Edgar Filing: CATERPILLAR INC

Form 10-Q for 3rd quarter 2006

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549

FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ________________
Commission File Number: 1-768
CATERPILLAR INC. (Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation)	37-0602744 (IRS Employer I.D. No.)
100 NE Adams Street, Peoria, Illinois (Address of principal executive offices)	61629 (Zip Code)
Registrant's telephone number, including area code: (309) 675-1000
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]
At September 30, 2006, 650,534,474 shares of common stock of the Registrant were outstanding.

Page 1

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Caterpillar Inc. Consolidated Statement of Results of Operations (Unaudited) (Dollars in millions except per share data)
		Three Months Ended
		September 30,
		2006		2005

Sales and revenues:
	Sales of Machinery and Engines	$	9,842	$	8,392
	Revenues of Financial Products		675		585

	Total sales and revenues		10,517		8,977

Operating costs:
	Cost of goods sold		7,610		6,547
	Selling, general and administrative expenses		988		775
	Research and development expenses		329		285
	Interest expense of Financial Products		266		197
	Other operating expenses		246		233

	Total operating costs		9,439		8,037

Operating profit			1,078		940

	Interest expense excluding Financial Products		72		68
	Other income (expense)		72		80

Consolidated profit before taxes			1,078		952

	Provision for income taxes		334		303

	Profit of consolidated companies		744		649

	Equity in profit (loss) of unconsolidated affiliated companies		25		18

Profit		$	769	$	667


Profit per common share		$	1.18	$	.98

Profit per common share - diluted ¹		$	1.14	$	.94

Weighted average common shares outstanding (millions)
	- Basic		653.2		678.8
	- Diluted ¹		677.2		710.7

Cash dividends declared per common share		$	-	$	-
¹ Diluted by assumed exercise of stock options and SARs, using the treasury stock method.
See accompanying notes to Consolidated Financial Statements.

Page 2

Caterpillar Inc. Consolidated Statement of Results of Operations (Unaudited) (Dollars in millions except per share data)
		Nine Months Ended
		September 30,
		2006		2005

Sales and revenues:
	Sales of Machinery and Engines	$	28,541	$	24,965
	Revenues of Financial Products		1,973		1,711

	Total sales and revenues		30,514		26,676

Operating costs:
	Cost of goods sold		21,578		19,652
	Selling, general and administrative expenses		2,690		2,308
	Research and development expenses		979		794
	Interest expense of Financial Products		754		551
	Other operating expenses		738		654

	Total operating costs		26,739		23,959

Operating profit			3,775		2,717

	Interest expense excluding Financial Products		206		198
	Other income (expense)		165		278

Consolidated profit before taxes			3,734		2,797

	Provision for income taxes		1,153		850

	Profit of consolidated companies		2,581		1,947

	Equity in profit (loss) of unconsolidated affiliated companies		74		61

Profit		$	2,655	$	2,008


Profit per common share		$	4.01	$	2.95

Profit per common share - diluted ¹		$	3.86	$	2.84

Weighted average common shares outstanding (millions)
	- Basic		662.4		680.5
	- Diluted ¹		688.5		707.4

Cash dividends declared per common share		$	.55	$	.46
¹ Diluted by assumed exercise of stock options and SARs, using the treasury stock method
See accompanying notes to Consolidated Financial Statements.

Page 3

Caterpillar Inc. Consolidated Statement of Financial Position (Unaudited) (Dollars in millions)
					September 30, 2006			December 31, 2005

Assets
	Current assets:
		Cash and short-term investments			$	553		$	1,108
		Receivables - trade and other				8,246			7,526
		Receivables - finance				6,376			6,442
		Deferred and refundable income taxes				403			255
		Prepaid expenses				2,107			2,146
		Inventories				6,411			5,224

	Total current assets					24,096			22,701

	Property, plant and equipment - net					8,424			7,988
	Long-term receivables - trade and other					742			1,037
	Long-term receivables - finance					11,178			10,301
	Investments in unconsolidated affiliated companies					606			565
	Deferred income taxes					986			857
	Intangible assets					646			424
	Goodwill					1,877			1,451
	Other assets					1,928			1,745

Total assets					$	50,483		$	47,069

Liabilities
	Current liabilities:
		Short-term borrowings:
				Machinery and Engines	$	745		$	871
				Financial Products		4,930			4,698
		Accounts payable				3,857			3,412
		Accrued expenses				2,747			2,617
		Accrued wages, salaries and employee benefits				1,388			1,601
		Customer advances				742			454
		Dividends payable				-			168
		Deferred and current income taxes payable				685			528
		Long-term debt due within one year:
				Machinery and Engines		99			340
				Financial Products		3,492			4,159

	Total current liabilities					18,685			18,848

	Long-term debt due after one year:
			Machinery and Engines			4,007			2,717
			Financial Products			14,138			12,960
	Liability for postemployment benefits					3,510			3,161
	Deferred income taxes and other liabilities					1,115			951

Total liabilities						41,455			38,637

Stockholders' equity
	Common stock of $1.00 par:
			Authorized shares: 900,000,000 Issued shares: (9/30/06 and 12/31/05 - 814,894,624) at paid-in amount			2,441			1,859
	Treasury stock (9/30/06 - 164,360,150; 12/31/05 - 144,027,405) at cost					(7,031	)		(4,637	)
	Profit employed in the business					14,100			11,808
	Accumulated other comprehensive income					(482	)		(598	)

Total stockholders' equity						9,028			8,432

Total liabilities and stockholders' equity					$	50,483		$	47,069

See accompanying notes to Consolidated Financial Statements.

Page 4

Caterpillar Inc. Consolidated Statement of Changes in Stockholders' Equity For the Nine Months Ended (Unaudited) (Dollars in millions)
			September 30, 2006						September 30, 2005

Common stock:
	Balance at beginning of period		$	1,859					$	1,231
	Common shares issued from treasury stock for stock-based compensation			71						135
	Stock-based compensation expense			123						-
	Tax benefits from stock-based compensation			161						117
	Common shares issued from treasury stock for Progress Rail acquisition			227						-
	Impact of 2-for-1 stock split			-						338

	Balance at end of period			2,441						1,821

Treasury stock:
	Balance at beginning of period			(4,637	)					(3,277	)
	Shares issued for stock-based compensation: 2006 - 14,180,353; 2005 - 16,391,795			312						277
	Shares repurchased: 2006 - 39,855,000; 2005 - 22,057,200			(2,858	)					(1,039	)
	Shares issued for Progress Rail acquisition: 2006 - 5,341,902			152						-

	Balance at end of period			(7,031	)					(4,039	)

Profit employed in the business:
	Balance at beginning of period			11,808						9,937
	Profit			2,655		$	2,655			2,008		$	2,008
	Dividends declared			(363	)					(309	)
	Impact of 2-for-1 stock split			-						(338	)

	Balance at end of period			14,100						11,298

Accumulated other comprehensive income:
	Foreign currency translation adjustment:
		Balance at beginning of period		302						489
		Aggregate adjustment for period		117			117			(141	)		(141	)

		Balance at end of period		419						348

	Minimum pension liability adjustment - consolidated companies:
		Balance at beginning of period (net of tax of: 2006-$449; 2005-$485)		(897	)					(993	)
		Aggregate adjustment for period (net of tax of: 2005-$24)		-			-			(46	)		(46	)

		Balance at end of period (net of tax of: 2006-$449; 2005-$509)		(897	)					(1,039	)

	Minimum pension liability adjustment - unconsolidated companies:
		Balance at beginning of period		(37	)					(48	)
		Aggregate adjustment for period		-			-			1			1

		Balance at end of period		(37	)					(47	)

	Derivative financial instruments:
		Balance at beginning of period (net of tax of: 2006-$13; 2005-$58)		18						110
		Gains/(losses) deferred during period (net of tax of: 2006-$27; 2005-$2)		54			54			(5	)		(5	)
		(Gains)/losses reclassified to earnings during period (net of tax of: 2006-$27; 2005-$40)		(47	)		(47	)		(75	)		(75	)

		Balance at end of period (net of tax of: 2006-$13; 2005-$16)		25						30

	Available-for-sale securities:
		Balance at beginning of period (net of tax of: 2006-$9; 2005-$10)		16						18
		Gains/(losses) deferred during period (net of tax of: 2006-$4; 2005-$2)		10			10			4			4
		(Gains)/losses reclassified to earnings during period (net of tax of: 2006-$9; 2005- $1)		(18	)		(18	)		(2	)		(2	)

		Balance at end of period (net of tax of: 2006-$4; 2005-$11)		8						20

Total accumulated other comprehensive income				(482	)					(688	)

	Comprehensive income					$	2,771					$	1,744

Stockholders' equity at end of period			$	9,028					$	8,392

See accompanying notes to Consolidated Financial Statements.

Page 5

Caterpillar Inc. Consolidated Statement of Cash Flow (Unaudited) (Millions of dollars)
			Nine Months Ended
			September 30,
			2006			2005

Cash flow from operating activities:
	Profit		$	2,655		$	2,008
	Adjustments for non-cash items:
		Depreciation and amortization		1,220			1,113
		Other		110			(89	)
	Changes in assets and liabilities:
		Receivables - trade and other		(165	)		(521	)
		Inventories		(902	)		(794	)
		Accounts payable and accrued expenses		327			313
		Other assets - net		(345	)		69
		Other liabilities - net		666			31

Net cash provided by (used for) operating activities				3,566			2,130

Cash flow from investing activities:
	Capital expenditures - excluding equipment leased to others			(905	)		(709	)
	Expenditures for equipment leased to others			(798	)		(965	)
	Proceeds from disposals of property, plant and equipment			440			447
	Additions to finance receivables			(7,817	)		(7,310	)
	Collections of finance receivables			6,204			4,889
	Proceeds from the sale of finance receivables			1,004			916
	Investments and acquisitions (net of cash acquired)			(512	)		(12	)
	Proceeds from sale of available-for-sale securities			255			443
	Investments in available-for-sale securities			(357	)		(508	)
	Other - net			201			145

Net cash provided by (used for) investing activities				(2,285	)		(2,664	)

Cash flow from financing activities:
	Dividends paid			(531	)		(449	)
	Common stock issued, including treasury shares reissued			383			412
	Treasury shares purchased			(2,858	)		(1,039	)
	Excess tax benefit from stock-based compensation			159			-
	Proceeds from debt issued (original maturities greater than three months)			8,629			9,796
	Payments on debt (original maturities greater than three months)			(8,517	)		(7,619	)
	Short-term borrowings (original maturities three months or less) - net			905			(58	)

Net cash provided by (used for) financing activities				(1,830	)		1,043

Effect of exchange rate changes on cash				(6	)		13

Increase (decrease) in cash and short-term investments				(555	)		522

Cash and short-term investments at beginning of period				1,108			445

Cash and short-term investments at end of period			$	553		$	967

All short-term investments, which consist primarily of highly liquid investments with original maturities of three months or less, are considered to be cash equivalents.
Non-cash activities:
On June 19, 2006, Caterpillar acquired 100 percent of the equity in Progress Rail Services, Inc. A portion of the acquisition was financed with 5.3 million shares of Caterpillar stock with a fair value of $379 million as of the acquisition date. See Note 14 on page 25 for further discussion.
See accompanying notes to Consolidated Financial Statements.

Page 6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

A. Basis of Presentation

In the opinion of management, the accompanying financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of (a) the consolidated results of operations for the three and nine months ended September 30, 2006 and 2005, (b) the consolidated financial position at September 30, 2006 and December 31, 2005, (c) the changes in stockholders' equity for the nine months ended September 30, 2006 and 2005, and (d) the consolidated statement of cash flow for the nine months ended September 30, 2006 and 2005. The financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain amounts for prior periods have been reclassified to conform to the current period financial statement presentation.

Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with Management's Discussion and Analysis and the audited financial statements and notes thereto included in our company's annual report on Form 10-K for the year ended December 31, 2005 (2005 Form 10-K).

Comprehensive income is comprised of profit, as well as adjustments for foreign currency translation, derivative instruments designated as cash flow hedges, available-for-sale securities and minimum pension liability. Total comprehensive income for the three months ended September 30, 2006 and 2005 was $764 million and $645 million, respectively. Total comprehensive income for the nine months ended September 30, 2006 and 2005 was $2,771 million and $1,744 million, respectively. The difference from profit primarily consists of foreign currency translation adjustments and gains on derivative instruments that were reclassified to earnings.

The December 31, 2005 financial position data included herein is derived from the audited consolidated financial statements included in the 2005 Form 10-K.

	B. Nature of Operations We operate in three principal lines of business:
	(1)	Machinery - A principal line of business which includes the design, manufacture, marketing and sales of construction, mining and forestry machinery - track and wheel tractors, track and wheel loaders, pipelayers, motor graders, wheel tractor-scrapers, track and wheel excavators, backhoe loaders, log skidders, log loaders, off-highway trucks, articulated trucks, paving products, telehandlers, skid steer loaders and related parts. Also includes logistics services for other companies and rail related products and services.
	(2)	Engines - A principal line of business including the design, manufacture, marketing and sales of engines for Caterpillar machinery; electric power generation systems; on-highway vehicles and locomotives; marine, petroleum, construction, industrial, agricultural and other applications; and related parts. Reciprocating engines meet power needs ranging from 5 to 21,500 horsepower (4 to over 16 000 kilowatts). Turbines range from 1,600 to 20,500 horsepower (1 200 to 15 000 kilowatts).
	(3)	Financial Products - A principal line of business consisting primarily of Caterpillar Financial Services Corporation (Cat Financial), Caterpillar Insurance Holdings, Inc. (Cat Insurance), Caterpillar Power Ventures Corporation (Cat Power Ventures) and their respective subsidiaries. Cat Financial provides a wide range of financing alternatives to customers and dealers for Caterpillar machinery and engines, Solar gas turbines as well as other equipment and marine vessels. Cat Financial also extends loans to customers and dealers. Cat Insurance provides various forms of insurance to customers and dealers to help support the purchase and lease of our equipment. Cat Power Ventures is an investor in independent power projects using Caterpillar power generation equipment and services.
	Our Machinery and Engines operations are highly integrated. Throughout the Notes, Machinery and Engines represents the aggregate total of these principal lines of business.

Page 7

New Accounting Pronouncements

SFAS 151 - In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 151 (SFAS 151), "Inventory Costs - an amendment of ARB No. 43, Chapter 4." SFAS 151 discusses the general principles applicable to the pricing of inventory. Paragraph 5 of ARB 43, Chapter 4, provides guidance on allocating certain costs to inventory. This Statement amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) should be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of production facilities. As required by SFAS 151, we adopted this new accounting standard on January 1, 2006. The adoption of SFAS 151 did not have a material impact on our financial statements.

SFAS 123R - In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment," (SFAS 123R). SFAS 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. SFAS 123R also establishes fair value as the measurement method in accounting for share-based payments. The FASB required the provisions of SFAS 123R be adopted for interim or annual periods beginning after June 15, 2005. In April 2005, the SEC adopted a new rule amending the compliance dates for SFAS 123R for public companies. In accordance with this rule, we adopted SFAS 123R effective January 1, 2006 using the modified prospective transition method. We did not modify the terms of any previously granted options in anticipation of the adoption of SFAS 123R.

We expect the application of the expensing provisions of SFAS 123R will result in a pretax expense of approximately $135 million in 2006. As a result of the vesting decisions discussed in Note 3, a full complement of expense related to stock-based compensation will not be recognized in our results of operations until 2009.

See Note 3 for additional information regarding stock-based compensation.

SFAS 154 - In June 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (SFAS 154), "Accounting Changes and Error Corrections." SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement requires retrospective applications to prior periods' financial statements of a voluntary change in accounting principle unless it is impracticable. In addition, this Statement requires that a change in depreciation, amortization or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. This new accounting standard was effective January 1, 2006. The adoption of SFAS 154 had no impact on our financial statements.

SFAS 155 - In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155 (SFAS 155), "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140." SFAS 155 allows financial instruments that have embedded derivatives to be accounted for as a whole, eliminating the need to separate the derivative from its host, if the holder elects to account for the whole instrument on a fair value basis. This new accounting standard is effective January 1, 2007. The adoption of SFAS 155 is not expected to have an impact on our financial statements.

SFAS 156 - In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156 (SFAS 156), "Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140." SFAS 156 requires that all separately recognized servicing rights be initially measured at fair value, if practicable. In addition, this Statement permits an entity to choose between two measurement methods (amortization method or fair value measurement method) for each class of separately recognized servicing assets and liabilities. This new accounting standard is effective January 1, 2007. The adoption of SFAS 156 is not expected to have a material impact on our financial statements.

FIN 48 - In July 2006, the FASB issued FIN 48 “Accounting For Uncertainty In Income Taxes - an interpretation of FASB Statement 109.” FIN 48 clarifies that an entity’s tax benefits recognized in tax returns must be more likely than not of being sustained prior to recording the related tax benefit in the financial statements. As required by FIN 48, we will adopt this new accounting standard effective January 1, 2007. We are currently reviewing the impact of FIN 48 on our financial statements. We expect to complete this evaluation by the end of 2006.

SFAS 157 - In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (SFAS 157), "Fair Value Measurements.” SFAS 157 provides a common definition of fair value and a framework for measuring assets and liabilities at fair values when a particular standard prescribes it. In addition, the Statement expands disclosures about fair value measurements. As required by SFAS 157, we will adopt this new accounting standard effective January 1, 2008. We are currently reviewing the impact of SFAS 157 on our financial statements. We expect to complete this evaluation in 2007.

Page 8

SFAS 158 - In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (SFAS 158), "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans", which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. Also, the measurement date -- the date at which the benefit obligation and plan assets are measured -- is required to be the company's fiscal year end. As required by SFAS 158, we will adopt the balance sheet recognition provisions at December 31, 2006 and the year-end measurement date in 2008 using the prospective method. The adoption of SFAS 158 is currently expected to reduce December 31, 2006 assets by approximately $600 million, increase liabilities by approximately $2.00 billion and reduce stockholders' equity by approximately $2.60 billion. Also, we expect a shift of approximately $500 million from current liabilities to long-term liabilities based on the classification guidelines provided in SFAS 158. We do not expect any violation of debt covenant agreements as a result of the reduction in stockholders' equity. The Statement does not affect the results of operations.

Stock-Based Compensation

On January 1, 2006, we adopted SFAS 123R using the modified prospective transition method. SFAS 123R requires all stock-based payments to be recognized in the financial statements based on the grant date fair value of the award. Under the modified prospective transition method, we are required to record stock-based compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards outstanding as of the date of adoption. In accordance with the modified prospective transition method, our Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R.

Prior to the adoption of SFAS 123R, we used the intrinsic value method of accounting for stock-based employee compensation in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Under the intrinsic value method, no compensation expense was recognized in association with our stock awards. The following table illustrates the effect on profit and profit per share if we had applied SFAS 123R for the three and nine months ended September 30, 2005 using the lattice-based option-pricing model:


(Dollars in millions except per share data)			Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005

Profit, as reported			$	667		$	2,008
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects				(6	)		(129	)

Pro forma profit			$	661		$	1,879

Profit per share of common stock:
	As reported:
		Basic	$	.98		$	2.95
		Diluted	$	.94		$	2.84
	Pro forma:
		Basic	$	.97		$	2.76
		Diluted	$	.93		$	2.66

Stock Incentive Plans

In 1996, stockholders approved the Stock Option and Long-Term Incentive Plan (the 1996 Plan), which expired in April of 2006. The 1996 Plan reserved 144 million shares of common stock for issuance (128 million under this plan and 16 million under prior plans). On June 14, 2006, stockholders approved the 2006 Caterpillar Long-Term Incentive Plan (the 2006 Plan). The 2006 non-employee Directors’ grant was issued from this plan. The 2006 Plan reserves 37.6 million shares for issuance (20 million under the 2006 Plan and 17.6 million transferred from the 1996 Plan). The plans primarily provide for the granting of stock options and stock-settled stock appreciation rights (SARs) to officers and other key employees, as well as non-employee Directors. Stock options permit a holder to buy Caterpillar stock at the stock's price when the option was granted. SARs permit a holder the right to receive the value in shares of the appreciation in Caterpillar stock that occurred from the date the right was granted up to the date of exercise. The plans grant options and SARs that have exercise prices equal to the average price on the date of grant.

Page 9

Our long-standing practices and policies specify all stock option and SAR awards are approved by the Compensation Committee (the Committee) of the Board of Directors on the date of grant. The stock-based award approval process specifies the number of awards granted, the terms of the award and the grant date. The same terms and conditions are consistently applied to all employee grants, including Officers. The Committee approves all individual Officer grants. The number of stock options and SARs included in an individual’s award is determined based on the methodology approved by the Committee. The stockholder approved plan provides for the exercise price methodology to be the average of the high and low price of our stock on the date of grant.

Common stock issued from Treasury stock under the plans during the three months ended September 30, 2006 and 2005 totaled 1,349,301 and 7,015,003, respectively. Common stock issued from Treasury stock under the plans during the nine months ended September 30, 2006 and 2005 totaled 14,180,353 and 16,391,795, respectively.

Options granted prior to 2004 vested at the rate of one-third per year over the three-year period following the date of grant. In anticipation of delaying vesting until three years after the grant date for future grants, the 2004 grant was vested on December 31, 2004. In order to better align our employee stock option program with the overall market, the number of options granted in 2005 was significantly reduced from the previous year. In response to this decrease, we elected to immediately vest the 2005 grant. In order to further align our stock award program with the overall market, we adjusted our 2006 grant by reducing the overall number of employee awards granted in the first quarter of 2006 and utilizing a mix of SARs and option awards. The 2006 awards generally vest three years after the date of grant. At grant, all awards have a term life of ten years. Upon retirement, the term life is reduced to a maximum of five remaining years.

Our stock-based compensation plans allow for the immediate vesting upon retirement for employees who are 55 years old or older with more than ten years of service and who have fulfilled the requisite service period of six months. Prior to the adoption of SFAS 123R, compensation expense for awards associated with these employees had been recognized in the pro forma net profit over the nominal vesting period. With the adoption of SFAS 123R, compensation expense is now recognized over the period from the grant date to the end date of the requisite service period for employees who meet the immediate vesting upon retirement requirements. For those employees who become eligible for immediate vesting upon retirement subsequent to the requisite service period and prior to the completion of the vesting period, compensation expense is recognized over the period from grant date to the date eligibility is achieved. Application of the nominal vesting period for these employees for the three and nine months ended September 30, 2005 decreased pro forma profit by $2 million and $11 million, respectively.

SFAS 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. In 2006 and 2005, the fair value of the grant was estimated using a lattice-based option-pricing model. The lattice-based option-pricing model considers a range of assumptions related to volatility, risk-free interest rate and historical employee behavior. Expected volatility was based on historical and current implied volatilities from traded options on our stock. The risk-free rate was based on U.S. Treasury security yields at the time of grant. The dividend yield was based on historical information. The expected life was determined from the lattice-based model. The lattice-based model incorporated exercise and post vesting forfeiture assumptions based on analysis of historical data. The following table provides the assumptions used in determining the fair value of the stock-based awards for the nine months ended September 30, 2006 and 2005, respectively.


	2006		2005

Weighted-average dividend yield	1.79	%	2.11	%
Weighted-average volatility	26.79	%	26.48	%
Range of volatilities	26.56 - 26.79	%	21.99 - 26.65	%
Range of risk-free interest rates	4.34 - 4.64	%	2.38 - 4.29	%
Weighted-average expected life	8	Years	7	Years

Page 10

Please refer to Tables I and II below for additional information on our stock-based awards.


Table I
Stock option/SAR activity during the nine months ended September 30, 2006:	Shares			Weighted Average Exercise Price

Outstanding at January 1, 2006		74,860,582		$	32.23
Granted to officers and key employees		9,720,340		$	72.05
Granted to outside directors		91,000		$	66.77
Exercised		(14,398,497	)	$	28.62
Forfeited		(260,708	)	$	53.71

Outstanding at September 30, 2006		70,012,717		$	38.47

Options/SARs exercisable at September 30, 2006		60,374,645		$	33.13

Stock options/SARs outstanding and exercisable:
		Outstanding						Exercisable

Exercise Prices		# Outstanding at 9/30/06	Weighted- Average Remaining Contractual Life (Years)	Weighted- Average Exercise Price		Aggregate Intrinsic Value¹		# Outstanding at 9/30/06	Weighted- Average Remaining Contractual Life (Years)	Weighted- Average Exercise Price		Aggregate Intrinsic Value¹

$	19.20-72.05	70,012,717	6.79	$	38.47	$	2,010	60,374,645	6.37	$	33.13	$	2,009

1 The difference between a stock award's exercise price and the underlying stock's market price at September 30, 2006, for awards with market price greater than the exercise price. Amounts are in millions of dollars.

Of the 9,811,340 awards granted during the nine months ended September 30, 2006, 9,479,534 were SARs.


Table II
Additional stock-based award information:
	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in millions except per share data)	2006		2005		2006		2005

Weighted average fair value per share of stock awards granted	$	-	$	-	$	23.44	$	11.95
Intrinsic value of stock awards exercised	$	54	$	199	$	598	$	419
Fair value of shares vested	$	1	$	-	$	38	$	228

The impact related to stock-based compensation for the three and nine months ended September 30, 2006 is shown in the table below:


(Dollars in millions except per share data)	Three Months Ended September 30, 2006		Nine Months Ended September 30, 2006

Stock-based compensation expense, before tax	$	31	$	123
Stock-based compensation expense, after tax	$	21	$	82
Decrease in profit per share of common stock, basic	$	.03	$	.12
Decrease in profit per share of common stock, diluted	$	.02	$	.08
Income tax benefit recognized in net income	$	10	$	41

Cash received from stock awards exercised	$	33	$	382
Tax benefit realized from stock awards exercised	$	13	$	161

Page 11

The amount of stock-based compensation expense capitalized for the nine months ended September 30, 2006 did not have a significant impact on our financial statements. Prior to our adoption of SFAS 123R, stock-based compensation was not capitalized in our pro forma disclosure.

At September 30, 2006, there was $116 million of total unrecognized compensation cost from stock-based compensation arrangements granted under the plans, which is related to non-vested shares. The compensation expense is expected to be recognized over a weighted-average period of approximately 2.4 years.

In accordance with Staff Accounting Bulletin No. 107, we classified stock-based compensation within cost of goods sold, selling, general and administrative expenses and research and development expenses corresponding to the same line item as the cash compensation paid to respective employees, officers and non-employee directors. We do not allocate stock-based compensation to reportable segments.

In November 2005, the FASB issued FASB Staff Position No. FAS 123R-3 “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.” We have elected in the third quarter of 2006 to adopt the alternative transition method provided in the FASB Staff Position for calculating the tax effects of stock-based compensation. The alternative transition method includes simplified methods to determine the beginning balance of the additional paid-in capital (APIC) pool related to the tax effects of stock-based compensation, and to determine the subsequent impact on the APIC pool and the Statement of Cash Flow of the tax effects of stock-based awards that were fully vested and outstanding upon the adoption of SFAS 123R. In accordance with SFAS 154 “Accounting Changes and Error Corrections,” this change in accounting principle has been applied retrospectively to the 2006 Consolidated Statement of Cash Flow. The impact on the Consolidated Statement of Cash Flow was a decrease in operating cash flow and an offsetting increase in financing cash flow of $20 million for the three months ended March 31, 2006 and $27 million for the six months ended June 30, 2006.

We currently use shares that have been repurchased through our stock repurchase program to satisfy share award exercises.

4.	Derivative Instruments and Hedging Activities

Our earnings and cash flow are subject to fluctuations due to changes in foreign currency exchange rates, interest rates and commodity prices. Our Risk Management Policy (policy) allows for the use of derivative financial instruments to prudently manage foreign currency exchange rate, interest rate and commodity price exposure. Our policy specifies that derivatives are not to be used for speculative purposes. Derivatives that we use are primarily foreign currency forward and option contracts, interest rate swaps and commodity forward and option contracts. Our derivative activities are subject to the management, direction and control of our senior financial officers. Risk management practices, including the use of financial derivative instruments, are presented to the Audit Committee of the Board of Directors at least annually.

Foreign Currency Exchange Rate Risk

Foreign currency exchange rate movements create a degree of risk by affecting the U.S. dollar value of sales made and costs incurred in foreign currencies. Movements in foreign currency rates also affect our competitive position as these changes may affect business practices and/or pricing strategies of non-U.S. based competitors. Additionally, we have balance sheet positions denominated in foreign currency thereby creating exposure to movements in exchange rates.

Our Machinery and Engines operations purchase, manufacture and sell products in many locations around the world. As we have a diversified revenue and cost base, we manage our future foreign currency cash flow exposure on a net basis. We use foreign currency forward and option contracts to manage unmatched foreign currency cash inflow and outflow. Our objective is to minimize the risk of exchange rate movements that would reduce the U.S. dollar value of our foreign currency cash flow. Our policy allows for managing anticipated foreign currency cash flow for up to four years.

We generally designate as cash flow hedges at inception of the contract any Australian dollar, Brazilian real, British pound, Canadian dollar, euro, Japanese yen, Mexican peso, Singapore dollar, Chinese yuan, New Zealand dollar, Indonesian rupiah, Russian ruble or Swiss franc forward or option contracts that meet the requirements for hedge accounting. Designation is performed on a specific exposure basis to support hedge accounting. The remainder of Machinery and Engines foreign currency contracts are undesignated.

Page 12

As of September 30, 2006, $1 million, net of tax, of deferred net gains included in equity ("Accumulated other comprehensive income" in the Consolidated Statement of Financial Position) are expected to be reclassified to current earnings ("Other income (expense)" in the Consolidated Statement of Results of Operations) over the next 12 months when earnings are positively/negatively affected by the hedged transactions. As of September 30, 2005, this projected reclassification was a gain of $10 million, net of tax. These amounts were based on September 30, 2006 and September 30, 2005 exchange rates, respectively. The actual amount recorded in Other income (expense) will vary based on exchange rates at the time the hedged transactions impact earnings. There were no circumstances where hedge treatment was discontinued during the three or nine months ended September 30, 2006 or 2005.

In managing foreign currency risk for our Financial Products operations, our objective is to minimize earnings volatility resulting from conversion and the re-measurement of net foreign currency balance sheet positions. Our policy allows the use of foreign currency forward and option contracts to offset the risk of currency mismatch between our receivables and debt. All such foreign currency forward and option contracts are undesignated.


Gains / (losses) included in current earnings [Other income (expense)] on undesignated contracts:
		Three Months Ended September 30,					Nine Months Ended September 30,
(Millions of dollars)		2006			2005		2006			2005

Machinery and Engines:
	On undesignated contracts	$	(3	)	$	9	$	16		$	25
Financial Products:
	On undesignated contracts	$	(3	)	$	16	$	(4	)	$	49

Gains and losses on the Financial Products contracts above are substantially offset by balance sheet translation gains and losses.

Interest Rate Risk

Interest rate movements create a degree of risk by affecting the amount of our interest payments and the value of our fixed rate debt. Our practice is to use interest rate swap agreements to manage our exposure to interest rate changes and, in some cases, lower the cost of borrowed funds.

Machinery and Engines operations generally use fixed rate debt as a source of funding. Our objective is to minimize the cost of borrowed funds. Our policy allows us to enter into fixed-to-floating interest rate swaps and forward rate agreements to meet that objective with the intent to designate as fair value hedges at inception of the contract all fixed-to-floating interest rate swaps. Designation as a hedge of the fair value of our fixed rate debt is performed to support hedge accounting. During 2001, our Machinery and Engines operations liquidated all fixed-to-floating interest rate swaps. The gain ($8 million at September 30, 2006) is being amortized to earnings ratably over the remaining life of the hedged debt.

Financial Products operations have a match funding policy that addresses interest rate risk by aligning the interest rate profile (fixed or floating rate) of their debt portfolio with the interest rate profile of their receivables portfolio within pre-determined ranges on an on-going basis. In connection with that policy, we use interest rate derivative instruments to modify the debt structure to match assets within the receivables portfolio. This match funding reduces the volatility of margins between interest-bearing assets and interest-bearing liabilities, regardless of which direction interest rates move. This is accomplished by changing the characteristics of existing debt instruments or entering into new agreements in combination with the issuance of new debt.

Our policy allows us to use floating-to-fixed, fixed-to-floating and floating-to-floating interest rate swaps to meet the match-funding objective. To support hedge accounting, we designate fixed-to-floating interest rate swaps as fair value hedges of the fair value of our fixed rate debt at the inception of the contract. Financial Products' practice is to designate most floating-to-fixed interest rate swaps as cash flow hedges of the variability of future cash flows at inception of the swap contract. Designation as a hedge of the variability of cash flow is performed to support hedge accounting. Financial Products liquidated fixed-to-floating interest rate swaps during 2006, 2005, 2004, and 2002. The gains ($8 million remaining at September 30, 2006) are being amortized to earnings ratably over the remaining life of the hedged debt.

Page 13


Gains / (losses) included in current earnings [Other income (expense)]:
			Three Months Ended September 30,						Nine Months Ended September 30,
(Millions of dollars)			2006			2005			2006			2005

Fixed-to-floating interest rate swaps
	Machinery and Engines:
		Gain/(loss) on liquidated swaps	$	1		$	1		$	3		$	3
	Financial Products:
		Gain/(loss) on designated interest rate derivatives		79			(53	)		(7	)		(50	)
		Gain/(loss) on hedged debt		(79	)		53			7			50
		Gain/(loss) on liquidated swaps - included in interest expense		2			1			6			3

			$	3		$	2		$	9		$	6

As of September 30, 2006, $20 million, net of tax, of deferred net gains included in equity ("Accumulated other comprehensive income"), related to Financial Products floating-to-fixed interest rate swaps, are expected to be reclassified to current earnings ("Interest expense of Financial Products" in the Consolidated Statement of Results of Operations) over the next 12 months. As of September 30, 2005, this projected reclassification was a net gain of $7 million, net of tax. There were no circumstances where hedge treatment was discontinued during the three or nine months ended September 30, 2006 or 2005.

Commodity Price Risk

Commodity price movements create a degree of risk by affecting the price we must pay for certain raw materials. Our policy is to use commodity forward and option contracts to manage the commodity risk and reduce the cost of purchased materials.

Our Machinery and Engines operations purchase aluminum, copper and nickel embedded in the components we purchase from suppliers. Our suppliers pass on to us price changes in the commodity portion of the component cost. In addition, we are also subjected to price changes on natural gas purchased for operational use.

Our objective is to minimize volatility in the price of these commodities. Our policy allows us to enter into commodity forward and option contracts to lock in the purchase price of a portion of these commodities within a four-year horizon. All such commodity forward and option contracts are undesignated. Losses on the undesignated contracts of $2 million and gains of $1 million were recorded in current earnings ("Other income (expense)") for the three months and nine months ended September 30, 2006, respectively. Gains on the undesignated contracts of $5 million and gains of $6 million were recorded in current earnings ("Other income (expense)") for the three and nine months ended September 30, 2005, respectively.

5.	Inventories Inventories (principally using the "last-in, first-out" method) are comprised of the following:


(Millions of dollars)	September 30,		December 31,
	2006		2005

Raw materials	$	2,106	$	1,689
Work-in-process		994		814
Finished goods		3,043		2,493
Supplies		268		228

Total inventories	$	6,411	$	5,224

6.	Investments in Unconsolidated Affiliated Companies
	Our investments in affiliated companies accounted for by the equity method consist primarily of a 50 percent interest in Shin Caterpillar Mitsubishi Ltd. (SCM) located in Japan. Combined financial information of the unconsolidated affiliated companies accounted for by the equity method (generally on a three month lag, e.g., SCM results reflect the periods ending June 30) was as follows:

Page 14


	Results of Operations				Results of Operations
	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(Millions of dollars)	2006		2005		2006		2005

Sales	$	1,158	$	1,077	$	3,291	$	3,100
Cost of sales		931		844		2,625		2,410

Gross profit	$	227	$	233	$	666	$	690

Profit (loss)	$	61	$	41	$	169	$	132

Caterpillar's profit (loss)	$	25	$	18	$	74	$	61


	Financial Position
	September 30,		December 31,
(Millions of dollars)	2006		2005

Assets:
Current assets	$	1,759	$	1,714
Property, plant and equipment - net		1,105		1,120
Other assets		216		194

		3,080		3,028
Liabilities:
Current liabilities		1,353		1,348
Long-term debt due after one year		289		318
Other liabilities		170		188

		1,812		1,854

Ownership	$	1,268	$	1,174

Caterpillar's investments in unconsolidated affiliated companies
Investments in equity method companies	$	586	$	540
Plus: Investments in cost method companies		20		25

Total investments in unconsolidated affiliated companies	$	606	$	565

7.	Intangible Assets and Goodwill
	A. Intangible assets Intangible assets are comprised of the following:


(Dollars in millions)	Weighted Amortizable Life (Years)	September 30, 2006		December 31, 2005

Customer relationships	20	$	241	$	40
Intellectual property	11		209		206
Other	13		72		33

Total finite-lived intangible assets - gross	15		522		279
Less: Accumulated amortization			128		107

			394		172
Pension-related			252		252

Intangible assets - net		$	646	$	424

Page 15

During the second quarter of 2006, we acquired finite-lived intangible assets of $221 million due to the purchase of Progress Rail Services, Inc. (Progress Rail). See Note 14 for details on the acquisition of these assets. Amortization expense on intangible assets for the three and nine months ended September 30, 2006 was $10 million and $23 million, respectively. Amortization expense for the three and nine months ended September 30, 2005 was $6 million and $16 million, respectively. Amortization expense related to intangible assets is expected to be:


(Millions of dollars)
2006		2007		2008		2009		2010		Thereafter

$	32	$	35	$	35	$	34	$	37	$	244

B. Goodwill

On an annual basis, we test goodwill for impairment in accordance with Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets." Goodwill is tested for impairment between annual tests whenever events or circumstances make it more likely than not that an impairment may have occurred.

During the first quarter of 2006, we determined that the business outlook for the parts and accessories distribution business of MG Rover Ltd., acquired in 2004, required a specific impairment evaluation. Based on the fair value of the reporting unit calculated by discounting projected cash flows, we determined the reporting unit could no longer support the carrying value of its goodwill. Accordingly, a goodwill impairment charge of $18 million was included in "Other Operating Expenses" in the Consolidated Statement of Results of Operations and reported in the "All Other" segment during the first quarter of 2006. No other goodwill was impaired or disposed of during the three or nine months ended September 30, 2006 and 2005.

During the second quarter of 2006, we acquired assets with related goodwill of $405 million as part of the purchase of Progress Rail. During the third quarter of 2006, we acquired assets with related goodwill of $39 million as part of the purchase of the large components business of Royal Oak Industries, Inc. See Note 14 for details on the acquisition of these assets. No other goodwill was acquired during the three or nine months ended September 30, 2006 and 2005.

Available-For-Sale Securities

Financial Products, primarily Cat Insurance, has investments in certain debt and equity securities that have been classified as available-for-sale in accordance with Statement of Financial Accounting Standards No. 115 and recorded at fair value based upon quoted market prices. These fair values are included in "Other assets" in the Consolidated Statement of Financial Position. Unrealized gains and losses arising from the revaluation of available-for-sale securities are included, net of applicable deferred income taxes, in equity ("Accumulated other comprehensive income" in the Consolidated Statement of Financial Position). Realized gains and losses on sales of investments are generally determined using the FIFO ("first-in, first-out") method for debt instruments and the specific identification method for equity securities. Realized gains and losses are included in "Other income (expense)" in the Consolidated Statement of Results of Operations.


	September 30, 2006							December 31, 2005

			Unrealized							Unrealized
			Pretax Net							Pretax Net
(Millions of dollars)	Cost Basis		Gains (Losses)			Fair Value		Cost Basis		Gains (Losses)			Fair Value

Government debt	$	345	$	(5	)	$	340	$	305	$	(6	)	$	299
Corporate bonds		510		(6	)		504		422		(7	)		415
Equity securities		147		25			172		146		38			184

Total	$	1,002	$	14		$	1,016	$	873	$	25		$	898

Page 16


Investments in an unrealized loss position that are not other-than-temporarily impaired:
	September 30, 2006

	Less than 12 months ¹				More than 12 months ¹					Total

(Millions of dollars)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses

Government debt	$	104	$	1	$	187	$	4		$	291	$	5
Corporate bonds		101		1		267		6			368		7
Equity securities		16		1		-		-			16		1

Total	$	221	$	3	$	454	$	10		$	675	$	13



	December 31, 2005

	Less than 12 months ¹				More than 12 months ¹					Total

(Millions of dollars)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses

Government debt	$	155	$	2	$	113	$		3	$	268	$	5
Corporate bonds		220		3		136			4