Ladies and gentlemen, thank you for standing by and welcome to the Q2 2020 Caterpillar Inc. Earnings Conference Call. At this time, all participants are in a listen only mode. [Operator Instructions] I would now like to hand the conference over to your speaker today, Jennifer. Please go ahead.

Thank you. Good morning, everyone. Welcome to Caterpillar's second quarter earnings call. Joining our call today are Jim Umpleby, Chairman of the Board and CEO; Andrew Bonfield, Chief Financial Officer; Kyle Epley, Vice President of our Global Finance Services Division; and Rob Rengel, Senior IR Manager. The call today builds on our earnings release, which we issued earlier this morning. You may find the slides that accompany today's presentation along with the news release on our recently relaunched Investors Relations website in the Investor Sector of caterpillar.com. When you have some time please take a moment to check out the new look and improved organization. We welcome your feedback on any ways that we can make it a better tool for you. Moving on to slide 2, the forward-looking statements we make today are subject to risks and uncertainties. We will 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 an aggregate could cause our actual results to vary materially from our forecast. Caterpillar has copyrighted this call. We prohibit use of any portion of it without our prior written approval. This year’s quarter included a $0.19 per share remeasurement loss resulting from the settlement of pension obligations. We provide a non-GAAP reconciliation in the appendix to this morning’s news release. Now let's flip to slide 3 and turn the call over to our Chairman and CEO, Jim Umpleby. Jim?

Thank you, Jennifer and good morning everyone. The second quarter brought unprecedented challenges for our customers, dealers, employees and suppliers. We thank those in healthcare as well as the first responders helping fight the pandemic on the frontline. We also want to thank Caterpillar's global workforce for their commitment to support our customers while keeping each other safe. 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 pandemic. During this time Caterpillar is leveraging our strong safety culture and remains dedicated to the safety, health and well-being of our employees. Our workforce is successfully navigating this uncertain environment by focusing on keeping period costs down, managing inefficiencies and continuing to meet customer needs. The execution of our strategy including the disciplines and management of structural costs during the last three years is also helping us weather the storm created by COVID-19. We've reduced discretionary expenses including consulting travel and entertainment. Effective July 1 to support our employees we reinstated 2020 base salary increases except for our most senior executives. Short-term incentive compensation plans for 2020 will remain suspended for most salaried management employees and all senior executives. We've also reduced production to match customer demand. Our teams continue to focus on improving operational excellence which includes making our cost structure more flexible and competitive. We've worked through a number of operational challenges relating to the pandemic. As of mid-July substantially all our primary production facilities across the three main segments continue to operate, although many are operating at reduced capacity. We've worked to mitigate disruption to our supply chain by using alternative sources, redirecting orders to other distribution centers and prioritizing the distribution of the most impactful parts. Our global supply chain is…

Thank you Jim and good morning everyone. I will begin with a review of our second quarter results as well as our cash flow. Then I will comment on the third quarter and the liquidity position before ending with a brief update on actions we're taking to improve our competitiveness and profitability. As you can see on slide 7, total sales and revenues for the second quarter decreased by 31% to $10 billion. Operating profit declined by 65% to $784 million. Profit per share for the quarter was down 70% to $0.84 per share including a pension remeasurement loss of $0.19 per share. This quarter's top and bottomline results were largely driven by volume. Sales to users declined by 22%, which was less of a decline than we had anticipated. However, this had a minimal impact on reported sales and revenues because dealers used the opportunity to reduce their inventory levels by more than we had expected. Services revenues also declined but as anticipated they were down less than original equipment sales. As you see on slide 8, second quarter sales declined by $4.4 billion, $3.9 billion of which was the volume decline. The volume decline reflected in approximately $2 billion reduction in end-user demand and a $1.9 billion movement in dealer inventory. As Jim mentioned, dealers decreased inventory by $1.4 billion this quarter compared with an increase of $500 million in the prior year's quarter. Volume declined in all segments but were most pronounced in construction industries and resource industries. While sales were low in all regions the declines were led by North America which fell by 42%. Price realization lowered sales by $259 million. The negative price was a combination of changes in geographic mix and continued competitive pressures primarily in construction industries. The Brazilian Real and the…

Thank you. Our first question comes from the line of Ross Gilardi from Bank of America. Your line is open.

Good morning, Ross. Ross, are you muted? We'll move on to our next question from the line of Stephen Volkmann from Jefferies. Your line is open.

Hi, good morning. I think I am here. Can you hear me?

Yes. Good morning, Steve.

All right. Great. Thanks and thanks for all the detail here today. I guess if it's possible, you may not want to go too far down this path but I am trying to think a little bit about 2021 not in terms of an outlook but in terms of just sort of the comparative things and so I am guessing we're going to get some benefit from that under producing the $2 billion which is probably substantial $500 million or $600 million of tailwind I guess from that but we'll have a headwind because I guess you'll be reinstating incentive compensation and various other sort of temporary things. So I guess my question specifically is what costs were sort of temporary this year that may come back next year irrespective of whatever volume we may choose to forecast.

Well, thanks Stephen. As you mentioned certainly, we're not giving guidance for next year obviously because of the all the uncertainty that's there so much depends upon the pandemic and the resulting impact on the economy but you correctly stated that it would be reasonable to assume that short-term incentive would be a cost next year that we wouldn't have this year. We are certainly continuing to look for other ways to reduce costs. We challenge all of our leaders to continue to find ways to be more efficient. We're working on what we do inside, what we do outside, things we do inside if they continue to be done inside can we do them in a more efficient lower cost way through a location change or some other change. So again we're continually working every cost angle we can think of but probably the biggest one that comes to mind is that short-term incentive comp as you mentioned.

And Jim, are you willing to talk at all about the benefits of all the restructuring that Andrew laid out for us this year? What you might see for benefits in ‘21?

I mean at this stage Steve, we won't talk about it but probably we'll give you a little bit more of an indication in January when we give the outlook because obviously there will be lots of puts and takes as you clearly point out.

And again the biggest determining factor I suspect will be volume. So we'll have to see how the economy plays out.

Fair enough. Thanks.

Our next question comes from the line of Ross Gilardi from Bank of America. Your line is open.

Thank you. Sorry about that guys. Can you hear me now?

We can. Thanks Ross. Good morning.

Good morning. I'm trying to piece together what's happening with pricing in construction you mentioned that it was influenced by geographic mix and I'm wondering if the overall 4% decline is heavily biased towards China perhaps. The reason I'm asking is in your Asia-Pacific construction is down 10% despite the strength that we're all aware of in the China excavator market, yet of course as you show your pricing is down 4% for the segment. So is the 10%, down 10% Asia-Pacific because China excavator pricing is particularly challenged or is it because the rest of Asia-Pacific was hit significantly harder than the China excavator market? Any color there would be really appreciated.

Ross one of the issues is we call geomix, I mean the biggest pricing factor was the fact that North American sales were down. So that has a big impact on pricing. So that was the number one impact. Certainly, yes there is competitive pressures in China. We're confident in our ability to compete in China long term, continue to expand our products and our dealers are well positioned but to answer your question the biggest single issue impacting pricing was the fact that North American sales were down so significantly.

Okay.

Sorry Ross. Just to give a little bit more color as well don't forget there's currency impacts in the reported China sales and also remember we had built inventory ahead of the Chinese new year. So some of that inventory got burned down in the CI in Q2.

Okay. Got it. And then just as a follow-up, I'm just curious about mining and when do you think will, will see positive margin comps again in resource industries and the copper and iron ore prices are very strong. Capital with the big miners is very strong yet it’s little bit puzzling the revenue declines are seem to be intensifying and the segment and margins are billing lower despite what you're doing on digital, I'd also think you'd be seeing a very favorable mix shift towards parts as miners refurbished existing fleet. So I understand that miners are being frugal on deferring CapEx but just curious about that sort of persistent margin or erosion aside from the COVID-19 impacts and are you getting paid for your new technology that's obviously generating enormous cost savings for your customers.

Yes. The biggest issue affecting margins of course is volume because of the leverage we have there. So you've seen that as volume came down, you saw an impact there. So again we'll have the biggest impact on operating margins in NRI is higher volume. As we mentioned we continue to be a positive on mining outlook medium and the long term. It's not surprising that in the short term given what's happening with COVID customers are being a bit cautious but as I mentioned in my remarks we haven't seen any projects that were involved in being canceled. The greenfield and brownfield projects are moving forward. So we haven't seen any significant kinds of cancellations. So again we're bullshit about that. So the biggest thing that'll have an impact certainly is the biggest impact will come from volume due to operating leverage.

And please remember one question per person. Thank you.

Thank you.

Our next question comes from the line of Jerry Revich from Goldman Sachs. Your line is open.

Yes. Hi. Good morning everyone.

Good morning, Jerry.

Question on digital. Can you talk about how much progress you've been able to make in this environment and rolling out the full suite of digital tools to your dealers in terms of the ability to assess market share by product and all the analytics that you folks are providing? Where are we in that rollout? Where we slowed by the obvious challenge travel environment? And by the same token can you also comment on with all the telematics data that you're getting have you seen any slowdown in utilization rates in July with the flare-up in COVID in parts of the U.S.? Thanks.

You bet. Well, we continue to invest in our digital capabilities from a whole variety of perspectives. I mean, we have created and continue to create tools which give us ability a better read internally and where some of the biggest opportunities are in the aftermarket. So that's a tool for both Caterpillar and our dealers to use. In addition to that we talked about the fact that we hit a million connected assets at the end of last year and we're looking at ways of leveraging that data. Clearly in parts of the world where economic activity was shut down as you can imagine we saw an impact in utilization rates but again it's a very fluid dynamic situation. Some areas that went down have come back up and so again it's very fluid and dynamic as the pandemic impacts economies differently around the world. But again it's an area that we continue to invest in and I think we're making good progress. So we really haven't slowed down.

And sorry just a clarification, when do you expect the full suite of market share tools by product to be available to your dealers globally? Can you just provide an update there?

It's a never-ending journey. So I don't think we'll ever get there. So what we're doing is looking at continually adding on new capabilities as we move forward. So we still have a ways to go. There is no question and again we'll continually add upon those capabilities; that's our intent.

Okay. Thank you.

Our next question comes from the line of Ann Duignan from JP Morgan. Your line is open.

Hi, good morning everyone.

Good morning, Ann.

Good morning. I just wanted to ask a step back and ask a more long-term question. Back in the old days when I visit CAT dealers they would always say that their life begins and ends with residential construction because if you're building new houses, you're eventually putting in surge systems and schools, etc. etc. So I am just curious if there's any reason to believe that we're not kind of back at the beginning of a brand new cycle where residential leads, non-residential in terms of at least infrastructure and then what is your thinking in terms of rental as opposed to purchase as we move forward given the uncertainties out there and how would that impact your business long term?

Well, thanks for your question Ann and certainly as you ask that question, I think it's important to think about our dealer network and business from a global perspective. So I suspect your question is more slanted towards North America and clearly residential construction is important as you say if in fact there are build out new homes that requires infrastructure to support all of that. So I certainly understand your question but again obviously we have to keep in mind that we have a very strong mining business and oil and gas business and other kinds of businesses as well. Rental, I think will be important and will continue to be important. It's an area that we're focused on. I am not ready to make a call as to whether or not the COVID will have a significant step change in purchase versus rental but we view rental as an important business and that market will continue to grow over time.

Okay. I will leave it there in the interest of time. Thank you.

Thanks Ann.

Our next question comes from the line of David Raso from Evercore ISI. Your line is open.

Hi, good morning. My question relates to incremental margin. Can you give us some sense of how to think about a lot of puts and takes you threw out there for 3Q year-over-year? How to think about the decrementals in 3Q versus the 30% you just posted for 2Q and on the way back up there were some questions alluding to this earlier but Jim you mentioned short-term incentive comp coming back. You would continue to look for other ways to cut costs to offset that. Would you be willing to give us some sense of how you think of incremental margins on the way up in totality? I know there's a lot in there with [mix] and so forth but I mean historically CAT after a year of revenue decline has put up pretty significant incrementals. I know the business has changed a bit but just wanted to get some level set how you're thinking about it. Thank you.

Yes David. I think this comes down to the fact and as Jim did alluded to in the script the fact that we haven't built in structural costs over the last three years does enable us to actually when you think about absolute margins going forward, we are obviously most sensitive to volume variances which is probably the biggest single factor driving margin performance. So obviously in an environment where margin, where volumes are improving, you'll see obviously very significant improvement in overall margins. You'll notice, I am not using incrementals or decrementals again but I do think that really is obviously the biggest single benefit to us. As we look out in Q3 as we mentioned obviously normally as you would always expect there is some seasonality because of lower volume in Q3 versus Q2 that does have an impact on particularly on gross margin. You obviously also we are lapping those material cost changes. So that will have a slightly negative impact on gross margin as I mentioned in my notes. We will see a lower absolute dollar number in step savings in Q3. It was a lower number in the quarter last year. So that will have some impact. So overall what we're saying is probably margins, we shouldn't expect a margin improvement as we move into Q3. What that does mean though obviously is normally overall I think margins last year in Q3 was slightly lower than they were in Q2. So actually that would be what we would call relatively good performance year-on-year within that regard because I think overall the margin in Q3 last year actually slightly higher than 15.8% rather than 15.3%. So but that would sort of hold those sorts of levels.

So that last comment just be clear, it should be roughly around the 30 that we saw in 2Q just ballpark?

It shouldn't be. If you do the math and you assume margin, there is no improvement in operating margins from the 7.8% we've just posted against the 15.8% that will be slightly higher as a percentage.

Okay. Thank you very much. I appreciate it.

Our next question comes from the line of Andrew Casey from Wells Fargo Securities. Your line is open.

Thanks a lot. Good morning, everybody.

Good morning, Andy.

Good morning. I just wanted to ask a question, it's around the benefits if you will from the pandemic. Other companies have mentioned cost benefit pull ahead from acceleration of initiatives due to the pandemic and things like technology. Could you help us understand whether you're seeing similar opportunities internally and then are they meaningful and then also kind of back to Jerry's question have you seen any increased, I guess indication of interest in your digitally enabled product as an outcome of the response to the pandemic?

Yes. It will certainly again as I mentioned we're continually looking for ways to reduce costs and to be more efficient and certainly a situation like this causes – I think company to step back and look at ways they can accelerate cost reduction activities and think about their structural costs and so again we're no different than anyone else. We're thinking about those things as well. In terms of digital, obviously if in fact things can be done remotely as -- and not an individual does not have to travel and be face to face there's an advantage in that. So we're using digital capabilities where we can but certainly our dealers continue to support our customers and we have technicians that continue to work on equipment. So again what this pandemic has really demonstrated is that digital strategy is correct.

And I think the other area where obviously is the autonomous solutions where people will be looking for those and obviously we are optimistic that this will actually encourage further uptake rather than make it expand it faster.

Yes. That is a very good point because think about our mining operation the number of autonomous mining trucks we have, if in fact you can do more using autonomous technologies it reduces the need for think about camps and all the things that our mining customers have to do with people in close proximity. So that certainly could be an acceleration from a market perspective.

Sure. I guess are you seeing any of that, the external response at this point or is it more optimism it's going to come?

No, as I mentioned in my prepared remarks, we see very strong interest in our autonomous solution and we do believe quite strongly that we have the best solution there and that gives us a competitive advantage but yes interest and autonomy and mining has been very strong. Lots of conversations with customers about that.

Okay. Thank you very much.

Our next question comes from the line of Jamie Cook from Credit Suisse. Your line is open.

Hi, good morning everyone. I guess Jim, I think you mentioned in the prepared remarks while you don't expect your margin performance to be what you outlined at the analyst day, you do expect to get, have better margins relative to another downturn, I think with on similar sales. Is there any way you could help us understand sort of which downturn you're talking about so we can understand the comp? And then I guess just as a follow-up, relative to Ann's question or maybe even Ross's outside of the pandemic there does seem to be some green shoots. Can you just speak to markets that you would be more positively inclined to sort of think would recover first or which markets structurally you're more concerned about. Thank you.

Yes, Jamie when we talk about margin comparisons to the historical past, we're looking at a year when we had a similar year sale. So I believe if memory serves that would have been 2016. So again, I think we were about $39 billion. So again if you think about margin, we always think about it is we think about for a similar level of sales we expect higher operating margins and we expect that to be the case this year as well. I mean in terms of green shoots I mean China was an area that, the pandemic hit China first and business has been quite strong in China. So that's quite positive. So again it's very much a fluid dynamic situation. Obviously the virus starts to go away in an area then starts then starts to come back. So again it's very fluid. So it's difficult for me to really predict any area other than right now again we see a lot of strength in China.

And just to elaborate that's 10% to 21% then range across the cycles.

Okay. Thank you.

And our next question comes from the line of Rob Wertheimer from Melius Research. Your line is open.

Thank you. Good morning everyone.

Hi Rob.

So just a simple question I think you talked a lot about sales to end-users and the trend and the expectation of dealers e-stock. Those are very helpful. How did after market kind of trend in 2Q? I know you don't get a lot of disclosure. We've seen other companies down like 20 is disruption caused less repair. I don't know if that's a relative tailwind in the 3Q if it dipped that much for year or less and whether you expect it to come back?

Yes. So services in total were down but they were down less significantly than new equipment sales were which is what we'd expect which is one of the reasons that it's an advantage to build out our services revenue. So yes, there was a drop but it wasn't as significant as new equipment.

And then as the economies of [side] restarted is utilization we've seen that from Kamatsu and others up and therefore an expectation that services kind of comes back or you're not seeing that trend yet. I will stop. Thanks.

It's a mixed bag. It depends on geography and it depends upon the area that we're talking about but again in areas where economic activity has strengthened certainly we're seeing improvement there. So it tends to follow economic activity leads to more utilization which leads to more services sales.

Thanks.

Our next question comes from the line of Nicole DeBlase from Deutsche Bank. Your line is open.

Yes. Thanks. Good morning.

Good morning, Nicole.

I guess my question is around the outlook for retail sales to remain in the same range as they were in 2Q and 3Q on a year-on-year basis. I guess, I am a little surprised by that 2Q obviously saw the worst impact of the pandemic in April and May with respect to end user demand and definitely the comps get easier in the second half. So just curious if maybe there's some conservatism baked in there and maybe if there's scope for some upside as if trends continue to improve like into July and the rest of the fall.

Yes. So obviously there is a couple of things one which is obviously there is a seasonable pattern to some of our retail stats. So obviously if people have missed the summer season obviously is unlikely that they would revert back. So whether there's any pent-up demand is unlikely to come through. Secondly what we do believe is that if retail stats do improve and not slightly better we've actually done most of our production shuttling for the quarter. We would probably see a further acceleration in the reduction in dealer inventory. So probably not much of a surprise to CAT Inc. but obviously we would obviously improve pull through the dealer inventory reductions a little bit quicker.

And maybe just to restate the obvious we're in a very dynamic market and what we've said is that we're ready for changes positive or negative. So we're giving you a sense of what we see as to where we see things today we're not, what we're saying is we're not expecting a further decline in sales to users is what we're saying basically right and so that's really the message. We don't expect things to get worse based on what we see today and again things could get better. Again it's very difficult to judge just based on for obvious reasons.

Totally understand. Thanks. I will pass it on.

Thanks Nicole.

Your next question comes from the line of Mircea Dobre from Baird. Your line is open.

Thank you. Good morning and just to follow up on that previous question. If we're kind of thinking about the third and the fourth quarter here you're essentially saying that at retail level things aren't really getting worse maybe they're getting a little bit better. The billion dollars worth of dealer destock that you're expecting in the second half won't really create a headwind on a year-over-year basis. So I guess my question is this is we're thinking about normal seasonality here is it fair to expect that normal seasonal uptick in revenue in the fourth quarter and if so how do you think that's going to translate to margins based on all the moving pieces to the cost structure that you talked about previously?

Yes. So interesting seasonality varies by business by business as you go through. As you know Mircea one of the things you'll see probably in the fourth quarter is particularly transportation and solar normally traditionally have a strong fourth quarter which drives their uptick and in particular in energy and transportation. Nothing we see today would expect that to be any different. As regards Q3 and Q4 for both of those CI does have obviously it tends to be a little bit negative in Q3 and Q4. Obviously the timing of Chinese New Year in Q4 last year, the inventory build won't probably really happen this year. So again that's another factor to build in as you think about the outlook on a higher level sort of look through and then ROI just remains lumpy. It is very much related to project by project particularly on the mining side. So that's difficult to predict and doesn't really have a seasonality. It's really based around customer orders.

Maybe just one comment about dealer inventory just to add on to that. One of the things we're doing is again positioning ourselves both within Caterpillar and dealers to respond quickly to positive or negative demand by -- our dealers are independent businesses that make their own decisions about inventory but by in fact having that dealer inventory go down that allows us to produce to demand. So again that will remove a potential headwind obviously for next year.

But just to clarify if revenues are up sequentially in a fourth quarter, is it fair for us to expect lower decrementals than what you've just talked about for the third quarter?

At this stage we are not, but yes normally you would expect if there is a volume increase that obviously quarter-on-quarter that does help reported margins, however, just to point out always we do always see a fourth quarter of decline in margins in CI in particular . That is one of the biggest factors. So again it may not, the decrementals may not change from quarter to quarter. We just need to see what we think the volume will be at that point in time.

And it depends on mix as well, I mean so typically as Andrew mentioned we have a strong fourth quarter. Solar typically has a strong fourth quarter and we don't expect that to be any different this year and that helps from a mixed perspective. So again it's mixed dependent as well.

All right. Thank you guys.

Our final question today will come from the line of Steven Fisher from UBS. Your line is open.

Great. Thanks. Good morning. So your machinery ENT cash and your enterprise cash were up by quite a bit. It sounds like you're still kind of reserving a little bit of caution on deployment there. Is there a certain level of cash that you'd like to have such that you'd be then comfortable returning more of it or deploying it or is it really just a matter of timing until you really feel comfortable that activity levels have bottomed and we have some visibility to things possibly turning a little bit better.

Yes. It's just really a function of us looking at global economic conditions and the pandemic and just the uncertainty that's there. So it really is a function of the pandemic.

Okay. Fair enough. Thanks.

So now I would like to turn it back to Jim for some closing remarks and then I will close it at the end.

Alright. Well again thank you for your questions today. We greatly appreciate it. As we mentioned we are very well-positioned we believe to profitably grow our company. Although we've got challenges due to the pandemic we're continuing to invest in our long-term future in new products enabling our services capabilities and again we greatly appreciate your time this morning. Thank you.

Thank you, Jim. Thanks everyone who joined us today. A replay of our call will be available online later this morning. We'll also post a transcript on the relaunched investor relations website probably on Monday. Click on investors.caterpillar.com and then click on Financials. If you have any questions please reach out to Rob or me. You can reach Rob at rengel_rob@cat.com. I'm at driscoll_jennifer@cat.com. The investor relations general phone number is 309-675-4549. I hope you have a nice weekend and now let's jump back to the operator to conclude our call.

Ladies and gentlemen thank you for participating. This concludes today's conference call. You may now disconnect.