Earnings Call: Q2 2014

Jul 24, 2014

Summary

Q2 sales declined ~3% YoY, while adjusted profit per share rose to $1.69. FY profit guidance increased, with mining weakness and dealer destocking offset by construction strength, record E&T profit and substantial planned buybacks.

Good morning, ladies and gentlemen, and welcome to the Caterpillar Second Quarter 2014 Earnings Results Conference Call. At this time, all participants have been placed on 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. Thank you very much, and good morning, everyone, and welcome to our second 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 Group President and CFO, Brad Halverson. 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 will be posting it in the investor section of our caterpillar.com website, and it'll be in a section labeled Results Webcast. This morning, we'll be discussing forward-looking information, and it certainly involves risks and uncertainties and assumptions that could cause our actual results to differ materially from the forward-looking information. A discussion of some of those 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, which is risk factors, out of our Form 10-K filed with the SEC in February of 2014, and also in the forward-looking statements language in today's release. In addition to that, a reconciliation of non-GAAP measures can also be found in our release today. Again, it's posted on caterpillar.com in the investor section. Okay, let's get started this morning, and I'll be covering three things before we get into the Q&A: second quarter sales and profit, the outlook for 2014, and our announcement this morning of additional share repurchase expected in the third quarter. Before we really get into the quarterly numbers, I thought it might be helpful to summarize the major themes from this morning's release. In other words, what were the key points we're trying to get across? The first point is around stability and consistency. Back in October of 2013, we provided a preliminary outlook for 2014 sales and revenues. Back then, we said it looked to us like 2014 would be a relatively flat year with 2013. That was the case then, and that's the case today. The midpoint of our outlook today is within about 1% of 2013 sales and revenues. The second main theme this morning is around execution, which has been good. Manufacturing, SG&A, and R&D costs are close to $500 million favorable in the first half versus the first half of 2013. Cash flows continue to be strong. We've improved inventory turns. PIMs continue to improve. We have raised our profit outlook again this morning. The third major theme this morning is cash deployment and the actions we have taken to help drive shareholder return. With the stock buyback we announced this morning, we expect that from the start of 2013, last year, to the end of the third quarter of this year, that we will have repurchased $6.2 billion worth of Cat stock and made two substantial increases in the quarterly dividend. So that is three themes, consistency, execution, and shareholder-friendly cash deployment. Now let us get into the second quarter results. Sales and revenues were $14.2 billion, and that was about 3% below the second quarter last year. Construction Industries was up 11%, Resource Industries down 29%, and the rest, Energy & Transportation, Financial Products, and our All Others segment combined to be roughly flat with the second quarter of last year. For construction, North America has been an area of strength, and you might be surprised to hear, so has our EAME region, particularly Europe, in the second quarter. It has been better as well. Construction sales in Latin America were about flat with the second quarter last year. But as we get into the third quarter, Latin America will likely turn a bit negative versus last year. That is not driven by big economics. It is primarily related to large sales of backhoe loaders and motor graders that we have had to the Brazilian government. It was positive for sales last year and through to the first half of this year, but those orders are complete. You should expect to see, in the retail statistics that we release each month, some decline there. So do not be surprised if you see that. We expect that. It is included in our outlook. Construction sales in Asia Pacific were down slightly, and that includes weaker sales in China. In China, we started the year 2014 with improving construction equipment demand, but over the second quarter, it weakened a bit. Our Resource Industries segment, which again is mostly mining, was down 29%. It was down 35%-40% in every region of the world except North America. North America was much less negative than the other regions, partly because the steep sales decline in North America started earlier. In other words, it was probably closer to the bottom a year ago. In addition, better sales to quarry and aggregate customers was also a factor. That part of Resource Industries tends to be a little more closely aligned with construction. Particularly in North America, that has been performing better. So again, overall, mining sales weak. However, this was the first quarter since 2012 that Resource Industries sales were higher than the previous quarter. That means second quarter of 2014 sales were about 6% higher than the first quarter. Sales improved from first to second for both new equipment and for parts. In fact, for parts, it is the second consecutive quarterly improvement. Q1 of 2014 was up slightly from Q4 of 2013, and Q2 this year was a little better than Q1. Now, it is too soon to suggest that the mining business is turning around, but it is good to see sequential improvement. Moving on to Energy & Transportation, it's been an incredibly stable, high-performing business over the past few years, and this quarter was no exception. Overall, sales for Energy & Transportation were stable with the second quarter of last year. Even if you take it down to the next level, and you look at sales in the major industries served by Energy & Transportation, and that's oil and gas, power gen, transportation, and industrial, the sales were individually pretty flat with the exception of power gen, and that was down high single digits. Even there, we see that being an issue around the timing of some large projects. In summary, on second quarter sales, and as you probably expected going into the quarter, construction sales were up nicely, mining sales were lower, everything else was pretty much flat. Okay, let's shift from sales to profit in the second quarter. Headline numbers. Profit per share of $1.69 excluding restructuring, and $1.57 including restructuring costs. In comparison, profit was $1.45 in the second quarter of 2013. By segment, Resource Industries was the only segment that we had that declined versus the second quarter last year, the rest were up. A couple of big bright spots were a profit increase of more than 80% for Construction Industries and an all-time record profit for Energy & Transportation, and in fact, their first quarterly profit over $1 billion. From a consolidated perspective, we provide an operating profit comparison by reason in our release. Today, that's the graphic on page 6 of our financial release. Because the individual buckets in that waterfall graph are relatively small, I'm not going to go into each one of them in any detail. I would summarize by saying that manufacturing costs and price realization were modestly positive, and the negatives were a bit lower sales volume, the restructuring costs in the quarter, and absence of a sizable $135 million gain that we had in the second quarter last year, related to a settlement with previous owners of our Siwei acquisition. That's the quarter. Let's turn to the outlook for 2014, where we've made a modest change to sales and revenues and increased our outlook for profit. For sales, half of the year is behind us, and we've tightened up the range and lowered the midpoint slightly. As I mentioned at the outset of the call this morning, our view of 2014 sales and revenues has remained reasonably constant. In other words, a flattish year versus 2013. We thought that was the case last year, we think that's still the case today. That said, with half of the year over, we've tightened the range, and the updated range is a forecast of $54 billion-$56 billion in sales and revenues. For reference, the previous range was $56 billion plus or minus 5%. That meant a range of just over $53 billion to just under $59 billion. The middle of the new range is $55 billion, and that is slightly lower than the previous midpoint of $56 billion, and most of that change is in Construction Industries and reflects the weaker sales expectations in China. Based on the reporting out of China, that probably shouldn't be much of a surprise. A decline in expectations in the CIS and in the Africa, Middle East region. Given the political turmoil in those parts of the world, that's probably not a big surprise. In terms of profit, for a better understanding of results, we're providing the outlook again, both with and without restructuring costs. Today, we've increased the outlook for both. Excluding restructuring costs, we've increased it to $6.20 a share. That's a 10 cent increase from the prior forecast. Our expectation for restructuring costs is near the bottom end of our $400 million-$500 million range. With restructuring costs all in, our updated outlook is profit per share of $5.75, which is 20 cents per share better than the previous outlook. To help you think about the rest of the year, the third and the fourth quarter, there's one more thing I'd like to cover, and that's how we're thinking about the last two quarters. There's typically seasonality in our sales, and we think that's going to be the case this year as well. We've got half of the year behind us, and you know the midpoint of our outlook. We basically have the second half of the year, not a lot different than the first half. We expect sales and revenues in the third quarter to be similar to the first quarter of 2014, and fourth quarter sales to be more in line with the second quarter of 2014. In terms of profit per share with lower sales in the third quarter, it'll likely be the weakest profit quarter of the year. With higher sales in the fourth quarter, profit per share should be similar to the average of the first and second quarters of 2014. I hope that helps you think about our expectations and how the third and fourth quarter could play out. If you missed writing that down, again, we'll be reposting the transcript of this call on our caterpillar.com website. In addition to our financial results, this morning, we announced that we expect to repurchase another $2.5 billion of Caterpillar stock in the third quarter. This repurchase is a part of the $10 billion that the board authorized earlier this year. The context behind our repurchases, really over the past two years, is consistent with our cash deployment priorities. Coming out of the 2008 and 2009 Great Recession, we had work to do to improve the strength of the balance sheet. We needed to invest for growth, and with very low interest rates, our employee benefit plans needed additional funding. Over the past few years, we've made significant progress. Our Machinery, Energy & Transportation debt-to-capital ratio is at the low end of our target range. Benefit plan funding is in good shape, and we generally have the production capacity in place that we think we'll need for the next few years. Although we will continue to be opportunistic, we aren't expecting any large acquisitions. With nearly $9 billion of Machinery, Energy & Transportation operating cash flow last year in 2013, and nearly $4 billion in the first half of this year, and with significant cash on hand, we've had the opportunity to take substantial actions to improve shareholder return. In 2013, we repurchased $2 billion worth of stock and raised the dividend by 15%. In June of 2014, we increased the dividend again an additional 17%, and by the end of the third quarter of this year, we expect to have repurchased about $4.2 billion of stock in 2014. That is the $1.7 billion in the first quarter and the $2.5 billion in the third quarter. Rewarding stockholders is an important goal, and our actions demonstrate our commitment. In summary, we had a pretty good second quarter. We raised the profit outlook for 2014, and we announced another $2.5 billion of stock repurchase. With that, we are ready to shift over to the Q&A portion of the call. 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. Pressing 1, 4 a second time will also remove yourself from the queue should your question be answered. Lastly, we ask that while posing your question, you please pick up your handset if listening by speaker phone for optimum sound quality. Again, to ask a question, please push 1, 4 now. Okay, we will take our first question from Andrew Kaplowitz. Please announce your affiliation. I am from Barclays. Good morning, guys. Nice quarter. Hey, Andy. Good morning. Mike, you said in the release that dealer inventories declined about $500 million in the quarter, and you also talked in the release about the decline in inventories this year now being more than you previously expected, mostly driven by Resource Industries. How much did this contribute to the reduction of your sales forecast, and what kind of visibility do you have to a bottoming in destocking really across the company, but particularly in Resource Industries? Yeah, good question, Andy. Dealer inventory has certainly been a factor. Versus our original outlook when we started the year, it kind of looks now like dealer inventory is going to be down maybe $1 billion or so more than we thought. In fact, the first quarter and the second quarter combined were still up slightly for the year. We had a $700 million increase in the first quarter, a $500 million decrease in the second quarter, and a lot of that is seasonality. But in the second half, we're looking for about $800 million of decline per quarter, so about $1.6 billion coming out in the second half. That's having an impact on second quarter, or I'm sorry, second half results. It's a couple of things. One, we've not really had a turnaround in mining yet, and so dealers are continuing to satisfy some demand out of inventory. We thought it was going to be a lot less coming into the year and things might start picking up. We really haven't seen that yet. That's one factor. Then I think on Construction, dealer inventory, we're going to end the year probably a little bit lower than we thought. That's actually despite a pretty darn good year so far for Construction. I think it's a case where we talk a lot about execution. We've actually been able to take down our Lane 1 channel inventory that we have, and dealers have been able to take their inventory down as well. When you think about what's an adequate supply, kind of going back to your question, it's within a range. I think particularly for Construction, it's getting down to a pretty good level. If demand doesn't decline, then you'd have to think going forward that dealer inventory is going to be in even better shape at the end of this year than it was last year. In summary to your question, I know it was kind of long-winded. Dealer inventory is having a bit more of an impact this year, and it's a principal reason why the second half sales aren't going to be better than what's in our forecast. Okay, Mike, that is helpful. Then maybe just shifting gears. You talked about the timing of large projects negatively impacting your E&T retail sales, but your outlook for your E&T really has not changed. Can you talk about your visibility in this segment? Do you still feel good about it because backlog is up? Maybe specifically about power generation, what you see there? Yeah. I would say E&T overall, I would say we feel very good. Second half looks like it is going to be pretty strong. We have had, I would say, very good order rates over the last quarter, particularly for oil and gas. For large engine products in general, but oil and gas has been particularly good. So that has contributed to the increase in the backlog there. With electric power, we kind of have a couple of different businesses. We break it down between the industrial business, which is essentially large scale installations, and then small, we call it retail gensets. The big genset business, the big end has been pretty good, and that is the piece of it that can tend to be lumpy around big projects. We had some last year, we will have some this year. The timing affects how that plays out, certainly by month and by quarter. You see that in the retail statistics. It will move around quite a bit. I would tell you, we feel pretty good about Energy & Transportation overall. Really most of the sectors within there, and particularly oil and gas. Thank you, Mike. Okay, we'll take our next question from Robert Wertheimer. Please state your affiliation. Hi, it's Vertical Research Partners, and good morning, everybody. Mike, you mentioned the oil and gas strength, and I know fracking's been picking up and some of your channel partners have been bullish on that and pipeline, a bunch of other stuff. If I'm not mistaken, you have a Tier 4 changeover in some of the oil and gas engines for next year. Could you talk generally about the high horsepower Tier 4, how many engines you have running, how confident you feel, whether there's any kind of a pre-buy going on there? I'm going to have to defer that question, Rob. I'm not an expert on that. I don't know the number. Sorry. Okay. No, that's fine. I'll follow up after. I should have said that before. I guess the second question you just kind of addressed at length, so I apologize for going back to it, but the dealer inventory, which you give good disclosure on. Are you comfortable that the construction, which has been very strong and you're gaining share in enough markets, so it's really hard to sort out, but are you comfortable that the construction inventory hasn't restocked a little bit too much? Can you tell that, especially in LATAM, where some of the markets look really soft? You mentioned the big government project. I'm just curious if you think the construction inventory overinflated at all in the first half. Your margins were quite good in the first half and you're signaling down. So that's my second question. Yeah. I think the first and second quarters played out pretty close to what we thought. If you think about it, the first quarter, for sales to end users is always one of the lowest quarters of the year. Dealers commonly stock up and then sell it down in the second quarter, which they did this year. It came down. The third quarter is usually pretty weak as well. A lot of Europe is on vacation. A lot of other parts of the world take vacation time, and we feel that in all business. Certainly a bit more of that will come out in the third quarter and then again, more probably in the fourth quarter. It's always tough to forecast this with massive accuracy. We look at what a reasonable months of sales are, but that varies by region, and it's a reasonable range. I think Construction Industries, based on where we are in terms of the timing of the year, what their expectations are for year-end, is definitely within that reasonable range. Thank you. Are you able to say what the total mining dealers destock is this year? You've kind of said it, but I just want to make sure I back into it right. Yeah. I think it's going to end up being about $1 billion, if memory serves me. Yeah. I'm not 100% sure on that, but I think that's order of magnitude. Thanks, Mike. Which is more than we thought coming into the year. Yep. Thank you. Okay, we'll take our next question from Jamie Cook. Please state your affiliation. Hi. Good morning. Credit Suisse. I guess, a couple questions around the mining or the Resource Industries business. The sales were up sequentially, which was nice. The margins were down sequentially. I get the year-over-year issues, but I guess the margins in Resource Industries disappointed a little relative to my expectations, in particular when you said aftermarket was up again. Can you just talk about that? Is that just investment that you incurred this year that you held off on last year? Then I think, last quarter you said in terms of Resource Industries margins, you expected them to be about flat with the first quarter. Is that still the way to think about it? Then my second question, again, sorry, a follow-up on just the Resource Industries business. You said, I think OE and aftermarket was up. Can you give a little color around what markets or both on OE and aftermarket, just a little more color on that commentary you mentioned in the prepared remarks. Thanks. Yeah, this is Brad Halverson. Just one comment on our Resource Industries segment in terms of its margins. This segment is critically important to us, and we've made a conscious effort to continue to invest in the technology and autonomous mining and those types of things, as well as our initiatives around Bucyrus. I would say that we have made a conscious decision relative to maybe our normal expectations on pull-through to continue to invest in this segment, even where their sales are at. Jamie, their incrementals, I think, too, were really operationally better than the numbers look like just right off the face of the statement. Last year, they had a $135 million gain from the Siwei settlement. So, if you adjust for that operationally, they look pretty good. No, I get that. But is there any way you can tell us what the investment number this year relative to sort of what you were thinking about last year, and then again, how to think about margins for the full year? Yeah. We're at a point now where margins are low enough and sales are low enough. The percentages, I think the dollars are probably, in some ways, a little more important and easier way to think about it. We were $140 million something in the first quarter, $130 million something in the second quarter. I don't think you're going to see material changes from that, probably for the rest of the year. Okay, sorry. Then just any additional color in the commentary with the aftermarket being up again in the second quarter. Oh. Was that a sequential uptick from Q1? Just color on where you're seeing it on the OE side as well. Yeah. Actually, from first to second, in fact, what I looked at last night was sort of less about regions and more about products. Okay. It was actually small numbers. I'm going to start with that. Small numbers, but fairly widespread on the OE. The part sales, we have strength in part sales on things like underground coal, trucks, traditional Cat product were actually a little better than most. Where we're seeing downside on the aftermarket now are on things like deferred maintenance on big shovels and draglines and the like. I say that, and the numbers aren't huge. Even the increase quarter over quarter was actually relatively small, but thankfully, turned in the right direction. Okay, great. Thanks. I'll get back in queue. Okay. We'll take our next question from Nicole DeBlase. Please announce your affiliation. Yes. Morgan Stanley. Good morning, guys. Good morning. I just wanted to address the locomotive business a little bit. Your biggest competitor there saw pretty strong equipment order growth this quarter, I think 40%. I'm just curious how locomotive orders are trending for Cat. Are you guys seeing the positive impact associated with the Tier 4 pre-buy at all yet? Yeah. This is a big year for locomotive sales, probably the biggest since we've owned EMD. There've been a lot of misconceptions about this, and this is a good opportunity, I think, to clear some of those up. EMD has been a great acquisition on our part. Their market share has gone up in North American locomotives quite a bit since we bought them. Their sales have gone up quite a bit. I wouldn't use the words pre-buy, but certainly dealers have ordered a lot of locomotives from us, as well as our competitors, for delivery this year. Okay. When will we start seeing the sales pick up in 3Q, or is it mostly a 4Q event? Well, again, production has been going pretty solid all year long. Effectively, we're booked solid. If we could have built more, we probably could have sold a little bit more this year. But we are booked solid on locomotives. The timing of the sales is around when we deliver them, and we'll probably have a better both third quarter and fourth quarter. Now, on the whole Tier 4 question, we're close to our customers. There are not that many in North America. They're largely the big Class I railroads, and we have very close relationship with essentially all of them. We've been talking to them about Tier 4 expectations for a long time. They've been telling us they don't expect to order much for the next couple of years. We've talked to them about our Tier 4 plans. It's no surprise to them. Our view is that the marketplace expectations over the next or that the industry in North America over the next couple of years is going to be down a lot from where we are right now. The impact of the timing of our Tier 4 product is not going to have a very material impact on our sales at all. Okay, Mike. That is really helpful. I would just add, it is Doug Oberhelman here on the EMD acquisition in general. As Mike said, we are really happy with that business. Since we have owned it, sales have more than doubled. This is a big year, a big pre-buy year for sure. We would expect and have, in talking to our customers, a post-buy anemia in 2015 and 2016. Based on that, we modified the Tier 4 development program that was in place when we acquired EMD, because we did not really like what we saw in terms of the end product with that engine. In doing that, we contemplated that there would be virtually no or little demand in 2015 and 2016 in North America. That is why we ramped up this year. That is why we delayed our Tier 4 program, and we will have a really good offering late 2015, 2016 in Tier 4. Not to mention, our natural gas program for locomotives that is already in place, and some of those will be available, in fact, are running today. We think we have really got a good program going. Our market share has gone up significantly, as Mike said, in North America, and outside North America, sales have been fairly active as well. I am really pleased with the EMD acquisition, one of our better ones. Okay, thanks. My second question is on E&T margins. The segment margins there were really good, reaching a new high this quarter. Was there anything special to call out that drove the 19.5%, or do you think that level of strength could continue into the second half? Well, I won't make any comments on their margin in the second half because we don't really do guidance by segment. They've been doing just a fabulous job of executing on sales that were actually down a couple percentage points. They managed costs down and improved their margins, and they've been very stable. Whether or not it's going to be exactly the same as this quarter, that depends a lot on production, mix of products, regions they're sold. You can always expect some bit of up and down in the margin rate. I think overall, they've just done a great job, not just this year, but really over the past three years. Sales have been stable and profits have been going up. Okay, thanks. I'll pass it on. Thank you. We'll take the next question from Timothy Thein. Please announce your affiliation. Great. Citigroup. Thanks. Good morning. Mike, just coming back to the comments on oil and gas, and specifically within well servicing in North America. I am curious, as the capacity is starting to come back, how do you feel about your relative position in that market in terms of now having the full offering in terms of pumps, transmissions, and engines? Related to that, are you seeing any, just given how quickly demand has come back after being dead for 18 months or so, are you seeing or experiencing any particular kind of product delays or extended backlogs for your products? Well, it is not a business so much, Tim, that orders today and expects it tomorrow. We are increasing production of large engines. We are taking up the build rates in Lafayette because of the increasing demand. Back to your original point, we have been a leader in this kind of business for a long time, and I think the addition of transmissions and now the pressure pumps with our JV strengthen that. I think it is a great business. It lines up well with kind of the strengths of Caterpillar, durability, reliability, service, dealer network, parts supply. It is a great thing. You are right, if you go back a couple of years ago, let us just say there was plenty of equipment in the market, and it slowed down pretty dramatically from there. Last year was quite a down year for well servicing. But I think they have gone through the maybe the excess inventory they have had, that plus a little bit lower supplies of softer supplies of gas, supportive prices. In good orders from our standpoint, it looks like it is going to be a pretty good business. Okay, thanks. Just switching back over to, you touched earlier on parts sales and mining, and I saw one of the majors the other day, actually the largest miner who they are guiding to production growth across some of their key industrial commodities of 4%-10% in their fiscal FY 2015. I recognize that the industry is doing a lot more now to kind of sweat their assets. But just going back to what is embedded in your guidance, obviously, you have taken the forecast down a bit on mining, but how long, I guess, do you expect before we start to see more of a recoupling between your parts sales versus underlying production? Tim, that is the $64,000 question. It's been, baffling is probably the wrong word, but generally, mine production has been pretty good. But equipment sales have been very poor. They probably had a little more equipment that they needed. It's a little bit almost like the fracking situation. It will come back, there's no doubt about it. They're selling or they're buying right now at levels that are far below what a normal, sustainable replacement level would be. But again, the question is on a little bit like fracking and well servicing. When will it turn around? It's hopeful to think that with parts sales starting to edge up a bit and the equipment sales not going down anymore, that we're at an inflection point. But I Both our mining customers and ourselves have proven that it's an industry that's extremely tough to forecast. The honest answer is it needs to go up. It will go up. It's just the timing of when that's going to happen that we don't know. Just a little more color on that, Michael and Tim. There's no question that there was an artificial boom up until 2011, 2012 in the world. The bust since then is equally, I would say, of the same magnitude, if not worse. We are seeing our customers delay maintenance, defer maintenance, do things that they have not done in the past. So at some point, and as Mike says, we don't know when this will come back to us, even if it's replacement part cycle, which we haven't seen yet. Now, I fully believe, and as do our customers, that the bottom is just behind us, and our numbers are just almost minuscule in terms of ticking up, but they are ticking up. And I think anecdotally with our customers, they see that too. When they start to get back into a normal parts replacement cycle and even a normal OE replacement cycle is unknown. But a lot of that will depend on how they're mining. And I saw that announcement as well with a big one or two. I've met with a lot of them in the last couple of months, and a number of them are talking about taking production down, but most of them are just talking about continuing more of the same. The bottom line is we don't know when it's going to come back, but it will come back. And I suspect we'll see a replacement part cycle first of some magnitude. Thanks, Tim. Thank you. Okay, we'll take our next question from Larry De Maria. Please state your affiliation. Thanks. Larry De Maria, William Blair. Just stick with EMD for one minute. I think you mentioned that you have an offering late 2015 or 2016 for Tier 4. Is that ahead of schedule for the 2017 launch? And how successful are we now in building an international book to offset the decline you mentioned domestically? Yeah, a couple of things. Our view is that we should have a Tier 4 diesel offering for 2017. We have actually a big aftermarket rail business, a big service rail business, and we sell locomotives and components internationally, and we're increasing our passenger rail business as well. So there's a lot of aspects to this, and I think with the big push in North America that we've had this year, with a big demand from customers, one of the things that we've done our best to do is to defer as much of the non-North American demand as we can into next year. So, we've done that. I'm not going to maybe give a forecast for next year at this point. It's a little early for that. We'll talk about 2015, maybe a little bit more next time we get together for one of these calls in October. But we have actively tried to focus as much as we possibly could more in North America this year because of the big demand. Okay, thanks. Moving over a little bit, I know the business clampdown obviously calls to increase field population, and you got some price in Construction Industries. But in the strong markets like North America, are we any closer to pushing through bigger price increases? Or are we still concerned with decreasing gains at this point? I know it's having some, obviously, reverberations in the industry, and maybe you're under-earning a little bit compared to potential, but you're improving your market position. So just curious if we're any closer to getting more outsized price gains. I think our strategy over the last few years, and we've been just pounding through this quarter after quarter, is to have very modest pricing, get cost reduction, improve quality, improve delivery performance, and get market share, and that's what we've been doing. Through that period, we've had a very stable pricing environment, not much up, not much down, and I don't see that changing in the near future. Okay, thanks. Okay, we will take our next question from Theoni Pilarinos. Please state your affiliation. Hi, Raymond James. You made it clear at your Analyst Day that it was a priority for you to take some of the cyclicality out of your business and make your cost structure more flexible. Just looking at the mining segment and talking about when it returns, eventually it will return, and when it does, how do we balance the uptick in demand that we have seen in previous cycles and the backlog that we get to with some of the restructuring and layoff costs that you are taking now? Do you think that you are going to be caught, as you have in the past, with not enough capacity to meet demand? Well, we put in capacity, physical capacity in the last cycle, and I think we have adequate capacity in mining, even for a sizable upturn when it comes. What we have tried to do with our cost structure, as you say, is make it more flexible, and that means being able to take out costs when volume goes down and add cost when volume comes back. In other words, try to make more of the cost structure as variable as we can. We have done that. Over the past two years in mining, we have taken a lot of cost out. We have taken fixed cost out, or we call it period cost out, in our major manufacturing facilities. But we have done that without materially impacting capacity. So when things turn up, there is no doubt we will need to hire more people to get the work done. I will just give you an example of the kinds of things that we have done to make that happen. We increased capacity quite a bit for large trucks over the course of 2010, 2011, and 2012. We essentially did that in our Decatur facility. We did not add any square footage to do that. It was all about how we laid out the factory, the equipment, the processes, to get more production out of that facility. So, other than depreciation, we did not add a lot of fixed costs to get extra capacity. So that is just an example of the kinds of things that we have done. I hope we do get a big turnaround that causes us to need more people. That would be good for us, that would be good for the industry, that would be good for the country. Let me just add a little bit more to that. Looking back at 2012, we did $65 billion in volume at that time. This will apply to both Construction Industries, Resource Industries, as well as Energy & Transportation, for that matter. We have been working hard, as you know, on lean manufacturing, which is adding capacity every day in a very lean way as we go forward. That will come home to help us as well. So you have seen our CapEx numbers come down the last 2 or 3 years. We invested early during this cycle to take advantage of that, which we did. We built market share. So our CapEx needs are pretty well met, we think, organically the next few years, at least early through the next upturn. So we are in pretty good shape with all of that. I do not expect to miss a sale, to tell you the truth, on the way up when the business returns in mining. I would go so far as to say I expect the same thing in construction because of the lean activities we are doing there that help us with lead times, short lead times, and better availability. Okay, great. Thank you. My second question has to do with your recovery. You have kind of described it as slow and steady so far this year in the U.S. We have seen a couple of months now of non-res pickup, and this has typically been the key turning point for you in addition to the highway bill. How do things sit now that we have had a month or 2 of non-res pickup? How does that change anything from the slow and steady recovery we have seen, if at all? Well, it's been slow and steady overall. Actually, North America and construction has been pretty good this year. I would describe North America as a little better than slow and steady. Although we didn't change it a lot, as a part of the updated outlook, the principle change was down for construction, as I said before, a little China and then the turmoil in the Middle East and the CIS causing caution. But in the midst of all that, we actually edged U.S. construction up a little bit, and I think the signs there are encouraging. To put it in some context, though, Theone, we've had a few years of improvement in North American construction. This has been actually a pretty decent year. But even through all of that, we're still thinking this year is on a kind of unit basis. We're still thinking this year is going to be sort of 15%-20% below the 2006 peak. So there's still a lot of room, I think, to run in construction in North America. We just need some sustained decent economic growth in North America. We need a highway bill to get sorted out. We need economic activity. Housing starts are well below what the long term needs to be to support population growth. At some point, it's a little bit like mining. That stuff is going to come back, and when it does, it'll be positive, and it's starting to now. Okay, great. Thanks a lot, Mike. Okay, we'll take our next question from Ross Gilardi. Please state your affiliation. Bank of America. Thank you. Mike, with respect to E&T and margins, shouldn't mix work strongly in your favor in the second half versus the first half, given the pickup in oil and gas orders that you mentioned, which at least the turbine business, I think, is your highest margin business. You've got the sharp pickup in locomotive orders as well, which is still in front of you for the rest of the year, or at least the locomotive deliveries, excuse me, coupled with a weaker power gen market. I would think margins would be that the mix would definitely be a benefit in the second half of the year. The stuff that you said was true, or much of it was, but it doesn't necessarily all come to the conclusion that you've drawn. Oil and gas should be, we think, good in the second half. I think most of the areas of the Energy & Transportation business we think are going to improve in the second half. It's not all going to be concentrated in oil and gas. I don't see a big impact on mix in the second half. We do have a couple of big orders going out, or one big sale that we're expecting that'll probably be a little below the average. That'll temper or be certainly less than the average margin rate. That'll temper E&T expectations I think a bit later in the year. E&T is in some ways similar to a lot of the rest of the business. We have higher discretionary costs in the second half of the year than we do in the first half of the year. Some engineering programs are likely going to ramp up there a little bit, too. I wouldn't get carried away on. Margins this quarter were quite good. I wouldn't get carried away at all thinking they're going to get a lot better in the second half in E&T. We had a great second quarter there. Okay, great. You talked about pricing as the principal driver of the margin expansion year-on-year in E&T. Can you flesh out a little bit more what's happening there, and is it sustainable? Say that again? Yeah. In your press release, you attributed the year-on-year operating profit improvement for E&T to pricing, and I was wondering what's happening there. Any particular businesses where you're seeing more pricing power, and is it sustainable? Yeah. Here's the thing. When the numbers are relatively small in terms of change, operating profit, if memory serves me, was up a little over $50 million. It wasn't a lot. When you have small changes in operating profit like that, and we're describing the reasons, sometimes it makes it seem as though it's maybe more important than it was. The changes that we had in pricing for Energy & Transportation certainly weren't outsized. Again, it's like, just for the total company, if you look at the waterfall chart, all of the buckets are relatively small. Describing anything that's inside them can make them seem a little more important than they are. So no, there's not a big price increase going on there. I don't see any big change in pricing activity going forward. Okay, thanks. This is the last one real quick. Was Russia and CIS, how big is it, and what are you seeing with the sanctions? Yeah. The CIS is not huge for us. We do not do sales by country. It's, as you would expect, a lot less than some place like China. The industry there is just not as big. But it has come off. Even though it's not big, it's come off a lot, and that's what makes it worth mentioning. Okay. All right. Thanks very much. Thank you. We'll take our next question from Jerry Revich. Please state your affiliation. Hi, good morning. It's Goldman Sachs. Good morning, Jerry. Mike, at the Analyst Day, we spent some time talking about the focus on supplier development and just improving the connectivity. I am wondering if you could just give us an update on how those efforts are tracking, if you can share supplier on-time deliveries or other metrics that you are willing to talk about just to give us a sense for progress. Jerry, that is a great question, but of all the things I tried to prepare for this call, that wasn't one of them. I would be happy to ask the purchasing guys or our procurement group that question, but I am afraid I do not have a good answer for you. How about a second question? Well, Jerry, maybe I will just comment quickly in general terms, and Mike can get the numbers back in terms of percent. But I would say that our global purchasing group under the lead of Dave Bozeman, combining that with our Lean initiative, focused on built-in quality, right part, right time, and then more importantly perhaps, the customer lead times. The collaboration with our suppliers is outstanding right now, and we are seeing good progress connected to our Lean initiative across the board. So I would say relative to our engagement with suppliers and collaboration, and you are kind of seeing that I think in our material cost results over the last year and a half, it is all been very positive. Okay. My second question, just on the restructuring costs, sounds like the timing's moving around a bit. Can you just give us a sense for what kind of cost savings you'll be delivering by the fourth quarter on a run rate basis and what kind of tailwind we should look for next year? Separately, Mike, I guess in the past when sales have stabilized at low levels in places like Resource Industries, you've been able to deliver improved profitability and margins even at flat sales once you stop cutting production. I'm wondering if that's a possibility as we think about 2015, if you're willing to address that. Yeah. I'll let Mike handle, this is Brad again, handle 2015 in the back half. I would say the restructuring has just moved a little bit. We'll have some of that cost move into 2015. I would say probably roughly around the midpoint of $450 million is still a good number in total, but some of that will spill over to 2015. I would say the benefits are by and large consistent with what we've talked about before. It's not the only thing we're doing around cost restructuring or cost management, I would say. We talked a little bit about what we said in terms of the last conference. We're embracing the fact that we do have some cyclicality, but I think the thing to remember is the fact that we have a lot of diversity. We really have one segment right now that's not performing. It's in the bottom of their cycle, but we have a strong Energy & Transportation business and a Construction Industries business, strong in North America, a little concerned in the developing world, but the margins have improved significantly. I would say from an execution standpoint, how we're managing these businesses and where we're spending our money, we had good cost reduction last year. We had $500 million, roughly, in the first half of this year, and it's kind of part of how we're operating now. So I feel pretty good about the fact that we have good, consistent execution. Yeah. You didn't ask this, but I just wanted to chime in one more thing that I thought might come up but hasn't. If you look at the second half of the year and the first half of the year, we got a headwind in the second half of the year that was a small headwind. It was a small tailwind in the first half. For the year, it's going to be pretty neutral, and that's inventory absorption. Not dealer inventory, but Cat inventory. We had a small increase in the first half, and we expect that to come down in the second half and finish the year basically fairly neutral. What that's meant is that's been a little positive in the first half of the year, and it'll be a little negative in the second half of the year. That is also one of the reasons why you are seeing a little difference in first half and second half profit. Thank you. I think we have time for one more. Okay, we will take the next question from David Raso. Please state your affiliation. ISI. Can I clarify the dealer inventory comments? Sequentially, did you say down 800 each the next two quarters? Yes, sir, we did. That includes engines and machines or just machines? Yeah, that's machines. I don't think engines is forecast to change much. Okay. Dealer inventory in engines is small and has been much more stable. What I was talking about was machines. Just to be clear then, the second half of the year, on a year-over-year basis, production then is going to be largely in line with retail. Say that again, David. The first half of the year, you've had some nice help from the dealer swings in inventory. Well, overall it wasn't much. We went up 700 first quarter, down 500 second quarter. The first half was a couple of hundred million. Well, I'm speaking year-over-year, Mike. The first half of the year- Oh. You had about $1.8 billion. Yes. Yeah, it was about $1.8 billion help, right? Just the year-over-year changes. The second half of the year, just so I'm clear, it looks like the year-over-year change will be pretty much neutral, because last year, third quarter, inventory went down 800. Last year, fourth quarter, inventory went down 700 sequentially, right? The year-over-year- Similar. is a bit of a push. Yeah. So that said, if production's going to be basically in line with retail year over year, it implies the dealer stats, the retail stats. You must be looking at something from the dealers that are telling you that the retail data is going to get also pretty close to flat year over year, because that's how you're forecasting your own sales for the second half. I know the dealer stats don't include pricing, don't include parts. So just to make sure I'm reading that right, as I see the dealer stats come out, there must be some implication here that the dealer stats do get close to flat over the course of the second half of the year. Is that fair? Yeah, I think we would see it trending more towards that as the year goes on. I think that's a very reasonable assumption. Okay, and the last one, the sequential from mining revenues. David, I'll just go on from that. Sure. Throughout much of last year, the mining numbers were continuing to go down. What a lot of that will be is we will be lapping what was actually quite low Resource Industries. That's probably where you'll see a lot of the improvement. You've already started to see that. This last month on Resource Industries, it was less negative than the prior month by a reasonable margin. Well, to that point, obviously, people watch the monthly retails. The fact is, if you look at the last 3 months for machines, it was still down 10%. Engines was also down 10%. The way the guide plays out, obviously, you must be looking at something from the dealers that tell you we're going to get pretty close to flat year-over-year in the second half. I don't mean just one month, I mean basically for the second half, right? That's how you get to your own sales. That moment retail turns positive, obviously the stock's going to respond to that. I'm just trying to figure out, am I reading that properly, that there's something you're seeing from your dealers that's telling you you're going to have a machine number, I don't care if it's Resource, Construction, but combined, those numbers are going close to flat soon, as well as in engines, or you couldn't have a flat Cat sales in the second half because there's no longer that big production retail gap. Yeah. I'm not going to give you an exact kind of number because as you started out, parts and service matters. Right. Pricing matters, currency impacts matter a bit. But I think your underlying premise is that the retail stat should, relative to a year ago, start looking better is absolutely true. All right. Now that we're past 12:00 P.M. Eastern, I'll cut it off. I'll ask you my second question offline. So thank you very much. Yeah. I appreciate it. Okay, with that, we are a couple of minutes over. We will wrap it up. Thank you very much, everyone, and we will see you again in October. 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.