Andrew R.J. Bonfield
Chief Financial Officer at Caterpillar
Thank you Jim, and good morning everyone. I'll begin with commentary on the second quarter results, including the performance of our business segments. Then I'll discuss the balance sheet and free cash flow before concluding with our assumptions for the remainder of the year, including color on the third quarter.
Beginning on Slide 8, our team delivered a very strong second quarter as overall results exceeded our expectations on strong operating performance. We saw healthy top line growth, improved operating margins and robust ME&T free cash. For the year, we now expect our adjusted operating profit margin to be close to the top of the targeted range at our anticipated sales level. We also expect ME&T free cash flow to be around the top of our $4 billion to $8 billion target range. To summarize the results, sales and revenues increased by 22% or $3.1 billion to $17.3 billion. Sales increased versus the prior year was due to higher sales volume and price realization.
Operating profit increased by 88% or $1.7 billion to $3.7 billion. The adjusted operating profit margin was 21.3%, an increase of 750 basis points versus the prior year. Adjusted profit per share increased by 75% to $5.55 in the second quarter compared to $3.19 last year. Profit per share was $5.67 in the second quarter of this year. This included discrete deferred tax benefit of $0.17 per share, while restructuring costs were $0.05 per share flat compared to the prior year. We continue to expect restructuring expenses about $700 million for the full year.
Other income of $127 million in the quarter was lower than the second quarter of 2022 by $133 million. Year-over-year decline was primarily driven by an unfavorable currency impact related to ME&T balance sheet translation and a recurring increase in quarterly pension expense of approximately $80 million, which we initially spoke to you about in January. Higher investment and interest income actually is a partial offset. The provision for income taxes in the second quarter, excluding discrete items reflected global annual effective tax rate of approximately 23%, which remains our expectation for the full year.
Moving on to Slide 9. The 22% increase in the top line versus the prior year was due to higher sales volume and price. Volume improved sales to users increased by 16% and from changes in dealer inventory. Sales for the quarter were higher than we had anticipated, mostly due to volume. The volume outperformance reflected a dealer inventory increase, which was primarily due to a stronger-than-expected shipments in energy and transportation, particularly in power generation, which was in-line with strong data center demand. Price realization was in line with our expectations for the quarter. As I mentioned, sales to users grew by 16% in the quarter. As Jim has discussed, demand remains healthy across most end-markets for our products and services and is supported by healthy order backlog.
Moving to Slide 10. Second quarter operating profit increased by 88%, while adjusted operating profit increased by 87% to $3.7 billion. Year-over-Year, favorable price realization and higher sales volume were partially offset by higher manufacturing costs, which largely reflected higher material costs. An increase in SG&A and R&D expenses included higher strategic investment spend. The adjusted operating profit margin of 21.3% was better than we had anticipated. Volume exceeded our expectations, which supported the margin outperformance. In addition, manufacturing costs increased less than we expected due to lower freight costs and lower-than-anticipated impact from cost absorption. SG&A and R&D expenses were about in line.
Moving to Slide 11, I'll review the segment performance. Construction industry sales increased by 19% in the second quarter to $7.2 billion due to price realization and higher sales volume. By region, sales in North America rose by 32% due to higher sales volume and price realization. Stronger demand and supply-chain improvements enabled stronger-than-expected shipments in North America. This supported stronger sales of equipment to-end users and some dealer restocking, in what remains our most constrained region. Sales in Latin America decreased by 11%, primarily due to lower sales volume, partially offset by price realization. In EAME, sales increased by 20%, primarily the result of higher sales volume and price realization. Sales in Asia-Pacific were about flat. Second quarter profit for Construction Industries, increased by 82% versus the prior year to $1.8 billion, the increase was mainly due to price realization and higher sales volume. The segment's operating margin of 25.2% was an increase of 880 basis points versus last year. Margin exceeded our expectations, largely due to better-than-expected volume and freight costs, which were lower than we had anticipated.
Turning to Slide 12, Resource Industries sales grew by 20% in the second quarter to $3.6 billion. The increase was primarily due to price realization and higher sales volume. Volume increased due to higher sales of equipment to end users. Although aftermarket sales volumes were lower, dealer sales to customers for services remained positive. Second quarter profit for Resource Industries increased by 108% versus the prior year to $740 million, mainly due to price realization and higher sales volume. This was partially offset by unfavorable manufacturing costs largely material costs. The segment's operating margin of 20.8% was an increase of 880 basis points versus last year. The segment's margin was better than we had expected, primarily due to favorable volume, timing of SG&A and R&D spend, and lower-than-anticipated freight costs.
Now on Slide 13. Energy and Transportation sales increased by 27% in the second quarter to $7.2 billion. Sales were up double digits across all applications. Oil and gas sales increased by 43%, power generation sales increased by 39%, industrial sales rose by 18% and transportation sales increased by 12%. Second quarter profit for Energy and Transportation increased by 93% versus the prior year to $1.3 billion. The increase was mainly due to higher sales volume and price realization, partially offset by unfavorable manufacturing costs and higher SG&A and R&D expenses. The segment's operating margin of 17.6% was an increase of 600 basis points versus last year. The margin was generally in line with our expectations.
Moving to Slide 14. Financial Products revenue increased by 16% to $923 million, primarily due to higher average financing rates across all regions. Segment profit increased by 11% to $240 million. The increase was mainly due to a lower provision for credit losses at CAT Financial, partially offset by an increase in SG&A expense. Business activity remains strong, and our portfolio continues to perform well. Past dues in the quarter were 2.15%, a 4 basis points improvement compared to the second quarter of 2022. This is the lowest second quarter past dues percentage since 2007. Retail new business volume performed well, increasing versus the prior year and the first quarter. In addition, we continue to see strong demand for used equipment.
Now on Slide 15. Our ME&T free cash flow generation was again robust as we generated $2.6 billion in the quarter. This was an increase of $1.5 billion compared to the prior year. With approximately $4 billion generated in the first half, we now expect ME&T free cash flow to be around the top of our $4 billion to $8 billion target range for the full year. Capex in the second quarter was about $300 million, and we still expect to spend around $1.5 billion for the full year. As Jim mentioned, we returned about $2 billion through share repurchases and dividends in the second quarter. Our balance sheet remains strong. We have ample liquidity with an enterprise cash balance of $7.4 billion, and we also hold an additional $2 billion in slightly longer-dated liquid marketable securities to improve yields on that cash.
Now turning to Slide 16. I will share some high level assumptions for the second half and the third quarter. In the second half of 2023, we expect higher total sales and revenues as compared to the second half of last year. We anticipate both sales to users and price realization will be positive in the second half. Keep in mind that on a comparative basis, we start to lap the stronger price we saw from the third quarter onwards last year. Caterpillar sales will be impacted by changes in dealer inventories as dealers increased their inventories in the second half of last year, which is not typical versus our expectation of a more typical reduction in the second half of 2023. I want to spend just a few moments talking about dealer inventories. Dealers are independent businesses, and they make their own decisions around the level of inventory they hold. We obviously work closely with them because this impacts our production levels. As Jim mentioned, we are very comfortable with the levels of inventory that dealers are holding. We talk about dealer inventory in aggregate. This is difficult to predict with certainty as it arises from three different business segments, over 150 dealers and hundreds of different products.
In Resource Industries and Energy and Transportation, dealer inventory is mainly a function of the commissioning pipeline. Keep in mind that over 70% of dealer inventory in these segments is backed by firm customer orders. For Construction Industries, dealer inventory is principally a function of end-user demand and availability from the factory. In Construction Industries, dealers typically increase inventories during the first half of the year. Around 60% of the $2 billion increase during the first half of this year was from products in this segment, the remaining 40% is in Resource Industries and Energy and Transportation. For Resource Industries and Energy and Transportation, we currently anticipate a slight reduction in levels in the second half but this is dependent on commissioning. In Construction Industries, dealers are currently holding around the midpoint of the typical three month to four month range. Some dealers would like to increase inventories of certain products, such as BCP and earth moving due to strong customer demand. Conversely, some dealers would like to reduce the levels of excavated inventory because of high availability. In addition, we are scheduled to replace third-party engines with CAT engines and certain products, which will impact production in these products during the second half. Our current planning assumption for the Construction Industries is that dealers will reduce their overall levels in inventory in the second half of 2023 with a principal focus on excavators. Overall, at the enterprise level, we currently expect dealer inventory should be slightly higher at the end of 2023 versus last year.
Moving on. On this slide, we provide our adjusted profit margins target change [Phonetic] to assist you in your modeling process. Based on our current planning assumptions, we anticipate full year adjusted operating profit margin to be close to the top of that 300 basis points target range at our expected sales level. Your expectation for total enterprise sales this year will inform you where on the curve margins should finish for the year. Specific to the second half, we anticipate adjusted operating profit margins in the remaining quarters of the year will be above the year ago levels, although they will be lower than the levels we saw in the first two quarters of this year. As compared to the first half, we anticipate a margin headwind from cost absorption in the second half. We do not expect to build our inventory as we did in the first half and anticipate that there will be some inventory reduction if we continue to see sustained supply chain improvement. In addition, spend related to the strategic growth initiatives should continue to ramp. Price realization should remain positive that the magnitude of the favorability versus the prior year is expected to be lower in the second half as we lap the more favorable pricing trends from last year. Therefore, the increases in margins that we have occurred -- that have occurred from price outpacing manufacturing cost inflation should moderate in the second half of this year.
Now let's move on to our assumptions that are specific to the third quarter. We anticipate third quarter sales to be higher than the third quarter of 2022, but to exhibit the typical sequential decline when compared to the second quarter of 2023. In Construction Industries, as is our normal seasonal trend, we expect lower sales compared to second quarter. In Resource Industries, which can be lumpy, we anticipate slightly lower sales compared to the second quarter. We expect sales in Energy and Transportation will increase slightly compared to the second quarter.
Specific to third quarter margins versus the prior year, adjusted operating profit margins at the enterprise level and segment margins should be stronger. However, we do expect lower enterprise adjusted operating profit margins in the third quarter compared to the second quarter of this year on lower volume and impacts from cost absorption. We also anticipate investment spend will ramp across our primary segments as we continue to accelerate our strategic investments in area like autonomy, alternative fuels, connectivity and digital and electrification. At the segment level, for Construction Industries, we expect a lower margin compared to the second quarter as is typical. This is largely due to lower quarter-on-quarter volume, increased investment in strategic initiatives and slightly higher manufacturing costs, including a headwind from cost absorption. Favorable price realization will act as a partial offset. We also anticipate lower third quarter margins in Resource Industries compared to the second quarter, primarily due to lower volume quarter-on-quarter. Conversely, we expect third quarter margins in Energy and Transportation will be slightly higher compared to the second quarter on higher volume and stronger price realization, partially offset by higher manufacturing costs and spend relating to strategic initiatives.
Now turning to Slide 13, let me summarize. We generated strong adjusted operating profit margin with 750 basis point increase to 21.3%. We now expect to be close to the top of the targeted range for adjusted operating margin -- profit margin for the full year based on our expected sales levels. ME&T free cash flow generation was robust at $2.6 billion in the quarter. We returned $2 billion to shareholders through share repurchases and dividends. We now expect ME&T free cash flow to be around the top of our $4 billion to $8 billion range for the full year. Lastly, we continue to execute our strategy for long-term profitable growth.
And with that, we'll now take your questions.
