on investors that caterpillar Dot com and then click on financial finer material.
If you have any questions. Please reach out to rather me you can lease rabbit wrangle underscored Rob at Cat Dotcom and I'm, just going to ask grant Jennifer.
The industry Relations General phone number is 309675 Fourfive ordinary I hope you enjoy the rest of your day and now let's turn it back to Jason to conclude our call.
That concludes today's conference call. Thank you everyone for joining you may now disconnect.
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