Terex Corp Q2 FY2020 Earnings Call

Good morning. Welcome to Terex Corporation's Second Quarter 2020 Results Conference Call. I will now turn the conference over to your host, Randy Wilson, Director of Investor Relations for Terex Corporation. Thank you. Mr. Wilson, you may begin.

Good morning, and welcome to the Terex Second Quarter 2020 Earnings Conference Call. A copy of the press release and presentation slides are posted on our Investor Relations website at investors.terex.com. In addition, the replay and slide presentation will be available on our website. I'm joined by John Garrison, Chairman and Chief Executive Officer; and John Duffy Sheehan, Senior Vice President and Chief Financial Officer. Their prepared remarks will be followed by Q&A. Please turn to Slide 2 of the presentation, which reflects our safe harbor statement. Today's conference call contains forward-looking statements, which are subject to risks that could cause actual results to be materially different from those expressed or implied. In addition, we will be discussing non-GAAP information that we believe is useful in evaluating the company's operating performance. Reconciliations for these non-GAAP measures can be found in the conference call materials. Please turn to Slide 3, and I'll turn it over to John Garrison.

Good morning. Thank you for joining us and for your interest in Terex. Safety is and will remain the top priority of the company. Globally, very few of our team members have tested positive for the COVID-19 virus. This reflects our Zero Harm safety culture of Think Safe, Work Safe, Home Safe. The vigilance of our team members, both inside and outside of work, and the rigorous COVID-19 safety protocols we implemented early on have made a real difference and have helped us to avoid any significant impact to our operations. We will keep our guard up as we remain focused on protecting the health and safety of our team members, their families, and communities. Turning to Slide 4. After suspending production in most of our facilities around the world in March, we resumed manufacturing in all of our plants globally beginning in late April and increasing in May and June. This resumption was accomplished with a rigorous focus on safety protocols and production that has been calibrated to meet customer demand. Our teams are continuing to work closely with our customers to understand their demand, proactively manage their production operations, closely partner with suppliers to control the incoming supply of materials and maintaining supply chain continuity and utilize available government furlough programs. These and other actions have enabled us to tightly manage our variable manufacturing expenses, which make up over 80% of our cost of goods sold and dramatically reduce our cost base. In addition to rigorous cost control, we have remained focused on having ample liquidity to operate the business. As of June 30, we had approximately $1 billion of available liquidity. We may not be able to control the macroeconomic factors that drive the demand of our products. But we are aggressively executing on the levers that are within our control. Please turn to Slide 5. Q2 sales stabilized, but were below pre-COVID-19 levels. As a result, we continue to take swift action in response to changing end market demand. In addition, we delivered strong overall decremental margin performance of approximately 20%. During our last earnings call, I discussed the actions that we were taking to rightsize our cost structure, highlighting that we were taking out at least $100 million of cost. We implemented these and other actions during April, and our decremental margins reflect these decisive actions. To be specific, in the second quarter, we took out over $40 million of SG&A cost, which was down 32% year-over-year from furloughs, permanent layoffs, team member salary reductions, and deferral of merit increases. Finally, we generated positive free cash flow of $71 million in the quarter. We achieved this by reducing net working capital by $180 million or more than 20%, reflecting great teamwork by our supply chain, commercial, and financial teams. We will execute and are focused on delivering positive free cash flow for the second half of 2020. Turning to Slide 6. In the first half of 2020, we transitioned our strategy to execute, innovate and grow. The natural evolution of our Focus, Simplify and Execute To Win strategy. The Focus and Simplify elements were essentially completed, and it was time to emphasize execution, driving innovation, and growth, specifically focused on profitable growth. Terex has done a great job of innovating our products and technology. Our innovation needs to include lowering our manufacturing costs and what it costs customers to operate our equipment. Our ANSI-compliant J-Boom is an excellent example of this purposeful innovation, offering operators the essential performance they need to get work done at height, with an unrestricted platform capacity of 660 pounds. It offers rental companies the opportunity to increase their return on invested capital by mixing their fleet with a range of Genie Booms, matching the right boom to the right application. In addition, our innovation will improve our ease of doing business through the life cycle of the product by delivering industry-leading customer service. In Parts & Service, we are providing our distribution partners easy-to-use digital tools, which are highly integrated and consolidated into a convenient and optimized digital portal, helping them serve our customers more efficiently. Terex is well positioned for future growth. We have clear objectives to deliver on our execute, innovate, grow strategy by driving continuous improvement in execution, winning with more customers around the world, driving profitability and shareholder returns, equipping the organization to win in the global marketplace. This will result in Terex emerging as an even stronger company. And with that, let me turn it over to Duffy.

Thanks, John. Turning to Slide 7. Let me begin by reviewing our Q2 financial results. I would call your attention to our financial reporting structure. As you will notice, consistent with Q1, we did not report adjusted Q2 2020 financial results. Instead, we are identifying the specific financial impacts from COVID-19 and certain other amounts affecting our Q2 reported results. We continue to provide information that will help the investment community more easily compare our year-over-year results going forward. Looking at our second quarter financial results. Revenue of $690 million was down 47% year-over-year. As discussed during our last earnings call, we were operationally planning for a challenging quarter. That said, throughout the quarter, we did see the markets in which we operate stabilize and begin to recover. For the quarter, we recorded an operating profit of $7 million compared to adjusted operating profit of $132 million in the second quarter last year. The lower operating profit resulted from revenues being only approximately half of Q2 2019, combined with significant unabsorbed manufacturing costs. These costs were due to the combination of fixed costs associated with plant closures and production levels below customer demand to reduce finished goods inventories, principally within AWP. As John discussed a few minutes ago, with the onset of the pandemic, we took aggressive steps in April to reduce our overall cost structure to align with the current level of customer demand. While lower revenues impacted our gross margin and increased SG&A as a percent to sales, our aggressive cost-reduction actions allowed Terex to achieve an approximately 20% decremental operating margin for Q2, more favorable than our targeted 25% decremental margin. This decremental margin was achieved despite $22 million of gross profit charges, primarily associated with fixed costs at our manufacturing facilities for the periods they were closed. In addition, SG&A was adversely impacted by $4 million, primarily due to employee severance and restructuring. Excluding these charges, Terex's decremental margin would have been 16% in the quarter. Below operating income, interest expense was $7 million lower than Q2 2019 as a result of lower borrowings versus a year ago, principally related to our revolving credit facility being undrawn for most of this past quarter. In addition, other income was positively impacted by $1 million related to the marking to market of a publicly traded holding. For Q2, we recorded a tax benefit of 48%, which reflects the impact of adjusting our Q1 tax rate to our forecast tax rate. In general, when the pretax earnings amount is low, as was the case in the first half of this year, small changes to the tax benefit or expense can have a relatively large impact on our quarterly tax rate. Finally, our reported EPS loss of $0.05 per share includes the COVID-19 and other impacts that I just discussed, amounting to pretax charges of approximately $25 million or $0.25 per share. Turning to Slide 8 in our segment's financial results. Starting with AWP, AWP's sales of $414 million contracted by 52% compared to last year, driven by continued challenging global end markets. The U.S. and Europe remain significantly below last year's levels. We continue to aggressively manage production levels to ensure we are not building excess inventory. Our Changzhou, China facility ramped up production over the course of the second quarter to pre-COVID-19 levels. Overall, the utilities market stabilized in the quarter but remained soft in certain customer segments. AWP delivered strong decremental margin performance of 20% in the quarter by aggressively rightsizing production and costs to align with end market demand. Backlog at quarter end was $509 million, down 32% from the prior year, while second quarter bookings of $190 million were 63% lower than Q2 2019. Aerial products Q2 bookings and backlog at June 30 were impacted by customer booking administrative changes, which resulted in the cancellation of their orders and the pushout of orders due to delays in the availability of financing. These customer booking changes reduced AWP Q2 bookings and backlog by approximately $100 million. Most of these orders are expected to be rebooked and shipped in the second half of 2020. Excluding the impact of these customer orders, Q2 bookings were down approximately 40%, and backlog was down approximately 20%. During the quarter, we also continued to experience a shifting of customer orders from the second quarter to the second half of 2020, although to a much lesser degree than we experienced this past March. Now turning to Materials Processing. MP had another solid quarter, achieving a 9% operating margin despite challenging markets. It is a testament to their operational strength to deliver relatively strong positive operating margin and significantly lower revenues. Sales were $264 million, down 39% from the second quarter 2019, driven by extremely cautious customer sentiment, resulting in delay in capital purchases. The MP team has been aggressively managing all elements of cost in a challenging market environment, resulting in decremental margin performance of 25%. Backlog of $262 million was 36% lower than last year and down low single digits sequentially. However, MP customer bookings trended up each month in the quarter, with June higher year-over-year, which gives us optimism going into the second half of the year. Customers in both segments continue to operate through the COVID-19 pandemic and existing equipment is being utilized, but at lower levels. Both our AWP and MP businesses are industry-leading in their respective segments with very strong brands. They are well positioned to grow in their markets as conditions improve. Turning to Slide 9. Now I would like to provide you with some perspectives on how we currently anticipate the second half of 2020 to develop financially. It is important to realize that with COVID-19, we are operating in an unprecedented period and customer demand could change negatively or positively, very quickly depending upon developments with respect to the pandemic. While we believe it is important to provide you with insights into our business expectations for the second half of 2020, you must understand the potential for variability of results to our expectations is higher than normal. With that said, as for commercial demand, we have seen our markets stabilize, although at a much lower level of demand than 2019 or we expected at the beginning of 2020. We currently expect revenue over the second half of 2020 to be approximately the same as the first half of this year, with the revenue generated being relatively evenly split between each of the remaining quarters. From a segment perspective, we anticipate the year-over-year quarterly revenue declines will be greater in AWP versus MP. We remain fully committed to aggressively managing our overall cost structure in line with reductions in customer demand, such that we maintain our decremental margin target of 25% for the full year, for the company as a whole and for each of our segments. We also remain committed to these decremental margin targets for the second half of 2020, although as a result of summer shutdowns in many of our facilities, we do expect our fourth quarter decremental margin will be better than the third quarter. Finally, we expect the full year 2020 corporate and other cost structure will be incurred equally between the first and second half of 2020. We are intensely focused on overall liquidity and free cash flow generation. Based upon our current customer demand outlook and cost reductions, we expect to be free cash flow positive for calendar year 2020. As is typical in our business, we were approximately $40 million free cash flow negative during the first half of 2020 and would expect to generate more than this amount of free cash flow in the back half of the year. Net working capital reductions will be a primary source of second half 2020 free cash flow generation. Finally, we view our $600 million revolving credit facility, which is fully available to us, as an insurance policy for demonstrating the financial security of Terex to our customers, suppliers, team members, and shareholders. We anticipate having ample cash on our balance sheet during the remainder of 2020 and would not expect to utilize our revolving credit facility. Please turn to Page 10, and I'll review our disciplined capital allocation strategy. Despite the challenging environment, the entire Terex team drove positive free cash flow of approximately $71 million in the quarter. Our continuing operations, free cash flow benefited from our producing below retail demand. As a result of the COVID-19 impact on commercial demand, we continue to aggressively manage production, especially within our AWP segment, which further benefited our Q2 free cash flow. We continue to expect net working capital will be a source of liquidity for the remainder of 2020. With the support of our revolving credit facility banks, we have sufficient liquidity available to be successful through this global pandemic, such that we will be positioned to come out the other side and grow again. Given the economic uncertainty, we have reduced our 2020 capital spending by 35%. While we remain prudent in our capital spending, we are investing for growth as demonstrated by our new utilities manufacturing facility and Changzhou, China facility expansion. We continue to align our cost structure with commercial demand and have taken aggressive cost-reduction actions. Most importantly, we have aggressively reduced the supply of material into our manufacturing facilities. To illustrate, 70% of our cost of goods sold are materials from suppliers that we are assembling into machines. These actions reduce the liquidity requirement of paying suppliers for that material. We have been adjusting our cost structure very aggressively to the demand environment in which we are operating. We continue to temporarily suspend our dividend and share repurchase activity. In conclusion, we will continue to aggressively manage the business and generate strong free cash flow, while ensuring we have the right capital structure, a strong capital structure, which we do have today. And with that, I'll turn it back to you, John.

Thanks, Duffy. And turning to Slide 11. First, let me take a moment to acknowledge Matt Fearon, who is leaving the company after 25 years of service. Matt is a dynamic leader who has helped Genie grow from a regional brand to a global powerhouse in the Aerial Work Platform industry. As announced, I have assumed responsibility as President of AWP for the foreseeable future. I'm excited to work even more closely with the Genie and Utilities teams to improve profitability and growth. AWP's future success will be driven by investing in new technology and industry-leading products, investing in world-class manufacturing at Watertown and Changzhou and rigorously following our Zero Harm safety culture. We like our global position, global brands, and long-term prospects, and we are investing to enable future growth. But investment can only happen when you execute, which the AWP team demonstrated by safely ramping up production and driving sequential and year-over-year revenue growth in China, proactively and swiftly taking significant SG&A reductions in response to lower demand and aggressively managing working capital by delivering strong inventory performance. It is a competitive industry. So we must be laser-focused on controlling what we can control: superior execution and aggressively reducing costs to improve margins and win in the global marketplace. Turning to Slide 12. Materials Processing demonstrated again this quarter that it continues to win in the marketplace. As MP continues to grow by finding product adjacencies and new geographies for its leading products and brands, all while demonstrating strong operational execution. The MP team has integrated the Cranes business into its portfolio of specialty businesses. As an example, our Australian-based Franna business is growing globally. Pictured here is a Franna crane being delivered in Mongolia, an excellent example of how the MP team continues to find new geographies for MP products. The expansion of MP's environmental business under the Terex Ecotec brand to deliver environmental solutions is an example of the business finding logical product adjacencies for continued growth. For example, the Terex Ecotec pictured here will further enhance an already significant range of shredding products. The new machine will be manufactured in our new state-of-the-art manufacturing facility in Derry, Northern Ireland, which supports the ongoing growth and development of Terex Ecotec's expanding product portfolio. The strong financial performance of MP relative to market conditions, achieving an operating margin of 9% and decremental margins of 25% demonstrates the MP team is executing well. Finally, MP's bookings stabilized and increased throughout the second quarter, resulting in bookings only being down 10% year-over-year at the end of the second quarter. MP is a diversified and consistently strong performer, even in these challenging times. Turning to Slide 13. To wrap up our remarks, we are laser-focused on our strategy. While many things are difficult to predict today, what is certain is Terex team members around the world are focused on the right things: health, safety, customers, and improved productivity. We will reduce complexity and cost and drive returns with a focus on improving margins, especially within AWP. Our businesses have a strong future, so we will continue to invest in innovative products and services to be prepared as market demand returns. And with that, let me turn it back to Randy.

I'd like to open it up for questions.

Our first question comes from the line of Mig Dobre with Baird.

My first question is a clarification regarding the disclosure on Slide 7. I'm interested in understanding more about the $22 million in fixed manufacturing charges. Are you adjusting the footprint, or is there something else we should be aware of?

So I'll take that one, Mig. This is Duffy. Under U.S. GAAP, which is what we're reporting, we are not adjusting anything from the reported results. When our manufacturing facilities are closed and not producing, the fixed costs of those facilities, many of which were closed especially during April and early May, cannot be capitalized into inventory according to U.S. GAAP. As a result, there was $22 million of fixed costs that were directly charged to the income statement for the periods when those manufacturing facilities were closed. I hope that helps to explain.

It does. And then I guess my follow-up, I'm looking for you to put maybe a finer point on your cost savings. You talked about better than $100 million. But I'm curious as to how much of that was realized in the second quarter. What else is there still to come in Q3 and Q4? And is there maybe a view here in terms of what percentage of these costs could potentially reverse as we look beyond 2020?

Mig, this is John. I'll take the first part and then if Duffy can add, follow up with any clarifications. We have been decisive, Mig, in adjusting our cost structure to the market demands that we had. And as we said, and we're using all available opportunities to do so, things like furloughs. Our great team members have had salary reductions, MIB type of reductions. So some of the reductions are 'temporary.' I will say the salary reductions in MIB are temporary, and those will be reinstated as we move forward into the '21 time period. Other of the cost reductions are permanent. We had reductions in force in our AWP businesses and our Utility businesses as well. So we are committed to exceeding, frankly, the $100 million that we laid out and as Duffy said in our outlook, our target, as a team, as an organization, is to drive to this 25% decremental margin level, and we will continue to adjust the cost structure of the organization, such that we can deliver on that target. That's the focus. That's the target of the team as we go through this down period.

Yes. The only thing I would add, Mig, is that that aggressive cost reduction of taking the actions to reduce the cost structure really started at the beginning of Q2, end of March, very beginning of Q2. And that's what allowed us to achieve the better than 25% decremental margins in Q2, and those savings will continue through Q3 and Q4, which, as John said a moment ago, allows us to have the confidence to be talking in our outlook about our commitment to the decremental margin targets.

Our next question comes from the line of Joe O'Dea with Vertical Research.

First, just if you would elaborate a little bit on back half revenue expectations at the segment level and whether we're looking at a narrower gap in trends between the 2 segments and MP that might be down high teens and AWP down sort of low 20s? Or is it a bit wider spread than that? So just trying to understand kind of what you're looking at for the different segment trends.

Duffy, if you could take a shot at that, and then I can perhaps talk a little bit on the market commentary.

Sure. Let me address your question by looking at what happened in the second quarter and what we anticipate for the latter half of the year. In the second quarter, our AWP segment revenue was down 52%, while the MP segment revenue decreased by a high 30s percentage. The decline in the MP segment was not as significant as in the AWP segment. As we move into the third and fourth quarters, I expect the MP segment to continue showing smaller declines compared to AWP. Additionally, I anticipate that neither segment will fall as much in the third or fourth quarters as they did in the second quarter. While I can't provide precise percentages due to the current volatility in the market, I want to emphasize that we observed a stabilization in our operating markets throughout the second quarter. Orders increased, particularly in the MP segment, which should positively influence the revenue changes for Q3 and Q4, making them less negative year-over-year compared to Q2.

Does the outlook for a flat performance mean that the $100 million in cancellations and delays seen in AWP will be fully recovered in the second half, or just a part of it? How are you viewing that in relation to a flat second half?

Right. Joe, please continue, Duffy. I apologize, go ahead, Duffy.

I would just say we use the word most, and so the answer is that the outlook does contemplate that most of those orders are both rebooked and machines delivered in the back half of the year. John, you can expand, sorry.

Yes. And I think just to add on that, Joe, is, again, it's an outlook. But as we look at the market now in our AWP segment, we did see utilization improve as we went through the quarter, likewise in our MP segment around the world. So again, it's just an outlook. As we sit here today, that's our outlook. It's not a financial forecast, it's not financial guidance, but looking at the business as we're seeing everything here today, that's how we see the back half unfolding. And obviously, it could change, as we said, dramatically either way, depending how the COVID pandemic plays out. But as we sit here today, that's the outlook that we see.

And then last one on AWP inventory. A lot of sort of attention and effort on getting that to comfortable levels. Can you talk about where you are today, the degree to which you've got any more work in the back half of the year and your comfort level with exiting the year and allowing you to produce to retail?

I'll respond to that, Joe. We have frequently discussed how to align our AWP inventories with market demand. For an extended period, we have been producing less than what the retail demand requires, and this trend continued in the second quarter. Our production sales declined, with a 66% reduction in production during the quarter following a 47% decrease in Q1. Consequently, we are seeing our inventories adjust effectively. The teams have done an excellent job reducing inventory both sequentially and year-over-year, which positively impacts our cash flow performance. With my involvement in the business, we will maintain this focus. We are closely connected with our customers, keeping track of their daily demand and adjusting our production schedules to ensure we continue to underproduce relative to retail demand. Although we do hold finished goods inventory, we manage it carefully by model and category globally to avoid overproduction. This year, we have made significant production cuts to align our inventory properly, and we will stick to this strategy to prevent ending up with excessive inventory. As the year progresses, particularly in the AWP segment, it's crucial for us to remain close to our customers and be aware of market fluctuations, as there is potential for a sharp rebound. Our team will stay focused on this consistently moving forward, and I'm pleased with how they have aligned our inventory with our current outlook for the segment.

Our next question comes from the line of David Raso with Evercore ISI.

John, now that you're even closer to the AWP business being out in Washington state at times, and obviously, it's under your watch, 100%. For the stock to really work, right, it's about AWP kind of having a real upcycle. And just given the last couple of years, the divergence between AWP margins versus your largest competitor, it's been really stark. So just given you've gotten even a little closer to the business, can you explain kind of the last couple of years, kind of what happened and diverged? Because you used to not be that different in the competitor on the margins. And what are you looking at to give us comfort that you could get the margins back to where your competitor, even where they are right now, even in a down market?

Thank you for your question, David. I want to express my enthusiasm for working closely with our AWP team, including both the Genie and Utilities teams. I have a strong support system at the corporate level that allows us to handle various opportunities and workloads effectively. Our teams at Genie and Terex Utilities are excellent. We have also established a new role in our Genie business for Simon Meester as COO to ensure we maintain our focus. Moving forward, my team and I will operate the business with a strong emphasis on process efficiency and execution to significantly improve our margins. It's clear that our underproduction relative to retail demand has contributed to our margin challenges in AWP, and aligning that will be beneficial. We will examine all facets of the business to enhance efficiency, including SG&A, manufacturing, and sales. One constant is the Genie team's strong commitment to customer satisfaction, and we will continue to prioritize that. However, we need to tackle cost issues and challenges in the business to achieve the margin improvements we aim for in the future.

I appreciate the comments, but can you just help us a little bit more to understand? Because underproduction obviously hurts, but even your competitors had similar, say, sales declines this year, as you're seeing. And again, the margin spread is really wide. So I was just curious if you've seen something being even closer to it, that the expansion in the Chinese facilities is a big cost save coming versus other facilities in the past. Something glaring within the business that maybe we don't see in the disclosure when it comes to SG&A or whatever it may be, just because it's such a wide gap. I think it's a question people are going to have. How do I gain comfort in the margin improvement? Because clearly, if you go back to where you were on the margins, the operating leverage is huge. But is there something structural that you're seeing that you feel you can attack? Because we know the competition is getting harder this decade in aerials than we've probably ever seen over the roughly 25-year history of the product being of real full scale. So I'm just curious, if there's something you're seeing that can explain the big margin gap and why it can be gotten rid of.

Right. David, the gap between production and retail demand, along with the reductions in inventory during a period of declining revenue, is significantly affecting the AWP margin. As we move forward, we need to improve our alignment between our sites, retail, and production demand, especially since we've had to make deeper cuts to align inventory levels. This will remain a key focus for us as we seek to improve. We are exploring all aspects of the business. We believe in the potential of our operations, particularly in China, which not only offers growth opportunities but also allows us to export to the Asia Pacific market and Europe, providing a cost advantage over time. We are committed to thoroughly examining every aspect, and we acknowledge the margin differences compared to other industry players. Our aim is to bridge that gap.

Our next question comes from the line of Jerry Revich with Goldman Sachs.

John, I'm wondering if you could talk to us about what utilization levels you're seeing for your equipment in the field based on your customers' reports. It looks like they're running roughly 10% down year-over-year in terms of fleet on red. And I'm wondering, is it similar for your products? Can you just give us some context? And can you talk about the cadence that you've seen into July? Any areas, any let up in areas where we've seen the coronavirus pick back up?

Yes, thank you, Jerry. We gain information in two main ways. First, by closely engaging with our customers to understand their utilization experiences. Second, we now have over 20,000 machines equipped with telematics data, which, combined with customer insights, is enhancing our understanding. Over time, we believe this will improve our forecasting capabilities. Looking worldwide, let's start with China. Early in the first quarter, China was closed down, but we have observed a significant recovery in the market, with a notable increase in utilization and both sequential and year-over-year sales growth. North America has shown similar trends, where customers reported and our telematics data confirmed that the lowest point in utilization occurred around April. However, there were regional variations, as the East was slower to recover than other parts of the country. Texas experienced a decline in utilization due to COVID-19 and issues in the oil and gas sector. Throughout the quarter, utilization in Texas increased and stabilized, although it remains slightly below pre-COVID levels. In Europe, the situation mirrors this, with varying recovery timelines depending on when COVID-19 affected different regions. Southern Europe faced a quicker downturn in utilization, while Northern Europe saw the impact a bit later. Overall, we have observed an improvement in utilization across the second quarter, with stabilization, though levels are still below those prior to the pandemic. Some markets, like China and specific areas in the U.S. and Europe, are getting close to pre-COVID levels, and overall improvements are reflected in both customer feedback and telematics data.

And John, just to make sure we're on the same page. That pace of improvement, it sounds like, has continued into July. Is that correct?

I'm going to be careful, Jerry, not to go in-quarter commentary. So my comments were to the second quarter. So I'm going to leave it there, if that's okay, Jerry. I'm going to try to avoid an in-quarter commentary.

Okay. Fair enough. And then as we think about incremental margins in '21, obviously, really nice decremental margin performance this quarter. Anything we should keep in mind? Because things like no travel will obviously unwind or hopefully, I should say, will unwind. So any of the steps that are driving attractive decremental margins in 2Q that we should think about that potentially don't follow through into higher decrementals in '21? And hopefully, price cost will be a tailwind depending on how pricing sticks? But can you just talk to those points, please?

Yes. Duffy, could you comment on that real quick?

Sure, I would start by saying our main focus right now is on the second half of 2020. Regarding 2021, I hope we can discuss incremental margins rather than decremental margins, as COVID-19 hopefully becomes a thing of the past and markets grow, leading to an increase in our top line. Time will tell, but concerning margins in 2021, we will remain vigilant about our cost structure and work on reducing costs to align with the commercial demand environment. We are fully committed to achieving either 25% incremental or decremental margins. Additionally, investors should keep in mind that these margins are influenced by year-over-year changes in revenue and operating income. Given the low operating income levels we've experienced in the first half of 2020 due to COVID-19, this indicates potential for improved margins in 2021.

Our next question comes from the line of Jamie Cook with Crédit Suisse.

So Duffy, I apologize for juggling multiple earnings calls this morning, but I wanted to follow up on Jerry's question. Regarding your outlook for 2021, if volumes recover—though it's uncertain—your incremental margins should exceed the 25% target based on your comparisons. That's my first question. My second question is about your underproduction in retail and aerials. When do you expect to align production accordingly? Is that expected in the fourth quarter or in 2021? Finally, could you provide an update on the strategic sourcing efforts and any potential cost savings associated with that? It may extend into 2021, but any insights would be appreciated.

That's a lot of questions there.

Yes. Regarding production levels, we are focused on maintaining the right inventory levels as we believe we have too much finished goods inventory. Therefore, we have been producing less than retail demand to adjust that inventory. Where we end up by the end of this year will largely depend on our forecast for 2021, which is still uncertain. Our approach will be to exercise the same discipline our customers are demonstrating by not overproducing. We will carefully manage our production to ensure a healthy pricing environment without feeling pressured to adjust prices due to excess inventory. Our production schedules will be closely aligned with retail demand, while remaining aware that markets can recover quickly. It is important for us to maintain close communication with our customers regarding production levels, and this strategy will remain unchanged.

And Jamie, in terms of the strategic sourcing initiative, in my prepared remarks, I called out our sourcing teams. I think they've really done a great job in an incredibly challenging environment where we're asking suppliers to reduce the amount of products coming into our facilities, the raw and whip as our production levels have been cut, while also simultaneously ensuring that we have continuity of supply, with a significant amount of supply chain disruption around the world. And so the teams have done a great job with that. As it pertains to savings, Jamie, I will just say that the savings rates, the percentages that we're getting, are in line with what our expectations were. Obviously, with the volumes being down so dramatically, the actual dollar savings are not there, but the rate savings are. And so as volumes continue to pick up, we would anticipate that, that would be a tailwind for us as we go forward. In terms of implementing the strategic sourcing process in the COVID pandemic period, Jamie, the teams continued to move their sourcing activities. It has slowed in some cases, especially if we're in a position where we're thinking of changing a supplier, and we need to do on-site visits to check the quality systems, production systems, so on and so forth. So COVID has impacted the timing of the strategic sourcing initiatives. But even with that said, the team is continuing to progress it and where we can go with existing suppliers and vendors, we're making those types of awards as well. But we would anticipate it being a tailwind for us as we move forward into the future.

Our next question comes from Courtney Yakavonis with Morgan Stanley.

Maybe just first on cancellations, appreciate you gave us some color on utilization through the quarter. But I think last quarter, you kind of talked about taking a pretty heavy hand with the cancellations and the pushouts, yet it continued this quarter. So I was just curious, is that kind of something that was more at the early part of the quarter and has since stopped? Or did you see it kind of reaccelerate as we've seen some of the utilization trends maybe falter a bit in some of these areas where the outbreaks have been? Just any color you can kind of give us on how cancellations are trending.

Yes, I'll address that. Regarding AWP, earlier in the quarter, we had advanced purchase orders. When customers faced issues with financing or timing, or couldn't provide shipping addresses, we chose to manage and remove those orders. However, we expect them to be booked back. Throughout the quarter, we've been tracking cancellations and delays daily, and we've observed a decrease in those numbers as the quarter progressed. For MP, they conducted a thorough review of their backlog at the end of the first quarter, removing orders from dealers who couldn't specify when and where the products needed to be shipped. Consequently, they experienced fewer cancellations and delays in their backlog and order books. This pattern remained consistent throughout the quarter. That’s how I would describe the changes in the backlog as we moved through the second quarter.

Okay. That's helpful. And then just within AWP as well, just on the Utilities business. I think you mentioned that it stabilized but still soft in certain customer segments. Any more color you can kind of give us there? Just quantify how much that market is down relative to aerials more broadly and just how you're thinking about that business in the second half of this year relative to the results.

Overall, the Utilities business has proven to be more stable than the aerials business in this environment. Its rate of sales decline was not reflected at the overall segment level. There are three main customer segments within this group, each showing different trends. One steady segment is the investor-owned utilities and major integrated utilities, whose capital expenditure plans remain unchanged. However, we did experience some delays in deliveries due to travel restrictions preventing customers from accepting their customized vehicles. Despite this, that part of the market remains strong. We have noticed some contraction in the specialty utility contractor market, which has softened like most rental channels during the pandemic, and we are observing signs of stabilization. Lastly, specialty products like our tree care products have remained strong, as electrical utilities continue to invest in maintenance. Thus, while COVID has impacted the overall business, it hasn't affected us to the same extent as our AWP, Genie side.

Okay. And just any comment on the outlook for that business, given that you opened the new utilities facilities?

Yes. The team is currently transitioning to the new facility as we move from the late second quarter into the third quarter, and they are enthusiastic about it. We still believe, Courtney, that this business is a solid growth area for us, considering the ongoing trends in electrification and 5G requirements. Additionally, as China has increased its activity, we have the chance to utilize manufacturing space in our Phase 3 Changzhou expansion for utility products. Therefore, the Utilities business within AWP remains robust, and we expect it to continue growing as we progress.

Our last question is from Seth Weber with RBC Capital Markets.

Just making it in time, thank you. I wanted to revisit the $100 million comment regarding cancellations and delays. Are you noticing any distress among your smaller rental customers, especially independents? Additionally, if they are facing financing issues, would you consider being more proactive with Terex Financial to assist them?

Duffy, could you take the financing side of that one? And I'll follow up at the end.

I would say that the financing situation is fairly limited, and overall, our independent customers have been managing quite well throughout the pandemic. We're not observing significant financial strain. Many have utilized available government programs. There were only a few cases where customers needed additional time to secure funding for their 2020 orders due to the pandemic. Consequently, until they were able to arrange the funding, we removed those orders from the backlog. We've made progress with this small group of customers and expect that they will secure the financing to place the orders, allowing us to ship the equipment in the second half of the year.

Okay. So you’re not looking to take a more aggressive approach with Terex Financial? You're leaving that decision up to the customer?

No. Look, I think we work very closely with our customers to provide financing where appropriate, recognizing that it's a combination of third-party funders as well as their own balance sheet. And I think we've been exercising an appropriate level of aggressiveness to support our customers through this pandemic.

Okay. And have you seen any uptick in bad debt or orders during the crisis?

No, we did have a specific situation that we addressed in Q1, which we discussed during our Q1 earnings call, but we have not encountered any additional challenges related to the pandemic.

There are no further questions at this time. I'll turn the call back over to Mr. John Garrison for closing comments.

First and foremost, thank you for your continued interest in Terex. Please stay healthy. I would encourage all of us to please continue to follow the COVID-19 protocols, so that you can keep yourself, your families, and your community safe. If you have any further or additional questions, please do not hesitate to follow up with Duffy and Randy. And operator, you can now disconnect the call. Have a great day.

This concludes today's conference call. You may now disconnect.