We will, as we always have, face the challenges head on and deliver the products
and services that will keep Caterpillar the industry leader tomorrow, as it is today.
Dear Fellow Shareholders,
Caterpillar faced a tough year in 2015, but we have successfully managed through many difficult economic cycles since our founding in 1925. This current cycle is particularly long – the external factors affecting us include weak economic growth, especially in developing markets; depressed commodity prices; and mining, construction and infrastructure investments down across much of the world.
Yet we remain financially strong and because of the actions we’re taking I believe we will, as we have in the past, emerge stronger and always able to compete very effectively around the world.
Even in this environment, our market share for machines increased for the fifth year in a row. I think that says a lot about what we’re getting done during this downturn, and what is possible when conditions recover. Our Enterprise Strategy was updated in 2014, with full consultation and support of our board, and it continues to guide us as we build on our strengths and shape our future.
Our product quality continues to improve and is as strong as I’ve ever seen it. Our safety record improved again in 2015, with a 17 percent reduction in Recorded Injury Frequency (RIF), continuing the trend we’ve been on for many years. We believe we’re achieving world-class levels of safety compared to those who have similar operations.
Why does safety matter to shareholders? Safety matters because it’s a solid indication of our employees’ and leadership’s commitment to each other; it reduces costs and, in my opinion, indicates sound operational management.
Implementing Lean manufacturing from top to bottom in our operations – addressing the root cause of delays, defects and inefficiencies – is bringing these good results in quality and safety, and in gross margins and productivity. We’ve already seen an up to 95 percent reduction in internal defects per unit and improvements in warranty, and we anticipate substantial improvements as we further deploy Lean.
The capital expenditures we’ve made over the last few years mean our plants are modern, and our machinery and equipment are up to date. These investments, coupled with Lean manufacturing improvements, also mean we’re prepared to handle more volume and well positioned when recovery does come to our markets.
We continue to invest in new products and technologies, maintaining research and development spending throughout the downturn. In fact, research and development spending as a percentage of sales is as high as it’s been in more than a decade.
We are aggressively moving through this tough business cycle focusing on cost management, innovation and producing the highest quality products, including our Tier 4 emissions offerings, in the safest factories possible.
As a result of these efforts and ongoing restructuring, our balance sheet is strong. During 2015, we bought back $2 billion of shares and increased the quarterly dividend by 10 percent. We ended the year with a 39.1 percent Machine, Energy & Transportation (ME&T) debt-to-capital ratio and $6.5 billion of enterprise cash, which gives us the financial strength to manage now and prepare for future opportunities. We have paid higher dividends for 22 consecutive years, and since 2007 our cash dividend has more than doubled. Maintaining our dividend is a priority use of our cash.
One area that continues to frustrate us is inventory turnover. We have seen our top line decrease by $19 billion – almost 30 percent – since 2012. Our inventory declined $2.5 billion in 2015 and, while it’s difficult to improve efficiencies when so many plants run on interim schedules, overall, it’s a favorable report on the status of our Lean journey. We’ll continue to focus on this as we see more opportunity for upside in terms of inventory and asset turnover efficiency.
Our captive finance company, Cat Financial, is not only a great business, it’s also a great example of our integrated business model. It’s been proven through several ups and downs, and its key metrics are in line with long-term averages. Past dues actually improved last year and were down to 2.14 percent at the end of 2015, compared with 2.17 percent at the end of 2014. Cat Financial is healthy, well managed and risk is very much under control. It’s also proven to be a bit countercyclical. In 2015, Cat Financial represented 6 percent of our sales and revenues; in the deep recession of 2009 it peaked at 9 percent. It’s also important to know that we “stick to our knitting” with Cat Financial and provide financing only to Caterpillar customers and Cat® dealers.
We’ve continued to take costs out of our business to align with lower demand, including a painful but necessary major restructuring announced in September 2015, which is in addition to significant restructuring that’s been occurring since 2013. Our team moved quickly once we determined a recovery was unlikely in 2016. Our first step was a voluntary early retirement program. We followed that with involuntary workforce reductions for a total workforce reduction of about 5,000 in 2015, and we plan a total reduction of 10,000 by the end of 2018. At the end of 2015, our workforce was down more than 24,000, or about 17 percent, from its 2012 peak.
Through the end of 2015, we have already reduced about 4 percent of our manufacturing square footage. We plan further closures and consolidations affecting about 20 facilities around the world, impacting more than 10 percent of our manufacturing square footage by the end of 2018. We anticipate approximately $1.5 billion of annual cost reductions through this major restructuring and, because we acted quickly, we’ll recognize roughly half of that in 2016.
Our board is an actively engaged, full partner reviewing and supporting our strategy and the actions we’re taking. We’re restructuring to remain strong now and become even stronger tomorrow, because this down cycle is not permanent.
World population growth will continue to drive increased demand for energy, commodities, infrastructure and transportation – all of which require the power, endurance and sophistication of Cat® equipment. With our strategic focus on the long term, and the prudent steps we’re taking now, we’ll be prepared to take full advantage of recovery when it comes.
You can read even more about our investments for the future in this report. I’ve already mentioned overall cost reductions, how Lean manufacturing is improving our quality, safety and efficiency, and that we’re maintaining research and development spending.
You can also read about our sustainability accomplishments and goals in the Caterpillar 2015 Sustainability Report, What We’ve Built. What We’re Solving. A few of the highlights in that report include how our products bring traditional, renewable and alternative energy options to urban, rural and remote communities across the world. We do this, for example, through distributed power systems, which improve energy access while emitting fewer greenhouse gases than traditional power grid systems. Additionally, we have been remanufacturing our products for more than 40 years, returning them to same-as-when-new condition, and this conserves natural resources.
In 2015, we joined an effort to emphasize the vital role that restoration of natural infrastructure – forest, prairies, farmlands, wetlands and coastal landscapes – plays in sustainable global development. Sustainability is an integral part of who we are, how we conduct our business and an essential commitment to our employees, customers and shareholders. Caterpillar also supports the Caterpillar Foundation; and, since 1952, the Foundation has invested hundreds of millions of dollars to transform lives through education, environmental stewardship and emergency relief. Today, the Foundation focuses on its mission to alleviate the root causes of poverty by supporting microfinance and access to clean water and better sanitation worldwide.
We’re executing our strategy on several other fronts as well.
This was our second year implementing what we call Across the Table, named after the title of a book written by three Caterpillar managers in 1926. That book defined then – and to a large extent still does today – the principles that have built our unparalleled worldwide distribution network of 175 Cat® dealers with more than 160,000 employees and thousands of locations serving 182 countries.
Our strong dealer distribution network thrives on the existing machine population. So when times are difficult, as they are now, we’re able to add value for our customers by helping them achieve the lowest owning and operating costs through our sales and service network that reaches every corner of the globe.
Through Across the Table, we’re strengthening our expectations of Cat dealers and the Caterpillar teams that support them. We’re working with our dealers to improve their capabilities, governance and accountability. There are about a dozen specific projects underway, everything from expanded e-business to digital technology solutions connecting our machines and engines to our customers.
And this leads me to our ongoing investments in digital technology. We talked a lot about that this year, including a joint venture with a key partner and closer ties with other existing and traditional partners. Digital transformation is a reality for the world and for our industry and while the investment is challenging given current business conditions, we are going to lead that transformation.
What we are aiming at is quite a bit different than others. We want our customers to get the most out of – not only their Caterpillar equipment – but all the equipment in their fleet. We already have more than 350,000 Cat machines and 50,000 engines, turbines and locomotives actively connected worldwide, and a total installed base of three million machines and engines.
We’re going to enhance telematics and data analytics offerings across our equipment – and across other brands, too – because we want to help our customers succeed, just as we’ve been doing for 90 years.
We will continue to create even more value for our customers, reducing downtime and lowering owning and operating costs by predicting failures and, for example, enabling them to take fewer passes across the dirt to get the job done. Our customers will see even better fuel economy and efficiencies as we analyze the overwhelming amount of data we receive and then send it back to them, to our dealers, and even to our factories in a way we’ve never been able to do before. I’m pleased with how quickly we are growing our capabilities here – in a much shorter cycle than our traditional iron-product development – and that’s what is needed.
In these difficult times, we’re investing in the future while managing what we can control today. We will, as we always have, face the challenges head on and deliver the products and services that will keep Caterpillar the industry leader tomorrow, as it is today.
Chairman & CEO