This paragraph introduces the Second Quarter 2023 Caterpillar Earnings Conference Call by introducing the speakers, discussing the materials available on investors.caterpillar.com, and warning listeners that the content is copyrighted and protected. It also reminds listeners of the risks and assumptions associated with forward-looking statements, and provides a link to the SEC filings and the earnings call slides for a reconciliation of any non-GAAP numbers.

In the second quarter of 2023, the company saw strong results with double-digit top-line growth, higher adjusted operating profit margin, record adjusted profit per share, and robust ME&T free cash flow. Sales and revenues increased 22% to $17.3 billion due to higher sales volume and price realization. The company also generated $2.6 billion of ME&T free cash flow in the quarter, and ended the quarter with a healthy backlog of $30.7 billion. The company now expects their 2023 results to be better than previously anticipated.

Sales volumes were higher than expected, with double-digit increases in sales and revenue in each of the three primary segments. In North America, sales to users increased due to strong demand for non-residential and residential construction. In EAME, sales to users declined due to weaker market conditions in Europe. In Resource Industries, sales to users increased 26%, supported by growth for infrastructure-related projects. In Energy & Transportation, sales to users increased 47%, due to strong sales of turbines and turbine-related services, as well as favorable market conditions for power generation.

In the second quarter, industrial and transportation sales to users increased, leading to an adjusted operating profit margin of 21.3%. The company generated strong ME&T free cash flow of $2.6 billion and returned $2 billion to shareholders. With the strong customer demand and operating performance, the company now expects adjusted operating profit margins to be close to the top of the targeted range and ME&T free cash flow to be around the top of the $4 billion to $8 billion range for the full-year.

The Construction Industries are expected to see positive growth in North America due to government-related infrastructure investments and a healthy pipeline of projects. In Asia/Pacific excluding China, public infrastructure spending is expected to support growth. In EAME, the Middle East is expected to show strong construction demand while Europe is expected to be down. Resource Industries are expected to remain healthy due to capital discipline and the energy transition, while heavy construction and quarry and aggregates are expected to be up due to major infrastructure projects. Energy & Transportation is also expected to see growth.

Cat reciprocating engines and oil and gas applications have seen strong demand, especially for gas compression and power generation. New equipment orders and services for solar turbines remain robust, and transportation has seen strength in high speed marine. Cat has also continued to invest in new products, technologies, and services to help customers reduce emissions and fuel consumption. Andrew Bonfield will then discuss the second quarter results, balance sheet, free cash flow, and assumptions for the remainder of the year.

In the second quarter of this year, sales and revenues increased by 22%, or $3.1 billion, to $17.3 billion due to higher sales volume and price realization. Operating profit increased by 88% or $1.7 billion to $3.7 billion, resulting in an adjusted operating profit margin of 21.3%, an increase of 750 basis points compared to the prior year. Profit per share was $5.67, including a $0.17 per share discrete deferred tax benefit, and $0.05 per share restructuring costs. Other income was lower due to an unfavorable currency impact and an increase in quarterly pension expense. The global annual effective tax rate was approximately 23%.

In the second quarter, Construction Industries sales increased by 19% due to higher sales volume and price realization. This was mainly driven by strong demand and supply chain improvements in North America, which enabled higher sales of equipment to end users and some delivery stocking. As a result, operating profit increased by 88%, while adjusted operating profit increased by 87% to $3.7 billion. Price realization and higher sales volume were partially offset by higher manufacturing costs, but the adjusted operating profit margin of 21.3% was better than expected due to higher volume and lower freight costs.

In the second quarter, sales for Construction Industries, Resource Industries, and Energy & Transportation increased by 82%, 20%, and 27% respectively. Profit for each of these segments increased significantly, due mainly to higher sales volume and price realization. The operating margin for each segment also increased significantly, mainly due to favorable volume, timing of SG&A and R&D spend, and lower than anticipated freight costs.

In the second quarter, Financial Products revenue increased by 16% and segment profit increased by 11%. ME&T free cash flow generation was robust, generating $2.6 billion in the quarter. CapEx in the second quarter was about $300 million and $2 billion was returned through share repurchases and dividends. For the second half and third quarter, high level assumptions have been shared.

In the second half of 2023, Caterpillar sales are expected to be higher than the second half of last year, with both sales to users and price realization being positive. Dealer inventory is mainly a function of the commissioning pipeline in Resource Industries and Energy & Transportation, and end user demand and availability from the factory in Construction Industries. For Resource Industries and Energy & Transportation, a slight reduction in inventory levels is expected in the second half, but this is dependent on commissioning.

Dealers in the Construction Industries are currently holding inventory around the midpoint of the typical range, and some dealers are increasing or decreasing levels of certain products. In the second half of 2023, dealers are expected to reduce overall inventory levels with a focus on excavators. The adjusted operating profit margin is expected to be close to the top of the 300 basis points target range, and higher than the year before, though slightly lower than the first two quarters of the year. There may also be a margin headwind due to cost absorption, and inventory reduction if supply chain improvement continues. Strategic growth initiatives are expected to continue ramping up.

In the third quarter of 2023, sales are expected to be higher than the third quarter of 2022, but to exhibit a typical sequential decline compared to the second quarter. Margins are expected to be stronger than the prior year, but lower than the second quarter due to lower volume, increased investment in strategic initiatives, and slightly higher manufacturing costs. Price realization will act as a partial offset.

The company generated strong adjusted operating profit margins with a 750 basis point increase to 21.3%, and they now expect to be close to the top of the targeted range for adjusted operating margin for the full-year based on expected sales levels. ME&T free cash flow generation was robust at $2.6 billion in the quarter, and they returned $2 billion to shareholders through share repurchases and dividends. It was asked if the company should adjust their margin targets on lower sales, and the company responded that they are expecting to be close to the top of their targeted range for adjusted operating margin for the full-year.

James Umpleby discussed the company's strong backlog and stated that the adjusted operating profit margin is expected to be near the top of the targeted range for the year. He also mentioned that they are closely monitoring economic conditions, but feel good about the business, and would not make a prediction for 2024 at this point. In response to a question about the backlog, Umpleby stated that it remained healthy and had only increased modestly quarter-to-quarter. He also mentioned that they are considering pricing for 2024, with the base order management program opening up this month.

Andrew Bonfield explains that, unlike in past destocking periods, the current inventory reductions are not due to a decline in demand. Instead, the modest inventory adjustments are being made to accommodate healthy demand and can be absorbed more easily.

Cat is being proactive with their dealers to reduce inventory while retail sales remain strong. Andrew Bonfield states that they are not predicting whether or not sales will accelerate or decelerate in the second half, but inventory levels should decline by the end of the year due to increased sales. Rob Wertheimer then asks about Cat's own inventories, inquiring about safety stock, finished goods, and how much cash could come out of inventory if levels normalize.

James Umpleby is proud of the team's performance despite the supply chain challenges they are still facing, such as delays in large engines and displays. He believes that when supply chain conditions improve, they will be able to free up additional cash. He also notes that they are managing production and factory flow well and that safety is a priority.

Andrew Bonfield and James Umpleby of Caterpillar discussed the company's increase in backlog of $300 million, which was mainly due to pricing, but was also impacted by fluctuations in order volumes. They also noted that backlog could decrease if they are able to ship products more quickly and reduce customer wait times.

Andrew Bonfield and James Umpleby answered a question from Nicole DeBlase about the retail sales trends in the machines businesses in EAME (Europe, Middle East, and Africa). They explained that Europe is seeing some slowing, but the Middle East is strong with a lot of construction activity. The operator reminded everyone to ask one question at a time out of courtesy to other analysts.

James Umpleby responds to a question about productivity headwinds and penalties due to supply chain issues by explaining that the situation has improved, but shortages still exist, which has prevented them from running factories as leanly as they would like. He believes that as supply chain conditions improve, they will be able to reduce inventory and increase inventory turns. He then moves on to answer a question about parts volumes in RI, saying that they are prioritizing whole goods due to constrained availability and there may be some destocking going on with the dealer.

Andrew Bonfield discussed the breakdown of orders between retail and stock for Construction Industries, noting that a significant portion of purchases are based on customer orders and involve customization. He also mentioned that there is some commissioning for CI, but nowhere near the 70% plus that is seen in E&T and Resource Industries. Lastly, he mentioned that there are areas where dealers are constrained and would like to have more inventory available to them, which impacts their orders.

James Umpleby explains that Caterpillar is not dependent on rig counts to drive their oil and gas segment. They are encouraged by the strong demand for gas compression and reset engines, and have seen some slowing in well servicing, but that is expected to increase again in the coming months. Solar applications are also seeing robust sales for gas compression, offshore platforms, and international business. Overall, Caterpillar is optimistic about the future of their oil and gas segment.

James Umpleby and Andrew Bonfield answered a question from Kristen Owen about pricing in the second quarter. They explained that price realization was in line with expectations and that it was affected by mix and the competitive situation in certain markets. They also noted that price increases from the second half of last year will lap in the second half of 2023, but there will still be positive price in the second half. Price will be slightly stronger in the third quarter than the fourth.

James Umpleby and Andrew Bonfield responded to a question from Mircea Dobre regarding the impact of dealer inventory destock on production levels and manufacturing costs. They explained that production levels will be slightly different this year, and that production adjustments are being made to accommodate the destocking. They also said that manufacturing costs will decrease, but this will be offset by a decrease in price benefit, so there will be no real benefit to margins in the second half of the year.

In the second half of the year, Caterpillar expects to experience a seasonal decrease in operating margins in both Construction and Resource, due to lower production and the BCP changeover. Additionally, Caterpillar expects to be close to the top of its targeted range for adjusted operating profit margin.

James Umpleby discussed the positive effects of the numerous infrastructure bills that have passed and the permitting process that takes time. He expects the effects to last for some time, but it's difficult to estimate the acceleration in a six-month or one-year period. With regards to cash flow, Umpleby stated that the intent is to return substantially all of the ME&T free cash flow to shareholders through dividends and share repurchases.

In the mining industry, James Umpleby reports that large truck sales and quotation activity is robust, though other products are not as strong. He believes that the industry will gradually increase over time, and that Caterpillar has the best autonomous mining solutions, with 600 autonomous trucks in operation around the world.

Caterpillar's autonomous solutions are becoming increasingly popular due to the reduced cost, which allows smaller mines to make a capital investment. Additionally, they have seen mines adapt autonomy with a low number of trucks. Caterpillar is optimistic about the future of their business and have revised their expectations for their 2023 adjusted operating profit margin, ME&T free cash flow, and other metrics due to their strong performance in the second quarter. A replay of the call and transcript will be available online, as well as a second quarter results video and sales to users data.

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This summary was generated with AI and may contain some inaccuracies.