Good morning, ladies and gentlemen, and welcome to the Caterpillar full year and Q4 2013 results conference call. At this time, all lines have been placed on a listen-only mode, and we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Mr. Mike DeWalt. Sir, the floor is yours.

Thank you very much, and good morning everyone, and welcome to our year-end earnings call. This is 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. Any use, recording, or transmission of any portion of the call without the expressed written consent of Caterpillar is strictly prohibited. If you would like a copy of today’s call transcript, we’ll be posting it in the Investor section of our Caterpillar.com website, in the section labeled Results Webcast. This morning we’ll be discussing forward-looking information that involves risks, uncertainties and assumptions that could cause our actual results to differ materially from the forward-looking information. The discussion of some of the factors that individually, or in the aggregate, could make actual results differ materially from our projections can be found in our cautionary statements under Item 1-A, Risk Factors, of our Form 10-K filed with the SEC in February of 2013, and also in the forward-looking statements language continued in today’s release. Now, in addition to that, there’s a reconciliation of non-GAAP measures, and that can be found in today’s financial release, which has also been posted on our website at caterpillar.com. Okay, let’s get started. And this morning I’ll be covering four main topics before we get to the Q&A. They’re fourth quarter financial results, a recap of 2013, the 2014 sales and profit outlook, and I’ll start this morning with the fourth topic, and that’s the $1.7 billion of stock repurchase that we’re expecting in the first quarter, and the new $10 billion stock repurchase authorization that we announced this morning. Now, to set the stage for stock repurchase, it’s good to know that we…

[Operator instructions.] Our first question today is coming from Andrew Kaplowitz.

Your backlog declined to $18 billion in Q4. It was $19.1 billion in Q3, and it’s down $2.2 billion in the year. Yet you’re guiding to 5% increase in power systems, and you did mention in the release that some of the backlog decline was in power systems. So can you talk about the conviction of your forecast here, especially you do have some decent emerging market exposure in this business. Where is the growth coming from in power systems, and why?

It’s probably worth noting that for construction, we still had a headwind in the fourth quarter on dealer inventory. Certainly not as much as it was in the fourth quarter or year ago, but the improvement in the fourth quarter, if we would have had flat dealer inventory, would have been a little bit more. On power systems, we’re not looking for a big increase next year. We’re in the ballpark of about 5%. And I would tell you that it’s not any one sector. If you look at what’s in power systems, you’ve got industrial, you’ve got oil and gas, [unintelligible], and turbines. You’ve got electric power, you’ve got marine, you’ve got rail. And we don’t really have any one of those sectors that up a lot. In fact, probably one of the smallest, which is marine, in the transportation piece, it’s probably a little bit stronger than the rest, but I wouldn’t really call that out too much. They’re all kind of in the same ballpark. You asked about conviction and backlog, when we do our outlook, we try to give you our best guess at what we see in our backlog, what we’re hearing from customers, what we think is going to happen in the economy. And we try to put that together and do our best shot. So I would say it’s an outlook, so it’s not a sure thing, but I’d say we’re as confident as we usually are in an outlook.

Just shifting gears, in [unintelligible] you said that you were not expecting a significant inventory changes at the company level. But it still looks like, if I’m doing the math right, that you lowered company inventories by about $700 million in the quarter. Was this mostly in resource industries, and that’s why your margins were so weak there? And how do you get conviction that these kinds of declines are behind you, when you kind of had similar issues all year, with company inventory destocks?

I’d say one thing is our sales in the fourth quarter were higher than we thought, and the change in dealer inventory was about the same as we expected. And with production schedules relatively not changing a lot in the short term, some of that came from inventory. And I’ll tell you what gives us a little bit of conviction that it’s not going to go down as much as last year is essentially the amount of our inventory that is finished goods. We’ve got the PDCs, for example. And a year ago, we had a lot of inventory in the PDCs. And it has come down substantially. I don’t have the numbers in front of me, but my recollection is that it’s down more than half. So I think that we expected that to happen this year. You know, there will be seasonal fluctuations, but by and large, I just don’t think there’s the likelihood that that finished inventory would come down as much as it did in 2013.

Our next question today is coming from Ross Gilardi.

Just first on mining, can you talk a bit more about what happened to both OE and aftermarket orders from Q3 to Q4? And do you need a major pickup in orders in the second half of ’14 to deliver minus 10% for the year on the top line?

I’m going to pull aftermarket out of this, because for us, aftermarket is kind of a daily thing. Our order board, if you will, is about 24 hours. So customers order, we fulfill and send. So sales are probably a better indicator of the future than what happened on the last day of the year. So I think if you look at order rates for new equipment, they have remained very very low. That’s despite mine production. Our customers, they’ve actually had pretty decent years. Mine production has been up, and we think it will be up again overall, in 2014. Despite that, they’re not ordering much. And we haven’t really seen much of a pickup. Certainly, order rates for resource industries were a little better in the fourth quarter than they were in the fourth quarter of the prior year, but that’s not saying much. And so I think to answer your question, we do need some improvement in order rates to be at minus 10, but I wouldn’t describe it as anything like robust or good or like 2012. But yeah, some improvement.

Maybe it’s time for me to just add a comment on mining here in general. The interesting thing with our mining customers, and I have met, in the last 60 to 90 days, with several of my counterpart CEOs at the mining customers, and all of our mining team has been with all of our alliance customers, certainly, over the last 60 to 90 days, in some way or another. The feedback is fairly consistent, and it’s not illogical at all. Their mining production continues. They are pulling ores out of the ground at faster and faster rates. They are just doing what we did, frankly, in ’13, and that’s pull our horns in, pull their horns in, with capex. We see that again in ’14. But what they all have cautioned us on is that at some point in the future, because we’re extending cycles, duty cycles, because we’ve cut back on new acquisitions and even some parts in some cases, be ready for us at some point in the future. None of them can predict when that is, and I can’t either. but this is sort of typical with what we hear through these deep cycles. When it’s over, it tends to come back fairly quickly. I’m not making that prediction here today. I hope it’s in 2014. I know it will happen in 2014 or 2015, but that’s kind of the quandary we’re in as well, trying to judge from our customers when they feel comfortable kicking back in with new purchases. Now, capex is going down with miners in 2014, and you’ve all seen the numbers. We watch that too. A big part of capex in mining is not around mobile equipment. So when that turns, I’m convinced we’ll see not, as Mike said, a 2012 style ordering, and I hope we don’t, but we should see a fairly prominent turn, when it happens. And as Mike said, we should see something in ’14 to make our forecast, but it’s out there, we just don’t know when. And I can’t provide any more clarity than that. That’s the feedback we get from our customers.

And then just my follow up question on construction equipment, how did you get such a dramatic improvement from Q3 to Q4 in EBIT, on essentially a $300 million sequential increase in revenues? And then more importantly, do you think that $500 million of quarterly EBIT for construction is a sustainable run rate into ’14, particularly, as you mentioned, with some lingering price pressure in the business?

For construction, I’ll say a couple of things. They had pretty good incrementals from third to fourth quarter. And there are a couple of things going on in there. Their pricing was a little bit better in the fourth quarter. They had more of this big order from Brazil in the third quarter that kind of dampened price realization a little bit. Again, sales were up. They actually did a great job on costs in the fourth quarter, and the impact on absorption of inventory decline for them was not a big deal in the fourth quarter. There was a little more of that in the third quarter. But no doubt about it, they had a pretty good quarter. In terms of going forward, I’m going to try not to give any specific guidance on profit by segment, but they were around 10% in the fourth quarter, and that’s probably in the ballpark of, you know, we’re not looking for a big decline. They were hurt this year by inventory declines, and we don’t see that happening in 2014. So their margins in 2014 ought to be better.

Our next question today is coming from Jamie Cook.

One, Doug, just philosophically, how should we think about the message you’re trying to send here with the share repurchase? Your views changed quite dramatically since you first became CEO. So should we think about the $10 billion over five year, like $2 billion a year? Would it be more front-end loaded? Would you look to be more opportunistic than the $1.7 billion you already talked about? And then my second question, Mike, as it relates to guidance, you gave some color on the first quarter. I guess outside of that, is there anything unusual we should think about as we think about the progression of earnings throughout the year? Anything not in line with your typical seasonality? Just given we have restructuring benefits that are going to hit, I’m not sure how that happened, in terms of your saying you’re expecting mining orders to pick up? I’m just trying to make sure we have the quarters correct.

I’ll take the second part of that, on the guidance. Of the $200 million ongoing benefit that we kind of expected for this year, a lot of that is based on the things that we did in 2013. So those kind of things are in place, the big reductions in people that we had. So I think that $200 million, I probably wouldn’t divide it by four, because we are doing more in 2014. But you know, I would say, if you divided it by four and then favored the second half of the year a little bit more than the first half, that’s probably reasonable. Probably the biggest issue on timing that we’re going to have during the year is when the actual restructuring charges for ’14 hit. I mentioned in the preamble that we need to have the Belgian government improve our program. And so until that happens, we won’t be booking the charges for Gosselies. So that needs to happen. Outside of that, I don’t know of any real big items. I do think that the first quarter, for example, will have more negative sales mix, likely, than the second half, a little bit. The first quarter of last year, mining was still quite a bit higher than it is right now. So I kind of was talking about the first quarter sales being relatively flat, but that’s with mining being down a bit, and construction being up.

Thanks for a thoughtful question on our buyback and cash. Let me give you a fairly broad answer to that, and I hope complete. I have changed my position since I became CEO. You’ll recall when that announcement was made, it was the end of 2009. Our debt to cap was way over 50% at that time. We struggled to be sure we kept our credit rating, and we vowed not to cut the dividend at that time, and both of those came true. But as we look forward, we all agreed that we had to have a strong balance sheet. A cycle like we saw in ’09 and now another mining cycle like we saw in ’13 really puts pressure on our balance sheet and we decided we’ve got to have a rock solid balance sheet, which we do today. You’ll notice at the end of the year it dropped below 30% debt to cap. If you take our cash into consideration, of about $6 billion at the end of the year, it was down 16% to 17%. And in my definition, that’s a pretty solid balance sheet. So we accomplished that. The second thing that we needed to do in the early days of me being CEO was to build up our capacity. We struggled with capacity, we did not have adequate capacity in the upturn of the 2000s. We gave up market share around the world. And our business model purely runs on field population, which allows our dealers to do what they do in a downturn, better than anybody else, but by servicing the field population that’s out there. We accomplished that one. We’ve got capacity in place today, obviously far above $55 billion. We did $66 billion in 2012, so somewhere north of that, we…

Our next question today is coming from David Raso.

Regarding resource industries, if you add back the restructuring in the fourth quarter, the margin was about 7%. Can you give us some help on how you’re thinking about the margins for RI if the revenue, as you said earlier, would stay around the same level that we saw in the fourth quarter?

I would say that fourth quarter usually has a little higher cost levels than the rest of the year. And with sales for resource industries kind of coming down to this $3 billion level, it has a little bit bigger impact on margin. So they had a little more of an inventory decline. That hurt in the fourth quarter. They had costs that were up a little bit in the fourth quarter. So that was a little negative from the third quarter. And as you mentioned, the restructuring charges that they had in the fourth quarter. In terms of going forward, at this volume level, if you were to take the sort of average margin for the year, it’s probably not far off of what you’d think for next year. There will be puts and takes, though. They’ve done a lot of work on cost reduction. So that would be a positive. They would like to spend a little bit more to drive synergy benefits and spend a little more on R&D. So that will go the other way. But I think by and large their margins, from 2013, are not significantly out of line at this kind of sales level.

It’s a little tricky though. If you think construction margins can be 10%, roughly, in ’14, that implies a incremental margin for CI of 65% next year. That seems aggressive. But then if you really think RI can do margins of 11 to 14, it implies power systems margins are down to 13 next year, after being 15. So the math’s not squaring up.

I’m not trying to give you specific numbers. I didn’t say that construction would be 10. I just said I think it will be probably closer to that than the 5% to 6% that they had earlier in the year. I think also one of the things that you need to remember kind of year over year too is there are other things that are maybe not in the segments. We had pretty substantial negative below operating profit currency losses in 2013 that we’re not expecting for 2014. So I don’t think, from an operating profit standpoint, there will be major changes, but I’m not suggesting it will be exactly the same in each segment as it was in the fourth quarter.

How about just qualitatively, then? Power systems, how do you think their margins, off of the 15.4 you reported for 2013?

Again, I don’t think it will be substantially different. Again, I’m not trying to do a forecast by segment. But probably not substantially different. It was a great quarter. I don’t want to pick on the quarter, but if you were to take the year, I don’t think their profit is going to be dramatically different year over year.

And lastly, for ConExpo, any framework we should be thinking about going into a meeting like this? Historically, you’ve spoken of long term targets before, in settings like this. Can you give us a little framework for this year?

Yeah, I think generically, what we’ll talk about is our strategy update. We’ve been working on that for the last several months of 2013. So we’ll spend time updating you on the changes that we made to the strategy, and we’ll talk a little bit about each of the major segments. And it will be kind of a longer term view, what we expect for the future. But coming out of such a tough year in 2013, I remember this back in 2009, when we had a similar meeting, we kind of gave specific number targets, and it was tough to get anybody to think the business could be that big, or that good. So I think what you’ll probably hear from us at ConExpo is more around strategy, business conditions, and the things that we expect to do going forward. It probably won’t be so much a here’s a forecast for a particular year.

That’s right, and a couple of things. We’ll talk about how our business has changed since [unintelligible], and how we see it kind of, to use your word, qualitatively going forward. But one other thing I’d ask all of you to do while you’re out there, those of you who are attending. Go down on the floor and look at our product offering. You’ll be seeing a couple of things that you haven’t seen from us before. Number one, fuel economy. Frankly, we have struggled in the past to get some of our competition on fuel economy. That period is over. Our tier four interim and final machines that you’ll see out there are, in almost every case, best in class, and best in class by quite a margin. So I’d really like you to spend time with our people on the floor. Secondly, equipment technology. Condition monitoring, job site, controls, everything around the electronics. We’ll operate a live dealer control room there. It’s [unintelligible], but it would look like a control room like we have all over the world today, monitoring our machines and what we can offer customers. And those two are very different than what we’ve talked about in the past. And then our meeting, I think you’ll enjoy kind of a little look back at how we’ve changed the company and where we’re going, as Mike said, between here and the next few years out.

And Doug, if you can help us, at ConExpo, or even right now, the strategy comment reminded me of, it appears that the majority of your dealers in China have dropped the SEM brand. You still have the original SEM dealers selling. That’s probably why you’re still doing okay in China. But SEM obviously been lagging the industry data, I guess in part because the traditional CAT dealers, the majority have dropped it. And thinking of SEM as maybe a lower cost solution, cost structure, around the world, do you care to maybe comment a little bit on that SEM decision by the CAT dealers, how it makes you rethink your kind of lower value price point strategy?

Yeah, and I’ll make sure that Ed addresses that at ConExpo. But generally, we encourage that change, from here. The market is huge over there for excavators and the things that CAT brand does, and we’ve decided over the last year that that’s really where we want them to focus. We went kind of back to a strategy of SEM brand for SEM products, inside and outside, although we still have quite a few dealers outside of China representing SEM. That has worked well for us. We’ll concentrate on that as a brand. It is a value brand, and of course we’ve been upgrading that technology a little bit within the value offering against SEM’s competitors. So we think we’re in a better position with that going forward, and again, that will be a relatively small play in the scheme of things, but it’s important inside China.

Our next question today is coming from Nicole DeBlase.

I just wanted to ask a question on material costs. I think you guys noted in the 2014 outlook of the release that you expect material costs to be favorable in ’14. But you’re also looking for an improving economic environment, and usually that causes commodity prices to increase. So I’m just curious what you’re expecting for material costs, and why you expect a decline.

We didn’t actually put it in the economic part of the release, but generally speaking, I would say, for mined commodities, like copper, for example, we’re expecting commodity prices for ’14 to be by and large around the 2013 average. So we’re not likely to get big increases or decreases in commodity prices, at least that’s our view. And so for material costs, you kind of have to look a little bit at how things have trended for the year. We’ve gotten kind of better and better as we’ve gone through the year. We’re exiting the year, 2013, at a lower level than where we came into the year. So even if we don’t get any other cost reductions at all, we have a bit of a carryover benefit that comes from the prior year. So that should be positive. And in addition to that, most of what we buy is not commodities, believe it or not. It’s components that have a lot of value added in it. And based on what we’ve negotiated with suppliers, the changes that we’ve made, we’re looking for overall material costs to be lower. And again, the bulk of what we buy is not commodities, it includes somebody else’s value added. And so a combination of reductions there and what we’re coming out of ’13 with already give us pretty good confidence on the material costs for ’14.

And I may just add quickly, you know, coming out of the strategy with Doug, a big part of it was supplier collaboration, and the idea that we would get to know our suppliers as well as we know our dealers. And we spent a significant amount of time on that coming out of the strategy. So what we see in terms of our material cost reduction is really a benefit of coming out with stronger supplier collaboration. Their resources, their expertise, combined with ours, is producing a lot better decisions for us, and a big piece of that reduction.

And then just on construction with respect to pricing, I saw in the release that you guys called out that there is some pricing degradation or challenges in the North American market too, which I think was isolated to Europe before. So if you could just provide us with an update on what you’re seeing in the competitive environment in North America, that would be helpful.

I think overall, for construction, there’s not really been anywhere where we’ve had a lot of strength. I think it’s been a tough environment around the world, North America included. We have had some issues here and there where we came out with tier four products in North America before some of our competitors. Some of our competitors had credits that they were using to sell tier three products over a longer period of time. So as that expires, as I’d say everybody gets on a more equal footing with regard to tier four, I think that will probably help us a little bit in North America, because it’s been a little bit of a drag.

Our next question today is going to come from Alex Potter.

I had a question on China in general. There’s been this downtick in PMI, obviously bearishness around emerging markets that has surfaced here just over the last week or so. But your commentary on China seemed at least relatively upbeat. Asia Pacific construction business is up really nicely in Q4. Power gen seemed to be holding up okay sequentially. So basically I’m just trying to see if you’ve seen anything recently to substantiate these initial signs of weakness in China.

The market reaction has really occurred over the past week or 10 days or so. I think in our business, it’s been pretty positive. We’ve seen not just our sales but kind of the overall construction equipment group sales in the industry ticking up year over year, over the past few months. And we saw that again in December. So I think what we’ve seen has been pretty good. We’ve done better than the market there as well. Our sales in China were up more than 20% this year. They were up in the quarter. So you know, it’s not been a big negative for us. Now, the flipside of that is, we’re not looking for improvements in overall GDP for China. We’re more expecting 2014 to be another year like 2013, like 2012. You know, in that sort of 7.5%-ish range. So that’s what we’re seeing in China, anyway.

Let me add a little bit on China. We are watching it very, very closely from a couple of aspects. Obviously liquidity in the banking system, and we keep a close eye on that, as well as their reform efforts. And we have been laser focused on being a leader in China, and that’s, again, around building field population. So we have seen our market share go up, our field population go up, and our business go up as a result. That is not to say China is not without lots of caution, which we are very much aware of, and we watch that every day. But at the same time, we have to have our dealers, with a field population they can work on, when times are bad or good. So that’s really our focus, is that business model inside China.

Last question here. I was just wondering if you could comment a little bit on power systems, maybe just qualitatively. Which segments, looking into 2014, do you expect to perform better, perform worse, and some of the [unintelligible] or reasoning behind that.

I think with the exception of industrial, which has had just a really really big up year this year, and is going to happen really tough comps as a result, I think we’re essentially looking year over year,’14 versus ’13, no really outliers. We have power systems overall up, we think, about 5%. And you know, for the big kind of subsectors, it’s not going to veer far off that. So with the exception of maybe marine, might be a little bit better, industrial might be a little bit worse, the rest of them, oil and gas overall, electric power overall, rail overall, kind of up a little.

Just a qualitative comment about power systems. Really sparkled in a tough year like 2013. And if you look back over the years, power systems has done that. Because there’s a fairly wide array of businesses in there. Take our rail business, between progress rail and EMD, EMD, in its third year of ownership, is just getting it done. We’ve seen a lot of cost reduction in locomotives, we’ve seen a lot of work around the aftermarket, kind of building up the Caterpillar DNA into locomotives. And we’re very, very happy with that acquisition and our current market position. Electric power has been very anemic, as you all know, but within that is our acquisition of MWM in Germany, which brings us a natural gas and gas in any form offering. We’re building that out, expanding through CAT theaters. Long term, that’s going to be a very good piece of business for us. And, again, kind of countercyclical to everything else in the power systems business. Our industrial business, which is really the reciprocating engines that we sell to everybody from ag to lift trucks, to other construction equipment makers, saw an increase in 2013 to make up for some of the shortfalls in the other segments. So within that power systems business, there’s a ray of diversity. And then finally, the turbine business, which has just been fantastic for us, really the whole time we’ve owned it, going back to the mid-80s. But with the oil and gas boom, the fracking boom, around this country and elsewhere, that has been a real stellar performer the last few years, and I expect it to continue. And then just an anecdote. I just returned from the Eagle Ford area, actually last week, and I had my ears to the ground on what they’re seeing down there. And actually our dealers there are a bit more optimistic than I expected. I’m not going to say wildly at all, but there’s still activity going on, and they feel like ’14 could be another solid year. So that’s anecdotal, but certainly a positive thing at this point in time. But our power systems business is one that we’re very happy with, and again, within that, it’s kind of a complete and various array of businesses in itself.

Our next question today is from Robert Wertheimer.

I wonder if I could follow up on what Doug was just mentioning. There’s a little bit of consternation in the market with some of the big oil majors talking about maybe declining returns on some of the expensive capex, maybe cutting back, and maybe some of the other segments in oil and gas being strong. Are you able to delineate your exposure to the big international oil companies? And maybe you could just say is [Solar] set to have another record year?

Yeah, I’d say, at this point in time, as Mike said also, our power systems in ’14 ought to look a lot like it did in ’13. We’re hopeful for a very modest increase, but that’s after a lot of gives and takes across that business. As you all know, the fracking business has changed the gas pipeline and gas compression business immensely in this country. And there’s still a lot of buildout on getting that gas out of the ground, and that’s what I think we’re seeing primarily around solar. The big nationals around the world certainly are questioning where they’re going, and we see that. I’ve got to believe the opening in Mexico, when that starts, because I do think they will pull that off, is going to change the dynamics completely again. And that could be some upside, although I don’t know how much of that we’d see in ’14. It ought to start. So really, I think you almost have to look at it country by country and see where that goes. But we’re not wildly optimistic about it, nor are we that pessimistic for ’14. I have been surprised with gas here the last month or so, going above $5. I would not have predicted that at all, but it’s quite interesting. I don’t know what that will do, but I think it’s probably a fairly short term phenomenon, based on the cold weather.

And I don’t know if you’re willing to answer this or not, and you have given a decent amount of mining information, but there are concerns that there’s a couple more years of capex decline out there, and obviously your sales have already maybe front loaded some of that decline, having fallen so far. Are you willing to say how far your unit deliveries in mining have fallen from peak in ’12 to what your outlook is in ’14? It’s more than 50%, I’m sure. It’s probably more than 60%. Maybe it’s more than 70%. I don’t know. Maybe you can help out?

I’ll help you maybe a little bit, Rob. We have a varied business, you know. It’s everything from drag lines to drills to big trucks to shovels. The largest selling product category for us is large mining trucks. And if you look at large mining trucks, and you look at what we’ve shipped this year, which would be relatively lined up with what our sales are, we’re down probably close to 60% in ’13 versus the peak. And if you look at what we kind of have baked into 2014, you’re looking at something like 75% below the 2013 peak for our shipments.

When we look at our resource industry business, you know, we’ll give you a forecast which is our best estimate in terms of that particular time. But from an operational standpoint, we clearly understand there’s risk. We knew there was risk in ’13, if you were in the resource industry business. And in that business unit, they started taking action in the first quarter. The companies joined in, and we really focused on structural cost reduction. And with that, we were able to deliver the $1.2 billion of cost reduction. And I’ll tell you that we’re bullish in mining in the longer term. Mike talked about our orders need to increase for the 10% down scenario. And we’ll walk into the first quarter in a cautious standpoint, and we’ll remains focused on cost reduction around here. But clearly, longer term, we see that as a great business for us. But we remain cautious, and we remain focused on the structural cost reduction in ’14.

Okay, with that, we are just past the top of the hour, and we’ll sign off. Thank you very much for joining us today, and we look forward to seeing many of you at ConExpo in March.