Ladies and gentlemen, thank you for standing by and welcome to the Q3 2020 Caterpillar Earnings Conference Call. At this time, all participants are in a listen only mode. Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Jennifer Driscoll. Thank you. Please go ahead.

Thanks Jason. Good morning, everyone. And welcome to Caterpillar's third quarter 2020 earnings call. Today I am joined by Jim Umpleby, Chairman of the Board and CEO; Andrew Bonfield, Chief Financial Officer; Kyle Epley, Vice President of our Global Finance Services Division; and Rob Rengel, Senior IR Manager. On our call we are expanding our earnings news release and sales users, which we issued earlier this morning. Our slides from today and the news release are all in the Investor section of caterpillar.com under events and presentation. The forward-looking statements we make today are subject to risks and uncertainties [Tech Difficulty]. We will also make assumptions that could cause our actual results to be different than the information we are sharing with you on this call. Please refer to our recent SEC filings and the forward-looking statements reminder in the news release for details on factors that individually or combined could cause our actual results to vary materially from our forecast. Caterpillar has copyrighted this call. And we prohibit use of any portion of it without our prior written approval. This quarter included a $0.12 per share remeasurement loss resulting from the settlement of pension obligations. We provide non-GAAP reconciliation in the appendix to this morning’s news release. There is also backlog information and couple other things. So in a moment Andrew will update on our third quarter results and our financial position but first please turn to slide 3 as I hand you over to our Chairman and CEO, Jim Umpleby. Jim?

Thank you, Jennifer. Thanks everyone for joining the call. I'm proud of how our global team has performed in a challenging environment, providing the essential products and services that enable our customers to support a world in need. We continue to leverage our strong safety culture, remaining both safe and productive in this pandemic altered work environment. We remain committed to our strategy launched in 2017, which is based on operational excellence, expanded offerings and services. The operational excellence element of our strategy has served as well, resulting in disciplined management of structural costs. As a result, we went into the pandemic with a strong balance sheet, and it continued to invest in expanded offerings and services to make our customers more successful. We're introducing several new products and are enhancing our digital capabilities. Now I'll briefly cover third quarter results starting with slide 4. While sales, earnings and profit per share declined versus the prior year's quarter, our performance in the quarter was better than we expected. Third quarter sales and revenues of $9.9 billion decreased by 23%. Lower sales volume drove the decline primarily due to lower end user demand. In addition, dealers decreased inventory by $600 million this quarter, versus a decrease of $400 million in the third quarter of 2019. That was more of a decrease than we anticipated, with dealers having reduced their inventories by $1.8 billion year-to-date; we now estimate they will reduce their inventories by about $2.5 billion by year end. This morning we also reported three months sales to users, which decreased by 22% versus the previous year. This was similar to the second quarter's trend and about in line with our assumptions. Machine sales to users decreased by 20% driven by a 31% decline in North America. Asia Pacific overall was…

Thank you, Jim, and good morning, everyone. I'll start on slide 8 with a recap of our third quarter results. Then I will walk you through the segment results and free cash flow, touch on the fourth quarter outlook and finish with our cash and liquidity position. To summarize, sales and revenues declined by 23% to $9.9 billion. Operating profit decreased by 51% to $985 $5 million. Third quarter 2020 profit per share was $1 22. This includes your pre tax remeasurement losses of $77 million or $0.12 per share, resulting from the settlements of pension obligations. Adjusted profit per share was $1.34, and $93 million or $0.17 per share discrete tax benefit is included in both our profit per share and adjusted profit per share figures. Last year's profit per share for the third quarter was $2.66. Overall, sales and revenues finished fairly close to what we thought in July, with the operating margin being better than we anticipated, although this was partially offset by negative foreign exchange impacts and lower investment income. As shown on slide 9, the top line declined by $2.9 billion, of which $2.6 billion were due to lower volume. A $200 million year-on-year movement in dealer inventory also contributed to decrease. As Jim mentioned sales to users overall decreased by 22% for the quarter. Sales to users for construction industries declined by 15%. Within that number Asia Pacific was a bright spot. It rose 4% benefiting from stimulus spending in China, where the industry is actually up year-to-date. North America while down 27% improved from the second quarter trend. Resource Industries which does tend to be lumpy had some unfavorable timing, and a 31% year- over-year decline mainly due to weakness in North America and Latin America. Energy and Transportation sales to users decreased…

[Operator Instructions] Your first question comes from the light of Jamie Cook from Credit Suisse.

Hi, good morning. I guess Jim, just trying to read between the lines here; just your comments on dealer inventory. It sounds like you think we've seen the bottom of declines in end user sales, your commentary just on orders or backlog? I mean, do you have a more positive view of 2021 in terms of the possibility of end user demand growth? And if so, can you sort of comment on which areas you're more constructive on versus less without understanding you're not going to want to quantify a revenue growth opportunity for next year? Thanks.

Good morning, Jamie. And yes, you're correct. I'm not going to give 2021 guidance, but I will try to make some comments just to provide some color. So certainly as we sit here today, I feel better today than I did a quarter ago. We've talked about the fact that we are quite constructive on what we see in mining. So mining quoting activity is quite high. I mentioned in my earlier remarks, we are tendering for some large projects that we feel good about that would involve multi year deliveries of large tractors and large mining trucks. Again, mining really is continues to improve. We've talked about the housing starts in the US driving activity on the smaller end of our construction industries business as well. And we believe that strength will continue going into next year as well. So again, we're not going to give guidance here for 2021. [Tech Difficulty] better today than we did a quarter ago.

Your next comes from a lot of David Raso from Evercore ISI.

Hi, good morning, sort of in the same spirit, I'm just trying to get a sense of you speak now a lot to revenues in sort of sequential historical terms. And now that we have a bit of a baseline for how you're thinking about fourth quarter, to extrapolate that into early 2021, I'm just trying to appreciate the commentary about the improvement, you're saying under production in CI to back in line with retail, the way the year is going to start in 2021, just for some perspective, should we still just think of it as normal sequential starting the year? Or what you're seeing on the order book, you mentioned maybe some timing issues with solar and mining, just to give us a little baseline and I think Andrew said positive momentum into 2021. I think we're just all trying to sanity check when can the company return to positive revenue growth. I mean 2Q is in relatively easy comp. I think people were just trying to figure out how much momentum to start 2021, just some perspective a bit, appreciate.

Yes, David, it's Andrew. Good morning. Obviously, if you remember in the first quarter, we did see some inventory build although lower than normal by dealers as a result of getting ready for the buying season. And obviously, as we hit that the pandemic hit, as well. I think a couple of thoughts on Q1, so that will be an impact. So obviously, the year-on-year comp, as you say is a little bit more challenging. We did see the big deal inventory reduction occur in Q2, we would expect also, for example, in China, China's a later Chinese New Year this year. So that means there may be some inventory build in Q1, Chinese New Year's sort of middle of February this year. So that may impact Q1 comps. And I think generally, as we say, we think that the underlying momentum in end user sales will start to have an impact more positively. But obviously first quarter had less of an impact. So it's going to be a little bit challenging as we go through the year. I think as we get to January, we'll be able to give you a little bit more feel for exactly how that pans out for the year.

Your next question comes from a line of Chad Dillard from Bernstein.

Hi, good morning, guys. I hope you guys can comment on CAT's own inventory, I think it's running about 34% of sales on a [pro forma] basis. How should we think the depletion managing destocking there? And where you would expect it to be at the end of the year? And what would you consider to be healthy level there?

Yes, Chad, this is Andrew. Good morning. As we said, we are holding more inventory than we would normally hold at the CAT end for a couple of reasons for that, one, which is obviously we had a little bit of extra safety inventory as we've gone through the year partly because obviously we have been concerned about supply disruption. So as safety inventory levels are a little bit higher. Second thing is actually, this is one of those odd years where actually we have a downturn and potentially getting ready for an upturn in demand in the same time. Historically, you would always have seen in a down cycle, obviously a reduction in Caterpillar owned inventory. Given the dealers are reducing their inventory levels, given that we are expecting the underlying demand to tick back up as we move into the next financial year. We believe it's right for us to hold a little bit more inventory than we would normally have held. Getting ready for that so that we aren't in a position where the bullwhip effect catches us out as we move into 2021. I mean, obviously normally, if we were in a situation where we didn't see that we obviously would be continued to reduce inventory levels. Obviously, again, we are we have plenty of cash on hand. We are in a low interest rate environment. So financially, it's not a big drag on us to hold a little bit more inventory than we would normally do.

Your next question comes from the line of Joe O'Dea from Vertical Research.

Hi, good morning, everyone. Questions related to services and we saw end user demand trends. The decline rates pretty similar between 2Q and 3Q. It looks like the decline rates on the services side of the business might have accelerated from 2Q to 3Q. I think you've talked about some deferrals. But if you could just comment on what you saw a little bit on the year-over-year trends if in fact it was getting a little bit tougher sequentially. And then in the recent announcements around the leadership changes and clear focus on services there. What you see in terms of opportunities in the near term to control what you can control and drive those revenues higher.

Yes, certainly, and thanks for your question And certainly we are continue to be very focused on services is an important element of our strategy. And as you would expect, services did decline by a lesser extent than OE, in this declining market. Having said that, again, we're continuing to invest to increase services. And I did make some comments, I believe in about what we expected mining in terms of just given that utilization is high, we expect moving into next year to see higher aftermarket sales, but again, continue to invest in that part of the business. And it's something that we're very excited about the opportunity.

Your next question comes from a line of Ann Duignan from JP Morgan.

Yes. Good morning. If we could just focus on the comments you made on quarry and aggregates being weaker and then road construction also, I think, you noted in construction equipment being weaker. Can you talk a little bit about the importance of a new FAST Act or new highway bill versus anything we could get some ginormous infrastructure bill? How important is it to get a new four year highway bill going into 2021, particularly for your customers who may not be able to invest with that long term contract?

Yes, the reason one year extension of the service highway bill does provide some certainty for state and local governments so they can plan for projects as we think about. And of course, we've continued to advocate for a long term reauthorization of the federal highway bill. We think it would be very appropriate in terms of economic stimulus. And, of course, the overall infrastructure bill that seems to have very broad, bipartisan support certainly would be a positive for our customers and for us, timing of all that, in fact, of course, is uncertain. It all depends on politics and when it gets passed. But again, based on everything we've seen, it's the one thing that the two sides tend to agree on at this point.

Your next question comes from the line of Tim Thein from Citigroup.

Great, thanks. Good morning. So this question relates to the interplay of price and material costs, as we look into 2021. Just given the recent moves we've seen in most grades of steel, and what looks to be a bit more of an inflationary environment, which of course, we coming down the pike for CAT, how should we think about the opportunity for pricing actions into 2021? Just given the state of markets globally and then CAT's ability to stay on the plus side of price versus material cost in 2021. Thank you.

Yes. Thanks, Tim. It's Andrew. Yes, just I mean from that perspective, I mean, obviously, we do bought forward a little bit of our steel. So we are still seeing the benefits of price reductions at this stage. As we're thinking about price actions in 2021, yes, you are completely correct; we are taking into account the demand side of the equation. Obviously, if demand is in a softer demand environment, you obviously do not want to push price too hard. And we are reflecting the fact that obviously at the moment, we are still seeing favorable material costs. In the event, obviously, that does change as we go through the year, we always have the option of thinking about that later. But at the moment, we're in a reasonably good position as we move into 2021.

Your next question comes from the line of Rob Wertheimer from Melius Research.

Good morning. You saw a transition two presidents this quarter, which is a little bit unusual. And I wonder if you could talk about that for a second perhaps what was accomplished? And if there's a different focus on the future for Joe and Tony, or whatever direction you want to take it. Thank you.

You bet. Well, certainly as I mentioned, we thank Billy and Ramin for their many contributions during their careers and wish them well on retirement. And we're very excited also about having Joe and Tony joining the executive office. It does not signal any kind of change in strategy; we're going to continue to execute the strategy that we introduced in 2017. Expanded offering and services and operational excellence. So we have a very strong bench and our board spends considerable amount of time on succession planning. So again, that's again, we wish Billy and Ramin all the best.

Your next question comes from the line out of Courtney Yakavonis from Morgan Stanley.

Hi, guys. Thanks for the question. If you can just comment -- you commented before the housing and resi was one of the parts of the business that seems to be driving activity on the small end of the business that it sounded like you're expecting more muted non-residential activity in the fourth quarter. If you can just comment maybe on those relative sizes of your business in the margin propel between the two and acknowledging that you'd kind of talked about resi heading into next directors, any comments that you would make on non resi? Thanks.

Yes, thanks, Courtney. It's Andrew. Obviously with a broad portfolio like Caterpillar, you have different margin structures within different parts of the business. And that varies across the portfolio. Obviously, as we have been clear, obviously, the smaller machines tend to have a slightly lower margin than the larger machines. But overall, we think that the portfolio mix, as you've seen even this year is relatively small and manageable within the context of the broader Caterpillar. So I think overall, we are not too worried about that having a drag impact on gross margins. Also the other thing to remember is obviously, if you get very favorable leverage from some of these products, it does help actually improve your margin structure. So that has been the way it's been managed, which is why it's been very manageable, and we expect it to be manageable going forward.

Your next question comes from the line of Ross Gilardi from Bank of America.

Thank you. Good morning. I had a question for Jim. Jim, the industrial economy seems to be getting better. I mean thus far you're not really seeing it and your retail sales growth in both mining and E&T, I mean, maybe some of that, as you guys discussed is lumpiness and delivery timing. But a lot of that has got to be due to a pretty anemic capital spending outlook in the energy sector and pressures in markets like coal, and you seem to be flagging, ongoing at least near term headwinds for solar, which has been very resilient the last few cycles, I know you're buying Weir assets. But is the company giving any thought to using its $9 billion cash hoard to diversify away from the fossil fuel industry, given the structural headwinds in the energy markets? And markets like coal? And if not, why not?

Well, Ross, certainly appreciate your question. I don't believe we signal any headwinds for solar. But probably the best way to start is by -- it's quite an expansive question you've asked so I'll give you a bit of an expansive answer. But we start by reminding me we're a large diversified business both in terms of end markets and geography. As I mentioned earlier, we're proud to have been named 19th out of 5,500 companies around the world to the Wall Street Journal's top sustainably managed companies. And we build the world's infrastructure. And that would include investments in future energy infrastructure around the world. And I'm confident our products will play a part in that. I believe that we're well positioned to benefit from both the period of transition and after the transition have occurred. And will continue to support our customers during the period of transition, no matter how long that is. But we're also very well positioned to succeed in the future. In terms of how we're supporting our customers today; we have world class products and services to support oil and gas customers. But we're helping them with their ESG goals as well, helping them to reduce their carbon footprint. Whether it's methane abatement by reducing flaring, we're providing battery storage solutions and efficiency improvement. We've introduced a dynamic gas blending engine that allows our online gas customers to substitute up to 85% of diesel fuel with natural gas, and we continue to support all of our mining customers as well. And by the way, our exposure, you mentioned coal; our exposure to coal is low. It's generally between 3% and 5% of company revenues including both machines and parts. And when our mining business look into the future, we see future opportunities due to…

Your next question comes from the line of Larry DeMaria from William Blair.

Thank you. Good morning, everybody. Obviously you discussed better environment and optimism in 4Q and early next year. But can you talk, maybe more of the profit side just assuming let's say apples-to-apples flat sales next year? What are some of the puts and takes in profits for example, what's the incentive comp, headwind, what are the benefits on run rate restructuring. Another items on an apples-to- apples basis on profit from this year to next year, without assuming any let's say incremental, or decremental margin?

Hi, Larry. It's Andrew. Yes, obviously, the -- from a top line perspective, if we produce closer demand, obviously, that means we won't have the negative impact of dealing big reductions. So there will be a positive rolling through the profit, assuming no other obviously changes from an operating leverage perspective. On the sort of cost side, we did see, obviously, step, normal step runs at about $800 million per year on the basis of a standard payout. We will have that as a headwind as we move into 2021. We did see some delays and discretionary spending. Some of that may not come back. Some of that may come back, but it's relatively very minor overall. For example, things like travel have been less. Obviously, there have been other projects, which haven't really got started as such because they've been delayed while people aren't in the office together. So we'll see how that pans out as we get in. And obviously we'll be able to give you a better guide to that as we get into January when we talk about 2021.

And with restructuring, run rate restructuring number to think about.

At this stage, we are still putting our plans together for 2021. Obviously, we assume normally on average about $200 million of base restructuring. And then obviously, we've seen some incremental relating to these challenge products. Some of the challenge products, restructurings will recur in 2021. But we're spending about $400 million this year probably wouldn't be that much significant at this stage different next year, we'll maybe even slightly less, we'll need to see how -- as we finish our planning process.

Your next question comes from the line of Nicole DeBlase from Deutsche Bank.

Yes, thanks. Good morning, guys. Just wanted to spend a little bit more time on E&T, I was a bit surprised by the retail sales deterioration there that you guys reported for the three months ending September, if you could just elaborate a little bit on that. And then also with respect to that segment, decremental margins were a bit higher this quarter. Anything special going on there and how to think about that into 4Q?

So I'll start with the, Nicole, with the margins piece. As I said in my comments, we did have a small one time credit last year income in E&T, this year we had a number of negative one timer equated to about $70 million that related to some asset write downs and also some inventory impairments. So that was actually the big driver of the margin change quarter-on-quarter.

In terms of sales, both in E&T and Resource Industries but particularly E&T. It's really a lumpy business so you can see deviations quarter-to-quarter in terms of retail sales. So that drives a lot of it.

Your next question comes from a line of up Steve Volkmann from Jefferies.

Hey, good morning, everybody. Thanks for taking my question. It's on the return of cash to shareholders and understandable to sort of pause the repo this year. I'm just curious how you think about next year assuming it restarts at some point? Do you over return cash to sort of make up the difference and get to where you want to be? Or do you restart at kind of the operating cash flow level and proceed that way. Thanks.

Obviously, good morning, Steve. It's Andrew. Obviously, any decision around that will be a board decision, which will take an update as we move into 2021. Remind you that our actual policy is to return substantially all of ME&T free cash flow. This year, we will already have over returned based on our free cash flow year-to- date. And the amount of buyback we've done probably will be over. So probably we'll just rebase back to what the number is. But again, we'll have a conversation and discussion around that probably back in January timeframe with you.

Your next question comes from a line of Jerry Revich from Goldman Sachs.

Yes, Hi, good morning, everyone. We've seen across the board, strong digital engagement in this environment for a lot of folks. And I'm wondering if you just quantify for your business out of your connected machines, what proportion of your customers use digital ordering over connected to dealers via the channel? I know you've put in a lot of work there. I am wondering if you could just quantify for us how much traction you're building in that way or any other way you're comfortable talking about it. Thanks.

You bet, Jerry. We certainly are going to quantify number. But that's something that we're very focused on. And we're seeing improvement over time. So as we continue to invest in our dealers investing as well, and their capabilities, we're seeing improvements, and we expect that to continue, but I really can't quantify it for you this morning.

Your next question comes from the line of Steven Fisher from UBS.

Great, thanks. Good morning, wondering how much visibility you guys have on China construction, it looks like the retail sales activity is maybe moderating. But Jamie noted you expect continued strength in the next year. So can you just talk a little bit about the visibility there and maybe the drivers in terms of some of the policy shift versus market share and any other key factors? Thank you.

As I mentioned earlier, Steve, we do see continued strength in China. It's been quite strong. And we do expect that strength to continue into next year. Based on what obviously, we don't have a crystal ball. But based on everything we see today, we expect the business to continue to be strong. Again, hard to elaborate much more than that frankly.

Your next question comes from the line of Seth Weber from RBC Capital Markets.

Good morning, everybody. Just kind of along in the lines of a prior question, your R&D spend has been down here for a couple of years. I mean in a scenario where revenue starts to come back up, would you expect a material pickup in R&D spend next year? Thanks.

Yes. I mean, I think one of the things it's obviously, one of the bigger factors this year on R&D spend actually has been short term incentive compensation reductions that has a year-on-your, one of the most significant impacts. Yes, there have been some project delays. Obviously, as we've gone through the year, just inevitably, not having all the engineers in the room together does mean that some of the R&D projects are going slightly slower. As a percentage of sales, actually R&D is actually up year-over-year because obviously spend is held up slightly better than the rate of decline of revenues. So obviously, we'll see an absolute dollar increase. But obviously, maybe not quite as a big maybe slightly lower percentage as a percentage of revenues.

But, again, we're confident that we are investing in the most important R&D projects, and continue to build up those expanded products, continue to invest in digital. So again, we're very committed to continue developing new products and investing in the most important R&D programs.

Your final question comes from a line of Mircea Dobre from Baird.

Thanks. Good morning. Thanks for squeezing me in. Want to go back to mining if we could and maybe Jim, question for you here. If we're kind of looking at the current environment, you sound constructive on mining. It sounds like there are some things in the pipeline and the customers are starting to move on deploying a little bit of capital. How would you compare the discussion in the pipeline that you have now versus where you were in, say, 2016 going into 2017? And I asked because the fleet we all know it's older. So I'm presuming that the decision making, which for your customers is a little bit different today than it was say in 2016?

Yes, I say that the conversations are very different indeed. I mean, by the end of 2016, frankly, our customers were shell shocked, just given them what they had gone through between 2012 and 2016, a very, very tough time for them. And all the discussions were about continued cost reduction, about finding ways they could squeeze more cost out of everything you're doing. The conversations are quite different today, conversations around autonomy, how we can help our customers be more successful. They're talking about Greenfield projects, expanding Brownfield projects, retrofits of autonomy on existing fleets. The conversations are very, very different. And I'd say the mood couldn't be more different. I'm not expecting a wild spike up. As I've said previously, I think the best thing for both the industry and for us is more of a moderated increase over time. But the confidence, the mood is very, very different than it wasn't 2016.

That concludes Q&A. I now turn back to the presenters for closing remarks.

Well, thank you, Jason. Thank you, everyone for your time this morning. Just to kind of summarize here, we're pleased with our performance in the quarter; the company is performing well. We believe we're very well positioned for next year and the longer term future as well. And we look forward to discussing our fourth quarter results with you in January. Thank you.

Thanks, Jim. Thanks, Andrew, and everybody who joined us today. Before we close, let me point out slide 20, where we're providing our preliminary dates for quarterly earnings in 2021 January 29, April 29, July 30, and October 28 2021. A replay of our call will be available online later this morning. We'll also post the transcript on our Investor Relations website later today. Click on investors.caterpillar.com and then click on financials to find those materials. If you have any questions, please reach out to Rob or me. You can reach Rob at rengel_rob@cat.com and driscoll_jennifer@cat.com. The investor relations general phone number is 309-675-4549. I hope you enjoy the rest of your day and now let's turn back to Jason to conclude our call.

That concludes today's conference call. Thank you everyone for joining. You may now disconnect.