Andrew Bonfield
Chief Financial Officer at Caterpillar
Thank you, Jim. And good morning, everyone. I'll start by walking you through our third quarter results including the performance of our segments. Then I'll discuss the balance sheets and ME&T free cash flow before concluding as usual with our expectations for the fourth quarter and full year.
Beginning on slide 8, sales and revenues for the third quarter increased by 21% or $2.6 billion to $15 billion. The increase was due to strong price realization and volume, partially offset by currency impacts.
Operating profit increased by 46% or $761 million to $2.4 billion as price realization and volume growth were partially offset by higher manufacturing and SG&A and R&D costs. Our adjusted operating profit margin of 16.5% increased by 280 basis points versus the prior year's quarter as the impact of price realization and volume growth outpaced continued manufacturing cost increases.
Adjusted profit per share increased by 48% to $3.95 in the third quarter compared to $2.66 last year. Adjusted profit per share for both quarters excluding restructuring costs, which were $0.08 per share this quarter compared to $0.06 in the prior year.
In total, taxes benefited profit per share by about $0.06 per share for the quarter. During the third quarter of 2022, we reached a settlement with the US Internal Revenue Service that resolves all issues for taxes 2007 through 2016. We are pleased to have settled the audit without any penalties and within our reserves. The settlement includes, amongst other issues, the resolution of disputed tax treatment of profits earned by Caterpillar SARL from certain parts transactions. The final tax assessed by the IRS for all issues under the settlement was $490 million for the 10-year period. $467 million of this was paid in the third quarter of 2022 and the associated estimated interest of $250 million is expected to be paid by the end of the year. The settlement was within reserves and the company recorded discrete tax benefit of $41 million to reflect changes in estimates of prior year taxes and related interest net of tax.
Now on, slide 9. The top line increased by 21% on strong price realization and volume, while currency was a headwind, given the strong US dollar. Overall, sales were about as we expected. Regarding volume, the largest benefit versus the prior year was $1 billion favorable quarter-over quarter change in dealer inventory.
Sales to users increased by 7%. While there is continued uncertainty regarding the macroeconomic backdrop, demand indicators remain supported as sales to users increased by 7%, backlog grew by $1.6 billion to $30 billion and dealer inventory remains at the low end of the typical range.
As we've seen in recent quarters, the dealer inventory increase was primarily due to issues resulting from the timing of deliveries from dealers to customers and delays in the commissioning machines as a result of labor shortages at dealers. And the impact was that sales to users were slightly lower-than-expected with a corresponding offset increase in dealer inventories. As both Jim and I have indicated, we believe that the majority of this is timing and is not an indicator of changing market dynamics. Dealer inventories remained at the low-end of the typical range.
Moving to slide 10, as I mentioned, third quarter operating profit increased by 46% on favorable price realization and volume. Price realization was in line with our expectations and was supported by healthy demand. Manufacturing costs continue to increase versus prior year, primarily due to material and freight cost increases, as well as manufacturing inefficiencies due to supply chain constraints. Overall, the impact of favorable price realization exceeded manufacturing costs for the quarter.
Finally, SG&A and R&D costs increased primarily due to investments aligned with our strategy for profitable growth, which included services growth and technology such as digital, electrification and autonomy.
Our third quarter adjusted operating profit margin of 16.5% was a 280 basis point increase versus the prior year. The impacts of price actions accelerated, so price realization was strong. Although we began to lap the significant increases in material and freight costs seen in the second half of last year, we are still seeing cost increases from suppliers for materials, in particular.
Finally, related to our recent price cost performance, keep in mind that we are still catching up from the increases to manufacturing costs which have occurred over the last few years. In particular, material and freight costs have increased by about 20% since 2020. Our gross margin of 28.5% for the third quarter is now only just getting back in line with the levels seen in the third quarter of 2019, despite sales from revenues being higher.
Moving to slide 11. As we expected, segment sales and margins improved in the third quarter. Starting with Construction Industries, sales increased by 19% to $6.3 billion, driven by favorable price realization and sales volume, partially offset by currency. Volume increased primarily due to changes in dealer inventories which increased in the quarter compared to a reduction last year.
Sales in North America rose by 29% due mostly to strong pricing and a favorable change in dealer inventory. Dealers in North America decreased their inventories in the third quarter of last year, whilst we saw some build this year. North American dealer inventories still are very low, which impacts their ability to supply the region.
Sales in Latin America increased by 51% on strong price realization, higher sales of equipment to end users and a favorable impact due to changes in dealer inventories.
In both the EAME and Asia-Pacific, sales were relatively flat as strong price realization was offset by currency.
Third quarter profit for Construction Industries increased by 40% to $1.2 billion versus the prior year. Price realization and higher sales volume drove the increase as price more than offset manufacturing costs. Unfavorable manufacturing costs largely reflected higher material and freight costs in addition to manufacturing inefficiencies. The segment's operating margin of 19.3% was an increase of 280 basis points versus last year.
Turning to slide 12, Resource Industries sales grew by 30% in the third quarter to $3.1 billion. The improvement was primarily due to favorable price realization and higher sales volume. Volume increased due to the impact of changes in dealer inventories, higher sales of aftermarket parts and higher sales of equipment to end users.
Third quarter profit for Resource Industries increased by 81% to $506 million as price realization more than offset manufacturing costs, which largely reflected higher material, freight and manufacturing inefficiencies. The segment's operating margin of 16.4% was an increase of 460 basis points versus last year.
Now, on slide 13. Energy & Transportation sales increased by 22% to $6.2 billion, with sales up across all applications. Oil and gas sales increased by 22% due to higher sales of reciprocating engine aftermarket parts and engines used in well servicing applications and gas compression. Power generation sales increased by 31% as sales increased to both turbines and reciprocating engines as data center activity remains strong. Industrial sales rose by 22% with strength across all regions. Finally, transportation sales increased by 9% on reciprocating engine aftermarket parts and relative strength in our marine applications. International locomotive deliveries also benefited sales.
Third quarter profit for Energy & Transportation increased by 32% to $935 million. The improvement was primarily due to favorable price realization and higher sales volume, partially offset by higher manufacturing and SG&A and R&D costs. As anticipated, price realization narrowly offset manufacturing costs. Manufacturing cost increases largely reflected higher material and freight costs coupled with manufacturing inefficiencies.
Also, SG&A and R&D expenses increased due to investments aligned with our strategic initiatives, including electrification and services growth, in addition to higher short-term incentive compensation expense.
The segment's operating margin of 15.1% was an increase of 120 basis points versus last year.
Moving on to slide 14. Financial Products revenue increased by 7% to $819 million, benefiting from higher average financing rates in North America and Latin America. Segment profit increased by 27% to $220 million. The profit increase was mainly due to a favorable impact from a lower provision for credit losses at Cat Financial.
Moving to our credit portfolio, our leading indicators remain strong. Past dues, a good proxy for the financial health of our customers, were 2.00% compared with 2.41% at the end of the third quarter of 2021. We also saw a 19 basis point decrease in past dues compared to the second quarter of this year.
Retail new business volume did decline compared to the record levels in the prior year. However, at this point, Cat Financial mentioned is not seeing slowing business activity, but is instead impacted by strengthening competition from banks. This is typical in a rising interest rate environment as banks benefit from a lower cost of funds, especially due to customer deposits.
Finally, used equipment demand remained strong as elevated prices have stabilized and inventories remain low.
Now on slide 15, ME&T free cash flow in the quarter increased by about $1.2 billion versus the prior year to $2.1 billion. The increase was primarily due to higher profit and favorable net working capital.
We did continue to build production inventory to support shipments and mitigate component delivery delays, an increase of about $1 billion versus the second quarter. Cumulatively, ME&T free cash flow year-to-date is $2.8 billion, despite the increase in inventories and the payment of incentive compensation in the first quarter of 2022.
Looking ahead, we continue to expect to achieve our Investor Day ME&T free cash flow target of between $4 billion and $8 billion for the full year.
As Jim mentioned, we paid around $600 million in dividends in addition to repurchasing about $1.4 billion worth of common stock, supporting our objective to be in the market on a more consistent basis.
Enterprise cash was $6.3 billion, about a $300 million increase compared to the second quarter 2022. The increase was primarily driven by higher free cash flow.
Our liquidity remains strong as we continue to hold some of our cash balances in slightly longer-dated liquid marketable securities in order to improve the yield on that cash.
Now on slide 16, I will share some thoughts on the fourth quarter and the full year. As a reminder, the third quarter was generally in line with our expectations on the top line. And while margins were better than the prior year, they were marginally lower than we had anticipated.
Pricing gained momentum against the backdrop of stronger demand, while manufacturing cost increased on continued inflationary cost headwinds for our suppliers and manufacturing inefficiencies due to the ongoing disruption to the supply chain. We also continued to invest for future profitable growth.
Looking ahead, we anticipate the fourth quarter will reflect our highest quarterly sales for the year, which is in line with typical seasonality. Compared to the prior year, higher sales to users and price realization should support the top line growth.
At year-end, we expect dealer inventories to remain at similar levels as they ended in the third quarter. We also expect sales increases across the three primary segments, both year-over-year and sequentially. Infrastructure spending should continue to benefit our segments over time as non-residential building accelerates and large projects commence.
On margins, we should see slightly higher adjusted operating margins in the fourth quarter compared to the third on higher volume and continued pricing momentum. We do anticipate that manufacturing cost increases, including manufacturing inefficiencies, will act as a partial offset.
At the segment level, we expect to see similar margins to the strong third quarter performance in Construction Industries. In Resource Industries and Energy & Transportation, margins should strengthen compared to the third quarter and prior year.
Compared to last year, all three primary mid segments should benefit from price realization and higher volume. We expect price realization to more than offset manufacturing costs across our three primary segments in the fourth quarter.
Finally, to assist you with your modeling, we continue to expect our accrual for short-term incentive compensation expense of about $1.6 billion this year. Capex is expected to be about $1.4 billion. We anticipate a global effective tax rate of around 23%, slightly lower than previously expected due to changes in the geographic mix of profits from a tax perspective.
Finally, restructuring charges are expected to be up to $800 million for the full year. There is a possibility that the largest item, which is a non-cash charge of approximately $600 million relating to the divestiture, may slip into 2023.
So turning to slide 17, let me summarize. Sales grew by 21%, led by strong price realization and volume gains across all the segments. The adjusted operating profit margin increased by about 280 basis points to 16.5%. ME&T free cash flow was strong at $2.1 billion and we continue to return cash to shareholders on a consistent basis.
The outlook remains positive, with sales to users up 7% and the backlog up $1.6 billion to $30 billion. We continue to execute our strategy for long-term profitable growth.
And with that, we'll take your questions.
