U.S. Markets close in 1 hr 60 mins

Edited Transcript of CAT earnings conference call or presentation 25-Apr-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Caterpillar Inc Earnings Call

PEORIA Apr 28, 2017 (Thomson StreetEvents) -- Edited Transcript of Caterpillar Inc earnings conference call or presentation Tuesday, April 25, 2017 at 3:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Amy Campbell

* Bradley M. Halverson

Caterpillar Inc. - CFO and Group President of Finance Services Division, Human Services Division, Global Information Services, Financial Products Division, Strategic Services Division & Corporate Auditing

* D. James Umpleby

Caterpillar Inc. - CEO and Director

================================================================================

Conference Call Participants

================================================================================

* Adam William Uhlman

Cleveland Research Company - Partner and Senior Research Analyst

* Andrew Millard Casey

Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst

* Ann P. Duignan

JP Morgan Chase & Co, Research Division - MD

* David Michael Raso

Evercore ISI, Research Division - Senior MD, Head of Industrial Research Team and Fundamental Research Analyst

* Jamie Lyn Cook

Credit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst

* Jerry David Revich

Goldman Sachs Group Inc., Research Division - VP

* Joseph O'Dea

Vertical Research Partners, LLC - VP

* Robert Cameron Wertheimer

Barclays PLC, Research Division - Director and Senior Industrials Analyst

* Stephen Edward Volkmann

Jefferies LLC, Research Division - Equity Analyst

* Steven Fisher

UBS Investment Bank, Research Division - Executive Director and Senior Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning, ladies and gentlemen, and welcome to the Caterpillar 1Q 2017 Results Conference Call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Amy Campbell. Ma'am, the floor is yours.

--------------------------------------------------------------------------------

Amy Campbell, [2]

--------------------------------------------------------------------------------

Thank you very much, Kate. Good morning, and welcome, everyone, to our first quarter earnings call. I'm Amy Campbell, Caterpillar's Director of Investor Relations. And on the call today, I'm pleased to have our CEO, Jim Umpleby; our Group President and CFO, Brad Halverson; and our Vice President of Finance Services, Joe Creed.

Remember this call is copyrighted by Caterpillar Inc. and any use, recording or transmission of any portion of the call without the expressed written consent of Caterpillar is strictly prohibited. If you'd like a copy of today's call transcript, we will be posting it in the Investors section of our caterpillar.com website. It will be in the section labeled Results Webcasts.

This morning, we will be discussing forward-looking information that involves risks, uncertainties and assumptions that could cause our actual results to differ materially from the forward-looking information. A discussion of some of the factors that either individually or in the aggregate could make actual results differ materially from our projections can be found in our cautionary statements under Item 1A, Risk Factors of our Form 10-K, filed with the SEC in February of 2017, and is also in our forward-looking statements language that was included in today's financial release.

In addition, there is a reconciliation of non-GAAP measures that can be found in this morning's release, and it is also posted at caterpillar.com/earnings.

We're going to start the call this morning with a few words from Jim, and then Brad will walk us through first quarter results and our revised outlook, and then we will turn it back to Kate to begin the Q&A portion of the call. Jim?

--------------------------------------------------------------------------------

D. James Umpleby, Caterpillar Inc. - CEO and Director [3]

--------------------------------------------------------------------------------

Thank you, Amy. Before I talk about our quarterly results, I'll spend a few minutes talking about my perspective since becoming Caterpillar's CEO on January 1. It's a privilege to lead this iconic company and the strong leadership team, and I'm confident we are well positioned for the future. As you know, generally weak economic conditions and commodity price volatility have made the last few years challenging and have significantly impacted the industries we serve. We've responded to these challenges with a thoughtful approach to restructuring and strategies to improve our market competitiveness. Our product quality has improved. We're continuing to invest in R&D and expanded our digital offerings to help our customers be more efficient and productive. We've made progress implementing lean manufacturing and have strengthened our dealer network, which provides us with an unrivaled competitive advantage. We are focused on controlling costs and maintaining the cost flexibility necessary to invest in products and services to drive future growth and shareholder value. The goal of our entire leadership team is to return Caterpillar to profitable growth. Given the industries we serve, we will always be subject to cycles, but our goal, through focusing on profitable growth, a disciplined resource allocation methodology and a more flexible and competitive cost structure, is to sustain profitability through the cycle.

Before I turn it over to Brad to talk about the quarter in detail, I'd like to congratulate our team on the great start to the year. Quarterly sales and revenues were up for the first time since 2015. The difficult but necessary decisions we've made since the downturn have resulted in outstanding operational performance. Profit per share, excluding restructuring, is twice what it was a year ago. There were encouraging signs and promising quotation activity in many of the markets we serve, and retail sales to users have turned positive for both machines and Energy & Transportation for the first time in several years. However, there is still a great deal of geopolitical and market uncertainty, along with economic volatility, around the world that continues to present risks.

Now I'll turn it over to Brad to walk through the results and the outlook in detail.

--------------------------------------------------------------------------------

Bradley M. Halverson, Caterpillar Inc. - CFO and Group President of Finance Services Division, Human Services Division, Global Information Services, Financial Products Division, Strategic Services Division & Corporate Auditing [4]

--------------------------------------------------------------------------------

Well, good morning, and thanks, Jim. If you have the slide deck in front of you, I'd ask, if you could, please, turn to Page 4 - Slide 4, and we'll start with our first quarter results.

2017 had started off very well and exceeded our expectations for the quarter. Sales and revenues increased about $400 million or about 4% from the first quarter of 2016 to $9.8 billion in the first quarter of this year. This is the first time in 10 quarters that sales and revenues were higher than the prior year, although sales are coming off a very low base. Resource Industries had the largest increase, followed by Energy & Transportation and Construction Industries.

In the quarter, we announced our decision to close the Gosselies, Belgium and Aurora, Illinois facilities. Total restructuring cost was $752 million in the quarter, $591 million more than the first quarter of 2016. As a result, profit per share was down $0.14 from $0.46 to $0.32 in the first quarter 2017. On a 4% increase in sales and revenues, profit per share, excluding restructuring, doubled from a year ago from $0.64 in the first quarter 2016 to $1.28 this quarter. The increase was driven by higher sales, favorable mix, improved price and lower cost. As you know, we've been working hard on lowering our cost structure, rightsizing our footprint and allocating resources directly to the highest-profit opportunities. All these actions were key in delivering a very strong quarter.

Let's turn to Slide 5, and we'll look at first quarter operating profit. First quarter operating profit was $417 million as compared with $494 million in 2016. As I already mentioned, restructuring costs were up $591 million. Excluding restructuring costs, operating profit was up $514 million. Positive changes to operating profit came from several areas. The largest increase to profit was the result of higher sales volume and favorable mix. About half of the sales volume profit change came from a favorable mix of products sold in the quarter, and that favorable mix impact was about equally spread across all 3 of our primary segments. While the market remains very competitive from a pricing perspective, price realization was favorable $88 million, with more than all of the positive variance coming from Construction Industries, partially offset by negative price in Resource Industries. Variable manufacturing costs were favorable by $96 million, with about half of that positive variance coming from continued improvement in material cost. We continue to reap the benefits of collaboration efforts between our dedicated procurement team, suppliers and engineers, - but we do expect material cost to be under pressure as the year proceeds due to an expectation of higher commodity prices, especially steel, in the back half of the year. Total period costs were better by $140 million. Lower period costs are a result of our restructuring and cost-reduction initiatives that we have implemented over the last several years and delayed timing of R&D spend, partially offset by higher incentive compensation expense of about $100 million. We also had strong ME&T operating cash flow, which was $1.5 billion in the quarter compared to $200 million in the first quarter of 2016, and we ended the quarter with $9.5 billion in cash.

Now let's look at each of the segments, starting on Slide 6. Construction Industries' sales and revenues were up slightly to $4.1 billion. Positive price realization of $123 million drove more than all of the sales increase. While the construction industry market remains very competitive, especially in North America, favorable price realization was due to a particularly weak pricing environment in the first quarter of 2016 and previously announced price increases impacting the first quarter of 2017. However, the sales story is more than just price. Very strong demand in Asia Pacific was largely offset by lower sales volume in North America. The strong demand in China resulted in a reduction in Asia Pacific dealer inventory as demand outpaced our sales to dealers. Strength in China has mainly been driven by a strong execution of public-private partnership projects, particularly related to infrastructure, and strong housing investment. Credit growth has remained supportive and better than we previously expected. High replacement demand and a tight used machine inventory market have also helped. While March and April are traditionally the highest months for industry opportunity and China's peak selling season, if policy remains supportive, we expect strong market conditions in China to continue at least through midyear. North America dealer inventory increased but by less than a year ago, and end-user demand was lower. Both contributed to the sales decline in North America. However, order activity in North America has been very strong, which has contributed to the increase in the backlog. The Middle East and Brazil remained weak. Construction Industries' operating profit was favorable by about $200 million on about flat sales as a result of favorable price realization and lower cost. Construction Industries' multiyear focus on OPACC, as we call it, our operating profit after capital charge, delivered the strongest quarter for operating margin percent in a long time, and this on sales at about 20% below the highs reached in the second quarter of 2011.

If we move to Slide 7, we'll look at Resource Industries. We are very happy to report that we have good news in our Resource Industries segment. Sales were $1.7 billion or up 15% versus 2016, and operating profit was $158 million. After 4 years of declining sales, the parked fleet has come down and is now under 20%. Hours of utilization on trucks is up. And for the fourth quarter in a row, part sales have increased to support rebuild and maintenance needs. Sales increases for aftermarket parts were broad-based, and they were the primary driver of the change in sales. As you saw in the retail stats that were published yesterday, sales to users remain negative. However, after 16 quarters of underproducing retail demand, dealer inventory remained about flat in the quarter, with a positive change in inventory more than offsetting negative retail sales and driving Resource Industries' OEM sales up. We are seeing sporadic order activity for mining equipment and expect to ship significantly more mining trucks than we did in 2016. Resource Industries delivered positive operating profit for the first time since the second quarter of 2015, which is the result of significant actions that have been taken to lower their breakeven point. The improvement in operating profit resulted from higher sales volume and lower cost, partially offset by higher incentive compensation expense.

Let's move to Slide 8 and look at E&T. Energy & Transportation sales were up slightly in the quarter from $3.3 billion to $3.4 billion. Higher sales into oil and gas applications, primarily in North America, were partially offset by lower power gen sales into EAME. Sales into industrial and transportation applications were about flat. The number of oil and gas rigs in service continues to increase and is more than double the lows that were reached last May. This has resulted in an increase in aftermarket parts demand to support the overhaul and rebuild of well-servicing fleets. We are also seeing a significant increase in demand for our large reciprocating engines used for midstream gas compression applications. Demand for drilling and production application remains very low. Operating profit for Energy & Transportation was up $142 million from $410 million to $552 million. This was largely attributable to higher sales volume, a favorable impact from cost absorption and improved material cost. Period costs were about flat as the favorable impact of restructuring and cost-reduction actions was about offset by higher short-term incentive compensation expense.

I want to add a quick comment on financial products. Operating profit was up $15 million. The portfolio remains healthy, and past dues were 2.64% versus 2.78% in the first quarter of 2016. Write-offs were down, and used equipment prices are starting to recover.

Okay. Well, let's move to Slide 9, and we'll look at our full year outlook. We announced this morning that we are raising the outlook for full year sales and revenues. In January, we provided an outlook for sales and revenues of $36 billion to $39 billion. As a result of better-than-expected first quarter, strong order rates and an increase in our backlog, we are providing new guidance for sales revenues in a range of $38 billion to $41 billion, with the midpoint of $39.5 billion, which is up $2 billion from our previous outlook. At the midpoint of the sales and revenue range, we have changed the profit per share outlook to $2.10, reflecting our decision to close the Gosselies and Aurora facilities. And we have raised the profit per share, excluding restructuring costs outlook, to $3.75.

We turn to the next. While there are positive signs across many of our end markets, and we have seen a significant increase in order activity and the backlog, we believe, given the political uncertainty around the globe and the potential for volatility in commodity prices, that it is prudent at this point in the cycle and at this point in the year to consider both the positive and negative as we look at our end markets and what could impact sales as the year progresses. There are several positive sentiments. World business confidence is at 2-year high, and world growth is accelerating. There are also positive indicators for North America construction demand. Many states have passed infrastructure bills. Pipeline projects that were previously stuck in permitting are now moving ahead, and residential and nonresidential demand in certain parts of the U.S. remains robust. We believe business optimism, which may be contributing to elevated quoting and ordering activity in North America, is partially a reflection of the benefits of pro-business policy in regards to infrastructure and tax reform. However, we don't expect to see any meaningful impact from these changes until 2018. The backlog is up $2.7 billion on strong order activity in all segments. China construction equipment industry is robust with industry sales up sharply versus last year. Gas compression demand for reciprocating engines is very strong, and miners' balance sheets are improving, and they're expecting increases to CapEx.

However, there are other risks to the outlook that we believe are prudent to take into account. Outside of Asia Pacific, retail stats for Construction Industries remain negative. Demand for overhauls and rebuilds in mining and oil and gas could diminish as those units go back to work. Brazil remains weak. The Middle East continues to struggle as a result of lower oil prices. Competitively, the pricing environment remains very challenging. The potential for oversupply of oil could drive volatility in the price of that commodity, and geopolitical uncertainty across the globe is elevated.

If we go to Slide 11, we'll look at it quickly by segment. We now expect Construction Industries' sales for the year to be about flat to up 5%, driven largely by demand in China. We have yet to see retail stats on the rest of the world turn positive. While order rates are encouraging, they will need to be sustained by continued strength and business confidence. For Resource Industries, we now expect sales and revenues to be up 10% to 15% for the full year, driven by higher part sales in the first half of the year to support rebuilds and maintenance work, and then transitioning in the second half to new equipment sales to support increased CapEx spending from the miners. We now expect Energy & Transportation sales revenues to be about flat for the year. Improvements in oil and gas to support overhauls and maintenance for well-servicing fleets and higher demand for reciprocating engines using gas compression applications are largely being offset by slight weakness across power gen, industrial and transportation.

If we move to Slide 12, we'll look at the outlook for profit. While there are several small puts and takes, the raise in the profit per share from $2.90 to $3.75, excluding restructuring, is primarily a result of the increase in sales volume of about $2 billion and the corresponding variable margin we would expect on higher sales, partially offset by an increase in short-term incentive compensation expense of about $200 million. The outlook reflects just slightly more than half of the year's sales and revenues in the first half, which would be similar to trends in recent years. We had a very strong quarter. And if you compare the first quarter to the average of the last 3 quarters, we expect some real headwinds due to less favorable mix than we experienced in the first quarter, pressure on price and material cost and the timing of period cost spend. That said, at a midpoint of $39.5 billion in sales and revenues, and a PPS excluding restructuring costs outlook of $3.75 for the full year, at this sales range, we would expect - we expect to deliver an operating profit pull-through of just less than 50%, well ahead of our target range of 25% to 30%.

So we'll wrap up on Slide 13. First quarter was a great way to start the year, with higher sales and very strong operating performance across the board. We raised the outlook for sales and revenues to reflect a strong quarter and improved market conditions across many of our end markets. While uncertainty and the potential for volatility in commodity prices remain, we are ready to respond if demand increases. We remain very focused on cost management, and we are using our operating and execution model to be very deliberate about where to invest so that we deliver the highest shareholder value, investments that include lean, R&D and digital.

Before we turn it back to the operator for the Q&A portion, I believe Jim has a few additional comments.

--------------------------------------------------------------------------------

D. James Umpleby, Caterpillar Inc. - CEO and Director [5]

--------------------------------------------------------------------------------

Thanks, Brad. My first quarter as CEO has certainly been eventful. We had great first quarter results, announced the relocation of our headquarters to the Chicago area, the closure of our Gosselies, Belgium facility and the relocation of manufacturing out of Aurora, Illinois. We've also ratified a new 6-year contract with the UAW. Each of these are significant actions. Taken together, they will strengthen our company and create long-term value for our shareholders. Also, I want to provide an update related to the search warrants executed at three Peoria area facilities in March. At Caterpillar, we take very seriously our obligation to follow the law, and we are committed to maintaining our long tradition of pursuing the highest ethical standards in conducting our business. If we find something that violates our values and our code of conduct, we will take appropriate action. At this time, we have nothing more to report. Caterpillar has retained former U.S. Attorney General William Barr, currently of counsel to the firm of Kirkland & Ellis, to take a fresh look, get all the facts and help bring these matters to proper resolution. We are continuing to cooperate with the government investigation. Amy?

--------------------------------------------------------------------------------

Amy Campbell, [6]

--------------------------------------------------------------------------------

Thanks, Jim. And now we will turn it back to Kate to open the phone lines for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question today is coming from Joseph O'Dea.

--------------------------------------------------------------------------------

Joseph O'Dea, Vertical Research Partners, LLC - VP [2]

--------------------------------------------------------------------------------

First question, just on the guide, and what you're looking at for margin in the rest of the year. I think you talked to a number of headwinds, but if you could just talk maybe a little bit more specifically about some of the details, whether or not price you see continuing as a tailwind or if you have visibility into that reversing to some headwinds, what you see on the mix front, and anything else with material costs that are on the horizon, just so we get some comfort with the implied step down in the margins.

--------------------------------------------------------------------------------

Amy Campbell, [3]

--------------------------------------------------------------------------------

Sure, Joe. I think you have to look at it kind of 2 different ways. If you look at the new outlook that was provided this morning and compare it against the outlook from January, really broadly speaking, the only 2 changes are those that Brad talked about, higher sales volume of about $2 billion, which will generate higher variable margin, offset by about $200 million more in short-term incentive compensation expense. In the original outlook, we communicated that we expected material cost to be favorable about 1% for the full year. While we expect that number to come down some, we still do expect some positive - maybe closer to 0, but still some positive material cost for the full year. Our outlook for price has not changed really very much at all since the original outlook. And our period cost assumption, excluding that short-term incentive compensation expense, is also, broadly speaking, about the same. So versus the outlook that we provided back in January, it's really just higher volume minus the higher incentive compensation expense. If you look at what's changing from the first quarter to the rest of the year, there's a couple of things to keep in mind. We had very favorable mix in the first quarter. About half of the sales volume mix impact was from mix. And we don't expect to see that kind of favorable mix impact as we go forward. We do expect pressure on price and material cost in the back half of the year, especially around steel. So even though we expect them to be favorable versus last year, we don't expect them to be as favorable as we saw in the first quarter. And there was some period cost timing of spend. Traditionally, the first quarter is a low quarter for period cost spending, so some of our projects initiatives that we have planned for the year did not pick up to their full spend rates in the first quarter. That would also increase as the year progresses. So I think if you take it all in - and we're committed to incremental profit pull-throughs for the full year, and the outlook reflects almost 50% operating profit pull-through, well ahead of our 25% to 30% commitment and goal.

--------------------------------------------------------------------------------

Joseph O'Dea, Vertical Research Partners, LLC - VP [4]

--------------------------------------------------------------------------------

That's really helpful. And then just one more on mining. And I think it looked like in the quarter actually the benefit of some sell-in to dealers that was better than what you saw in kind of pull-through demand, but you also commented on expecting significantly higher volumes, I think, in mining truck shipments this year. I believe you've talked about large mining truck shipment volumes in the kind of 70 to 80 units last year. Can you give any kind of frame for exactly what kind of volumes you're anticipating in 2017?

--------------------------------------------------------------------------------

Amy Campbell, [5]

--------------------------------------------------------------------------------

Yes. So if you look at Resource Industries' dealer inventory, it really broadly stayed about flat quarter-over-quarter. And so since we've been on kind of 16 sequential quarters of taking dealer inventory down, that was a positive to sales, but dealer inventory did remain -- it was actually up just slightly in the quarter. As you mentioned, Joe, we probably sold about 70 to 80 trucks or so last year. It's probably closer to 70. We do expect shipments for large mining trucks to increase significantly. Most of those will be in the back half of the year. Several of those are going to large customers in less price-favorable regions, I guess you could say. But we have good demand. I think even if we double the number of truck sales, and I think that's certainly very doable this year, it would still be the second-lowest year for large mining truck sales. So we're still at very low levels, even in 2017, with what will probably be some pretty significant increases in our total shipments versus last year.

--------------------------------------------------------------------------------

Operator [6]

--------------------------------------------------------------------------------

Our next question today is coming from Jamie Cook.

--------------------------------------------------------------------------------

Jamie Lyn Cook, Credit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [7]

--------------------------------------------------------------------------------

Jim, not a bad way to start off as CEO. I guess back to Resource. Amy or Brad, I'm just trying to understand what's implied in your guidance for Resource margins in 2017, given where we started the year at a 9.5% margin. I think that was better than what anyone would have hoped. Or did the margins get eaten away by selling to less profitable regions? I'm just trying to understand that. And then I guess -- or was there anything unusual, I guess, in the first quarter that the 9.5% sort of isn't sustainable? And then I guess, the second question I have is just sort of how you're handling the cyclical upturn. When I talk to your dealers, a lot of them are complaining about lead times and that lead times are extended. So I'm wondering if, when I think about your sales forecast, is any of the upside constrained by your inability to ramp? Or could you just talk about how you're thinking about ramping production in your supply base?

--------------------------------------------------------------------------------

Amy Campbell, [8]

--------------------------------------------------------------------------------

Sure, Jamie. If you look at Resource Industries' margins, like I said, we were very pleased with the margins that Resource Industries put up this quarter, $158 million in operating profit. If you kind of revert back to the fourth quarter call and Mike's discussion, we expected Resource Industries to lose a little money, but be close to breakeven. And so it really had a great quarter. We don't expect this quarter to repeat either in terms of operating margin dollars or operating margin percent. But moving forward, for the rest of the year, we would expect Resource Industries to either break even or do a little better through the next -- the rest of the quarters remaining this year.

--------------------------------------------------------------------------------

Jamie Lyn Cook, Credit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [9]

--------------------------------------------------------------------------------

But is there a particular reason for the step down? Like I understand you're saying it's not...

--------------------------------------------------------------------------------

Amy Campbell, [10]

--------------------------------------------------------------------------------

Yes. So Resource Industries, as we talked about, the -- that mix number was about equally spread across the 3 primary segments. We wouldn't expect that favorable mix to continue. There will also be, like in the other segments, some material cost pressure. And we do expect some sales for some mining equipment into some regions in the world that maybe aren't as price-advantaged as other parts of the globe.

--------------------------------------------------------------------------------

Jamie Lyn Cook, Credit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [11]

--------------------------------------------------------------------------------

Okay. And then just sort of lead times or how much of your sales forecast is being constrained by you guys not being able to ramp quickly enough?

--------------------------------------------------------------------------------

Amy Campbell, [12]

--------------------------------------------------------------------------------

Sure. I think there are probably 2 areas. Maybe I'll step back a little bit. If you look at Construction Industries, with a significant increase in orders for BCP products in the fourth quarter and first quarter, several of those products have been moved to managed distribution. And with the announcement that we were considering the closure of both Gosselies and Aurora, we also put all medium wheel loaders on managed distribution at the beginning of the year. In both cases, that was to make sure that we got shipments to where they needed to go and to discourage some panic ordering or some unnecessary ordering to make sure we managed that, but we don't expect either of those actions to impact or drive a loss-in-sales situation. If you look at China, I would say that for Construction Industries, while we continue to grow market share there and we're very pleased with how the year is shaping up so far, I'd say if demand continues at these levels, we'll continue to keep an eye on China and make sure that we can continue to meet the higher demand in that region. But the other notable comment, and I've seen a lot that's being discussed out there, is for our large 3600 reciprocating engine. We have seen lead times for those extend out. We're bringing the production back to our Lafayette, Indiana facility, but we wouldn't expect that to result in any lost sales either.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

Our next question today is coming from David Raso.

--------------------------------------------------------------------------------

David Michael Raso, Evercore ISI, Research Division - Senior MD, Head of Industrial Research Team and Fundamental Research Analyst [14]

--------------------------------------------------------------------------------

Given your comments about the supply chain is not an issue at the moment or loss of sales from any production ramp that you feel you can do, I'm just trying to reconcile really simply the sales guide. The rest of the year sales growth is implied at only 2%, but the backlog is up 13%. The implied orders are up twice as much as that. The revenues are already up 4% in the first quarter. So can you just help us square -- do you see something that would suggest growth has to slow from what you've been seeing of late? Because even if I just annualize the first quarter, for example, in CI or even RI, you're already at or above the high end of your range for those segments. So if you could just help us better understand the sales guide.

--------------------------------------------------------------------------------

Amy Campbell, [15]

--------------------------------------------------------------------------------

I think -- and David, if we go back and revisit some of the positive sentiments but also some of the negative or risks that are out there in the outlook, we wanted to be thoughtful and mindful that there's still a lot of uncertainty in the world and there's still the potential for volatility both in commodity prices and oil prices. And seeing -- if you walk through a few of those, first of all, we would expect -- we're seeing a lot of demand for overhauls and rebuilds of both mining equipment and oil and gas well-servicing fleets. We would expect that demand to taper off -- or I don't know if we would expect that, but it could taper off as the year goes on and all of those units get overhauled and repaired. We also -- we do need to watch the volatility. It's possible that too much supply comes back online in North America, which drives some additional volatility in oil prices. When it comes to commodity prices, while the demand and supply seems to be in better balance, there still is some persistently high inventories for several commodities, which could put some pressure on commodity prices. If you look at North America, order rates, as Brad mentioned and you mentioned, have been very strong. Certainly, there are some good fundamentals to support that, that Brad talked through, pipeline, a lot of states have passed infrastructure bills. But we believe some of that has to do with business optimism, and we need to see that business optimism continue through at least the second quarter, I think, before we get more comfortable and confident about what the back half of the year will look like.

--------------------------------------------------------------------------------

David Michael Raso, Evercore ISI, Research Division - Senior MD, Head of Industrial Research Team and Fundamental Research Analyst [16]

--------------------------------------------------------------------------------

I mean, just to be clear, those are all very valid potential concerns, but these aren't things you're necessarily seeing in your current order books or trends. Is that correct? I mean, all those points are valid, but I mean, I'm just making sure nothing there sounded like we are seeing in the second half the rebuild. So if anything, the lead times are getting longer out of Lafayette, right? So I'm just trying -- that some of the comments you made, I just want to make sure those aren't trends you're seeing in your orders. It's just understandably -- it's April and things could change from a macro level. But from a micro level, are there any particular concerns? Because even the last 9 months of last year, the dealers took out $1.9 billion of inventory. The year-over-year swing on inventory, I assume, in the next 9 months is a positive. Could you maybe help us with how you view dealer inventory in the next 9 months?

--------------------------------------------------------------------------------

Amy Campbell, [17]

--------------------------------------------------------------------------------

So if you look at dealer inventory, we didn't include that in the Q&A. I think it's really going to shape up to what we expect 2018 to be in. It was really too early to make a forecast for 2018. Embedded in the outlook is a slight decrease in dealer inventory. Certainly, quite a bit less than what -- the $1.9 billion or $1.6 billion for the full year that we saw in 2016. I think, back to your earlier question, we have seen, I'd say, the pace of order activity slow a little bit, but it is still doing better than a year ago, as we said, in April.

--------------------------------------------------------------------------------

David Michael Raso, Evercore ISI, Research Division - Senior MD, Head of Industrial Research Team and Fundamental Research Analyst [18]

--------------------------------------------------------------------------------

Okay. The reason I asked is the dealer inventory swing, if you even just get -- you took out $1.9 billion in the last 9 months of last year, say you take out only $650 million. That $1.25 billion of improved year-over-year dealer inventory, the rest of the year would give you almost 5% revenue growth. So it seems like your sales guide is not even a dealer inventory swing. So that's why -- I'm just trying to make sure I understand what's in it. It just sounds like -- completely fair. Just a little more of a potential macro concern that could materialize. Okay.

--------------------------------------------------------------------------------

Amy Campbell, [19]

--------------------------------------------------------------------------------

Yes, I think if you look at any one of those assumptions in isolation, I think you could conclude that there's some upside. And I think that makes sense and we would agree with that. But as we sit here in April, there still is a lot of uncertainty. There still is a volatility. We're only three months through the full year. We need to see order rates continue at the levels we saw in the first quarter in order to get more comfortable about the rest of the year. But we are, I think, very pleased with our ability to raise the outlook by $2 billion here one quarter into the year.

--------------------------------------------------------------------------------

Operator [20]

--------------------------------------------------------------------------------

Our next question today is coming from Ann Duignan.

--------------------------------------------------------------------------------

Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [21]

--------------------------------------------------------------------------------

Just to take a step back. Again, you're talking about products being on managed distribution, and yet at the same time we're looking at stubbornly high days on hand at Caterpillar of 123 days. Can you help us reconcile just why your own inventories remain so high? Is that just seasonal? Should we expect a significant improvement as we go through the year? Or are we going to see write-downs of inventories as we go forward? Just trying to reconcile that.

--------------------------------------------------------------------------------

Amy Campbell, [22]

--------------------------------------------------------------------------------

Yes. So I think dealer inventory, we have taken production up at several of our facilities. A few that we've talked about, Lafayette, Indiana as well as in China. We are having to build inventory in Gosselies and in Aurora and then our component plant across -- in order to manage through the closure and consolidation of several of our facilities. So that is driving some dealer -- or some dealers, excuse me, some of our inventory up here in the first quarter. I think where our inventory lands for the full year will have a lot to do with what 2018 looks like. We do, at this point, I would say expect Cat inventory to remain broadly about flat for the full year, certainly continue and -- both Brad and Jim mentioned this, continue to be focused on lean, driving an increase in inventory turns. Certainly have no expectations that there would be any write-downs in inventory or any -- of any significance for the remainder of the year.

--------------------------------------------------------------------------------

Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [23]

--------------------------------------------------------------------------------

Okay. I appreciate the color, and I do appreciate when you're closing large facilities, you have to build up inventory. And then switching gears. I mean, you mentioned a few times demand for reciprocating engines is strong in oil and gas midstream. You didn't mention Solar at all on the turbine side. Can you talk about what's going on with Solar and how the backlog looks there on a year-to-date and so far?

--------------------------------------------------------------------------------

Amy Campbell, [24]

--------------------------------------------------------------------------------

Sure. So Solar, I think in the outlook -- the original outlook from the last quarter, we shared that we expect Solar to be about flat 2017 versus 2016. That remains our expectation. We have a really good backlog to support the outlook for the year. The backlog for Solar was up slightly in the quarter as we continue to take orders moving out into 2018. So I'd say Solar is kind of continuing as we expected on about flat sales for the year versus last year.

--------------------------------------------------------------------------------

Operator [25]

--------------------------------------------------------------------------------

Our next question today is coming from Stephen Volkmann.

--------------------------------------------------------------------------------

Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [26]

--------------------------------------------------------------------------------

I'm wondering -- you gave a little bit of color, which is quite helpful on sort of the trajectory of the Resource Industry margin as we go through the next 3 quarters. I'm wondering if you might be willing to do that with the other 2 segments. Because, obviously, margins in both of those other 2 segments also were, I think, higher than most people were looking for. So should we expect some deflation there as well? And if so, why?

--------------------------------------------------------------------------------

Amy Campbell, [27]

--------------------------------------------------------------------------------

Yes. I'd say the reasons for the second through fourth quarter operating margin percentages to be lower in Resource Industries are pretty consistent across the other 2 primary segments as well. As Brad mentioned, Construction Industries had a great quarter for operating margin percent. We would expect, for the full year, which would weight in the first quarter operating margin for Construction Industries, to be just up slightly versus 2016 with pressure in the back half of the year from less favorable mix, pressure on price and material cost and some period cost spend timing that didn't occur in the first quarter. For Energy & Transportation, which also had, I'd say, a very good quarter for operating margin percent versus a year ago, versus first quarter of 2016. It was just slightly better than the full year for 2016, the first quarter of 2016 for Energy & Transportation was the lowest quarter by several hundred basis points versus the other 3 quarters in 2016. We would expect Energy & Transportation operating margin to be about flat for the full year versus 2016.

--------------------------------------------------------------------------------

Stephen Edward Volkmann, Jefferies LLC, Research Division - Equity Analyst [28]

--------------------------------------------------------------------------------

Okay. That's helpful. Would you be willing to sort of ballpark how much in terms of period costs that the first quarter was below normal?

--------------------------------------------------------------------------------

Amy Campbell, [29]

--------------------------------------------------------------------------------

Well, what I would say is for -- as we revert back to the outlook that we provided in the fourth quarter of 2016, we expected period cost to be about $450 million to $500 million. I think in the 10-K, we communicated $450 million lower for the year, excluding the higher short-term incentive comp and wage increases for the full year. And that assumption, with the exception of short-term incentive comp being up $200 million, hasn't changed with this outlook very significantly.

--------------------------------------------------------------------------------

Operator [30]

--------------------------------------------------------------------------------

Our next question today is coming from Adam Uhlman.

--------------------------------------------------------------------------------

Adam William Uhlman, Cleveland Research Company - Partner and Senior Research Analyst [31]

--------------------------------------------------------------------------------

It's Cleveland Research. I guess to start with, the strong performance in the quarter seems to have been driven by part sales and directionally that should have helped the price realization, I'm thinking, as well. So I'm wondering if you could just dimension overall how much the parts business grew in total and what your outlook is for the full year.

--------------------------------------------------------------------------------

Amy Campbell, [32]

--------------------------------------------------------------------------------

Yes, I think it's certainly more complicated than that. Aftermarket parts were up. That primarily impacted the Resource Industries and Energy & Transportation as mining equipment was coming in and well-servicing units were coming in for overhaul and rebuilds. Yes, I think you have to take into account Construction Industries' price was quite favorable as well. And Construction Industries didn't see really a significant increase in their aftermarket part sales. So if we look at aftermarket parts sales, we would expect that to be a little heavier in the first quarter and in the first half as those -- that mining equipment and the oil -- the well-servicing fleets for oil and gas in North America kind of are coming in as we speak to be overhauled and repaired, but that work may decline as the year goes on and there's less units that need overhaul.

--------------------------------------------------------------------------------

Adam William Uhlman, Cleveland Research Company - Partner and Senior Research Analyst [33]

--------------------------------------------------------------------------------

Okay. And then secondly, could you speak to the restructuring savings that you expect to get out of Gosselies and Aurora and the cadence of those savings? Are we capturing very much in 2017? And what should we expect for '18 and beyond?

--------------------------------------------------------------------------------

Amy Campbell, [34]

--------------------------------------------------------------------------------

Sure. I think -- we haven't changed the period cost guide for the full year in this new outlook. We wouldn't expect to see -- I mean, I'll start here. We wouldn't expect to see any cost improvements from the Aurora and Gosselies decision in 2017. In fact, we would likely see some inefficiencies as we take production down in those plants in the back half of the year, which is kind of -- something that we're keeping an eye on. The Aurora -- the move and the relocation of production out of Aurora to the other two U.S. facilities, that work kind of wraps up in the 2018 time frame, so we shouldn't see benefits for that until after 2018. And we do expect the Gosselies, Belgium facility to start ramping down towards the end of this year, but we also wouldn't expect maturebenefit for Gosselies until 2019 and beyond as well.

--------------------------------------------------------------------------------

Adam William Uhlman, Cleveland Research Company - Partner and Senior Research Analyst [35]

--------------------------------------------------------------------------------

How big are those savings?

--------------------------------------------------------------------------------

Amy Campbell, [36]

--------------------------------------------------------------------------------

We're not disclosing those savings. In particular, what I would say is they were included in our original September 2015 announcements or they were being contemplated in a part of that broader commitment of $1.5 billion of total cost savings for restructuring. We delivered that through 2016. We expect about $500 million more -- $450 million more period cost reduction from restructuring and cost-reduction actions this year, which should bring us to about $2 billion in total. And that's really -- it's really -- we're not going to comment at this time on 2018.

--------------------------------------------------------------------------------

Operator [37]

--------------------------------------------------------------------------------

Our next question today is coming from Steven Fisher.

--------------------------------------------------------------------------------

Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [38]

--------------------------------------------------------------------------------

Just how did the increase in the aftermarket in Resource Industries play out in the quarter? Was the demand pickup from a broad swath of customers and a small part of their fleet? Or a small number of customers and a large part of their feet getting reinvestment? Or was it some combination of both? Just trying to understand the sustainability of that trend.

--------------------------------------------------------------------------------

Amy Campbell, [39]

--------------------------------------------------------------------------------

Sure. I think if you look at the increase in aftermarket parts sales for Resource Industries, it was broad across all four regions. We're seeing good activity in iron ore and coal in Australia. Good activity for copper in Latin America. We are seeing a lot of machines get back -- get put back to work around coal in North America, and the CIS region is doing very well for gold mining. And there would be some other positive stories among those, but those are the ones on the top of my head. So it is broad-based from a higher aftermarket parts perspective. And if you look at kind of order rates and -- that were driving increase in the backlog for Resource Industries, I'd also say that those are fairly broad-based as well.

--------------------------------------------------------------------------------

Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [40]

--------------------------------------------------------------------------------

Okay. And then I just want to ask the revenue guidance question from the other direction. Because clearly, there's been a lot of volatility in the stock price related to revenue guidance changes over the last couple of years. So just want to ask what is giving you the confidence to raise the revenue guidance by the $2 billion so early on in the year. And I know you mentioned, obviously, the backlog and quoting activity, and Slide 10 had a lot of number of puts and takes there. But what would you say are giving you that confidence that -- the most amount of confidence and what are the most important things that have to go right to at least hit that $2 billion before we talk about more upside?

--------------------------------------------------------------------------------

Amy Campbell, [41]

--------------------------------------------------------------------------------

Yes. I mean, I think one thing I'd say -- I mean, have to step back and look at the revenue increase versus 2007 -- versus 2016, excuse me. So the sales and revenues increase is up just 3%. It's not a significant increase versus 2016. And so while we certainly are pleased and excited that we're able to raise the outlook this morning, it's not a significant raise versus last year. So we still are remaining cautious. Certainly, still many, many of our end markets are at very depressed levels. I think from a perspective of what we need to see to -- one, I would say, as you mentioned, and it's in the release, what gave us the confidence to raise the outlook was a very strong quarter, very strong order rate and an increase in the backlog that should be fairly sustainable. What we continue to keep an eye on is business optimism in North America and do we continue to see order rates stay at higher levels than we incurred in 2016. We do want to watch the volatility of oil and other commodity prices. And there's still tremendous geopolitical uncertainty around the world that we're keeping our eye on and want to make sure I think before we would take another step that we're comfortable about sustainability of the order rates versus what we saw in the first quarter.

--------------------------------------------------------------------------------

Operator [42]

--------------------------------------------------------------------------------

Our next question today is coming from Robert Wertheimer.

--------------------------------------------------------------------------------

Robert Cameron Wertheimer, Barclays PLC, Research Division - Director and Senior Industrials Analyst [43]

--------------------------------------------------------------------------------

A question on resources mining. Would you be able to characterize the increase in part sales? Was it more big rebuilds and sort of scheduled maintenance and people coming in and doing big projects? Or was it more flow in consumables, maybe a restock in the dealers or a restock in the mines, et cetera? I'm just a little bit curious on the mix of that.

--------------------------------------------------------------------------------

Amy Campbell, [44]

--------------------------------------------------------------------------------

Yes. I don't have that breakdown, Rob, kind of more it would just be anecdotally what the business teams share. Certainly, we believe that a lot of it has to do with overhaul and rebuild of mining equipment. We do believe that there may have been some restocking of dealer shelves in the first quarter. And certainly, if you look at the hours of utilization of the mining equipment versus where it was at its depth kind of middle of last year, mining equipment is being used quite a bit more extensively. And I think that you can conclude from that, that it's driving consumables of filters and fluids and other things like that as well. So I think it's pretty broad-based across all three of those categories.

--------------------------------------------------------------------------------

Robert Cameron Wertheimer, Barclays PLC, Research Division - Director and Senior Industrials Analyst [45]

--------------------------------------------------------------------------------

And if I could ask a follow-up - a second. I mean, in construction, CAT has spent a number of years sort of improving its competitive position relative to peers through limited pricing. And I guess, successfully done that. I mean, do you have any thoughts on what you think your sustainable margin is, whether this is -- this quarter is starting to be more a reflection, as you normalize your pricing versus competition, what construction can do? Or just thoughts on normal?

--------------------------------------------------------------------------------

Amy Campbell, [46]

--------------------------------------------------------------------------------

Sure. I -- as you would expect, I'm not going to give you a guide kind of on the normal operating margin for Construction Industries. As I said a little earlier, we do expect a small improvement -- a slight improvement in operating margins for the full year for Construction Industries versus a year ago. And that's going to be on significantly higher incentive compensation expense. So I think it continues to reflect the great work that, that team has done and their focus around OPACC, or operating profit after capital charge. The pricing environment for Construction Industries, especially in North America, is very competitive right now. We are looking at that. I'd say it's across numerous competitors, not just with transaction pricing, but also with financing deals. That's certainly a risk that we have in the back half of the year that we continue to keep our eye on to make sure that we're meeting our market position goals.

--------------------------------------------------------------------------------

Operator [47]

--------------------------------------------------------------------------------

Our next question today is coming from Andrew Casey.

--------------------------------------------------------------------------------

Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [48]

--------------------------------------------------------------------------------

Question on the outlook. If I take the implied $3.75 midpoint, subtract the really good Q1 from that, it implies about a $0.30 earnings decline for the last 3 quarters of the year compared to last year. And then if I take the 50% pull-through expectation for this year, kind of implies flat machines and E&T operating profit for the last 3 quarters. Could you help us understand the factors, if I'm doing the math right, below the operating profit line that are driving this $0.30 headwind?

--------------------------------------------------------------------------------

Amy Campbell, [49]

--------------------------------------------------------------------------------

Yes. So there's a couple of things. The tax rate is a little bit higher. I think it's about 28% now in the outlook versus 25%, I believe, for 2016. We do have a slightly higher assumption for shares. And then there are several things that happened in the other income and expense line, some hedging gains or losses that we don't put in the outlook as well as some income -- or interest income, excuse me and a couple of other small things that are all occurring kind of below that operating profit line that will net you out to that reconciliation you're trying to do, Andy.

--------------------------------------------------------------------------------

Operator [50]

--------------------------------------------------------------------------------

Our next question today is coming from Jerry Revich.

--------------------------------------------------------------------------------

Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [51]

--------------------------------------------------------------------------------

I'm wondering if you're able to talk about -- now that you're closer to completing the manufacturing footprint restructuring program, can you update us on your next set of strategic priorities? I do appreciate it's only a quarter in, but I'm wondering if you could just outline for us the next areas that you folks are focusing on and how you're thinking about the business over the next cycle.

--------------------------------------------------------------------------------

D. James Umpleby, Caterpillar Inc. - CEO and Director [52]

--------------------------------------------------------------------------------

Yes, Jerry, we have a group of senior executives that we pulled together to really lay out our strategy moving forward. We call it a Strategic Planning Committee. Something that Caterpillar CEOs typically do when they come into office. And so we're working our way through that. It's too early for us to talk about that. But certainly, at the analyst meeting we're having later in the year, we'll lay those out.

--------------------------------------------------------------------------------

Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [53]

--------------------------------------------------------------------------------

Okay. I guess, on the shorter-term front here, you folks have rolled out the general contractor-grade product lines across your developed market construction equipment product lines. And I'm wondering if there are any other strategic priorities that are near term that you folks can talk about outside of what's planned for later this year.

--------------------------------------------------------------------------------

Amy Campbell, [54]

--------------------------------------------------------------------------------

Yes. I think certainly -- and there's certainly a lot of them. But one that comes quickly to mind, Jerry, would be our focus on digital, making sure that we have the best services and solutions to meet our customers' needs and help them be successful and make more money using our products than our competitors. So all the advancements, a lot of them on display at CONEXPO, is a huge area of focus for us right now. We believe we have the largest industrial connected fleet in the world of about half a million connected assets. And we continue to expect to grow that this year. And so I think that's one area of many, as well as continued focus on new product development. And then I'd say, lastly, using the operating and execution model to make sure we're very deliberate about where we put our resources to make sure they're being put around projects and investments that will drive the highest shareholder value.

--------------------------------------------------------------------------------

Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [55]

--------------------------------------------------------------------------------

Okay. And Amy, in Resources, you spoke about a substantial production ramp for a new equipment. I'm wondering if you can put that into context for us. So I guess from some of your competitors, we're seeing book-to-bill, depending on the product line, but in the 1.5 range. And I'm wondering, as you folks plan your production, are you folks maintaining or gaining share? Or are you down a little bit? Can you just give us a flavor relative to statistics we see from your primary competitors?

--------------------------------------------------------------------------------

Amy Campbell, [56]

--------------------------------------------------------------------------------

Yes. And I think the number I gave was specifically around large mining trucks, which was one of the more depressed from its peak volumes and off a -- and probably one of the most off of what we would consider kind of mid-cycle volume levels in some of our other mining equipment. I think if you look at book-to-bill, we don't -- as you know, we don't disclose that information specifically, but I would say we don't believe that we're losing any market share. We are seeing very healthy order rates, good, sporadic. I mean, a year ago, there was almost no ordering activity going on in Resource Industries, so we are coming off of a very low base, but we are seeing sporadic orders and good demand for mining equipment.

And I think with that -- well, that will be the last question. So Kate?

--------------------------------------------------------------------------------

Operator [57]

--------------------------------------------------------------------------------

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.