Good morning, ladies and gentlemen, and welcome to the Caterpillar 4Q 2019 Analyst Conference. At this time, all participants have been placed on a listen-only mode and we will open the floor for your questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Jennifer Driscoll. Ma'am, the floor is yours.

Thank you, Paul. Good morning, everyone. Welcome to Caterpillar's fourth quarter earnings call. Joining us today are Jim Umpleby, Chairman of the Board and CEO; Andrew Bonfield, CFO; and Kyle Epley, Vice President of our Global Finance Services division; and Rob Rengel, Senior IR Manager. Our call today expands on our earnings release which we issued earlier this morning. You'll find slides to accompany today's presentation along with the release in the Investors section of caterpillar.com, under Events & Presentations. For retail stats, look at our 8-K filed a few minutes after that. As shown on slide 2, any forward-looking statements we make today are subject to risks and uncertainty. We also make assumptions that could cause our actual results to be different than the information we discuss today. Please refer to our recent SEC filings and the forward-looking statements reminder in today's news release for details on factors that individually or combined could cause our actual results to vary materially from our forecasts. Let me remind you that Caterpillar has copyrighted this call. We prohibit use of any portion of it without our prior written approval. As previously indicated, today we're reporting adjusted profit per share in addition to our US GAAP results. Our adjusted profit per share for the fourth quarter excludes our pension and OPEB mark-to-market adjustment for the remeasurement of pension and other postemployment benefit plans. The adjustment was $0.65 per share in the fourth quarter or $0.64 per share for the fiscal year. Our adjusted profit per share for the full year also excludes the $0.31 discrete tax items from the first quarter of 2019. In the 2018 fiscal year, our adjusted profit per share excludes restructuring cost in addition to both tax related and pension OPEB mark-to-market adjustments. our US GAAP-based guidance for 2020 profit per share includes estimated restructuring costs for the year and continues to exclude pension and OPEB mark-to-market impacts. Now, let's turn to slide three and turn the call over to Jim for his perspective on 2019 and our outlook for 2020.

Thanks, Jennifer. Good morning, everyone. Thank you for joining Caterpillar's fourth-quarter earnings call. I plan to cover three topics this morning. First, I'll summarize our fourth quarter and full-year 2019 results. I'll also provide an update on the progress of our enterprise strategy as well as some color on how the year ended versus our investor day targets. I'll finish with our expectations for 2020. I'm pleased with the way your team is executing, notwithstanding the difficult economic environment which led to a decline in sales to users during the fourth quarter. I'll describe this segment later in the call, but just to give you a brief overview. Sales to users for all three segments were lower than our expectations. In Resource Industries, we continue to see strong quoting activity in mining as most commodities remain at investable levels, but customers are being cautious due to global economic conditions. While we experienced a decline in mining sales in the fourth quarter, we continue to believe there will be a gradual recovery in our sales to mining customers. Our mining sales are lumpy, so there can be significant variation between quarters. Energy & Transportation was a mixed bag due to the diversity of our end markets. North American onshore oil and gas activity remained depressed as we expected. Both solar and rail had a solid fourth-quarter. In Construction Industries, end user demand has softened, particularly in North America. As our earnings guidance indicates, we see some slowing across all three primary segments. We are ready to respond quickly to positive or negative developments in our end markets. We're doing what we said we'd do at our Investor Day in May by achieving our financial targets, continuing to invest in services and expanded offerings, and returning cash more consistently to shareholders. Sales…

Thank you, Jim. And good morning, everyone. I'll begin on slide 10 with total company results for the fourth quarter. I'll cover the segment results for both the quarter and the full year, then I'll walk you through our 2020 guidance and close with some comments on cash flow and capital deployment. In total, sales and revenues for the fourth quarter declined by 8% to $13.1 billion. Operating profit decreased less than sales and was down 2% to $1.9 billion. Adjusted profit per share for the quarter increased by 3% to $2.63, mostly reflecting the benefit of the lower-than-expected tax rate. Note that this year's adjusted profit per share results include restructuring expense, whilst last year's excludes it. Mark-to-market adjustments were similar in both periods, about $470 million in 2019 and about $500 million in 2018. As you see on slide 11, sales decreased by $1.2 billion in the quarter. This result was below our expectation of a mid-single digit decrease in sales in the quarter. While price and currency was slightly unfavorable, the primary factor was a 7% decrease in volume. As we discussed in the third quarter, we expected dealers to reduce their inventories, partly due to our improved lead times which allow dealers to hold less inventory and partly due to uncertainty in the global economy, resulting from trade tensions and other factors. This morning, we released the quarter's retail sales data, which showed a decrease in retail sales to users of 4%. We had anticipated the retail sales across all three primary segments will be flat, but Construction Industry sales to users declined by 3%, Resource Industries declined by 10% and Energy & Transportation sales to users declined by 3%. This weaker-than-expected end user demand and that whilst we cut back our shipments to dealers, dealer…

Thank you, Andrew. We will now move to the Q&A portion of the call. In order to include questions from more of our covering analyst, we ask that you please limit yourself to a single question. If you have a follow-up question, we'd invite you to reenter the queue. Paul, please begin the Q&A.

Certainly. [Operator Instructions]. And the first question is coming from Ann Duignan of JP Morgan Securities. Ann, your line is live.

Hi. Good morning, everybody. So many questions. I don't know how to pick one, but I think I will focus on pricing. If you could just expand on your flat pricing guidance for 2020, where are you seeing pricing improvement versus pricing degradation? And then, you said you increased your marketing programs in Q4 to stimulate demand, but it doesn't look like it's happened. So, if you could just talk about pricing across the businesses and across the regions, I'd appreciate it. Thank you.

Yeah. Ann, thank you. It's Andrew. So, couple of factors within Q4. As I mentioned, one, geographic mix was a factor as well. So, obviously, if you think about the way we price, particularly North America as a stronger pricing region, and so that geographic mix, given the reduction in inventory came through the price line. We expect that to continue as we do reduce dealer inventory through 2020. So, that will have an impact on pricing, particularly as you look at mix through the year. So, probably actually first half pricing will be a little bit weaker than we see, expect it for the for the second half. We have put modest price increases through. Obviously, we need to see how much of that sticks again and how much you have to put back into programs. Yes, your point about, we didn't see much demand being stimulated, yes, because we did see a reduction in the sales to users in the fourth quarter. We believe that had we not actually put that pricing behind, they may have actually a little bit worse than that. So, that was part of the programs being put in place.

I'm sorry. Didn't fully understand your North America answer. You said pricing is stronger in North America or price reductions are greater in North America?

No. It's the geographic mix. So, as you go through, if you look what's in our pricing line, it includes changes in geographic mix. We base it on a rate per unit. And, obviously, North American units tend to have a higher price because they are higher stakes than prices across the rest of the world. So, therefore, you do tend to then see a negative price variance coming through as a result of that with lower new North American sales.

And just so I'm clear, China pricing is down year-over-year. Is that the expectation going forward? And is it contained to China?

I don't think we've said anything about China pricing. We're talking about China sales. We said we expect China sales to be down flat to slightly down in 2020. We haven't talked about pricing by territory or market.

Okay. In the interest of time, I'll get back in queue, but I would like some clarification offline. Thank you.

Thank you. And the next question is coming from Joe O'Dea of Vertical Research Partners. Joe, your line is live.

Good morning. I wanted to ask about retail sales. When we look at the trends, it looks like a rather sharp sequential slowing from 3Q into 4Q. And you commented that it was a bigger step down than you expected. But just in terms of how you interpret those trends and based on conversations you're having with customers and dealers, the degree to which you're able to parse out how much of that is a bit of a spend freeze at the end of the year, the degree to which you have any insight based on January versus you're noting kind of December demand levels as something that we should be extrapolating going forward?

Good morning, Joe. So, really have to look at it by our various industry. There's no kind of one answer that covers all of those. We talked about the fact that, in mining, that business can be quite lumpy and that can be reflected in both our sales and our retail stats as well. Activity in mining continues to be strong. A lot a discussions with customers, lots of quotes, but our customers are being cautious, as we mentioned earlier. But we do expect that slow gradual increase to occur in mining and we're expecting a stronger six months than – last six months of the year be stronger than the first six. In oil and gas, we do anticipate the depressed market conditions in North American onshore production to continue in well servicing, recip gas compression and drilling. We do expect that to continue. CI is a bit of a mixed bag. Again, we talked about our expectations there for CI. I really don't have anything to add on top of that.

Okay, thank you.

Thank you. And the next question is coming from Ross Gilardi of Bank of America Merrill Lynch. Ross, your line is live.

Yeah. Thanks, guys. Good morning.

Good morning.

Good morning, Ross.

Jim, you know this oil and gas business that Caterpillar has a bit better than anybody. And I am just wondering how your spare parts and service for E&T, both upstream recips and turbines, how they are behaving? Were they stable in the fourth quarter? And are you expecting them to be stable within your outlook? Clearly, the new equipment outlook is very soft, but solar has traditionally been able to weather a lot of these downturns. And I'm wondering if you expect the parts and service components of your oil and gas business to remain resilient, particularly in an oversupplied natural gas market.

Yeah. Starting with solar, as we indicated, solar had a solid fourth quarter both on the OE and on the service side. And we do expect their service sales going forward to remain resilient. That's been proved many, many times. So, we do expect that to be the case. We had mentioned a number of times over the last year, there's a bit of a pent-up demand for oil and gas parts for rebuilds that resulted in increased sales in 2017 and 2018. So, with the pressure on North American oil and gas, that business will remain challenged through 2020.

Okay, thank you.

Thank you. And the next question is coming from Jerry Revich from Goldman Sachs. Jerry, your line is live.

Hi. Good morning, everyone.

Good morning, Jerry.

I wonder if you could just expand on your decremental margin assumptions. It looks like you're embedding 35% decrementals give or take in the 2020 outlook. And when we look at your decremental in the last sales downturn, they were generally in the 20% range. So, I'm just wondering if you'd just bridge that as that could give yourselves room to execute in a challenging environment. But can you just share the pieces just to bridge us between the historical decremental margin performance versus the target for 2020?

Great question, Jerry. It's Andrew. Thank you very much. This is exactly why we don't talk about incrementals and decrementals anymore. What we have done, obviously, through the last downturn, the company took out a significant amount of structural costs. And as we've gone through the last couple of years where we've seen an upcycle, we have not put that cost back in the business. What that meant, obviously, is margins improve, absolute margins improve over time, which is why we gave the Investor Day targets of improving margins by 3% to 6% against historical performance. On the way down, because we are not – we haven't put a lot of structural costs back in, there's not a lot of structural cost to cut, so you will see, obviously, higher deleverage as you go down. Also, because we're expecting this relatively to be a pause rather than some fundamental change in the market, we are continuing to invest in both services and in R&D, particularly for NPI, new product introductions. That is important for us because that drives long-term growth. So, we maintain the flexibility. How we are managing it? We're managing against those margin targets. We look at the absolute margin to make sure we stay within that 3% to 6% range against the level of sales and revenues we're expecting next year and we do believe the plan we've got does do that.

And, Andrew, can you just expand maybe a little bit on the variable cost structure part of that discussion because more variable cost structure would suggest lower incremental and decremental margin. So, I appreciate the comment on – we have less restructuring opportunities now, but maybe you can expand on that point because that would sound like it would reduce the cyclicality and operating leverage.

Yeah. So, obviously, volume is going to have a major impact next year as we go through. Obviously, that is the biggest single factor. And, obviously, operating leverage is a factor in the margin. With regards to the other part, obviously, we're expecting pricing to be about flat next year. We are expecting some favorability in material cost, as I mentioned, particularly around steel, and also because of some programs we've put in place. How much of that feeds through into margins next year will depend on how quickly we get those programs through out of inventory and actually into sales. We're also start expecting lower freight next year. Freight costs have been high for the last couple of years, and partly because of, obviously, trying to meet end user demand. But now with lead times being in a better place, we don't expect as much premium freight to occur.

Thank you.

And maybe just to expand on that answer just a bit, one of the things that Andrew mentioned earlier is we're really paying a lot of attention to end user demand. Our dealers are independent businesses, but we're working with them to ensure that we don't have too much dealer inventory. And in the past, I'd argue that some of our cyclicality has been exacerbated by movements in dealer inventory. So, by shortening our lead times, having a dealer inventory that is appropriate for market demand, we believe that we will have a dampening effect on our cyclicality, which is part of what we're trying to accomplish.

Thank you.

Thank you. And the next question is coming from Seth Weber of RBC Capital Markets. Seth, your line is live.

Hey. Good morning.

Good morning, Seth.

I wanted to ask about the China construction market. I know you mentioned your expectations for the market to be kind of flat to down. CAT's been picking up share there recently over the last few months. Can you speak to your expectations for CAT, particularly what's been driving the market share gains? Have you sort of changed tact with some of your marketing programs? Is there new product that's kind of gaining good acceptance? And can you just talk broadly about your expectations relative to the market? Thanks.

Yeah. What we indicated, I believe, is that we expect our sales to be flat to slightly down in 2020. We talked earlier about the fact that we're continually introducing new products as part of our expanded offering strategies. GC products and certainly a big part of that target customer audience is in China. We're continuing to build out our dealer network, continue to build out our footprint there, along with connected assets and all the other things we're doing. We believe that we're well-positioned to compete in China moving forward.

Okay, sorry. So, CAT is flat to down. Is that better than what you're seeing for the market then? I thought that was a market commentary?

I believe it's roughly similar.

Roughly similar. Okay. Thank you very much.

Thank you.

Thank you. And the next question is coming from David Raso of Evercore ISI. David, your line is live.

Hi. Thank you. My question is about EPS guidance, but can I go about it related to the dealer inventory swings. So, the inventory reduction this year you're targeting, midpoints, $1.25 billion, but the headwind for you is actually greater on a year-over-year basis, right, because the inventory went up $700 million last year. So, we're looking at a $1.95 billion drag year-over-year. But the way you spoke to the inventory sequentially, it appeared – and correct me if I'm wrong – almost all of that $1.95 billion, a very large majority of it, that year-over-year drag is really concentrated in the first half of the year, is that correct?

David, it's Andrew. Yes, that is correct.

So, when I think about the EPS cadence, pricing, a little bit of a struggle to start the year. The big inventory swing for the full year is really focused on the first half. Sort of set you up for the answer that I'm just trying to figure out then. Normally, the first quarter, the last, whatever, 20 years, the median, it's up a little bit from the fourth quarter. Your fourth quarter was on the high side. So, is it fair to say that's not the case this year? We start low in the first half. The first quarter is below the 4Q and then it climbs from there? I'm just trying to get, again, a sense of how much is the…

Part of the reason why I tried to talk a little bit about the phasing for next year is, yes, do not expect the historic trends to prevail. As you know, normally, first quarter is a relatively strong quarter. Always a strong quarter from a margin perspective as we build inventory heading into selling season. And then, obviously, the second half is slightly weaker than the first half, but that is the normal pattern, both from a sales and revenue and also from a profitability perspective. Your assumptions you're making are fairly accurate based on what we're seeing. We do expect dealer inventory to have an impact on the first half. As I said, CI will see some build in Q1, but that should be broadly flat by Q2. RI will see a steady decline through the first half of the year versus a build last year. So, that is the likely outcome as we move. And so, yes, you can't just – you won't be able to just simply be able to use the seasonal trends as a plug in your model, I'm afraid.

And just to be clear, Jim, last year, obviously, the inventory reduction was a little disappointing. The management's commitment to take care of this inventory in the first half of the year, I just want to be clear, I know they're independent dealers, but are we looking to take out year-over-year swing, completely avoid the normal seasonal build, you're not looking to build inventory at all in the first half of the year and that's that big year-over-year drag? I'm just making sure, from the prior, let's say, disappointments on the inventory the last couple of quarters, is there a firm commitment to address this in the first half and not let this linger into the back half?

Yeah. David, we work with our dealers, but they are managing their businesses themselves. So, we can't manage their inventory for them. However, based on our expectations on order patterns we're seeing from dealers, we do expect that they will be working hard to reduce their inventory in the first half of the year. We can't make a 100% commitment, but, obviously, we do expect the vast majority of that to happen in the first half.

And one of the reasons that our fourth-quarter inventory didn't decline as much as we anticipated is because end user sales were lower than our expectations. So, obviously, end user sales has an impact on inventory in the quarter.

I appreciate it. Thank you so much.

Thank you. [Operator Instructions]. Your next question is coming from Rob Wertheimer of Melius Research. Ron, You may ask your question.

Thank you. Let's see if it works. Just a quick clarification. On North American construction, you have residential and non-residential construction to decline. Is that industry dollar spent on construction or is that construction equipment for the industry? And if I can, my question is really – the reduction in lead time is a fantastic thing for CAT and reduction in volatility would be a great thing for CAT. Any color around just the work you've done to achieve that and if dealers are starting to recognize that in wanting to hold structurally lower inventory? Thanks.

With regards to residential/non-residential, construction equipment relating to that is what we're expecting to see the decline.

Perfect.

And then, as regards the inventory, let me hand that back to Jim.

Yeah. In terms of lead times, we were working on this lean journey for a long time. And, obviously, if we can find ways to reduce our lead times, it helps us both in the up cycle to respond more quickly to increases in changes in demand and also allows us to cut back more quickly, so we don't have an overhang, which help to dampen the impact of the cycles. Again, we've got our total team focused on reducing cycle times, all part of that lean journey and really trying to synchronize across the value chain. And I think we're doing a better job of that than we have in the past. But it's a never-ending journey.

Okay. Thanks, Jim.

Thank you. And the next question is coming from Ashish Gupta from Stephens. Ashish, your line is live.

Great. Thanks so much. Just wondering if you could expand on your GC comments related to China. Maybe you can give us a sense of what went right or where you're looking for incremental improvement in 2020? I guess I'm just referring to sort of the market share losses through most of the year, although it did improve in the end. Just kind of trying to think about how much of a contributor that could be in 2020 and beyond, where the successes were and where you could see some incremental improvements?

Yeah. Whether it's China or any other part of the world, the competitive landscape is continually changing as we introduce new products, our competitors introduce new products. So, that's nothing new. And so, again, you look anywhere in the world over time, we see changes in the competitive situation. We have demonstrated our ability to successfully compete in China. We've localized – we have a local leadership team. We have dozens of factories. We have localized our supply chain and we continue to build out our dealer network and increase services and connectivity and introduce new products. So, again, competitive situation in China or anywhere in the world is fluid, but we're very committed to be successful in that market and I believe it demonstrated we can be successful competitively.

Thank you. And the next question is coming from Jamie Cook from Credit Suisse Securities. Jamie, your line is live.

Hi. Good morning. A clarification, if you could just elaborate. You talked about the normal restructuring of $200 million and then the – I'm sorry, normal restructuring which I assume is $200 million; and then the strategic stuff you're reviewing, another $200 million. I'm just trying to understand what's in the EPS guide that you're not adjusting out. And then, I guess, my question is, you talked about reviewing products. You talked about some cost-cutting, realizing it's not what we had – there's not the opportunity in prior cycles. But as we get to the back half of the year, I'm just trying to understand are there any savings associated with these measures or does that play more into 2021? Thanks.

Okay. Jamie, so we have said we would – this year we expect – beginning of the year, we said that, for 2019, that we expect the restructuring cost now to normalize at between $100 million and $200 million a year. We were slightly above that. You will have heard me say that we were $236 million for 2019. We expect a normal level in 2020. So, between the $100 million to $200 million is the sort of normal level we would have. The $200 million, actually, yes, you're correct. It does relate to some products which are delivering OPACC. We've got to go through with doing the evaluation of the actions we can do. And at the moment, our guidance does not take into account that there would be any savings associated with these measures in 2020. We think more likely that will be in 2021 anyway.

And is there any way to think about savings associated with that or just too early? And to confirm, repurchase is in your EPS guide, right?

Yeah. Repurchases in the EPS guide. And, yes, we will keep you updated on this because, I think, as the charges come through, we'll pick it up and then we'll talk to you about what we're expecting from a benefit perspective.

Jamie, to add in there, we're also continuing to look at ways to reduce our structural cost, particularly in the areas of back office, procurement and all the rest. And we do expect, again, over time, to have improved performance as a result of that. Again, relatively limited impact in 2020. But we're really trying to take the right steps in 2020 to set ourselves up for the future with a lower structural cost.

Thank you. That's helpful.

Thank you.

Thank you. And your final question is coming from Stephen Volkmann from Jefferies & Company. Stephen, your line is live.

Great. Hi. Good morning, guys.

Hi, Steve.

Andrew, thank you for all the comments relative to sort of the EPS cadence. But I'm wondering, Jim, if I can ask how you're thinking about the markets. You talked about this earlier. I think you sort of characterized it as a pause. So, the down 4% to 9% in end user demand, is that sort of significantly lower in the first half? And then, maybe closer to breakeven in the second half? Or do you think this kind of runs its course and the fourth quarter run rate could actually be kind of back to growth again? Or are you just sort of predicting kind of steady continuous weakness in end user demand?

I think you really have to look at it by segment. So, in Resource Industries, and mining in particular, we believe that the second half will be stronger than the first half. Again, we feel there is a slow gradual recovery occurring in mining. Our customers are cautious. But just based on the quoting activity and the amount of that that's going on, we do anticipate that there'll be a stronger last half of the year than first half. In construction, don't anticipate any dramatic changes first half to second half. Oil and gas, onshore, we expect that to remain depressed throughout the year. Solar and rail typically have strong fourth quarters. It's that way almost every year. And we have no reason to think that wouldn't happen again.

Great. I appreciate. Thanks, guys.

Thank you.

Okay. With that, let me turn it back to Jim for his closing remarks.

Thank you all for joining the call and appreciate your questions. CAT faced several challenges in 2019 and I'm very proud of our team of employees, how they met those challenges with determination. They've allowed us to meet our operating margin targets that we set on our Investor Day and do the other things we said we would do. And we continue to advance our strategy for profitable growth. We are investing significantly in services, expanded offerings and working on that operational excellence. Record safety year, shortening lead times, working on the cost structure. And certainly, 2020 will bring its own set of challenges and opportunities, but we remain focused on delivering additional value to our customers and our shareholders, and we'll continue to execute our strategy for profitable growth. Thanks for your time.

Thanks, Jim. Thanks everybody who joined us for our call today. If you missed any portion of the call, you can catch it by replay online later this morning. We will post a transcript on the Investor Relations site within one business day. If you have any follow-up questions, please reach out to Rob or me. Rob is at rengel_rob@cat.com. I'm at driscoll_jennifer@cat.com. And the general phone number in investor relations is +1-309-675-4549. And let me ask Paul to conclude our call.

Thank you. Ladies and gentlemen, this does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.