Earnings Call: Q3 2012

Oct 22, 2012

Summary

Q3 delivered record third-quarter sales and tied record profit, including a $273M logistics-sale gain. Weaker demand and excess dealer inventory cut FY12 guidance, while FY13 revenue was expected near 2012 levels.

Good morning, ladies and gentlemen, and welcome to the Caterpillar third quarter 2012 earnings results. At this time, all lines have been placed on a listen-only mode, and we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Mr. Mike DeWalt. Sir, the floor is yours. Thank you very much, and good morning, and welcome everyone to our third quarter earnings call. I'm Mike DeWalt, the Director of Investor Relations. On the call today, I'm pleased to have our Chairman and CEO, Doug Oberhelman, Group President and CFO, Ed Rapp, and Brad Halverson, who'll be replacing Ed as Group President and CFO in January, as Ed is transitioning over to be the Group President heading our Construction Industries business. This call is copyrighted by Caterpillar Inc. and any use, recording, or transmission of any portion of the call without the express written consent of Caterpillar is strictly prohibited. If you'd like a copy of today's call transcript, we will be posting it in the investor section of our caterpillar.com website, and it'll be in the section labeled Results Webcast. This morning, there's no doubt we're going to 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 could make actual results differ materially from our projections can be found in our cautionary statements under Item 1A, Risk Factors of our Form 10-K filed with the SEC back on February 21st of 2012, and it's also in the forward-looking statements language contained in today's release. In addition, we have a reconciliation of non-GAAP measures, and that can be found in today's financial release, which has also been posted on our website at cat.com. Okay, I'll start this morning with a few top points that summarize this morning's release. First, we reported a good third quarter. In fact, it was the highest sales and highest profit of any third quarter in our history. Sales and revenues were a little over $16.4 billion, an increase of about 5% from the third quarter of 2011. Profit in the quarter was $2.54 a share, and that tied the second quarter of this year for the all-time record. Profit was helped in the quarter, though, by a pre-tax gain of $273 million on the sale of a majority interest in our third-party logistics business, and that happened in the third quarter. Now, incremental operating profit pull-through was extremely high in the quarter, and that was the case whether or not you adjust the logistics gain. That said, the sales increase in the quarter, I think, was small enough that incremental margin in a quarter like this is probably not that useful a metric. However, there's been enough of a sales increase, I think, year-to-date for it to be a more useful metric. Year-to-date, it's been over 30%, and I think that's an indication of good cost control and execution on the part of the company. While we reported a good third quarter, we did lower the full-year outlook for 2012, and we provided preliminary sales and revenue guidance for 2013. I'll cover both of those in a couple of minutes, but first, a little more color on the quarter. Again, let's start with sales and revenues, up $729 million or about 5% from third quarter of last year. When we look at sales, there are three perspectives that we take. The first perspective is by reason. In other words, was the change due to volume, price, currency, acquisitions, and the like. From that perspective, sales volume improved $622 million. Price realization was favorable, $305 million. Acquisitions and divestitures, and we actually had both, was a net positive of $36 million, and Financial Products revenues were up $13 million. Currency was negative on sales, and it partially offset the increase by about $247 million. That's largely because the US dollar was generally stronger versus the EUR and Brazilian real than the third quarter a year ago. The improvement in price realization at $305 million is lower than we reported in the second quarter, but it's held up pretty well this year, and it's been higher than we've expected most of the year. The next way we look at or views the sales change is by geographic region. From that perspective, North America was up 9% in the quarter. Sales in Asia Pacific rose 8%, and EAME, which is Europe, Africa, Middle East, and Latin American sales were about flat. The increase in North America was primarily driven by higher sales of construction equipment in the United States, which has been a relative bright spot all year. With expectations around U.S. housing on the mend, we're cautiously optimistic about construction sales in the U.S. going forward. I said a minute ago that it was a relative bright spot, and that's because although it's still improving, it's still well below the prior peak. Within Asia Pacific, it's a little bit of a different story. Sales are up in the region overall, despite lower construction equipment sales in China. That's because mining and Power Systems sales have been up throughout the region. Latin America was about flat, and so was EAME. While EAME was flat overall, Europe was modestly lower and Africa, Middle East, and the CIS, moderately higher. The third way that we look at sales is by segment. In this quarter, most of our sales increase was in the Resource Industries segment. Which is mostly mining, and that was up 13% from the third quarter last year. Power Systems was up 5%, and most of that increase was related to the acquisition of MWM. Construction Industries sales were about flat in the quarter. Financial Products revenues were up about 3%, and our all other segment was actually down 31%, and most of that was a result of the sale of our third-party logistics business. All right, let's shift to third-quarter profit, which at 254 was a tie for the highest quarter ever. Operating margin was 15.8% of sales and revenues. If you exclude the logistics gain, it was 14.1%. Cost control was good. Material costs were actually slightly favorable in the quarter, and variable labor productivities held up pretty well this year. When comparing profit to the third quarter of 2011, acquisition impacts had a pretty significant impact on operating margin. That is mostly two things. The logistics gain was a plus in the third quarter of this year, and then last year, we had a lot of the upfront Bucyrus-related costs related to that acquisition in the third quarter of last year. So it is less of that from last year and the logistics gain this year. On the negative side, we have had higher taxes all year long. Our estimated annual tax rate for this year is 30.5%. That is higher than the third quarter of last year, and it is higher than the full year of 2011. That is really because of two things. One is the absence of the R&D tax credit that Congress has not yet renewed and a geographic mix change in terms of where our profits are. That is a quick review of the third quarter. Let us move on to the 2012 outlook. In this morning's release, we did lower the outlook for both sales and profit. We are expecting 2012 sales and revenues of about $66 billion and profit in a range of $9 to $9.25 a share. That is down from the previous outlook range on the top line of $68 billion to $70 billion and profit at $9.60 a share at the middle of the sales range. At MINExpo about a month ago, we said we were in the middle of our forecasting process, and it was evident that sales estimates were going to come down. Since then, we have completed the forecast, and we have another month of actual results under our belt. The sales outlook is down from July for two primary reasons. First, end-user demand, while better than a year ago, is not growing as fast as we were expecting it would. From a product standpoint, it is fairly widespread across Construction Industries, mining, and Power Systems. From a geographic standpoint, it is also spread across the globe. The second reason for our decline today in the sales outlook is dealer inventory. Based on the finished inventory that we have, significant improvements we have made in delivery times to dealers, and some moderating growth in end-user demand, our dealers find themselves with too much inventory. In response, they have cut order rates to levels that are well below what they are selling to end customers. As a result, in the fourth quarter, we will be reducing production levels quite a bit. We have already announced a number of temporary plant shutdowns, and there will be more coming. It means that for the next quarter and into 2013, our production will be below end-user demand. By segment, about two-thirds of the outlook decline is Construction Industries, and the other third is split about evenly between mining and Power Systems. Based on our new outlook of $66 billion of sales and revenues this year, the fourth quarter will be just slightly below the third quarter of this year. If you look at the decline in our profit outlook range, the $9 to $9.25 range, it is primarily a result of the lower sales, but partially offset by the gain on our third-party logistics business, which happened in the third quarter. Now, in addition to 2012, as we usually do at this time of the year, we've provided a preliminary economic and sales outlook for 2013. You can boil down what we're thinking about 2013 to a short statement, and that goes both for economic environment and sales. That statement is, "Steady as she goes, not much change from 2012." As we look forward on the positive side, in many countries around the world, monetary and credit policies have eased over the past year, and we do expect that to continue into 2013. However, economic growth has been slow to respond, and we're not expecting any improvement in world economic growth until maybe the second half of 2013. Even then, for the full year, we're only expecting economic growth for the world of about 2.7%, and that's just a couple of tenths of a point above what we're expecting for this year. In the developed world, we continue to expect growth at levels that are well below potential, at about 1.5% in total for the developed world, with about 2% growth in the U.S. and the Eurozone close to zero. In the developing world, we're expecting growth of about 5.5%. That's about a half a point better than 2012. We think Brazil will continue to improve some, and that China's growth rates will improve to about 8.5%. Again, to summarize our view of the 2013 economic prospects, we're not expecting much change from this year. We're not planning for a significant pickup in the world economy. That said, we're also not expecting a recession. We're expecting a continuation of the slow growth path the world seems to be on. I'll just repeat that for emphasis. We're not seeing, expecting, or reflecting the world being in recession in our outlook for 2013. Based on our steady-as-she-goes slow growth economic outlook, we're expecting 2013 sales and revenues to be roughly the same as 2012 in a band of about plus or minus 5%. We are expecting our Resource Industries segment, which is primarily mining, to be down somewhat in 2013. Lower metals and coal prices and increasing operating costs have hurt profit margins at many mining companies. That profit pressure, combined with economic uncertainty and slow growth, has resulted in mining companies delaying some investment. Although metals prices have recently improved, we expect mining companies will reduce capital spending in 2013 and sales of mining equipment will decline. However, we expect the lower mining sales to be about offset by higher sales of construction equipment. We are expecting some improvement in construction activity in the United States, and you're already seeing some of that in housing. Sales of construction equipment in China should also improve somewhat in 2013 after quite significant declines in 2012. To be clear, we're not expecting China to make up the ground that was lost in 2012. But we do expect some modest improvement from a very disappointing 2012. We're seeing Brazil continue to improve and expect that construction equipment sales in the developing world in general will be a little better in 2013 than 2012. On the downside in construction, we're not expecting economic recovery in Europe and are planning sales there to be lower. For our third large segment, Power Systems, we're expecting sales to be roughly flat with 2012. In terms of timing, how we're thinking about sales first half versus second half, we're not expecting a major economic pickup in the year, and we're not expecting a big demand pickup next year. But we and our dealers will be continuing to work off inventory early in the year, which will probably cause early sales in 2013 to be a little bit weaker than the usual seasonality. I'm going to finish here this morning with the three main points we're trying to get across today in this call and then this morning in our release. Point number one is we're doing a very good job of managing costs. Margins are good, and incremental margins so far in 2012 have been much better than our goal of 25%. Point two, we recognize we have too much inventory, and dealers are telling us they have too much inventory. As a result, we're lowering production. We've already announced widespread temporary layoffs and rolling factory shutdowns or temporary shutdowns, and there's more coming. It'll take a little while to work down the inventory, and it means that our production levels and sales will be lower than dealer sales to end users in the fourth quarter and into 2013. The third and final key point that we're making today is we're taking a pragmatic, steady-as-she-goes view of 2013. We're not seeing or predicting a worldwide recession, but if one happens, we know what to do. As I mentioned a minute ago, we're already taking actions to lower production to deal with the inventory, and we're ready to do more if we need to. On the flip side of that, and this is also an important point, we're not banking on a big pickup in the economy. If we get a better economy next year, that's upside to the outlook. So that's it. We're ready to take your questions. Thank you. Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments, please press the numbers one followed by four on your touch-tone phone at this time. Pressing one for a second time will remove you from the queue should your question be answered. We do ask, if you are listening on a speakerphone, to please pick up your handset for optimum sound quality. Please hold for just a moment while we poll for questions. Our first question of the day is coming from Eli Lustgarten. Please announce your affiliation, then pose your question. Longbow Securities. Good morning, everyone. Morning, Eli. Can we get a little more into the production cuts and the timing of it? At MINExpo, you told us you were basically taking $2 billion out of the fourth quarter. Looks like you took a little bit third, now you gave us a little bit distribution. Can you give us some quantification of how much production are you taking out this year and how much will go into next year, so we can get a sense of the size and magnitude of what's going on? Yeah. When we were at MINExpo, we weren't done with the forecast at that time. It was pretty clear that it was going to come down. Order rates for both mining and construction were lower. For mining, it's been evident that customers wanted to lower CapEx next year, and we were seeing that in our orders. It was becoming pretty clear, despite decent sales to end users, that dealers were reducing orders to cut inventory in the third and fourth quarter. At MINExpo, the sum of all of that looked around $2 billion. It ended up being more like $3 billion, and that's the change that we have in the outlook. So directionally, we knew which direction it was going to go. We could see what was happening. We have another month under our belt. It's going to be this year, and there'll probably be some reduction in the first quarter as well. So the $3 billion is what you scheduled for this year, and somewhere on top of that, or the $3 billion will spill over? Well, I wouldn't view the $3 billion as entirely inventory reduction. I think the $3 billion is a combination of inventory reduction, and demand is not as high as we thought, just in general. If you look at sales to end users, still positive versus a year ago. Along those lines, I would mention that the September number was a little weaker than you might have expected, and that's because we had an extra weekend in September. We'll have more workdays in October. So workdays were about 10% less in September. But the point is, even though sales to end users are up versus a year ago, well in positive territory, our expectation is it was actually going to be a bit better than it's turning out in the fourth quarter. The decline in the outlook is both inventory and increases in demand are a little less than we thought. Yeah. In a follow-up, you talked about mining being down next year. Can you give me some sort of quantification, whether that's double digit or single digit, or some magnitude of how we should think about the impact on the mining sector? Yeah. I'll tell you what, we don't do the guidance by segment, but if you were to look broadly at generally what mining companies are saying about CapEx, I think the numbers that I've seen are 5%-10%. That'll give you some order of magnitude anyway in terms of what they're thinking. All right. Thank you very much. Thank you. Our next question today is coming from Vance Edelson. Please announce your affiliation, then pose your question. Hi, Morgan Stanley. Good morning. Follow up on that last question. With the mining customers delaying some projects and reducing orders, could you give us a feel for just how widespread this has already become? In other words, do you have some customers that are taking the early steps, perhaps they're acting quite concerned, while others are still taking more of a wait-and-see approach, or have the vast majority started to delay already? Vance, it's actually been going on since late in the second quarter. It hasn't really changed too awful much here in the last month or two. It's a pattern that's continued. I think basically what's happened is mining companies actually have quite a bit in the order book already. Particularly for the long lead time mining products like large mining trucks, we have pretty good order cover for next year. I think they're just taking a wait-and-see attitude to see what happens here with China and the U.S. elections, and to get some direction on next year before they start ordering again. Okay. That's helpful. Then, in the past, you've referred to a potential inflection point in China. Any update on when you might see that happening? Does the first quarter of 2013 now seem too early, given the back-end weighted overall expectations that you have for next year? Well, actually, China's continued to be pretty weak. In fact, I would say that's one of the reasons why our finished inventory hasn't come down maybe a little bit faster. We were thinking we would start seeing at least a little bit of a pickup here in the fourth quarter. Within the economy there, they're going to accelerate some infrastructure spend. They've taken monetary policy easing. Sentiment on the ground from the dealers is a bit better. But in terms of translating it into sales, I'd say it hasn't happened yet, so the selling season is mid-February on, so probably not going to see much till then. Mike, let me add in here. It's Doug Oberhelman. I want to just add on China a little bit. Mike is exactly right. We don't see anything concrete differently today than we have really the last few months. However, we were just there two weeks ago, all of us with our board of directors for our October meeting. We met with all of our distributors in China and most of them in Asia. I would say for the first time that I've talked to them in a while, as Mike said, the attitude is better and their outlook is better without concrete orders in hand, however. We heard, I would say, story after story of positive anecdotes from their customers inside China, but none of them yet are on the order books. The presidential transition or the leadership transition happens the first half of November. Unanimously, they all believe that's a watershed event. We all know that. They also look for substantial change, whatever that means, by Chinese New Year. Which typically is a selling season over there anyway. But these are anecdotes at this point, but I would note that it's the first positive anecdotes we've had across the board inside China in some time. So we all are somewhat encouraged without any concrete things to put in our pocket book as yet. From the Chinese officials themselves, are you hearing anything, either directly or indirectly, in terms of what they might focus on to the extent they try to spur growth? Do you think infrastructure, for example, or anything else that you could benefit from is going to be high on that list? Well, they've had the easing spigot open almost all year. We've seen increased levels of building permitting this year over last year. We've also seen in the last six weeks or so, a major infrastructure effort announced. I suspect all of that is aimed after presidential or leadership transition, and most of that's aimed towards spring of next year, which is kind of a confluence of events that around Chinese New Year. If it happens, it's going to happen then. If it doesn't, we're in for another kind of slow year in 2013. But right now, the cards in the hand are looking better than they have for a while. But I would emphasize nothing concrete in terms of orders as yet. Yeah. The only thing I'd add to that in terms of the government officials is I think it's quite clear from the discussions is they're trying to moderate the stimulus maybe more effectively than they did back in the '08, '09 timeframe, where they felt things really got overheated. We look at that as a positive. There'll be a point in time when we look back on 2012, and I think we'll be pleased with the fact that China slowed and put this thing under more control. I think it's going to be better for our business, better for our business model over the long pull. Okay. That's very helpful. Thanks, guys. Next question. Our next question today is coming from Stephen Volkman. Please announce your affiliation, then pose your question. Hi. Good morning. It's Jefferies & Company. Hey, Steve. I'm wondering, Mike, you gave us some data regarding your backlog. I'm wondering if you could share your book to bill in mining specifically. Well, we've never disclosed that. We put out a backlog for the total company. We're not even splitting that by segment. What I would tell you, though, is the decline in the backlog occurred in all three major segments. It wasn't all mining. It was a combination of mining, Construction Industries, and Power Systems. Again, most would have been Construction Industries and Power Systems. Mining companies are taking delivery certainly on products that they've ordered. In fact, our sales of mining equipment in the third quarter for Resource Industries were up 13% from a year ago. But they're not ordering much. Again, I think they're taking a wait and see. They have CapEx expectations next year that are a little bit lower than this year. So we're seeing that in the backlog. For construction, it's a little more of a, I think, a short-term issue. With construction, it's not long lead time product. Dealers try to keep on hand or have orders that are, let's just say, in the ballpark of delivery times from us, so kind of a few months sales. Orders on construction have been quite low over the past few months, actually improving a little bit as we've gone through, well below their sales to end users, the order rates. What that means is as those orders over the last quarter kind of move into our production schedules for the fourth quarter and the first quarter, it means that there should be some fairly significant reductions in dealer inventory. Again, I think that's a temporary situation. Dealers can't go on for a very long time selling or ordering less than they're selling. We'll see that for probably a couple of quarters, but then it has to move back up in line with selling rates. Okay. That's helpful. I guess what I was trying to get at, though, is to think about the mix shift as we get into 2013. Are you seeing any cancellations? I know you allowed that at one point in a previous downturn. Is it that aftermarket is kind of holding in okay and that the OE side is weaker, or is it more broad? Yeah. I think the OE side is where the order rates are dropped. For parts, we ship in about 24 hours, so our order backlog for parts is usually limited to about a day. So it doesn't really play much into the order backlog numbers. The decline would definitely be OE. Again, we have pretty good visibility in the backlog. We've not had massive cancellations. I wouldn't say we haven't had any, but the primary reason the backlog has come down is they've just eased off ordering, I think, until they get a better picture for what next year is going to look like. Thank you very much. Thank you. Our next question today is coming from Ted Grace. Please announce your affiliation, then pose your question. Hey, guys. Ted Grace, Susquehanna. Morning, Ted. How you doing? The first thing I was hoping to ask is on the 2013 revenue guidance, could you just maybe clarify, is that a top-down perspective or is that bottoms-up, having gone through the business segments, dealer conversations, and all the other things that would drive a bottoms-up forecast? It's a little of both. From the top down, we do an economic forecast, and we try to translate that into what we think that means Region by region, sort of product by product category around the world. Then we play into that from a bottoms-up standpoint, the uniqueness that's going on in individual products. Do you have new products? Are you having a particular push into a region? Do dealers have unique things going on in the territory? So it's a little bit of a combination. It's kind of a top-down economic view, coupled with a bottoms-up view of the territories and the products and the product dynamics. So it's a little bit of both. Okay. I realize you haven't given any kind of formal guidance or any guidance whatsoever on earnings for next year, but just a little hand-holding to think about the key variables. You did walk through sales mix next year, and obviously mining, you mentioned would be down, which all equals a headwind, and you mentioned some of the production issues. But when we think through the key levers or variables, could you just give us maybe some framework of how to think about mix next year and puts and takes? Yeah. I can do a little bit of that under the kind of qualification that we haven't really provided profit guidance. To a large degree, we're still working on the details of next year's plan. But certainly, one of the things for sure you would have to take into consideration is in the third quarter of this year, we had the third-party logistics sale gain. That was $273 million pre-tax in the third quarter. We're not going to sell that thing twice. So that'll definitely come out. Sales mix, as you mentioned, that would likely be a little bit negative. We have some decline in mining next year, some increase in Construction Industries. We make a little more money in mining than we do Construction Industries. So to your point, that would not signal a positive sales mix. We've been investing for the future, and our CapEx has been up, probably a little bit less than $4 billion this year. So that means depreciation next year will be a little bit higher. Kind of the flip side of that, though, is we've done a pretty good job on managing the factories. We've held our fixed cost growth. So I think in terms of managing costs, we've done a good job. Efficiency in the factories, all in, is held up pretty well. We do have some pricing next year. We've announced, not huge, but some price increase for next year that would certainly be positive. I think those are probably some of the bigger things to think about. I guess the last point that I would make is that this year, even with what we're expecting to take out in inventory in the fourth quarter, we'll still end up this year with an inventory increase, and we would certainly be planning on an inventory decrease next year. Order magnitude, we're still working on, and that will likely be a little bit negative for profit as well. The last thing I will ask, Mike, is just at the guidance for 2013 revenue, could you give us a sense for how to think about what the embedded dealer inventory levels would be, either year-on-year or versus normal ratios of inventory to sales? You mean how it would end next year, or just where it is today? Yeah, either where it would end or how we should think about that pattern next year or path. Yeah. I think it depends a little bit on how next year plays out. Dealer inventory, by and large, they have somewhere by historic standards, around 3.25 to 3.5 months of inventory. So it will really depend upon what sales are looking like towards the end of next year in terms of how much they will have. But I think if you look at selling rates today, they have more than that, a pretty good size chunk of what we took out of. Not all of it, certainly. Some of it will come from our inventory. But we would expect to make pretty good reductions in dealer inventory in the fourth quarter, probably again in the first quarter, but maybe a little bit less than the fourth quarter. Not because they don't have more to do, but because commonly in the first quarter, dealers build inventory for the selling season. I think the specifics of how it's going to play out by quarter will probably depend on next year and how confident dealers get in the second quarter. But certainly down $1 billion or $2 billion from where they're at now. Okay, that's great, guys. Best of luck. Thank you. Our next question today is coming from Andy Casey. Please announce your affiliation, then pose your question. Wells Fargo Securities. Good morning, everybody. Good morning, Andy. A couple questions, but first on Cat corporate cash flow inventory liquidation benefit from the inventory cut that you kind of forecast. How much of that is coming from purchased material and work in process, or are you considering rolling back some of the PDC inventory? Well, it is actually a little of both. In fact, if you look at the purchase content and our work in process and raw material inventory, we actually took that down several hundred million dollars in the third quarter. So in fact, in the cash flow for the third quarter, payables were a little bit less of a help, and partly that is because we have cut the front end of that inventory pipeline. I think if you look at what will happen in the fourth quarter, it will probably be less work in process and production stores and a bit more of the finished goods as we try to take that down. Okay. Thanks, Mike. If I could go back to the topic of the day, the mining equipment, CapEx cycle. Last month, you discussed the longer-term extension of the current mining investment cycle. Today, although short-term, you are talking about the 2013 backlog for orders from your customers are pretty full. You acknowledged 2013 CapEx may decline from 2012. I am just trying to understand kind of where we are in the potential cycle and whether, if nothing changes in 2013 in the macro environment, do all the puts and takes suggest that in 2013 you would see accelerating declines through the year? Or is it just kind of, like you said, in the overall revenue mix down first half, up second half? Well, just before I answer the point on mining, this whole first half, second half thing, I'd just like to clarify just a little bit. We're not looking for a Hail Mary second half of the year, that is a big increase after a decrease in the first half. That is not what we're predicting. We're not out there expecting a big economic recovery in the second half that's going to somehow save the year from a weak first half. I think what we're saying is it's going to be a bit of a ho-hum probably is not the right word, but a pretty stable year. Our sales will probably be a little bit lower in the first half relative to normal seasonality, just because we're still working on dealer inventory. I think it's worth noting that we're not banking on a giant second half of the year to somehow bail the year out. I think with regard to mining in general, I'd tell you, we couldn't be more positive about the long-term potential for mining. The world's population is continuing to go up. More and more people are moving into the middle class as standard livings improve. Those are big commodity drivers. I think long term, we're very comfortable with mining. In the short term, there are economic swings. The developed world, particularly China, are big incremental users of commodities. In 2012, their growth rates tipped down, and it's been negative, at least for a while, to commodity prices. It's given miners an opportunity to take a breather, and that's okay. That's a normal economic situation that happens. That doesn't, I don't think, change the longer-term view of mining, which in our view is actually quite positive. I think that next year should be a fairly steady-as-she-goes year overall. But with us probably selling a little less in the first half of the year because we know dealers are cutting inventory. I don't know if that answered it, but Yeah, I just want to talk a little bit. It's Doug Oberhelman here, a little bit about my view of 2012 and 2013, and 2011 for that matter, but 2012 for this company will be a record year at top line and bottom line. What we're looking at is going into 2013 with a lot of uncertainties right now, most of which will be cleared out, good or bad, in the first half of the year. So I think there's about three things going on that Mike talks about. The fact that the second half is likely to give us a little more clarity around economic conditions, the inventory maybe turn around that he talked about, and so on. But we're looking at two really good years here, 2013 and 2012. Around CapEx, given the fact that 2013 and 2012 likely top line will both be near record years, saying nothing about the bottom line yet for 2013, I would expect CapEx could be, and we haven't rolled it up yet, but won't be down an awful lot. We're looking at a growing economy here out through 2015, as we talked about in MINExpo, and we're going to need capacity. Not additional capacity necessarily from where we are, but certainly the build-out of what we have, our parts warehouse system and distribution centers for spares around the world. Given the fact that 2013 is going to look a lot resemble, as I said in Las Vegas, 2012, moving on up in 2014 and 2015, we're going to need some capital spending. If the year doesn't turn out like we think it will in 2013, we'll slow down, but I just want to kind of work on expectations a little bit around capital because we see the base case is pretty good through 2015. No recession in sight globally. That means we're going to need to spend a little bit to keep up with what should be good growth between here and 2015. So maybe that's a little more long-term perspective on it, but certainly how I see it at this stage today. Thank you. Thank you. Our next question today is coming from Timothy Thein. Please announce your affiliation and then pose your question. Great. Thank you. Citigroup. First question, just Mike, to come back on segment mix, specifically on Power Systems. There is obviously a couple different segments within there, where the margins and returns can vary quite a bit. But given the outlook in the release on your expectations for Brent averaging $110 a barrel next year would seem to be supportive for E&P spending and obviously petroleum. Can you maybe provide a little bit more color in terms of how you are currently thinking about mix within that Power Systems number for 2013, to the extent you have? Yeah. If we look at the lower-level components of it, actually we are not forecasting a very significant change up or down in sort of those different end markets, industrial, marine, oil and gas. The forecast, even by kind of lower level, is not dramatically different. So I would say the mix is probably maybe just a slight bit negative in that one of the segments that will probably have some growth after a pretty poor year in 2012 is industrial. That has been down quite a bit so far this year. I think that is looking at maybe a little bit of improvement next year. But even as I say that, the change overall is fairly flat. The change even below that level is not very dramatic. Okay. Got you. And just back on mining, as the outlook there has come in, is this impacting the expected pace of distribution sales and/or leading to any meaningful change in your dealers' thoughts regarding the valuation of distribution rights? No. Okay. Sorry, it is a couple answers. Yeah. In the interest of time, I will not take a lot of time saying no. I do not think it has changed anything, no. Okay. Thank you. Thank you. Our next question today is coming from Ross Gilardi. Please announce your affiliation and then pose your question. Good morning. Bank of America, Merrill Lynch. I was just wondering, in China, clearly you have been working on getting your inventories down for several quarters now. Where do you think the industry is in that regard? From here, do you think it is a 6-month process to clear the excess inventory for the industry or do you think it is more of a multi-year process? What is happening to pricing in the region? Are you seeing any customer trade-down in terms of product quality? Well, a couple of things. Very good question, Ross. A couple of things. One, just in terms of shifting around customers, we tend to be certainly the premium product there. Although sales are depressed in China, not very good, we've tended to do a little bit better than the market overall. So in a down market, we're doing okay. In terms of the inventory part of your question, I think the way I would describe it is we've made steady inventory reductions in China, both us and dealers of finished inventory. But it's not been as fast as we would've thought, and it's not because we're producing any more than we were expecting. It's because the sales have just remained pretty low. We've not really seen a pickup there yet. So a part of the inventory reduction that we were expecting as we march through the year, we were thinking we would get a little bit of help from sales, which isn't happening. So I think if you look at how weak it is there, my guess is the rest, and I don't know this, our competitors don't report their inventories to me, but if they're anything like us, it's probably a case where it's going down, but not as fast as we'd all like. I think it's probably going to remain elevated until the selling season starts. That would probably begin mid-February. That's the first opportunity, I think, for a more meaningful reduction. Yeah. Hey, Ross, this is Ed. The one I'd add to that, you asked about the pricing side, and as we talked about before, you're seeing a lot of, if you would, packaged merchandising. I think the other thing we've seen happen in China is the tried and true business model and the way we work with Cat Financial has really played out. You do hear a certain amount of noise out of competition with their struggles on the receivables side. But if you look at Cat Financial's reported results for the third quarter, very solid, past dues down, and it just gets back to the discipline at which we run that business. I think it's serving us well in places including China. Yeah. Overholt here. I want to pile on again on China and inventory. We have been reluctant to massively lower inventory suddenly, and we are doing it in a very measured way. Most of our production there today is for export around the world. We need more capacity. We have it today. But frankly, I'm worried about any kind of recovery in China and not having inventory ready. So we have done this in a very measured fashion all the way down this year, and I would expect that to continue. While we want inventory down and we are a bit high, we cannot let ourselves get into a position where we don't have inventory to match the market when it does recover. And we'll be there, I suspect, fairly soon. And again, it comes back to what happens with demand on the ground inside China going into 2013. We'll know this. We're going to know this likely in the first quarter which way this is going. Just a follow-up on your growth projects. At MINExpo, you had made it clear that you had temporarily delayed several of your projects. Is that still the case? In your outlook, you mentioned GDP accelerating at 8.5%. If you see signs of that really unfolding in the first half of the year, do those projects come back on very quickly? We have slowed the expansion of our China facilities, as I mentioned it at MINExpo. In fact, we've just delayed it and deferred it. We haven't canceled it at all. We're going to look at, again, what happens in 2013. As I've said before on many occasions, I'll say it again, having just come back from China is under-excavated on a per capita basis by any metric to the rest of the world. So we know where that's going to go over time, and we have to be there with capacity. So right now it's a juggling act between how much do we lower inventory, how much do we slow capacity expansion, knowing full well that, I don't know if it's six months, one year, two year, or five years, we're going to need a lot more than we have today. Your second question, I'm sorry, was? I forgot. No, I think you got most of it there. Thanks very much. Okay. Thank you. Thank you. Our next question today is coming from Ann Duignan. Please announce your affiliation, then pose your question. JPMorgan. First, just a clarification on the model. How should we think about modeling the logistics business going forward? It wasn't really clear in the press release or in any of the Q&As. Ann, with the logistics business, we have actually several things going on with acquisitions and divestitures. We bought Siwei in the quarter. That is a Chinese underground coal company. A year ago, we bought MWM, or not quite a year ago. Then we sold a part of the logistics business. So there are pieces coming in and pieces going out. I think for the logistics piece in and of itself, if you look at our all other segment, most of the sales decline there was logistics. It is probably a little less than $100 million a month in terms of sales. But then again, we have an add-on for Siwei as well. So we have things that are going in both directions. Overall, certainly from a top-line perspective, the net of them is not going to be a big difference next year. In other words, when we talk about our expectations that next year is kind of plus or minus the same as this year, we did not mention acquisitions because we have some coming in and some going out. Yeah, it is just that we know where Siwei goes, we know where MWM goes, but there is no reference to. So you said logistics is about $100 million in sales per month? No, it is a bit less than that. You can look at our release today. Based on when we sold it, we had absence of about two months of sales. It would have been less than $200 million in the quarter impact. Okay. That is somewhat helpful. My second question is, you had noted that in order to reduce inventories quickly in China, that you were going to have to use some marketing programs. Yeah. Can you talk both about what kind of marketing efforts you are having to make in China to liquidate the inventories? Also, are we looking now at very broad-based marketing dollars being spent to move products all over the world, both out of dealer inventory and out of your inventory? I think the best guy to answer that question is going to be the new head of our construction business sitting to my right. Yeah. Ann, I would say in China today, you have a fairly broad-based push in terms of the merchandising programs. As we reported last time, a good portion of that is coming through the packaging of different offerings, all the way from financing to trade-in allowances, to those types of things. I think that, as Doug said earlier, we are seeing some good results relative to our position in that market because it really plays to the strength of our business model. We have slowed some of the capital as we have talked about in China, but we have not slowed the build-out of that business model. Dealer locations, building out our services, be it insurance or financing, building out the product support side of it with things like logistics capability and reman. We continue to build out that business model, but going after that complete merchandising package really does, I'd say, play to our strengths. I think in terms of how that's playing out around the world, it's a bit different in different parts of the world depending on what segment you're operating in. As you've seen year-over-year progress in the States, sales users still with a pretty good growth rate. We talked about Europe being weak, but Africa, Middle East, and CIS holding. There's a different play out depending on the different geographies around the world. But you've seen third quarter overall price realization was quite positive. Okay, and just while I have you on the line, I was curious just what the thinking was in terms of moving the headquarters for the Construction Industries business out of Hong Kong, which is obviously closer to China, to Singapore. Was there any reason for that in particular? Ann, I'd say it's twofold. First of all, also included in the announcement is the appointment of Chih-Hua Chen as an officer based in Beijing. I tell you, one of our great leaders, and I'd say great leader who just happens to be Chinese. And so having an officer on the ground in China is a huge step forward, and he'll play a great role. The other reason is that if you go back in history, we really moved our Asian operation headquarters to Singapore. It's where we got a bigger concentration of our people, product managers, purchasing organization, those kinds of resources. So it puts me right smack in the middle of that. Trust me, I fully understand it's a mailbox because a good portion of the time is going to be spent on the road. But those are the two things that really led to that decision. Okay. I appreciate the color. Thank you. Thank you. Our next question today is coming from Robert Wertheimer. Please announce your affiliation and pose your question. It's Vertical Research, and good morning, everybody. I just had two quick questions on mining. Have you seen any reduction in hours run on mining equipment? Do you expect, and you forecast any diminution in parts, either growth or contraction parts, whether due to destock or cut hours? Second, are you allowing cancellations? You had been at one point, I think, kind of sold out for '13. I know you've allowed push-outs, so I'm just curious if you allowed any cancellations or whether just the decline seemed a little bit surprising given how robust the backlog had been. Just wanted to see if this stuff had been pushed all the way to '14 or canceled. Yeah, Rob, just a comment on the whole hours worked question. I think if we use our aftermarket business as probably a reasonable indicator of that, it would tell us that activity levels, and actually, if you look at mine production levels as well, they look pretty good. I think the one place where that's not the case, where versus a year ago, it's actually down, is eastern coal in the U.S. So I'd say that's the one spot of weakness, certainly in the aftermarket part of it. In terms of your cancellation question, yeah, there have been some cancellations. It's not been hugely significant. For the most part, what customers have done is two things. One, and you can see this based on the backlog, there's not a lot of new order activity for new equipment. Of course, the aftermarket piece has just cycled through. And two, you've had some pushed out. We had some sales shipments that we would've thought would've come in the fourth quarter of this year that are pushed into 2013, some from 2013 pushed beyond that. So it's a combination of low orders and some delays, not big cancellations. Hey, Rob, this is Ed. One other thing on the cancellation, because you mentioned the past. We've openly communicated to our dealers that the order cancellations in the late 2008 timeframe was an anomaly or an exception. It was a liquidity crisis. No one's certain where it was going to end up, and so we made some steps there. But it's not part of our ongoing practices with our dealers, and we want them to understand the risk that comes with the ordering process to keep good honesty in the order board. Also, as we've talked openly, we don't see a recession coming in 2013. We see things a lot differently than we did in that period. So like I said, an exception to our standard ordering practice back in 2008 and 2009. You're seeing us now move back to more of our standard practice. Thanks, Ed. Okay. I think we have time for one more question. Thank you. Our final question today is coming from Andrew Kaplowitz. Please announce your affiliation, then pose your question. Good morning, everyone. Barclays. Morning, Andy. Mike, maybe I could ask you about the Western Hemisphere in terms of construction. Obviously, the U.S. market has held up better than some other markets. Have you seen any order slowdown from dealers in that market? You talked about growth in the market next year. Confidence level around that. I noticed your housing start number was pretty good, too. Yeah. A couple of things. Sales to users in, let's say, North America, the rate of growth has slowed down a little bit. Now, again, September is a little bit unusual. We had four weekends last year in September, the way the calendar fell. This year we had five. The flip side of that will happen in October. September, I think because of the calendar, was probably a little weaker month. But if you go back to the fourth quarter of last year, North America was up close to 50%. It was up a lot. There was, I think, a little bit of probably extra buying in the sales to users because of the depreciation rules at the time. Probably a little bit of a pull forward, if you will, into the fourth quarter, I think, particularly at a dealer level. I would fully expect that if you're looking at year-over-year growth rates, I expect those growth rates to come down a little bit in North America. That doesn't mean that sales to users are kind of sequentially, seasonally adjusted, getting worse. It just means that the fourth quarter of last year was quite a bit better than the second and third quarter of a year ago. We are reasonably constructive on U.S. in terms of construction activity. Housing really does seem to be on the mend. It's not booming, but it really seems to have turned a corner and is getting a little better. So that should help if we can get this election and year-end tax and spending cliff dealt with. I think there's opportunity for confidence even to get a little bit better. So I think we're fairly constructive. Now, you said the Western Hemisphere, so I'll move to Latin America. In Brazil, which is one of our more important countries in Latin America in terms of sales, we've had a pretty steady improvement year-over-year in terms of sales to end users. The government there has been constructive, I think, on monetary and credit policies. We've seen our sales to users, our dealers, deliveries to end users get better. So I think we're reasonably positive on that as we move forward as well. I don't know, Andy, did I answer all your questions or? You did, Mike. Just in Latin America, your sales were still down sequentially. Is the Argentina stat sort of run its course where you just haven't been delivering a lot there? But I think that stopped sort of in February of this year or something like that, so you should have easy compares there as you go forward. Yeah. Argentina has been just quite severe declines there. I think if you look at our sales in Latin America too, you have a little bit of a different situation. The construction business in Brazil, dealers have actually been cutting inventory there a little bit. Actually, in the country of Brazil, dealer inventories went down a little bit in the quarter. So our sales there are a little bit less than real demand already. Okay. As the demand continues to increase there and dealers get their inventory in line, at some point here, orders and sales of ours will start matching or get closer to end user demand. So that's a temporary thing. Okay, and then just real quickly, Bucyrus profitability was a little lower sequentially. It looks like less than 5%. Usually, they have a strong fourth quarter, so is that kind of what we're anticipating here? Is that one of the reasons why operating profitability was lower? Yeah, I think our view of Bucyrus, if you look at what happened in the fourth quarter a year ago, just a shift in their both sales and profitability going from third to fourth, there's an uptick. They just historically have made a higher portion of their profit and sales in the fourth quarter, so we'd be looking for that to improve in the fourth quarter as well. Thank you. Thanks, Andy. Thanks, everybody.