開拓重工 (CAT) 2016 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Caterpillar 2Q 2016 results conference call. (Operator Instructions)

It is now my pleasure to turn the floor over to your host, Mike DeWalt. Sir, the floor is yours.

Thank you very much. Good morning, everyone. Welcome to our second-quarter earnings call. I'm Mike DeWalt, Caterpillar's Vice President of Finance Services. As usual, on the call with me this morning we have our Chairman and CEO, Doug Oberhelman, and our Group President and CFO, Brad Halverson.

Today I will start by walking you through a short slide deck similar to what we have done over the past couple of quarters and then we will move on to the Q&A after that. So if you don't have the slide deck in front of you right now, it's available on our website, Caterpillar.com, in the investor section, and it's where the webcast link was.

This call is copyrighted by Caterpillar Inc. and any use, recording, or transmission of any portion of the call without the expressed written consent of Caterpillar is strictly prohibited. If you would like a copy of today's call transcript, we will be posting it in the investors section of our Caterpillar.com website and that will be in the section labeled "results webcast."

If you go to page 2 of this morning's slide deck, you will see our forward-looking statements. This morning we will 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.

In addition to page 2 of the slide deck, a discussion of some of those factors that, either individually or in the aggregate, could make actual results differ materially can also be found in cautionary statements under Item 1a of our Form 10-K filed with the SEC and the forward-looking statements language in today's financial release. In addition, a reconciliation of non-GAAP measures used in both the financial release and this presentation can also be found in the financial release on our website and is also the back page of today's slide deck.

So with that let's get started on the slide deck and I would ask you to flip over to page 4. It's the comparison of second quarter 2016 with the second quarter of 2015.

It has the key lines for the second quarter versus last year. Sales and revenues down about $2 billion. About half of that was Energy & Transportation and the other half was split close to evenly between Resource Industries and Construction Industries. And I'll talk a little bit more about sales in a minute.

And profit, the primary drivers of the decline in profit from $1.31 to $0.93 a share this quarter and, excluding restructuring, $1.09, down from $1.40, so a $0.31 decline.

By far the biggest negative in the quarter was the decline in sales volume, and that included negative sales mix, as more of the decline was in higher-margin products like oil and gas. Price realization was also a pretty substantial negative in the quarter and that was off $233 million.

Now on the favorable side, below operating profit other income and expense was a positive $156 million. And that was mostly all due to the absence of below operating profit exchange losses from a year ago. An important point I think to note about this second quarter was exchange had actually little impact on the quarter itself.

Then the bottom, the most substantial positive in the quarter from a profit standpoint was cost reduction. Period and variable costs were favorable $670 million versus a year ago. And that just brings up the point here that we have been really focused on execution; that includes the cost reduction, but is not exclusively cost reduction. We have improved our market position as well around the world and, in particular, in China as well.

So let's switch on to the next page, page 5. It's a discussion of the sales and revenues.

Again, the biggest sales decline in the quarter was in Energy & Transportation, just shy of $1 billion. We've been talking about this for the last, oh, year or so. The decline really started about midyear last year, so this second quarter is the last, I think, of the big declines that we are going to see particularly related to oil.

First to first, second to second; by the time we got to the third quarter and certainly by the time we got to the fourth quarter of last year it was pretty much all baked in. In fact, I think by the time we get to the fourth quarter of this year the comps will be a lot like the prior year. So this should be the last quarter of declines, at least in this size.

Resource Industries down about $600 million and most of that decline was lower end-user demand and a little bit from pricing. Mining is just -- continued to be a very challenged industry. Customers are pushing out replacement purchases. They are delaying as much repair as they can and we see that in our sales.

Now, relative to the trend, it's about flat with where we were in the first quarter, so no continuing deterioration from where we were last quarter but down from a year ago.

Then, finally, Construction Industries down just under $400 million. A little more than half of the decline was price realization and it is a pretty tough pricing environment out there today in construction and we see it everywhere. We see it in the US; we see it outside the US.

Now, a word about this because I know it may seem to you like it's accelerating, but it's kind of not. It started going up about midyear last year, the sales variance, the discounting, and so we had negatives in the second half of last year. The first half of this year is comparing with a better period year ago, so it looks like it's quite a bit of an increase, but it's not much of an increase actually from where we've been over the last two or three quarters. And I think as we go on and talk about this in the outlook we kind of see it starting to flatten out.

Sales were down in North America, Latin America. Europe/Africa/Middle East was pretty flat year over year; Europe up, Africa/Middle East down. And sales in Asia were actually up year over year despite price pressure. So that's a quick run through of sales.

I know related to Energy & Transportation there's a lot of concern around the turbine business because it's been pretty strong for quite some time. Just a couple of facts about that.

We reported on the backlog last quarter, said it was up slightly from year-end. Second quarter of this year is about spot on where we were at the end of the quarter, so we are not seeing any deterioration there.

It's a little early to talk about 2017, but all indications are the year is progressing pretty well. Oil is lower; work, backlog. Sales around the natural gas and natural gas pipelines are still pretty strong. Okay, so that's sales.

Let's flip over to page 6 and talk a little about the operating profit change and cost in particular. This is the waterfall chart that we have actually in the release. No big, new information on here outside of the release. It just highlights how well we've done on cost reduction.

In total between variable and period, or you might call relatively fixed costs, were down about $670 million and that has gone a long way to offset the impact of lower volume and product mix. And you can see on here price realization, the negative $233 million. Actually, we've had more variable cost reduction. If you think material costs and efficiency and that type of thing, we've about offset the impact on price realization with that.

So year-to-date, if we turn to the next page, just talk a little bit about what we've done on costs. On the first quarter, between period costs and variable costs, we were down just under $0.5 billion. This quarter again was $670 million, so through the first half of the year we have taken over $1.1 billion of costs out.

If you look at the top of this page in the yellow bubble up there, what we are saying is we are on track. Our expectations are that we will end this year with well over $2 billion of cost reduction. And that's coming really in three sort of general buckets.

The most significant is restructuring and that is everything from combining office functions and reducing people to taking out manufacturing floor space and related costs. Material costs have also been favorable and we've had a good track record on material costs over the past few years. We're down over $1 billion over the last few years and it really comes from mostly design- and sourcing-related cost reduction. And then important, but to a lesser degree, commodity-related cost reduction.

And then everything else. It's everything from a bit lower short-term incentive pay, based on lower results, and then cost reductions throughout the Company everyplace we can find it. Everything from travel and entertainment expense to consulting spend. Wherever we can take money out, we are working really hard to do that.

Bottom line, we are investing in the things we need to for the future, things like digital and really important product programs. Everything else we are really trying to put a lid on and cut where we can. And the results have actually been pretty good.

Let's flip over to the next page, that would be page 8, talk a little bit about the outlook for the year. When we were sitting here a quarter ago, we were expecting sales in the range of $40 billion to $42 billion, so $41 billion as a midpoint. We have taken that down about -- from midpoint to midpoint, about $0.75 billion.

The gist of that is just everything that we are seeing today in the economy around the world; additional risk. Everything from the results of the Brexit vote and the short-term uncertainty that that causes; the trouble we have seen in Turkey; all the negative rhetoric around the US elections. Oil prices have come off a little over the last couple of months.

It's not any one thing I would say, and we said this in the outlook. We have sluggish economic growth throughout the world in general, but not enough to drive growth in our end-markets. The news we've seen over the last few months is definitely not giving us more confidence.

So the outlook for profit is $2.75 a share and that's all-in. Excluding restructuring costs, which are going to be about $700 million now this year, net of that we are at about $3.55 a share. Both on the top line and the bottom line our estimate is actually pretty close to the last consensus analyst estimates that we've seen, so we're pretty close to where we think the market is.

Now one point about this outlook and this is on -- in Q&A 11 in our release, on page 15. It has been negatively affected about $0.08 a share by taxes, so if we hadn't made the change in how we are looking at taxes on our profit excluding restructuring costs, the outlook would've been $0.08 higher. Which isn't too bad of performance considering $750 million decline in the top line.

And I think it just goes back to the main theme of execution, cost reduction. Doing everything we possibly can to keep the Company strong and give us the ability to invest in the future.

One last point I will make about sales, and this might well be on your minds as well, and that is the status of dealer inventory. We are pretty flat right now on dealer inventory with year-end last year, but we think it's going to come down quite a bit over the next two quarters. And that's not entirely unusual. Last year we had a reduction as well.

Full-year reduction in dealer inventory this year is probably going to be, not quite but close to, double what we did last year. And it's not so much -- you've asked this question before: do we have a glut of inventory? And I certainly would not describe it as that.

I think one of the things that's happening out there is a little bit of our own doing and it's around Lean. If you look at our delivery performance and the stability of our delivery performance to dealers, it's actually improved quite a bit over the last five years. We're to the point now where dealers, we think, have a lot of confidence in our ability to deliver what they need and when they need it.

And we think that's causing them to both order less -- so as our delivery times have come down in construction, our backlog comes down a little. Think of it this way; this is an oversimplified example, but if we had delivery times that were one day, we wouldn't have much backlog. Dealers would order and we would ship it.

So I think one of the reasons the construction backlog is a little lower and one of the reasons that we are getting probably more aggressive dealer inventory declines is how well we are performing on Lean relative to delivery performance. We knew that was likely to happen in the scheme of things; it's a good thing.

So that's the outlook. Let's move on to the next page and that's -- I think it's probably a good time to talk about first half versus second half. We're through half of the year, probably time to reflect little bit on how the second half of the year is likely to shape up.

End-user demand should be a fair bit higher than the first half of the year. We have our sales, which we think are going to be $600 million to $700 million higher than the first half, and that does include some substantial dealer inventory reduction. And we have profit per share, excluding restructuring costs, up $0.09. With restructuring it's down a little and that's because of the extra costs for restructuring in the back half.

So if you look at how the sales shape up, that $0.65 billion increase in sales, Construction Industries is likely to be down a little bit. End-user demand pretty flat, but because of dealer inventory reductions, their sales are likely to be a bit down. That's our forecast anyway.

Resource Industries just slightly up from the first-half run rate and not a lot, no big changes there in terms of trends. Then Energy & Transportation is responsible, essentially, for the increase in sales. That is mostly seasonal pattern on some of the big project sales that we have -- turbines, for example -- and we expect a bit more sales out of rail in the back half of the year, particularly in the fourth quarter.

In terms of profit, we have the $0.09 a share better profit in the second half of the year than the first half. And the higher sales volume is the most significant reason for that.

Pricing, let's talk about this and I touched on it a minute ago. On a year-over-year basis, the negative impact of pricing ought to start easing a little bit and that's because we really saw it kick up midyear last year. First half versus second half, though -- forget about last year -- we don't see much change in the pricing environment.

Inventory cost absorption will be a modest negative in the back half of the year. We are looking at taking inventory down -- our own inventory, not dealer inventory, down $500 million, $600 million in the back half of the year. It will be a little hit to profit, but positive for cash flow.

We also had some sale of security gains in the second quarter for financial services division and for the insurance portion of that. And we are not expecting that to repeat in the second half.

Cost overall we think will be fairly neutral first half to second half. We do have additional period cost reduction that we are looking at in the second half of the year, but with kind of low seasonal cost in the first quarter and probably a little bit of efficiency negatives, production is going to come down because of the decline in dealer inventory. We think those will come close to offsetting during the second half of the year.

Now we don't actually have an outlook for the third quarter, but if you think about the second half of the year, in a lot of ways I think it'll look similar to the first half of the year. And if you think to the first half of the year, we had a low first quarter and a pretty good second quarter. And I think, as we look at the rest of the year, the third and fourth quarter will play out similarly. We'll have probably a weak third quarter and a much better fourth quarter. Again, a lot of that is the timing of some of this E&T sales around larger projects.

We are thinking that third quarter will probably be $400 million or $500 million in sales better than the first quarter and profit will be in the range of $0.05 to $0.10 a share better than the first quarter. Then the fourth quarter will look a lot like second quarter: sales slightly higher, profit about the same as Q2. So that's how we think the rest of the year will shape up.

Let's move on to the last slide that I'm going to cover today; that's slide 10 and that's key discussion points. Just a little quick recap of much of what I've talked about.

On balance, there's not much change in demand from the industries that we are serving. Construction demand is relatively steady, but with continuing price pressure. We have no clear signs of recovery in mining or oil and gas or rail for that matter.

Good operational performance continues. Overall our market position has improved and that has been a continuing story for most of the last five years. Our decremental margins are pretty good and better than our target range and that is despite a pretty negative sales mix second quarter to second quarter.

Cost reduction is substantial: $1.1 billion year to date and we're thinking over $2 billion for the full year. We are on track with our restructuring actions. They have contributed to cost reduction this year and that will contribute to more in 2017.

Then finally, our balance sheet is strong and that is very important to us, because maintaining our credit rating and the dividend are very high priorities for us. In the second quarter, operating cash flow was $1.2 billion, our debt-to-cap ratio for Machinery, Energy & Transportation business was 39%; about 21% net of about $6.8 billion of cash that we had on hand at the end of the quarter.

So that's a wrap up. We are now ready to move into the Q&A portion of the call.

(Operator Instructions) Ross Gilardi.

Bank of America, thank you. Mike, some of your competitors sound maybe a little bit more sanguine on stabilization in the mining markets, at least in the aftermarket, and there just seems to be some scattered new project activity around the world. Can you elaborate a little bit more on what you are seeing? Is there any chance you are losing any share right now?

I would say there's some improvement in mining on the horizon around aftermarket. We are seeing a little more activity on dealer rebuilds and we would hope that that would translate into higher sales for us.

I think one of the things that might distinguish us a little bit from competitors is that we sell through dealers, so a lot of these projects might hit them quicker than they hit us. We are still expecting a decline in dealer inventory this year and particularly in the second half of the year. So if we were just selling to end-user demand, sales would be a bit better than they are right now.

I don't want to sound totally negative. It doesn't look to us like it's continuing to go down and there are a few small signs like that, particularly like the rebuild activity, that's a little positive. But we track share of what's being sold and we're not seeing deterioration there. It would be nice if it would improve a lot quicker and, hopefully, somewhere down the road it will.

Thank you. Can you just comment on the impact of lower interest rates on your pension and provide any preliminary thoughts on cash outflows into the pension next year to the extent you can?

I'll try not to get too far in front of myself, but I think, based on where we sit now, we don't see the requirement for substantial increases in contributions next year. The number I think is less than $0.5 billion, if memory serves me.

Thank you.

Seth Weber.

Good morning; it's RBC. Mike, you mentioned a couple times in the release there were comments about the US construction equipment supply/demand imbalance. Can you comment on where you think we are in the process of that smoothing out?

Does equipment continue to need to be moved out of the energy markets? Where are from an absorption perspective? Thank you.

As we sit now, the thing that has actually been pretty good is sales that go directly to end-users, rather than through a rental fleet. So the weakness right now is -- mostly what we've seen is in and around our dealers loading rental fleets and I think that's where this sort of hangover of equipment that was being used for oil and gas, a lot of it resides right now.

They are pretty stocked up on rental fleets. Used prices are down a bit, so that's not encouraging them to sell used equipment out of a rental fleet and replace it with new. So I think that is right now the reason that we are not seeing a more positive construction number in the US.

You would hope -- time heals all things and you would hope here sometime over the next couple of quarters that we would be through that.

That's helpful, thank you. If I could just ask a follow-up on the Chinese construction equipment market, the numbers there have been probably -- I think you talked a little bit more positively there last quarter. Any updated thoughts on what you are seeing in that market?

Thankfully, it's not another down year there. It's sort of flattish there for the full year, up for the industry. We're doing a little better than the industry and that's kind of continuing a trend that's been going on now for a couple years.

We've got great product, great dealer distribution there. I think customers are kind of coming around to the quality business model. Again, hopefully next year can build on this. We'll have to wait and see, but at least for this we're looking for, from an industry standpoint, of flattish industry.

Okay, thanks very much, guys.

Adam Uhlman.

Cleveland Research. I guess back to the second-half outlook for the year, I'm a little surprised that the profits aren't going to be up more than the forecast sales increase. But I guess, Mike, you touched on some of the factors that are behind that.

Could you talk to what you are seeing in material costs and how do you expect that to play out as we go into 2017 with steel prices moving higher?

That's actually a great question and I'm remiss for not having mentioned that when I talked about the second half.

We have had good cost reduction during the first half of the year for material and our view is we will continue to have cost reduction in the second half of the year versus 2015. But commodity prices have come up a little, so we are probably going to have less than the first half of the year. In other words, full-year, even second half versus the second half of last year, positive, but the positiveness has probably peaked and it will probably go down a little bit in the second half of the year.

So that is one of the reasons, I think, that second-half profitability -- that plus the inventory declines, plus the absence of the sort of $0.04 we got on the security sale in the second quarter all kind of make it look like it doesn't hang together first half, second half with sales.

Okay, got you. Then related to the Mining business, I was wondering if you could just talk about high level how you folks see the industry changing, if at all, related to the Komatsu and Joy Global merger?

I'll take that one; it's Doug Oberhelman here. I don't think it was any surprise that Joy was acquired with what has happened to them and the mining industry in general and all the mining customers, particularly coal customers, that are out there around the world.

Obviously we have known Komatsu for decades. We've known Joy intimately as well the last decade or so since they emerged from bankruptcy and we entered mining in a bigger way. So neither one of these are new players.

Certainly it's a consolidation that makes sense. In the mining world, it's going to be smaller for at least a period of time. Again, we know them; they know us and I think, going forward, we will continue the competition just as we have in the past. And I expect us to continue winning where we win.

Great. Thanks, Doug.

David Raso.

Evercore ISI. Just trying to think about the carryover cost savings of 2016 to 2017. And then second question about the orders continue to fall sequentially.

I can appreciate some of the seasonality in rail for second half versus first half. But just thinking about the exit rate exiting 2016 to 2017, can you help us a bit with where you see orders playing out from here? Have orders stabilized? Because obviously they continue to fall sequentially.

No doubt about that, and it's particularly in construction. Part of that, as you mentioned, is seasonal and I think part of that again is related to dealers taking inventory down during the second half of this year. Again, partly seasonal; I think partly delivery performance. We are doing a much better job of delivering on-time stably to customers, so I think both of those things are contributing to lower orders.

If you look at end-user demand -- I'm talking construction here -- for the second half of the year, our sales to users that's going to be pretty steady in the second half of the year. So it's not as though we are seeing a deterioration in demand from end-users. It's more dealers have lowered orders to take out some more inventory.

So if you exit the year with an order run rate annualized below 2016, you're saying don't necessarily imply down revenues in 2017. You just feel your shipping capabilities are allowing a lower order rate, so to speak, or like a quicker turn in backlog than the revenues?

Yes, I think that is exactly what we're saying.

I think that's a fair assumption. The retail sales numbers are the ones to watch and really drive this whole supply chain. And as long as they are steady, the chain will work itself out.

As Mike said, second half will look different than the first, but that's the one that really drives us. Of course, that gets back to market share and a lot of other things as well, David.

Do you expect to see the retail sales get flat by the end of the year so we feel more comfortable about that assumption for 2017?

I don't know if they will be flat flat, but they should be closer than they are right now, yes.

Then the carryover cost, slide number 7, when you say on track for over $2 billion, I'm not sure if that's an annualized number. But assuming it's a $2 billion run rate exiting the year, looking how the quarters play out or really first quarter, second quarter, second half are you implying a carryover cost savings of $1 billion?

So that's 2016 versus 2015 costs and we start -- a lot of that started coming out very early in 2016. Our first quarter was quite favorable; our second quarter was even more favorable. So I think we will probably end the year with a -- as you look forward, based on the timing of the cost reduction, a tailwind but I don't think it would be $1 billion.

Okay, that's helpful. I appreciate it, thank you.

Jamie Cook.

Good morning, Credit Suisse. Couple clarifications. One, Mike, in the press release and I think in your commentary you implied Solar was flat with the first quarter, up from the beginning of the year. But you also talked about some customers pushing out orders into 2017.

So I'm just wondering is the backlog flat because of pushouts or are you actually seeing order activity?

Then my second question is for Doug. Doug, you've talked historically about managing to sort of targeted $3.50 trough-ish EPS. As we sit here today, given the markets don't seem to be getting better, we are already at $3.55 this year. Is that off the table or do you think there are incremental levers that you could pull to manage profitability as we think out over the next 12 months?

I will start with that on the Solar piece and then I will turn it over to Doug. But on Solar what we see customers pushing out a little bit is the timing of some maintenance and that doesn't have usually as long a backlog as the new product, so it probably impacts this year's sales a little quicker than it does backlog, just by the nature of it.

I think the reason that we made a comment on Solar backlog is because everybody is concerned about it and we're just trying to reassure everyone that what they're selling they're replacing with new orders. That's not falling off a cliff or off the table, and the gas business keeps on chunking along.

I'll turn it over to Doug.

Thanks. In terms of your trough earnings question, I think your question is a reasonable one to assume.

As you say, without all the restructuring costs, we're at $3.55. And as Mike said, you take $0.08 back, we are a little bit above that even. But certainly around 40, where we are now, that's a reasonable assumption to go after and that's where we are going to fight to try and find a bottom, if that's what we are fighting in the future.

This is Brad Halverson. I might just add a quick point, Doug. The trough earnings number has been stated between $2.50 and $3.50. I'd say if you look at how -- I would say the sales decline modeled in those scenarios would not have been as severe as what we've experienced in the four-year trend.

So going from above 60 down to 40, we've been absolutely trying to stay ahead of the process to be prepared if things did not get better. If we were not staying ahead, quite frankly, there was no way we could have done $2 billion of cost reduction this year to offset some of the price pressures and the drop in volume.

We really like our midcycle numbers. Everybody wants to know when we're going to start recovering in that trend towards midcycle, but we still need to be prepared for what could happen in the short term on the downside. And so we have talked about kind of a 25% to 30% decremental. I would say we are still committed to that.

I would also say that we are being extremely directive in the things that we fund. Things like digital, which will be up significantly this year over last year. Things like funding the businesses that we believe have the highest opportunity to improve the value of the Company and our operating profit after capital charge, which we call OPACC, in the medium term.

So we want to fund those industries which we think are attractive for us and where we play well. And things that are not as attractive are the places that we look first to cut.

We are still in that process and we're still preparing to stay ahead of the game. And I would say that, if required, we would be ready.

That's right, Brad. I would just come back to the incremental/decremental pull-throughs on the way up and the way down that have served us pretty well. Going back to 2009, on the way up from $30 billion to $66 billion and then on the way down from $66 billion to $40.25 billion this year.

We managed to stay inside of those targets all the way up and down. I think that's probably one of the single-biggest differences we've been able to accomplish from prior deep slowdowns in the 40% range top line is we've got everybody targeting those and that's where we go after with our cost reductions. And, as Brad said, our capital allocations in those businesses we really want to stay in and thrive in long term.

Okay, thank you. I'll get back in queue.

Jerry Revich.

Good morning, everyone. It's Goldman Sachs. Mike, you spoke about roughly $2 billion or so in implied dealer inventory reductions, which I think is mostly in the back half of this year. Could you just give us a flavor for the mix between Construction and Resources, and any regional color you can give us where you expect inventories to come down? And as we enter 2017, do you think we are at normalized dealer inventory levels for the current demand environment?

So a couple of things. One, $2 billion is a little too high a number. It's probably more like year-over-year $1.5 billion. And it's probably split two-thirds Construction, one-third Resource, in that sort of ballpark. In terms of adequate levels, I tried to address this point. I think adequate levels is a little bit of a moving target around delivery performance.

So again, if we were able to cut delivery performance in half from where it's at now, dealers would feel comfortable holding less inventory. If our delivery -- let's say things ticked up, orders ticked up, the markets heated up, and let's say we had trouble keeping up, that would concern dealers and they would order even more. They would want to hold even more.

But just the opposite is happening right now. We have excellent delivery performance. They can get pretty much what they need when their customers need it. So that's causing them to hold or want to hold less, and the more -- the better we do with Lean, the more that will probably be the case.

So I'm trying to stress the point I don't think dealer inventories are excessive. There's a reasonable range, but I think they will come down over the second half of the year.

Okay. And you were talking about the major restructuring changes as we think about the eventual recovery. Can you update us on how you are thinking about incremental margins and recovery, given the change in the manufacturing footprint?

Well, it should be -- and Doug has talked about this quite a bit -- on the way up, we previously kind of had a 25% incremental target. But I think while we have not quantified it, certainly our expectation is that the first chunk of what goes up would certainly be at a higher rate than that.

Thank you.

Robert Wertheimer.

Barclays Bank, thank you. Construction margins are really quite impressive, given negative pricing and given volumes that are troughy in LatAm and maybe low cycle elsewhere. Can you see steep falls from here, or do you think that's bottoming?

Then I'm curious if you have any view or are willing to share any view, rather, on the structural margin upside if you actually get a healthy market given what you are doing at low cycle?

Yes, that's a good question. I think our construction business is a great example of how our managing for maximum OPACC, operating profit less the capital charge, can work. They've been on this path to maximize OPACC for the last few years, which is fundamentally around figuring out where you make the most money and where you don't; fixing where you don't, and reinvesting in where you do to increase sales.

So that's over-simplification of it, but that has worked.

They have also taken out -- they are also very cost-conscious. They have taken out costs, but relative to where we think a trough, a midcycle, a peak would be, they are not as bad off as, say, oil or rail or mining.

But I think there's plenty of upside for them. North America is still well below the peak. Brazil is, wow, so far down you can hardly see it. So I think there's plenty of scope for improvement and, based on the work that these guys have done to figure out where to invest to drive OPACC, I think there's still plenty of upside left for them.

Do you see signs of stabilization in North American construction? As you said, we are well below the prior peak and some of the fleet is older. Do you think there is material downside chances there or are you seeing stable?

I don't see material down side at the moment, frankly. We've seen so many states step up with bond issues. We've seen many states step up with tax increases for infrastructure spending.

Anecdotally, a lot of our customers are busy across the country. A 2% growth rate of the -- 1.5% to 2% does not spur a lot of investment, but there's enough going on to tell me that we are not facing a cliff here unless there's some outside event of some kind that occurs. So I don't see it collapsing or, as you said, a big fall off. I would sure like to see the growth increase based on increased economic activity.

Thanks, Doug and Mike.

This is Brad. I'll just make one other comment; and we're not going to give you kind of an incremental number this year to plot in. We've talked about it being fairly high.

One thing I would say for reference is that the vast majority of costs we have taken out we would not add back. And so as we have restructured, as we have changed things, if you think that there are costs that we are ready to add back that we've taken out, I would say, outside of some very minor amounts, most of those costs we're not going to add back.

So as we add period costs in an upturn relative to our incrementals, it would be focused really around our OPACC improvement agenda; those places we want to invest more because we think there's a significant amount of value. And so that will probably drive that incremental discussion when we get to that point.

Thanks, Brad.

Timothy Thein.

Thank you, Citigroup. The first is on the Energy part of E&T, and I guess specifically in well servicing where I think you would see a recovery first in a more stable oil price environment. So the question just revolves around where the service companies that you and your dealers speak to, where they sit from a sentiment standpoint on CapEx.

There's been some comments of some restocking of consumables, but just curious what you are seeing out there.

I think probably the best way to say that is where oil prices are today it's probably not enough to drive a lot of incremental investment there. I think the thing you will see first is the idle fleets being put back to work, particularly around drilling, before we see some investment. Oil prices this morning I guess were in the $42-plus range; we are probably still a ways away from that.

Okay, got it. Maybe the second one on Cat Financial. I don't know if Brad is still around, but the question relates to the penetration rate in the quarter.

I think new retail financing has now eclipsed 30%. It hasn't been there, I don't think, post the financial crisis. So I'm wondering is that a shift in the underlying business mix that's driving that or is that perhaps more of a strategy shift for Cat. Maybe you could you speak to that, thank you.

This is Mike. Cat Financial is always trying to increase their share. Just like every other part of our business, they are trying to increase their market share, if you will; the percentage of deals that they do versus their competitors. And they've actually done a very good job over the last couple of years in increasing that and I think that's what you are seeing.

The limit on that is you certainly don't want to do shaky deals. You don't want to sacrifice credit quality to do it, but you want to work very closely with the dealers, with the customers, and capture as much market share as you can.

This is Brad; I will add on to that. We are very proud of the people at Cat Financial and how they run that business very independently. In partnership with our product groups, but very independently.

And so you will see our allowance being very well-maintained at around 1.25%. Past dues, a similar trend at 2.93%; fairly close to previous quarter and below historical average. And we have grown our share there.

But one thing I want to comment on, which we had a few questions come in on, there is pressure in the used equipment market. It's probably down 2% or 3% from the last quarter; it's probably down 5% to 10% if you look from a year ago. We carry a little over $600 million of used equipment, both from repossessions and residuals.

Still pretty well-behaved. We had a gain last year and we had a very small loss this quarter and so we don't see any big issues in that regard. But I would tell you that that is an area that does have some pressure and that we are watching that is, at this point, very well maintained.

Thanks a lot.

Steven Fisher.

Thanks, good morning; UBS. Just a question on the restructuring. How anticipatory would you say is the incremental $150 million in the quarter versus just kind of reflecting what current conditions warrant?

In other words, you talked in your question eight in the back about too early to really say what impact Brexit would have. But would this incremental restructuring be intended to mitigate a potential slowdown from the UK Brexit and a potential slowing in US non-res construction activity? Or would you might want to do more restructuring if those things play out?

That's a good question. I wouldn't relate it specifically to any one of those. I think you have to look at it in the aggregate and Brad made actually a really important point a couple minutes ago and that is that we are trying to get -- we don't have a crystal ball. We don't know what's going to happen in the marketplace, but we want to be positioned to deal with it if it does happen.

So I would say that over the course of the past quarter we are a little more negative on the world economy; the Brexit, the Turkey, the elections, oil price, you name it, all of that contributes. And we are less bullish on second-half sales because of that. Whatever impact that would have in the future, we are trying to get ahead of that with additional cost reductions.

So I would say it's us trying to get ahead of the potential, not what we actually know. And not specifically related to any one of those items.

Okay, that's helpful, Mike. Then in terms of mining profitability, the $163 million loss was a step down in the quarter compared to Q1. How are you thinking about where that goes from here? How contained can your restructuring actions keep those losses going forward?

Hopefully, this is the worst quarter we will see. I think embedded within our outlook we see it getting a little bit better.

Second quarter, price wise, was deteriorated a little bit from the first quarter. And when you get to numbers as -- we're talking a change quarter to quarter of a couple hundred million; not for pricing, but in total for them. Costs were a little higher because of some inventory adjustments, just kind of normal surplus and excess inventory.

And then we had little negative inventory absorption for RI. They took out inventory in the second quarter; that hurt a little bit. They are certainly a part of the extra cost reduction that we are going after in the second half of the year.

When I talked a little bit about first half/second half, we think their sales are going to be up a little bit in the second half of the year, so I think the combination of extra cost reduction and a few more sales, hopefully, will make this the -- make the second quarter the worst of the year.

Great, thank you.

Stephen Volkmann.

Good morning, Jefferies. Doug, I'm going to take you up on this since you mentioned infrastructure trends getting a little bit better. How big of an opportunity is that for Cat? How much of revenue might that be or how should we think about sizing that going forward?

It's hard to tell actually. The highway -- the Federal Transportation Act that was passed last year, in itself, did not increase overall funding an awful lot in this country. It held it at inflation plus a little bit, but it did give it five years.

I think as most states have recovered from their fiscal problems the last few years, they are starting to recognize the need for infrastructure and we are seeing that. If there is any impact, and I've said this all year long, from that transportation act of last year, it's going to be a 2017 event.

We might feel it. I don't think it would move the needle a great deal, but we would certainly feel it, and it's hard to quantify until states start lining up for their matching funds. So there's quite a big effort underway to get that done as well.

We'll just have to see it play out. It's certainly going to be a positive, but I would doubt we'd see it move the needle in a big way in 2017. But we would feel it.

Great, that's helpful. Then, Mike, maybe just a couple quick modeling questions. How do we think about taxes going forward with the various changes you've had? And then what's a normal level of short-term incentive compensation if we are thinking into the out-years?

Two good questions, Steve. First, on taxes. All-in we're looking at a 25% tax rate this year, but that is a little lower because of all the restructuring, which has tended to be in a little higher tax jurisdictions. So the restructuring is attracting somewhere around I think low 30%s, 34% I think. So excluding restructuring, it will vary a little bit by quarter depending upon how much restructuring there is, but probably around 27%, excluding restructuring.

And then what's normal on incentive pay, I'm going to qualify it a little bit here: it depends on how many employees we have, because it scales if you look at it in terms of dollars. But based on the number of employees we have right now, if we were to pay everyone at a 1.0 payout, which we would consider to be normal, in a normal year, you are looking at something in the order of magnitude of, let's say, rough number $850 million.

Super, that's perfect. Thanks.

Joe O'Dea.

Good morning, Vertical Research. First question just on the rail side. It sounded like, from a geographic standpoint, that the softness that you would've seen year over year was more international. But could you just give a little bit of a commentary on what the North America trends are like for you? Incremental softness with North America rail flat year over year; just how stable you think that is as we start to think about more downside risk, upside risk, and how stable those North America trends are?

Joe, I feel a little bad here; I didn't -- I tried to prep a little on rail, but I didn't do it by region, so can't talk too much about North America specifics. Sorry I'm just not further up to speed.

What I would say is we're looking for a bit better rail sales in the back half of this year. Remember, we have just introduced our new locomotive at midyear. And while sales aren't huge for that right now, given the state of the overall industry, we certainly are going to sell some. So that's part of the increase in the back half of the year.

Okay. Then, on Resources, it seemed like in the first quarter one of the challenges was aftermarket came in a little lighter than we would've expected to start off the year with the expectation that moving deeper into 2016 that would improve. From a margin standpoint, it didn't look like there was a mix benefit the second quarter.

Could you just talk about sequential trends, what you're hearing from dealers with scheduled rebuilds? It sounds like that's a little bit better. Did you see some improvement in aftermarket from first quarter to second quarter?

Well, we are hearing that dealers are booking a bit more. In fact, I verified that with our Mining group last night. They are seeing -- dealers are seeing an uptick of bookings around rebuilds.

Hasn't really hit our parts business quite yet, but hopefully it will. And your synopsis of no big upturn in parts sales around Mining is actually correct. At least so far.

Great, thanks very much.

I think we are at the top of the hour here, actually a minute or so over, so we will conclude the call. Thank you very much.

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.