Earnings Call: Q3 2014

Oct 23, 2014

Summary

Q3 sales were nearly flat YoY, but EPS improved and 2014 profit guidance rose. The 2015 sales outlook was flat to slightly up amid uneven end markets and lingering macro risks.

Good morning, ladies and gentlemen, and welcome to the Caterpillar Third Quarter 2014 Earnings Results Conference Call. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions and comments following the presentation. Now I'd like to turn the floor over to your host, Mike DeWalt. Sir, the floor is yours. Hey, good morning everyone, and we're very happy to have you with us this morning for our third quarter earnings call. I'm Mike DeWalt, Caterpillar's Vice President of Strategic Services. On the call today, I'm pleased to have our Chairman and CEO, Doug Oberhelman, and our Group President and CFO, Brad Halverson. Remember, this call is copyrighted by Caterpillar Inc. and any use, recording, or transmission of any portion of the call without the expressed written consent of Caterpillar is strictly prohibited. If you'd like a copy of today's call transcript, we'll be posting it in the investor section of our caterpillar.com website, and it'll be in the section labeled Results Webcast. This morning for sure, we'll be discussing forward-looking information that involves risks, uncertainties, and assumptions that could cause our actual results to differ materially from the forward-looking information. A discussion of some of the factors that either individually or in the aggregate, we believe could make actual results differ materially from our projections, that can be found in the cautionary statements under Item 1A, Risk Factors, of our Form 10-K filed with the SEC in February of 2014, and our 10-Q filed with the SEC in August of 2014. It's also in the forward-looking statements language contained in this morning's financial release. In addition, a reconciliation of non-GAAP measures can be found in our financial release this morning. Again, that's been posted on our website at caterpillar.com. Let's get started. I'll be covering three things this morning, our third quarter results, the increase in our profit outlook for 2014, and our preliminary outlook for 2015 sales and revenues. Now before I get into the quarter though, I thought it might be helpful to summarize just a couple of themes from this morning's financial release. Key points that we were trying to get across. The first one is around stability and consistency. Last year at about this time, we provided our first view of 2014. That was our preliminary outlook of sales and revenues for 2014 that we did with our third quarter release. Back then, we said it looked to us like 2014 would be a relatively flat year with 2013. That was the case then. That's about what's happened through the first nine months of this year, and that's still our full year view today, so consistency. Second point is around profit. While sales and revenues for the first nine months of both 2013 and 2014 have been around $41 billion, profit per share is up year to date and every quarter of this year it's been higher than the corresponding quarter of 2013. Profit per share so far through the first nine months of 2014 are $4.64 all in, and $5.03 excluding restructuring. Both of those are up from the first nine months of last year, which was $4.21. While there are a number of puts and takes, the point is we've worked hard on operational execution and cost management, and that's helped results. With that, let's turn to the third quarter. Sales and revenues were $13.5 billion, and that was up about $100 million from $13.4 billion in the third quarter of last year. While sales and revenues didn't change much, profit per share rose from $1.45 last year to $1.63 this year, or $1.72 without restructuring costs. In that increase, there were a number of puts and takes. On the positive side, price realization was up. Currency impacts, both in operating profit and below the line and other income and expense, were positive. Our share count was lower, and that was positive for profit per share as well. On the other side, SG&A, R&D, and manufacturing costs were a little higher. Positives included material costs, which were favorable, but more than offset by higher employee incentive compensation, expense, and a little higher warranty costs. The incentive compensation increase is a result of 2014 performance being well ahead of the targets we set when we started the year. Now, results by segment. Energy & Transportation sales were up $663 million or about 13%. Their profit was up $250 million or about 29%. Most of that sales increase was from improved volume. In Energy & Transportation, remember, we have several different industries that we're serving. Oil and gas, power gen, transportation, and that's rail and marine, and industrial, and that's where we sell engines to other equipment manufacturers. Sales were up in all of those industries. Oil and gas and industrial were up relatively in line with the segment average. Transportation grew a little faster than the segment average. Power gen a little less than the average. The profit increase for Energy & Transportation in the quarter was largely a result of the higher sales. Now, for Construction Industries, sales were down $98 million. The profit improved $194 million or about 67%. For sales, on the plus side, Construction Industries had positive price realization. On the down, volume was a little lower. Most of that was from Cat dealer inventory reductions as Cat dealers lowered inventories a little more in the third quarter of this year than they did in the third quarter of 2013 for Construction Industries. End-user demand was also down slightly from the absence of a large sale to the Brazilian government that we had last year, and I mentioned that in our second quarter financial release. We also had a little lower demand throughout most of Asia, including China and weakness in the Middle East and in the CIS. On the plus side, demand was up in North America and we had a small improvement in Europe. The profit improvement was a result of the positive price realization, some of the currency impacts and favorable manufacturing costs. In Resource Industries, which is principally mining, sales were down $496 million or about 19% from the third quarter of last year. Profit was off $239 million or about 62%. The decline in sales was primarily lower volume. Price realization wasn't significantly different one way or the other. The volume decline was largely a continuation of what we've been seeing all year. While overall mine production has been good and many of the global mining companies are improving their performance, their purchases of new equipment are at low levels. While sales this year are below last year, the 2014 quarterly sales trend has been pretty stable, with $2.1 billion in the first quarter, $2.2 billion in the second quarter and $2.2 billion in the third quarter. Not a lot of change quarter to quarter as we progressed through the year. The decline in profit from the third quarter of last year was primarily a result of the lower sales. While profit in Resource Industries is down from a year ago, much like the sales, it's been in a fairly tight band throughout 2014. In the first quarter, profit was $149 million, second quarter was $133 million, and the third quarter was $147 million. Again, similar to sales, it's been pretty stable but at a low level. Our Financial Products segment revenues were up $44 million and operating profit was up $2 million, so not much change from a year ago. Before I move on to the outlook, I'd like to touch on the balance sheet and cash flow. We generated another $1.4 billion of machinery and Energy & Transportation operating cash flow this quarter and are at $5.4 billion through the first three quarters of 2014. Our balance sheet remains strong with the machinery, Energy & Transportation debt to total capital ratio less than 35%, which is comfortably towards the low end of our desired range. Given the current demand environment, we generally have the capacity we need and CapEx expectations this year are less than $2 billion. Our strong cash flow has enabled us to repurchase $4.2 billion of stock so far this year and we announced an increase of 17% in the quarterly dividend last June. We've maintained a healthy cash balance at about $6 billion with the ability to invest. With that, let's turn to the outlook. For 2014, we now expect sales and revenues to be about $55 billion, which was the midpoint of our previous $54 billion-$56 billion outlook range. We have, however, increased our profit outlook for the year. Previously at the $55 billion midpoint of our sales and revenues range, we'd expected profit of about $5.75 a share or $6.20 excluding the restructuring costs. We're pleased this morning to have announced that we've raised that to $6 a share all in and $6.50 excluding the restructuring costs. In addition to the outlook for 2014, as we typically do in our third quarter financial release, we provided what we call a preliminary outlook for next year's sales and revenues. As we look towards 2015 from an economic perspective, we think there's a reasonable likelihood that world economic growth could improve a bit in 2015. In the developed countries, growth-oriented monetary policies we think could support continued modest improvement. In developing countries, several governments raised interest rates to constrain liquidity in 2013 to either control inflation or protect exchange rates. Those measures slowed growth in 2014. More recently, interest rates in some of those countries have stabilized, and we've seen the first monetary policy easings in the third quarter of 2014. In addition, we think there's some potential for increased investment in infrastructure, particularly in countries like the U.S., if we could get a highway bill, India and Turkey. Despite cautious optimism for improved global economic growth, significant risks and uncertainties remain, and that could temper growth in 2015. Political conflicts and social unrest continue to disrupt economic activity in several regions, in particular in the CIS, Africa, and the Middle East. In addition, the Chinese government's push for structural reform has slowed growth some, and the ongoing uncertainty around the direction and timing of fiscal policy and monetary policy in the U.S. could temper business confidence. As a result of all that, our preliminary outlook for 2015 sales and revenues is flat to slightly up. One thing you won't find in this morning's release is a discussion about 2015 profit. That's typical for this time of year. We start our planning process with sales. We provide a top-line view of next year's sales with our third quarter release. We complete our planning process in the fourth quarter, and we'll provide a more complete view of 2015 in our January release, along with our year-end 2014 results. So, in summary, profit per share was up in the third quarter. We had another good solid quarter of cash flow. Our sales outlook for 2014 is similar to our previous outlook, and we raised the profit outlook for 2014. Our preliminary outlook for 2015 is flat to slightly up. With that, we're ready to take your questions. Thank you very much, ladies and gentlemen. The floor is now open for questions. If you do have any questions or comments, please push 1 4 on your telephone keypad now. Pushing 1 4 a second time will also remove you from the queue should your question be answered. Lastly, we ask that while posing your question, you please pick up your handset or listen in by speakerphone for optimum sound quality. Again, to ask a question, please push 1 4 now. Thank you very much. We'll take our first question from Ted Grace. Please announce your affiliation, then pose your question. Hey, guys. Ted Grace. Congratulations on the quarter. Thanks, Ted. Mike, I know you said that you didn't want to give too much on or really any guidance on profitability, but could you speak to at least- But you're going to ask anyway, right? Well, no. What I was going to say is, as a starting point, could you frame out at least across the three segments how you're thinking about each in the context of sales being flat to up slightly? Where would you have the most optimism, the most caution, and maybe start there? Yeah. I think in the scheme of things, our view around each of the segments is much like the total. We don't see big swings up or down really in any of the segments. It's always, as you know, looking out that far, it's tough to always be exact or ever be exact, I guess. But by and large, we don't see a lot of change going forward in any of the three segments. Okay. The second thing I was hoping to ask either you or Doug is, one of the big initiatives you've talked a lot about is making the company a lot more nimble and reactive to the demand environment that gets served to the company, something that's outside your control. Can you just speak to the progress you've made in 2014 and how you think that sets you up for 2015? To the degree you can talk about specific metrics, whether it's cycle times or velocity, that would be great. Yeah. That actually could be a quite long answer delving into operations. I think what I'll do is summarize it for you a little bit. One of the key metrics that we have that measures the success or failure of that is the incremental operating profit pull-through. We've had a target of around 25%, and we've taken the actions needed to be flexible enough to achieve that. But embedded in that, lean helps if you improve cycle times, that helps. We're down that path. But I think the ultimate measure of this is when either profit goes up or goes down, do we have the flexibility to take cost out going down? I think we've shown that we do. I'll just add that, Mike. It's Doug here, and I agree with that completely. In terms of really lean manufacturing, lean Six Sigma standard work, I think we're still early in the process here. We've probably got about a third of our sales, we're manufacturing anyway, covered to some degree with where we want to be in our first wave of lean, really deep lean manufacturing. In every one of those cases, whether it's a medium wheel loader line in Aurora, Illinois, wheeled excavators in Grenoble, France, and I can go on. Certainly, Solar is a good example of that, too. We've seen really tremendous improvements in quality, in throughput, in inventory, in almost all metrics, and we're encouraged. But there's a lot more work to do, and as I've said to you all many times, we really expect to see big chunks of this come in 2014 and 2015. I think we saw some of that in some of the year-to-date numbers. We certainly have seen it in the quality of margins in the third quarter. But in my mind, we've still got plenty of work to do on that. I also said earlier today that in a way, flat production really gives us time. Flat production output gives us time to get to work on this. When things are booming, it's hard to work on efficiency because we're trying to satisfy the market. In 2013, when the bottom fell out in mining, we're cutting costs at every moment, and we really can't think about how we want to organize a manufacturing line. Well, since mid-2012 or so, certainly into 2013 and now 2014 in Construction Industries and in Energy & Transportation, that team has been doing that and it shows in the margins. Mining will be next. When mining recovers, we'll really, I think, prove what we can do with that because a lot of that work is being done now too. So I think we've seen a down payment on it, but in my mind, there's more to come. Thanks, Jim. Thanks, guys. Thank you very much. We'll take our next question from Eli Lustgarten. Please announce your affiliation, then pose your question. Good morning, everyone. Morning. Can we first talk a little bit about the fourth quarter as we look out? You're sort of giving us guidance of about a little over $14 billion. While I recognize there's about $0.15, $0.16 from lower taxes and foreign currency in this quarter, your midpoint guidance is $1.47 or so for the numbers. Can you give me a bridge of why the fourth quarter will be, with higher volume, will be somewhat weaker profitability? You've been pretty stable in production, pretty stable in profitability for the year. Hello? Hello? Thank you very much, ladies and gentlemen. Please remain on the line. We're going to get Mr. DeWalt reconnected. One moment. Okay, gentlemen, we are live. Eli, could you ask it again? We got cut off. It was nothing personal. I was wondering whether I did something wrong or not. Yeah. Sorry. Okay, well, I was saying first question very quickly, on the fourth quarter, you are guiding to a little bit over $14 billion. You have been very stable in production, very stable in profits almost for the year. You are guiding us to lower numbers in the fourth quarter profitability, and I know this is like $0.16 of lower taxes and benefits and some currency in the quarter. Can you give us a bridge of what you are expecting in the fourth quarter that is different that drops the profitability to under $1.50 from the $1.60 level that you have been doing? Yeah, Eli, I will. You are right. With our fourth quarter outlook or our full-year outlook, it is not too hard to turn that into a forecast for the quarter. We do expect profit to be down a little bit in the fourth quarter. A couple of things that you mentioned, we had currency gains in the quarter. There are a lot of things that we think we can do a decent job of forecasting. Exchange rates is not one of them. We are not forecasting changes in exchange rates from here. There is no continuation of the gains. We had a favorable tax item in the quarter. That goes away as well. Those are two positives that were in the third quarter that will not be in the fourth. We typically have seasonally higher costs in the fourth quarter. We are wrapping up the year and discretionary spending tends to rise a bit. That happens essentially about almost every year that I can remember since I have been at the company. We have got that worked in. One other item probably of note is we expect a little bit of negative mix in the fourth quarter. We will have a big electric power sale that we think will be completed in the fourth quarter at quite a bit lower margins than the total. I think I would say mix, seasonal costs, and the absence of a couple of the favorable items from the third quarter. That pretty much bridges it, I think. Okay. Can we talk a little about the Construction Industries segment? You warned us in the second quarter about lower emerging market business that is taking $1 billion out of production. We are hearing strong things particularly in the U.S. in the quarter. We have emissions coming next year. The Cat dealers are saying that they are having trouble even getting inventory out of Caterpillar for some of the demands that they would want. Yeah. Can you give us some insight of what you expect for the Construction Industries in the fourth quarter, and particularly as you go into next year? Because that should be one of the better markets, particularly in North America. I'll try and answer your question, but I'm going to try and answer another one that you kind of touched on but didn't actually ask directly, and that's on inventories. Yes. Sometimes I think there's confusion around dealer inventories. Since we sell through dealers, we frequently talk about changes in dealer inventory to help give a complete picture of what's going on. But just because inventories go up or down doesn't mean that they're, in and of themselves, that doesn't mean that it's well-managed or poorly managed. There are a lot of seasonal impacts that go on during the year. In Construction Industries, for example, we had a sizable increase in the first quarter in inventory, and that kind of builds up for the spring and summer selling season. Then it gets worked on for the rest of the year. That happened in the third quarter last year. That happened in the third quarter of this year. Fourth quarter, that usually tends to happen as well. Dealers tend to sell a little more than we ship them. That occurred in the third quarter. That'll probably occur again next quarter. In terms of Construction Industries, it's a mixed bag around the world. We live in the U.S., and we get influenced by what we hear in the U.S. a lot, and that's been actually pretty positive. It's been quite a bright spot. Although I would make the pitch that while it's better, that doesn't mean it's great. We are, I guess, seven, eight years now past where the peak was, and that was 2006 and 2007. So we still have a ways to go to get to where we would think it's really, really good. But it has been better. Other parts of the world, it's a little bit of a different story. China's been weak. Our share there has been pretty good and rising, but that doesn't offset a weaker industry. Europe has been flat to slightly up for us, which I think is a surprise to a lot of people. But again, you have to think back to where it's come from and how low it got. My comment about the U.S. not being back to peak goes even more so for Europe. There's a lot of room for Europe, I think, to improve if they can ever get economic growth kicked back in there. So, that's a little bit of a rundown through the world. Hi, Eli. It's Doug here. I want to talk about the Tier 4 that you alluded to also. We're in the throes of 2014, 2015. By the end of 2015, virtually all construction equipment will be Tier 4 final compliant. As we go through that, we're about halfway done, maybe a little bit more than that right now in terms of individual models. That has, as we phase out of Tier 4 interim and phase into Tier 4 final, and again, it's depending on horsepower size or kilowatt class, that has doubled the degree of difficulty in some of those assembly lines, certainly around implementation. We're seeing some of that availability go out. You mentioned you heard that from dealers. I do too. I would expect that to continue for a little bit more, but all of our product managers are all over it, and I suspect by the time we're done with Tier 4 final the end of next year, if not before, this will work its way through as well. We're really happy, by the way, with the Tier 4 final machines that are out there. A lot of them are running up a lot of hours and doing very well in the marketplace. As soon as we work through this bubble of introductions, I think we'll like what we see. But it's a bit of a challenge right now. You are right. Great. Thank you very much. Thanks, Eli. Thank you very much. We'll take our next question from Andrew Casey. Please announce your affiliation then pose your question. Wells Fargo Securities. Good morning, everyone. Good morning, Andy. A couple questions. First on E&T margin performance. Q3, obviously very strong at 20.1%. You talked about volume helping the quarter and then a negative mix going forward into Q4 because of the electric power contract. I'm just trying to understand how to handicap the impact of presumably lower U.S. locomotive sales in 2015 on mix. Was there a positive mix in Q3? No. Or was it all due to volume? Well, there are several questions wrapped in there. If we take locomotives specifically, no doubt next year is going to be lower. If you are just looking at locomotives, that would actually be a positive for mix. The margin of a locomotive would be not the same as the segment average. No, that would not have a negative mix impact next year. In fact, big sales of that in the fourth quarter would be another reason that fourth quarter mix might be a little weaker. I think it is probably a good time to take that whole rail sector and frame a bit how it could impact next year. Our view, at least at this point, is that certainly locomotive sales will be down. Remember our rail sector, or that industry, our business there has more than just new locomotives. We have a very large service business, and then we have a pretty sizable parts business for locomotives, and we have a healthy international business that we expect to be up actually next year. So overall, our view is that rail will have a negative but probably less than 2% impact on Energy & Transportation next year. Hope that helps. It does, Mike. Thank you. If I could ask another question within E&T. There has been a lot of concern about some recent changes in commodity prices as it relates to oil. Yeah. Could you comment on maybe what percent of revenue is exposed to upstream production for oil and natural gas? Is there any point at which oil prices may start to impact demand? Thanks. Yeah, that is a good question, Andrew. I know that is certainly been on everyone's mind with what has happened to oil prices over the last few weeks. Certainly lower oil prices are not a particular help. They are about where they were right now a couple of years ago, and our business did not fall apart 2 years ago in oil and gas. While it is not a big positive, we do not think it is going to be a significant negative as well, at least not where it is at now. You asked a question about how low would oil prices have to go, and that is always kind of a sliding question. It would depend a lot on where they were, how long they stay. It is a very difficult question to answer. I can say that we are at now kind of where we have been over the last, not last year, but a couple of years ago, we were down at this level, and again, it was not all that negative. Remember, the majority of our oil and gas business is gas compression and oil and gas production and transmission. Production is a big driver in our business. Also, particularly for our turbine business, it tends to be pretty long-term. The kind of projects that our customers are doing are big, many of them multi-billion dollar projects that go several years. Most of those big oil companies, they understand that there are short-term fluctuations in price, and those big investment projects that they have in flight, which would effectively be in our backlog at the moment, they generally do not change those based on short-term fluctuations. All in all, I would say, we would like to see a little higher oil price, but kind of where it is at now, we do not see it having a big negative impact. One other just minor point maybe around that, and that is the dividend that could play through potentially in other parts of the business. When oil prices are down, there is usually a pretty direct consumer impact of that, people purchasing gasoline, and the lower price of oil leads to a lower pump price, which puts a little more money in everybody's pocket. So maybe that would be helpful for the economy overall. I just want to add here, it is Doug here again. We are obviously watching oil and gas prices very closely. We are trying to stay close to our customers on this and what they are saying, and I think you are seeing their quarterly announcements come out. Generally, the feedback we've been getting that, say, mid-80s, or say, 80-90, somewhere in there, on a sustained basis, certainly will take the really agitated top off of it. But there's still plenty of room for reinvestment. Like Mike said, it's still where it was a couple of years ago. I think you see low 70s on a sustained basis, there'd be a chill across the market. I'd say gas coming down below $3 substantially on a sustained basis may do that as well. The other wild card here that we're really anxious about and looking forward to is Mexico opening. The oil and gas industry there is about to go. We're confident it will. They passed laws down there. They've made changes in the industry. That's going to go at almost any oil or gas price. There's so many moving parts on this all over the world that it's just hard to predict. But basically, in the U.S., mid-80s, we think is on a sustainable level we can all live with. Thank you very much. Thanks, Andy. Thank you very much. We'll take our next question from Ann Duignan. Please announce your affiliation, then pose your question. Yes, good morning. JPMorgan. Morning, Ann. Morning. I think just following up on that, Jim. One of the things that come up that said recently, and not to quote a competitor, but I'd be interested in your comment on it, is that a lot of their construction equipment is being supported by domestic oil and gas also. Can you talk about that a little bit, Doug, and then what indirect impact might that have if oil prices were to fall to the low $70s? Yeah. Sure, Ann. I think that's right. We've seen everything from pad preparation to road building around all the shale zones in the country. That has impacted, to some degree, our construction equipment. I don't think it's probably going to move the needle. I don't think it's material. It would certainly impact that a little bit in our case. Again, we get down to low 70s, a lot of bets are going to change on a lot of things. There's no doubt that would be impacted to some degree. I would agree with that. So in your view, Doug, most of the increase in construction equipment sales you're seeing now in the U.S. are pure resi and non-resi construction driven? I'd say, yeah, it's across the table, or across the board, yes. Okay. Certainly, the fracking site preparation has been a help. But boy, we're seeing kind of across the board, steady growth, lower than we'd like, but steady growth in the other businesses as well for construction equipment. Okay, thank you. Just a clarification on your outlook for 2015. You said in the U.S., you were hopeful that we would get a highway bill. Is that included in your outlook, or would that be upside to your outlook? I don't know if I said I was hopeful, but I said it could be upside. There's a possibility, and it depends on a lot of things in Congress. I think in terms of India, we're definitely going to see infrastructure spending increase at a significant rate. We mentioned Turkey in the write-up. I'm also optimistic in Brazil, although there's election there this weekend. But both candidates, both parties, are talking about reflating the economy, and Brazil's always used infrastructure as a way to do that. In our case, we could see some kind of either a steady extension of what we're doing or a bit up as Congress tries to stimulate the economy or do what they do. But I wouldn't say I'm hopeful, but it could happen. I'll put it that way, Anne. Yeah. Anne, I made the comment a few minutes ago, and I think there's been a lot of elections this year. The one in the U.S. is coming up, so hopefully, we'll have a window where the government can work together to make some progress before the next election. Yeah. In a lame duck session, indeed. No, I don't think it would happen in a lame duck, although anything can happen. I would say it's more going into post-election in 2015 as maybe there's some consensus to try to get after job creation, grow the economy faster. That could push on some element of tax reform a little bit and infrastructure. Those would be the two things that have an outside chance of something happening. Bigger than right now, but I'm not going to call it's going to happen. Back to your original point, Ann, we're not counting on a big- Yeah, right. we're not counting on a big upswing as a result of that, no. Okay. I'll leave it there. Thanks. I appreciate it. I'll leave my questions for offline. Okay. Thank you very much. We'll take our next question from Seth Weber. Please announce your affiliation, then pose your question. Hey, good morning. It's RBC. Mike, it sounds like you bumped up your restructuring cost expense a little bit this year to $450 million from $400 million. And it sounds like that's targeted at the mining, the Resource Industries business. Can you give us any color on the incremental details or where you're stepping up the spending there? Yeah, actually, I won't point to any one thing. We started the year by saying $400 million to $500 million, and some of the projects we understood very specifically. Some were being studied, and that was the reason we had a range. There were some that we might do, some that we might not do. Last quarter, our estimate was closer to $400 million, so we kind of revised it down a little bit. That estimate right now is closer to $450 million, so there are a couple more things that we're doing. None of them are material. None of them would we want to call out separately. About the only thing we've talked about separately that individually is pretty material is the European restructuring we did in Construction Industries. Again, we started out the year saying $400 million to $500 million, and I think we're going to basically come in there. But just to clarify, the vast majority of that is not Resource Industries or mining. It's in and around the construction equipment business. In fact, Resource Industries restructuring in 2014 of the $450 million is one of the smaller pieces. Okay. Thanks for that clarification. Then just on the performance of the business, I think you called out the mining, the aftermarket parts sales were down. Can you talk about any color on the aftermarket order activity in the Resource Industries business? For us, sales and orders are pretty much the same thing. We turn around parts orders usually in about 24 hours, so there's no significant backlog there. So one is about the same as the other. For the company overall, parts sales were positive and I think seem to be starting to build some momentum, and that's a good thing. Was there Mining is still, I would say, weak and really not much changed one way or the other. Did you see any pickup sequentially in orders, aftermarket orders? No, we did not. Oh. Okay, that's all I had. Thank you, guys. Thank you very much. We'll take our next question from Stephen Volkmann. Please announce your affiliation, then pose your question. Hi. Excuse me. Good morning, guys. It's Jefferies, and I'd actually like to go back. Doug, you were just talking about the restructuring that was mostly done in Construction Industries. I guess I was under the impression, certainly, that the first half of 2014, Construction Industries margins were probably overearning a little bit. You guys built a fair amount of inventory, I think. I guess I had assumed that those numbers were sort of not something I should think about as we move forward. Yet, there's a fair amount of restructuring going on here. I guess I'm just having trouble trying to parse out how much of the restructuring has sort of permanently improved those Construction Industries margins and how much you had sort of temporary things going on in 2014. Yeah, I'll answer that. This is Mike. We're talking about Construction Industries here. Yes. In 2014, I think, this is maybe an odd way to say it, but I think Construction Industries is a little bit, this is probably not the right choice of words, but more back to normal. If you go back to starting in late 2012 and throughout much of 2013, in Construction Industries, we were reducing inventory, both ours and Cat dealers. That had negative impacts on production. It made price realization tougher. I think 2013 was a very tough year for Construction Industries because of that. I think this year, if you look at dealer inventory changes, there's been changes by quarter, but by and large, they're likely to end the year about where they started. Production levels are kind of matching demand, in other words, and have been pretty stable. To the point that Doug made earlier, that's really helped efficiency. We don't have kind of the downward changes, if you will. In fact, you see a part of that in their price realization, this quarter versus a year ago. I think in terms of the restructuring charges, there's a little bit of benefit in this year. Again, much of it is around restructuring our Belgium facility and some of the benefits are in this year and more will be added in next year, a bit, and then after. I think there's more to come in terms of restructuring benefits for Construction Industries. Okay, great. That's helpful. Can you just update us, Mike? I thought I remember you were going to try to reduce inventories in Construction Industries. Maybe it was more broad than that, but something like $800 million this quarter and in Q4, and it looks like maybe you didn't quite get there. Can you just talk about how you feel about all that? Yeah. Again, this goes back. What we're talking about here is dealer inventory. Last quarter, we said we thought that dealer inventory was going to come down somewhere around $800 million. This quarter, dealer inventory went down $600 million. Now, I would call that, given your ability to forecast all the moving parts of that side, actually pretty good. I think it's directionally what we thought it was going to be, and I think the fourth quarter is probably going to be directionally what we thought it would be. It's a couple of things. Part of it is seasonality. Construction Industries adds to inventory. If you think about the northern hemisphere where you're in winter, there's not a lot of activity going on then, and so we tend to produce more and Cat dealers tend to stock up. You can kind of smooth load things a little bit better, and then it gets sold throughout the rest of the year. That is pretty common. That has happened. That has happened this year. We have had absolute reductions that I would not call seasonal in mining, and that has continued. Although, the reductions are a little bit, maybe less than they were a year ago. That dealer inventory is coming down, and it is at a pretty low level right now. If I look at dealer inventory overall, barring the seasonal changes that occur, I would say it is in pretty good shape. We do not have a dealer inventory problem, per se. Great. I appreciate it. Thank you very much. We will take our next question from David Raso. Please announce your affiliation, then pose your question. ISI Group, good morning. The question is on oil and gas, the order book. Can you give us some feel for where the order book is year-over-year and how far does it extend into 2015? Also how are you extrapolating that order book when you lay out your 2015 sales guidance? Yeah. Okay, David. I would say overall, and this is one of the industries where we actually do have a little bit better visibility than, say, Construction, where relative to sales, the order book is usually a little less. It turns over quicker. I would say it is pretty healthy. In fact, if you look at Solar Turbines, it is actually roughly where it was a year ago. It has not changed much during the year. If you look at the rest of Energy & Transportation, in the reciprocating engine piece of it is up. We had a nice increase in the third quarter, and I would say it is at pretty healthy levels. When we forecast next year, we do not just look at the backlog and forecast forward. It is more like we are out there trying to figure out what we think will actually happen in terms of sales, and then we use the backlog as maybe kind of a reality check to see if that makes sense. I would say, for Energy & Transportation, we still have a pretty good backlog. To be clear, though, oil and gas within E&T was my question. Can I take that- Well, yeah. preceding comment as Yeah similar to what you have in oil and gas, up on recip and flat on Solar Turbines? I gave you Solar Turbines because that's mostly oil and gas. The recip, remember, think factories, we build engines, they get sold into different applications. The data that I see around backlog is around product, not end market necessarily. But I would tell you, I think anecdotally, a lot of the strength has actually been oil and gas. Okay. And then lastly, on the puts and takes for 2015, I know we're not giving an earnings guidance, but just trying to think of the moving parts, things we've said in the past. Do they still stand for restructuring savings for next year? Any carryover or incremental benefits from repo, the short-term incentive comp? I know you bumped it up to $1.3 billion today for this year. Just trying to think about those puts and takes, maybe even a comment on pension, just something to frame the puts and takes for the 2015 earnings model. Yeah, David, this is Brad Halverson. I will take a shot at this without giving you guidance for 2015, but try to tell you how we think about it internally. We remain very committed to our pull-through targets on operating profit of 25% on the way up and 25%-30% on the way down. We have demonstrated that, demonstrated as well this year with our profit being up year to date with sales being down, and that is driving focus across all the units in terms of restructuring, lean, I would say also improv- Thank you very much, ladies and gentlemen. Please remain on the line. We are going to check the line once again, so please remain on the line. Thank you very much. David, we lost the line again. We are not sure why. I am not sure how far we got before we lost you. Brad, if you can hear me. Basically, you started to talk about a little bit beyond the comment of incrementals 25 on the way up, 25-30 on the way down, and just how the segments kind of impact those. Yeah. I'm just trying to give you a flavor of how we're looking at it without giving guidance. If I repeat something, we'll just do that since we're starting over here. We talked a little bit about being nimble earlier. Somebody made the comment. We feel that internally, and we think it's driving kind of our flexible cost structure. It's driving our delivery around incrementals and decrementals. Again, we're happy that profit is up with sales actually being down on a year-to-date basis. It's driving the lean initiative. It's driving the restructuring efforts division by division, and it's driving, I would say, pretty strong supplier collaboration as we look to improve our margins. If we look out to next year, we have targets across each of our segments for incremental and decremental margins. If we were to get some sales growth next year, as we said, sales could be flat to up slightly. Assuming we get some sales growth, we remain committed to that 25% incremental pull-through. I think the other question you had comment about pension, and we wouldn't see much of a change in pension year over year in terms of our pension costs. Well, you know what it is, Brad? Obviously, flat sales or sales don't move up or down much. Incrementals are a little less telling, right? Right. It's a law of small numbers. I think what we're just trying to figure out, we used to speak of restructuring savings over time being $400 million-$500 million with a lot of the savings after 2015 would be significant. Even 2014, I think we used to speak of maybe a couple of hundred million in savings. Trying to think what that number could be in savings for next year. Again, trying to think through the repo, and we can all make our own projections around sales, but we're just trying to think of non-volume sensitive items. Yeah. I think in terms of giving more guidance, again, if you look at this year and you look at our original outlook, again, we've been pleasantly surprised with some operational items, particularly our margin. And we've also been helped in the last quarter by currency. But I think clearly on an operational basis, we're really happy with where our margins are relative to flat sales, and we see them moving forward. We see to be absolutely committed to the 25% pull-through, which we think is a pretty good number. Yeah. All right. I appreciate the non-answer, but David, we're not trying to be tricky on profit. We just didn't make a profit outlook, and we're trying really hard not to give all the pieces that make a profit outlook for next year. That doesn't mean that it's terrible. That doesn't mean it's great. It just means that we didn't give an outlook. Can you at least, the one thing, though, the restructuring savings that we used to speak to $400 million-$500 million by exiting 2015. How much of those savings do you think you'll have captured in 2014 and at least some concept of 2015, just on that one item? Yeah. I suspect we will talk more about that in January. We have savings in 2014, and we will certainly have more in 2015. Okay, I appreciate it. All right, thank you. Okay. Thank you very much. We will take our next question from Steven Fisher. Please announce your affiliation, then pose your question. Great. Thanks. It is UBS. Can you guys talk about how the rental channel is influencing your Construction Industries sales in 2014, and how do you see that in 2015? I guess, how is demand in Construction Industries outside the rental channel? Wow, that's a good question. Actually, rental has been affecting the business, I would say, increasingly for, I don't know, 10, 15 years. Particularly when times are more uncertain, customers have a tendency to rent more. Remember, we tend to not sell through rental houses. We sell to Cat dealers who are in the rental business. We've had, particularly in the U.S., we've had positive sales through the rental channel and positive sales through the end user owner channel. I don't think there's anything out there that is driving a big structural change that impacted 2014 or that'll drive a big directional change in 2015. But I think it is true that as customers get more and more focused on asset utilization, the rental channel can be more attractive. That's why we're big time in the rental business. It's a key element of the Across the Table initiative. It's a definite part of the channel, and here to stay. Okay, both channels, it sounds like they're up this year. Yes. Is that right? Yeah. Well, for North America. Right. Sure. Yeah. Then, Mike, you mentioned a lot of room for growth in European Construction. How do you feel about the visibility of European Construction right now? Is your base case for next year that that's maybe flat? Yeah. So when you look at Construction, I kind of touched on this a little bit ago. There are two parts of the business, parts, for example, where we have little to no backlog because we get an order, we ship it, we get an order, we ship it. So it's not the kind of thing that lends to a lot of visibility based on a backlog. Construction is a little bit like that, too. Generally, when a customer or when a dealer orders, kind of on average they get it in a few months. So the backlog isn't quite like it would be for maybe a big turbine or a big mining truck. So, again, I would say in Construction, we forecast based on what we think is going to happen economically, where the market is relative to replacements. We look at where dealer inventory is. We take in a lot of factors. Backlog and short-term visibility do not play into construction or parts sales at all as much as they do in some of the other parts of the business. I guess bottom line, that was a long-winded answer to say within Construction Industries, it is normal not to have a lot of concrete visibility through a backlog. The baseline probably would be about flat as your expectation for next year in Europe? Yeah. I think that is the case for all of our, this is a worldwide comment, but for all of our segments. We said flat to slightly up next year, and we do not see either Energy & Transportation, Construction Industries, or Resource Industries being kind of far from that. It looks pretty flat to up a little for much of the business. Terrific. Thank you very much. All right. We are at the top of the hour, so we will sign off. Thank you very much for joining us on the conference call today. We will talk to you next quarter. Thank you very much, ladies and gentlemen. This concludes today's presentation. You may disconnect your lines and have a wonderful day. Thank you for your participation.