Caterpillar Inc. (CAT) Earnings Call Transcript & Summary

Greetings, everyone. This is Tami Zakaria, the Head of U.S. Machinery, Engineering and Construction Equity Research at JPMorgan. It is my pleasure to host a virtual headquarter visit with Caterpillar's Chairman and CEO, Jim Umpleby; followed by Group President of Construction Industries, Tony Fassino. For anyone who needs an introduction of Caterpillar is a global leader in the design, manufacturing and marketing of construction, mining and forestry machinery along with engines and other related parts. Before we begin, I believe we have to go over some disclosures. So I'll pass it on to Ryan Fiedler, Head of Investor Relations at Caterpillar. Ryan?

Thanks, Tami. I really appreciate it, and thanks again for hosting us here today. So during today's meeting, we'll be making some forward-looking statements, which are subject to risks and uncertainties. We'll also make assumptions that could cause our actual results to differ from the information we're sharing with you on this call. Please refer to our SEC filings and the forward-looking statements reminder and a release on details regarding factors that individually or in aggregate could cause our actual results to vary materially from our forecast. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings. Today's meeting will also refer to non-GAAP numbers. For a reconciliation of any non-GAAP numbers to the appropriate U.S. GAAP numbers, please see the appendix of our earnings call slides. Additionally, please note that Caterpillar policy does not allow for meetings to be recorded with smartphones or other devices unless specific approvals have been sought and granted prior to the beginning of this meeting. And then lastly, we'll post a transcript available on our website as soon as we can. And with that, I'll turn it over to Tami.

Thanks, Ryan. And with that, let me welcome, Chairman and CEO of Caterpillar, Jim Umpleby. Jim, Welcome, and thank you for spending time with us today. How are you?

Thank you, Tami, and thank you for the invitation. I look forward to a good discussion.

Of course. Before I start, let me ask you the most important question that everybody wants to know how many cups of coffee do you have to drink a day to run a company like Caterpillar?

I have -- my wife has gotten me to cut back over the years. I had two very large cups, so it's not too bad.

Got it. Okay. Lovely. Okay. So on a more serious note, I wanted to start off on the heels of your third quarter print, very healthy sales and strong margin performance in the quarter, and it's looking like an impressive year for Caterpillar. So talk to me about what you've seen and why the company seems to have elevated performance versus prior periods.

Well, thanks, Tami. And I certainly am very proud of our team of what they've accomplished over the last 7 years as we implemented our new strategy. Just a recap for this year, our adjusted profit per share and ME&T free cash flow through the first 3 quarters of the year will be higher than any other record year in our history. So again, very proud of the team. We expect to finish the year slightly above our adjusted operating profit margin range and we expect to exceed our ME&T free cash flow target range of $48 billion. We implemented that new strategy back in 2017. Just really quickly to go through the main elements as sort of the answer to your question. And so we're focused on three key areas: Operational excellence, which is safety, quality and lean and a competitive and flexible cost structure, expanding offerings about new products and technologies and services, which I'm sure we'll talk more about here. But we also implemented what we call our operating and execution model, our O&E model. And it used to be a Caterpillar, I think, as the way it was in many legacy manufacturing companies, if we had a division, let's say that had a dozen products, as long as that division was performing acceptably, we'll just kind of go along and get a bit more -- get more expense, a bit more capital in the next year. What we've really done over the last few years is we peel the layers of the union. We've looked at all 12 of the products in that division. And understood by product, by model, by application, where we're creating shareholder value and where we're not. And that allowed us to shine a light on those underperforming products and businesses and challenge our leaders to improve the performance of those businesses. In a few cases, we concluded that it didn't make sense to stay in those products and we had some divestments. But even more importantly, the only model leads us to invest more in those areas that represent the best opportunities for future profitable growth. And that's one of the reasons that it's led us to increase our services revenue, our investments in services, which has led to increased services revenue. We started at $14 billion in 2016, $22 billion last year. And again, it's services, it's done right. It has a win for the customer, a win for the Cat dealer, and a win for us. But again, I couldn't be more pleased as to how the team is performing this year.

That's wonderful. So I want to spend a little time on the services piece that you mentioned. I believe you set a target to double services sales by 2026. Who were your customers buying these parts from, if not you in the past? And what would drive this growth? Would you be adding additional dealer locations or helping dealers train technicians or a combination of those? What would really drive this growth?

So we start to think about services at Caterpillar. We have our Cat-branded products. And our Cat-branded products are distributed and sales and serviced through an independent dealer network. And then for some of our products like solar, gas, turbines and rail, it's a direct model where we do the service ourselves. But let's -- I think let's talk about the Cat-branded products that are distributed through Caterpillar dealers. To answer your questions, in some cases, customers would buy from wheel fitters, they might buy from our suppliers. That's a way a lot of that happened. And one of the things that we've really focused on is working with our dealers to understand why are we losing a certain amount of business. And we've gone through this and been very purposeful by territory identifying the lost opportunity, identifying what the main reasons are for the lost sales and then more importantly, what is the dealer need you do and Caterpillar need to do to capture that business. And one of the things that we've done is -- and to answer your question about dealer locations. So dealers are independent businesses, so they make those decisions. But one of the things we're really focused on where we believe there's a big opportunity is what we call customers that don't use a Cat dealer. They buy parts, but they do the work themselves. Oftentimes, those are smaller customers. And so generally, our dealers do a very good job serving their largest customers, whether those customers be in mining, oil and gas or large construction. But for our smaller customers, that's where we believe there's a -- opportunity is everywhere, but there's a real big opportunity there with those smaller customers. And that's why e-commerce is so important in investing in those digital capabilities, on app, on a phone, I can talk more about that later. But again, we believe that's a big opportunity. So when you think about services for Caterpillar, a lot of it is the parts that we sell to our Cat dealers.

Got it. So let's say on digital, you mentioned that. How do you think about the focus on technology and digital innovation at Caterpillar? How does this transformation position Caterpillar for the future?

Yes. It's really important. So let's -- I'll start with the technology on our machines, and then I'll switch to talk more about digital and services. But one of the things that we're continually striving to do is to add more value to our customers. So it's not just an issue of cost or price. It's an issue of how much value we bring to our customers. So we put technology into our products that allows our customers now to do things like use a less experienced operator and they can take a basement for a foundation, they can then build a highway because of all the technology grade control, all the things that are in our machines now, they're much easier to use and they make customers much more productive. We also have something called Cat Command, which allows customers to take operators out of the equipment in hazardous situations, whether it's wildfires or maybe some unpleasant areas like landfills, where, in fact, the machines can be controlled remotely. So Cat Command allows one person to operate up to 5 machines remotely. And some of those machines, many of them are -- have semi-autonomy. So you can kind of get them going and they do their own thing and you can start the other one. So again, that's an example of the way we add technology into our products to add value to our customers. And then we have something like VisionLink, right, which monitors machines, can lower cost, boost productivity, simplify maintenance and improve job safety as well. So again, we're doing a lot in terms of adding technology. We have our next-generation HEX, which allows meaningful emissions reductions. So we've upgraded to about 50 models. And so the new models have reduced fuel consumption, which reduces emissions up to 25% compared to the previous model. Then, of course, I think most people are aware of our autonomous solution, the most visible example of that is our large mining trucks. We have now about 600 mining trucks around the world. We have had customers who state that they see up to 30% productivity improvement. You think about a mine that operates 24 hours a day, 7 days a week, they can produce more product. That is a significant improvement. And again, we believe gives us a competitive advantage. And one of the things we've been doing is working hard to reduce the cost required to make that autonomy investment by a customer viable. So it used to be you need about 50 or 60 trucks for the autonomous investment to make sense. Now we're down to 10 to 12 trucks. And that really does expand our total addressable market for our autonomy and give us an opportunity to serve a lot more customers. Then in energy and transportation, a lot of technology going in there allowing our oil and gas customers to produce oil and gas at a lower carbon footprint, whether it's our Tier 4 DGB engine, which allows about up to 85% of the diesel fuel to replace with natural gas. We have a whole -- practically, we have optimized a whole variety of things that we're doing there. Now on the digital end, again, investing in e-commerce capabilities. We have 1.4 million connected assets. We're using AI to provide prioritized service events to give our dealers leads to sell more parts and service. So I could fill up 2 hours talking about the whole technology that we're putting into our products and our services. Those are a few highlights.

Okay. That's very interesting to know. So Jim, historically, we've seen Caterpillar as more cycle-dependent with peak-to-trough sales ranging 40% or more. Given the changes you've talked about so far? And since you've become the CEO, do you expect the top line to be less volatile than it was in the past?

Well, we've done a number of things. Firstly, we have told our investors that we would perform at a higher level, both operating -- adjusted operating profit margins and free cash flow at different sales levels compared to what we picked a reference period of 2010 to 2016. So we do believe that regardless of the sales level, and we've demonstrated this, we operate at a higher level. In 2020, we lost more than 20% of our top line due to COVID, the pandemic-induced downturn and we still achieved our adjusted operating margin target. So having said that, to answer your question about the top line, one of the reasons to increase services, of course, is services tend to be less cyclical than OE than new equipment. And we saw that in 2020 as well, where services didn't drop the same percentage as OE did. And so again, we also have a new S&OP process, where I would argue that the quality of our backlog is quite good. We work hard to ensure that we -- our dealers are independent businesses, they can decide how much they order, but we can decide how much we ship. And so we, in fact, spent a lot of time looking at what's happening in the marketplace. And by ensuring that there isn't too much inventory out there, that also helps dampen cyclicality as well, and we've worked very hard on that.

Got it. Understood. And so going back to the free cash flow comment. Your free cash flow generation has been very strong. It looks like it's going to be above your target range this year. How do you think about your potential for cash generation going forward?

Well, we're very excited about it. And again, I mentioned that we expect to exceed that target range we set for ourselves of $4 billion to $8 billion this year. We -- and in the first 3 quarters of the year, we produced more free cash flow than we have in any other full year. So again, very good performance. You asked earlier about the top -- changes in the top line. And although if you look between 2017 and 2022, certainly we had strong cash flow generation to argue every year. So $5 billion to $6 billion between 2017 and 2022, except for 2020, where we had that 20% downturn. But even in 2020, when we had more than a 20% downturn in our top line, we still produced $3 billion of free cash flow. So one of the things that I think, frankly, is underappreciated about Caterpillar is how much cash we're able now to generate with the new disciplines we put into the business. We're continually looking at ensuring that we get good return on every dollar of capital that we invest. That's part of the O&E model. And of course, getting a return on invested capital, creates free cash flow. And our measure of profitable growth is what we call OPACC, which is operating profit after capital charge, and we believe that most closely aligns with TSR over time, which is why we picked that as our measure. So our measure is not just top line growth. Our measure isn't just higher margins. Our measure of success of that profitable growth is, again, operating -- absolute operating -- absolute OPACC. So again, very excited about the amount of cash we're generating. And if I would have -- Tami, if I would have asked you 4 or 5 or 6 years ago or even 3 years ago, if you would expect us to produced more than $8 billion of free cash flow in 2023, you may have -- laugh that. So again, I think we're performing quite well on the cash -- from a cash flow perspective.

For sure. So a quick follow-up on that. Given all this very strong cash generation that we've seen, are there any gaps in your portfolio right now for which you would want to turn to M&A. And can you discuss your process for evaluating investments?

Yes, certainly. We continually challenge our leaders to be looking for potential opportunities, things that make sense. Having said that, we're not elephant hunting. One of the things that's very exciting about our business is we believe that we have some outstanding opportunities to organically grow our business profitably. That include services. That includes the energy transition driving increased demand for commodities, for example, commodities that are used for EVs and other parts of the energy transition. Of course, our customers use our products to produce the commodities that enable that energy transition. So we think our total addressable market is expanding that way. We also believe that growing global energy demand and the fact that more renewables are being added to the grid that creates some grid instability issues, that creates an opportunity for what we call distributed generation, which is smaller increments of power distributed throughout the grid in our gas turbines and our generator sets -- in our reciprocating engine generator sets for a whole variety of fuels, whether it's natural gas, biofuels, hydrogen blends and all the rest. Which leads me to your question about M&A. So instead of just searching for M&A to grow, what we're really doing is we're looking at M&A as an opportunity to help us accelerate those organic growth opportunities, which I described. So we've done things like bought a company called Marble Robot to accelerate our progress in autonomy. We bought Lithos. We bought a company called Tangent, which allows our customers and own generator sets to monetize their investment in generator sets, again, part of that theme of growing global energy demand and also the issue that exists around grid instability. So we're also -- again, we're always open to opportunities, but we don't have to make a big acquisition to grow our company. We have outstanding organic growth opportunities, which, in my view, is the best way to profitably grow the business if you have those opportunities. We did buy -- and maybe a great example is SPM Oil & Gas acquisition we made. That's an area that we had -- we knew we had a gap in our product line. We followed it for a long time. It was on our radar screen and then the downturn came in oil and gas after COVID hit. The week that we were negotiating that deal, I believe oil prices actually went negative. So it was a great time to make that acquisition. So again, we have a list that we follow. And we move at the right time when it makes sense. But generally, we're looking for ways to enhance our technology to accelerate our progress along those organic and inorganic growth areas that I described.

Fantastic. So I wanted to switch to some near-term trends we've been seeing. So moving to our recent third quarter results. We saw some softness in order growth versus the prior quarters and some reduction in the backlog, which seems to be a big focus among investors. So could you comment on how you internally interpret a decrease in backlog? And any pattern of strength or weakness in the various buckets of your portfolio that you can talk to?

Yes. One of the things that we mentioned in previous earnings calls before this last one is that we -- as our supply chain normalizes, we expected to see our backlog come down, which is, again, in my view, a positive thing. It means that customers and dealers don't have to wait as long for equipment. It's really -- backlog really is a function of demand in the lead times. And so we are seeing improvements in our supply chain in many areas, not 100%, but in many areas. And so it's not a surprising that our backlog came down. We also had some other issues that went on where I think we mentioned in the call that we were making an engine changeover to put a Caterpillar engine in a BCP machine to displace a third-party engine and that impacts us because we had to close the order board temporarily, and we haven't opened the order board yet for the new product with the new Cat engine in it. So that has some impact as well. But if you look at backlog, based on historical trends, right, it's not a great indicator of demand, that stews are more of a greater effect in demand and they increased 13% in the quarter. But if you look at our backlog again, as a percentage based over the last 5 years or so, you feel very comfortable with our backlog. So again, not too concerned about that. If we think about our end markets, I think what's most helpful as we think about our business is to look at the various end markets that we serve. I mean, just starting running through our 3 primary segments. In Construction Industries, North American momentum continues. Everyone's aware of the different government bills that passed, like the IIJA. So there's government-related infrastructure investments that are occurring, and there's a healthy pipeline of objects. Now some of those projects take time to get permitted, but we are starting to see some of that flow through. Residential construction, the growth rate has moderated, but it's still growing. So we expect that to remain healthy as well. China is typically 5% to 10% of our total enterprise sales. We told our investors in our first quarter call that we expected it to be below that 5% to 10%, and then it's come down since then. But the good news is even with China relatively weak for us, we're having a record year. So -- but again, we don't see -- at this point, we haven't seen an improvement in China. And maybe in the EAME, quickly, some weakness in Europe, but that was offset by the strong construction demand in the Middle East, which we talked about before we started the call. Resource Industries, high level of quoting activity. There are some things that we look at in mining that kind of help us understand what's happening in the market. One is we -- because we have so many machines connected, we look at utilization. And the utilization of our products remains high, the number of parked trucks remains low and the age of the fleet is relatively elevated. So those are all good -- three good points. Our autonomous solutions continue to grow. We just announced on earnings day, a plan by one of our customers to put an autonomous solution in a copper mine in North America. That's a positive thing. Now our customers are both in mining and oil and gas. Our mining customers are displaying capital discipline and the business can be a bit lumpy and have variation quarter-to-quarter, right? So you can have some variation in there. But you have to kind of make a decision. If you believe that some percentage of the energy transition will occur and there'll be more EVs on the road regardless of what you think that adoption rate is going to be, hard to imagine a situation where over time, more materials are required to fuel that energy transition. And of course, our products are used by our customers to produce those commodities. And within -- for RI, maybe construction, quarry and aggregates remains at healthy levels. And again, that's -- a lot of that's around the major infrastructure and nonresidential projects. And in Energy & Transportation, strong demand in gas compression, solar turbines doing quite well in both oil and gas and power generation. In power generation, the demand is strong. A lot of that's been driven by data center growth. And again, as we think about our business, not many would perceive the data centers will slow down in the near term. So we're very, very bullish about that. And that's one area we're still dealing with supply chain. So we've been able to increase production around our large engines for both power generation and oil and gas, but the demand is going up faster than even our ability to increase production. So we're very focused on that.

Great. That's very helpful color. If you don't mind me asking about the backlog. So can you comment on the risk of cancellations in your existing order backlog. How does that has that panned out historically in terms of cancellations? And do you think this time it could be different or -- because you made process improvement? Any color on that.

Yes. So we certainly haven't seen any significant cancellations. Cancellations are any different now than they were a year ago or 2 years ago or 3 years ago. I'd argue again, pretty consistent. It's what we normally see. We feel good about the quality of our backlog. I mean for Energy & Transportation and Resource Industries for the projects that are in that backlog, those are typically tied to firm customer orders. We've been much more disciplined about our SLP process. And I spent a lot of years in my career working at solar and there's advanced payments and cancellation schedules tied to all of those projects. So it's very, very rare for someone to cancel one of those orders. So again, feel good about the quality of the backlog, and we're not experiencing anything significant at all in terms of order cancellations.

Got it. Perfect. And so switching gears to a different topic. I think Caterpillar has done an impressive job. The team has done an impressive job trimming the manufacturing footprint significantly while maintaining capacity. However, given sales momentum we've seen investors often ask if the current level of CapEx spend of $1.5 billion-ish is sustainable. Meaning, can the existing capacity that you have meet 10% to 20% increase in demand from all the macro tailwinds? You talked about IIJA. So should there be an increase in demand from here? Does Caterpillar have the capacity to produce more?

Yes, we are comfortable with our capacity and many of the supply chain issues that we experienced over the post-COVID, of course, were around our -- mostly around our suppliers, not around our internal capacity. Having said that, we continually evaluate our footprint, our demand. And I'd say the Caterpillar old would probably use a shotgun approach as opposed to a rifle approach in terms of making capital investments. And now we're getting very focused on -- absolute OPACC dollars. We're very careful about our capital investments. So we are certainly willing to make and have made capital investments if we need to improve internal capacity, but it's more of a rifle-shot approach in a small number of areas as opposed to across the board. So generally, we feel quite comfortable with our capacity. There's always areas that we need to make a relatively minor investment in, and we'll continue to do that.

Understood. And so going back to your profitability target, which you shared. And then I think last year, you have to tweak the margin targets down a bit, citing inflationary pressures. And so with inflation moderating again and you have exceeded the expectations. At least this year, you expect to be above the high end of that range. Would you consider revisiting those targets in light of this moderating inflation trend we are seeing?

Yes. As we said previously, we'll look at our ranges at the end of the year when we have the full year and we'll make an assessment to what makes sense moving forward. And I'm sure we'll talk about that in our next earnings call. So again, we'll evaluate that. I'm not going to make a prediction as to which way that's going to go. Again, as you said, we're going to be slightly above the top end of that margin range this year, in part due to favorable leverage -- favorable impact of leverage due to volume. But yes, we'll evaluate that at the end of the year.

Perfect. So going back to your last earnings call, I think we've heard you say that sales to end users, even in this quarter, you expect that to remain healthy despite some slowdown in orders because of some of the factors you mentioned. Against a steep interest rate environment, what do you think is sustaining this demand from end users?

Well, I think it's important to stop and think about what parts of our business are impacted by interest rates. So I talked about earlier the bills that have passed, the infrastructure bills that are government funded that are fueling a lot of the nonresidential construction in North America as an example. That really is not that sensitive to interest rates, of course, because it's money coming from the government. In oil and gas, generally, we don't see interest rates have an impact on ExxonMobil's ability to buy equipment from us. So that's not a change there. In residential in North America. Again, the growth rate has moderated, but that's an area that you would think housing starts would have a big impact on. But what's happening there, of course, is I think everyone knows there's a hub -- shortage of houses and people are staying put because they've locked in low interest rates. So that's there. We talked about the energy transition and our mining customers. So again, they are not watching interest rates all the time. Obviously, what they're looking at is what do they think demand is going to be going forward, taking into account the energy transition. Obviously, they think about things like, all right, what's happening in the global economy that could impact demand for the commodities they produce. So again, if you stop and think about interest rates in the various end markets that we serve, interest rates are just one of many considerations that can impact demand. And I talked about, again, from a macro level, and many of them, I'd argue, are not that sensitive to interest rates.

Understood. And so let me switch to another hot topic right now within the industrial space, pricing. Pricing for Caterpillar has been strong double digit in the past few quarters we've seen versus low single-digit growth historically. What is a realistic scenario looking forward as, again, inflation has moderated? So what should we expect going forward? Is it going to be somewhere between the double-digit and low single-digit or come back to the historical range? Any comments?

We look at a whole variety of factors when we make a pricing decision and of course, we haven't made a lot of pricing decisions yet, but we look -- certainly, we look at input costs. We look at the competitive situation in the various markets that we serve. It typically isn't one-size-fits-all. What's happening in one product line is different than another product line. So we really look at what's happening again competitively and for input cost. We do expect this year, as we said earlier, that our pricing will cover increases in manufacturing costs. One of the questions sometimes I'm asked is, okay, what about negative pricing? Does that happen a lot? How does that look? If you look at our history, that's pretty unusual. And if it does happen, it's pretty minimal. So in 2020, when we had that downturn, I talked about that was 20%. I believe our price realization was unfavorable by about 1%. And part of that is driven by geography as well. You may recall in 2020 that the U.S., for obvious reason, around COVID, volume was down and volume in China was up. It was a very strong year for us in 2020. And so the geographic mix can have an impact on pricing as well. And so again, if you look at our history, again, I conclude that we'll be able to manage this, and it's not going to have a major impact.

Got it. So staying on the geographic mix. Outside of North America, it appears that price competition is strong. And with the Japanese yen weak versus the dollar, the rise of competition from Chinese manufacturers, for example, in Asia and other developing countries. How do you ensure competitive advantage of the Caterpillar portfolio of products?

Yes. A whole variety of range. The first one is one that I mentioned earlier is that we continue to strive to add more value to our customers through putting more technology into our machines, improving our services, putting money into digital, making customers more successful. So it isn't just a price competition. Certainly, price is important, and we keep that in mind and we're continually working to lower our structural costs. And maybe just a couple of comments about that. We have changed our cost structure. We used to do a lot of things, a lot of back-office activities in the Midwest. I think now we're doing things with partners in places like India. We're doing more engineering in places like India as well and doing more in Mexico. And so again, I'd argue that we are changing our structural cost model as a way to try to become more competitive. And it really -- we really worked hard to make that a way of life for all of our leaders. So they're continually looking for ways to reduce cost. Having said that, okay, back to your question, how do you remain competitive? We certainly pay attention to our competitive situation for every product in every geography that we participate in. We're working hard to put more technology. I talked about how we're putting things like Cat Grade, that help operators hit grading targets faster with fewer passes with less experienced people. They can have up to 50% better grading productivity. That's an example. It's not just cost, not just A versus B. We believe that we have the best technology. I talked about autonomy and how important that was. So we're continuing to put that technology in -- around the new products, but also in the services as well. Digital capabilities, helping customers avoid unplanned downtime, maximizing availability. I talked about condition monitoring. So again, technology has a lot to do with it, but it really comes down to adding value to the customer. The customer gets value by certainly looking at first cost, but they also look at operating costs and other kinds of things as well.

Got it. And so Jim, any thoughts on China, particularly? Do you think -- you've mentioned China usually is 5% to 10% of your business, but it's been softer lately. Can China become a growth area for Caterpillar as we look into 2024?

Well, again, I'm not going to make a prediction about 2024. We said that we expect for the remainder of this year to China to be below that 5% to 10% of our typical range. And it's -- the market in China is -- our market in China is mostly hydraulic excavators, 10-ton and above. And that market was quite strong in 2020 and 2021, and we enjoyed the benefits of that. It declined in 2022 -- it further declined in 2022. So the market is down. And so again -- but the good news is, again, we're having a record year despite that fact. So generally, as you know, economies move up, economies move down over time, but too early for me to make a prediction about 2024 in China.

No worries. Got it. And so you've talked about -- in the past, you've talked about your operation and execution model and you've exited a few unprofitable businesses in the last several years, like you mentioned at the start of the call. Can you offer some details on what kind of benefits you've seen in the processes you use?

Certainly. Again, what we have -- we sat and reviewed this morning, actually. We spent a couple of hours -- our senior leadership team has spent a couple of hours and is looking at some businesses and how we can improve the performance. So again, what it starts with is really having a good understanding of where we're producing shareholder value and where we're not. So we look at OPACC or OPACC PV, which includes the future value of part sales. And of course, one just can't look at a single point in time. We have to look at multiple years because you can't make a decision just based on 1 year, you have to look over a cycle. And we look at, again, the performance of the business over time. We look at its performance and then we make a decision as to whether or not if the business is under -- the product is underperforming, do we have a sustainable competitive advantage if we change some things, we invest a bit more. Oftentimes, the vast majority of the times we've done this, we've been able to improve the performance of those businesses. And again, I'm very pleased with where it's gone. In some cases, we've concluded based on our the market dynamics, maybe the market's declining and we don't expect it to come back. Maybe we have a competitive situation where a competitor has a very long head start in a certain market. or we don't believe it makes sense just to keep slugging it out. And this is one of the thing that I think has changed about Caterpillar. We're much more willing to make those tough calls, that's all part of the O&E model, to exit certain products. And what -- and really the benefit of that, to answer your question, is it allows us to devote our resources, whether it's management attention, capital expense, to those areas that represent a better opportunity of future profitable growth. So really, it's a comparative process that we go through. Are we better off doing A or B? And that's one of the things that led us, again, to invest so much and focus so much management attention on services because it's an outstanding way for us to profitably grow our company.

Perfect. So Jim, I wanted to spend a little time on the financing company that you have the subsidiary. The provision for credit losses in the finco is near the lowest we've seen in many years. Could you share how do you mitigate the risk of default on that basis?

Yes, that's a great, Tami. I really glad you pointed that out because we start to think about people who are worried about the markets that we serve and worried about our customers as well. As we sit here, our portfolio is performing very well. Past dues, less than 2%, I think it's 1.96% write-offs at a historic low level. So again, our customers remain in great shape. So again, to me, that's one of the markers I also look at when I think about what's happening in the marketplace moving forward. So our -- we manage -- our team that manages Cat Financial, manages it conservatively. They maintain crude and underwriting standards, and they have, I'd argue, very good portfolio management practices. They have a good understanding of the industries in which our customers operate and they actively monitor past-due status and are on top of that very quickly. So again, I feel good about that business. Oftentimes, we have -- the units are connected oftentimes. And so if, in fact, there's a slow pay or a no-pay issue, we can disable a machine or slow it down or nowhere -- and nowhere it is to do those kind of things. That all helps as well. But again, I'd argue, and we work with our customers for a customer. It needs a little extra help and we're willing to do that. But again, the fact that our portfolio is performing so well with really good performance and historical low levels of write-offs, makes me feel quite good about the health of our customer.

That's fantastic. And on that note, interest rates have gone up a lot since the last couple of years. From your perspective, if you were to compare demand for loans now versus at the start of the pandemic or before that, how would you characterize the impact of high interest rates on demand for that specific segment of your business?

So demand for the loans as opposed to demand for the equipment.,, You mean the loans themselves?

Correct. Correct.

Yes, I think generally -- and I'm not an expert of this, but I think, generally, when interest rates go up, it makes it a little bit tougher for that to compete. But having said that, again, why do we have a finco? It's to help us sell equipment. And then importantly, one of the changes been made in the finco that, maybe to answer a question you didn't ask, one of the things we've been successful doing over the last couple of years is having Cat Finance focus much more on supporting the aftermarket. Previously, they were almost exclusively focused on helping customers buy new equipment. But if you start to think about it, what a wonderful opportunity to help our customers finance rebuild part sales and all the rest. So we've -- and they've done a wonderful job. They have more direct touch points with customers than any parts to category thousands a day, they're doing the customers. So we're starting to leverage the power of Cat Finance to really come around and support services as well.

Perfect. So I wanted to ask another question on your mining business. It's one of the important segments you have. What has your conversation or your conversations been like with your mining customers given they usually probably 5- to 10-year projects they look at? What has been the conversation like in light of high interest rates but as you pointed out, secular drivers of growth for the mining industry because of energy transition? So help us understand how your outlook of the mining space not just near term but over, let's say, 5 to 10 years down the road.

Well, again, we're quite bullish 5 to 10 years down the road around mining and for the reasons I mentioned earlier, when you start thinking about the energy transition, and much has been written about, the shortage that many believe will exist in copper and nickel and other kinds of commodities. So if we think about that long term, 5 to 10 years, if you believe that some percentage of that energy transition will occur, which I do, again, not as aggressively and quickly as some would like, but there will be more -- constant 24 EVs on the road 5 to 10 years now than there are now. that should be a positive thing for our mining business. And again, as I said, our customers use our products to produce the commodities to drive that energy transition. So if I look 5 to 10 years out, I feel quite good. Again, as I mentioned, our customers just plan capital discipline, the business can be a bit lumpy. There's variations in order rates and tend to get an order for -- a really big order, right? And then it will be a bit slow and get another really big order. So again, it's like a lumpy business, as we say, but hard to imagine, if you believe in any portion of the energy transition, that won't be good for mining business.

Perfect. I...

Permitting -- sorry, permitting takes time. That's there, too. We all understand that permitting is an issue. But again, either you believe in some part of the energy transition or you don't.

Yes. Yes, perfect. So Jim, I think we are almost near the end of our time with you today. So one last question for you before we let you go. As the CEO of Caterpillar, what's your vision 5 years out? How do you believe Caterpillar would be different from what it is today?

Well, I mentioned earlier how excited I am about the organic growth opportunities that are in front of us. And I'm confident that Caterpillar's best days lie ahead and you start to think about some of the things that we really talked about, think about mining demand driven by the energy transition, the ability to -- in fact, the energy demand continues to increase, traditionally, of course, as the developing world increases standards of living, of course, that always correlates with higher energy demands. Our customers use our products to produce the commodities to fuel the energy demand. Start to think about the reason -- the increase in AI and what that is around data centers, when you provide backup for data centers. That's a very exciting part of our business. But those data centers don't just increase our opportunity to sell backup generator sets. It also increases energy demand. So in the developed world, data centers go in, that increases global energy demand. All that has to be -- energy has to be produced as well. So that's a positive thing for us. Distributed generation, more renewables coming on the grid, the ability to sell those gas turbines and gen sets in the distributed power applications. I think 5 to 10 years out, that's going to be a very exciting business for us, which is relatively small now. So I think about mining, I think about power -- distributed power generation, I think about the ability to continue to grow services. We still have a big opportunity there, where I believe we can add more value to our customers, profitably grow our business. So what do I think it looks like in 5 years? I'd like to think that we will have higher OPACC. We'll continue to return cash to shareholders through dividends or repurchases. We'll keep our dividend status going. And we'll be a larger, more profitable business because of those trends that I just talked about. Higher mining demand through the energy transition, growing global energy demand, distributed generation and all the rest. And again, we're committed to keeping our technology edge by continuing to invest in products that provide more value to our customers. So I think look back over the last 7 years, we've had a very good run. And it's not just -- again, it's not just an issue of the market improvement. It's been -- a lot of it is around running our business more efficiently, continue to take out cost, being more competitive, leverage technology and services to profitably grow.

Fantastic. We are very excited to see where Caterpillar goes from here. Thanks, Jim. It's always a pleasure to hear you speak, and we hope to have you back again another time.

Thank you, Tami. Happy holidays to you and everyone on the call. Thank you.

Great. So next up, we have Caterpillar's Group President of Construction Industries, Tony Fassino but we will take a 5-minute break before that and come back. So stay tuned. [Break]

Hello, everyone. Welcome back. For those who are just joining, this is Tami Zakaria, the Head of U.S. Machinery, Engineering and Construction Equity Research at JPMorgan. We are in conversation with Tony Fassino, Group President of Construction Industries at Caterpillar. Tony, welcome, and thanks for joining us today.

Thank you, Tami. Very happy to be here and be able to talk to you and your whole team.

Great. So first off, can you provide us with the breakdown of the Construction Industries segment exposure in terms of road building versus heavy construction versus general construction. I think that would be helpful.

Sure. When we think about talk and interact on the construction industries, and we really keep it at the nonresidential, say, residential level, that is like a 75-25 split generally speaking. And the residential, of course, is single multifamily type housing traditionally. And the non-resi includes sort of all the infrastructure or in aggregate, all that is in that group. So that's generally how we think about splitting out the CI perspective. .

Great. And so could you share your thoughts on resi versus non-resi as you're seeing these two end markets today?

Yes, sure. And we talked a bit there in the third quarter, and I think many of you have seen it, if you start with residential first, and we talked about this at Investor Day, there's obviously a very strong demand for residential housing around the world in many markets. Now, is it the same in every market? Not necessarily. And if you kind of jump and narrow down to, let's say, the U.S., everybody thought and I talked to contractors here just recently, all interest rates, everything is going to crash. And if you talk to them, their work in the U.S. kind of came off a touch and then it sort of came back and sort of leveled out. So -- and one is, they've been pleasantly surprised by the durability of that housing demand even with the interest rates and where the interest rates have gone. And if you talk to some of the bigger builders out there and folks who are developing sites, they would tell you they've sort of tried to moderate that construction and not kind of make that big swing like they had been in the past and sort of level that out to have a little bit more consistency just because of the start/stop is so difficult kind of across that industry. So that's kind of residential. Non-resi, all the attention wants to jump right to the Jobs Infrastructure Act here in the U.S. And if you zero in on that, obviously, that's been very positive from a U.S. perspective. You talk to contractors, it's strong. The demand is there. They're doing the work. They have backlog. That said, there's been some limitations there through American Road & Transportation Builder Association meetings and talked about association. They would tell you that some of the permitting has been a little bit slower than they would have liked to see that come out. So that caused that to sort of moderate but just slow it down just a little bit, but it strings out a little bit longer is how they articulated it. And then we also talked about, if you talk to various DOT representatives across the U.S., they would tell you that the human resource power of getting the work out to bid has been a bit of a challenge for them. They've done well and there's quite a bit of work out there, but they could do more if they had more people to just get it out. That said, the contractors have been relatively busy. So in the end, if you talk to them, it's worked out fairly well for the industry.

That's fantastic. So we've been hearing a lot about these infrastructure stimulus-driven projects in the U.S. From your perspective, how would you assess in what inning we are in, in that journey?

Yes. So I mean, from what inning we're in, I'd hesitate to speculate on that. That's really hard to say for some of those reasons I had mentioned just a second ago there. It's probably better to talk about sort of how do we play into these and win. And of course, in some of the bigger projects, that initial site prep, groundbreaking type of work, we're obviously right there. A lot of people, in fact, associate us with just that work. But in fact, we're right there from the site prep to the main construction. And as that job matures, you're all the way through that job to the landscaping, finish up, prep the ground for grass seed, drop the trees in. And after the concrete is poured, you're ready to go. But even then, you can't just stop and sort of forget about the job because it oftentimes transitions to some type of a maintenance item even. And as you increase the number of distribution centers or increase the number of battery factories, whatever you want to make a list of, they still do a lot of equipment rental to do maintenance on those, and that goes right back to the Cat dealers who, of course, buy that product from us to keep those facilities up and running, everywhere from aerial to other types of reach equipment maintenance equipment, skid steers, generators, all that maintenance product that our dealer rental fleets that do so well providing.

Fantastic. And so that's for the U.S., the stimulus packages. But outside North America, any infrastructure packages you believe could be similar multiyear tailwinds in other regions?

Yes. Yes. I mean we touched on a couple of those. If you hit just Europe, right, while Europe had some challenges, of course, as everybody knows and I won't articulate those. But there was a thought that all it's going to stop everything, energy issues are going to stop everything. As you look at that, it just didn't happen. There's still some economic stimulus across Europe, specifically in the U.K. that they're doing. And even in the U.K., with the pullback of the HS2 project and descoping that, a lot of that money is still going into infrastructure work. So that's been essentially a positive signal. If you drop yourself down to the Middle East, you're walking to Saudi. I was there not too long ago, and we sort of went from job to job in Riyadh and they're massive jobs. There's quite a bit of money going in there, and it's everything from energy with solar, to water, to public works, sort of you name it. And like I said, they're big jobs that they are just determined to go through. And even if you walk through Dubai and others, Dubai is a little bit more developed than what Saudi is doing today. There's still a lot of good general construction work and demand taking place in that region. So we felt pretty good, and I felt pretty good coming off of a lot of different customer visits in those regions.

It seems like a lot of construction activity, not just here, but all around the world. And so how does Caterpillar differentiate versus competitors for the Construction Industries segment itself? If I were to ask you what are the top two or three key differentiators, which ones would you pick and why?

Sure. Sure. No, good question. When we go into the differentiate, of course, if you think about our high-level strategy, of course, profitable growth is key for us and using that O&E model, but that model doesn't work if you don't think about that customer profitability first. So zeroing on their customer profitability and ensuring their success, of course, requires a fantastic product, which a lot of our products are tailored to the customer economics and the job being done, a deep level understanding of that, to make sure the product development is right and is focused exactly on that what that customer needs to be most profitable. But even then once they get the product, it's really important to have a very strong services strategy. And Jim would have talked about the doubling services growth piece. But again, that strategy will not work unless it zeros in on making that customer more successful. So making it easier to own, making it easier to operate, easier to maintain. When you do that over time with our services strategy, with all the digital tools, with all the, say, more iron-based hard part tools and services we provide, customers generally are more loyal when things are easy to own. It's like anybody on the phone, when's the last time you bought something? I said, "Well, that was kind of a miserable experience, very hard to deal with. I think I'll go buy it again". That doesn't play. So of course, we're very focused on that customer experience and have them say, that was fabulous. I'm going to buy it again. So it's just your typical customer loyalty equation we're trying to work out. And I think we're doing very well at.

Absolutely. And so within the construction industry segment, what -- get -- piggybacking on the last answer you gave. The services opportunity, how do you plan to grow services revenue for this segment? Do you expect it to grow at par with the company average? Or do you think there's more opportunity in construction industry segment rather than the other two? How would you characterize that?

Well, I mean, Construction Industries has a very healthy opportunity to grow from a services perspective. And if you talk specifically about services and break that down a little bit, we focused in a few really key areas. And of course, the first one is the customer value agreements where we can offer everything from, say, your typical maintenance parts to come automatically subscribed based on machine hours through connectivity. Those parts show up with the instructions on how to do it, just the parts you need to conduct the maintenance. That's a fairly simple customer value agreement offering, all the way up to, say, the total maintenance and repair management of the entire fleet. So we've got that sort of spectrum of customer value agreements that we've been growing dramatically, by 60-plus percent of all new products going on with customer value agreements and, of course, us focusing across that entire life cycle of product. Because don't remember, we've got the roughly 2 million machines out in the field. We've got over 1 million of those connected. So we've got connectivity over 50% of the entire field population. We're adding 150,000 roughly new machines every year to that population, and that total population average age is about roughly 10, 11 years. And so we've got a really nice curve of product out there that we can go and service. So of course, those customer value agreements and as the age, you've got rebuild opportunities. So the rebuild is another really big initiative that we've been working again to give customers that option to rebuild to give them that solution to have it be a lower cost and get full value out of the product. And if you talk to contractors, they tell you, "Hey, I want to just keep rebuilding this because I'm going to get all the value I can out of that." That lowers their cost, that improves their efficiency, increases their uptime. And let me just zero in on that consistently with us, which is why we serve them there. And the third one, again, was probably one that Jim probably mentioned, which is that digital side. Of course, the e-commerce for ease of getting parts, the digital tools that allow customers to manage their fleet, watch their fleet, understand their fleet and again, get that parts and service when needed. So you package all that together, you've got a tremendous opportunity, a, the opportunity is there for growth; b, the tools there are to go capture that growth, it's really what we're focused on.

Got it. Understood. And so I want to ask a similar question I asked Jim a bit earlier. Where are you in the digitalization effort, last couple of years with Caterpillar? Talk about how it's been building up, for example. Talk about your progress there.

Yes. So if you talk about progress on -- and I'm going to take one specific example, Tami. And I would use sort of the predictive diagnostics or what we call condition monitoring of an asset or an entire fleet that a customer might have. And those diagnostic tools in terms of prioritized service events, which are simply, hey, the data that we have, we can present back out to the dealer and the customer that, say, indicates A, B or C. Maybe it indicates that maintenance is due. Maybe it indicates that there's an impending failure. Maybe it indicates that many components are towards the end of their life, you should be looking at a more major rebuild offering. And we can present that commercial offer at the time of that data analysis. So the tools to do that analytics work have accelerated dramatically. So our ability to predict that has gotten much better. Of course, our dataset, I would argue, is better than anybody in the world. We have access and have analyzed essentially all the service work orders that take place historically. We know all our major components, and we understand the metallurgy of all those major components in great detail. Therefore, our scheduled oil sampling output is very detailed. And as you start to string these things together, you get a very intelligent model based on an extensive history. It helps us understand here's the most opportune time for a customer to do it, most beneficial. Again, customer profitability and success being the #1 driver. Otherwise, you just don't come back. So we've got to have that at the forefront, which we do. And now we're definitely seeing results there because customers are telling us, "I can't believe how accurate it is." Even that kind of response from a customer is very promising.

Great. Fantastic. So Tony, I wanted to switch to some near-term topics for a second. Some of the Construction Industry data reads we've been tracking, they've been weaker in recent months. But Caterpillar sales to end users for the Construction Industry segment have remained quite robust. What do you think is causing this disconnect?

Yes. And I guess the first thing I would say is we, of course, look at a lot of the same numbers, and we probably see some of the ones you're referring to specifically. And all it does with us is reinforce the fact that you really can't boil it down to the one or two or three key metrics. You just won't do it, right? We look at every possible regression and analysis to see if we can track and it's just a much more complex business than that. everything from the complexity of backlog to governmental spending to the rate of release of bids from states and provinces and wherever you might be in the world. Combine that with the interest rates yet great housing demand, due to the complexity, gets very, very high. That said, again, like you've seen us in the third quarter articulate, there are still some very strong parts of the economy and even areas where, all this is down or that is down. Remember, again, take a U.S. number that I think we can all relate to very easily, housing starts, all they're off from where they were a year ago or they're off where they were from 2 years ago. They still operate at very high levels in the 2018, 2019 housing start level, which is very healthy from an industry perspective, and that's only talking about residential, not getting into all the major investments in infrastructure and think about the future, the investments that are needed for future infrastructure that the IIJA isn't even able to cover yet from a greater infrastructure maintenance perspective.

Got it. That's very helpful. So I wanted to ask you about, from a capacity perspective, where are the Construction Industries segment volumes now versus, let's say, pre-COVID? And can volumes grow over the next 5 years?

Yes. I won't necessarily say speculate on the 5 years, but let me speak a little bit to CI-specific capacity. And one thing that I think it's important to highlight is it's really more about flexibility and our ability to do that factory by factory and then between factories. Because we have a, what we call, flexibility capability or flexibility number at any given factory that can take us up to X levels, and we've improved that dramatically over the last 36 to 48 months. So that gives us that extra headroom we need in individual plants. And then we've increased the velocity and our ability to move production from one to another whatever it may be a capacity issue, whether it might be a currency issue, it could be a logistics and shipping issue. Unfortunately, we've seen all of those in the last 3 or 4 years. So it's put us in a position to have to get much better at each one of those elements. Which really goes to another question I'm sure you've got in terms of what's the impact of all those, say, negative conditions been on you. And I'd say we've been able to minimize them very much so because of that flexibility in a factory and in factory to factory with our very healthy footprint worldwide, and that's been a real strength. And essentially, it's a strong execution of lean tools is really what it's all about, which is really one of the things at the heart of the operating and execution model if you really boil it down.

That's fantastic, strong execution of lean tools, I like that. So let me ask you about your rental business. How do you expect to grow the rental business within the construction industry segments?

Well, the rental business, first, the rental stores are dealer-owned and independent businesses. So of course, they're working in growing that. Of course, we do that together with them and help them. Of course, they need a suite of products to go do that. And as we help them do that, of course, profitable rental revenue, profitable rental growth is, of course, a good thing for them. If they achieve that, naturally, they demand more product from us. So as we work and synchronize those two efforts together with our distribution teams who work very closely through Bob De Lange Group with the dealer rental organizations. We can do that together like we have, whether it has been work we've done on OE growth, services growth rental growth basically follows that very similar model, which definitely is one of our key strengths worldwide. That relationship and synchronization we have with the Caterpillar dealer network, that, generally speaking, is essentially unmatched worldwide in the industry.

Understood. And so Tony, switching gears, how do you see the demand for autonomy and, let's say, electrification or alternative propulsion playing out for your segment over the 5 to 10 years? Can autonomy be a software-as-a-service offering, for example, by Caterpillar in the future?

Yes. So let's talk about autonomy separate from electrification and then let's kind of bring them together maybe in the second part of the -- second or third part of the question. So let's just do electrification first. We're going to be launching the 301.9 full-battery electric mini excavator here late this year, had an order board opening shortly. We also got a 906 compact wheel loader that is fully battery electric. Also here in the first quarter of next year, order board opening for those. And so that's going to be available through Cat dealer rental fleets for customers to run and operate, and us to learn, for them to learn how this is going to work. That's going to be a teaching element for us. Of course, we've been learning from, say, close field follow in our engineering development programs, but now it's going to move more toward a commercial, get it out there and understand. Again, to your question, what is the potential for some type of service offering on the batteries or they're charging wherever it might be. We won't know that until the customers really get out and run it. If we know anything from 100 years of being in business, it's we know that you've get it in the hands of the customer because they'll do things you never thought. And they'll ask questions you never considered. And that's really, really important to get it in their hands. So electrification is going to be just that. And the adoption rate, can't really answer that yet. What we do find, honestly, is some of these field follow programs with the early battery electric machines is. The customer feedback is somewhat just sort of boring. And that doesn't excite and engineer more than anything possible because it means there were no issues. It runs like it was supposed to, and it basically gets the job done. So the customer is just pretty happy. The main thing they know is, boy, it's a lot quieter. And the ones who figured out the charging frequency, they don't talk about it much. We still have things to learn with customers who haven't figured out the charging location or the frequency because of locations. So job logistics and flow is something that we're looking at very close because you have to understand that if you're going to design a proper piece of equipment. So that's electric, set that aside from it and move to the autonomy automation. It's a different discussion altogether because the autonomy automation is looking to do a few things. And obviously, mining has accomplished this, especially with their trucks, that alleviate the challenges within the labor shortages and the labor capability. Shortages, pretty self-explanatory. Labor capability, there's some nuances in labor capability. Of course, there's only so many great operators in the world. I'd love to be one, I'm not. That said, some of our autonomous, semi-autonomous features make me literally a much better operator when we go out to our proving grounds and run our equipment. They'll have me run it without and put me right into it and flip the switch and run it with, and it's a noticeable difference. I literally become a better operator within seconds of turning the features on, whether it be auto dig, some of the loading, some of the tipoff we've gotten wheel loaders. There's a very long list of capabilities. Now you've also got to talk about what if you don't have an operator. Well, not having an operator, you have to ask yourself, why don't I? Did they just not exist? Do they not exist where you need them to be? Well, when that happens, you've got the Cat Command capabilities, which is remote control, essentially a more controlling a piece of equipment from pretty much anywhere in the world. And we've got customers today, where the operator of the drill, as an example, or the operator of the excavator and dozer is in the office. They don't actually go to the mine site anymore. You want to run 3 wheel loaders, you do it from the office, and you flip the switch wheel loader 1, wheel loader 2, wheel loader 3, you do your work that is periodic and it really alleviates that labor challenge, both labor location and labor quantity. As we continue to do that, again, it becomes a major problem solver from a customer perspective. I don't really go to a customer. In fact, the last 4 weeks, I've been with probably a half dozen of them in detail, and I haven't been to a one that didn't talk to me about what benefit that would provide them, and it's just a matter of them finding the job and the location to make that work. So we're working very closely with them to make that happen.

Got it. That's very helpful. And so the Construction Industries segment margin is reaching 25% plus by the end of this year. It seems like that's over 5% higher than the last peak. Can you help us understand what drove this margin expansion for the segment?

Yes. And it goes back to the strategy. And one thing that I've been questioned and I know Jim has been questioned on is the strategy and the consistency of that strategy, which Jim has been very consistent for the last several years, right? Launched it, defined it, communicated, started executing and just kept executing. And that's been very important because as we work to this maximize the absolute OPACC dollar strategy, which results in the profitable growth piece, it has created a structure in the company that had never existed before. And in fact, we weren't too sure how to get there until we launched that strategy. We're all trained in a common methodology with common vocabulary and common goals. So now you don't attend a meeting in Construction Industries or E&T or RI for that matter. In fact, we had a meeting this morning where it was a set of charts at a totally different group, you don't work with that much, pulls up a chart and you can look at it and you know exactly what it means. It's formatted the same way. It has the same OPACC nomenclature, has the same measurements. You could jump in there and run that meeting just as good as they could because they're using all those same methodologies. That operating profit after capital charge thought process and mentality is what has transformed the organization, especially CI in terms of our capital discipline utilizing the capital that we do have in place, which, again, goes back to very strong execution of the lean methodologies, which again is at the base of that operating execution model, I believe.

So we get a question from investors quite often, which is how much of this margin expansion is sustainable if construction segment volumes, for any reason, turns negative because of macro weakness or any other factors? How would you answer that question? How much of it is really sustainable and you can preserve?

Yes. I think the key thing to think about there is the sustainable piece. And that goes back to the structure that I articulated a little bit earlier. One thing you would have seen us behave with, anybody who's been with us for a number of years and kind of watching us and analyzing us, knew that in the past, we could see volumes come up strong, not get a whole lot out of it. And that doesn't happen anymore, right? When those volumes come up, we get good results. You also could say that in the past, sometimes when things would go down, we were to retrench, we get isolationist, we would be more siloed, that behavior also really isn't there anymore. So it's allowed us to focus on what's important. Again, operating execution model, maximize absolute OPACC dollars regardless of the industry and where it's going is what ensures that good profitability margin, bringing the cash in, I think, like Jim said in the earlier session. So you don't get that nervousness in the organization when people think about and worry about things either going up rapidly or down rapidly, people just know what to do and that sort of synergies within our organization. Again, I think what Jim has really driven over the last several years has just created a real comfort level for us to tolerate that and most importantly, generate good results even when some of those things happen in the industry.

Great. So Tony, talk about your pricing strategy for the segment. Are you seeing competitors -- domestic or overseas competitors take advantage of better availability or currency tailwinds? And how do you react to those competitive forces?

Yes. When I talk to analysts -- when COVID was going strong and supply chain was disrupted and there were dozens of ships parked outside the Long Beach port. And I think you and your peers remember those days, when I was talking then, I told people, I think our procurement and the supply chain organization is a competitive advantage for us. And fast forward, I had a meeting with our supply chain and procurement organization about a week ago, and I told them that I said, thank you first because they made that statement come true and I knew they would. So we've performed very well there. Have some competitors done well in pockets here and pockets there, of course, right? You're not strong in everything all the time. But on average, we've done very well in that area, and we've been able to pull out of some very dire situations that everybody is familiar with, again, over the last 24 months. So I feel pretty good about that. And that positioned us very well globally. But again, remember, the earlier point is important. Factories all over the world, take excavation division as an example. You got a problem in Japan or something changes with the yen, go ahead and build them at CXL. You got a problem there, build them in Brazil. Something's not quiet in Brazil, let's go ahead and build them in Victoria, Texas. Hey, could you ramp up in Grenoble if you had to? Leverage Eastern Europe or deleverage Eastern Europe to make sure you make Brazil more successful. Think of the number of permutations on excavation division alone. That creates an incredible amount of flexibility in the organization. Again, that flexibility allows you to handle capacity challenges, procurement challenges, logistics challenges, people, currency, right a fairly long list and having people who are good at that. And again, I'll go back, broken record, operating execution model gives them the guidelines on how to run that business since you don't make a big mess of it, which, without the discipline, let's say, 20 years ago, it wasn't that easy. But again, with the discipline, it's a lot easier to manage that complexity.

Got it. So switching gears, can you provide us with a view on how Caterpillar's Construction Industry segments would benefit from a boom in alternative energy and renewable energy sources?

Yes. It's probably best to give you like job site examples. I can give you the big picture numbers, the $1 trillion here and the $1 trillion there of the infrastructure needs, energy transition, mining. But you got to go to take it down to the ground level. And one really good ground level project, as an example, and I was on this job not too long. If you go out in the Western U.S., what you'll see is big green energy projects, let's say, where we have winds in Wyoming, right, a lot of good wind energy in Wyoming. The problem is not a lot of people there in Wyoming to consume it. So of course, they have to transmit that and move that to some where there are people. And essentially, they're moving that hundreds of miles across that Utah and Nevada region, getting it over to the California population with a 500 kVA high power line and if you're not familiar with those high power lines and we flew that with a helicopter kind of site to site, you need a tower about every quarter mile. I'm roughly speaking. So about every quarter mile. And it's every quarter mile for 400 miles, that's a lot of towers, right? And each one of those towers needs a site development, it needs multiple holes. It needs concrete in each one of those. I need a tower put in place. It needs an access road for maintenance needs a maintenance contract on those haul roads for the potential of the life of the power line. That's just one power line project. That's a green energy power line project that's been done a project was essentially an all-Cat fleet, which is great to see. That's a benefit. It creates service opportunity and it creates sort of a perpetual job, again, because somebody needs the maintenance contract on the roadways and the towers, and they have to do that with some type of equipment that clears, maintains, et cetera. So that would be one. And if you go across the IIJA and others, especially some of the sustainability green energy projects, it's just littered with examples like that, that have been really good from a business perspective.

Got it. So let's talk about China. How do you compete in markets such as China, where there is significant price competition from local players against a weak economy right now? So do you see a pathway to growth in China for Caterpillar?

Yes. Maybe the best way to think about that is, remember, Cat over 45 years in China, the economy today, the industry is much, much lower than it was 2 years ago, but it's not as low as it's been in the past. And we were there then, too. So we worked through that back then. We're in that again today, and we're using many of the same methodologies and strategies we use then today, which, of course, is being local with local leadership, local factories, local supply chain to understand how to compete locally in the local market. When you do all that, right, you're very much in touch with what's going on. You're there all the time. You've got the people who are in it, we live it. They are the Chinese. They are the community. They are the industry. And those are the best people and the best way to do that is being local, being involved and being essentially a pillar of the earthmoving industry, right, for nearly -- you're pushing 50 years here before you know it. So that is the key. Not to mention all the experience and lessons learned, what to do. And of course, there's a couple of what not to do in terms of lessons learned over history, and we've learned those very well and have executed on those this year, last year and the year before that. Because remember, less than, what, 30 months ago, roughly, you checked the industry numbers that above 10, 10 excavator market, which is a huge market for us there was at 150,000 roughly units. And we were in that situation. You think a certain way, you behave a certain way. Fast forward, not very much later, which is today, and you've dropped down into that, I think you're going to be in that 50,000, 60,000 range. So you're talking about a 60%, 70% cut in the industry. And we're, of course, right there participating and supporting customers.

Great. So let's stay on excavators. Are you halfway through rightsizing the excavator dealer inventory? Or will the fourth quarter will see the peak of this headwind? Help us understand.

Yes. I think third quarter results, we had said that we would continue to work with the excavators throughout the fourth quarter, which we're continuing to do. and we're continuing to do that as planned, both what we see in terms of these machines being sold to end users and what we are continuing to produce from the factories so that, a, the dealers can manage the inventory. Technically, independently owned businesses. They manage their own inventory. We, of course, manage the production of those machines that they can order from us. So with that very disciplined S&OP process, that's totally new than what we've done in the past, we're very much in tune with what they need, what their sales are and what their traditional orders have been that we can moderate that out and make sure that we're balancing that inventory where it's needed and not shipping too much to where it's not needed, and that has been the art here in the fourth quarter, and we're executing essentially exactly as we said that we would, Tami. So I feel pretty good about it.

Okay. And the other topic you talked about in the last call was an engine changeover in the BCP category. Can you help us understand how the engine change within BCP products will help Caterpillar in the medium to long term?

Sure. When you put that Cat engine in that product, it essentially moves us more towards that vertical integration piece. And a lot of people have different thoughts about what exactly -- what vertical integration means. I mean it can just be while you're selling the engine that's yours and the machine is yours, that's vertical integration. But there's much more important element to that is the fact that you know the engine better than anybody, you know the machine better than anybody and to integrate and create continuity and controllability in that system of the power unit, the hydraulic system and the controllability of the machine, weaving that together, we do that better than anybody when we have our engine, our system, our control system, our implements, our hydraulic designs. When we put all that together, it creates a fantastic machine. And I've tested these machines, driven in myself and the horsepower and torque on that engine is phenomenal, and it's going to be just a wonderful machine. In addition, of course, now with that fully connected machine in our aftermarket and parts distribution system together with our dealers, customer value agreements, rebuildability, CVAs digitization, as you do all that, now you can take advantage of the whole machine when you bring that offer that integrated customer offer out to them. Again, ultimately, now it's even easier to own because it's the full integrated Caterpillar solution. And that's really the key.

A quick follow-up on that. Does that engine change over help improve the margin profile from a financial perspective for Caterpillar?

When we integrate a comprehensive Cat solution in the total machine, we maximize absolute OPACC dollars to ensure profitable growth long term. So that would -- like if you sat with the NPI team, the new product introduction, the new product development team. If you sat with them, that's how they think when they look at that component solution and component integration in the machine. So that's how they're working forward with it. .

So Tony, I have time for one last question. As the Group President, what is your 5-year vision for the Construction Industry segment? How would it be different from the current state in terms of sales, profit margin, mix of revenues?

I think of it as -- everybody works for something dramatically different in getting the best people to execute the profitable growth strategy using the O&E model is going to continue going forward. What's different about that though is, right, every day that we're learning how to do that better rate an acceleration of that model. So as we compound the services growth strategy we've put in place, as we compound some of these great product development programs, we're seeing 35% improvements in efficiency, 25% reduction in fuel consumption. Customer success, again, being compounded on and them coming to us for those services and OEM solutions because we've made it so much easier with the digital tools, with e-commerce, with equipment management, when you sort of kind of put a bow around that, right, you kind of create that curve that you love to be on where you just keep distancing yourself out as a front runner in a solutions provider to the customer. Again, the only way to win is being that #1 solution provider to the customer. Ultimately, I want to be the easiest to own of any option they've got out there, and that's what I'm driving towards.

Perfect. I think with that, I want to thank everyone, especially Jim Umpleby and Tony Fassino for joining us today. We look forward to seeing you another time. Until then, everyone take care.

Thank you, Tami.