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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning ladies and gentlemen, and welcome to the Caterpillar 1Q 2018 Analyst Conference Call. At this time, all participants have been placed on the listen-only mode and we will open the floor for your questions and comments after the presentation.
It is now my pleasure to turn the floor over to your host, Jennifer Driscoll. Ma’am, the floor is yours.
Thanks, Kate. Good morning everyone, and welcome to the first quarter earnings call for Caterpillar. I’m Jennifer Driscoll from Investor Relations at Caterpillar. I’m pleased to have with me here in the room Jim Umpleby; Chairman of the Board and CEO; Andrew Bonfield, CFO; and Kyle Epley, Vice President of Global Finance Services Division.
We have provided slides on company's presentation. You can find the slides along with our earnings release and glossary on the Investors section of the caterpillar.com website under quarterly financial results.
Today we plan to make forward-looking statements which are subject to risks and uncertainties as well as assumptions that could cause our actual results to be different than the information discussed. For details on the factors that individually or in aggregate to cause actual results to vary materially from our projections, please refer to our most recent SEC filings and forward-looking statements included in today's earnings release.
As indicated earlier, we're not reporting adjusted profit for share in the first quarter as restructuring costs are expected to be lower this year. It's our intention to report adjusted profit per share in the fourth quarter of 2019 to exclude mark to market gain or loss for the re-measurement of pension and any other post-employment benefit plan and any other discrete items. Please keep in mind that today's call is copy righted by the company. Any use of any portion of the call without our written approval is strictly prohibited.
Before I turn the call over to Jim, let me remind you that we will be webcasting an Investor Day presentation next week May 2, from 1:00 PM to 3:30 PM Eastern time. We intend to differ until then any questions about capital allocation for long term target. To access the webcast or the transcript, please visit caterpillar.com, click on investors and then events and presentation.
And with that, I'll turn the call over to Jim.
Thank you, Jennifer. We're happy to have you with us at Caterpillar, and good morning to everyone on the call. As Jennifer mentioned we hope to see many of you at our Investor Day next week in Clayton, North Carolina, where we will provide an update on our enterprise strategy, financial targets and capital deployment plans.
Turning to the first quarter highlight on Slide 3, I'd like to thank our global team for delivering another strong first quarter. Profit per share was a first quarter record of $3.25 rising 19%. This result included a contribution of $0.31 per share of a discrete tax benefit. Consolidated sales and revenues grew 5%. Resource industries led the way, driven by higher demand for equipment and services and favorable price realization. Growth from Construction Industries was fueled by higher end-user demand for construction equipment and price utilization.
Operating profit rose 5%. We benefited from favorable price realization, volume gains and lower short-term incentive compensation expenses, which more than offset higher manufacturing costs, as well as investments in SG&A and R&D for future growth. Strong operating cash flow of $860 million allowed us to repurchase $750 million in company stock in addition to paying the dividend as part of our continued commitment to shareholder returns. These strong first quarter results are a reflection of stronger demand and the benefit of executing our strategy for profitable growth by investing in services, expanding our offerings and improving operational excellence.
Growing services is a critical element of our strategy. Services allows us to provide additional customer value in a variety of ways, including reducing downtime and maximizing machine availability. Digital is an enabler of this strategy with connectivity at the foundation. Last year we added about 250,000 new connected assets bringing our total to about 850,000 assets connected worldwide.
We look forward to sharing more on how we think about services during our upcoming investor day. Expanding our offerings enables us to grow our business and reflect our commitment to create greater customer value by providing solutions to meet diverse customer needs in different markets around the world.
Some of our progress was on display earlier this month at Bauma, a Construction Industries largest trade show of the Munich, Germany, every three years. I was proud to walk the floor of the Caterpillar exhibit and engage with our dedicated employees and valued customers. Among the highlights were the next generation hydraulic excavators with new semi autonomous features, which give operators more information and insight than ever before. We also displayed the world's first high drive Electric Drive dozer, the D6XE. It offers up to 35% better fuel efficiency than its predecessor.
We also showcase new hybrid technologies on three Perkins engines as well as five new engines from its range of EU stage five engines designed to meet new emission standards, increase productivity and lower lifecycle costs. To complement these expanded offerings on the stand customers also learned about new services, including aftermarket products, customer service agreements and our new CAT app which allows customers to easily track critical machine operating data from the field.
We continue to focus on enhancing operational excellence, including safety. Our safety goal is always zero incidents. We want all of our employees to return home safely every day. One of the metrics we track at number of recordable injuries for 200,000 hours worked. So far this year, we are tracking 9% better than 2018, and we will not miss focus on his priority to prevent injuries and keep our people safe.
Executing our strategy is allowing us to improve operating profit and free cash flow, which we define as operating cash flow less capital expenditures. During our Investor Day on May 2, we will discuss our expectations for operating margins and free cash flow.
Now turning to the 2019 outlook on Slide 4, we continue to have confidence in the fundamentals of our diverse end markets and expectations for 2019 performance are unchanged. However, we adjusted our range of 1,175 to 1,275 by the amount of the discreet tax benefit we realized in the first quarter. That brings our 2019 outlook to 1206 to 1306 profit per share. We continue to expect modest sales growth and continued cost discipline for full year 2019.
Now let's walk through what we're seeing in the external environment. In Construction Industries, we continue to believe that the healthy U.S. economy, along with stable local funding for infrastructure development will be a positive for us, partly offset by weakness in residential construction. We continue to expect demand to remain low in Latin America this year.
In the Europe, Africa and Middle East region demand remained steady despite the political and economic uncertainties. In Asia-Pacific infrastructure activity remains strong. Within China, we continue to expect our sales to be flat with last year. For resource industries, we continue to expect most commodity prices to remain at investible level. We are seeing mining companies becoming increasingly willing to invest in CapEx. While that is encouraging, mines remain disciplined in CapEx deployment. We expect demand for heavy construction and quarrying in aggregate equipment to remain strong.
In Energy & Transportation, oil prices are recovery, but the volatility in oil prices and take away construction in the Permian are impacting demand for well servicing equipment in the first half of the year. Later in the year, the U.S pipeline constraints are expected to ease, and we anticipate an increase in demand. GAAP compression should remain healthy for demand for power generation equipment continues to be a positive.
Finally in transportation, we expect improvements in our way of business including services.
With that, I will turn the call over to Andrew for a closer look at our financials.
Thank you, Jim, and good morning, everyone. We have reported record first quarter results today as we continue to execute our strategy and use our operating an execution model to drive profitable growth.
I will walk through the results starting with Slide 5 before turning to our updated outlook for the full year. Sales and revenues for the quarter totaled $13.5 billion up 5% from last year, driven by both volume gains and price realization with Resource Industries having a strong first quarter, in particular.
First quarter profit per share of $3.25 included a $0.31 per share discrete tax benefit, increased 19% from the prior year's first quarter. This is driven by higher sales, partly offset by higher manufacturing costs and higher spending on SG&A and R&D due to increased investments versus the first quarter of last year.
Now let's turn to top line on Slide 6. Sales and revenue growth in the quarter was driven by volume gains and price realization, partially offset by currency. Volume gains, primarily reflected strong demand in both Resource Industries and Construction Industries. Resource Industries from demand was due to growth in original equipment and services. For construction industry sales in North America rose double-digits this quarter. Energy & Transportation sales were flat versus the prior year. Currency pressures reflected dollar strengthening, principally primary against euro, the Australian dollar and the Chinese plan.
If you move to Slide 7, I will walk through the changes in operating profit. As shown on the chart, price realization and sales volumes drovethe operating profit increase contributing $292 million and $265 million respectively. Financial Products also added $26 million to operating profits for the quarter.
Manufacturing costs increased by $375 million due to higher material costs, freight and variable labor. These higher costs, while unfavorable, were improved from the fourth quarter levels, material costs included a direct tariff expense in the first quarter of about $70 million in line with what we expected. Remember tariffs only started in July of last year. So these will have an impact in Q1 and Q2 until we're passed their original implementation date. Also while steel prices have moderated, after procurement contracts have a light effect so these are still rising across.
Labor costs are impacted by production bottlenecks as our suppliers continue to ramp up volumes. SG&A and R&D spending increased despite lower levels of short-term incentive compensation expense, primarily due to investments in growth areas including services and expanded offerings, as well as some corporate level items. The competitors are also set against the low-level of spend in Q1 last year. Currency was unfavorable by about $20 million. Restructuring costs were not material for the quarter.
Now, let’s look at the performance of each segment in Q1 beginning with Construction Industries on Slide 8. Sales were $5.9 billion, an increase of $196 million or 3%. Construction sales increased in North America by $345 million due to higher demand for new equipment, particularly for road construction activities. Sales declined in Asia-Pacific, EAME and Latin America. Asia Pacific sales were down 4% or $66 million. Currency was the driver as volumes in China was about flat, which is what we expected. In the EAME, sales declined by 6% or $61 million due to smaller increase in dealer inventories and weaker euro partly offset by favorable price realization.
Lastly macro economic factors in Latin America contributed to a decline in sales 7% or $25 million off of a very low base.
Turning to profit Construction Industries segment profit declined by 3%, the segment profit margin of 18.5% was a decrease of 120 basis points from the first quarter of 2018. The favorable impact of higher price realization is more than offset by higher manufacturing costs. This increase in cost was led by high material labor on freight costs. While these costs increase, the magnitude was less we saw on the fourth quarter and was driven by the same factors are mentioned a moment ago. The backlog for Construction Industries rose as higher production levels supported an increase in orders rates. We continue to have most free line products from managed distribution.
Now let's go to Slide 9, look at Resource Industries. Resource Industries sales were $2.7 billion, up 18% from the first quarter of 2018. The $418 million increase in sales of the quarter reflected high equipment demand, favorable price utilization and increased services. We saw solid demand from mining and heavy construction equipment, including quarry and aggregate. Asia-Pacific was particularly strong with sales up $275 million or about 52%. The backlog declined in Resource Industries as our factories continue to ramp up production, which resulted in increased dealer inventories.
First quarter orders were higher than in Q4 2018. We continue to expect higher money CapEx in 2019, lean us to expect higher sales in new equipment this year.
Segment profit of $576 million, rose 52% versus first quarter of last year. Segment profit margin improved to about 21%, up 470 basis points in 2018. Resource Industries improved performance and margins expansion was primarily due to higher sales volumes. Favorable price realization was partially offset by higher manufacturing costs including increased material and fright costs as well as slightly higher warranty expense.
Turning to Slide 10, we will review Energy & Transportation results. Energy & Transportation sales in the first quarter were $5.2 billion comparable to same quarter last year. Favorable price realization and higher sales volumes were more than offset by unfavorable currency sheet. Sales into oil and gas applications decreased by $84 million or 7%, primarily due to the timing internal project delivers in North America. Sales in power generation rose by $67 million or 7%, due to higher demand for large diesel reciprocating engine applications.
Industrial sales were similar to last year's first quarter with gained North America more than offset by an increase in the EMEA. Transportation sales decline 2%. We recently marked one-year anniversary of acquisition of two rail service businesses in January 2018.
Segment profit for Energy & Transportation was $838, down $36 million or 4%. The segment profit margin contracted by 60 basis points drove about 16%. Energy & Transportation margins reflect to higher manufacturing costs driven by freight costs and warrantee expense. The increase in backlog in ENG was driven by rail related services and turbines, which will partially offset by specific engines due to softness in oil and gas that Jim referred to earlier.
Now let's go to Slide 11, and I will walk through our assumptions for the 2019 outlook. Our profit per share outlook range for 2019 is now $12.06 to $13.06. The change from our prior range of $11.75 to $12.75 reflects a discrete tax item mentioned earlier. Our assumptions with the business loss were largely unchanged. We continue to have competence in the fundamental of our diverse end markets and we expect sales to increase modestly this year. We also anticipate the price realization will offset higher manufacturing costs, short-term incentive compensation is expected to be a tailwind of about $500 million. We project restructuring costs of about $100 million to $200 million for the full year. This makes annual tax rate is unchanged at 26% except for the discrete types item we called out.
We see capital expenditures in the range of $1.3 billion to $1.5 billion. Our outlook assumes that the macroeconomic geopolitical environment is largely unchanged.
Looking ahead to the second quarter, we expect to continue the execution of our strategy, including additional investments for long-term profitable growth was appropriate. We anticipate stronger results in the back half of the year, including better variable margins and stronger demand from oil and gas customers in North America.
Depending on markets from based on internal assessment of enterprise in terms of value. We expect to be active in the market and repurchase another $750 million company stock in the second quarter of 2019. Any additional share repurchases will depend upon cash generation and alignment with our capital allocation priorities. We do not expect to make any additional voluntary pension contributions due to the $1 billion description pension contribution we made in the third quarter of last year.
So finally let’s turn to Slide 12 and recap today’s results. It was a record first quarter of profit per share following the record first quarter last year. We have updated our guidance to $12.06 to $13.06 in profit per share. Given that strong financial profile we were able to return $1.2 billion to shareholders from the quarter, while executing our strategy and investing for long term profitable growth.
With that, I will hand it back to cater operator to begin the question-and-answer portion of the call.
Thank you. Ladies and gentlemen the floor is now open for questions. [Operator Instructions] Thank you. Our first question today is coming from Jerry Revich at Goldman Sachs. Your line is live.
In resources, I'm wondering if you could update us on your expectations on when large project prospects are expected to turn into orders over the past year we’ve seen CapEx budgets and truck utilization moving the right direction. And I'm wondering what do you expect that to translate to backlog growth for your resource business?
Yes, Jerry, it’s Jim. I’ll take that one on. So we’re seeing healthy levels of business from our mining customers. As you know we had some issues in terms of ramping up production particularly with our suppliers over the last few months. And our backlog chain really is a reflection of the fact that we’ve been able to ramp up production as oppose to any softening of demand. So again the market is strong. We expect to continue to have good market activity here and we’re ramping up production, which has resulted in a reduction in our backlog.
Okay. And then I'm wondering if you could just expand on your dealer inventory comments. So healthy dealer inventory build in the first quarter you mentioned resource is still at low levels of dealer inventories and you’re looking for food business to be up low single due to organically. This year is the flat dealer inventory comment really an expectation or is that a place holder as we see activity ramp up in other words. It sounds like you either expect to reduce production over the course of the year or retail sales to accelerate if we do indeed see flat dealer inventories year end 19 versus year end 18?
Yes, so Jerry, obviously, keep in mind that dealers own and control the inventories so our expectations are based on what we expect their order levels to be. Obviously, we did see an increase in inventory levels in the first quarter for the usual seasonal regions. Obviously, we’re making sure that we work closely with our dealers to make sure we align their inventory with current market demands. We believe that is about appropriate. And we believe actually flat at the end of the year is a reasonable assumption to be making at this stage.
Thank you. Our next question today is coming from Jamie Cook at Credit Suisse. Your line is live.
First question just on the resource margin, very much higher than expectation, I know volume and price helped, but was there any benefit there from sort of restructuring or mix and given the shrink in the first quarter, how do we think about sort of full year margin? And then just a follow up question on the dealer inventory level, can you comment on dealer inventory levels? Your months of dealer inventory level either by region or product? Thank you.
Hi Jamie, it's Jim. As you know we don’t guide -- we don’t give segment margin guidance, but yes first quarter margins are quite strong. A lot of that was driven by volume leverage. We had good price as well, and also just looking at the timing of investment that we had throughout the year was relatively low in the first quarter.
And with regards to dealer inventories, generally, obviously, we try to keep dealer inventories to the sort of three to four month level is sort of target guide range, and we try to do that across everywhere and across all product groups. It would be our biggest guide. Obviously, in some areas as we know and see how we are on them distribution. So obviously some inventory levels are lower and could rise higher over time once we get those products off managed distribution.
Our next question today is coming from Rob Wertheimer at Melius Research. Your line is live.
If you look at your market share in China construction over the last 10 years, I think you're more or less doubled it if you use a tonnage basis as opposed to units. You do well in the bigger machines and you've done well in growing that category. Could you sort of talk about what's driven that and then what's changed in the last three, four months to cause some ebbing of those changes?
Yes, so China, obviously, this year we saw relatively flat first quarter sales in China, which is consistent, obviously, with prior year. Spring season, as you know, is usually a strong selling season in China, and goes stronger than normal across the whole of the sector mainly due to the timing of Chinese New Year, but there's also been some very competitive pricing. And that has had some impact on those market shares. We now expect the industry -- our expectation for the industry for the full year is China to be up. We expect our sales to be flattish for the year. So we will lose some market share in Q1, but we're taking actions to gain it back, working with dealers and also launching new models, which is the key part of the strategy, which we think is the right strategy that enables us to compete.
Thank you. Our next question today is coming from Ann Duignan at JP Morgan Securities. Your line is live.
I was just wondering if you could give us an update on your 1% to 4% price increase targets across your different segments and regions.
Yes. So Ann, as you saw that for the full year or for the full first quarter, we had saw price of about $292 million. That’s about 2% on net revenues, obviously, that was stronger in CI and RI than it was in ENT. That effect is basically partly some impact because of the midyear price increase, which is mostly in Construction Industries last year. And then, obviously, the price increase, which was more broadly brushed across the whole segments on the six segments on 1st January. We expect Q1 and Q2 to have better price realization, but once we get pass the anniversary of the midyear price increase CI in particular, will be less price realized in second half of the year. But so far we're holding good level of the prices increases we put through.
Okay. And then in that context, just one quick follow up on the CI. Were you comparable with your incremental margins even though they weren’t incremental? Or did anything specific happen in Q1's cost Construction Industries margins to be worst that you might have expected and how should we think about those margins going forward? Thank you.
Yes. So I’ll talk about comparables again just rather than I see because we don’t give a detailed guidance for that individual segment. But if you look at the comparables to CI, we are, I think, we’re seeing some material price increases both steel and tariffs had an impact as we talked about more broadly. They particularly impacted CI. Freight costs just authorized indeed towards the end of the -- in the middle of second quarter last year. So we’re still ramping past those. Obviously, as we get pass those comparable increases, our margins should stabilize and be better for the remainder of the year.
Thank you. Our next question today is coming from Steven Fisher at UBS Securities. Your line is live.
Just curious how you are thinking about the guidance for the year and the visibility for the second half, in general? Obviously, you hit your Q1 buyback plan still have plenty of cash to do more buybacks. I think you mentioned another similar quarter buybacks in the second quarter. So do you think the guidance is conservative given that you don’t have a lot more buyback in guidance and maybe clarify that next 750 is in guidance? Or is there something about the visibility in the second half of the year, whereby it’s making you cautious you might need the buybacks as an offset?
Yes, I think, on this point of year in terms of our guidance for our profitability, it’s early in the year so we're maintaining our range. In terms of buybacks, one of the things we’re going to discuss a bit next week at our Investor Day is our financial capital deployment. So we look forward to see you there having that conversation.
Okay. But just to clarify, is the $750 million for Q2, I think, you said is that now baked into guidance?
Yes, that guidance assumes that we have a consistent level of buyback activity quarter-on-quarter.
And then just a follow up on the North American construction business, you said a higher demand on road building. Can you just talk about what you’re seeing outside of road construction and what do you think about the mix later in the year?
Well, again, we talked about the fact that we have strong infrastructures, and local and state infrastructure investment is helping drive sales of residential was a bit soft. We don’t see -- we don’t expect a major mix change for the remainder of the year.
Anything on the commercial side?
There is nothing to add.
Thank you. Our next question today is coming from David Raso at Evercore ISI Institutional Equity. Sir your line is live.
If I look at your implied sales guidance for the rest of the year, and I utilize your historical sequential changes in your backlog, it would imply that year-over-year backlog does stay down year-over-year for most of the year and maybe back to flat in the fourth quarter. But that also does imply your orders term positive year-over-year in the third quarter and for the full second half. Is that what you’re hearing from your customers and dealers that we should be seeing the orders growing year-over-year in the second half of the 2019?
Yes, David, I mean there are couple of things, one which is, obviously, mining CapEx is one area where, obviously, we're expecting the order rate to continue to accelerate the year, particularly given we are to expect an increase from mining CapEx for the full year. And as replacement cycle starts to move ahead, obviously, that will help us on from a backlog perspective. In ENC, as we've indicated, well, we do expect to see some order improvement in second half of the year is around oil and gas, reciprocating engines, in particularly as the Permian Takeaway issues are started to moderate. So those are probably the two big factors, which we would say would drive orders from second half of the year.
And that sort there will be an aggregate drive in the total company orders albeit year-over-year, I guess, a key question that what you're seeing and obviously thinking about in your guidance. Is that what the numbers imply?
Yes, that is what we're thinking and our guidance implies.
And in that same regard, if orders were up in the second half of the year, price cost, the way you're guiding here that would imply the first quarter was the worst of the price cost for the full year. Can we extrapolate that into your thoughts on margins year-over-year in aggregate for second half?
Sorry, David, can I just clarify price/cost? You mean price realization?
Price, as in the waterfall chart, yes, price versus the manufacturing costs in this quarter was fair down 83 million negative, which actually worse than we saw at any quarter last year. I’m just making sure that where you laying it out, does that then set of the margins year-over-year go back to growing.
Yes, well basically as we've also said and guidance assumes this price offset material cost increases or manufacturing cost increases for the full year. So yes, that would imply an improvement from that part of the factor of the remainder of the year?
My last quick one. This might be my second question I apologize. But when you think about cash flow and use of it, that's fine, but even on the balance sheet, the amount of cash you are caring, you can define it as you wish, cash to total debt, cash to shareholder equity, cash to total assets, everyone, the cash on the equipment company seems very high. So when I hear share report number 750, which isn’t even pushing the cash flow usage. Can you help us understand specially as a new CFO to the company, Andrew, what do you think the appropriate cash level should be for the equipment company?
I assume we will talk about that in May 2 Day.
Yes. I appreciate that. Thank you.
And as a reminder could we have please one question per caller. Thanks
Thank you. Our next question today is coming from Ross Gilardi at Bank of America Merrill Lynch. Your line is live.
Jim, I’m just wondering across your overall portfolio what are you hearing from your biggest customers with respect to trade war into the field, in general, like there's pent-up demand for capital spending projects around the world in the next year if this whole thing is resolved?
Yes, I think, most of our large customers are as we are cautiously optimistic that we will work our way through this trade issues. Certainly, anytime there are trade tensions of this kind. It does put a certain amount of conservatism, I think, into all of our plans for capital spending. So I would expect this in fact the trade tension get resolved, that would be a positive for global economic growth and positive for us.
And just on the order trends, I mean, you had originally obviously guided in January and some of the macro data feels a little bit better more recently. Did you see any type of reacceleration in order trends? Would you say as the quarter unfolded and as commodity prices recovered or you could say kind of more March, April today versus January and February?
Yes, certainly. As you know we’re a very diverse business so just talk about some of the areas. In oil and gas reset, much has been written about the fact that there’s constraints in the Permian and that did have a bit of a negative impact on order rates for our reciprocated engines sold into oil and gas. As you mentioned earlier, mine activity both in the aftermarket and for new equipment, that quotation activity is quite strong, obviously, again, miners are being cautious based on what the cycle of the past. But generally we feel good about our business, and we feel good about the quotation activity in the segment we’re getting from our customers.
Thank you. Our next question today is coming from Noah Kay at Oppenheimer & Company. Your line is live.
Just on your comments on CapEx budgets, I think the company previously guided for CapEx to be about flat year-over-year. The guidance you provided in the slide to just immediate increases of about 10% at the midpoint? Is there anything in particular which you think about driving that or you having to ramp up your production infrastructure and maybe together segment?
No. I can’t -- generally, I would say CapEx is still below book depreciation reminds me that that is a positive from a cash flow perspective. And we are expecting it to be flattish, I think, last year it was about 1.3, so the bottom end of that range. There’s no significant big build up of incremental production and required.
Kate, are you there?
Jim had a question for you.
Thank you. Our next question today is coming from Andrew Casey at Well Fargo Securities. Your line is live.
I'm trying to understand the comments about manufacturing costs gone down a little bit in Q1 versus Q4, and then the back half improvement. And juxtaposing against last year it is seasonally a typical period where margins decline in Q2 from Q1. You might have answered it, but I'm still little unclear. Should we expect Q2 manufacturing margin to be higher than Q1 and then further improvement in the second half?
No. What it will be is, compared to the comps for the last year, if you look Q1, obviously, this year margin was lower as a result of the seal tariff and freight costs. We expect those to moderate as we go through, not there’ll be similar impact on Q2 because, obviously, those increases won't be fully in effect for most of the Q2 last year, and then obviously will moderate in the second half of the year.
Thank you. Our next question today is coming from Joe O’Dea at Vertical Research Partners. Your line is live.
A related question on manufacturing costs, and just I think you've talked to the tariffs related costs. If you could break that 375 down at all anymore, it doesn't sound like there are any mitigating actions in process to take that down. It's more about a wait and see and then comps get easier. But I just wanted to understand if there some opportunities for you to address those whether that's rerouting supplies whether that's any other kind opportunities you have. But just given if that was a pretty substantial headwind in the quarter, what kind of medication we could see?
Yes. So there are two areas where we do expect some mitigation, probably later this year, one which is around steel prices, just purely because we lag behind because of the effect of, as I said, our procurement practices. And as you look, currently, obviously, with the Vale issues or product prices all looking at slightly higher, but there should be some benefit of slightly lower steel price coming through later this year. And that’s one of the areas where we are going to obviously be looking for some potential cost savings. The other area, which is also issues around variable liable burden, which basically is really around the fact that obviously as we building our production, we're having some bottlenecks. So as a result of supplier issues, and we expect those to mitigate during the rest of the year as well. So we do expect some of these not just we mitigated by the comp period, but also by actual actions we are taking.
And then also on lag effects and related to the pricing, I mean, when we think about midyear 18, we implemented some price increases and then again on Jan 1, presumably 1Q doesn’t fully reflect at least what happened on Jan 1, because of some things that might've already been in backlog. But could you just talk about the degree to which there is still some lag effective seeing those price actions that were implemented?
Yes, we do expect the second half of price realization to be lower than the first half because of the midyear price increase last year. That was the -- that is one of the biggest factors in the -- in above the 2% rise is obviously that's fully baked in enterprising now. So we would expect second half to be lower. And as I said we had guided to have basically price offset manufacturing cost increases.
Thank you. Our next question today is coming from Seth Weber at RBC Capital Markets. Your line is live.
I guess first just a clarification on Jim, your comment that the orders were up in the first quarters versus the fourth quarter. Is that -- does that include traditional mining equipment? Or is that more skewed towards quarrying or big construction?
Yes, I think what I said was our order activity remains strong in our eyes. So hopefully, I gave a quarter-to-quarter comparison. But again, quotation activity is strong. And the general quotation activity and order activity is healthy.
Yes, I think from an overall prospective actually it was my comment, I think, I did say actually order rate in Q4 was higher -- Q1 was higher than Q4 2018. So we did see that increase -- some increase coming through. That was in mining, and there was some -- it was still strong though in Korean ag at the moment.
And then my question is really just on RI again, it sounds like a lot of the sales today are really on the OE side. I mean would you expect the mix to tilt more towards parts and service as you get as equipment usage starts picking up more. So I guess I'm just wondering could mix become more favorable later in the year or even next year? Thanks.
We didn't mean to give the impression that it's skewed towards O&E at this point, so both are quite healthy at the moment.
Thank you. Our next question today is coming from Stephen Volkmann at Jeffries & Company. Your line is live.
Most of its been answered, but I think there was some commentary about SG&A spending being a little bit elevated due to some growth initiatives. And I'm curious if there’s any detail you can give around that. And then does that sort of fade also in the second half as well?
We continue to make investments -- targeted investments for long term profitable growth in the area of services and in expanded offerings. In services, we continue to connect more assets. We’re more investing in our digital platform. We’re investing in our analytics. And we continue to develop expanded product offerings as well to ensure that we have the right product offerings and right price point for different markets around the world. So again, we’re in this for the long haul, obviously, and we’re making those targeted investments to grow services and expanded offerings.
And the run rate was slightly higher than you would normally -- remember, you got the short-term incentive compensation credit coming through this year and SG&A. So some of that was also there was some corporate one-time items relating to some compensation items in retail at the corporate level. And there were also, obviously, as Jim said, there’s investments that we’ve made in the business itself which helped very well. We also had very low comps last year for SG&A and R&D in the first quarter of last year. We had a very low slow ramp up of spend.
And looking forward is it sort of steady or is this burn half loaded?
I mean the first quarter is one of the highest levels of SG&A spend from an increase perspective through the reminder of the year.
Thank you. Our next question today is coming from Adam Colman at Cleaveland Research Company. Your line is live.
I was wondering if you could talk about the order trends that you’re seeing across the power churn business that was the one area of sales growth within E&T this quarter, but the retail sales have slowed here almost to flat. So I was wondering if you could talk about what you’re seeing by geography and product line and the order book for that chunk of the business?
We had seen a recovery in Powergen over the last few months in that and we expect that to continue. It is an area of strength for us. Obviously, that business is a cocoon and we had a bit of a downturn previously that we’re now recovering from. But can we expect that business to continue to be healthy.
And then related to that, in E&T, you had mentioned earlier that you expect your order trends across oil and gas for resent entrants improve in the second half. Have you seen any of that improvement yet so far or that’s still on the comment?
Again gas compression is remained strong and steady. We haven’t seen a pickup in order rates for well servicing and the reset portion of oil and gas yet. But again, we expect that to come. Another part of our oil and gas business is, of course, Solar Turbines, and that business has remained steady. We’re seeing a pickup there in international orders, which are typically tied more to the big CapEx projects, and there will be oil prices. So that business is starting pick up.
Thank you. Our next question today is from Larry De Maria at William Blaire. Your line is live.
First question, can you just provide the full year incentive comp benefit? And then secondly just a broader question, I have is around, CI dealer manage distribution. I'm just curious how much is being restrained? And when should we think about that getting maybe more in balance perhaps after the spring selling season when things come down. But how restrained is that? And when do that get more imbalanced? How do we think about that? Thank you.
So the first question on incentive comp, we expect about $500 million benefit there this year compared to last year. And in terms of manage distribution for CI, again, it's obviously dynamic situation based on how we ramp up supply and what's happen into the market place. I don’t anticipate a major change here over the next few months in that situation.
Okay. Based on the CI orders, probably shouldn’t get more out of whack than already is now. We may get more towards, more equilibrium situation, maybe later in this year. Is that fair?
Yes. We expected to be broadly flattish for the reminder of the year, yes.
Thank you. Our next question today is coming from Chad Dillard at Deutsche Bank Securities. Your line is live.
So I want to dig into the price realization seen in Resource Industries in the past quarter. Just want to understand how broad-based it was? And to the extend, it was driven by mix. And how should I think about that and how sustainable those on a go forward basis?
Yes. I mean, price utilization, again, was very strong in RI in Q1, and we do expect it to be the highest quarter for the year. So yes, I mean, it was little bit. There is a little bit of an element mix in that number wish to come through. So yes.
Right, because it’s a project based business and quite lumpy. You will see certain metrics jump around quarter-to-quarter. It's just the nature of the beast for show off for rail and for RI.
Got it. And then just a question on Cat Financial. It seems like there is a little bit of uptick on credit loss allowances. Just hoping to get a little bit additional color on that that’s driving either from regional perspective or end markets?
So, I mean, in Cat Financial, the actual past views actually were up from 3.55% in Q4 to 3.61% in Q1. So very small increase, obviously, a bigger increase year-over-year that mostly reflects the Cat Financial portfolio, which we talked about in Q4, which obviously has had an impact on the quality of the overall past views. You also, probably are seeing that we had a mark to market gain in Cat Financial this quarter. Remember in the last quarter we had a loss -- mark to market loss on that and this effectively is just an offset quarter-on-quarter.
Our next question today is coming from Courtney Yakavonis at Morgan Stanley. Your line is live.
Andrew, I think you outlined a little bit about how we should be affecting medication in steel prices and from the variable labor in the back half of the year in addition to lapping over there the entire costs from last year. Can you just comment a little bit on freight costs and whether we’ve obviously seen stock rates drop, but whether we should see that mitigate in the back half as well? And maybe just talk a little bit about how your freight costs are contracting out?
Yes, so obviously there were two factors driving freight costs, one which is actually cost itself, which did rise, probably mostly from the second quarter last year. So again, we should get past that on a comparable basis sometimes in second half of the year. The other factor which was a big issue for us last year and it becoming less of an issue is around backlog of orders. So as we have past few orders that we need to fill, we have had some freight inefficiencies, and again we’re working to make sure we mitigate those as best as we can going forward.
And then just quickly, one other clarification, I think you had mentioned in oil and gas some of the weakness is due to some timing of turbine product deliveries just want to understand how that should impact the back half of this year, especially given that you’re expecting gas compression or still kind of up this quarter. So just trying to understand and expect that acceleration in the back half to come and take away shoes just all the moves and takes in the oil and gas segment.
Yes. I would look at those separately. I try to separate it your mind reset versus turbines, so again turbine business is very lumpy so that you can revenue rack one large project in a quarter and it has a very big impact and you don't have that large project and also there is a decline. So again, our Solar Turbines business is solid and we expect a good year. On the research, and as I mentioned earlier, we have seen again oil and gas compression strong we saw a bit of the slowdown in the order intake in well servicing, and we expect that to recover later in the year.
Thank you. Our next question today is coming from Neil Frohnapple at Buckingham Research. Your line is live.
Within CI, can you talk about what you’re seeing from a used-equipment price standpoint? Are you seeing weakness creeping at all for any of the major equipment categories like to be concern as you look out?
I mean, Neil, that we found the well. There was one auction done in Orlando where there was weakness in prices from, but generally, aside from that is actually been flattish. So used-price equipment seems to be holding up reasonably well above from that one particular.
Thanks. And Kate, I believe we have time for one more question.
Thank you. Our final question today is coming from Mig Dobre at Robert W. Baird. Your line is live.
So going back to resources, I don’t want to put what the amount here, but to me it sounds like you’re more positive this quarter than you had been, say in the fourth quarter at the back half of 2018 in terms of your commentary and kind of how you’re talking about demand going forward. I want to make sure that I get that message properly here and maybe have you expand this to kind of what’s driving this incremental positivity? And related to that as replacement demand is starting to come through from some of your customers eventually, do you feel that the industry has the right amount of capacity available to serve there?
Yes. So again, I mean, we feel good about just to say the business, our quotation activity is good, the aftermarket activity is good. We have certain terms of thinking about parked equipment and that has certainly come down. And so I won't be so presumptuous as to make thinking about how our customers are positioned, but we believe based on all our conversations, we expect this recovery to continue. And obviously, there is timing issues and let's make a judgment call is to what you think will happen this year, what you think will happen next year, but generally we feel positive about RI business and the activity that we're seeing.
And from a capacity standpoint?
It's very -- its situational right. So it's geographic and it's also depends on the kind of commodity that is being mined. In certain areas there still a bit of excess capacity, in other areas there is not. And so really it's a mix bag, we can't really give one answer to that question.
We're still significantly below levels, which we saw in the previous peak. So we believe we've sufficient capacity to meet most of demand.
Right. It is just that has been a lot of restructuring that’s been done in the downturn as well, which is why I was asking. And then one last question on E&T pricing, obviously, little weaker versus the rest of the company, and I'm wondering is there any perspective you can provide on various businesses in that segment where there might be some pricing deviation from the average reported either positive or negative? Thanks.
I mean, I think, generally, obviously the pricing actions that occurred in E&T probably as a higher mix of services as well. Some model of that would spread through the price increase. So that would be a significant factor. There's obviously machines, particularly in parts, in particular for CI and RI were more broadly base.
Jim, turn it back to you for some closing comments.
Sure. Well thanks everyone for joining us today. We appreciate your questions. We're pleased with our team's performance, including another record first quarter for profit per share. We are executing our strategy of profitable growth that we lay out in our Investor Day May 17 by investing in services, expanding in our offerings and improving operational excellence. We do look forward to see many of you at our Investor Day next week. And again we will give you an update there about where we are in the strategy. We will talk a bit about financial targets and also our priorities for capital deployment. With that, I will turn back to Jennifer.
Thank you, Jim, and Andrew, and thanks everyone for joining us today. We appreciate your interest in the company. If you have questions, you can reach me at Driscoll_jennifer@cat.com. If you like a transcript of today's earnings call you will find it posted later today on the investor relations section of our website at caterpillar.com. Next week, on May 2, we will be hosting an investor day as we mentioned. It will be webcast and we will post the transcript of that event after the event on same website. And with that, let met turn the call back to Kate, our operator, to conclude our call.
Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.