Caterpillar, Inc.

Welcome to the fourth quarter 2021 Caterpillar Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jennifer Driscoll. Thank you. Please go ahead.

Thanks, Emma. Good morning, everyone. Thank you for joining the fourth quarter earnings call for Caterpillar. With me are Jim Umpleby, Chairman and CEO, Andrew Bonfield, Chief Financial Officer, Kyle Epley, Vice President of the Global Finance Services Division, and Rob Rangel, Senior Manager in Investor Relations. Earlier this morning, we issued our earnings news release. You can find the release and accompanying slides on Caterpillar.com in the Investors section under Events and Presentations. In the back of the slides, you'll find supplemental information on dealer inventory and order backlog. We've copyrighted this call. Please don't use any portion without our prior written approval. Now on slide two. During our call, we'll make forward-looking statements. These are subject to a host of risks and uncertainties. For more information about the risks and uncertainties that could cause our actual results to vary materially from any forward-looking statements, please refer to our SEC filings, including our 10Q filings for the most recent quarters. On today's call, we'll also refer to non-GAAP numbers. For a reconciliation of any non-GAAP numbers to the appropriate U.S. GAAP numbers, please see the appendix of the earnings call slides. This morning we announced profit per share of $3.91 for the fourth quarter of 2021. That compares with the profit per share of $1.42 in the fourth quarter of 2020. Our adjusted profit per share was $2.69 in the fourth quarter of 2021, compared with $2.12 in the fourth quarter of 2020. Adjusted profit per share for both quarters excluded restructuring and mark-to-market gains or losses, for remeasurement of pension and other post-employment benefit plans. In the fourth quarter of 2021, we had $1.19 per share of remeasurement gains and $0.03 per share of net restructuring income due to a gain on the sale of a facility. In the fourth quarter of 2020, we had $0.63 per share of remeasurement losses and $0.07 per share of restructuring expenses. Please keep in mind two dates. We'll announce our first quarter earnings April 28th, and we'll host our next Investor Day May 17th. And with that, turn to slide three. We'll give the call over to Jim Humplebee.

Thank you, Jennifer. Good morning, everyone. Thank you for joining us. I'd like to start by recognizing our global team for their continued resilience and hard work in what proved to be a challenging and dynamic environment. We're proud that we achieved our best year on record for employee safety for the third year in a row. In 2021, we continue to execute our strategy for long-term profitable growth while striving to meet strong customer demand. I'll briefly cover a number of topics. I'll start with my perspective on the quarter. Then I'll give a brief update on our supply chain, followed by comments on services and our end markets before closing with an update on Caterpillar's sustainability journey. We were encouraged by the continued strong customer demand in the quarter. Sales and revenues rose in all regions and in the three primary segments, due to volume gains and favorable price. And similar to the third quarter, absent the continuation of supply chain constraints, our top line would have been even stronger. On the other hand, our margins were lower than we expected, primarily because of two factors. First, freight costs were higher than expected due to inflationary pressures, as well as our decision to increase the use of premium freight to meet as much customer demand as possible. The second factor was production inefficiencies. As I mentioned, Underlying demand is stronger than we can currently supply due to ongoing supply chain constraints. We made the decision to keep our plants open and fully staffed to best serve our customers and meet as much demand as possible. We believe it's the right decision to incur some short-term margin impact rather than take actions that might limit our ability to more fully satisfy demand when supply chain conditions start to improve. We also continue to redirect components alter our assembly processes, and optimize where we can. Some of these actions aimed at maintaining our production flexibility come with additional short-term costs. When the supply chain bottlenecks begin to ease, we expect to be well positioned to increase our production to more fully meet demand and gain operating leverage from higher volume. Material costs also impacted us this quarter, but unlike freight and inefficiencies, it was within the range we had anticipated. As you know, we implemented price increases during 2021. We're taking further action in 2022 with the intent to offset the impact of underlying inflation. That's the general picture. Andrew will provide more details on our margins and how the combination of supply chain pressures and pricing will likely affect the cadence of our quarterly margins in 2022. Now on slide four, our top line rose by 23%. The primary drivers of the volume gains were increases in sales to users, including original equipment and services, and changes in dealer inventory. For the full year 2021, services sales grew 17% to $19 billion. Services growth in 2021 benefited from investments in our digital capabilities and the increased focus we and our dealers placed on meeting customer needs for services, particularly aftermarket parts. We saw significant increases in 2021 in e-commerce sales, in sales of customer value agreements, or CVAs, and in prioritized service events, or PSEs. In 2021, our e-commerce orders increased significantly, and now we have critical mass in connectivity with more than 1.2 million connected assets. It's encouraging to see services sales in 2021 higher than in 2019. while our total company sales in 2021 remained lower than in 2019. We continue to strive to meet our aspirational target of doubling services to $28 billion by 2026. Compared with the fourth quarter of 2020, sales to users rose 7%. Gains were across the three segments. For machines, including construction industries and resource industries, sales to users rose 5%. For energy and transportation, sales to users increased 12 percent. Sales to users in construction industries rose by 4 percent, with double-digit growth in Miami and Latin America. In North America, residential construction remained strong in elevated housing construction, while non-residential demand continued to improve at a slower pace. In Asia Pacific, end-user demand slowed, reflecting the expected moderation in China construction. However, excluding China, Sales to users were positive in Asia Pacific, driven by favorable commodity prices and government stimulus. In resource industries, sales to users rose by 10%. Mining saw healthy gains in the quarter, supported by strong commodity prices and the replacement of aging equipment. Sales to users increased versus the prior year in heavy construction and quarry and aggregates for the third straight quarter. In energy and transportation, Sales to users were up across all applications versus the prior year. We saw double-digit growth in industrial and transportation, although from a low base. We experienced strength across many applications for industrial and international rail deliveries benefited transportation sales as expected. Oil and gas grew from demand for both reciprocating engines and turbines. Finally, power generation sales to users increased as data-centered demand remained strong. Overall, total sales to users growth in the quarter moderated versus the second and third quarters. As a reminder, the impact of the pandemic lessened in the fourth quarter of 2020. In addition, the supply chain challenges have constrained our ability to fully meet end-user demand. As independent businesses, dealers make their own decisions about their inventories. Changes in dealer inventories drove about a $1 billion tailwind to sales compared with last year. Dealer inventory was nearly flat in the fourth quarter compared with the third quarter of this year. In the fourth quarter of 2020, dealers decreased their inventory by about $1.1 billion. To put it in context, our year-end dealer inventory in 2021 also finished about flat with year-end 2020 as we expected. Dealer inventories are generally near the low end of the typical range due to strong customer demand and our supply chain challenges. Currently, Availability is extended for some products due to the shortage of semiconductors and other components. With the exception of China, end-user demand for our equipment remains strong. Turning to slide five, in 2021, we met our 2019 Investor Day target for adjusted operating profit margins for the third year in a row. We also met our target for free cash flow for machinery, energy, and transportation, or MENT. Our strong cash flow enabled us to return $5 billion to shareholders this year through dividends and share repurchases. We paid a higher dividend annually for 28 consecutive years and are proud of our status as a dividend aristocrat. We expect to continue to return substantially all of MENT free cash flow to shareholders through dividends and share repurchases over time. Next on slide six, I'll share some high level assumptions for the full year. First in 2022, Based on what we know today, we expect to achieve our investor day targets for adjusted operating profit margins and MENT free cash flow. That said, the environment remains uncertain due to COVID and other issues, including continuing supply chain disruptions, freight and material cost inflation, and labor availability. Our focus is long-term profitable growth. Despite the challenging environment, we continue to invest in services, electrification, autonomy, alternative fuels, and digital technology, all of which support our strategy. Now I'll describe our outlook for key end markets this year. Demand remains strong as demonstrated by robust orders. In addition, we're receiving positive input from our customers and dealers. A key variable remains the supply chain, namely to what degree can we fully meet strong customer demand. In construction industries in North America, residential construction continues to be the main growth engine. with non-residential also improving. We believe the U.S. Infrastructure Investment and Jobs Act will begin to fuel increased investments in capital equipment late this year into 2023 and beyond. In China, we expect the industry for excavators above 10 tons to return to 2019 levels, reflecting weakness in housing construction. We expect the balance of Asia Pacific to have good growth fueled by higher investments in infrastructure. Turning to Miami, Positive fundamentals include government stimulus actions, construction confidence, new orders, and commodity prices. Latin America is expected to benefit from construction activity and mining, supported by commodity prices, although strong inflation could make it more challenging. In resource industries, we anticipate elevated commodity prices will support continuing improvement in demand for mining products and services. We also expect growth in heavy construction and quarrying aggregates to continue in 2022. We now currently operate autonomously on 18 sites on three continents with more than 500 large mining trucks and have now moved more than 4 billion tons. Technology and autonomy offerings deliver significant benefits across the board from boosting safety and productivity to more consistent and efficient operations. Autonomous operations enable higher machine utilization, leading to reductions in idle time and non-productive fuel burn. In energy and transportation, we see improved sales across most applications, and we had strong order rates, including for large engines, in the fourth quarter. While we expect our oil and gas customers to continue to display capital discipline, we do expect growth in our reciprocating engines and aftermarket services for oil and gas. We see growth in reciprocating engines for power generation with strength across many applications. Industrial, which includes engines for our own equipment and loose engines sold to customers, is projected to grow across many applications, including construction, agriculture, and electric power. We expect a modest increase in transportation, primarily in rail services. We also anticipate growth in marine from a low base as customers update aging fleets. In 2022, solar is expected to be impacted by the dampening industry cycle. We expect solar's new equipment sales to be lower this year, which will be partially offset by continued services growth. Solar is experiencing healthy inquiry activity, which indicates the likely recovery in customer deliveries in the late 2022 and into 2023. Now on slide seven, we significantly advanced our sustainability journey in 2021, and we continue to focus on this important element of our strategy. In 2021, Caterpillar and our customers announced a number of projects that will help contribute to a lower carbon future. I'll highlight several more that occurred since our last earnings call. In November, Newmont announced a strategic alliance with Caterpillar to deliver fully automated zero-emissions mining equipment and technology. The investment encompasses a U.S. surface mine and an Australian underground mine, while also deploying Caterpillar MindStar across all Newmont sites. We also announced a three-year collaboration with Microsoft and Ballard to demonstrate a power system with large-format hydrogen fuel cells to produce backup power for Microsoft data centers. Caterpillar is providing the system integration, electronics, and controls that form the central structure of the power solution, which will be fueled by low-carbon intensity hydrogen. The project is backed by the U.S. Department of Energy. In December, Progress Rail entered into a memorandum of understanding with BNSF and Chevron to advance the demonstration on BNSF's line of a locomotive powered by hydrogen fuel cells. Progress Rail plans to design and build a prototype hydrogen fuel cell locomotive with Chevron developing the infrastructure to support it. Earlier this month, Tech Resources, one of Canada's leading mining companies, announced a partnership with Caterpillar to deploy 30 zero-emissions large haul trucks, including CAT 794 ultra-class trucks, at their mining operations beginning in 2027. This collaboration will support their goals to reduce the carbon intensity of their operations by 33% by 2030 and be carbon neutral by 2050. And finally, Union Pacific is purchasing 10 Progress Rail battery electric locomotives, making them our fourth customer for this new technology. In railroads in California and Nebraska, they will be tested in diverse weather conditions and evaluated for broader deployment in support of Union Pacific's emissions reduction goals. We're excited about the opportunities associated with the energy transition, which includes rising demand for commodities used in electric vehicles and other applications benefiting resource industries. The significant infrastructure investments associated with the energy transition also support growth in construction industries. In addition, they increase demand for a number of products in our energy and transportation segment, including distributed power generation and our integrated systems and solutions to help our customers meet their climate-related objectives. Caterpillar continues to invest in research and development to support a wide variety of fuel types, energy storage, and hybrid solutions. In summary, we're continuing to execute our strategy for long-term profitable growth. The three core elements of the strategy remain, services, expanded offerings, and operational excellence. Services growth and our record safety performance are among the many highlights of 2021. We remain committed to a reduced carbon future both in our operations and helping customers reach their climate-related goals. We continue to introduce products and services that facilitate fuel transition, increase operational efficiency, and reduced emissions. While we continue to face supply chain challenges that negatively impacted our top line and our fourth quarter margin performance, we're focusing on meeting as much customer demand as possible and remain encouraged by the continuation of strong end market demand. Our team delivered 2021 adjusted operating profit margins and MENT-free cash flow consistent with the long-term targets we set at our 2019 Investor Day, while continuing to invest in our long-term strategy for profitable growth. With that, I'll turn the call over to Andrew.