Earnings Call Transcript - CAT Q4 2021

Operator, Operator

Welcome to the Fourth Quarter 2021 Caterpillar Earnings Conference Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Jennifer Driscoll. Thank you. Please go ahead.

Jennifer Driscoll, Investor Relations

Thanks, Emma. Good morning, everyone. Thank you for joining the fourth quarter earnings call for Caterpillar. With me are Jim Umpleby, Chairman and CEO; Andrew Bonfield, Chief Financial Officer; Kyle Epley, Vice President of the Global Finance Services Division; and Rob Rengel, Senior Manager and Investor Relations. Earlier this morning, we issued our earnings news release. You can find the release and accompanying slides on caterpillar.com in the Investors section under Events and Presentations. In the back of the slide, you’ll find supplemental information on dealer inventory and order backlog. We’ve copyrighted this call. Please don’t use any portion without a prior written approval. Now on slide 2. During our call, we’ll make forward-looking statements. These are subject to a host of risks and uncertainties. For more information about the risks and uncertainties that could cause our actual results to vary materially from any forward-looking statements, please refer to our SEC filings, including our 10-Q filings for the most recent quarters. On today’s call, we’ll also refer to non-GAAP numbers. For a reconciliation of any non-GAAP numbers to the appropriate U.S. GAAP numbers, please see the appendix of the earnings call slides. This morning, we announced profit per share of $3.91 for the fourth quarter of 2021. That compares with a profit per share of $1.42 in the fourth quarter of 2020. Our adjusted profit per share was $2.69 in the fourth quarter of 2021 compared with $2.12 in the fourth quarter of 2020. Adjusted profit per share for both quarters excluded restructuring and mark-to-market gains or losses for remeasurement of pension and other post-employment benefit plans. In the fourth quarter of 2021, we had $1.19 per share of remeasurement gain and $0.03 per share of net restructuring income due to a gain on the sale of a facility. In the fourth quarter of 2020, we had $0.63 per share of remeasurement losses and $0.07 per share of restructuring expenses. Please keep in mind, to a date, we’ll announce our first quarter earnings, April 28, and we’ll host our next Investor Day, May 17th. And with that, turn to slide 3. We’ll give the call over to Jim Umpleby.

Jim Umpleby, Chairman and CEO

Thank you, Jennifer. Good morning, everyone. Thank you for joining us. I’d like to start by recognizing our global team for their continued resilience and hard work in what proved to be a challenging and dynamic environment. We’re proud that we achieved our best year on record for employee safety for the third year in a row. In 2021, we continued to execute our strategy for long-term profitable growth while striving to meet strong customer demand. I’ll briefly cover a number of topics. I’ll start with my perspective on the quarter, then I’ll give a brief update on our supply chain, followed by comments on services and our end markets before closing with an update on Caterpillar’s sustainability journey. We were encouraged by the continued strong customer demand in the quarter. Sales and revenues rose in all regions and in the three primary segments due to volume gains and favorable price. Similar to the third quarter, absent the continuation of supply chain constraints, our top line would have been even stronger. On the other hand, our margins were lower than we expected, primarily because of two factors. First, freight costs were higher than expected due to inflationary pressures as well as our decision to increase the use of premium freight to meet as much customer demand as possible. The second factor was production inefficiencies. As I mentioned, underlying demand is stronger than we can currently supply due to ongoing supply chain constraints. We made the decision to keep our plants open and fully staffed to best serve our customers and meet as much demand as possible. We believe it’s the right decision to encourage some short-term margin impact rather than take actions that might limit our ability to more fully satisfy demand when supply chain conditions start to improve. We also continue to redirect components through our assembly processes and optimize where we can. Some of these actions aimed at maintaining our production flexibility come with additional short-term costs. When the supply chain bottlenecks begin to ease, we expect to be well positioned to increase our production to more fully meet demand and gain operating leverage from higher volume. Material costs also impacted us this quarter, but unlike freight and inefficiencies, it was within the range we had anticipated. As you know, we implemented price increases during 2021. We’re taking further action in 2022 with the intent to offset the impact of underlying inflation. That’s the general picture. Andrew will provide more details on our margins and how the combination of supply chain pressures and pricing will likely affect the cadence of our quarterly margins in 2022. Now on slide 4. Our top line rose by 23%. The primary drivers of the volume gains were increases in sales to users, including the original equipment and services and changes in dealer inventory. For the full year 2021, services sales grew 17% to $19 billion. Services growth in 2021 benefited from investments in our digital capabilities and the increased focus we and our dealers placed on meeting customer needs for services, particularly aftermarket parts. We saw significant increases in 2021 in e-commerce sales and sales of customer value agreements or CVAs and in prioritized service events or PSEs. In 2021, our e-commerce orders increased significantly, and now we have critical mass in connectivity with more than 1.2 million connected assets. It’s encouraging to see services sales in 2021 higher than in 2019 while our total company sales in 2021 remained lower than in 2019. We continue to strive to meet our aspirational target of doubling services to $28 billion by 2026. Compared with the fourth quarter of 2020, sales to users rose 7%. Gains were across the three segments. For machines, including Construction Industries and Resource Industries, sales to users rose 5%. For Energy & Transportation, sales to users increased 12%. Sales to users in Construction Industries rose by 4%, with double-digit growth in EAME and Latin America. In North America, residential construction remained strong with elevated housing construction, while nonresidential demand continued to improve at a slower pace. In Asia Pacific, end-user demand slowed, reflecting the expected moderation in China construction. However, excluding China, sales to users were positive in Asia Pacific driven by favorable commodity prices and government stimulus. In Resource Industries, sales to users rose by 10%. Mining saw healthy gains in the quarter, supported by strong commodity prices and the replacement of aging equipment. Sales to users increased versus the prior year in heavy construction and quarry and aggregates for the third straight quarter. In Energy & Transportation, sales to users were up across all applications versus the prior year. We saw double-digit growth in industrial and transportation, although from a low base. We experienced strength across many applications for industrial, and international rail deliveries benefited transportation sales as expected. Oil and gas grew from demand for both reciprocating engines and turbines. Finally, power generation sales to users increased as data center demand remains strong. Overall, total sales to users growth in the quarter moderated versus the second and third quarters. As a reminder, the impact of the pandemic lessened in the fourth quarter of 2020. In addition, the supply chain challenges have constrained our ability to fully meet end-user demand. As independent businesses, dealers make their own decisions about their inventories. Changes in dealer inventories drove about a $1 billion tailwind to sales compared with last year. Dealer inventory was nearly flat in the fourth quarter compared with the third quarter of this year. In the fourth quarter of 2020, dealers decreased their inventory by about $1.1 billion. To put it in context, our year-end dealer inventory in 2021 also finished about flat with year-end 2020, as we expected. Dealer inventories are generally near the low end of the typical range due to strong customer demand and our supply chain challenges. Currently, availability is extended for some products due to the shortage of semiconductors and other components. With the exception of China, end-user demand for our equipment remains strong. Turning to slide 5. In 2021, we met our 2019 Investor Day target for adjusted operating profit margins for the third year in a row. We also met our target for free cash flow for Machinery, Energy & Transportation or ME&T. Our strong cash flow enabled us to return $5 billion to shareholders this year through dividends and share repurchases. We paid a higher dividend annually for 28 consecutive years and are proud of our status as a dividend aristocrat. We expect to continue to return substantially all of ME&T free cash flow to shareholders through dividends and share repurchases over time. Next, on slide 6, I’ll share some high-level assumptions for the full year. First, in 2022, based on what we know today, we expect to achieve our Investor Day targets for adjusted operating profit margins and ME&T free cash flow. That said, the environment remains uncertain due to COVID and other issues, including continuing supply chain disruptions, freight and material cost inflation and labor availability. Our focus is long-term profitable growth. Despite the challenging environment, we continue to invest in services, electrification, autonomy, alternative fuels and digital technology, all of which support our strategy. Now, I’ll describe our outlook for key end markets this year. Demand remains strong as demonstrated by robust orders. In addition, we’re receiving positive input from our customers and dealers. A key variable remains the supply chain, namely to what degree can we fully meet strong customer demand. In Construction Industries in North America, residential construction continues to be the main growth engine with nonresidential also improving. We believe the U.S. Infrastructure Investment and Jobs Act will begin to fuel increased investments in capital equipment late this year, into 2023 and beyond. In China, we expect the industry for excavators above 10 tons to return to 2019 levels, reflecting weakness in housing construction. We expect the balance of Asia Pacific to have good growth, fueled by higher investments in infrastructure. Turning to EAME, positive fundamentals include government stimulus actions, construction confidence, new orders and commodity prices. Latin America is expected to benefit from construction activity and mining, supported by commodity prices, although strong inflation could make it more challenging. In Resource Industries, we anticipate elevated commodity prices will support continuing improvement in demand for mining products and services. We also expect growth in heavy construction and quarry and aggregates to continue in 2022. We now currently operate autonomously on 18 sites on 3 continents with more than 500 large mining trucks and have now moved more than 4 billion tons. Technology and autonomy offerings deliver significant benefits across the board, from boosting safety and productivity to more consistent and efficient operations. Autonomous operations enable higher machine utilization, leading to reductions in idle time and nonproductive fuel burn. In Energy & Transportation, we see improved sales across most applications, and we had strong order rates, including for large engines in the fourth quarter. While we expect our oil and gas customers to continue to display capital discipline, we do expect growth in our reciprocating engines and aftermarket services for oil and gas. We see growth in reciprocating engines for power generation with strength across many applications. Industrial, which includes engines for our own equipment and loose engines sold to customers, is projected to grow across many applications, including construction, agriculture and electric power. We expect a modest increase in transportation, primarily in rail services. We also anticipate growth in Marine from a low base as customers update aging fleets. In 2022, Solar is expected to be impacted by the dampening industry cycle. We expect Solar’s new equipment sales to be lower this year, which will be partially offset by continued services growth. Solar is experiencing healthy inquiry activity, which indicates the likely recovery in customer deliveries in late 2022 and into 2023. Now on slide 7. We significantly advanced our sustainability journey in 2021, and we continue to focus on this important element of our strategy. In 2021, Caterpillar and our customers announced a number of projects that will help contribute to a lower carbon future. I’ll highlight several more that occurred since our last earnings call. In November, Newmont announced a strategic alliance with Caterpillar to deliver a fully automated zero-emissions mining equipment and technology. The investment encompasses a U.S. surface mine and an Australian underground mine while also deploying Caterpillar MineStar across all Newmont sites. We also announced a three-year collaboration with Microsoft and Ballard to demonstrate a power system with large format hydrogen fuel cells to produce backup power for Microsoft data centers. Caterpillar is providing the system integration, electronics and controls that form the central structure of the power solution, which will be fueled by low carbon intensity hydrogen. The project is backed by the U.S. Department of Energy. In December, Progress Rail entered into a memorandum of understanding with BNSF and Chevron to advance the demonstration on BNSF’s line of a locomotive powered by hydrogen fuel cells. Progress Rail plans to design and build a prototype hydrogen fuel-cell locomotive with Chevron developing the infrastructure to support it. Earlier this month, Teck Resources, one of Canada’s leading mining companies, announced a partnership with Caterpillar to deploy 30 zero-emissions large haul trucks, including Cat 794 ultra-class trucks at their mining operations beginning in 2027. This collaboration will support their goals to reduce the carbon intensity of their operations by 33% by 2030 and be carbon-neutral by 2050. And finally, Union Pacific is purchasing 10 Progress Rail battery-electric locomotives, making them our fourth customer for this new technology. In railroads, they will be tested in diverse weather conditions and evaluated for broader deployment in support of Union Pacific’s emissions reduction goals. We’re excited about the opportunities associated with the energy transition, which includes rising demand for commodities used in electric vehicles and other applications, benefiting Resource Industries. The significant infrastructure investments associated with the energy transition also support growth in Construction Industries. In addition, the increased demand for a number of products in our Energy & Transportation segment, including distributed power generation and our integrated systems and solutions to help our customers meet their climate-related objectives. Caterpillar continues to invest in research and development to support a wide variety of fuel types, energy storage and hybrid solutions. In summary, we’re continuing to execute our strategy for long-term profitable growth. The three core elements of the strategy remain: services, expanded offerings and operational excellence. Services growth and our record safety performance are among the many highlights of 2021. We remain committed to a reduced carbon future, both in our operations and helping customers reach their climate-related goals. We continue to introduce products and services that facilitate fuel transition, increase operational efficiency and reduce emissions. While we continue to face supply chain challenges that negatively impacted our top line and our fourth quarter margin performance, we’re focusing on meeting as much customer demand as possible and remain encouraged by the continuation of strong end-market demand. Our team delivered 2021 adjusted operating profit margins and ME&T free cash flow consistent with the long-term targets we set at our 2019 Investor Day, while continuing to invest in our long-term strategy for profitable growth. With that, I’ll turn the call over to Andrew.

Andrew Bonfield, Chief Financial Officer

Thanks, Jim, and good morning, everyone. I’ll begin with a recap of Caterpillar’s fourth quarter results, including the performance of each segment, then I’ll comment on the balance sheet and cash flow, before concluding with a few assumptions about the first quarter and full year of 2022. Starting with the fourth quarter on slide 8. Our sales and revenues rose by 23% or $2.6 billion to $13.8 billion. Volume growth led the way and was broad-based as demand remained strong. Operating profit increased by 17% to $1.6 billion as volume growth and favorable price were partially offset by freight, material and short-term incentive compensation headwinds. As Jim has mentioned, operating margins were lower than we had anticipated, primarily due to elevated freight costs and plant inefficiencies, which I’ll discuss further in a few moments. Fourth quarter profit per share was $3.91 compared to $1.42 last year. We had our usual impacts from mark-to-market accounting for remeasurement of pension and OPEB plans. That included $1.19 per share favorable in the fourth quarter of this year compared to $0.63 per share unfavorable last year. Restructuring was actually a net income of $19 million in the quarter, due to the gain on the sale of the facility. In addition, some of our planned restructuring activities that we’d originally expected to complete in the quarter will push back into 2022. We reported adjusted profit per share of $2.69 in the fourth quarter compared to $2.12 last year. This performance included a lower-than-expected global tax rate and some discrete tax items, which, together, added approximately $0.36 to fourth quarter profit per share. Now on slide 9. As we had anticipated, the top line for the fourth quarter was the strongest of the year, coming in slightly better than normal seasonality would imply. Dealer inventory provided about a $1 billion tailwind versus the comparable quarter in 2020 when dealers reduced their inventories by $1.1 billion. Sales to users growth decelerated a bit sequentially, but remained strong despite a tougher comparison period, particularly in China. Price realization strengthened as we saw the benefit of additional price actions begin to flow through. Services continue to be a bright spot. I want to take a moment to provide some color on dealer inventory. Caterpillar dealers typically hold between three and four months worth of inventory based on projected sales for the next 12 months. For the past year, they’ve been near the low end of that range. Because of strong sales to end users and supply chain constraints, dealers have prioritized customer orders over building inventory. As a result, dealers have been unable to restock as would have been their normal practice. Given the current constrained environment, we don’t expect to see a significant benefit from dealer restocking in 2022. Fourth quarter sales and revenues increased in every region. In North America, our largest region, sales increased by 27%, with strong growth in all three primary segments, but led by Construction Industries and Resource Industries. In EAME, sales rose by 24% as fundamentals remain strong. Latin America sales grew by 38% from a low base. Asia Pacific sales increased by 9% as gains in Energy & Transportation and Resource Industries more than offset lower revenues in Construction Industries. Excluding China, Construction Industries sales in the regions grew versus the prior year’s quarter. Just to remind you, the quarterly sales profile for China in 2020 was very different from the normal seasonal pattern, with a strong second half due to the timing of stimulus activity. In 2021, we have returned to the more typical profile of a stronger first half of the year ahead of the selling season. This made for a particularly tough comparison as China sales were abnormally strong in the fourth quarter of 2020. Now, let’s review the bottom line on slide 10. Fourth quarter operating profit increased by $231 million or 17%. Compared to the prior year, strong volume and favorable price realization were the principal drivers of the increase. Higher manufacturing costs and SG&A and R&D expenses partially offset these gains. Acceleration in freight, manufacturing inefficiencies and material costs drove the manufacturing cost increases. The freight costs included both inflation and standard rates and the increased use of premium freight. The reinstatement of short-term incentive compensation had an impact on manufacturing costs and SG&A and R&D expenses, albeit at a slower rate than previous quarters. Beginning in the second quarter, we told you that we had expected price realization to offset higher manufacturing costs for machines in 2021. We have come up just short of that goal as the unfavorable impacts of rising freight costs and the manufacturing inefficiencies during the fourth quarter were more significant than we had expected. As we had noted previously, due to taking price action later in the year, we had expected a lag in Energy & Transportation price realization, so material cost increases and sharply rising freight costs negatively impacted Energy & Transportation’s margins more significantly than they did for the machine groups. Moving to margins. The adjusted operating profit margin was 11.4%, a decrease of 140 basis points, with short-term incentive compensation expense, a headwind of roughly 150 basis points of margin in the quarter. As both Jim and I have acknowledged, margins for the fourth quarter deteriorated by more than we had expected. To provide a bit more perspective, we typically see margins decrease sequentially by between 100 to 200 basis points from the third quarter to the fourth quarter. However, in the fourth quarter of 2021, the spike in freight costs, along with the plant inefficiencies that Jim described, caused an additional unfavorable impact of around 100 basis points or so. Most of this was due to the need to ship components using premium freight and factory inefficiencies that resulted from challenges caused by component shortages as we prioritize meeting customer demand. We believe that these margin headwinds are temporary and will only last as long as the supply chain challenges remain. Our price actions are designed to cover increases in underlying input costs, but do not anticipate factory inefficiencies or premium shipping, which had to be used to serve our customers. There’s no doubt that this will impact some part of 2022, but it’s impossible to be certain when these costs will abate. Now looking at the full year. Our adjusted operating profit margin was 13.7%. As Jim mentioned, we’ve achieved our 2019 Investor Day margin target of adjusted operating profit margins being 300 to 600 basis points better at a comparable level of sales to the reference period of 2010 to 2016. We’ve done so while investing in new product launches, services and sustainability. Of note, R&D expense, including higher short-term incentive compensation, increased by 19% for the full year. Our global effective tax rate for the fourth quarter was approximately 23% versus the 25% we had assumed previously. The improvement primarily related to changes in the geographic mix of profits from a tax perspective. Adjusted profit per share was $2.69, reflecting the stronger volume, favorable price as well as the lower-than-expected global tax rate. Moving to slide 11. Let’s take a look at the segment performance, starting with Construction Industries. Sales increased by 27% in the fourth quarter to $5.7 billion, primarily driven by strong sales volume and favorable price realization. The improvement in volume was due to a smaller reduction year-over-year in dealer inventories and higher end-user demand. End-user demand improved in three of the four regions. In North America, we saw our largest sales growth as nonresidential demand continued to improve, and housing construction remained supportive. End-user demand eased in Asia Pacific due to the challenging comparatives in China that I spoke about earlier. The segment’s fourth quarter profit increased by 25% to $788 million on higher sales volume and favorable price realization. Cost increases related to material and freight were more than offset by price increases. However, the segment’s operating margin decreased by 30 basis points versus last year to 13.7% due to the headwinds of factory inefficiencies and higher short-term incentive compensation expense. Turning to slide 12. Resource Industries sales increased by 27% in the fourth quarter to $2.8 billion. The improvement was mostly due to higher end-user demand and favorable price. End-user demand increased in mining as well as heavy construction and quarry and aggregates. Fourth quarter profit for Resource Industries increased by 12% to $305 million. Increased manufacturing costs, including freight and material costs, and higher SG&A and R&D expenses were more than offset by higher sales volume and favorable price realization. The increase in SG&A and R&D expenses was driven by investments and higher short-term incentive compensation. In Resource Industries, price realization takes longer to come through results because of the equipment’s longer lead times between the time of an order and date of delivery. However, as we progress through 2022, we expect more benefits to flow through from the price increases we have taken. The segment’s operating margin decreased by 150 basis points versus last year to 11.0%. Now on slide 13. Energy & Transportation sales increased by 19% to approximately $5.7 billion with sales up across all applications. That included a 22% sales increase in oil and gas, including aftermarket parts for reciprocating engines. Gas compression also supported reciprocating engine sales. Power generation sales increased by 7%, driven by reciprocating engine aftermarket part sales. Industrial sales rose by 29% with strength across many applications. Last, transportation rose by 17% on strong international rail deliveries and services in the quarter. Profit for Energy & Transportation decreased by 2% to $675 million. Volume and price gains were more than offset by higher manufacturing costs, short-term incentive compensation expense and investments in growth initiatives such as the energy transition. Keep in mind that the majority of our core investments in the energy transition, for example, in electrification, impact this segment. Freight cost increases were particularly significant in the quarter, driving the higher manufacturing costs. The segment’s operating margin decreased by 250 basis points versus last year to 11.8%. On Slide 14, financial products had a very strong quarter. Revenue increased by 4% to $776 million. Segment profit increased by 27% year-over-year to $248 million. The year-over-year profit increase was partly due to continued strong demand for used equipment, where worldwide new sales were our highest on record in 2021. The segment also benefited from a lower provision for credit losses at Cat Financial. Moving to our credit portfolio, it's in good shape as customer health indicators remain positive. Past dues continue to improve across all portfolio segments to 1.95%. That’s down 154 basis points year-over-year and down 46 basis points compared to the third quarter. It’s the lowest past due levels we’ve seen in 15 years. New retail lending hit an eight-year high in the fourth quarter. On slide 15, ME&T free cash flow was $1.8 billion in the quarter, an increase of about $116 million versus the fourth quarter of last year. The increase was due to higher profit adjusted for noncash items, which includes higher accruals for short-term incentive compensation. ME&T generated $6 billion in free cash flow this year, almost double compared to the prior year and in line with our Investor Day target of between $4 billion and $8 billion. We recently declared a quarterly dividend of $1.11 per share or around $600 million per quarter. In 2021, we paid around $2.3 billion in dividends. We are proud of our dividend aristocrat status, which we maintained following the 8% quarterly increase announced in June of last year. We completed $1 billion in share repurchases in the fourth quarter for a total of $2.7 billion in 2021. In aggregate, we returned $5 billion to shareholders, which represents 83% of our ME&T free cash flow for 2021. Over the past four years, on average, we’ve returned 99% of our ME&T free cash flow to shareholders. That aligns to our target to return substantially all of our ME&T free cash flow to shareholders over time. The Company ended the year with $9.3 billion in enterprise cash, a strong position. As always, given our captive finance organization, which helps our customers acquire our equipment, we continue to maintain a strong balance sheet as we prioritize our mid-A credit rating. Now on slide 16. In light of the fluid environment, we will continue to not provide guidance for our annual profit per share. However, to assist with modeling the Company, we’ll continue to share some high-level assumptions for the upcoming quarter and full year. Looking to the first quarter, we expect the top line to increase versus the prior year on stronger end-user demand and higher prices. We also expect to see a dealer inventory increase, which would follow our normal seasonal pattern as dealers prepare for the spring selling season. However, we anticipate that increase will be slightly less than normal, given the supply chain constraints and the high levels of committed orders. For the full year, we expect the environment to support strong end-user demand and higher pricing. The extent that we’ll be able to fulfill that demand will be impacted by the supply chain challenges we’ve discussed today. As these alleviate, we would expect to see an acceleration in sales to end users. As we have noted, our order books and backlog are robust, but we do expect the supply chain to constrain our volumes. Before I discuss margins, I want to highlight how unusual the last two years have been. In 2020, the full impact of the pandemic started to be felt from the end of the first quarter. While demand started to improve through 2021, we then started to see the impacts of commodity and freight inflation as well as significant supply chain pressures build through the year. This makes our normal quarterly phasing more difficult to model as there are fundamental changes in the underlying comparatives that make historic norms less relevant. Let me explain. In 2021, pricing was slow to ramp up and picked up in the third and fourth quarters of the year following midyear and October price increases. From a cost perspective, material and freight costs were about flat in the first quarter and then ramped up through to be at their highest in absolute terms in the fourth quarter. So, that sets up our comparisons. Then this year, we will begin with a carryover pricing from midyear and October 2021. And then we expect to have additional pricing in 2022. That’s why we expect pricing to be more or less evenly spread across the quarters as we move through 2022. Then we will lap those rising material and freight costs and manufacturing inefficiencies as we move towards the back half of the year, so we will have easier comparisons. In a nutshell, we anticipate the greatest headwinds to margin in 2022 to occur in the first quarter. This is completely counter to the normal historic pattern of strong margins in the first quarter, with margins decreasing sequentially to the fourth. We expect those headwinds to margins to abate as the year goes on, as we realize more price and as we lap the higher costs. More importantly, we intend price increases to more than offset manufacturing cost increases in 2022, assuming the current level of supply chain disruption does not deteriorate. I’ll provide a few more key assumptions for you to keep in mind as well. Our short-term incentive compensation expenses anticipate to be around $1 billion for the year or $250 million per quarter. That’s a $50 million tailwind in the first quarter. Also, we’ll have about $1.3 billion cash outflow in the first quarter related to the payout of last year’s incentive compensation. We anticipate an increase in R&D, reflecting continued acceleration of investments related to initiatives such as sustainability, electrification and digital. Restructuring expense should be a headwind for the year. We anticipate around $600 million in restructuring expense in 2022 compared to $90 million in 2021. The increase is larger than usual due to the actions to address certain challenged products we’ve already announced, some of which were delayed a bit. Keep in mind that our adjusted profit per share calculation excludes restructuring costs. We also estimate prior restructuring actions will benefit 2022 by around $75 million. In addition, we assume an annual global effective tax rate of around 25%. Finally, we anticipate CapEx to be in the $1.4 billion range. Turning to slide 17. Let me recap today’s key points. We met our adjusted operating margin and ME&T free cash flow targets in a challenging year. End-user demand remained strong. And in a challenging supply chain environment, we kept our factories open, maintained our production flexibility and recognized $2.6 billion more in revenues. We continue to execute our strategy for long-term profitable growth as we expand our offerings in preparation for the energy transition. We anticipate stronger sales volume in the first quarter versus the prior year, while margins will be pressured in the first quarter as costs remain elevated and the full benefits of pricing flow through evenly throughout the year. With that, I’ll take your questions.

Operator, Operator

The first question comes from Jerry Revich of Goldman Sachs.

Jerry Revich, Analyst

I’m wondering if you can update us on your order prospect pipeline in resources. Are you expecting an acceleration in replacement orders this year as the utilizations would suggest, or to what extent are replacement orders being held back by customers waiting for scaled zero-emissions products over the next couple of years?

Jim Umpleby, Chairman and CEO

Well, thanks, Jerry, for your question. As we’ve been discussing in the last several earnings calls, we’re positive about mining in the general environment. Everything from the energy transition driving the need for more commodities is creating opportunities in mining. We’re continuing to see strong inquiry and quotation activity and increases in orders as we discussed. We’re working very closely with our customers to help meet their emissions goals as well. There’s been a number of announcements over this year. So again, I don’t believe it’s holding up orders. We’re seeing orders play out much as we had expected. Generally, we’re still on the path of expecting not a big spike up, but a continued gradual improvement in mining orders.

Operator, Operator

Your next question comes from the line of Robert Wertheimer with Melius Research.

Robert Wertheimer, Analyst

So, I wonder if you’d be willing to give us any expanded comments on aftermarket strategy. It’s good to see the growth. I don’t know where you stand versus your internal goals when you set this. I don’t know if you’ve identified all the workflows to get you to your 2026 goal, what those workflows are. I wonder if you could just give any more commentary on that. Thank you.

Jim Umpleby, Chairman and CEO

Well, thanks, Rob. We were encouraged to see the 17% increase this year up to $19 billion. This is something that our company is very focused on. Our dealers are very focused on it, and we’ve talked about a number of the things that we’re doing, including continuing to invest in our digital capabilities, using analytics or what we call PSEs or Prioritized Service Events to send targeted leads to our dealers, signing more CVAs so that we have those contracts that help us better serve the customer, minimize downtime, maximize equipment availability and capture more of the aftermarket. It’s a win for the customer, for the dealer and for Caterpillar. We are pleased with the progress that we’re making. I’m never satisfied that we’re moving fast enough in every area of the business. I want us to move faster, but I am very pleased to see the commitment by our dealers and by our teams to continue to execute on this initiative. We said it wouldn’t be a straight line up. We knew we had to make a number of investments, and we’re making those investments and we are starting to see progress on the top line as well. So far, so good. We know it will be a tough slog, but the whole company is aligned behind that goal.

Operator, Operator

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

David Raso, Analyst

If I heard you correctly about the first quarter margins expected to be down sequentially from the fourth quarter, that would put us about 400 basis points down year-over-year or so in the first quarter. And I know it’s a difficult environment. So, we’re just trying to get some sense of the comments you made of price cost being positive for the year, and obviously, that gets stronger as the year goes on in that assumption. How would you characterize after that first quarter margin decline year-over-year on the prospects for full year margins getting back to flat?

Andrew Bonfield, Chief Financial Officer

Apologies if you heard that we were expecting margins to decline sequentially. Actually, we do not expect them to decline sequentially. We expect them to be impacted year-over-year as a result of the impact of higher manufacturing costs versus price. Sequentially, we do expect the normal pattern where margins improve as you progress through the year. Obviously, there is normally a big ramp up between Q1 and Q4, and we expect to see an increase, but it won’t be as big an increase as you would normally have seen. When we look at what we saw in the fourth quarter, price was favorable by just over $500 million and manufacturing costs adverse by about $800 million. We expect a little bit better price in Q1 because of the impact of the October price increase we put through. That will help a little bit. Manufacturing costs will continue at a similar level because last year we actually had a small reduction in material costs in the first quarter. Freight did increase a little bit. So, there’ll be some change between those two. As we go through the year, we start to lap the very significant manufacturing cost increases that we saw in Q3 and Q4, so the comparisons become easier. Price will remain pretty consistent throughout the whole year. Our expectation is that revenues will rise in 2022, which will impact margins as a result of trying to maintain that comparable 300 to 600 basis points improvement versus the reference period of 2010 to 2016.

Operator, Operator

Your next question comes from the line of Jamie Cook with Credit Suisse.

Jamie Cook, Analyst

Just another question on the backlog. Obviously, it was very strong at $22.8 billion. Is there any way you could help us break down how that looks sort of by segment and to what degree the backlog is price protected? And then, I guess, historically, you’ve seen improvement in backlog or backlog is highest in the first and second quarters. Is that the way we should think about backlog this year on a seasonal basis? Thank you.

Jim Umpleby, Chairman and CEO

Good morning, Jamie. I’ll start, and then I’ll kick it over to Andrew. We do have a strong backlog, and the biggest increase was in Energy & Transportation. We feel good about that because in E&T we tend to typically have a good line of sight to actual customer orders. So, we do feel positive about that. Now I’ll let Andrew take you there.

Andrew Bonfield, Chief Financial Officer

On price protection, as you know, it depends segment by segment. We have a mix of some longer-term contracts where you do have escalators. But depending on the timing of an order, there will be some impact on backlog from pricing or price protection. When we look at our overall expectations for manufacturing cost increases versus price, we do take into account any price protection when we’re forming our view and when we say we intend for price to more than offset manufacturing costs next year. It depends by segment. A long-term mining order will have a different contractual response versus a retail customer purchase.

Operator, Operator

Your next question comes from the line of Larry De Maria with William Blair.

Larry De Maria, Analyst

You guys mentioned semiconductors in the prepared remarks. I think we’re all hearing mixed things, in some cases, getting better, and in many cases, getting worse. Can you just talk to semiconductors specifically, your outlook on the timing and magnitude of the improvements? And how much inventory is idled and waiting to go out the door because of semiconductor shortages?

Jim Umpleby, Chairman and CEO

Semiconductors have been a challenge for us, and I would not say that they have started to get better from our perspective. It’s very difficult to predict when the improvement will occur, but it’s still creating a challenge for us. Semiconductors go into many electronic components, including engine controllers. As we look at margins in E&T in the fourth quarter, part of the premium freight usage resulted because we couldn’t get engine controllers; the engine controller manufacturers couldn’t get semiconductors, so we ended up air freighting more engines than we had anticipated. Many experts are making predictions on when things will start to improve. We haven’t seen that yet. We’re hopeful as we go through the year that it will improve, but we haven’t seen it yet.

Operator, Operator

Your next question comes from the line of Chad Dillard with Bernstein.

Chad Dillard, Analyst

I was hoping you could talk about your volume production outlook for 2022. What’s the current supply chain situation, can you grow production this year? And are there any segments that we’ll see better production growth versus others?

Jim Umpleby, Chairman and CEO

We certainly do expect to have higher production this year. Customer demand is strong. It’s difficult to predict the exact extent because it really comes down to the supply chain. The demand is there, but our ability to scale production depends on whether the supply chain can deliver the components we need.

Andrew Bonfield, Chief Financial Officer

To add, the only area where we are potentially seeing some slowdown will be in construction in China in 2022. Everywhere else, we’re looking at good volume potential growth across the board.

Operator, Operator

Your next question comes from the line of Nicole DeBlase with Deutsche Bank.

Nicole DeBlase, Analyst

Focusing on the comment that E&T faced the most price/cost headwinds: when we look forward into 2022, you mentioned a growing backlog there. Have you increased prices in backlog? And when should we start to see pricing show up and be reflected in improving sequential margins within the segment?

Jim Umpleby, Chairman and CEO

We did not increase prices as quickly in E&T earlier, given the market conditions at the time. The world has changed since then with increasing oil prices and demand, so we have taken price increases since then and intend to continue to offset input costs. Supply chain constraints will also have an impact, so as they ease, that will help.

Andrew Bonfield, Chief Financial Officer

As we’ve indicated, price will be pretty even throughout the year. As time goes on, we will see the benefit of the manufacturing cost increases we saw in Q3 and Q4 of last year when those comparisons become easier. Energy & Transportation does have higher short-term incentive compensation, so that was more significant as a percentage for E&T, and E&T will also be the area where we’re making investments, particularly in electrification. Price is starting to flow through and we need to ensure it sticks and pulls through into 2022.

Jim Umpleby, Chairman and CEO

Again, supply chain constraints will also have an impact. As they start to ease, that will help margins as well.

Operator, Operator

Your next question comes from the line of Ross Gilardi with Bank of America.

Ross Gilardi, Analyst

Can you give a little color on what the $600 million of restructuring expenses are for? It seems like a big number. And on R&D spend, you alluded that it will be up this year with many initiatives on zero emissions. Are you back above $2 billion in 2022? Do we get back to the prior peak from 2012 of $2.5 billion in the next couple of years?

Jim Umpleby, Chairman and CEO

On restructuring, we task our leaders to continually find ways to improve our competitiveness. The increase we mentioned for 2022 is associated with specific projects we have going on that we’ve known about for some time. Regarding a customized approach to zero-emissions projects, we are working to meet the unique needs of our customers, but many solutions have applicability across products and customers. Different mine sites have different needs—some have grid availability, some will look at hydrogen, some at electrification—so there is variability, but a lot of the core technologies we’re developing will apply across product lines and segments. It’s not a completely customized approach.

Andrew Bonfield, Chief Financial Officer

To add some color on the $600 million: the biggest single item is a noncash item relating to one of those challenged businesses, so it will not actually result in a cash outflow but is part of the reason why it’s such a large charge. On R&D spend, there will be puts and takes in 2022. There will be slightly lower short-term incentive compensation which helps, and there will be increased investment. We don’t guide on individual line items, but we do expect continued growth in R&D as part of our investment to drive long-term profitable growth. Part of the reason we set ourselves 300 basis points of flexibility within the margin target was to enable those right investments.

Operator, Operator

Your next question comes from the line of Tami Zakaria with JP Morgan.

Tami Zakaria, Analyst

From your dealers’ perspective, I believe you mentioned dealer inventory will not be a significant benefit this year. Do you see dealer inventory gradually making its way back to pre-pandemic levels over time, or has anything structurally changed in their business to keep it lower now that they’re learning to operate with less inventory?

Jim Umpleby, Chairman and CEO

Dealer inventory is toward the low end of the normal range, and that’s a function of strong demand and supply chain challenges. We do expect, as supply chain conditions start to ease, that dealer inventories would get within a normal range. We typically think about dealer inventory in months of supply rather than absolute dollars. We don’t expect a significant change in dealer inventory this year, but assuming supply chain conditions improve and demand remains strong, over time dealer inventory should start to come up toward the middle of the normal range.

Operator, Operator

Your next question comes from the line of Stephen Volkmann with Jefferies.

Stephen Volkmann, Analyst

You mentioned the infrastructure bill might start to benefit you in the second half of 2022 and into 2023. Can you expand on that a bit? How much of an improvement could this be for Caterpillar? Have you had a chance to dig through the bill by now?

Jim Umpleby, Chairman and CEO

It is a challenge to quantify specifics, but given the amount of investment and the way our products are used for infrastructure, we do believe it will provide a tailwind. One of the effects is it provides more certainty to customers: if a contractor sees a pipeline of work, they are more likely to make capital investments in new machines. It will take time to manifest into projects and then into orders for us, but we do expect it to start impacting us toward the end of this year and into next year. If supply chain challenges ease, we expect to be able to meet that increased demand. We are positive about the passage of the bill.

Operator, Operator

Your next question comes from the line of Courtney Yakavonis with Morgan Stanley.

Courtney Yakavonis, Analyst

When you said pricing would be relatively even through the year, did you mean the absolute level of pricing or the year-over-year growth rate? For two of your divisions the growth rate was about 5% to 6% and lower in E&T. Should we think that growth rate is constant through the year, or was that a comment more on the absolute level? Also, can you expound on premium freight? You’ve been talking about freight costs all year. Was this a significant difference in the fourth quarter with respect to premium freight? Can you help quantify how big of an impact that is relative to regular freight costs?

Jim Umpleby, Chairman and CEO

Whether you think about absolute or percentage terms, we expect pricing to be pretty even through 2022. We expect some variability quarter-to-quarter in sales volumes, but not huge variability. We’re carrying over earlier price increases from 2021 and expect additional pricing through 2022. That is subject to not having to implement further increases beyond what we’re already planning. E&T has lagged other segments, but we expect it to catch up. On premium freight, freight historically is a relatively small number versus material costs, but we have seen an exponential rise in freight. Two factors: underlying inflation and increased use of premium freight. We are premium freighting more parts, some of which we recover from dealers, and some premium freighting internal components to keep factories going. You trade off the cost of keeping a factory open and running versus the freight cost. Freight increased a lot. If you remember, I mentioned margins were about 100 basis points worse than originally anticipated for the quarter. Part of that was freight and part was manufacturing inefficiencies—about half and half. So freight was roughly 50 basis points in the quarter. One thing to watch is how bottlenecks, particularly freight, unwind as we go through 2022.

Operator, Operator

Your next question comes from the line of Joel Tiss with BMO.

Joel Tiss, Analyst

Can you give us a rough sense of the size of the buckets, dollar-wise: how much dealer inventories are below normal? How far below potential is your production versus normalized levels? Is it $10 billion, $7 billion, or any sort of idea would be helpful.

Andrew Bonfield, Chief Financial Officer

On dealer inventory, they are at the low end of the range. Given the current constrained environment, it’s not likely to change much in 2022. It would be speculative to give you a concrete dollar number for 2023 because it depends on what dealers expect for revenues in 2023. We’ll be as transparent as we can as we get more clarity. On production levels, we can scale production and we are not running anywhere near capacity, so we have plenty of capacity to scale. The question is the supply chain’s ability to deliver. Backlogs increased by $9 billion over the year, which is significant. We could produce more, but many items in backlog are long lead-time items, particularly in Energy & Transportation and Resource Industries.

Jim Umpleby, Chairman and CEO

One of the things we are doing is prioritizing meeting customer orders rather than rebuilding dealer inventory while we deal with supply chain constraints. That is our focus with our dealers.

Operator, Operator

Your next question comes from the line of Matt Elkott with Cowen.

Matt Elkott, Analyst

Can you talk about the impact on your overall pricing from lower China sales? Any way to better gauge the potential benefit on pricing? And as China demand softens domestically, is there risk that their exports would increase enough to intensify competitive pricing dynamics in regions outside China?

Jim Umpleby, Chairman and CEO

On the last part, we also have the ability to export from China, so if there is additional capacity in China it allows us to export from there to meet demand around the world. We can do the same as others from that standpoint. Andrew, I’ll let you answer the geo mix question.

Andrew Bonfield, Chief Financial Officer

When China volumes reduce, you can see a small benefit to price from geo mix. However, a lot of the machines we sell in China are lower-spec GC and GX machines, so the impact on the geographic mix is slightly less than you might expect in Q4.

Operator, Operator

Your final question today comes from the line of Mig Dobre with Baird.

Mig Dobre, Analyst

Andrew, just a clarification on manufacturing cost progression: you had an approximate $816 million headwind in the fourth quarter. I believe I heard you saying you’re expecting something similar in Q1. My own thought was this figure could be higher sequentially. Can you confirm? Also, how are you planning raw material purchases for 2022? Given developments in steel markets, is it plausible you see some benefit from lower raw material costs year-over-year as the year progresses?

Andrew Bonfield, Chief Financial Officer

Mig, fourth quarter is our highest quarter for sales and revenues, so sequentially we go down slightly in Q1 versus Q4. That is why we expect manufacturing cost increases to slightly moderate in Q1 compared to Q4, but not hugely. As for input cost decreases, remember we tend to have a three-to-six-month lag on passing through material cost changes. If steel prices reduce, that could be a benefit later in the year, but we are not relying on that in our expectations. Given the lag, any benefit would likely come very late in the year.

Jennifer Driscoll, Investor Relations

Well, thank you, Jim and Andrew, and everybody who joined us today. A replay of our call will be available online later this morning. We’ll also post a transcript on our Investor Relations website as soon as it’s available. In addition, you’ll find a fourth quarter results video with our CFO and an SEC filing with our sales-to-users data. Click on investors.caterpillar.com and then click on Financials to view these materials. If you have any questions, please reach out to Rob or me. You can reach Rob at rengel_rob@cat.com or me at driscoll_jennifer@cat.com. The Investor Relations general phone number is 309-675-4549. We hope you enjoy the rest of your day and have a great weekend. I’ll turn it back to Emma to conclude our call.

Operator, Operator

This concludes today’s conference call. Thank you for attending. You may now disconnect.