Good morning, ladies and gentlemen, and welcome to the Caterpillar 1Q 2018 Analyst Conference Call. At this time, all participants have been placed on a listen only mode and we will open the floor for your questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Jennifer Driscoll. Ma'am, the floor is yours.
Thanks, Kate. Good morning, everyone, and welcome to the Q1 earnings call for Caterpillar. I'm Jennifer Driscoll from Investor Relations at Caterpillar. I'm pleased to have with me here in the room Jim Umpleby, Chairman of the Board and CEO Andrew Bonfield, CFO and Kyle Eppley, Vice President of Global Finance Services Division. We've provided slides to accompany the presentation.
Can find the slides along with our earnings release and a glossary on the Investor Relations section of the caterpillar.com website under Quarterly Financial Results. Today, we plan to make forward looking statements, which are subject to risks and uncertainties as well as assumptions that could cause our actual results to be different than the information discussed. For details on factors that individually or in aggregate could cause actual results to vary materially from our projections, please refer to our most recent SEC filings and forward looking statements included in today's earnings release. As indicated earlier, we are not reporting adjusted profit per share in the Q1 as restructuring costs are expected to be lower this year. It's our intention to report adjusted profit per share in the Q4 of 2019 to exclude mark to market gain or loss for the remeasurement of pension and any other post employment benefit plans and any other discrete items.
Please keep in mind that today's call is copyrighted by the company. Any use of any portion of the call without our written approval is strictly prohibited. Before I turn the call over to Jim, let me remind you that we'll be webcasting an Investor Day presentation next week, May 2, from 1 p. M. To 3:30 p.
M. Eastern Time. We intend to defer until then any questions about capital allocation or long term targets. To access the webcast or the transcript, please visit caterpillar.com, click on Investors and then Events and Presentation. And with that, I will now turn the call over to Jim.
Thank you, Jennifer. We're happy to have you with us at Caterpillar and good morning to everyone on the call. As Jennifer mentioned, we hope to see many of you at our Investor Day next week in Clayton, North Carolina, where we will provide an update on our enterprise strategy, financial targets and capital deployment plans. Turning to the Q1 highlights on slide 3, I'd like to thank our global team for delivering another strong Q1. Profit per share was a Q1 record of $3.25 rising 19%.
This result included the contribution of $0.31 per share of a discrete tax benefit. Consolidated sales and revenues grew 5%. Resource Industries led the way, driven by higher demand for equipment and favorable price realization. Growth from Construction Industries was fueled by higher end user demand for construction equipment and price realization. Operating profit rose 5%.
We benefited from favorable price realization, volume gains and shorter and lower short term incentive compensation expenses, more than offset higher manufacturing costs as well as investments in SG and A and R and D for future growth. Strong operating cash flow of $860,000,000 allowed us to repurchase $750,000,000 in company stock in addition to paying the dividend as part of our continued commitment to shareholder returns. These strong first quarter results are a reflection of stronger demand and the benefit of executing our strategy for profitable growth by investing in services, expanding our offerings and improving operational excellence. Growing services is a critical element of our strategy. Services allows us to provide additional customer value in a variety of ways, including reducing downtime and maximizing machine availability.
Digital is an enabler of this strategy with connectivity at the foundation. Last year, we added about 250,000 new connected assets, bringing our total to about 850,000 assets connected worldwide. We look forward to sharing more on how we think about services during our upcoming Investor Day. Expanding our offerings enables us to grow our business and reflects our commitment to create greater customer value by providing solutions to meet diverse customer needs in different markets around the world. Some of our progress was on display earlier this month at bauma, the construction industry's largest trade show held in Munich, Germany every 3 years.
I was proud to walk the floor of the Caterpillar exhibit and engage with our dedicated employees and valued customers. Among the highlights were the next generation hydraulic excavators with new semi autonomous features, which give operators more information and insight than ever before. We also displayed the world's 1st high drive electric drive dozer, the D6XE. It offers up to 35% better fuel efficiency than its predecessor. We also showcased new hybrid technologies on 3 Perkins engines as well as 5 new engines from its range of EU Stage 5 engines designed to meet new emission standards, increase productivity and lower life cycle costs.
To complement these expanded offerings on the stand, customers also learned about new services, including aftermarket products, customer service agreements and our new CAT app, which allows customers to easily track critical machine operating data from the field. We continue to focus on enhancing operational excellence, including safety. Our safety goal is always 0 incidents. We want all of our employees to return home safely every day. One of the metrics we track is the number of recordable injuries per 200000 hours worked.
So far this year, we are tracking 9% better than 2018 and we will not lose focus on this priority to prevent injuries and keep our people safe. Executing our strategy is allowing us to improve operating profit and free cash flow, which we define as operating cash flow less capital expenditures. During our Investor Day on May 2, we will discuss our expectations for operating margins and free cash flow. Now turning to the 2019 outlook on slide 4, we continue to have confidence in the fundamentals of our diverse end markets and expectations for 2019 performance are unchanged. However, we adjusted our range of $11.75 to $12.75 by the amount of the discrete tax benefit we realized in the Q1.
That brings our 2019 outlook to 12.06 to 13.06 in profit per share. We continue to expect modest sales growth and continued cost discipline for full year 2019. Now let's walk through what we're seeing in the external environment. In Construction Industries, we continue to believe that a healthy U. S.
Economy along with state and local funding for infrastructure development will be a positive for us, partly offset by weakness in residential construction. We continue to expect demand to remain low in Latin America this year. In the Europe, Africa and Middle East region, demand remained steady despite the political and economic uncertainties. In Asia Pacific, infrastructure activity remains strong. Within China, we continue to expect our sales to be flat with last year.
For Resource Industries, we continue to expect most commodity prices to remain at investable levels. We are seeing mining companies become increasingly willing to invest in CapEx. While that is encouraging, miners remain disciplined in their CapEx deployment. We expect demand for heavy construction and quarry and aggregate equipment to remain strong. In energy and transportation, oil prices are recovering, but the volatility in oil prices and takeaway constraints in the Permian are impacting demand for well servicing equipment in the first half of the year.
Later in the year, U. S. Pipeline constraints are expected to ease and we anticipate an increase in demand. Gas compression should remain healthy. Demand for power generation equipment continues to be a positive.
Finally, in transportation, we expect improvements in our rail business including services. With that, I will turn the call over to Andrew for a closer look at our financials.
Thank you, Jim, and good morning, everyone. We have reported record Q1 results today as we continue to execute our strategy and use our operating and execution model to drive profitable growth. I will walk through the results starting on Slide 5 before turning to our updated outlook for the full year. Sales and revenues for the quarter totaled $13,500,000,000 up 5% from last year, driven by both volume gains and price realization, with Resource Industries having a strong Q1 in particular. 1st quarter profit per share of 3.25 dollars included a $0.31 per share discrete tax benefit, increased 19% from the prior year's Q1.
This was driven by higher sales, partly offset by higher manufacturing costs and higher spending on SG and A and R and D due to increased investments versus the Q1 of last year. Now let's turn to the top line on Slide 6. Sales and revenue growth in the quarter was driven by volume gains and price realization, partially offset by currency. Volume gains primarily reflected strong demand in both Resource Industries and Construction Industries. Resource Industries' strong demand was due to growth in original equipment and services.
For Construction Industries, sales in North America rose double digits this quarter. Energy and transportation sales were flat versus the prior year. Currency pressures reflected the dollar strengthening, principally primarily against the euro, the Australian dollar and the Chinese yuan. If you move to Slide 7, I will walk through the changes in operating profit. As shown on the chart, price realization and sales volume drove the operating profit increase, contributing $292,000,000 $265,000,000 respectively.
Financial products also added $26,000,000 to operating profits for the quarter. Manufacturing costs increased by $375,000,000 due to higher material costs, freight and variable labor. These higher costs, while unfavorable, were improved from the 4th quarter levels. Material costs included a direct tariff expense in the Q1 of about $70,000,000 in line with what we expected. Remember, tariffs only started in July of last year, so these will have an impact in Q1 and Q2 until we have passed their original implementation date.
Also, while steel prices have moderated, our procurement contracts have a lagged effect. So these are still rising for us. Labor costs are impacted by production bottlenecks as our suppliers continue to ramp up volumes. SG and A and R and D spending increased despite lower levels of short term incentive compensation expense, primarily due to investments in growth areas, including services and expanded offerings as well as some corporate level items. The comparators are also set against a low level of spend in Q1 last year.
Currency was unfavorable by about $20,000,000 Restructuring costs were not material for the quarter. Now let's look at the performance of each segment in Q1, beginning with Construction Industries on Slide 8. Sales were $5,900,000,000 an increase of $196,000,000 or 3%. Construction sales increased in North America by $345,000,000 due to higher demand for new equipment, particularly for road construction activities. Sales declined in Asia Pacific, EAME and Latin America.
Asia Pacific sales were down 4% or $66,000,000 Currency was the driver as volumes in China was about flat, which is what we expected. In the AME, sales declined by 6% or $61,000,000 due to a smaller increase in dealer inventories and a weaker euro, partly offset by favorable price realization. Lastly, macroeconomic factors in Latin America contributed to a decline in sales of 7% or $25,000,000 off of a very low base. Turning to profit. Construction Industries segment profit declined by 3%.
The segment profit margin of 18.5 was a decrease of 120 basis points from the Q1 of 2018. The favorable impact of higher price realization is more than offset by higher manufacturing costs. This increase in cost was led by higher material, labor and freight costs. While these costs increased, the magnitude was less than we saw in the Q4 and were driven by the same factors I mentioned a moment ago. The backlog for Construction Industries rose as high production levels supported an increase in order rates.
We continue to have most CI products on managed distribution. Now let's go to Slide 9 and look at Resource Industries. Resource Industry sales were $2,700,000,000 up 18% from the first quarter of 2018. The $418,000,000 increase in sales for the quarter reflected high equipment demand, favorable price realization and increased We saw solid demand for mining and heavy construction equipment, including quarry and aggregate. Asia Pacific was particularly strong with sales up $275,000,000 or about 52%.
The backlog declined in Resource Industries as our factories continued to ramp up production, which resulted in an increase in dealer inventories. 1st quarter orders were higher than in Q4 2018. We continue to expect higher mining CapEx in 2019, leading us to expect higher sales of new equipment this year. Segment profit of $576,000,000 rose 52% versus the Q1 of last year. Segment profit margin improved to about 21%, up 4 70 basis points from 2018.
Resource Industries improved performance and margin expansion were primarily due to higher sales volumes. Federal price realization was partially offset by higher manufacturing costs, including increased material and freight costs as well as slightly higher warranty expense. Turning to Slide 10, we will review Energy and Transportation results. Energy and Transportation sales in the Q1 were $5,200,000,000 comparable with the same quarter last year. Favorable price realization and higher sales volumes were more than offset by unfavorable currency.
Sales into oil and gas applications decreased by $84,000,000 or 7%, primarily due to the timing of turbine project deliveries in North America. Sales in power generation rose by $67,000,000 or 7% due to higher demand for large diesel reciprocating engine applications. Industrial sales were similar to last year's Q1 with gains in North America more than offset by an increase in the AME. Transportation sales declined 2%. We recently marked the 1 year anniversary of acquisition of 2 rail services businesses in January 2018.
Segment profit for Energy and Transportation was $838,000,000 down $36,000,000 or 4%. The segment profit margin contracted by 60 basis points to about 16%. Energy and transportation margins reflected higher manufacturing costs driven by freight costs and warranty expense. The increase in backlog in E and T was driven by rail related services and turbines, which were partially offset by reciprocating engines due to softness in oil and gas that Jim referred to earlier. Now let's go to Slide 11, and I will walk through our assumptions for the 2019 outlook.
Our profit per share outlook range for 2019 is now $12.06 to $13.06 The change from our prior range of $11.75 to $12.75 reflects the discrete tax item mentioned earlier. Our assumptions for the business are largely unchanged. We continue to have confidence in the fundamentals of our diverse end markets, and we expect sales to increase modestly this year. We also anticipate the price realization will offset higher manufacturing costs. Short term incentive compensation is expected to be a tailwind of about $500,000,000 We project restructuring costs of about $100,000,000 to $200,000,000 for the full year.
The estimated annual tax rate is unchanged at 26% except for the discrete tax item we called out. We see capital expenditures in the range of $1,300,000,000 to $1,500,000,000 Our outlook assumes that the macro geopolitical environment is largely unchanged. Looking ahead to the Q2, we expect to continue the execution of our strategy, including additional investments for long term profitable growth where appropriate. We anticipate stronger results in the back half of the year, including better variable margins and stronger demand from oil and gas customers in North America. Depending on markets and based on an internal assessment of enterprise intrinsic value, we expect to be active in the market and repurchase another $750,000,000 of company stock in the Q2 of 2019.
Any additional share repurchases will depend upon cash generation and alignment with our capital allocation priorities. We do not expect to make any additional voluntary pension contributions due to the $1,000,000,000 discretionary pension contribution we made in the Q3 of last year. So finally, let's turn to Slide 12 and recap today's results. It was a record Q1 of profit per share following a record Q1 last year. We have updated our guidance to $12.06 to $13.06 in profit per share.
Given our strong financial profile, we were able to return $1,200,000,000 to shareholders in the quarter, while executing our strategy and investing for long term profitable growth.
With that, I will hand
it back to Kate, operator, to begin the question and answer portion of the call.
Thank Our first question today is coming from Jerry Revich at Goldman Sachs. Your line is live.
Yes. Hi. Good morning, everyone.
Good morning.
In Resources, I'm wondering if you could update us on your expectations on when large project prospects are expected to turn into orders. Over the past year, we've seen CapEx budgets and truck utilization moving in the right direction. And I'm wondering when do you expect that to translate to backlog growth for your resource business?
Yes, Jerry, it's Jim. I'll take that one on. So we're seeing healthy levels of business from our mining customers. As you know, we had some issues in terms of ramping up production, particularly with our suppliers over the last few months. And our backlog change really is a reflection of the fact that we've been able to ramp up production as opposed to any softening of demand.
So again, the market is strong. We expect to continue to have good market activity here and we're ramping up production, which has resulted in a reduction in our backlog. Okay.
And then, I'm wondering if you could just expand on your dealer inventory comments. So healthy dealer inventory build in the Q1. You mentioned resources still at low levels of dealer inventories and you're looking for the business to be up low single digit organically. This year. Is the flat dealer inventory comment really at expectation?
Or is that a placeholder as we see activity ramp up? In other words, it sounds like you either expect to reduce production over the course of the year or retail sales to accelerate if we do indeed see flat dealer inventories year end 2019 versus year end 2018?
Yes. So Gerry, obviously, keep in mind that dealers own and control their inventory. So our expectations are based on what we expect their order levels to be. Obviously, we did see an increase in inventory levels in the Q1 for the usual seasonal regions. Obviously, we are making sure that we work closely with our dealers to make sure we align their inventory with current market demands.
We believe that is about appropriate. And we believe actually flat at the end of the year is a reasonable assumption to be making at this stage.
Okay. Thank you.
Thank you. Our next question today is coming from Jamie Cook at Credit Suisse. Your line is
live. Hi, good morning. First question just on the resource margins. They were much higher than how do we think how do we think about sort of full year margins? And then just a follow-up question on the dealer inventory levels.
Can you comment on dealer inventory levels, months of dealer inventory level either by region or product? Thank you.
Hi, Jamie, it's Jim. As you know, we don't guide segment we don't give segment margin guidance, but yes, 1st quarter margins in IRR were quite strong. A lot of that was driven by volume leverage. We had good price as well. And also just looking at the timing of investments that we have throughout the year was relatively low in the Q1.
And then with regards to dealer inventories, generally, obviously, we try to keep dealer inventories to the
sort of 3 to 4 month level is the sort of target guide range. We would try to do that across everywhere and across all product groups would be our biggest guide. Obviously, in some areas, as we know and see how we are on managed distribution. So obviously, some inventory levels are lower and it could rise higher over time once we get those products off managed distribution.
Okay. Thank you. I'll get back in queue.
Thank you. Our next question today is coming from Rob Wertheimer at Melius Research. Your line is live.
Thank you and good morning. If you look at your market share in China construction over the last 10 years, I think you've more or less doubled it if you use a tonnage basis as opposed to units. You do well in the bigger machines and you've done well in growing that category. Could you sort of talk about what's driven that and then what's changed in the last 3, 4 months to cause some ebbing of those gains?
Yes. So China, obviously, this year, we saw relatively flat 1st quarter sales in China, which is consistent obviously with so the sales levels are consistent with the prior year. Spring season, as you know, is usually a strong selling season in China and it was stronger than normal across the whole of the sector, mainly due to the timing of Chinese New Year. But there's also been some very competitive pricing, and that has had some impact on our relative market shares. We now expect the industry our expectation for the industry for the full year is for China to be up.
We expect our sales to be flattish for the year. So we will lose some we did lose some market share in Q1, but we're taking actions to gain it back, working with dealers and also launching new models, which is a key part of the strategy, which we think is the right strategy to enable us to compete.
Okay. Thank you.
Thank you. Our next question today is coming from Ann Duignan at JPMorgan Securities. Your line is live.
Hi, good morning.
Good morning, Ann.
I was just wondering if you could give us an update on your 1% to 4% price increase targets across your different segments and regions?
Yes. So Anne, you saw that in the for the full year or for the full Q1, we had saw price of about $292,000,000 That's about 2% on net revenues. Obviously, that was stronger in CI and RI than it was in ENT. That effect is basically partly some impact because of the midyear price increase, which was mostly in Construction Industries last year. And then obviously, the price increase, which was more broadly brushed across the whole of the segments on the 1st January.
We expect Q1 and Q2 to have better price realization. But once we get past the anniversary of the midyear price increase, CI in particular will be less price realized in the second half of the year. But so far we're holding on to a good level of the price increases that we put through.
Okay. And in that context, just one quick follow-up on CI. Were you comfortable with your incremental margins even though they weren't incremental? Or did anything specific happen in Q1 to cause construction margins to be worse than you might have expected? And how should we think about those margins going forward?
Thank you.
Yes. So I'll talk about comparables again just rather than actually because we don't give, as I say, detailed guidance for the individual segments. But if you look at the comparables for CI, we are effectively seeing some material price increases. Both steel and tariffs had an impact as we talked about more broadly. They particularly impacted CI.
Freight costs did start to rise towards the end of the in the middle of Q2 last year. So we're still ramping past those. Obviously, as we get past those comparable increases, our margin should stabilize and be better for the remainder of the year.
Okay. I'll get back in queue. Thank you.
Thank you. Our next question today is coming from Steven Fisher at UBS Securities. Your line is live.
Thanks. Good morning. Just curious how you're thinking about the guidance for the year and the visibility for the second half in general. Obviously, you hit your Q1 buyback plan, still have plenty of cash to do more buybacks. I think you mentioned another similar quarter of buybacks in the Q2.
So do you think the guidance is conservative given that you don't have a lot more buyback in guidance and maybe clarify if that next $750,000,000 is in guidance? Or is there something about the visibility in the second half of the year, whereby it's making you cautious that you might need the buybacks as an offset?
Yes. At this point in the year in terms of our guidance for our profitability, it's early in the year, so we're maintaining our range. In terms of buybacks, one of the things we are going to discuss a bit next week at our Investor Day is our plans for capital deployment. So we look forward to seeing you there and having that conversation.
Okay. But just to clarify, is the $750,000,000 for Q2, I think you said, is that now baked into guidance?
Yes. Our guidance assumes that we have a consistent level of buyback activity quarter on quarter. Correct.
Okay, great. And then just a follow-up on the North American construction business. You cited higher demand on road building. Can you just talk about what you're seeing outside of road construction and what do you think about the mix later in the year?
Well, again, we've talked about the fact that we have strong infrastructure. Some local and state infrastructure investment is helping drive sales. Residential was a bit soft. We don't see we don't expect a major mix change for the remainder of the year.
Anything on the commercial side?
I don't have anything to add.
Okay. Thank you.
Thank you. Our next question today is coming from David Raso at Evercore ISI Institutional Equities. Sir, you're welcome.
Hi, good morning. If I look at your implied sales guidance for the rest of the year and I utilize your historical sequential changes in your backlog, it would imply the year over year backlog does stay down year over year for most of the year, maybe back to flat in the Q4. But that also does imply your orders turn positive year over year in the Q3 and for the full second half. Is that what you're hearing from your customers and dealers that we should be seeing the orders growing year over year in the second half of twenty nineteen?
Yes, David. I mean, there are a couple of things. 1, which is obviously mining CapEx is one area where obviously we are expecting the order rate to continue to accelerate over the year, particularly given we do expect an increase in mining CapEx for the full year. And as the replacement cycle starts to move ahead, obviously, that will help us on from a backlog perspective. In E and T, as we've indicated, where we do expect to see some order improvement in the second half of the year is around oil and gas reciprocating engines, in particular, particularly as the Permian takeaway issues are starting to moderate.
So those are probably the 2 big factors, which we would say would drive orders in the second half of the year.
And that should be in aggregate driving total company orders up year over year, I guess, is the key question. Is that what you're seeing and obviously thinking about in your guidance? Is that what the numbers imply?
Yes. That is what we're thinking and our guidance implies.
And in that same regard, if orders are up in the second half of the year, price cost the way you're guiding the year, it would imply the Q1 was the worst of the price cost for the full year. Can we extrapolate that into your thoughts on margins year over year in aggregate? Sorry, David,
can I just clarify price cost you mean price realization?
Price as in the water polo chart, you have price versus the manufacturing cost.
Yes. Yes. Sorry, yes. And
this quarter was be fair, it was down it was $83,000,000 negative, which is actually worse than we saw at any quarter last year.
Yes.
I'm
just making sure the way you're laying it out, does that then set up the margins year over year go back to growing?
Yes. Well, basically as we Yes. We definitely second half. Yes. What we've sort of said and guidance assumes is that price offsets material cost increases or manufacturing cost increase for the full year.
So yes, that would imply an improvement from that part of the factor for the remainder of the year.
And my last quick one, this might be a May second question, I apologize. But when you think about cash flow and use of it, that's fine. But even on the balance sheet, the amount of cash you're carrying, you can define it as you wish, cash to total debt, cash to shareholder equity, cash to total assets, however you want to do it. The cash on the equipment company seems very high. So when I hear a share repo number of $750,000,000 which isn't even pushing the cash flow usage, Can you help us understand, especially as a new CFO to the company, Andrew, what do you think the appropriate cash level should be for the equipment company?
Yes. I think we'll talk about that on May 2, Dave.
Yes. I appreciate that. Thank you.
And as a reminder, could we have please one question per caller? Thanks.
Thank you. Our next question today is coming from Ross Gilardi at Bank of America Merrill Lynch. Your line is
live. Yes. Thanks. Good morning. Jim, I'm just wondering across your overall portfolio, what are you hearing from your biggest customers with respect to the trade war?
And does it feel in general like there's pent up demand for capital spending projects around the world in the next year if this whole thing is resolved?
Yes. I think most of our large customers are, as we are, cautiously optimistic that we will work our way through these trade issues. Certainly, anytime there's trade tensions of this kind, it does put a certain amount of conservatism, I think, into all of our plans for capital spending. So I would expect if in fact the trade tensions get resolved that would be a positive for global economic growth and a positive for us.
Okay,
got it. And just on the order trends, I mean, you had originally obviously guided in January. I mean, some of the macro data feels a little bit better recently. Did you see any type of reacceleration in order trends, would you say, as the quarter unfolded and as commodity prices recovered? Or anything you could say kind of more March, April the date versus Jan, Feb?
Yes, it's tough. I mean, as you know, we're a very diverse business. And so just to talk about some of the areas, in oil and gas and RECIP, much has been written about the fact that there's constraints in the Permian and that did have a bit of a negative impact on order rates for our reciprocating engines sold into oil and gas. As we mentioned earlier, mining activity, both in the aftermarket and for new equipment, that quotation activity is quite strong. Obviously, again, miners are being cautious based on what the cycle of the past.
But generally, we feel good about our business and we feel good about the quotation activity and the signals that we're getting from our customers.
Thanks a lot.
Thank you. Our next question today is coming from Noah Kaye at Oppenheimer and Company. Your line is live.
Good morning. Thanks for taking the question. Just on your comments on CapEx budgets, I think the company previously guided for CapEx to be about flat year over year. The guidance you provided in the slide suggests maybe increase of about 10% at the midpoint. Is there anything in particular we should think about driving that?
Are you having to ramp up your production infrastructure in a particular segment?
No. Generally, I would say CapEx is still below book depreciation. I remind you that, that is a positive from a cash flow perspective. And we are expecting it to be flattish. I think last year it was about 1.3, so the bottom end of that range.
There's no significant big buildup of incremental production and
required. Kate, are you there?
Do you have
another question, please?
Thank you. Our next question today is coming from Andrew Casey at Wells Fargo Securities. Your line is live.
Thanks a lot. Good morning, everybody. I'm trying to understand the comments about manufacturing costs gone down a little bit in Q1 versus Q4 and then the back half improvement and juxtaposing against last year at a seasonally atypical period where margins decline in Q2 from Q1. You might have answered it, but I'm still a little unclear. Should we expect Q2 manufacturing margin to be higher than Q1 and then further improvement in the second half?
No. What it will be is comparing to the comps for last year, if you look at Q1, obviously, this year, margin was lower as a result of the steel tariff and freight costs. We expect those to moderate as we go through not there'll be similar impact on Q2 because obviously those increases weren't fully in effect for most of Q2 last year and then obviously will moderate in the second half of the year. Okay.
So okay. All right. Thank you.
Thank you.
Thank you. Our next question today is coming from Joe O'Dea at Vertical Research Partners. Your line is live.
Hi, good morning. A related question on the manufacturing costs and just the I think you talked to the tariff related costs. If you could break that $375,000,000 down at all anymore. It doesn't sound like there are any sort of mitigating actions in process to take that down. It's more about a wait and see and then the comps get easier.
But I just wanted to understand if there are some opportunities for you to address those, whether that's rerouting supplies, whether that's any other kind of opportunities you have. But just given that was a pretty substantial headwind in the quarter, kind of what kind of mitigation we could see?
Yes. So there are two areas where we do expect some mitigation probably later this year. 1, which is around steel prices, just purely because we lag behind because of effectively, as I said, our procurement practices. And as you look currently, obviously, with the Vale issues, or product prices are looking up slightly higher, but there should be some benefit of slightly lower steel prices coming through later this year. And that's one of the areas where we're going to obviously be looking for some potential cost savings.
The other area, which is also an issue is around variable labor burden, which basically is really around the fact that obviously as we built up building our production, we are having some bottlenecks still as a result of supplier issues and we expect those to mitigate during the rest of the year as well. So we do expect some of these not just to be mitigated by the comp period, but also by actual actions we are taking.
And then also just on lag effects and related to the pricing. I mean, when we think about mid year 2018, you implemented some price increases and then again on Jan 1. Presumably 1Q doesn't fully reflect at least what happened on Jan 1 because of some things that might have already been in backlog. But could you just talk about the degree to which there is still some lag effect of seeing those price actions that were implemented?
Yes. We do expect the second half price realization to be lower than the first half because of the mid year price increase last year. That was the that is one of the biggest factors in the in about the 2% rise because obviously that's fully baked into pricing now. So we would expect second half to be lower. And as I said, we have guided over the year to have basically price offset manufacturing cost increases.
Okay. Thanks a lot.
Thank you. Our next question today is coming from Seth Weber at RBC Capital Markets. Your line is live.
Hey, good morning. I guess first just a clarification on, Jim, your comment that the RI orders were up in the Q1 versus the Q4. Is that does that include traditional mining equipment or is that more skewed towards quarrying or big construction?
Yes. I think what I said was our order activity remains strong in our eyes. So I don't believe I gave a quarter to quarter comparison. But again, quotation activity is strong and just general quotation activity and order activity is healthy in our eye.
Yes. I think from an overall perspective, actually it was in my comments, I think I did say actually order rate in Q4 was higher Q1 was higher than Q4 2018. So we did see that increase some increase coming through. That was in mining and there was some and we're still strong though in quarry and ag at the moment.
Okay. Thank you. And then my question is really just on RI again. It sounds like a lot of the sales today are really on the OE side. I mean, would you expect the mix to tilt more towards parts and service as you get as equipment usage starts picking up more?
And so I guess I'm just wondering, could mix become more favorable later in the year or even next year? Thanks. Yes. We didn't mean to give
the impression that it's skewed towards OE at this point. So both are quite healthy at the moment.
Okay. Thank you. Sorry, Jim.
Thank you.
Thank you. Our next question today is coming from Stephen Volkmann at Jefferies and Company. Your line is live.
Hi, good morning. Thanks for taking my question. Most of it's been answered, but I think there was some commentary about SG and A spending being a little bit elevated due to some growth initiatives. And I'm curious if there's any detail you can give around that. And then does that sort of fade also in the second half as well?
We continue to make investments targeted investments for long term profitable growth in the area of services and in expanded offerings. In services, we continue to connect more assets. We're investing in our digital platform. We're investing in our analytics. And we continue to develop expanded product offerings as well to ensure that we have the right product offering at the right price point for different markets around the world.
So again, we're in this for the long haul obviously and we're making those targeted investments to grow services and expanded offerings.
Yes. And the run rate was slightly higher than you would normally I don't remember you got the short term incentive compensation credit coming through this year in SG and A. So some of that was also there were some corporate one time items relating to some compensation items which are held at the corporate level. And there were also, obviously, as Jim said, those investments that we've made in the business itself, which helped to do that. We also had very low comps last year for SG and A and R and D in the Q1 of last year.
We had a very low slow ramp up of spend.
Okay. And looking forward, is it sort of steady or is this front half loaded?
I mean, the Q1 is one of the high will be one of the highest levels of SG and A spend from an increased perspective through the remainder of the year.
Okay. Thank you.
Thank you. Our next question today is coming from Adam Uhlman at Cleveland Research Company. Your line is live.
Hi, good morning. I was wondering if you could talk about the order trends that you're seeing across the PowerGen business. That was the one area of sales growth within ENT this quarter, but the retail sales have slowed here almost to flat. And so I was wondering if you could talk about what you're seeing by geography and product line in the order book for that chunk of the business?
We have seen a recovery in Power Gen over the last few months and that we expect that to continue. It is an area of strength for us. Obviously, that business is cyclical and we had a bit of a downturn previously that we're now recovering from. But we expect that business to continue to be healthy.
Okay. And then related to that, in ENT, you had mentioned earlier that you expect order trends across oil and gas for reset engines to improve in the second half. Have you seen any of that improvement yet so far or that's still on the come?
Again, gas compression has remained strong and steady. We haven't seen a pickup in order rates for well servicing in the recent portion of oil and gas yet. But again, we expect that to come. Other part of our oil and gas business is of course solar turbines and that business has remained steady. We've seen a pickup there in international orders which are typically tied more to big CapEx projects and elevated oil prices.
So that business is starting to pick up. Great.
Thank you.
I'll let
you there. Yes.
Thank you. Our next question today is coming from Larry De Maria at William Blair. Your line is live.
Hi, thanks. Good morning, everybody. First question, can you just provide the full year incentive comp benefit? And then secondly, just a broader question I have is, CI dealer managed distribution. I'm just curious how much is being restrained?
And should we when should we think about that getting maybe more in balance perhaps after the spring selling season, but things calm down? But how restrained is that? And when does that get more in balance? How do we think about that? Thank you.
So the first question on incentive comps, we expect about a $500,000,000 benefit there this year compared to last year.
Got you.
And in terms of managed distribution for CI, again, it's obviously a dynamic situation based on how we ramp up supply and what's happening in the marketplace. I don't anticipate a major change here over the next few months in that situation.
Okay. But based on the CI orders, it probably shouldn't get more out of whack than it already is now. We may get more towards a more equilibrium situation maybe later in this year. Is that fair?
Yes. We expect it to be broadly flattish for the remainder of the year, yes.
Okay. Thank you.
Thank you. Our next question today is coming from Chad Dillard at Deutsche Bank Securities. Your line is live.
Hi, good morning.
Good morning.
So I
wanted to dig into the price realization in Resource Industries this past quarter. I just want to understand how broad based it was and to what extent it was driven by mix and how should we think about that and how sustainable it is on a go forward basis?
Yes. I mean price realization again was very strong in RI in Q1 and then we do expect it to be the highest quarter for the year. So yes, I mean it was a little bit there's a little bit of an element of mix in that number which did come through. So, yes. And one thing I
would add in our eye, because it's a project based business and quite lumpy, you'll see certain metrics jump around quarter to quarter. It's just the nature of the beast for solar, for rail and for RI.
Got it. And then just a question on Cat Financial. It seems like there's a little bit of an uptick on credit loss allowances. I was just hoping to get a little additional color on that, what's driving it either from a regional perspective or end markets?
Yes. So in Cap Financial, the actual past dues actually were up from 3.55% in Q4 to 3.61% in Q1, so very small increase. Obviously, it was a bigger increase year on year, And that mostly reflects the Cat Power Financial portfolio, which we talked about in Q4, which obviously has had an impact on of the overall past dues. You'll also probably have seen that we had a mark to market gain in Cat Financial this quarter. If you remember, in the last quarter, we had a loss, a mark to market loss on that, and this effectively just an offset quarter on quarter.
Great. Thank you.
Thank you. Our next question today is coming from Courtney Yakavonis at Morgan Stanley. Your line is live.
Hi, thanks for the question. Andrew, I think you outlined a little bit about how we should be expecting mitigation in steel prices and some of the variable labor in the back half of the year in addition to lapping over those higher costs from last year. Can you just comment a little bit on freight costs and whether we've obviously seen spot rates drop, but whether we should see that mitigate in the back half as well? And maybe just talk a little bit about how your freight costs are contracted out?
Yes. So obviously, there were 2 factors driving freight costs. 1, which is actually cost itself, which did rise probably mostly from the Q2 of last year. So again, we should get past that on a comparable basis sometime in the second half of the year. The other factor, which was a big issue for us last year and is becoming less of an issue, is around backlog of orders.
So as we have past few orders that we need to fill, we have had some freight inefficiencies. And again, we're working to make sure we mitigate that as best as we can going forward.
Okay. Thanks. And then just quickly one other clarification. I think you had mentioned, that in oil and gas, some of the weakness was due to some timing of turbine project deliveries. Just wanted to understand how that should impact the back half of this year, especially given that you're expecting gas compression or so gain engines were still up this quarter.
So just trying to understand when you expect that acceleration in the back half to come when the Permian takeaway issues, just all the moves and takes in the oil and gas segment?
Yes, I would look at those separately. So I'd try to separate in your mind reship versus turbines. So again, the turbine business is very lumpy. So you can revenue rack 1 large project in a quarter and it has a very big impact. And you don't have that large project in the next quarter and it looks like there's a decline.
So again, our solar turbines business is solid and we expect a good year. On the RECIPs end, as I mentioned earlier, we have seen, again, although gas compression is strong, we saw a bit of a slowdown in order intake in well servicing and we expect that to recover later in the year.
Okay, thanks.
Thank you. Our next question today is coming from Neil Frohnapple at Buckingham Research. Your line is live.
Hi, thanks. Within CI, can you talk about what you're seeing from a used equipment price standpoint? Are you seeing weakness creeping at all for any of the major equipment categories that give you concern as you look out?
I mean, the only time I will, there was one auction done in Orlando where there was weakness in prices, but generally, aside from that, it's actually been flattish. So used price equipment seems to be holding up reasonably well apart from that one particular auction.
All right, great. Thanks. I'll pass it on.
Thanks. And Kate, I believe we have time for one more question.
Thank you. Our final question today is coming from Mig Dobre at Robert W. Baird.
So going back to resources, I don't want to put words in your mouth here, but to me it sounds like you're more positive this quarter than you have been, say, in the 4th quarter or the back half of twenty eighteen in terms of your commentary and kind of how you're talking about demand going forward. I want to make sure that I get that message properly here and maybe have you expand as to kind of what's driving this incremental positivity. And related to this, as replacement demand is starting to come through from some of your customers eventually, do you feel that the industry has the right amount of capacity available to serve that?
Yes. So again, I mean, we feel good about just the state of the business. Our quotation activity is good. The aftermarket activity is good. We have certain terms of thinking about parked equipment and that has certainly come down.
And so I won't be so presumptuous as to make a statement about how our customers are positioned. But we believe based on all of our conversations that we expect this recovery to continue. And obviously there's timing issues and let's make a judgment call as to what you think will happen this year, what you think will happen next year. But generally, we feel positive about the RI business and the activity that we're seeing.
And from a capacity standpoint?
It's very it's situational, right? So it's geographic. And it also depends on the kind of commodity that is being mined. In certain areas, there's still a bit of excess capacity. In other areas, there is not.
And so it's really it's a mixed bag. You can't really give one answer to that question.
And just remind you, we are still significantly below levels, which we saw in the previous most all demand.
Right. It's just that there's been a lot of restructuring that's been done in a downturn as well, which is why I was asking. And then one last question on ENT pricing, obviously, a little weaker versus the rest of the company. And I'm wondering, is there any perspective you can provide on the various businesses in that segment where there might be some pricing deviation from the average reported either positive or negative? Thank you.
No, I mean, I think generally, obviously, the pricing actions that occurred in Energy and E and T remember, E and T probably has a higher mix of services as well, so not all of that was fed through as a price increase. So that would be a significant factor. There's obviously machines, particularly in parts, in particular for CI and RI were more broadly based.
Got it. Thanks.
Jim, can we throw it back to you for some closing comments?
Sure.
Well, thanks everyone for joining us today. We appreciate your questions. We're pleased with our team's performance, including another record Q1 for profit per share. We are executing our strategy of profitable growth that we laid out at our Investor Day in 2017 investing in services, expanding our offerings and improving operational excellence. We do look forward to seeing many of you at our Investor Day next week and again we'll give you an update there about where we are in our strategy.
We'll talk a bit about financial targets and also our priorities for capital deployment. With that, I'll turn it back to Jennifer.
Thank you, Jim and Andrew, and thanks everyone for joining us today. We appreciate your interest in the company. If you have questions, you can reach me at driscolljennifercat.com. If you'd like a transcript of today's earnings call, you may find it posted later today on the Investor Relations section of our website at caterpillar.com. Next week, on May 2, we'll be hosting an Investor Day.
As we mentioned, it will be webcast, and we'll post a transcript of that event after the event on the same website. And with that, let me turn the call back to Kate, our operator to conclude our call.
Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.