Caterpillar, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Q1 2020 Caterpillar Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. I would now like to hand the conference over to your speaker today, Jennifer Driscoll. Please go ahead, ma'am.

Thanks, Jacqueline. Good morning, everyone. Welcome to Caterpillar's First Quarter Earnings Call. Joining the call today are Jim Umpleby, Chairman of the Board and CEO, Andrew Bonfield, CFO, Kyle Epley, Vice President of our Global Finance Services Division, and Rob Rangel, Senior IR Manager. Our call today expands on our earnings news release, which we issued earlier this morning. You can find the slides that accompany today's presentation along with the news release in the Investors section of Caterpillar.com under Events and Presentations. The forward-looking statements we make today are subject to risks and uncertainties. We'll also make assumptions that could cause our actual results to be different than the information we discussed today. Please refer to our recent SEC filings and the forward-looking statements reminder in the news release for details on factors that individually or combined could cause our actual results to vary materially from our forecasts. Caterpillar has copyrighted this call. We prohibit use of any portion of it without our prior written approval. This year's quarter included a $0.38 per share benefit from a remeasurement gain, while last year's quarter included a discrete tax benefit of $0.31 per share. There is a non-GAAP reconciliation in the appendix to this morning's news release. In a moment, you'll hear from Andrew about the first quarter results, the actions we've taken to boost our liquidity, and a few key financial assumptions for the rest of 2020. But first, please turn to slide three as we turn the call over to our Chairman and CEO, Jim Humplebee. Jim.

Thank you, Jennifer. Good morning and welcome to Caterpillar's first quarter earnings call. During this difficult time, our thoughts are with those affected by COVID-19. We extend our deepest sympathies to those who have lost a loved one during the pandemic. We thank those individuals in healthcare, as well as the first responders helping fight the pandemic on the front line. I also want to thank Caterpillar's global workforce. This month, we are celebrating 95 years of operation at Caterpillar. For nearly a century, we have faced and overcome many challenges. As in the past, our employees are rising to the occasion. I appreciate their commitment to support our customers while keeping our facilities and coworkers safe. As the COVID-19 pandemic spread around the world, many governments classified Caterpillar's operations as essential activity for support of critical infrastructure. Working with our dealers, Caterpillar is delivering products and services that enable our customers to provide critical infrastructure that is essential to support society during the COVID-19 pandemic. Customers use our products to provide prime and standby power for hospitals, grocery stores, and data centers, to transport food and critical supplies in trucks, ships, and locomotives, to maintain clean water and sewer systems, and to mine commodities and extract the fuels essential to satisfy global energy demand. While we are serving these important needs, Caterpillar remains dedicated to the safety, health, and wellbeing of our employees. The Caterpillar team achieved our best safety performance on record in 2019, and we are leveraging our strong safety culture during the pandemic. Employees who can work from home are doing so. In our facilities that remain open, Caterpillar is implementing safeguards to protect our team members in accordance with regulatory requirements and guidance from health authorities. We've also introduced a number of enhanced employee benefits to help them deal with the pandemic. These benefits vary by country based on local medical care systems and various regulatory requirements. Since Caterpillar was founded, a world-class global dealer network has provided us with a competitive advantage. And during this pandemic, our 165 dealers and their employees around the world continue to support our customers as they maintain critical infrastructure. Our team at Cat Financial also continues to support our customers as Andrew will describe in more detail. Cat Finance supports our customers through good times and challenging times, which is one of the reasons we have so many loyal customers. The Caterpillar Foundation has also committed $10 million to support COVID-19 response activities being taken by organizations around the world. Now, turning to slide four. Caterpillar is well positioned to navigate the COVID-19 pandemic. Our financial position is strong, and we are confident in our ability to continue serving our global customers. We will continue to execute the strategy we introduced in 2017, which is based on growing services and expanded offerings while improving operational excellence. The execution of our strategy during the last three years positions us well for these challenging times. Our disciplined management of structural costs will help us weather the storm created by COVID-19. We held our period costs of SG&A R&D, and manufacturing, along with our salary and management headcount, flat from the end of 2016 to 2019, even though sales and revenues increased 40% during the same time frame. While this leaves us less to cut in a downturn, the lower cost base and the need for significantly less restructuring costs mean that our absolute margins and cash flow will be higher than they would have been had we allowed period cost and salary and management headcount to increase during the last three years. In response to the pandemic, we've taken actions to improve our already strong financial position and increase liquidity. On a consolidated basis, Caterpillar ended the first quarter with $7.1 billion of cash in available global credit facilities of $10.5 billion. In April, we raised $2 billion of incremental cash by issuing new 10- and 30-year bonds and arranged $8 billion of additional backup facilities to supplement the company's liquidity position. We've reduced discretionary expenses, including consulting, travel, and entertainment. We've suspended 2020 base salary increases and short-term incentive compensation plans for most salary management employees and all senior executives. We are also reducing production costs to match customer demand. We continue to focus on improving operational excellence which includes making our cost structure more flexible and competitive. We are working through a number of operational challenges related to the pandemic and have suspended operations at certain facilities due to a combination of supply chain issues, weak customer demand, and government regulations. As of mid-April, approximately 75% of our primary production facilities across our three main segments continue to operate. Some facilities that were temporarily closed have reopened such as in China. We have worked quickly to mitigate disruption to our supply chain by using alternative sources, increasing air freight as needed, redirecting orders to other distribution centers, and prioritizing the redistribution of the most impactful parts. Our employees and dealers continue to serve our customers. Now I'll give you a summary of the first quarter's results on slide five. Sales and revenues of $10.6 billion decreased by 21%. The decline was mainly due to lower sales volume, including lower end-user demand and the impact from changes in dealer inventories. End-user demand was below our internal expectations for the quarter. Sales to users for the first quarter declined by 16%. The decline was most pronounced in Asia Pacific, where we compete primarily in construction industries and in North America, which had weakness from machines and energy and transportation engines. Oil and gas declined 24% for the quarter. Small bright spots included construction in Latin America, mining in Asia Pacific and IEMI, and power generation. During the first quarter of 2020, dealers increased inventory by $100 million in anticipation of normal seasonal demand from end users. This compares with a $1.3 billion increase in dealer inventory during the first quarter of 2019. The year-over-year change of $1.2 billion in dealer inventory also placed pressure on our sales. Our first quarter operating profit margin was 13.2%, down 320 basis points. The decline was primarily driven by lower sales volume. Favorable SG&A, R&D, and manufacturing costs partially offset the volume decline. The R&D decline was mostly due to lower short-term incentive compensation as most of our R&D projects are proceeding consistent with our strategy. Profit per share was $1.98, compared with $3.25 in the prior year's period. This year's quarter included a $0.38 per share benefit from a remeasurement gain, while last year's quarter included a discrete tax benefit of $0.31 per share. Now, moving to slide six. In the first quarter, we returned $1.6 billion to shareholders, through dividends and share repurchases. In addition, we declared our normal quarterly dividend earlier this month, and we continue to expect our strong financial position to support the dividend. As a reminder, Caterpillar has paid a quarterly dividend every year since 1933 through a variety of challenging business conditions. We remain committed to returning substantially our free cash flow to shareholders through the cycles. We are temporarily suspending our share repurchase program upon completion of the 10B51 program that we established in January. We retained the balance sheet to do M&A for compelling opportunities. Our focus on operational excellence, shorter lead times, and flexibility in manufacturing operations will allow us to react quickly to future changes in market conditions, either positive or negative. The ultimate impact of the pandemic on our 2020 results remains uncertain, and will be based on the duration of the virus and the magnitude of the economic impact on global demand for our products. We expect the impacts of the pandemic on our results to be more significant in the second quarter and to linger until global economic conditions improve. Due to the uncertainty associated with COVID-19 and its effects, we withdrew our financial outlook for 2020 on March 26 and are not providing one today. At our investor day in May 2019, we discussed our strategy based on services, expanded offerings, and operational excellence. We highlighted our focus on operational excellence and our goal to be profitable and operate more efficiently through the cycles as we leveraged our foundational strengths, our competitive and flexible cost structure, lean processes, the safety first culture, and quality, including product reliability and durability. We described our success delivering the targets we had set out during our 2017 investor day and we laid out new targets based on the improvements we've made in structural costs that I described earlier. One was to improve annual adjusted operating margin by 300 to 600 basis points versus 2010 to 2016, when margins ranged from 7% to 15%. The second was to increase annual M, E, and T free cash flow by $1 billion to $2 billion above our actual 2010 through 2016 performance. to a range of $4 billion to $8 billion per year. However, the impact of COVID-19 on our business has been significantly more severe and chaotic than any cyclical downturn we had envisioned. Governments have closed suppliers with little or no notice, impacting Caterpillar's operational efficiency. Importantly, while we have taken actions to reduce costs, we have made a conscious decision to continue to invest in enablers of services growth and expanded offerings key elements of our strategy for long-term profitable growth. As a result, in 2020, depending upon how the pandemic unfolds, while we expect our margins and free cash flows to be better than our historical performance of 2010 to 2016, it will be challenging for us to achieve the margin and cash flow targets communicated during our 2019 Investor Day. Our goal is to emerge from this crisis as an even stronger company, better positioned for long-term profitable growth. Now let me turn the call over to Andrew for a recap of our first quarter results, short-term actions we've taken, and the strength of our balance sheet.