Q2 2019 Earnings Call
Good morning, ladies and gentlemen, and welcome to the Caterpillar Two Q2 019 Analyst conference at this time, all participants have been placed on a listen only mode and we will open the floor for your questions and comments after the presentation.
It is now my pleasure, Sir the floor over to your host Jennifer Driscoll Ma'am the floor is yours.
Thank you Catherine good morning, everyone and welcome to Caterpillar second quarter earnings call.
Joining us today are Jim Umpleby, Chairman of the board and CEO , Andrew Bonfield CFO in college athletes Vice President of our Global Finance Services Division.
We've provided side slides to accompany the presentation you can find them along with our earnings news release in the investors section of Caterpillar dotcom under events and presentations.
Today, we will make forward looking statements, which are subject to risks and uncertainties. We will also make assumptions that could cause our actual results to be different than the information discussed.
For details on factors individually or in aggregate could cause actual results to vary materially from our projections. Please refer to our recent SEC filings and the forward looking statements reminder, in todays news release.
As indicated on last quarter's call, we're not reporting adjusted profit per share again this quarter as restructuring costs are expected to be lower in 2019, It's our intention to report adjusted profit per share at the end of the first quarter fourth quarter of 2019 to exclude any mark to market gain or loss for the remeasurement of pension and any other post employment benefit plans as well as any other discrete items.
As a reminder, our U.S. GAAP based guidance for profit per share continues to include the benefit of a 31 cents discrete tax item, we recognized in the first quarter.
Please keep in mind that caterpillar as copyright if its call. We expressly prohibit use of any portion of the call without our written approval.
Before I turn the call over to Jim Let me inform you about a change we're making due to investor preferences around the timing of earnings calls beginning luck next quarter, we plan to shift our earnings call to begin at 830 am Eastern time. This timing allows us to conclude our call before the U.S. stock market open. Accordingly, we also plan to accelerate the news release timing to 630 am Eastern time, beginning next quarter.
And with that I now turn the call over to Jeff.
Thank you Jennifer good morning, everyone on the call.
Please turn to slide three for our second quarter highlights.
Sales and revenues this quarter rose, 3% to $14.4 billion or police operating profit rose, 2% to $2.2 billion.
Profit per share of $2.83 was slightly ahead of last year's record second quarter of $2.82.
We delivered strong operating cash flow of $2 billion in the quarter.
At our Investor day in May we announced our intention to return substantially all free cash flow to shareholders through a combination of dividend growth and more consistent share repurchases.
As previously announced we recently increased the quarterly dividend by 20% to one dollar and three cents per share or $4.12 on an annualized basis.
So far in 2019, we paid dividends of almost a billion dollars.
In addition, we repurchased about $1.4 billion in company stock this quarter, which brings the total to about $2.1 billion for the year.
From a top line perspective, we experienced strong sales in the quarter.
Overall demand remains positive.
While some customers appear to be more cautious about making large capital expenditures, including oil and gas. We continue to expect modest sales growth for the year.
We are only two and a half years into a recovery in many of our end markets.
Well, we had strong topline sales, we experienced some unfavorable changes in mix and higher than expected restructuring charges.
Andrew will discuss both of these items later in the call.
Although we are guiding you to the lower end of the profit per share range. We still expect 2019 profit per share to be higher than the record we set in 2018.
Now lets review, our 2019 expectations for the external environment on slide four.
He construction industries, we expect to it we continue to expect North America will be a positive for us.
This is due in part to infrastructure spending at the state and local level, although we expect that to be partly offset by weakness in residential construction.
Turning to Asia Pacific, We expect continued pressure from competitive pricing in China.
Partly offset by growth in other areas of Asia Pacific.
Yeah, I mean, it is a mixed bag.
Sales in Europe are projected to be steady, while Africa, and the middle East remain weak.
Latin America continues to improve from very low levels.
We expect demand for heavy construction as well as Corey and aggregate equipment to remain strong in resource industries. This year.
Most commodity prices remain in investable levels.
Mining equipment sales continue to improve and large mining truck sales have further room for growth to reach their normal replacement levels.
We continue to anticipate that miners will remain disciplined in our capital expenditures in these early stages of their multiyear recovery.
We will do the energy and transportation space is more mixed amid continued volatility in oil prices and tightened to oil and gas capital spending.
In reciprocating engines, we expect our sales into the Permian basin will strengthen in the fourth quarter as takeaway capacity improves.
We expect solar turbines to have a strong fourth quarter as will progress rail.
Power generation continues to be an area of expected growth.
Please turn to slide five Bush, where a progress update on our strategy for profitable growth.
We continue to execute our strategy by investing in services and expanded offerings, while improving operational excellence.
We've been working hard to improve product lead times.
Due to the significant increase in volume during the past two and a half years, we've struggled to keep up with demand for some products. This was primarily due to ramp up issues at our suppliers.
We're pleased that product lead times have improved even though volume remained strong.
We have achieved or close to achieving target lead times for the vast majority of our products.
Resource Industries for example, our current scheduled average lead time now is just 12 weeks.
More than a 50% improvement compared to March of 2018, when we had a weighted average of 26 weeks for the entire portfolio.
Shorter lead times allow customers and dealers more flexibility on when to initiate orders.
We also continue to focus on enhancing operational excellence, including safety.
Our safety goal was always zero incidents.
We want our people to return home safely every day. So what are the metrics. We track is the number of recordable injuries per 200000 hours workers Jan to May and June were two of our best safety month, [laughter], we intend to keep the momentum going and make it a great year for safety.
Earlier this year, we announced a goal to double and Ian T. services sales to $28 billion by 2026.
Services increased customer value by improving asset utilization and availability, while reducing owning and operating costs.
We continue to invest to expand our digital capabilities, enabling services grow former and we remain on track toward our goal of 1 billion connected assets by the end of the year.
Yes, the product rebuilds and Repower as are just one of our services, helping customers be more successful.
Progress rail recently won a contract to Repower several locomotives for UK rail customer.
The new easy engine for need new emission standards. So much cash in the first three power is expected to be delivered next year.
Tuck in Geneva, Repowering Modernizations are growth areas has our locomotive customers sheet greater utilization of existing fleets.
They are going after kind of many of our meetings with mining customers. These days include discussions around technologies like autonomy in automation and how they improve safety and productivity.
We have recently been selected for Threed Greenfield projects that will further grow our penetration of autonomy with mining customers in South America and Australia.
More than 220 trucks have accumulated 50 million kilometers of autonomous driving in fleets already deployed.
Our autonomous solutions are now being utilized by seven customers across 11 sites and three continents.
We believe that we are at a tipping point for adoption of autonomy in mining.
For example, this quarter, we announced that we will be working with Rio Tinto to create a technologically advanced iron ore mine in Western Australia.
We will supply and support mining machines automation and enterprise technology systems for this project.
Working closely with West track, our local dealer Rio Tinto plans to create an automated mine operation.
Using data analytics and integration to enhance safety optimize production boost mining machine utilization and lower costs.
We also continued to expand our offerings enable us to continue to grow by addressing the diverse needs of our customers around the world.
This year, we introduced the first cat, particularly to truck Jushi model the 740 G.
As you May know the GC designation means for the machine target segment that we refer to as lifecycle value.
This segment is for customers, who have lighter duty applications or work in less extreme conditions.
They value simple tough machines that perform well with caterpillar quality product support.
The 740 is particularly attractive in the North American rental market, where it offers an additional value proposition in that size class.
That said the machine is also gaining traction in every region of the world.
Interest in the 740 G. She has been strong with year to date demand exceeding our initial forecast.
With that I will turn the call over to Andrew for a closer look at our financials.
Thank you Jim and good morning, everyone.
Starting with slide six I will begin with a closer look of results.
Then I'll touch on backlog and dealer inventories before turning to our outlook for the second half and full year.
Starting with the hedge funds sales revenues for the quarter totaled $14.4 billion up 3% from last year's quarter, driven by construction industries and resource industries.
Overall operating profit increased by 2% or $46 million to $2.213 billion.
Second quarter profit per share was $2 83 was up by one cents versus the prior year's record second quarter.
There were a number of factors, which impacted the overall performance for the quarter.
First mixer mix had an unfavorable impact on profits.
This was both of the products and the segment level.
Second oil and gas sales remained weak as we wait for the Permian takeaway issues to be resolved.
We now expect this to occur in the fourth quarter.
Finally, we booked significant restructuring expenses in the quarter, which means that we expect to spend to be immaterial to the rest of the year.
We completed $1.4 billion and share repurchases in the second quarter, I'm paid $492 million and dividends as part of our commitment to returning substantially all of our free cash flow to shareholders.
We also announced a 20% increase in the dividend effective from the third quarter, which reflects our confidence in the company's ability to continue to grow cash flows.
We ended the quarter with strong liquidity, including $7.4 billion of cash on hand.
Let me dive deeper into the topline on slide seven.
Consolidated sales growth of 3% reflects a price realization and maybe into your 3% with gains in the three primary segments.
Volumes grew by 2% and the demand environment remains strong.
As we reported this morning machine retail sales to users grew by 4% during the quarter.
Looking by segment construction industry. So some good news rose, 5% led by price realization, including the 2018 major increase as well as the increase on the first of January .
So some revenues from resource industries increased by 11%.
Fueled by high equipment demand a favorable price realization.
Energy and transportation sales revenues declined by 4%, primarily due to continued softness in oil and gas as well as timing.
Challenges from projects and locomotive deliveries.
A financial partner product segment revenue rose 5%.
Currency pressures reflected the dollar strengthening principally against Euro and Australian dollar.
Overall, our topline growth were affected customers and do this confidence in the value proposition of our equipment.
If you move to slide eight I'll walk through the changes in operating profit.
As shown on the chart price realization low SDMA in R&D.
Expenses drove the operating profit increase contributing $427 million and $119 million respectively.
Financial products also had $14 million to operating profits for the quarter.
Manufacturing costs increased by $328 million due to higher material costs, including $72 million in tariffs.
Variable labor and burden, including will also presume incentives.
Im warranty expense.
Unfavorable sales volumes about $190 million, primarily due to mix changes in both construction industries and then June transportation.
And construction industries and mixers sales reflects an increase in smaller products in North America.
The mix and the anti reflects changes and medication mix, including small engines.
Importantly, price realization more than covered higher manufacturing costs this quarter, an improvement versus Q1.
We also continue to expect price realization to fully cover higher manufacturing costs for the full year.
It's now been two years since towers, we implemented an input prices are moderating.
Freight costs have also stabilized.
Currency lowered sales by two percentage points and reduced operating profit by about $20 million.
Moving down the piano low short term incentive compensation expense impact of SGN and R&D favorably, while also benefiting manufacturing costs.
We expect 2019 short term incentive compensation expense to be about $600 million lower than in 2018.
Before taking look at the segment results I want to comment on how the second quarter trended against our first quarter performance.
Second quarter sales rose versus the first quarter driven by seasonal trends.
Hi, North American construction industry sales sales of original equipment in resource industries and high rail service revenue.
From an operating profit perspective, the second quarter was about flat compared to the first quarter.
The favorable sales performance was offset by negative mix and negative operating leverage due to lower absorption costs into inventories driven by the reduction in production levels as we reduce caterpillar inventories.
The operating profit margin contracted by 110 basis points.
From a segment perspective, the sequential margin deterioration was highest in resource industries, which as you know had a very strong first quarter.
The change in resource industries operating margin was due to unfavorable operating leverage from inventory changes coupled with higher warranty expenses.
To keep it in perspective.
Resource industries in the first and second quarters had the highest profit margin since 2012, a year when sales were twice as high as they are now.
Units a day restructuring charges are $158 million.
We don't expect these to recur at these levels in the second half.
We still expect to a maximum of $200 million of restructuring expenses for the full year.
Now, let's look at the performance of each segment in the second quarter versus the prior year, beginning with construction industries on slide nine.
Construction industries had a record quarter for both sales and profit.
Sales and revenues totaled $6.5 billion getting 5% versus the prior year.
Construction sales increase in North America by $774 million due to demand changes and keeping dealer inventories on price realization.
Sales were flat in Latin America, where construction remained at low levels.
Declines in Asia Pacific reflected continued aggressive competitive pricing the timing of the selling season as well as unfavorable currency impacts.
Weakness in the Amy was primarily due to a weaker euro.
Construction industries profit increased by $93 million or 8% to a record $1.247 billion.
Segment profit margin of 19.3% increase by 60 basis points.
The favorable impact of higher volume and price realization was mostly offset by higher manufacturing costs plus on favorable mix.
Now, let's go to slide 10 look resource industries.
Resource industries sales were $3.8 billion up 11% from the second quarter of 2018.
The $274 million Sosa reflects increases in demand unfavorable price realization.
Sales growth resource industries was driven by strong money market.
Nonresidential construction inquiry and micro customers.
Segment profit of $491 million rose 17%.
Resource industries profit margin improved to 17.2% up 90 basis points.
The improvement was primarily due to favorable price realization on higher sales volume.
Gross in original equipment remains strong as management to replace aging equipment.
If you turn to slide 11 energy and transportation sales in the second quarter were $5.5 billion down 4%.
Power generation sides increased by 3% on continued demand for large feasible reciprocating engines.
The other applications, so lower sales volume and unfavorable currency impacts.
Of note sales into oil and gas applications decreased by $162 million or 11%.
Due to the timing of Turban project deliveries in North America in last year's quarter.
Lower demand for new equipment in the Permian Basin, and part which were partly offset by higher showed on so for production applications in the Amy.
Industrial sales declined by 1% with gains in most regions more than offset by currency related impacts in the gaming.
Transportation sales declined by 3%, primarily due to the timing of locomotive deliveries and reduce marine activity in North America, partially offset by higher sales for ROE services.
Segment profit for energy and transportation totaled $896 million.
On the $126 million or 12%.
The segment profit margin contracted by 150 basis points to 16.2%.
Energy and transportation margins reflected lower sales volume.
Including an unfavorable mix of products and slightly higher manufacturing costs, partially offset by price realization.
Turning to slide 12, let me touch on dealer inventories in backlog, which play into our assumptions for the year.
[noise] sealing machines and engine inventories increased by about $500 million during the second quarter compared with an increase of about $100 million during the second quarter of 2018.
The largest impact was and construction industries with Telus decrease inventory in the probably this period.
We previously projected the total dealer inventories would be about flat for the full year.
Based on current inventory levels, now expect but dealer inventories will increase for the full year by about $900 million driven by construction industries on resource industries.
Was dealer inventory levels are closer to the top end of our range. At this time, we are comfortable with this level of supportive but positive end user demand.
At the end of the second quarter 2019, the order backlog was $15 billion about $1.1 billion lower than the first quarter of 2019.
Down $2.7 billion from the balance at the end of the second quarter of 2019.
The order backlog decreased across three all three property segments with the largest declines and construction industries and resource industries.
And construction industries, we connect the backlog decline to slowing orders due to growth in dealer inventory.
Also keep in mind, the construction industries had a record quarter and it's not unusual for backhaul to the currency in the second quarter itself.
In resource industries, we improved throughput in factories and improved lead times as Jim described.
And remember orders do tend to be lumpy.
As a point of reference the total to fund in the backlog of $2.7 billion. Since Q2 last year is about offset by the increase in field inventories at the same time period.
Now, let's walk through our assumptions for the 2019 outlook.
We now expect profit per share to be near the low end of our range of 12006 cents to $13.06, assuming a recovery in oil and gas and at the end of the year and team is working through part of the higher machine inventory levels.
Quotation activity is unchanged, we assume price realization offsets manufacturing costs and the associated restructuring costs for the remainder of the year will be significant lower new lower with a maximum spend of $200 million.
Other key assumptions are broadly unchanged, including $250 million to $350 million interest for the year.
We expect short term incentive compensation to be a tailwind of about $600 million.
We now project capital expenditures of about $1.3 billion.
The estimated annual tax rate is unchanged at 26% excluding discrete tax items.
Consistent with our intention to return substantially all free cash flow to shareholders. We are now projecting share repurchases in the second half to be similar to the first call.
In fact, including all shares repurchased since the first of January 2019, we expect to reduce our tungsten shows outstanding by about 9% by the end of 2019.
All the while executing our strategy and investing for long term profitable growth.
This reduction in share count is fully reflected in that guidance.
Looking ahead to the third quarter, we will continue to execute execute our strategy, including making appropriate additional investments for long term profitable growth.
We anticipate stronger results in the fourth quarter, including increases in demand from oil and gas and low customers.
So finally, let's turn to slide 13 recap today's key takeaways.
We grew sales 3%.
Operating profit rose 2%.
Profit for show was comparable with the second quarter of last year.
We have maintained our profit per share outlook, although we would expect to be at the lower end of the range of $12.06 to 13 goes and six cents.
Again this adjustment reflects mix changes a fourth quarter recovery in oil and gas and Peter is working through higher machine inventory levels, partially offset by lower restructuring charges in the second half of the year.
We still expect modest sales growth a share and profit growth on top of last year's record results.
We're also on track, including 2019 buybacks to retire a total of about 9% of our shows outstanding by the 31st of December .
And our financial position remains strong.
With that let me hand, it back to Jennifer to begin the question and answer portion of the call.
Catherine Thank you if you could now queue up the questions.
Certainly ladies and gentlemen, the floor is now open for questions.
If you have any questions or comments. Please press star one on your phone at this time.
We ask that will pose your question you. Please pick up your handset is listening on speaker phone to provide optimum sound quality.
Please hold them on the call for questions.
Your first question is coming from Rob Wertheimer from Millennials capital.
Sir your line is live.
Thank you and good morning, everyone.
Hi, good morning quarter of.
So thanks for the color on dealer inventory I think though.
Italy, something investors want to talk about I wanted to ask for just a little bit more clarity around it.
Obviously, you don't controller control, what the dealers do and it's their own decisions, but do you have a sense of what led to the sort of change to be building a little bit of inventory through the year versus the prior expectation. It doesn't seem like sales inflected up sharply since then and then again as Rob My follow up into it I mean is the 900 million gap between where you thought and what sounds like it will be is that the difference between your ideal level and where it may end in other words is that the downside risk for you know for ongoing or maybe you could just characterize.
How big that gap is versus ideal thanks.
Hey, Rob This is Jim I'll I'll take the first part of the question and maybe ask Andrew to do the second part. So as you mentioned dealers are independent businesses and they control their own inventory levels.
Inventory levels were lower than.
They normally are and were now that would that increase where it back up to what is considered more of a normal level.
I did talk about the fact that we had a.
We have been successful in reducing our product lead times, which also has an impact here as well so that goes to the dealers a lot more flexibility in terms of where they they place orders.
Andrew I'll, let you have exactly on the $900 million reduction we expect for the remainder of the no reduction to about $900 million. I mean, we are slightly at the high end.
We'd like to be in the middle of a range, we keep a range for each segment.
We always comfortable being in the mid sort of midpoint of the range. This gives us a roundabout the midpoint.
From from that perspective, Rob so that would be potentially further reduction, but we were very low in that range previously and as Jim indicated that did have some impact on availability also move into the day you want to make sure that you guys have the right amount of inventory to be able to meet customer demand and probably there was you know.
Given that to the challenges we've had previously there may have been some loss of sales and field level as a result of not being able to supply quickly enough.
Okay I beg your pardon so so with the.
I guess production from here to the end of the year, you're saying you're going to be kind of roughly in the middle of the range showed low of where you'd like to be is that.
Yes, I would characterize it yes, Rob.
Okay. Thank you.
Your next question is coming from Jamie Cook from credit Credit Suisse.
Your line is live.
Hi, Good morning, I, just wanted to follow up on that the mix issues in the second quarter, how much that hurt earnings and what's implied.
For the the back part of the year and then just within oil and gas specifically I think before you said you had expected waters to pick up in the back part of the year in the second half now you're saying the first fourth quarter I guess, just sort of what gives you gives you confidence that you should see that acceleration and how much cushion could we potentially get from from solar in the fourth quarter. Thank you.
Good morning, Jamie, it's Jim so our oil and gas up.
Guidance for the year is depended on certainly still are having a strong fourth quarter solar has as you know the breadth. The lead times are relatively long they have that the orders in hand to for the new equipment side to execute that there is always some variability in service, but we are expecting a big fourth quarter from solar and fully expect to expect them to make that happen.
We are also expecting in the fourth quarter some recovery in reshape engine sales in North America as the Permian constraint issues continue to be resolved.
And Jamie on the mix issues, obviously the mix.
Did have quite an impact in the year in the quarter. If you look at.
We sold a small increase in volume the sales level, but a negative.
Moving the operating profit level.
Principally in supply that was mostly due to the fact that we actually sold more small machines in the quarter, while they have similar margins that kind of be quite sensitive.
To the overall mix impact and then obviously this will solve a segmental mix and there was a mix within me into some of the mix issue in the anti particularly with those smaller engines are being sold.
And then also there's a segmental mix impact obviously because.
He and she does have very strong margins and obviously the margin deterioration impacted of the reports of mix as we look at variable margin in that business.
All of those factors have been built into our guidance. So we have.
Put that into why we expect to be at the low end of the range along with the delay, particularly in oil and gas so.
Okay. Thank you I'll get back in queue.
Your next quest.
But the EPS grows about 25 to 50 cents.
And I'm just trying to understand I can see about 15 cents from lower restructuring sequentially.
And maybe about a nickel from a lower share count so it's about 20 cents.
But then I would have figured the rest would have been you see better price cost second half than first half.
More than offsetting some overhead absorption issues with the lower volume.
But I thought early made a comment price cost maybe I missed it sort of sort of neutral the rest of the year can you can you clarify that just trying to get the EPS walk first half to second half okay. Thanks, David and.
Yes. So first of all we don't give sales guidance. So your assumption around sales may be slightly different.
Assumption so that may have been part of the impact.
We are seeing as Jim indicated we do expect both rail and so law and oil and gas to pickup in the fourth quarter. All of those will have an impact and remember that obviously in Ti is down for the first half of the year.
When you look at that so as you think about it from a top line perspective, there may be some variability we see versus where you are on your topline.
With regards to margins and operating margins, obviously, there are seasonal factors that come into play.
But as we did indicate we are starting to see.
A little bit of relief from pricing from underlying manufacturing cost increases obviously the towers. We start start now anniversarying freight costs have started to pickup in the second quarter of last year. So those factors will have less of an impact on overall manufacturing costs offset against our little bit will be some variability if we do actually take down some production, obviously, we'll have a little bit lower industry absorption. So those are all factors, which we weighed into our guidance that may you know obviously, we are starting to see some things like steel costs come down steel, obviously, we do a lot of our steel buying on a on a contractual basis and there is a lag.
But we are starting to see some of those things flow through as well.
In the second half.
And then trying to set up to look into 2020, we've already discussed the inventory, but for the backlog.
Seasonally you can see how CDAI might continue to go down.
But when you think about your commentary the rest of the year on mining and engines TNT.
Are we making the assumption that the backlog is somewhat bottoming out here, because ri and NT.
Offset sea ice sequentially, we're just trying to.
Trying to get a baseline kind of exiting the year have we seen generally speaking the bottom of the backlog with this 15 billion.
Yes, I mean, yes.
I think David one of the problems.
No with focusing very much on the backlog is remind you that this is reflective of dealer demand.
They will have been some elements or as a result of.
Our inability to delays in supplying orders.
At availability of product the dealers may actually have been putting slots in the queue.
We have seen that happened before and that May have happened this time as well.
Obviously, what does happen with.
Order backlog is it is lumpy, particularly in places like all right.
Rails so law.
So you know.
We are keeping an eye on that.
There's nothing indicating that from a retail if you look at the retail stats just remind you they are up again.
So there's nothing indicating underlying customer demand is changing this maybe behavior by dealers and their ordering patterns as well and again just to just a definitive to expand upon that you think about the lumpiness in solar and rail obviously, if you have a big fourth quarter is a lot of shipments that were in the backlog. Obviously the backlog will go down again that happens every year. That's the nature of the Beast. Okay. I'm sorry, Jim said part of the 15 billion. You would argue is reflective of why you're confident in the fourth quarter shipments of those businesses.
But at the same time it could help drive the back backlog down from here, if there aren't new orders to fill it in so to speak yet and certainly and again that happens every year. So typically say every year typically.
Solar in particular has a big fourth quarter. So we would expect again shipments occur backlog goes down but again the business continues to be healthy and good quotation activity. So we would expect that there will be a normal seasonal pattern.
It's solar in terms of backlog and inventory.
Terrific. Thank you very much.
Your next question is coming from Ross Gilardi from Bank of America.
Your line is like.
Hey, good morning, guys.
Part of running for us.
I was just wondering if you could give a little more color on the unit.
Three new Greenfield Green field sites for autonomous and the timing there are these retrofits or.
New trucks and equipment and.
Is that a positive driver into 2020 or is it is it much further out.
Yes, it's a multi year that we're going to make deliveries over a number of years and so they are new trucks again. These are greenfield sites. So again, a lot of new technology, but the deliveries will occur not just in one year it'll be over.
More than one year.
Okay and then.
Can you talk a little bit about your confidence in the you know that China excavator outlook for the second half of 19, I mean, it sounds like your your full year outlook is broadly unchanged as you cited theirs.
Some kind of competitive pressures there I mean, how much visibility do you have.
On on that business for the rest of 19.
Yeah based on everything that we see we believe that overall the market demand will be will be stable. We have mentioned the fact that we have some competitive pricing pressures from local competitors. We're certainly taking steps to ensure our competitiveness long term in China, we're introducing a number of new GC products.
That will help us compete as well, but again.
We are we feel good about.
Our forecast there in China.
And just lastly, Andrew you mentioned in your share count should be down 9% by the end of this year with the buybacks beyond 19, if you did $4 billion to $5 billion in buybacks.
I think that will retire about 6% of the share count at today's price and just wondering how much of that 6% is fair to assume for.
Is offset by share issuance for employees options et cetera, just net of equity issuance I'm, just trying to get a better sense for how much the share count should be falling each year beyond this year.
Yes, so obviously the the 9% around 9% is a net number so thats net of new issuance.
So effectively given the we'd spend 3.8 last year, we expect somewhat to be in this sort of but we did 2.1 in the first quarter first half something similar in the second half.
If you're doing about four you generally require about four and a whole percentage the share capital each year.
Okay. So so share count just sort of as a base case assumption at the current stock price is probably fallen 4% to 5% a year beyond 2000 getting.
Yep, Okay bye.
Thank you.
Your next question is coming from Joel Tiss from BMO capital.
Your line is live.
All right Hey, guys has it gone.
Good how are they have on all right. So so just.
It sounds like some some pieces are setting up 2020 to be a little bit more of a difficult year with the incentive comp down so much this year and the dealer inventories up a little more can you give us some of the pieces that to kind of balance that out what what would be on the other side of that you know I'm not asking for forecast just kind of.
A couple of factors bigger factors to think about.
Yeah, I mean, that's remember that weve.
We have had quite a tough year and you can see so far.
Obviously Permian takeaway issues are resolved and drilling activity goes up that will be one area, where we would see some upside in 2020 I think if you look also.
Underlying demand.
For machines remain strong and so again that other opportunities for us.
As we move into 2020.
We will always retain our focus on a flexible and competitive cost structure.
We want to invest in the right things for the business to drive long term profitable growth.
But we still have ways do need to look to make sure that we are operating as efficiently as possible and those are other areas. We will continue to see some opportunity.
To drive growth as we move forward.
That's great and then my second question is about something you mentioned there too the cost reductions like it's you know you've guys have done a lot a lot of work there and it seems like the cost structure is seemingly not as responsive to the to the fluctuations like quarterly fluctuations in the business is that more structural or is it is it cyclical just that youre kind of scrambling to get stuff out the door can you give us any color behind the scenes of what to think about or are those kind of more long term changes to the company and we can't worry about you know the near term results.
I think we don't respond to quarterly quarter movements were trying to drive the business for the long term. So Joel as we look at the cost structure, we do try to make sure.
We've got a long term focus on that and don't do things just for short term cost cutting measures.
We can all do those we've all seen people do those longer term is not what drives you well because 10, what tends to happen is investment then gets cut off which isn't the right thing to do for long term shareholder value creation.
But having said that you always certainly a challenge all of our leaders to find ways to become more efficient and reduce costs. So we're we still believe we have opportunities over the next few years to continue to improve our our cost structure.
So again again, while as Andrew mentioned, while continuing to invest in those areas, particularly like services like our digital capabilities that drive long term profitable growth and sorry, Joe just one thing on 2020 , which I did forget was about resource industries. I mean, obviously mining we are only used to in the start of the recovery plays phase and replacement cycle. There is a lot of potential still but barriers to run.
As mine to start actually pumping on Capex, all commodities remain of investable levels. So we do expect that to continue to improve as we look out as well.
That's awesome. Thank you so much.
You're welcome.
Your next question is coming from Jairam Nathan from <unk> capital.
Your line.
Hi, Thanks for taking my question. My question is regarding rail. This you mentioned for a strong for Q, but I know you are seeing is on the implementation of PSR under railroad side.
They are cutting down the number of locomotives they use.
And at the same time volumes are starting to decline as well as the rail volumes. So just wondering if this a unit.
This expectation us or more international.
Yeah, its really based overall the backlog that we have in rail for new locomotives, but certainly I mentioned earlier. The one example, we gave of Repower. So our rail business is a direct business and there is a large service element to it as well. So it is not completely dependent upon new locomotive sales, having said that of course, we are expanding internationally. We've shipped are some our first transit locomotives. Since we made the acquisition of MD a number of years ago. So again, we're not totally dependent upon new locomotives in North America.
We certainly understand the environment in which we're operating but again what were talking about as a as an expected strong fourth quarter based on backlog in hand for rail.
Thanks, and my last question was on on margin margins on resource you mentioned warranty.
<unk> expense increase can you expand on that it's had more volume related or is it from.
Something.
No. It was a particular issue with a particular product that happens these things do happen they do tend to be lumpy.
And that's been a driver in this quarter.
Okay. Thank you Thats all I had.
Your next question is coming from Samir Aside from Macquarie Research.
Your line. Thank you for taking my question.
Thank you for taking my question.
There.
It's an interesting developments made.
Electrifying the factory. So my question is how does kind of color to this market evolving do you think it could pose a risk longer term to the diesel engine and parts business, where do you think the applications are limited. Thank you.
And I'm sorry, just think can barely hear you did you say electrification and fracking is that what was that the question.
Yes electrification in fracking.
You bet so so.
We have been very involved working with customers both on the Recip engines side and on the gas turbine side on what people call. The fracking opportunity. So we are well positioned to participate in both of those areas.
We have sold some gas turbines, which are generator sets that allow customers to do Refracking. We're also working on every ship solutions as well working with customers. So.
I believe it will be a mixed market with both and we will see which one is stronger in the end, but we participate both in both ways both both.
For for.
Lets vacation in non and also both in our Recip engines and with gas turbines.
So we're well positioned to play across that value chain.
Thank you.
Your next question is coming from Jerry Revich from Goldman Sachs. Your line is live.
Yeah, Hi, good morning.
Morning, everyone Andrew.
You folks it sounded more positive tone on large money truck order cadence move and I think we've heard from you in a while can you just talk about what in your view has driven slower replacement cycle in this recovery. So far is that the autonomous decisions that.
Have to be made and can you just expand a bit more Andrew on your comments that there is scope for a move towards replacement as you think about the moving piece around twentys. So it does sound like you expect.
Order decisions to be made obviously in advance of 20 for for that to play out. So maybe I can get you to expand on that too.
Injury Alton This is Jim I'll take it so we see strong quotation activity on a global basis for all commodities. So as we work directly with our customers and with our dealers.
There is.
Increasing quotation activity. There is a lot of projects that are being developed we talked about some orders that weve received certainly I believe and I actually hope there'll be less volatility than we will be in that there has been in the past it will be more of a slow steady ramp up but the quotation activity is quite strong.
And again, it's it's it's across all commodities.
Okay.
And just just said I mean, the portfolio is at an all time lows since we began tracking that number in 2013. So it is an opportunity definitely we do believe that now we will be starting to see replacement solvency, it's come through and we do expect our cost our mining customers to be disciplined in their capital expenditures. So again that that ties into my earlier comment about more of a slow steady increase then a volatile increase they will be again cautious and disciplined but we expect the business to continue to improve on a slow and steady basis.
Okay, and then construction industries you folks have worked really hard to get the cost structure to where it is today given that dealer inventory builds.
Both across new equipment used equipment on the utilization pressures I guess can you talk about.
What's the potential for you folks to more actively manage orders you mentioned there are some slots that are potentially placeholders et cetera. So what's the opportunity for you folks to get ahead of the eventual.
Order declines given what some of the leading indicators are doing cut production.
Earlier to keep the swings from being really painful on the manufacturing base.
Yes, just to be clear so so firstly, let me start with it we we released our retail stance. This morning.
And so business is.
Is improving so that start with that but certainly shortening lead times is very important we've been on this lean journey for a long time and having shorter lead times allows us to respond much more quickly to changes in demand.
Andrew the Com was.
I just more focus on North America than overall, so the retail sales were up 7%. The company sales were up 28% and so we're building inventories in North America, specifically, so I'm wondering what is the potential to get out in front and cut production yes.
So so we did so Jerry part of as we as I spoke in my comments.
We did see some take down of caterpillar inventory.
Finished goods inventories. So we do continue to focus on that.
Obviously with lean manufacturing.
We are obviously, Mike we don't hold lot of finished goods inventory.
Most of the inventories held to actually to an a component level. So actually boughten sachi that is one thing we continue to focus on but obviously, we will look at making sure that we don't as we said we will take down dealer inventory in the second half and that will have some impact on production rates.
Okay. Thank you.
You're welcome next question please.
Your next question is coming from and Dagan from JP Morgan.
Your line is live.
Hi, good morning, a tight good to turn back to oil and gas. So yeah, I'd like to really understand your confidence in a fourth quarter pick up in sales is the products, but dealers have ordered so its shipments to dealers or.
And is it really end market demand and if you could just talk about your mix in oil and gas well completions versus drilling. So we know which one is more important to demand for your products. Thank you.
Yes, and so good morning, again, starting what part of the oil and gas pick up as I mentioned earlier is due to solar where we have the backlog and the orders in hand, and it's a matter of executing always some some variability in service, but we feel good about that so that is part of it. If you go to the Recip side of it the gas compression remains strong.
We are expecting an increase in.
End user demand for fracking.
That will impact our business towards the end of the year.
And on the fracking side is that actually drilling or is that well completions I'm trying to understand so you're right that's more mostly mostly well service.
Okay I appreciate that and then my follow up questions more for looked back at year to date performance sales are up but in fact.
Adjusted net income is down so Jim you know should we be growing concern should investors be growing concerned about your commitment to profitable growth I mean, I know you can say you are at record levels, but.
Net income, it's actually down and then just a basis year to date.
Yeah. So we're still very committed to profitably growing our business business, and we're making investments to make that happen.
We and we are we talking about us in Investor day, as well that we do expect quarterly variability in our performance, but we're very much focused on improving year to year.
We've talked in the call. This morning about some of the issues we had in terms of.
The lumpiness in restructuring charges, we had some inventory impact we did have some mix impact and we will have just given the nature of our business. We will have quarterly deviations in our performance, but we're we're really driving for his.
Is medium to long term profitable growth and we're investing to make that happen. We're committed to take on its continued to improve our cost structure structurally I talked about that earlier and we believe we have opportunities there over the next few years to take that on and we're very committed to that profitable growth story, but again, we will have quarterly deviations Theres Theres no question.
And yes, but if I look at that six of the last seven quarters your stock has underperformed.
Is there something you can do structurally going forward.
Help us understand this variability.
Yes again.
What we're driving towards is is profitably growing our company and if we profitably grow our company.
I believe that will be reflected in the stock price.
And we can say, we're going to have again as I as we talked earlier, we expect to have another record year in earnings per share this year.
It's another record year.
Okay I'll leave it there thank you.
Thank you.
Your next question is coming from Timothy Thein from Citigroup.
Your line is live.
Thank you and good morning first question is on on Ri, and specifically, Andrew you'd mentioned earlier that OE was was it a big driver or a driver for growth in the quarter. So I'm.
Im not sure exactly what that means for park sales, but but really the question relates to the sustainability of pricing, which was up against a pretty tough comp again in the second quarter and just as you see it basically has the question is the trade off on as your OE volumes, presumably capture a bigger part of the total within mining how should we expect that trade off to play out in terms of.
Pricing on on on OE relative to parks.
Yes. So obviously, we do have in the first quarter actually we had a really strong quarter I think was a record quarter for part sales within resource industries and part of that was driven by the fact overseas rebuilds are still continuing.
Yes that will be a mix impact it depends on what the equipment was selling.
And the relative mix of parts was and services businesses.
We.
No that will be part of why how we manage that business. Obviously the advantage you have on Ob is as you improve throughput you do improve operating leverage and as I say, we actually have seen.
These two quarters, the first and second quarter have been the two best quarters in all rise since 2012 when.
Actually sells a revenues were nearly double what they are today. So I think Joe you, we will see Lumpiness, we will see movement thats the nature of that business, particularly given.
The way, we we actually deliver.
Products to that to customers.
But we're quite comfortable with the sort of the relative margin performance and again, we will look at them over time, rather than just purely quarter to quarter.
Okay got it and Jim maybe one one last one on the oil and gas and specifically your comments to a question.
Recently, just on on well servicing.
A number of the big service companies have.
We have commented just in the past few days about cutting capex budgets some of them pretty significantly. So I'm just I just want to come back in terms of.
Of kind of what's underlying that that assumption that we do get this this pickup a recovery in the fourth quarter.
Yes, again, its our perception of what's going to happen as the.
Is the takeaway issues in the Permian our result.
So ill leave it there.
All right. Thank you.
And thank you I think we have time for one last question.
Your last question is coming from Courtney Ecovadis from Morgan Stanley . Your line is live.
Hi, Thanks, just a couple of clarifications first on restructuring.
Can you just help us understand I think the first quarter you said it was pretty minimal so how much of that 158 million, what's hitting this quarter on and in which segments. It was showing up and then if you could also quantify the warranty charge that was in resources and then you know just more broadly when we think about your China business with APAC settles down as much as they were this quarter and construction how should we thinking about the margin for that business.
You know as you are continuing to introduce these GT products, you know relative to what you had been getting.
In light of all these can competitive pricing pressures.
Yes can you maybe saw with restructuring.
The the charge in the first quarter was $14 million in the second quarter was 110.
The 48 million goes in that too. So you can always refer back to that.
Most of it actually was incurred and as is held within the corporate awesome.
There is some move back into the business has been very limited base will not materially impact team.
The reported margins.
With regard to warranty expense, we don't actually break down the analysis of manufacturing costs.
But the fact, we cooling two shows it was a significant milestone in the quarter.
But obviously.
You know and it did have an impact on the overall performance in all right.
In the in the comparison in Q1 versus Q2.
China, New products, yes, sorry on China, new products the.
Yes, obviously GC products.
On lower price point, but to have similar margins as we said before.
Overall, the student impact reported margins as much obviously, the most important thing is.
Making sure we retain a good competitive position this quarter was impacted in part the reported revenues were impacted in part by the timing of Chinese new year, we did see the benefit of that in Q1, we did have a negative impact in Q2.
Okay. Thank you.
And with that we'll turn it back to Jim I will thank everyone for joining us on the call today, just a few closing comments, we view our competitive position is very strong we're continuing to invest to achieve our strategy of long term profitable growth, including double in services sales in EMEA and T. by 2026.
We had we expect to record profits this year the second consecutive record from an EPS perspective.
And as we talked about we continue to generate strong cash flow, which underpins our commitment to return substantially all free cash to shareholders through buybacks and dividends and as Andrew talked about if you take into account 2018 in 2019 by the end of the year, we expect to.
Have a 9% share count reduction by the year end of the year.
With that I. Thank you for your questions and we look forward to chatting with you next quarter.
Thank you, Jim and thanks, everyone, who joined US today, we appreciate your interest and caterpillar.
If you have any questions. Please reach out to me are Rob wrangle and IR at email him address underscore Jennifer at Cat that Tam.
Or our NGL underscore I'll be at Cat Dot Com and now let me ask Catherine to conclude our call.
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.