October 11, 2010 1
Don Johnson
Chief Economist
Caterpillar Inc.
Caterpillar’s Trough Planning
October 11, 2010 2 Caterpillar Inc.
Agenda: Trough Planning
• Background on Caterpillar’s Trough Planning
• Advance Preparation for the Last Downturn
• Reacting to the Downturn
• Looking Ahead
Must be an ongoing process
October 11, 2010 3 Caterpillar Inc.
Yielded a Two-Phase Approach
Develop plans in advance
• Determine likely challenges
• Prepare specific plans to cope with those challenges
Determine when plans might be needed
• Identify warning indicators
• Keep everyone informed
Started when the last recovery was a little over 2 years
old
October 11, 2010 4 Caterpillar Inc.
Business Unit Actions
Reports Developed and Maintained in Preparation for a Downturn
Company-wide participation
Pricing
Plan
Employment
Policy
Supplier
Actions
Capital
Planning
Not Accepted
Why should we worry about a downturn when
business is strong?
The next downturn won’t be that bad.
Conditions are different today; a recession is
unlikely.
October 11, 2010 5 Caterpillar Inc.
U.S. Leading Indicators
8 8
1 2
13 1210
8
20 1917
12
Inverted YieldCurve
LeadingIndicator
Index
HousingPermits
S&P 500
Shortest Average Longest
Lead times can vary significantly
Months Lead before a Recession Begins
(Post WWII)
October 11, 2010 6 Caterpillar Inc.
Agenda: Trough Planning
• Background on Caterpillar’s Trough Planning
• Advance Preparation for the Last Downturn
• Reacting to the Downturn
• Looking Ahead
May need to discount current thinking
October 11, 2010 7 Caterpillar Inc.
Fed Actions Unfavorable
1. “… the economy seems likely to expand at a moderate pace over coming quarters.”
2. “Core inflation remains somewhat elevated.”
3. “Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.”
4. “… the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected.”
FOMC statement, May 9, 2007
Inflation is the risk … … so tightening continues
Bank Reserves
(Million Dollars)
050095908580Source: Federal Reserve Board /Haver Analytics
70000
60000
50000
40000
30000
20000
10000
70000
60000
50000
40000
30000
20000
10000
We felt Fed policy could damage the
economy
October 11, 2010 8 Caterpillar Inc.
Conclusion: U.S. Recession in 2008
Economic
GDP Growth 1.5%
Fed Funds rate (EOY) 2.5%
Housing starts 1.51 mil.
Nonres. Construction 0.4%
Coal prices 0%Political
Democratic sweep in 2008
Tax hikes in 2009
More protectionism
More regulations
Increased Possibility of a
Recession
October 11, 2010 9 Caterpillar Inc.
Public Announcement
Third Quarter 2007 Release (October 2007)
Unpopular view at the time
“We expect 2008 to be the sixth consecutive year of sales and revenues growth, despite a U.S. economy near to, or even in, recession. Expectations for 2008 reflect the easing of two significant negative factors that impacted ….”
Selectively implemented trough actions
October 11, 2010 10 Caterpillar Inc.
Credit Crisis Planning Intense planning in early 2008
0
100
200
300
400
2002 2003 2004 2005 2006 2007 2008
TED Spread (3-mo. LIBOR vs. 3-mo. Treasury
Bond Spread (Moody’s Baa vs. 10-year Treasury
Focusing on the problem
October 11, 2010 11 Caterpillar Inc.
Key Concern
Asset prices fall
Banks take write-offs
Banks reduce lending
Spending declines
Asset prices fall
Banks take write-offs
Banks reduce lending
Spending declines
Asset prices fall
Banks take write-offs
Banks reduce lending
Spending declines
*
*
*
*
Must stop price
declines
Significant fears of a downward spiral
October 11, 2010 12 Caterpillar Inc.
Agenda: Trough Planning
• Background on Caterpillar’s Trough Planning
• Advance Preparation for the Last Downturn
• Reacting to the Downturn
• Looking Ahead
Worse than anyone
expected
October 11, 2010 13 Caterpillar Inc.
Formed Stay Strong Strong focus on cash flow
Be Profitable with Strong Cash Flow
Hold Our Credit Rating
Maintain Our Dividend
1H 2009
2H 2009
2010
October 11, 2010 14 Caterpillar Inc.
Other Actions
• Planned for sales decline
• Allowed dealers to cancel orders
• Downsized the workforce and cut labor costs
- Reduced full-time employment by 19,074 workers
- Reduced flexible workforce by about 18,000
- Eliminated short-term incentive payments for 2009
- Took temporary layoffs in many divisions
• Slashed company inventories by $2.4 billion
• Continuously, and carefully, monitored ongoing sales to determine if actions were sufficient
All-out effort
October 11, 2010 15 Caterpillar Inc.
Results
-29
-11
-37
1981 1991 2009
CAT Net Sales and Revenues
(% Change from Prior Year)
-180-404
895
1981 1991 2009
CAT Profits after Tax
(Million Dollars)
Preserved profitability
Worst sales decline
Stayed profitable
October 11, 2010 16 Caterpillar Inc.
Agenda: Trough Planning
• Background on Caterpillar’s Trough Planning
• Advance Preparation for the Last Downturn
• Reacting to the Downturn
• Looking Ahead
2000s were not good years for the
U.S. economy
October 11, 2010 17 Caterpillar Inc.
The Race to the Bottom
5.9
10.4
4.44.15.2
3.22.3
4.4
3.01.9 1.5
3.2
1.50.7
1.8
France Japan U.S.
1960s 1970s 1980s 1990s 2000s
Average Yearly Percent Growth in Economic Output
Developing Economies becoming more
important
October 11, 2010 18 Caterpillar Inc.
Developed Country - Real Construction Spending
Real Construction Spending(1990 = 100)
60
80
100
120
140
160
1990 1994 1998 2002 2006
U.S.
Euro-zone
Japan
Average Annual Decline
2000-present
U.S. -0.3%
Euro-zone -0.2%
Japan -2.6%
Difficult to deal with long periods of
weak/no growth
October 11, 2010 19 Caterpillar Inc.
Summary Thoughts Prepare in advance and
stay agile
• Recessions will always be with us
• Cannot consistently, accurately predict recessions
• Definite delays in knowing where we are
• Need to have up-to-date recession plans in hand
• Constantly watch economies and question developments
• Developed economies need to improve their growth game – risk is irrelevance