Caterpillar Inc. (CAT) Earnings Call Transcript & Summary

Hi. Good afternoon, everyone. I'm Jerry Revich from Goldman Sachs, and I'm delighted to host Caterpillar Chairman and CEO Jim Umpleby; and Ryan Fiedler, Vice President of Investor Relations. Jim, Ryan, thank you very much for joining us.

Great to be here. Thanks, Jerry.

Thanks, Jerry.

Let me hand it over to Ryan for the legally sponsored portion of our program. Ryan, the floor is yours.

Great. Thanks a lot, Jerry. Really appreciate it. 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 be different from the information we're sharing with you today. Please refer to our recent SEC filings and the forward-looking statements reminder in our release for details on 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. In today's meeting, we'll 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 the 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. Lastly, we'll post a video and transcript on our website as soon as we can. With that, I'll turn it back to Jerry.

Great. And our lawyers want to say in this, too, we're required to make certain disclosures and public appearances about Goldman Sachs relationships with companies that we discuss. The disclosures relate to investment banking relationships, compensation received or 1% or more ownership. We were prepared to really disclosures for any issue or upon request. However, these closures are available in our most recent reports available to U.S. clients on our firm portals, that's gs.com/research/hedge.html. With the legal portion of the program out of the way, Jim, thank you so much for joining us. Really looking forward to our conversation.

Great to see you see again, Jerry. Thank you.

Jim, looking back, it's been about 8 years since you became the CEO, the company's earnings power has tripled over that time frame. Sales are up 50%, incremental margins up 40%. Looking back from your vantage point, what have been the 2 or 3 most significant drivers of delivering the sharply higher margins on that profitable growth trajectory?

Jerry, we introduced a strategy for profitable growth in early 2017. And we worked really hard to get it on one piece of paper so that everybody in the company could explain it and understand it. Obviously, there's lot of details below it, but at the top level, it's pretty simple. And our strategy really focuses on some key areas, operational excellence, which is safety, quality, lean and a competitive and flexible cost structure, expanded offering services and then we later added sustainability. The operating and execution model, the O&E model has really been a key part, I believe, of our success, that really requires that we understand the financial performance of our various products in a much more granular way than we did in the past. And maybe the way to illustrate that is it used to be at Caterpillar, let's say we had a division, that division had 12 products in it. And if, in fact, that division was performing acceptably, they would, okay, get a little more capital, a little bit more expense every year and they would kind of roll along. What we've really done over the last few years is, again, peel the layers of the onion so we can understand of those 12 products in that division by product, by market, by application, where are we creating shareholder value and where we're not. And what we often found is that, oftentimes, there were a number of products within the portfolio in that division that were not giving us an accessible return on invested capital. And what that allowed us to do is really shine a light on those underperforming products and challenge our leaders to get the returns to an acceptable level. And in most of the cases, they were able to do that. And in a few cases, we determined that it didn't make sense for us to continue to invest in those products. So we did have a small number of divestments as well, things we got out of. But even more importantly, what the O&E model leads us to do is to allocate our resources towards those areas that represent the best opportunities for future profitable growth. It sounds obvious. It's easy to say. I'd argue that many big legacy manufacturing companies don't do a great job at it. We certainly didn't and we've gotten better, but we have a ways to go. And that really leads us to invest more in areas like services, which we can -- I'm sure we'll talk about a bit more later. But like I say, those are the key areas. Again, just getting the whole organization focused on a strategy which has remained consistent for the last 8 years and it's really showing in good results.

And Jim, in terms of the levers that you folks as an organization have pulled for those product lines that you just mentioned that weren't getting there. Can you talk about some of them? I remember building construction products. You folks made it essentially a logistics business instead of heavily vertically integrated given the velocity, other areas you pushed pricing. Can you just give us a flavor of any other ranges of actions that you've most commonly seen as you've taken businesses from not earning their return to generating the appropriate return?

Yes, a whole variety of actions have been taken. One of the things we have now is an enterprise component strategy. And with that, again, with the goal of increasing services, we've now tasked our leaders to think about every component that goes into a machine or an engine and to decide from a total life cycle perspective, what does it make sense to make and buy, in some cases, that makes sense for us, we design it, we build it. In some cases, we find that we don't have the scale to be competitive. So maybe there will be our IP, our design, we'll get someone else to build it. In some cases, we'll just brand something from somebody else. In some cases, we'll just buy products. But being very purposeful about that and thinking about how that positions us from a first cost perspective, but also importantly, in the aftermarket as well. One of the things we've also done is, I think we've got better cooperation across the business in really integrating our engines, our hydraulics, machine designs to make them more efficient to help make our customers more successful. We invest significantly in our digital capabilities to help us increase services. And I'm sure we'll again talk about that a bit more later. But it really has resulted in a higher-performing company. As you know, our measure of profitable growth is what we call OPACC, which is operating profit after capital charge. So it's basically a return on invested capital. So we look at what we call OPACC PV, which is the return that we receive on invested capital over the life cycle of the products, the new equipment shipments and what we perceive will come through services over the life of the product. And that really has changed the way we think about the business. That's the way we do our reviews. That's the way we really evaluate our leaders. And it's made a big difference. And of course, it's allowed us to produce higher, more consistent free cash flows, higher operating profits. And as you know, we have targets that we set out for both operating profit margins and free cash flow. And I think one of the things that's underestimated frankly or underappreciated -- excuse me, underappreciated, is our ability to generate cash. Since 2017, we generated $5 billion to $10 billion of free cash flow except for 2020, where we had a pandemic and more than a 20% loss in our top line. But even that year, we still produce $3 billion of cash flow. So again, that focus on invested on of return on invested capital, thefocus on increasing services and getting very granular in understanding our business, and that's really yielded good results.

And Jim, you alluded to this, the OPACC process, you're continuing to apply it today. Are you finding the same magnitude of improvement opportunities today that you were uncovering 3, 4, 5 years ago? It sounds like in terms of investing towards the highest ROE opportunities, yes, but what about some of the lower-hanging fruit? Can you talk about those factors?

Yes, I'd say there are still opportunities certainly for us to improve. And we didn't have a big bang. It wasn't that we divested a very large underperforming division. We really did this through a lot of individual efforts. So not a lot of home runs, but a lot of singles, doubles and triples over the last 7 or 8 years, and they all add up. So we certainly have an opportunity. Again, I think we've done a good job of, for the most part, taking care of underperforming products and businesses. And -- but -- we know that we have an excellent opportunity to continue to be profitably grow. And one of the things maybe just to step back for a minute, that when we set the strategy in 2017, one of the things that I was convinced about is that we had an outstanding opportunity to organically grow our business. I think you know our history, and we've made some acquisitions in the past, a lot of them hadn't worked out. And of course, I think the fashion was, if you go back 10 years ago, people loved to make acquisitions and a lot of interesting stories we can tell there about capital allocation going wrong. We're open to acquisitions. We've made a few small ones. But we have such an opportunity to organically grow our business, particularly around services and some other areas as well that that s what we decided to focus on. And again, I think it's really turned out well.

And what's interesting about the company's historical performance and for the industry as well, unpacking the volume disclosures that you and your finance team lay out for us in your annual reporting, the past 7 years have not been great from an end demand standpoint, volumes have grown 2% to 3% sort of CAGR, but the profit for every unit company sales has doubled over that time frame. As we look forward with rising labor costs, economy, data availability, how do you think about for your equipment to continue to be more valuable to your customers over time? And to drive a higher profit pool for your business?

Well, again, just to repeat that our measure of profitable growth is absolute OPACC dollars. We believe that absolute OPACC dollars most closely aligns to TSR over time. So better return for our shareholders. So again, we're focused on things like putting technology into our products to make sure that our customers are more successful with us than it will be with our competition. We continue to invest in our digital capabilities, again, to help do things like minimize downtime, maximize availability to help our customers be successful. So some of the technology examples and one of the challenges that many of our customers have, particularly in developed markets, in the United States and Western Europe, is to find qualified operators. So now due to the kind of technology that we put into our products, things like Cat Grade Assist, it enables less skilled operators to perform like skilled operators. And so Jerry, we could take you and pretty quickly, have you dig in a really good basement for a house, right? If we get you in one of our machines as an example, just because of the automation that we put into it, we get automate grading, we boosted precision, speed and efficiency. So those kind of things, I believe, help differentiate us and really help us, again, grow those absolute OPACC dollars. We also have now more than 1.5 million connected assets, engines and machines and that provides a significant amount of data points for us that we can utilize condition monitoring, again, trying to minimize downtime, maximize uptime, but it also helps us understand what's happening with the equipment. We can combine that with AI, with advanced analytics, to help give our dealers leads on things our customers might need. And also, we communicate directly with customers as well. We have things called prioritized service event. So again, we're quite excited about the opportunities here moving forward.

I think we're going to need Cat Insurance to sponsor me for that dig, Jim. In terms of the downside of posting the performance and margins as strong as they have just mathematically, you're just well ahead of the high end of your margin framework this year. And so the debate that investors have is whether that means the company is over earning and could see a price caused drag the business down within the range. That feels unlikely considering the decisions are made under the OPACC framework. But can I ask you to please weigh in on that topic?

Yes. And I never tell our folks were over-earning, so we can always earn more. But again, it's key to keep in mind that our focus is absolute OPACC dollars, not margin percent. Certainly, we provide margin targets to give investors a sense of where we expect to be. And yes, this year, we're doing better than those targets. And as is always the case who we're visiting those at the beginning of the year and see if that makes sense to move them. But the key is absolute OPACC dollar growth. So if we can, in fact, increase those absolute dollars on invested capital that we can produce, we believe that will drive TSR over time and it certainly has so far. So again, we'll continue to execute the O&E model. We'll continue to take action on underperforming products. We'll continue to invest in those areas that we're quite excited about to continue to grow. I mean, services is a great example. We still have an opportunity to grow services. We believe it's a big opportunity there. Even when we get beyond our target we set for 2026. And I'm sure we'll talk here about data centers and distributed generation as well. So again, a lot of opportunity to continue to grow our business. But again, the key is growing absolute OPACC dollars. That is our goal.

Super. And Jim, earlier, you spoke about bolt-on M&A, the Weir U.S. acquisition, particularly well-timed as well as other bolt-ons. Under what scenario could you envision a higher allocation of capital for acquisitions based on your strategic planning for the next 5 years?

The good news is we have a really strong balance sheet. And I'm -- we've got a little bit of grief before COVID about, gee, you really need -- shouldn't you be more levered? Or do you have too much cash? And I'm really pleased that we were in a really strong cash position. Unlike some other businesses, I slept like a baby knowing that we would be payroll with COVID hit. So that's not a bad thing to have. But having said that, we're very open to M&A, but we're not out elephant hunting because we have to grow. As I mentioned earlier, we have -- we believe, a significant number of organic growth opportunities, which we are pursuing. You mentioned the one acquisition we made in the oil and gas space. I think when we -- when we bought SPM, we were oil and gas, I believe that as we were negotiating that and finalizing the deal, oil prices actually went negative. That was the week that, that happened. So not bad timing. But we made some other acquisitions to acquire technology, to acquire some products we don't have and things like Tangent, which is an acquisition, I'm really pleased we made that Tangent helps customers that buy power generation assets to monetize those assets. So it helps monitor grid patterns. Helps them understand when they turn on the units, when they turn them off, if they have a deal to sell electricity back to the grid. It helps them with that. So a lot of examples. We bought Lithos, we bought CarbonPoint, which is a carbon sequestration technology. So we'll continue, and we always ask a lot of our leaders to be looking for opportunities. And back to the Weir, SPM example. We had that business on our radar screen for a number of years. And then because of the changes in the marketplace, it became a great time to buy and we moved at that time. So again, we don't need big M&A to grow because we have some of the organic opportunities, but we have the balance sheet and we have the capability to be opportunistic if we see something that makes sense for us.

And Jim, if we could just transition and talk about parts and service in 2019, you folks laid out the path to $28 billion in revenue by 2026. That's up from $14 billion in 2016, and you're essentially as of 2023, you're at $23 billion. So really good progress so far. Can you talk about which initiatives had an outsized contribution to building out that business so far?

Well, the way I would say is we don't break it out by area. But what I will say is that we've seen improvements across the business. We've seen it in CI and RI and E&T Again, part of that is just that purposeful focus on services. And traditionally, at CAD, our culture has been to be very focused on having the best products, the most productive products, highest quality and all the rest. And that's kind of a natural thing in our DNA. And also very focused on new equipment market share are very important to us. But we weren't as focused on services. And we know that our dealers have done an outstanding job over the years, taking care of their biggest customers, whether they're big oil and gas customers, the biggest mining customers, or biggest construction customers. But we recognize that we were losing a certain amount of -- a significant amount of business, frankly, for those smaller customers or small contractors. They have 8 to 12, 20 machines. And so one of the reasons that we've invested so much in our digital capabilities, it reduces our dealers' cost to serve to go after that business. Think about connected assets, think about the fact that there's now QR codes on machines and engines and an app on the phone, so a customer scans a QR code. We know where they are. They know who we are. It makes it easier for them to -- on their phone to buy the right part. It makes it easier for them to get service, if they need it. So again, we see a lot of opportunities there as well. So digital is a -- it has been a big part of it and will continue to be a big part. And one of the things we had to do with digital over the last few years is we had to really build a foundation, which we didn't have. We had kind of started fitfully over a decade or so before going back 20 years in digital. We've laid the foundation now and now we're adding things on top of that and leveraging that strong foundation that's been built to allow us to really accelerate what we believe are opportunities for our customers, for us and for our dealers, utilizing those digital tools, utilizing AI, everything from VisionLink, Cat Inspect all the rest. So again, we're quite excited about that opportunity going forward. It is -- we identified that as one of our -- still one of our key areas for future profitable growth even after we hit that 2026 target.

And Jim, in our past conversations with [ AGI ], what was really interesting is that a couple of years after new digital initiatives have been rolled out, the growth rate in terms of adoption really hasn't slowed. So for some of the tools that are consecutive years of 50% user growth. Has that trajectory continued? Can you give us an update on how the end user and dealer uptake of Cat Digital offerings has trended?

Yes, I don't have the exact number what he gave you, but I will say that we continue to be very pleased at the progress we're making around digital in terms of customer uptake. So again, we're making it -- working really hard to make it easy to do business with us, making it easy to transact online. I mean -- and again, do the things that many of us do in our personal lives with all the apps that we have and then add the connectivity to that, it's a pretty exciting opportunity.

Yes, I need a QR code for my printer that -- longer than I expected. And in terms of -- the interesting thing about all the data that you're gathering as part of Cat Digital is it sounds like there's additional opportunities that are being uncovered just by virtue of getting data and finding correlation between fault codes and subsequent breakdowns. Any areas of unanticipated benefits that have escalated to your level, Jim, that you're coming across just by virtue of the big data that you're gathering?

I don't know unanticipated or not, but we certainly knew that would -- having those 1.5 million connected assets would give us data that we could really use in our business. And there's a whole variety of things, things like customer utilization levels. So it gives us a sense of what to expect from a service perspective. It also gives us a sense of what's coming in terms of the marketplace. So do you understand how heavily the equipment is being utilized by your customers? So that really helps us. And that feeds into our S&OP process, which allows us to anticipate implant for future demand. The other thing, of course, is a lot of that data is useful to our engineering teams as they figure out, okay, how do we make our products more robust? What are some issues that we potentially need to deal with. Again, I go on and on about some of the advantages of having things connected and everything from helping us have the right parts in the parts warehouse, by understanding the utilization, but understanding specifically what products are being used the most heavily in a certain region that allows us using our analytics tools to ensure that we have the optimal number of parts in warehouses and with our dealers to be able to satisfy that demand. And of course, then we have predictive capabilities. An example would be the CI engine rebuild priority service events, the PSCs, combined with our detailed understanding of a dealer-specific history, historical customer repair behavior. We use something called [ [ Lens ] ], which delivers specific part number level demand signals with the probability for parts ordering. And I don't think when we started all this, we understood how powerful this could be.

Very interesting. And Jim, earlier in our conversation, you mentioned designing machines with services in mind in terms of higher number of proprietary parts or Cat IP parts. Can you talk about how that looks in the field population? That sounds like the sort of initiative that grows exponentially years 5 plus as opposed to during the first 5 years, if I...

Yes, it does take time. There's no question about it. So you think about our design process. So when someone makes a decision -- a design decision on the component on a machine, just given our NPI process, it takes time for that to get incorporated into the new machine, then it also takes time for it, obviously, we have to start selling those products that start giving hours on them and then you start realizing the benefit of that. So you're right, that is something which is a longer-term kind of benefit, but it really is important to set the stage for future continued services growth over the next decade.

And in terms of the proportion of parts going forward that are Cat proprietary IP versus prior? Is it possible to get just a frame of reference at all, Jim?

Yes, we don't quantify it. But again, it's just -- we really -- again -- and focus on having the right strategy for every part, and that could be anything from it's our design and we build it. Could be our design and somebody else builds it so they could leverage their scale. In some cases, we say, you know what, we just don't have the scale to be competitive for that component. We're just going to buy it from somebody else and brand it. And so again, it's -- the key is having a specific thing in mind. Because it used to happen previously, people were just focused on first equipment cost. And if they could outsource something and say, 5% or 10%, people thought that was a good idea and they were doing the right thing because they really weren't thinking about services in the right way. They were thinking about, okay, how can we reduce our first cost. And now, again, I believe we've got this ingrained in the culture so that everybody making those decisions, and we have formal reviews and formal processes in place. So you really think about your designing a new machine, what is the enterprise component strategy for every single component, and it takes time to see the benefit of all that, but we're well on the way. And again, I think it's really embedded in our culture now.

And the path to the 2026 parts service target, roughly $5 billion off of 2023 levels. Jim, can you talk about any significant stepping or building blocks that stand out to you that provide visibility on that path?

Yes. Again, it's really just continuing to do what we've done, continuing to take advantage of our connected assets, continue to have provide more value to our customers. And again, done right, services provides value to our customers, our dealers in Cat. One of the things that is requiring a culture change as well and something that's occurring within our dealer -- within the dealerships. So dealers, we have 150, 160 independent businesses. And so you're all aware of change management challenges within any organization. Now we're dealing with 150, 160 independent dealers. And we have some dealers who have done an outstanding job kind of changing the way they run their dealership to leverage the digital tools. Some that are laggards and a bunch that are in between doing okay. So we're working really hard with our dealers to have -- to ensure that they have the right incentives in place, the right organizational structure and the right kind of people to leverage these digital investments that we've made to continue to grow services because it is a different ball game. I'll give you an example. If somebody comes into the parts counter to buy some part the person on the service counter needs to be incented to have that person what we call onboarded. So we know who they are, we have permission to market to them. They're part of our ecosystem. And if that person at the service counter thinks that they might hurt their own livelihood if they sign somebody up because they'll start buying online, they might not do it. So our most forward-thinking dealers have changed their incentives so that there isn't any kind of damage done to that service person's compensation if they sign up a customer, maybe quite the opposite. So those are just some little examples of how, again, culture eats strategy for breakfast. So making some changes in culture, really changing behaviors is really required to help us leverage those digital investments that we've made. And really, it should reduce our dealers' cost to serve for those smaller customers. Dealers obviously can't provide the same level of service support and coverage for the really small customers that with their largest mining customer doesn't make sense. But by utilizing these tools, the QR codes, the connectivity, the e-commerce, the prioritized service events and all the rest, it allows them to reduce their cost to serve, to be able to capture more in that aftermarket for those smaller customers.

Very interesting. The democratization of service. And the buy-in, Jim, from dealers, I know it varies a lot but what proportion of network has a passing grade in this area?

I won't give percentages, but we've been to a number -- our whole executive office has been attending dealer meetings this year. We were at one 2 weeks ago, overseas, and we've had a number of them, and this is the one thing that we're really pushing. And again, we have some dealers that have embraced it that are leading the way. Some that are laggards and a bunch in between that are doing okay that we want to get to be better. So it's always the case, right? When you're making a change, it's same thing within our own organization. We have employees that lead the way, some of that are really slow and a bunch in between. So we're working hard. And the good news is that many of the dealers see the benefit. So there isn't a -- and our economic interest are aligned here, right? If we do this in the right way, we provide more services to our customers, make our customers more successful. And that's a good thing financially for the dealer and for us. And so because their economic interest aligned -- and sometimes you'll see manufacturers or produce their products, where their economic interests are not aligned with their distribution network. That's certainly not the case with us. This is good for everybody. So it's just a matter of, again, going through the change management process to ensure that we can execute at a higher level and leverage those investments that we made around our digital capabilities.

And on the topic of dealers, Jim, any other changes in dealer incentives that you folks are managing the business to? Or anything else that you're focused on from a distribution standpoint?

Well, one of the things we're always focused on, we talked a lot about services and how important that is. We're also working with our dealers on rental. We believe that's a growth opportunity for us and our dealers, and we want our dealers to have a profitable growing rental business. A couple of years ago, we set up a separate division run by one of our senior leaders to help our dealers be better at rental. To help support them. And our dealers' rental revenue does continue to grow and of course, to measure independent businesses and they make decisions based on a whole variety of factors and look at utilization including age and all the rest. But we are excited about the opportunity around rental and think that's an opportunity for us. And one of the things we're doing is we're leveraging that Cat Digital ecosystem to help around rental as well. So we think there's some real opportunities.

Got it. And earlier in the conversation, Jim, you spoke to a longer-term opportunity to grow the business beyond the $28 billion in terms of parts and service. So I think you've grown at roughly a 7% growth rate in parts and service over the past number of years. Is that how we should be thinking about the long-term trajectory? Can you expand on what you had in mind when you said longer-term growing beyond that?

Yes. We have a sense, based on our analysis, of customers that own Caterpillar products and primarily they are smaller customers that choose to get a significant portion of their aftermarket needs met by other providers, meaning other than the Cat dealer. So I can't tell you that number, but we know what that number is, and it's a big number. And so that's what we're after. We're after capturing more of that over time by, again, continuing to invest in our digital capabilities. Changing our -- again, help working with dealers to see that our idea is where we can -- you can potentially change the way you run the dealership to capture more of those opportunities. So we're very excited about it. It's one of a -- we still believe it's one of our biggest opportunities for future profitable growth even after we meet our 2026 target.

And the growth that you see in the parts business has gone with pretty -- really strong revenue growth in the new machine and engine business as well. Over time, would you expect parts and service as a percent of total to move higher? And obviously, that will vary based on where we are in the cycle. But is the momentum on the part of the service side is strong enough where we could see it rising as a percent of total?

Yes, it certainly can. But I'm always very reluctant to talk about that because, as you said, it really is driven a lot by what's happening in the end markets. So what we want to do is profitably grow services, and we want to profitably grow OE sales. That's our goal. We want both to grow. And so I don't want to say we have a goal to have a higher -- necessarily have a higher percentage because I want both on an absolute basis to go up and I want us to grow absolute OPACC dollars as well. But certainly, as we increase services, it does make us more resilient. And when we had our downturn in 2020 because of COVID, certainly, there was a drop in services, but it was not as significant on a percentage basis as the OE drop. So it does help dampen cyclicality which is a positive thing, obviously, that we're trying to accomplish.

Super. Can we talk about energy and transportation? So on the last earnings call, you brought up the Titan 350, Jim. To frame the conversation for our audience, we think the incumbent generates about $2 billion in annual sales in the power range that the Titan 350 would address. And so Jim, I'm wondering if you can just talk about the types of applications that your product will be a good fit for, compared to, an aeroderivative turbine as I understand it, the industrial frame turbine has a different maintenance versus upfront CapEx profile for the customer. So there should be a natural application fit, where the product is better, I think.

Yes. From our perspective, there isn't a major difference in application between the products that are out there in our new Titan 250 (sic) [ Titan 350 ]. So we're going to compete for the same business as we do today. We think there's outstanding opportunities, both in oil and gas and a whole variety of oil and gas applications, whether it's gas compression and large pipelines, whether it's on FPSOs offshore, offshore applications, but also and excitingly in power generation. One of the things that there's a market for now, both at our existing gas turbine line and in the larger gas turbine line, which we really can't participate in them because we didn't have the right size is trailerized units. And as I'm sure you're aware, just with data centers, not only has that created an opportunity for us to sell standby generator sets, recip engine gen sets and that business is very strong and you've heard us talk in a couple of earnings calls this year about incremental investments we're making to increase that large recip engine capacity. But those data centers are increasing base load energy demands in the developed world, which has really been more or less flat for about 12 years. So that's a very exciting opportunity. And we are selling trailerized gas turbines, and we believe that there's a substantial market and will be one going forward for the TITAN 350, whether it's sold to data centers or sold to utilities as peaking units. And some of it will be rental, some of it will be -- I'd call more permanent than rental. Actually, customers purchasing units, but we're really excited about it. And the -- I was still at Solar and had the responsibility of selling the first TITAN 250, I remember how tough it was to get that first sale. I'm amazed by the amount of customer interest and part of that is driven by Solar's reputation in the marketplace, the lead time for our major competitor is pretty long. And so people are looking for other alternatives. And just based on the track record we have supporting customers, I think it's a great opportunity, and we're very, very excited about it.

And Jim, in terms of the product rollout plan, when did the first commercial unit come off the line and when do you expect to get the full production rate for the 350?

Yes. I believe we expect the early units to start shipping next year in 2025, and we'll begin ramping up from there. Again, we're encouraged by the amount of customer interest and discussions that we're having. I mean, the exciting thing is that turbines -- I was a sales engineer in 1984 and sold a gas turbine, I was living in Asia in Thailand, and it's still operating. So that's been 40 years, and we have units that have run more than 50 years. And of course, they've been overhauled and a lot of parts have been changed. So it's a great service opportunity. So when you sell gas turbines, they typically run 24 hours a day, 7 days a week. They remain in operation. So the OPACC PV on those units is very good because of the service opportunity. So to answer your question, just the early units will begin to ship next year and then we'll go from there, and we're pretty excited.

And in terms of the use of the trailerized units for data centers, can you expand on that comment? Is that the next set of data centers that are being designed? Or are you starting to see data centers are coming online coming equipped with these trailerized units?

Yes. So it's a whole variety of things. So I'll give you an example, and these are not trailerized, these are permanently installed, if you will. There's a data center in Ireland that we have, I believe it's 10 TITAN 130 generator sets that burn natural gas and produce power to provide the baseload for the data center. So there's an -- that's already starting to happen when we're selling some units where data centers have concluded that the base power from the utility will not be sufficient for them to operate. So they -- in that case, in Ireland, they bought gas turbines to provide power for the data center. We believe that as base load demand increases around electricity, and if you talk to data center customers, they talk about one of their biggest --- and this is all very public in the press, where one of their biggest challenges and the biggest concern is will they have enough power, particularly in places like the United States, but it's a global issue to power those data centers. And there's a really interesting article on it in the last 48 hours or so from Blackstone that focuses on this issue and just the data center opportunity and the power that's required as more generative AI is used, it's a big opportunity. So we believe that there'll be an opportunity. And we talked about this a little bit in our Investor Day 2.5 years ago, when we talked about a distributed generation opportunity. So given the fact that investments in the grid, let's use United States as an example. I mean, again, [ Bush's ] demands are relatively flat. There hasn't been a lot of investment in the big old traditional power plants; used to be natural gas or coal or nuclear and the power used to be distributed throughout the grid. Now there has been -- many of those plants have been retired. More renewables have be added to the grid, solar and wind, but those are intermittent sources of power. At the same time now, you've got more power being required because of data centers in places that weren't traditionally big consumers of power. So we believe that presents an opportunity for us and we're very excited about to sell smaller units, I say small, our size range of power distributed throughout the grid, meaning smaller in those big power plants. So that's distributed generation for both our recip generator sets or recips engine generator set on our gas turbine generator sets in our recips and our gas turbines can burn natural gas, they can burn biofuels, they can burn hydrogen blends. And so we're very excited about that opportunity. So back to your question, we believe there's opportunities, and we're starting to see some of that activity, where a utility might say, you know what, we're worried about having enough power for a certain period of time, so they'll take on a trailerized unit, to -- maybe as a peaking unit, and our customer can do that as well. And we're selling some units into third-party rental fleets that some solar gas turbines, where those rental companies are positioning themselves and are providing rental power for a whole variety of end uses. But again...

Very interesting.

Yes, as power requirements go up. And we're uniquely positioned because I can't think of one of our competitors that has both reciprocating engines, gen sets, and gas turbine gen sets. And oftentimes, if you think about that data center in Ireland, it has backup, recip, generator sets and then it has solar, gas turbines providing the prime power for the gen sets. So we're really excited about this opportunity moving forward.

And the fuel economy and overall total cost of ownership of running a turbine versus paying for electricity from what we hear, it's within the stone s throw pretty comparable? Is that right? Or what are you hearing from your customers?

It all depends on what the price of natural gas. Let's assume the unit is burning natural gas. So it varies, right? So what is the price of electricity from the grid, what is the price of natural gas. Obviously, customers look at the capital investment they have to make. But in these times, based on just to hand over conversations with data center customers, their big issue is, will I have enough power. Will I have power for my data center, not is it going to cost me $0.01 or $0.02 more per kilowatt hour. That's not the big issue. The big issue is, will there be enough power for me? And again, much has been written about this.

Very interesting. And to go back to the last earnings call, you and the team spoke about energy and transportation backlog was up sequentially despite lead time, shortening for gas compression. It sounds like a significant part of the backlog growth was data centers. Can you talk about how far out lead times extend now for customers as to you, I want to recip engine for data center. I want turbine -- how far out until they get a delivery at this point?

For recip generator sets, they're 18 to 24 months. That backlog increase was -- really was driven, as you said, by Energy & Transportation. And that backlog increase was driven by increasing backlog for those recip gen sets, a lot of it for backup for data centers, but also so our turbines for both oil and gas and power generation, that backlog went up as well. So it isn't just power gen, but certainly, the recip gen sets for data centers is the primary driver of that. So again, all driven by data center growth, cloud computing, generative AI, so that's, again, exciting opportunity.

And Jim, what's interesting about your Energy & Transportation business is because you're in all of these different markets, you have the ability to produce different products at a different point in the cycle and upstream or well service demand for the industry has been pretty weak. How seamless is it for you when you're selling large reciprocating engines into power generation applications versus oil and gas applications? How easy or hard is that pivot in the field as opposed to in the spreadsheet?

Well, we do it in our factory. So it's quite easy, right? So let's take an example of 3500 engine, it's the base engine, right? And so it's pretty easy within our facilities to decide, okay, we're going to allocate this engine either towards a power generation customer, or oil and gas customer or a large mining truck, C175 kind of story power gen or large mining trucks. So the site prep and packaging can vary. But one of the beauties of our business model is that those engines are used for a variety of end users in a variety of end markets. So as we think about making a capital investment, as we're doing to increase the manufacturing capacity for those large engines, we know that they can serve a variety of purposes. It's not just data centers. It's also mining, big mining trucks. It's also oil and gas. And so I think the diversity of our end markets really positions us, positions as well. It's easy to do -- it's a short answer. It's easy to redirect those engines, when we're building them in the factory.

And it's interesting that lead times are 18 to 24 months, while the well servicing market is at a trough and mining truck demand, certainly not an elevated level either. How much capability would your team have to grow capacity beyond the 125% that you outlined on the last call, if you decide to pull the trigger? Are we at a point where we need significant new roof line? Or could we find -- if we decide to pull the trigger on additional capacity, that number can continue to move higher?

And again just to reiterate that 18 to 24 months number is for recip powergen, again, that's -- a lot of those go into data centers. So certainly, we continually evaluate our capacity and what we see happen in future demand, and you saw it happen this year. You saw that we announced earlier in the year that we were making a major capital investment that would last about 4 years -- 4, 5 years or so to double our capacity compared to what we produced in 2023 for large engines for both new engines and parts. And then we said in our last earnings call, okay, just given the strength of the opportunity we see, we're going to invest more. So now we're in 125%. So we certainly have the ability to increase -- and we'll do that. Again, we have a very strong balance sheet. We have plenty of cash available. We have the ability to invest for profitable -- for future profitable growth. And one of the things that also that we have the ability to do, you talked about switching between applications. We're doing a bit of that now while still meeting the needs of our oil and gas customers, just given the state of the markets and the strength of that data center market, we're able to redirect some of those engines to satisfy the power generation need while still meeting the needs of our oil and gas customers. So that is -- that's happened as well as we speak.

And Jim, can we switch gears to talk about resources and autonomy? So you folks have been focused on making autonomy economics work for small mines. Can you update us on your efforts? What size fleets are economic today? And any significant milestones that we should keep in mind just as you continue down that journey?

Yes. When we first started deploying autonomy and customer sites back in it's about 2013, a little more than 10 years ago, we were really focused on sites with a fleet size of 70 trucks or more because it really took that to really [ pencil out ]of customers making a capital investment. We've worked really hard to bring the investment down. And so now we're in a situation, where it can be economically viable with fleet as small as 10 to 12 trucks and we're starting to deploy at sites of that size. So as you think about it, I mean, not that many -- there's a relatively limited number of mines that have 70-plus trucks. There's a lot of mines that have 10 to 12 trucks. So that really does broaden the opportunity for that. And we recently announced an agreement with a company called Luck Stone, which is a family-owned quarry in the United States, and that will be our first autonomous deployment, we call the aggregates industry. And that opportunity will have us expand the model of trucks that's on its capability, you are at 110, 777 model. So we successfully demonstrated a solution at Luck Stone earlier this month, and we're very excited about the opportunity to continue to expand autonomy.

Super. And then from a production standpoint, in resources, you mentioned that essentially supply has caught up with demand post COVID. Customers got their deliveries. And so we had our production adjustment for the industry this year. Can you talk about where your lead times today for large trucks? And how would you characterize end demand based on customer inquiry levels?

Certainly utilization of our equipment is high. The number of parked trucks is relatively low and the age of the fleet is relatively elevated. So that's positive. As you mentioned, we did -- we had a really strong backlog coming out of COVID and the supply chain challenges on 2 products, articulated trucks and highway trucks. And as we discussed in our quarterly calls, that created a bit of a comp issue because it was so strong in 2023. For large money trucks, to answer your question, both the quotation activity and the order activity remains healthy. Commodities are at investable levels. Again, product utilization is high, and that's all positive. So we feel good about what we're seeing around large money trucks, and we continue to believe that the energy transition will support increased commodity demand over time. That there's different opinions as to how quickly EVs will replace internal combustion engine vehicles, but we probably would all agree. Everybody on this call would agree there will be more EVs on the road 10 years from now than they are today. And we believe that does expand our total logistical market and provide further opportunities for profitable growth. Think of all the copper that needs to get produced to do that. So in all -- plus other thing we're talking about data centers, all the rest, all that requires those commodities as well.

And the elevated backlog that you mentioned due to supply chain constraints, is it now at normalized levels in your view?

And so it depends on the product. So I believe that for machines, yes, we have largely got back to normal for machines. As we've been talking about, we're still -- and it's not because of a supply chain problem, it's because the demand is so high for those recip gen sets, that is still an issue. Those lead times are longer than we would like them to be, which is why we're making those incremental investments, both at Caterpillar facilities and our suppliers to increase our capacity. Again, it's not a situation, where we're producing more than we ever have. It's just the demand is increasing so dramatically.

Got it. And excellent profitability in resources. When looking at industry data, so Parker Bay, it looks like your truck unit share has declined. I think it's a function of just the move towards smaller units, given geographic mix of demand, but would love your perspective, Jim, on what the industry data shows? And how do you feel about your market share here?

Yes, we feel good about our -- certainly our ability to compete, and there's different data sets you can look at. The Parker Bay data focuses on the trucks of a certain size. And so it excludes a lot of the things that we do. So you have to be careful when you're drawing too many conclusions based on any one data set. But again, we feel good about our ability to compete. We feel good about our pins. We always like to have more. There's no question about that. But again, we're quite comfortable with our ability to compete. We strongly believe that we have the strongest autonomous solution and we're seeing an increased acceptance of that. You know what we're doing around helping our customers meet their sustainability objectives. So batteries and large mining trucks our early learning program we think, works very well with our autonomous solutions. So again, and we feel good about where we stand in the mining business.

Jim, if we could just shift gears and talk about Construction Industries. Earlier in our conversation, you mentioned the focus on free cash generation and the really strong and improve free cash flow targets that you folks laid out within the past year. I think part of it has been you folks have cut production and construction equipment earlier in this cycle than what we've seen in the past. Can you talk about how you've taken that approach to making sure we don't have as much of a bullwhip effect that we've seen in the past in this industry?

Yes, that's a great question. So one of the things we've been very focused on is performing better at different levels of business. So in my view, the pain that we experienced between 2012 and 2016 was somewhat exacerbated by there being too much equipment in the channel. It was -- and it's natural when business is strong, people are dealers to buy a lot in your independent businesses, but we're an independent business as well. So one of the things that we can do is, again, in the right value-based way, kind of look at how much inventories in the channel have conversations, and we're working very hard with our new S&OP process to ensure that we don't find ourselves in a situation, where there's way too much inventory in the channel. We feel comfortable with our inventory levels as we stand today, and it's something we're very, very focused on. So -- and I'd argue, over the last 8 years, we have performed better at different levels of business. And so we have taken that into account. I think 2020 is, I think, a proof point of that. Still meeting our margin targets even though we had more than 20 -- an unexpected 20% drop in volume and still producing $3 billion of free cash flow that year.

Got it. And for CI, customer value agreements have been a key focus for you folks. I'm wondering, if you could just update us on how performance has tracked since you gave us an update at the Analyst Day? Have we seen a step move higher in terms of the cross-selling?

We have. And just from a -- and we generally see about 30% more service to sales for machines when there is a CVA. And so we are certainly selling more CVAs. It's been a big focus at a total company level, about 2/3 of our new equipment comes with a CVA attached. That was certainly the case in 2023, and our goal is to provide CVA coverage globally to provide a more consistent customer experience and really provide more value to our customers by providing hassle-free ownership, proactive care. And the smaller customers are starting to realize the benefits of CVAs and promoting uptime and productivity gains. So we're pleased by how that's going.

Jim, the topic of tariffs is one that comes up. Obviously, Cat's stated view is a proponent of global trade. When we had tariffs last implemented on steel, you folks were able to pass through higher steel costs seamlessly in a scenario that whole good tariffs are implemented. Can you talk about just your level of confidence that higher cost would be passed through to end customers since obviously, Caterpillar doesn't control tariffs?

Yes. We certainly believe in free and fair trade. And one of the things that helps us is that, unlike some other companies, we don't manufacture all of our products in one country. So certainly our largest manufacturing presence by countries in the United States, and we're a net exporter out of the U.S. But as you know, we also have large manufacturing presence in a number of other countries like Mexico, like Brazil, like China, like Japan, a bit in Germany, India, U.K. And so that helps us, I believe the fact that we are a global manufacturer. We try to mostly produce in region for region, not completely. Certainly, we had things that move around. But we feel confident in our ability to continue to profitably grow to meet our margin targets and not going to get into, all right, well, it's if tariffs or X, how much of that you pass along. We'll have to see how it all plays out based on market conditions and what actually happens. And it's a bit early now. I mean it's -- I always like to wait to see what actually happens as opposed to making too many predictions before a new administration even gets in power.

Fair enough. So last question given the time constraints here, Jim. In our discussion, we focused on how Cat has really transformed over the past 7, 8 years and growing earnings power, free cash flow and performance. Can you just spend a few minutes to wrap up and talk about your vision for Cat going forward?

Yes. Certainly. Again, I believe we have excellent opportunities to continue to profitably grow our business organically. As I mentioned earlier, an outstanding opportunity to continue to grow services. We are very excited about the opportunities we see around distributed generation and data centers. So again, that's very exciting as well. We do believe that over time, increased commodity demand around electrification, electric vehicles and all the rest will drive opportunities in our -- in mining. So our customers, obviously -- our mining customers use our products to produce the commodities to fuel that transition. So I've never been more excited about our future. I mean, I can't think of a time when I've seen some secular trends occurring in our marketplace like power demand, like data centers, that we're uniquely positioned to satisfy both, again, given the fact that we have a combination of gas turbines and recip engines. So my vision is that we'll continue to profitably grow our business primarily organically going forward, and we have great opportunities to do that.

Super. Jim, thank you very much for your time and insights. Jim, Ryan, thank you both for making time for our group. Have a great day, everyone.

Thank you, Jerry. Take care.