Caterpillar Inc (CAT) — Q1 2015 Earnings Call Transcript

Thank you very much, Dana, and good morning, everyone. Welcome to our first quarter earnings call. I'm Mike DeWalt, Caterpillar's Vice President of Finance Services. Joining me on the call today are our Chairman and CEO, Doug Oberhelman, and Group President and CFO, Brad Halverson. This call is copyrighted by Caterpillar Inc., and any use, recording, or transmission of any part of the call without written consent from Caterpillar is prohibited. If you would like a copy of today's call transcript, it will be available in the Investors section of our website, caterpillar.com, under Results Webcast. This morning, we'll be discussing forward-looking information that includes risks, uncertainties, and assumptions that could lead to actual results differing materially from our expectations. A discussion of factors that could make actual outcomes deviate significantly from our projections can be found in our cautionary statements under Item 1A, Risk Factors, in our Form 10-K filed with the SEC in February 2015 and in our forward-looking statements language in today’s financial release. Additionally, there is a reconciliation of non-GAAP measures available in this morning’s release, which is also posted on our website. Let’s get started. Today, we will review financial results for the first quarter and our revised outlook for 2015. First, I want to mention that from a macro perspective, not much has changed since our last earnings conference call in January. Therefore, we remain focused on areas within our control, such as execution and operational improvements, including safety, quality, market share, efficiency, cost control, inventory turns, and cash flow, where we continue to make progress. Next, we were pleased with our first quarter results considering the current environment. Sales were close to our expectations, and we were satisfied with our bottom line. As a reminder from our year-end conference call in January, we anticipated that the year would start stronger than it would end, and that expectation remains valid based on our first quarter results. Sales and revenues for the quarter totaled $12.7 billion, roughly a 4% decrease from last year’s $13.2 billion in the first quarter. The decline included $342 million due to a stronger dollar, while unfavorable sales volume accounted for a $295 million decline. Those two losses were partially offset by a small improvement in price realization, which was $105 million, indicating progress though it was less than 1%. The only region showing an increase was North America, where sales rose 9%, with improvements across all segments. In contrast, outside of North America, sales decreased in Latin America, Europe, Africa, the Middle East, and the Asia-Pacific region. Overall, sales and revenues in Latin America fell 18%, with all Equipment segments—resource industries, construction industries, and energy and transportation—experiencing double-digit declines. Construction saw a 23% drop, primarily due to the absence of a large order from the Brazilian Government last year and overall weaker construction activity, especially in Brazil. Resource industries also dropped 23% in Latin America due to ongoing weakness in mining, a trend noted across all regions, while energy and transportation fell 11%. In Europe, Africa, and the Middle East, sales declined 12%, with significant drops in construction industries (14%) and resource industries (14%) primarily due to unfavorable dealer inventory changes and currency impacts. Asia Pacific sales declined 13%, with construction industries experiencing a 21% drop, largely attributed to reduced activity in China and Japan as a result of a stronger dollar. Profit per share was higher in the first quarter compared to the same period last year, at $1.81, up from $1.44. Both quarters had restructuring costs, with last year featuring $0.17 per share primarily from actions taken in European operations, while this year accounted for $0.05 per share. Excluding restructuring costs, profit per share improved from $1.61 last year to $1.86 this quarter. The increase in profit per share was driven by a $120 million gain from selling our remaining stake in our third-party logistics business, an increase in positive price realization of $105 million, and favorable currency impacts totaling $77 million that benefited operating profit. On the topic of currency, we have significant sales in currencies other than the U.S. dollar, and when the dollar strengthens, it can lead to lower translated revenues. However, our substantial manufacturing operations internationally resulted in lower costs when converted to U.S. dollars. This quarter, while sales translated into $342 million fewer dollars, the positive impact on costs amounted to $419 million, resulting in a favorable net effect of $77 million on operating profit. That being said, we did experience negative impacts due to lower sales volume, approximately $83 million, and higher costs, particularly related to changes in the timing of stock-based compensation expenses. Now, let’s shift our focus to the balance sheet and cash flow. Operating cash flow from machinery, energy, and transportation topped $1 billion this quarter, although that was about $800 million lower than last year, largely due to increased incentive compensation payments based on 2014 performance. We allocated around $400 million for share repurchases this quarter and plan to continue this strategy in 2015, though the timing and amount will depend on business and market conditions. Our balance sheet remains strong with a debt-to-total capital ratio of 37.1%, which is in line with our target range and slightly better compared to year-end 2014. The net debt to capital ratio at the end of the quarter was 18.3%. Before moving on to our revised outlook, I’d like to recap the changes in our order backlog over the last quarter. We ended Q1 with an order backlog of $16.5 billion, approximately $800 million lower compared to year-end 2014, with declines observed in both construction and resource industries. Although we anticipated a backlog decrease in energy and transportation due to oil industry weaknesses, it remained relatively stable overall, as gains in locomotive backlogs offset some declines. Now, regarding our 2015 outlook, we do not anticipate significant changes from what we provided in January. We are holding our sales and revenues estimate at approximately $50 billion for 2015; however, we expect this figure to be over $5 billion lower than 2014 levels largely due to the impacts of significantly lower oil prices. We expect that the most pronounced effects will be on engines and other equipment for drilling and well servicing, with ongoing declines in demand affecting our sales through the year. In addition to oil price impacts, several other factors are contributing to our anticipated year-over-year sales decline. The stronger dollar continues to hinder sales yet not profits, while weak commodity prices for mining, particularly iron ore and coal, as well as agricultural sector weaknesses, are impacting our resource industry segment. We also expect lower industrial engine sales and a downturn in our rail business this year, following a strong performance in 2014. Furthermore, we foresee continued weakness in construction industries in key developing markets like China and Brazil, as evident from our Q1 results. In summary, we are maintaining our top-line outlook for 2015 while raising our profit outlook. Previously, we estimated $4.60 per share, all-in, and $4.75 excluding restructuring costs; this morning, we revised our profit estimate to $4.70 per share, all-in, and $5 excluding restructuring costs. Changes are attributed to increased restructuring activities, raising our cost estimates from about $150 million to around $250 million, mainly concerning mining product facilities, as well as the previously mentioned $120 million gain from the logistics business sale that impacted our prior outlook. However, 2015 is shaping up to be a challenging year with ongoing uncertainties such as continued weakness in Latin America, concerns over China’s growth, economic recovery stability in the U.S., and unanswered questions in Europe. Mining has not yet shown signs of improvement, and we still anticipate a decline in oil-related sales this year. In conclusion, sales and revenues for the first quarter met our expectations, yielding a solid profit. We repurchased $400 million in shares, maintained a strong balance sheet, and are focused on operational performance and cost control. Nonetheless, we have not observed any meaningful signs of recovery in our cyclical businesses. Now, we are ready to move on to the Q&A portion of the call.

Hey guys, congratulations on the quarter.

Thank you.

Two questions on guidance. The first on revenue. Mike, I know you said you're reaffirming at $50 billion. Last quarter you walked through expectations for Construction Industries and Resource Industries and E&T. I was just wondering if you're reaffirming each of those or have there been any tweaks across the business segment at the revenue level?

Yeah. No, I would say by and large, it looks pretty close to what we said at the end of the year.

Okay, that's helpful. And the related question would be on the EPS side, you raised guidance $0.25. I know you mentioned $0.14 is from Cat Logistics. I'm just wondering if you could walk through the other puts and takes. It looked like incentive comp would have been about $0.05 tailwind if I read that correctly.

I would say that’s our fault. We rounded to the nearest $100 million last time and we rounded to the nearest $10 million this time. There was by and large little change in our forecast for incentive comp. We did raise guidance this $0.25, and you would normally think that would add to incentive comp. But most of the add was for the gain that we had on the sale of the logistics business. And our comp is based on OPACC, operating profit after capital charge and that gain was below operating profit, so it’s really not having any impact on the incentive comp.

Okay. Was there any incremental benefit from restructuring that you would realize in 2015 that was not previously anticipated?

I would say not that was not previously anticipated. I mean, we did expect benefits from restructuring to be better this year. So no, I wouldn’t say we added anything for that. Now we did add to restructuring cost. And down the road after those are complete, those should definitely lead to more benefits. But actually in the short-term, there are related costs for things like rearrangement that aren’t included in the number that tend to be a little bit negative around the time you are actually doing it. So I would say on balance that is relative to our original outlook not a big reason for change. We took the profit outlook up, mostly because of very good cost control in the first quarter. We don’t give quarterly guidance, but we were a little better than we thought we were going to be in the quarter. And some of that of course was timing, but some of it is spending that we don’t think we will have to make as the year goes on.

Okay. And FX, was that any dynamic in the revision?

No, not much. In fact, we didn’t really change our outlook for currency. We did do a spot check on the impact on profit of recent changes and that was pretty neutral. So we will take another look at that midyear and see if there is any changes need for that.

Great. Thanks a lot. And best of luck this quarter, guys.

Thanks, Ted.

Good morning. It’s Goldman Sachs. I am wondering if you could talk about what was just the magnitude of material cost benefit that you realized this quarter. And I know you're working hard with the supply chain, just help us understand how we should think about the puts and takes over the balance of the year for material costs with volumes coming down, but commodity costs that should be I think lower sequentially. Can you maybe give us more color there?

Yes. Absolutely, material cost control has been a real positive actually not just in the first quarter, but over the past few years the team has done a great job. That’s a combination of the purchasing group and the design group in terms of designing for cost reduction. So it’s been pretty good. It was a decent positive again in the first quarter. If memory serves me, it was in the neighborhood of 1.5%. Now to the extent that we buy things in non-U.S. currencies, we wouldn’t be including it and that kind of number we isolate the impact of currency on our expenses separately at least for those that are denominated in foreign currencies.

Okay. And my follow-up on the dealer inventory side, how should we think about inventory levels over the balance of the year? And out of the inventory build that we saw in the quarter, is it in the right regions, is it in areas that you folks want?

Yes. I mean, we did have an inventory build in the first quarter and we didn’t talk a lot about that in the release, partly because I think sometimes it gets taken out of context. We expect an inventory build in the first quarter. The selling season from dealers and customers tends to be heavier in the summertime and so dealers add inventories up ahead of summertime. That occurred this year in construction industries. We have an order of magnitude of 180 million dealers or 180 dealers roughly around the world. At any given point in time, you’ve got some of them, they probably have a little too much and some that have probably a little too little. If we look at our months of supply on hand, we kind of try to judge that in a reasonable range and we do look at that by region. And by and large, I think our dealer inventory we would say is in a reasonable range. Now from here, we definitely believe it will come down over the course of the year that happened last year. That’s kind of normal to have a build in the first quarter and then have dealers sell that down as we go through the year.

Thank you.

Good morning. It's RBC. I wanted to ask about the Resource Industries segment. The margin there in the first quarter actually went up sequentially even though revenue was down. I mean, do you feel like the margin has bottomed in that business at this point?

No, I wouldn’t say that, Seth. I think if you look at it sequentially, you always have to consider that we have some reasonable seasonality between the first quarter and the fourth quarter or fourth quarter to first quarter in discretionary costs. So fourth quarter was a pretty heavy quarter, first quarter was a pretty light quarter in terms of spending. So I think that has a lot to do with the sequential improvement. Now I think Resource Industries margins will likely come down as the year progresses. We kind of said before we thought something around breakeven was probably reasonable. I think that we are going to add the spending over the course of the year. We’ve got some R&D programs that we need to do there. We talked about that in January. So my guess is coming off of a pretty light quarter for cost and some increase in engineering as the year goes by and probably not a lot of change in the top line, margin will probably moderate from where it’s at.

So just to be clear to get to a breakeven kind of number, would you go negative in a given quarter for the year?

Once you get around breakeven, the numbers are so small that $10 million or $15 million one way or the other could cause that. I mean, if we’re positive in the first quarter, we are thinking breakeven for the year. If it’s slipped a little below that at the quarter during the year, that wouldn’t be surprising.

Thank you. I would like to ask a follow-up regarding the aftermarket business for Resource, as revenue has decreased. Is there any hope for improvement in that area? What do you believe needs to occur for the aftermarket business related to mining to recover?

That's a very good question. We've been contemplating that ourselves. We have customers with some equipment that is not being used. We believe there has been some overlap in the usage of equipment in the field. We are noticing that customers are extending their rebuild timelines. In our opinion, this can't continue indefinitely, but it has been occurring. When the situation changes, it will reflect the overall state of the industry. While it's challenging to predict the timing, we have an understanding of both parked sales and equipment sales relative to what is considered a reasonable replacement level, which is currently much lower than that. However, predicting when this will shift is difficult.

Fair enough. Okay. Thank you very much guys.

Good morning everyone.

Good morning.

Good morning, Eli.

It's a nice quarter. We are all impressed. We talked about the breakeven in our resource now. Can you talk to us about what we should expect profitability wise, which were very impressive in both construction and in E&T? Particularly, we know volume is going to drop in E&T but you did north of $0.15, almost 16% in construction and over 20% in E&T. And while we expect to come down in order to hold the guidance where you are, these numbers have to come down quite a bit. Can you give me some idea of what we should expect and do we think does construction go below double-digit operating margin for the year but what happens as the year unfolds and the business weakens?

I believe this situation affects the entire company. I will cover several segments. We anticipate that costs will increase slightly from the low levels seen in the first quarter, which is typical for this time of year. We plan to allocate more funds towards R&D as we discussed earlier this year. We are also facing a negative product mix in E&T due to the anticipated decline in the oil sector. Additionally, we expect some negative mix in Construction Industries. In the first quarter, sales were relatively balanced among the three segments of construction: earthmoving, excavation, and building construction products, with BCP representing the smaller equipment. Overall, new equipment sales were fairly even among these subsectors. However, looking ahead, we foresee a slight shift towards smaller BCP machines and not much overall change in construction sales. This shift is partly influenced by the early selling season in countries like China, which boosts excavation sales initially before tapering off later in the year. Therefore, we expect some negative mix in construction as the year progresses. For the year, we don't anticipate construction operating margins falling below double digits in our outlook. However, E&T operating profit margins will likely decrease, mainly due to declines in the oil business, which typically comprises higher-margin products.

And can you follow-up, can we talk a little bit about what's going on in pricing across the businesses? I mean, you did single out that one of the problems in the resource business was basically pricing more than anything else. So what's going on in the other two sectors pricing wise? Are things relatively holding or is there some more price competition showing up?

That's an interesting question. When the figures are this small, they can feel rather insignificant. Overall, the company had $105 million in price realization, which is under 1%. The segments currently performing better are construction, energy, and transportation, with construction showing a bit more strength. This is partly due to three factors: last year we received a significant order from the Brazilian government, which, although a good volume, was at a low price. Without that, our average price level has actually increased slightly. Additionally, we experienced a favorable geographic mix and implemented small list price increases at the beginning of the year, all of which contributed positively. In terms of Resource Industries, we've seen a decline year-over-year for the last few quarters, and I believe it was the same last year. The competition in this business is fierce. Although much of our sales are dollar-based, some of our key competitors, like Komatsu, operate more on a yen cost basis and are being quite aggressive. It's a challenging industry.

I will add. Doug Oberhelman here. Mike said dog eat dog, I’d rather say a cat eats dog. But be that as it may. We are seeing a very competitive marketplace right now. We did post up a little price realization in the first quarter, which I was very happy to see. But I will tell you with a yen that's off over 50% in three years, euro, Brazilian currency, pound currency off 20 to 30% in the last year. All of our competitors aren’t in the U.S. So it really is a competitive environment out there. But we are not giving up our PINS goals, our market share goals. We are doing as well as we can be expected in a tough market that we are. Certainly, our cost management in the last couple of years has helped that, our lean manufacturing where we generated cost advantage is helping. We are still very much focused on market share. But I would say the competition for every deal has gotten greater as we've seen this dollar strengthen.

Thank you very much.

Hi, J.P. Morgan. My first question, it's really I suppose it's to you Doug. We talk about Europe and the euro being weak and what that's doing to help the European manufacturers export but are you seeing any signs of European economies getting any better at all? Or is that something that you think might be on the op income going into ’16?

I think it's in our future. I said on the show this morning that it seems to me that with the QE coming in by the ECB with a euro that’s up, like I said 25% or so on a year’s time with energy prices where they are, the stimulus of all three of those and not to mention, continuing lowered rates, which has finally happened across Europe. I like in the euro zone, an awful lot to the period of say, 2010 ‘11 and ‘12 in the U.S. where there was a lot of stimulus. We didn't see much growth but we see better growth now. So I am convinced it’s coming. I don't know if it will be, when it will be and I’m not going to predict that. But we still see and I was just with several of our European dealers, we still have the North-South divide. I think the Germans would say they see some green shoots in that economy. We’re not seeing it in our numbers but they were a bit more optimistic in Germany, of course a euro at $1.07, $1.08 really benefits those exporters. So I think, we’re on the early stages of what will be a recovery. I don’t think it’s going to be a boom and I think it’s going to be an anemic growth probably looking a lot like what we've seen here. But it will feel better when it happens for sure, Ann.

I'm sure it will. And then just switching gears as my follow-up, we track the U.S. construction industry shipments from census data and those have been down but orders are down about 27% in Q1. That's just through February. Can you talk about what you're seeing out there on construction industry orders? Does that include exports that might have weakened because of the strength of the dollar or what's going on out there in terms of industry orders on the construction equipment side? Thanks.

I haven't analyzed it by region much. However, regarding our construction industry segment, I can say that orders in the first quarter are down, which is evident, and our backlog was slightly lower as well. Nonetheless, our orders did not decline to that extent.

Okay. And just that have anything to do with the fact that your dealers cannot cancel orders so we might be seeing some delivery. We may have inventories corrected later in the year or have you changed that policy? And then I leave it there.

We work closely with dealers to help them determine an appropriate level of inventory. The last thing we want is for a dealer to end up with too much inventory, as that doesn't benefit anyone. I don't believe there's any inventory issue present at this time. If you look back two years, that was a different situation, but it isn't now. I'm not reviewing the same data you are regarding the 27%. All I can say is that our orders are not down. Are you referring to comparisons from a year ago, Ann?

Yes. It's the U.S. consensus or census data, and it is year over year through February.

Yeah. I couldn’t. Any comment on how we are relative to that number would be pure speculation on my part but we’re not seeing that kind of a decline, no.

Okay. That's helpful color. Okay. I'll get back in line. Thanks guys.

Great. Thanks. It's UBS. Just a follow-up on that last question there, how did the 9% increase in North American construction sales compare to your expectations? I know you are earlier in the year looking for North America to be up for the year. Is that still the case and should we maybe now be prepared for some year-over-year declines in North American contraction as the year plays on?

Yeah. I think on balance and our outlook in January and I kind of updated that a little bit today. We expected construction sales to be down 5% to 10%. But then and now, the only region that’s likely to be in neutral to positive territory is North America. The first quarter was by and large about what we expected.

Okay. So North American construction still expected to be up for the year, is the context of that down 5% to 10%?

Yeah. I would say the total was down 5% to 10%. The only region that’s not really down is North America but the numbers are very small. I would say it’s within the margin of error to be neutral to positive.

Okay. And then can you just give us a sense of the pace of the bookings on the Solar Turbines in the quarter and maybe how far out that backlog extends now for the business? Are you putting anything in there for 2016 yet? Thanks.

I’ll take that, Mike. And I just came back from Solar in San Diego two days ago and got a pretty good briefing. I would say their forecast, which is rolled up into ours for ‘15 is a pretty good line of sight to that. They would not speculate it and really don't know much beyond that into ‘16 as yet. I would say around gas compression, of course, which is the big piece of solar business that has held up. And there's a lot of pipeline work going on. There is a lot of pressure behind it that’s required and that's our turbine and compressor in most cases. So I’d say it’s again a challenging environment but for gas compression the rest of the year, they’re pretty much, I think going to end up where we thought they would be and that’s good. And we’re not going to do anything about ‘16 and even speculate today. And we will later in the year because things are evolving so quickly here that I don’t know what it will be and we’re concentrating on ‘15. But solar I think it’s got a year that we’re pretty confident about that’s baked into here as well.

Okay. Thank you.

Thanks a lot. A bigger question, a bigger picture question within North America, have you seen any sort of equipment flow back from the energy production areas to date or do you think that's a potential more in the second half?

I believe we are noticing a decline in orders in the U.S. region, particularly in our construction business, along with a decrease in part sales. I think the lower oil prices are impacting our business in that area.

Okay. Thanks, Mike. And then if I could follow-up on the pricing question specific to construction, you gave a litany of things. Is it your sense that full-year pricing may be more like flat coming off the strong Q1 performance because you have more difficult comps related to Brazil construction, the shift to BCP and then what you describe the competitive marketplace?

Yes. When we did our year-end release, we said that we expected price realization to be favorable, but less than about 0.5%. And by and large, I think that is still the case. I mean, the first quarter was in positive territory. I think we expect to end the year in positive territory, but I mean pretty small numbers. By and large, if you think around 0.5% plus or minus, you're probably in the ballpark.

Okay. Thank you very much.

It’s Barclays. Good morning, guys. Nice quarter.

Good morning, Andy.

Mike, can you talk a little bit more about your backlog movements within the quarter? You noted an improvement in locomotive backlog and in your segment commentary you talked about a large locomotive project in Asia. So can you talk about what drove your locomotive backlog? Is that sort of the ending of the North American locomotives or is that more international related growth?

The comment regarding Asia was about the variability in locomotive shipments. We had a significant order for multiple locomotives that was fulfilled for a customer in Australia during the quarter, which is what prompted the mention of Asia. Regarding the backlog, we received an order from a North American railroad for new locomotives this quarter. Railroads typically place multi-year orders, and we produce portions of those orders throughout the contract duration. The North American railroad placed an order in the first quarter.

Got it. But it’s a long-term contract when it comes down to it?

Sure. Yes, absolutely.

Okay. So just shifting gears you increased restructuring cost at $250 million, up from $150 million with the increase primarily related to facilities that produce mining products. Can you talk about your decision process when it comes to restructuring Resource Industries? You disclosed in your 10-K that you have got 36 mining related facilities at the end of 2014. So how do you gauge when to take action regarding these facilities? And can you talk about the payback period and benefits you expect in your recent actions?

Yes.

It’s Doug here. Brad just before you do that, I’d like to come back to that locomotive order that Mike mentioned one of the big six in North America that was a tier 4 order for our new emissions locomotive, which will be available in 2016. And there has been a lot of discussion around our tier 4 readiness and that was a big order for us and we’ll start shipping at '16 our long-term contract. It starts pretty quickly as soon as we give that technology ready which as I said it will be next year. Sorry Brad.

No, it's good. Hi, Andy, it's Brad. Let me talk a little bit about this. There has been a lot of discussion about it, and we’ve been fairly active in terms of the studies we conduct here. We are cyclical and have seen this before. On one hand, we want to be prepared for the upturn. Our business model focuses on producing quality products, maintaining low operating costs, and ensuring parts and service come from us and the dealers, resulting in repeat business. Given that our sales can fluctuate significantly throughout the cycles, we want to be equipped to meet that demand. On the other hand, it’s clear that this current economic environment offers many opportunities. We have been working on this since 2013. If you consider our efforts over the last three years, including what we plan for 2015, we will incur approximately $900 million in restructuring costs. We’ve closed or downsized around 20 facilities, amounting to about 5 million square feet during this period up to 2015, along with about 15,000 employees, which is unfortunate. Overall, if you look at the benefits we have previously mentioned, we believe that after 2015, the benefits per year would be between $400 million to $500 million, and we have seen higher benefits than expected. The initiatives we have in place should meet or exceed the upper end of that range in terms of annual benefits. It’s a robust process led by our product source planning group, involving participation from all facilities and regions. There has been some conversation about large facilities, but it is very challenging to close the single source Decatur facility for the mining trucks, and similar considerations apply across periods. These decisions do not provide positive returns for our shareholders, and we conduct net present value calculations accordingly. I would say we are continuing to explore opportunities and have added a few more in the mining sector. Looking back to 2012, we had $66 billion in sales, and now we have $50 billion. We have lost about $16 billion, with 75% of that coming from mining, maintaining around a 25% decremental pull-through rate. There are many factors supporting this, including lean initiatives and material costs. Overall, we are satisfied with that pull-through over the three-year period, achieving this with minimal price changes, higher quality, and growing market share. We are not saying we won't have more to do, but that process is ongoing, and we’ve been quite active in it.

Okay. Thanks, Brad.

Good morning. I’ll keep it pretty simple. I am just trying to figure out the cadence of earnings for the year. The first quarter was $1.86 ex the restructuring and almost never is the second quarter not as high or higher than the first quarter or maybe once in the last 20 years and that was a quarter when you are just starting to buy Bucyrus. So even if I pull out the gain on the first quarter, call it $1.72, if the second quarter has also been $1.72 or higher to do your full year, the back half of year has to be doing $0.70, $0.75 per quarter. Is there conservatism in the guidance or does it drop-off that sharply?

What I can share is that when we review our internal forecast for the three quarters, they are quite similar. We anticipate that the second quarter will have lower sales compared to the first quarter, which is unusual. Our expectation for this year is that the second quarter will experience lower sales and profit than the first quarter, with only minor variations for the rest of the year. Overall, if you consider our full year, excluding the first quarter, the remaining quarters will align closely with our projections.

I am trying to understand if sourcing in the second quarter is expected to drop to around $1.20 compared to the last two quarters being $1. The decrease in energy and some locomotives raises the question of what will offset that in the second half of the year. The earnings are also decreasing significantly, so I want to know what improvements we can anticipate.

Yes. So a couple of things. You are correct that we will see significant declines in reciprocating engines during the second half of the year, starting around the second quarter and continuing through the year. However, other areas of the business, like solar, typically perform better in the second half compared to the first half, and we expect that trend to hold this year. Marine sales are also projected to increase in the latter half of the year compared to the first half. For most other parts of the business, the year looks relatively stable. The decline will primarily come from oil, but will be slightly offset by timing in some segments and an increase in marine sales.

And then it's not related to that, the inventory you mentioned a bit of a tickdown through the rest of the year. Can you help quantify at company level as well as dealer level?

At the company level, I will be somewhat general because we are still benefiting from our lean manufacturing journey compared to last year. We have ambitious goals in our forecast. Without specifying a number, we expect a steady improvement or a reduction in inventory as the year progresses. It won't be significant, certainly not like the decline we saw in the fourth quarter of last year, but our forecast anticipates modest decreases in each of the upcoming quarters.

So the dealer inventory for the year is expected to show a cadence of improvement or a decline as we progress, with modest decreases anticipated in each of the next few quarters.

The dealer inventory for the year?

About a $1 billion?

Yeah. Sure. Yeah. I don’t think that we’ve given a number but we added the inventory in the first quarter. Our forecast would reflect all of that coming out, plus a little bit more.

Okay. That’s helpful.

It’s a case where our sales for the year are coming down from $55 billion to $50 billion and not all of that is oil. Some of that maybe oil related but it’s still in construction. So, I think that we will probably end the year a bit less than we were last year. Mining inventory is going to continue to come down a little bit this year, not as much as last year. But it’s going to continue edging its way down like it did in the first quarter.

All right. I appreciate the detail. Thank you.

It’s Vertical Research. Good morning, everybody.

Good morning.

So, I guess the question is on capital allocation. The commentary on share repurchase in the press release was balanced I guess with that and other opportunities. I'm just curious if just given the maybe bounding opportunities in oil and gas, I'm not sure, whether it makes, whether we should expect you to cut back on share buybacks for a couple of quarters just in case something develops? Or how you think about staging that, if you'd buy something and then reassure shares, how are you thinking about that?

I’ll take that one. Doug Oberhelman here. We really haven’t changed our priorities regarding cash at all. If anything, maintaining our balance sheet has become even more important as uncertainty continues to grow. We reported that our debt to debt and equity ratio is around 37%, and that has been trending down, which we will continue to do throughout the year. In the first quarter, we bought back $400 million of shares, which I believe is a reasonable planning rate for the rest of the year, assuming our plans hold. I have no doubt we will end the year with significant cash, just like we did in the first quarter with over $7 billion. In this uncertain environment, where day-to-day situations can change unexpectedly, and remembering the impact of the downturn in 2008 on our weak balance sheet, this is our position. Additionally, we are always looking for growth opportunities, and having a strong balance sheet gives us flexibility for growth, protection, maintaining our dividend, and modestly increasing it. We’ve mentioned before our share buyback plans, and I would say we are in a strong position regarding cash generation, with improvements in our inventory turnover and lean manufacturing that are freeing up cash. As we address these other priorities, share buybacks will likely continue to be important for us over time. However, for 2015, we are currently planning on about $4 million each quarter, given the uncertainties and challenges we face every day in the marketplace.

That's wonderful. Thank you, Doug. If I can ask my follow-up, Mike, I think mentioned that oil and gas in the drilling and completions, and Doug, I believe you mentioned that solar looks okay. Is there any risk or is it long enough into this downturn to see if there's a risk to parts, all our mining not just in sort of fracing, completion drilling but just production pipeline and anything else? Do you anticipate right now that this is isolated to drilling and completion or could it spillover either on pricing or volume on the rest of it? Thank you.

You should never rule anything out entirely. Generally, if you're involved in producing or transporting oil through a pipeline, you need the right equipment to operate effectively. If there's some hesitation, particularly from customers in sectors like mining, it could lead to delays in overhauls and rebuilds, which might have negative consequences. At the moment, we're not observing significant issues beyond what's already happening in drilling and fracking, where activity has decreased. It's important to note that a substantial portion of our business in oil and gas is actually related to gas, and that segment has remained relatively stable. Demand for gas is strong, and our compression business is performing well. Thus, oil represents just a small part of our overall oil and gas operations.

Thank you, Mike.

Well. With that, I think we’re going to wrap it up. We are at the top of the hour. Thank you for joining us and we’ll talk to you again next quarter.