Caterpillar Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
August 1, 2022

There are 18 speakers on the call.

Operator

Welcome to the Second Quarter 2022 Caterpillar Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ryan Fiedler. Thank you. Please go ahead.

Speaker 1

Thank you, Emma. Good morning, everyone, and welcome to Caterpillar's Q2 of 2022 earnings call. I'm Ryan Fiedler, Vice President of Investor Relations. Joining me today are Jim Umpleby, Chairman and CEO Andrew Bonfield, Chief Financial Officer Kyle Eppley, Senior Vice President of the Global Finance Services Division and Rob Rangel, Senior IR Manager. During our call today, we'll be discussing the 2nd quarter earnings release we issued earlier today.

Speaker 1

You can find our slides, the news release and a webcast recap@investors. Caterpillar.com under Events and Presentations.

Speaker 2

The content of this call

Speaker 1

is protected by U. S. And international copyright law. Any rebroadcast, retransmission, reproduction or distribution of all or part of this content without Caterpillar's prior written permission is prohibited. Moving to slide 2.

Speaker 1

During our call today, we'll make forward looking statements, which are subject to risks and uncertainties. We'll also make assumptions that could cause our actual results to be different than the information we're sharing with you on this call. Please refer to our recent SEC filings On today's call, we'll also refer to non GAAP numbers. For a reconciliation of any non GAAP numbers to the appropriate U. S.

Speaker 1

GAAP numbers, Please see the appendix of the earnings call slides. Today, we reported profit per share of $3.13 for the Q2 of 2022 compared with $2.56 of profit per share in the Q2 of 2021. We're including adjusted profit per share in addition to our U. S. GAAP results.

Speaker 1

Our adjusted profit per share was $3.18 for the Q2 of 2022 compared with adjusted profit Per share of $2.60 for the Q2 of 2021. Adjusted profit per share for both quarters exclude restructuring costs. Now let's turn to Slide 3 and turn the call over to our Chairman and CEO, Jim Umbleby.

Speaker 3

Thanks, Ryan. Good morning, everyone. Thank you for joining us. As we close out the first half of twenty twenty two, I want to thank our global team for delivering another good quarter with double digit top line and adjusted profit per share growth Despite ongoing supply chain challenges, our 2nd quarter results reflect healthy demand across most of our end markets. We remain focused on executing our strategy for long term profitable growth.

Speaker 3

In today's call, I'll begin with my perspectives on our performance in the quarter, And then I'll provide some insights on our end markets. Lastly, I'll provide an update on our sustainability journey. For the quarter, sales were broadly in line with our expectations as we generated better than expected price and strong services revenue, which were offset by lower than expected sales to users. Similar to previous quarters, our top line would have been even stronger if not for supply chain constraints. We remain focused on executing creative solutions to help mitigate our supply chain challenges.

Speaker 3

Overall, we remain encouraged by the Strong demand in our end markets for our products and services. We're seeing strong momentum in services due to our service initiatives and investments. As I mentioned at our Investor Day in May, our confidence is increasing that we'll achieve our goal to double services to $28,000,000,000 by 2026. Operating profit margins came in slightly lower than our expectations, mostly due to lower than expected volume and unfavorable mix. Price realization more than offset manufacturing cost increases, which occurred earlier in the year than we had anticipated.

Speaker 3

However, this only partially offset the impact of volume and mix. Dealer inventory remains at the low end of the typical range $1,000,000,000 in the quarter. We expect the volume and price realization to improve in the second half of the year, which should lead to sales growth in the remaining quarters of the year, both sequentially and year over year. We also expect adjusted operating profit margins will improve both sequentially and year over year in the second half of twenty twenty two as our price realization will more than offset manufacturing cost increases. Despite ongoing inflation and supply chain challenges, We continue to expect to achieve our Investor Day adjusted operating profit margin and ME and T free cash flow targets for the full year.

Speaker 3

Moving to Slide 4. Sales and revenues increased by 11%, broadly in line with our expectations. The increase was primarily driven by 2nd quarter sales and revenues increased across our 3 primary segments versus the prior year, With sales higher in all regions except EAME. Sales in North America rose by 18% with double digit growth in the 3 primary segments. Strength in Latin America continued as 27% sales growth was supported by strong construction activity.

Speaker 3

In the Yaimi, sales decreased by 3%, primarily due to currency impacts. Asia Pacific sales increased by 3% As lower sales in China were more than offset by stronger sales elsewhere within the region. Compared to the Q2 of 2021, Sales to users declined 3%. For machines, including Construction Industries and Resource Industries, sales to users decreased by 4%, While Energy and Transportation was flat overall, sales to users were below our expectations, largely due to the impact of supply chain constraints. These constraints were mostly due to component shortages, which resulted in production delays and shortfalls against our schedules.

Speaker 3

For example, engine control modules have continued to be one of the most significant bottlenecks, mostly due to the shortage of semiconductors. We were unable to completely satisfy strong customer demand for our machines and engines and continue to incur additional costs due to factory inefficiencies and freight expenses. Sales to users in construction industries decreased 4%, primarily due to weakness in China and continued supply chain constraints. North America sales to users declined slightly, mainly due to supply chain challenges. Latin America saw higher sales to end users, While EAME declined slightly, Asia Pacific sales to users were down in the quarter.

Speaker 3

However, excluding China, The Asia Pacific region sales to users increased. The same holds true for Construction Industries overall. In Resource Industries, sales to users decreased 2% due to supply chain challenges and one off disruptions, including commissioning delays. Orders remain strong, although slightly lower than recent high levels. We continue to see high equipment utilization and parked trucks remain at low levels, both supporting continued demand for our equipment and services.

Speaker 3

In Energy and Transportation, sales to users were flat versus the prior year. Oil and gas sales to users were down in the 2nd quarter due to lower turbine and turbine related services, which were partially offset by continued improvement in reciprocating engines. As we mentioned during our last earnings call, we expected Solar Turbines new equipment shipments to be lower in the first half. Power generation and industrial sales to users remain strong due to favorable market conditions. Transportation decreased slightly.

Speaker 3

Now, I'll spend a moment on dealer inventory. Dealer inventory declined by about $400,000,000 in the 2nd quarter reflecting typical seasonality, similar to the Q2 of last year. Dealer inventories remain near the low end of the typical range and we continue to work closely with our global dealer network to satisfy customer demand. As a reminder, dealers are independently owned businesses. Operating profit increased 9% in the quarter to $1,900,000,000 The increase was driven by higher sales across our 3 primary segments, which largely reflected favorable price realization and volume Increased material and freight costs.

Speaker 3

As I mentioned, favorable price realization more than offset manufacturing cost increases. Operating profit margins were 13.6% in the Q2 of 2022 compared to 13.9% in the Q2 of last year. Although our adjusted operating profit margins improved sequentially in the quarter, they were slightly lower than our expectations, mostly due to lower than expected volumes and unfavorable mix. Andrew will discuss the consolidated and segment level margins in a few minutes. Our profit per share was $3.13 versus $2.56 in the Q2 of 2021.

Speaker 3

The adjusted profit per share was $3.18 versus $2.60 in the Q2 of last year. Now to Slide 5. We generated $1,100,000,000 of MENT free cash flow in the quarter. We continue to expect to be within our $4,000,000,000 to $8,000,000,000 M E and T free cash flow range for the full year 2022. Andrew will discuss this in more detail.

Speaker 3

Regarding capital deployment, in the quarter, we repurchased $1,100,000,000 of stock And returned $600,000,000 in dividends to shareholders. In May, our Board approved a new authorization to repurchase an additional $15,000,000,000 of common stock, which was effective on August 1. We also announced we're increasing our quarterly cash dividend by 8% to $1.20 per share. We remain proud of our dividend aristocrat status. We continue to expect to return substantially all I'll share some high level assumptions on our expectations for the full year.

Speaker 3

Overall, demand remains healthy across our segments. However, The environment remains challenging primarily due to continuing supply chain disruptions. Our teams are working hard to mitigate the supply chain challenges We expect to achieve our Investor Day targets for adjusted operating profit margins and ME and T free cash flow. We expect continued top line growth for the second half of the year, reflecting healthy demand, favorable price realization and our team's persistent efforts to mitigate supply chain disruptions. As I mentioned, our total backlog increased by about $2,000,000,000 in the quarter, led by Energy and Transportation.

Speaker 3

The backlog for Resource Industries and Construction Industries remain elevated. Although we continue to anticipate inflationary pressures in manufacturing costs, we expect price will more than offset these cost increases for the full year. Now I'll turn to our expectations for key end markets this year. In Construction Industries in North America, We expect non residential construction to continue to be strong due to construction backlogs. We also expect the ramping of projects from the U.

Speaker 3

S. Since early 2021. In China, the above 10 tonne excavator market was very strong during the first half of twenty twenty one. During our last earnings call, we indicated that the industry would be slightly lower than 2019 levels. We now anticipate the industry will be lower than we Previously expected.

Speaker 3

The rest of the Asia Pacific region is expected to grow due to higher infrastructure spending and commodity prices. In EAME, the EU has proposed an infrastructure investment package. However, business activity has moderated. Strong growth continues for construction activity in Latin America due to supportive commodity prices. Overall, we expect healthy demand for the remainder of the year Construction Industries.

Speaker 3

In Resource Industries, while our mining customers continue to display capital discipline, commodity prices remain supportive of investment Despite recent moderation, we expect production and utilization levels will remain elevated and our autonomous solutions continue to gain momentum. We expect the continuation of high equipment utilization and a low level of parked trucks, which both support future demand for our equipment and services. We continue to believe the energy transition will support increased commodity demand over the medium and long term, expanding our addressable market and providing opportunities for profitable growth. In Heavy Construction and Quarry and Aggregates, we expect continued growth in 2022. In Energy and Transportation, we expect improving momentum in 2022 with strong order rates in most applications.

Speaker 3

In oil and gas, although customers remain disciplined, we remain encouraged by continued strength in reciprocating engine orders, especially for large engine replacements as asset utilization increases. In 2022, while solar services are expected to remain steady, New equipment orders strengthened significantly in the first half, particularly in oil and gas, indicating sales growth in late 2022 and into 2023. Power generation orders remain healthy due to positive economic growth and continued data center strength. Industrial remains healthy with continued momentum in Construction, Agriculture and Electric Power. In Rail, North American locomotive sales are expected to remain muted.

Speaker 3

We also anticipate growth in high speed marine as customers upgrade aging fleets. Moving to Slide 7. Since our last quarterly earnings call, we published our 2021 sustainability report in May to highlight progress on our sustainability journey. In the report, we reiterated our commitment to further enhance our sustainability reporting and disclosures by utilizing The Task Force on Climate Related Financial Disclosures or TCFD framework and also committed to begin reporting estimated Scope 3 greenhouse gas emissions in 2023. As we continue to advance our sustainability journey through the Q2 of 2022, Caterpillar and our customers announced a number of Projects that will help contribute to a lower carbon future.

Speaker 3

In May, we announced a low carbon intensity fuel project with District Energy St. Paul to demonstrate a combined heat and power or CHP system fueled by various combinations of hydrogen and natural gas. CHP systems from Caterpillar provide both electricity and heat simultaneously, increasing overall efficiency and reducing exhaust emissions. With support and partial funding from the U. S.

Speaker 3

Department of Energy, the demonstration project will compare how hydrogen and hydrogen blends can be integrated This quarter, we also announced the acquisition of Tangent Energy Solutions, a U. S.-based energy as a service company. Tangent's suite of intelligent energy solutions will allow us to provide value to customers by helping them reduce energy costs, In summary, we continue to support our customers' climate related objectives with new equipment and services that facilitate fuel transition, increase operational efficiency and reduce emissions. We remain committed to contributing to a reduced carbon future as we help our customers build a better, more sustainable world. With that, I'll turn the call over to Andrew.

Speaker 4

Thank you, Jim, and good morning, everyone. I'll start by walking you through our Q2 results, including the performance of our segments. Then I'll comment on the balance sheet and free cash flow before concluding with our expectations for the Q3 and remainder of the year. Beginning on Slide 8, sales and revenues for the Q2 increased by 11% or $1,400,000,000 to $14,200,000,000 The increase was due to price and volume, partially offset by currency. Operating profit increased by 9% $155,000,000 to $1,900,000,000 as price realization and volume growth were partially offset by higher manufacturing And SG and A and R and D costs.

Speaker 4

Our adjusted operating profit margin was 13.8% was slightly below the year ago level despite the underlying inflationary and supply chain pressures. Adjusted profit per share was $3.18 in the 2nd quarter compared to $2.60 last year. Adjusted profit per share for both quarters excluded restructuring costs, which had a similar impact in both quarters. Taxes include discrete tax impacts, which benefited the quarter by about $0.10 Now on Slide 9. As Jim mentioned, the top line was generally in line with our expectations on strong price and services revenues, With a bit of currency as a headwind as the U.

Speaker 4

S. Dollar continued to strengthen. Machine sales to users were impacted by supply chain challenges That was slightly worse than we had anticipated. Overall, we are not seeing signs of slowing demand as order levels and backlog remain healthy. Our retail statistics or sales to users are normally strongly correlated to demand in a typical environment.

Speaker 4

However, the ongoing supply chain constraints continue to impact our ability to ship equipment. Dealer inventory changes had a minimal impact on the top line as the $400,000,000 decrease versus the Q1 It was similar to the reduction seen in the prior year. Services remained strong as we benefit from the impact of our services growth initiatives. Moving to Slide 10. As I mentioned, 2nd quarter operating profit increased by 9% on favorable price and volume.

Speaker 4

Price realization was better than we had anticipated due to the strong demand for machines. Manufacturing costs were also slightly higher than expected, primarily due to continued material and freight cost pressures as well as the impact of supply chain on our factory performance. Overall, price exceeded manufacturing costs for the quarter, which reverses the trend we had seen for most of the past year. SG and A and R and D costs increased partly due to investments aligned with our strategy for profitable growth in addition to higher short term incentive compensation. Our 2nd quarter adjusted operating profit margin of 13.8% This 30 basis point decrease versus the prior year.

Speaker 4

This is slightly lower than we had anticipated in April, principally as equipment volume lagged our expectations. We also saw some negative mix within our segments. The net impact of higher price and increased manufacturing costs was about neutral. Before I discuss segment results, I want to address the impact high inflation and inventory build Head on air segment margins in the quarter. For background, in periods with rapidly rising input costs and inventory growth, A portion of these rising costs will be appropriately included in Caterpillar's rise ending inventory.

Speaker 4

In order to promote effective management decision making within our segment results, we recognize material and freight cost changes as soon as they impact our input costs. For Enterprise reporting, this negative impact on segment results It's offset by a favorable impact at the corporate level. In a nutshell, inflationary cost pressures were elevated, Negatively impacting margins at the segment level, while Enterprise margins perform much closer to our expectations. This dynamic is timing related, meaning we'll see things balance out as our inventory starts to decline and inflationary costs subside. Moving to Slide 11.

Speaker 4

Let's review segment performance starting with Construction Industries. Sales increased by 7% in the Q2 to $6,000,000,000 driven by favorable price realization. Volume decreased slightly as lower sales were equivalent to end users was mostly offset by higher sales of aftermarket parts. North America had the highest growth in sales dollars, a 20% increase due to strong pricing, a favorable change in dealer inventory and continued strength in services. Sales of equipment to end users lagged the prior year slightly, driven by supply chain challenges.

Speaker 4

Residential and non residential demand remained healthy, although we saw some moderation in residential. Sales in Latin America increased by 48% as robust construction activity supported higher sales equipment to end users. In EAME, sales decreased by 7%, primarily driven by the changes in inventories and currency, while price was a partial offset. Asia Pacific sales decreased by 17% due in part to lower sales of equipment to end users, Primarily in China, which had a strong quarter a year ago. 2nd quarter profit for Construction Industries decreased by 4% versus the prior year to $989,000,000 Price realization more than offset manufacturing costs, The profit decreased due to the impact of lower sales volume and mix.

Speaker 4

Unfavorable manufacturing costs largely reflected higher material and freight. The segment's operating margin decreased by 180 basis points versus last year to 16.4% As inflationary cost pressures impacted the segment margins as I mentioned a moment ago. Turning to Slide 12. Resource Industry sales increased by 16% in the Q2 to $3,000,000,000 The improvement was primarily due to favorable price realization and higher sales volume. Volume increased on sales of aftermarket parts, 2nd quarter profit for Resource Industries increased by 2% to $355,000,000 As price and volume more than offset unfavorable manufacturing costs, which largely reflected higher material and freight costs.

Speaker 4

The segment's operating profit margin decreased by 170 basis points versus last year to 12% As inflationary cost pressures impacted the segment margins similar to Construction Industries. Now on Slide 13. Energy and transportation sales increased by 15% to approximately $5,700,000,000 with sales up across all applications. This included an 8% sales increase in oil and gas as sales of aftermarket parts, Reciprocating engines and engines used for well servicing and gas compression increased. Solar turbine sales in oil and gas applications lagged Power generation sales increased by 13% on stronger sales volume in small reciprocating engines and aftermarket parts.

Speaker 4

Sales of solar turbines increased in power generation. Industrial sales rose by 24% with Strength across all regions. Finally, transportation sales increased by 7% on reciprocating engine aftermarket part sales And strengthen Rail Services. 2nd quarter profit for Energy and Transportation decreased by 11% to $659,000,000 Higher manufacturing costs reflected continued headwinds from inflationary cost pressures in freight and material, which were partially offset by favorable price realization As a reminder, Energy and Transportation took price increases later in the year in 2021, given the different market dynamics as compared to the other primary segments. In addition, SG and A and R and D expenses increased due to investments aligned with our The segment's operating margin decreased by 320 basis points versus last year to 11.6%, impacted by the same inflationary cost pressures as our other primary segments.

Speaker 4

Moving to Slide 14. Financial Products revenue increased by 3% to $798,000,000 Segment profit decreased by 11% to $217,000,000 The profit decrease was mainly due to an unfavorable impact from movements in equity Securities and Insurance Services. Our higher provision for credit losses at CAAT Financial, primarily relating to reserves associated With Russia and Ukraine also weighing a profit, a favorable impact from return to repossessed equipment served as a partial offset. Moving to our credit portfolio, customers and dealers continue to perform well as our leading indicators remain strong. Past views, which are good proxy for the financial health of our customers, were 2.19% compared to 2.58% at the end of the Q2 of 2021, that's down 39 basis points year over year.

Speaker 4

As is typical, retail new book Business volume improved sequentially versus the Q1. And while we did see a 12% decrease versus the prior year, Nearly half of that decline was attributable to China, where we saw COVID restrictions reinstated. In addition, although our match Funding strategy serves to mitigate our risks from interest rate changes, rising rates typically do benefit banks from a competitive financing perspective. We saw this play out in the Q2 as our share of machines financed declined slightly. We continue to benefit from robust demand for used machines Now on Slide 15.

Speaker 4

We generated about $1,100,000,000 in AME and T free cash flow during the quarter, A decrease of about $600,000,000 versus the Q2 of 2021. We continue to build production inventory to help manage through supply chain challenges. Looking ahead, we expect stronger free cash flow in the second half due to the absence of the payment of incentive compensation. We also do not anticipate our working capital rise as it did in the first half of the year. Therefore, we continue to expect to achieve As Jim mentioned, we paid around $600,000,000 in dividends in addition to repurchasing about $1,100,000,000 worth of common stock, Supporting our objective to be in the market on a more consistent basis, enterprise cash was $6,000,000,000 a $500,000,000 decrease compared to the Q1 of 2022.

Speaker 4

The decrease was primarily driven by the $1,700,000,000 in shareholder return, net of MENT free cash flow generation. We also continue to hold some of our cash balances in slightly longer dated liquid marketable securities In order to improve the yield on net cash, our liquidity remains strong. Now on Slide 16. In light of the current environment, including supply chain constraints, we continue to refrain from providing annual profit per share guidance. However, I will share some thoughts on our Q3 and full year.

Speaker 4

As a reminder, the Q2 played out about as we had anticipated on the top line, Although the inputs varied somewhat, pricing was better than expected, while sales of equipment to end users lagged our expectations due to supply chain challenges and additional weakness in China. Looking to the Q3, we currently anticipate the top line will increase compared to the prior year On higher sales to users and favorable price realization, strong demand should support higher sales across the 3 primary segments, subject to our ability to navigate through the ongoing supply chain challenges. For the second half of the year, we expect revenues to be higher compared to the first half. To reiterate Jim's comment, we remain encouraged by the strong demand in our end markets for our equipment and services. Order levels and backlogs remain strong.

Speaker 4

Dealer inventory levels remain at the low end of the typical range and rental fleets are aging. Finally, infrastructure investment later in the year should be supported. On margins in the 3rd quarter, We anticipate gains across our 3 primary segments as compared to the prior year and first half. Construction Industries and Resource Industries margins In Energy and Transportation, we expect pricing to continue to gain momentum and offset manufacturing costs. For the second half of the year, both the enterprise and segment levels, we anticipate adjusted operating profit margin improvement compared to both the first half and the comparable periods of 2021.

Speaker 4

The impact of price actions should accelerate and though we anticipate continued increases in manufacturing costs, We are starting to let the significant increases, particularly in freight and material costs that we saw in the second half of the last year. Finally, to assist you with your modeling, we currently expect our accrual for short term incentive compensation to be around $1,600,000,000 a share. We continue to anticipate a global effective tax rate of around 24% and restructuring spend of approximately $600,000,000 for the full year. Turning to Slide 17. In summary, we performed well in the quarter where demand generally remained strong, Our ability to satisfy that demand was constrained by supply chain challenges.

Speaker 4

Despite this backdrop, we realized $1,400,000,000 Looking ahead, comparisons should ease in the second half of the year. And despite the challenging environment, we continue to expect to achieve our Investor Day targets for adjusted operating profit margin and ME and T free cash flow for the full year. And with that, we'll now take your questions.

Operator

As a reminder, management asks that we limit 1 question per analyst. Your line will close once the question has been posed. If clarification is desired, please rejoin the queue. Your first question comes from the line of Jamie Cook with Credit Suisse. Your line is now open.

Speaker 5

Hi, good morning. I guess my question Hey, good morning. Hi. Hi. Understanding challenging environment, it sounds like the Q2 was a little short of your Expectations yet we're raising our short term incentive comp.

Speaker 5

So just trying to get some clarification around that. And then any help on Confidence level sales to users are improving in the back half of the year. Are you seeing any improvement in supply chain and sort of how we should think about it? Thanks.

Speaker 3

Jamie, to answer your first question, so we accrue for incentive compensation based on our expectation for full year results. And as you know from our proxy, primarily our incentive compensation is based on operating profit, OPAC and services revenues. So again, the increase in the quarter was not due to the quarter, but it was due to our expectations for the full year. Your second question, we have Not seeing a significant improvement in supply chain. It's still hand to hand combat.

Speaker 3

Our teams are working their way through those issues. Again, very proud of the team that they were able to turn in double digit sales growth despite those supply chain challenges, but we have not seen them ease. It changes from component to component. One day it's one issue, one day it's another issue. But at the macro level, we have not yet seen an improvement.

Speaker 4

However, let me just add one of the things, if you recall, Jamie, is normally we have a stronger first half From a production perspective, particularly in Construction Industries, obviously, as you normally you would see revenues decline in the second half. We don't expect that because obviously we expect to be able to now use some of that production capacity to meet some of the end user demand. Within Resource Industries, we will expect we've had some commissioning delays. We've continued to see that. We expect those to ease, which will help us in the second half That's true perspective, so that's not really supply chain related.

Speaker 4

And then finally, in Energy and Transportation, you as always, we do expect a stronger second half of the year. That overall gives us confidence without actually any change in supply chain that we should be able to see through improvement in the second half of the year.

Operator

Your next question comes from the line of Tami Zakaria with JPMorgan. Your line is now open.

Speaker 6

Hi, good morning. Thanks for taking my question. Hi. Could you share what your volume expectation is for the back half? It seems like your volume growth in First half was in the 3% to 4% range.

Speaker 6

Do you expect that volume to improve sequentially in both 3Q and 4Q? And what about pricing? For the back half, should we expect similar 8% to 9% pricing as well, like you saw in the 2nd quarter?

Speaker 3

So to answer your first question, we do expect volume to grow, and price to improve sequentially and year over year in the 3rd 4th quarters.

Speaker 4

Yes. And as far as actually the percentage is concerned, obviously, The issue obviously in the second half on a volume basis, there's a volume includes both services, revenues as well as SKUs. So obviously, it's dependent on how both of those perform. And on the sort of pricing level, As we've said consistently, we expect pricing to improve in the second half of the year, which should drive overall improvement as we go through Reminder, we do have did have some price increases in the second half of twenty twenty one as well.

Operator

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

Speaker 7

Yes. Thanks. Good morning, guys. Hi, Nicole. Hi.

Speaker 7

Maybe just digging into that last question from Tammy a little bit. On the outlook for volume, is that improvement that you're expecting in the second half fall or predominantly a function of end user demand? Or Now what are your expectations for dealer inventories as well?

Speaker 4

Yes. I mean, obviously, our expectations So for the full year that we don't expect a significant change in dealer inventory. As you know, we have had a small build year to date. Obviously, it's dependent again where demand is product by product for how those dealer inventory movements will occur for the remainder of the year. But obviously and also part of the dealer inventory build is within Resource Industries where we are having some commissioning delays.

Speaker 4

We expect those to work out as we go through the year. It really is mostly a function of the end user demand. As we say, the challenge for us at the moment It is around being able to meet that end user demand from a supply chain perspective.

Speaker 3

And is it typically the case, energy and transportation will have strong will be

Operator

Your next question

Speaker 8

Surprisingly went up sequentially and the backlog right now seems like it covers most of your back half of the year, but Historically, not all the backlog ships that quickly. So I'm just curious, the order flow that you're getting for 20 20 Can you give us some insight into like we know you have a big backlog and still some supply chain issues, price cost It's getting better, but really trying to think about demand into 2023. You do have some window with some of the order programs, The BOM program that you have where guys can order early for 2023, can you just give us some perspective on what you're seeing for equipment appetite for next year?

Speaker 3

Yes, a couple of comments. So our backlog increase of $2,000,000,000 was primarily driven was led by Energy and Transportation. And as we've mentioned previously, we have seen an increase in orders from solar turbines, oil and gas customers that will start to impact us in late 20 22 and into 2023. Our backlog in Resource Industries remains healthy and would have increased if not for some Russia cancellations that we had. So again, as we look forward, we're not making a prediction about 2023, but again that strong backlog does Help us feel good.

Speaker 3

The other thing is, Construction Industries, the infrastructure bill, we believe it will start to impact us in late 2022 And the end of 2023. So again, for those REIT, I'll provide that as color, although obviously we're not making a 2023 prediction at this point.

Operator

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

Speaker 9

Hi, good morning, everyone.

Speaker 3

Hi, Jerry.

Speaker 4

Jim, I'm wondering if

Speaker 9

you could just weigh in with Your views on how your mining customers will respond given the commodity price volatility. We've seen over the past months how different is this environment versus 2018 where for a brief period of time and the correction we saw Slowing replacement demand as the miners hit the pause button, just wondering if you could compare and contrast based on your conversations With mining customers on prospective orders today? Thanks.

Speaker 3

Well, certainly, our mining customers continue to display capital discipline. Having said that, We're encouraged by the conversations that we're having with our mining customers. They're making decisions based on a very long term view. Vehicles think about other kinds of minerals that will need to be mined based to support the energy transition. Having said that, we mentioned that we had some cancellations in Russia.

Speaker 3

But again, we remain quite positive Based on for the medium and long term outlook for mining based on the conversations that we're having with customers.

Operator

Your next question comes from the line of Chad Dillard with Bernstein. Your line is now open.

Speaker 10

Hi, good morning guys. Hi, Chad.

Speaker 6

So I have a question for

Speaker 11

you guys on manufacturing costs. You did about, I It was $966,000,000 year on year increase. Is that the high watermark for the year? And then Just how

Speaker 10

to think about the or if

Speaker 11

you can quantify that inventory impact in corporate expenses For the quarter and how

Speaker 10

to think about for the year?

Speaker 4

Yes, Chad. So first of all, obviously, as we started the year, we did expect Moderation of supply chain or manufacturing cost increases as we went through the year. And obviously, we start to lap some of the significant increases in the back half. Both Material cost and freight cost inflation remains. So I think we've taken the appropriate pricing actions.

Speaker 4

So we're optimistic about the ability for us to more than offset. Obviously, I'm not going to predict about where we are looking in Q3 and Q4, however, the delta between price and manufacturing costs, which is really the most important part from our perspective, We'll actually get wider and that really is to help us actually catch back up some of the shortfalls we've seen over the previous few quarters. So From a margin perspective, that will be a positive. With regards to the corporate expenses, I mean, just again, just to reiterate, Corporate items and eliminations include a lot of items which are they relate to the business units, but obviously they're not accounted On a business unit specific basis, the inventory impact is a reasonably sized number. We Had a and we actually I think it was about 100 odd 1000000 last quarter And a similar number this year quarter.

Speaker 4

The other things in there include things like warranty costs And profit inventories, all of those things are impacts which actually do Underlyingly impact the overall margins within the segment. So just one thing challenging for you guys to model, but obviously, we're just trying to be As clear as we can about it.

Operator

Your next question comes from the line of Michael Feniger with Bank of America. Your line is now open.

Speaker 1

North America retail sales and construction, obviously, minus 3%. You discussed the supply constraints. I'm curious when we look at some of the rental branches and companies reported another quarter of double digit growth there. Do you feel there's any competitive dynamics going on there, maybe losing share in maybe smaller construction equipment By chance, because of the supply constraints, how does Caterpillar kind of deal with this issue with rental continue to feels like gain share in Tight market. Curious your views there.

Speaker 1

Thank you.

Speaker 3

Well, thanks for your question, Michael. And of course, we have a rental business as well that our dealers are very focused on. And again, we are in a supply chain constrained environment. So, a dealer has to make a decision between putting something in the rental fleet or selling it to a retail customer who wants that equipment. And so our retail fleet is aging.

Speaker 3

I haven't said that, we're not concerned about share. We're holding our own. It's really an issue of Still strong demand and just our ability to completely meet that strong demand. Again, we did turned in A total company level double digit sales growth.

Speaker 4

Yes. And fundamentally, I mean, obviously, rental is a financing decision and obviously has cost implications. And so obviously for a lot of our customers who are using the machine on a more frequent basis, rental is not necessarily the best option because The cost implications, that's why we do believe over time, as the supply chain eases, they will be buying machines, and we know they do want those machines. Obviously, in a short term basis, they may use rentals as a stopgap until they are able to get their machine from us.

Operator

Your next question comes from the line of Steven Volkmann with Jefferies. Your line is now open.

Speaker 4

Hi, Steve. Hi. Good morning, guys.

Speaker 12

Thanks for taking the question. My question is on the cost We've seen decreases in some of the metals and energy and freight indices that are sort of big and And I'm wondering if you're starting to see any moderation in those costs yet or if there's Perhaps another quarter or 2 before that would start to kind of flow through.

Speaker 3

Yes. We're still dealing with an inflationary environment and we have not seen A decrease from our suppliers as a result of commodity price reductions. As you know, it takes a while for Those kind of changes to work their way to the supply chain and of course there's volatility there as well. So no, the short answer to the question is no, we haven't seen any moderation in those costs.

Operator

Your next question comes from the line of Mig Dobre with Baird. Your line is now open.

Speaker 10

Thank you. Good morning. Good morning. Going back to the pricing discussion, you've done a little better The 9% in the quarter. But I'm sort of curious if we're sort of thinking about the order intake that you had this quarter relative to what Actually flow through the P and L.

Speaker 10

Can you give us a sense for how the pricing is looking for the most recent orders that you had here? And I'm also thinking about your competitors, right? We saw some of your Japanese competitors report much lower price increases. So I'm curious how you think about competitive dynamics globally around that? Thank you.

Speaker 4

Yes. So I mean, obviously, as we go through, I mean, obviously, as We do have some price protection on orders in the backlog that, as we say, is always taken into account when we're thinking about the decisions. As far as the competitive dynamic, we are not seeing any impact on share relative as a result of Price increases we've taken. So, we are obviously, we'll always keep a close eye on that. But generally, we are as we said, we actually saw price be slightly better than we expected in the quarter.

Speaker 4

And so that is a net positive for us and around and obviously demand for machines remains strong,

Speaker 3

And as you know, we've been very focused on services the last few years. And one of the main elements of that is to increase The value that we provide to our customers, so it's not simply always a price discussion. We know we must be competitive. That's very important. But we also strive to Deliver increased value to our customers, minimizing downtime, maximizing availability, great parts support, dealers do a great job supporting them.

Speaker 3

So again, It's more than just price. We're really focused on through our services initiatives increasing the value that we provide to our customers. And that's all part of their purchasing decisions.

Operator

Your next question comes from the line of Kristen Owen with Oppenheimer. Your line is now open.

Speaker 4

Hi, Christine.

Speaker 13

Hi. Good morning.

Speaker 10

Good morning.

Speaker 13

I wanted to follow-up actually on the services and aftermarket strength that you reported in the quarter. And just if you could offer some context around how much of that is owing to some of the service alert capabilities and the agreements that you've been Signing over the last several years versus just what you're seeing from a utilization perspective, how much of the aftermarket parts is related to just Equipment that's being used more frequently.

Speaker 3

Yes. It's a whole variety of issues and certainly utilization is up, which we feel good about. But we're also gaining traction on our service initiatives, everything from the investments that we've made to increase parts availability using a system that We call PIK, which allows us to work with our dealers to ensure that we have the right parts and anticipate what customers will need. We now have 1,200,000 connected assets, so that gives us much better visibility for everything from getting the right parts to the right dealer, So that the customers get them when they need it to allowing us to help customers avoid downtime, maximizing availability, maximize production. We've also invested significantly in our e commerce capability and we're seeing good progress there.

Speaker 3

Again, a whole range of digital Investments that we're making are really starting to produce results and we're very bullish on that. So it's really a combination of both. Certainly, Utilization is up, but also we're seeing positive results from all the hard work of our teams over the last few years.

Operator

Your next question comes from the line of Steven Fisher with UBS. Your line is now open.

Speaker 14

Thanks. Good morning. Just a regional question on the construction segment. On Europe, First, you talked about or can

Speaker 3

you talk a little bit

Speaker 14

more about what you're seeing from the end user demand there and the feedback you're getting from dealers in The wake of softer market conditions, is this kind of a maybe a 1 quarter thing ahead of what some of the stimulus might Flow through there or do you think we're kind of settling in for something that could be a little bit longer period of weakness there? And then similarly In China, are you getting any sense that recent announcements around stimulus could start

Speaker 3

To move the needle there more

Speaker 14

in the positive direction. Thank you.

Speaker 3

Well, starting with Europe, revenues were down in the quarter, largely a result of the strengthening dollar. So it's really a General business activity has moderated in the EU and we'll keep a close eye on that. But There are as you know, there has been there was an EU infrastructure package that passed and we're watching that closely as well and that certainly could Positively impact us moving forward. So again, we're watching it very closely. There's some positives and there's some things that aren't so positive.

Speaker 3

So we'll see how it all plays out. In China, we have seen the market weaken, as I mentioned. We had a couple of very strong years in 2020 and particularly in 2021. It's too early for us to really predict what's going to happen there. To your specific question, Again, we'll continue to support our customers there.

Speaker 3

And again, what we see now, of course, is a weaker market for that 10 tonne above excavator market And we had previously.

Operator

Your next question comes from the line of Matt Elkott with Cowen. Your line is now open.

Speaker 14

Amit. Hi, Amit. Good morning.

Speaker 15

Thanks, guys. Good to see the continued strong Net growth in the backlog, I was hoping you guys can tell us if you've had any backlog cancellations, not related to Russia as we discussed, But ones that can be attributable to directly or indirectly to higher interest rates, Lower commodity prices or the cooling in the housing market. And since the answer to this question may be short, on the locomotive side, I was hoping if you can comment on I think your competitor just received a $1,000,000,000 order from a Class 1 on Locomotive mods, I was hoping you can talk about your outlook for locomotive upgrades going forward and Do local upgrades go into your service revenue?

Speaker 3

Yes. So the first answer to your question is no, we haven't seen Cancellations outside of Russia. So again, demand remains strong across most of our end markets. And as we've been discussing here this morning, our backlog is up. So again, we haven't seen cancellations.

Speaker 3

In rail, yes, there are obviously, we're always working To produce our to maximize our service revenue in locomotives and yes, upgrades and that we Perform do go into services if we do service work on those locomotives. So again, as you know, the number of Upstored locomotives is still high. It's below the 2020 peak. But again, we continue to support our customers and that produces service opportunities for us in rail.

Operator

Your next question comes from the line of Tim Sien with Citigroup. Your line is now open.

Speaker 2

I just wanted to circle back To the discussion earlier on rental, but more from the standpoint of the potential Opportunity for Cat into 'twenty three. And you mentioned the aging of the fleet, but we're hearing a lot From dealers at least in the U. S. About the size of the rental fleet being smaller than they'd like. So I'm just Curious if there I know you're not going to give us a point estimate, but is there a way to think about a range of outcomes in terms of A reinvestment in rental assets into 23 by the dealer base and obviously what that Could mean from CAT's standpoint, just as you replenish those rental yards.

Speaker 2

Thank you.

Speaker 3

Right. Well, thank you. And certainly dealer inventory and dealer rental fleets are lower than most dealers would like at the moment due to Combination of strong demand and supply chain constraints we have. So I do believe that when supply chain constraints start to ease, Both of those represent an opportunity for us to get our dealer inventory back more towards what would be typical for them to expect and also give them an opportunity to increase their rental fleets as well. So I do believe again not time bounding that, but certainly when Supply chain conditions ease that does create an opportunity for us.

Operator

Your next question

Speaker 4

Just wondering if you could kind

Speaker 16

of expand on your prepared remarks in terms of what you're seeing on the resi side of the construction portfolio versus the non resi side. I think you mentioned resi in particular has been For almost the past 2 years, I'd imagine dealer inventories are probably pretty lean at this point. But I guess, do you feel like that part of the portfolio Might start to become a drag in the back half of the year and just into next year, just given some of the softening that we've seen in the housing related data points?

Speaker 3

Residential demand today remains healthy for us. Certainly, it could moderate somewhat due to some interest rates and inflation. However, Non residential demand is stable outside of China. And again, as I mentioned due to the infrastructure bill, we are bullish That non residential construction in North America, U. S.

Speaker 3

Particularly will improve due to the bill in late 2022 and into 2023.

Speaker 4

And just a reminder to everybody, when we do see demand softening in certain areas that always need because we're on a Supply chain constrained uptime and particularly around things like engine control modules, that means those can be reallocated to areas where there's stronger demand. So Net net actually shouldn't actually have any impact on this overall.

Speaker 1

Operator, we have time for one more question.

Operator

Your final question today comes from the line of Rob Wertheimer with Melius Research. Your line is now open.

Speaker 3

Hi, thanks. Good morning, everybody.

Speaker 10

Good morning, Robert.

Speaker 17

My question is really on kind of production and manufacturing. The segment discussion that you gave was interesting sort of maybe a leading indicator given the current cost accounting on the segments. And so one question is, Does price alone get you to your margin expectations for the back half or do you have to improve anything on supply chain manufacturing to get there Given the segments look lower than the total. And then more fundamentally, Jim, I don't know if you can address how you feel the production It's working how other metrics you look at whether it's quality or safety or flow are doing. Are we seeing just cost inflation and a mismatch with price versus cost?

Speaker 17

Or are we seeing any tangles in the production

Speaker 4

Yes. So obviously, yes, I mean, Rob, We are still seeing issues in the factories, which are causing some impact on variable labor and burdens across that. Obviously, our assumption in the second half is that those will be slightly better, but not necessarily flowing through as efficiently as possible. We're continually working through as best as we can to make sure that the price is the biggest driver Because obviously, as you know, we put through those increases in order to try and offset some of that material costs and inflation that's gone But yes, there is inefficiency, but we're hoping that some of that will ease as we go through the remainder of the year.

Speaker 3

And Rob, maybe just to add on to that. So as you know, we've worked Very hard on our lean manufacturing processes over the last few years and it has been a struggle just given the supply chain challenges and we have We all learned a new term called decommit where a supplier or one of their suppliers decommit, so we get some last minute surprises. So we're certainly not operating our factories as As we would like and as efficiently as we did before, we started to come out of the pandemic. But again, we're continuing to work those issues hard. And again, it's something that proud of the team despite those issues, which is creating some inefficiencies, which is creating some additional costs.

Speaker 1

All right. Thank you, Jim, Andrew and everyone who joined us today. A replay of our call will be available online later this morning. We'll also post a transcript on our Investor Relations website as soon as it's available. You'll also find a second quarter results video If you have any questions, please reach out to Rob or me.

Speaker 1

Investor Relations general phone number is 309-675-4549. We hope you have a great rest of the day. Now let's turn the call back to Emma to conclude our call.

Operator

Thank you for attending today's conference call. You may now disconnect.

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Earnings Conference Call
Caterpillar Q2 2022
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