Edgar Filing: CATERPILLAR INC

Form 10-Q for 1st qtr. 2007

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 March 31, 2007 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 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 March 31, 2007, 640,395,899 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
		March 31,
		2007		2006

Sales and revenues:
	Sales of Machinery and Engines	$	9,321	$	8,743
	Revenues of Financial Products		695		649

	Total sales and revenues		10,016		9,392

Operating costs:
	Cost of goods sold		7,136		6,552
	Selling, general and administrative expenses		890		821
	Research and development expenses		340		307
	Interest expense of Financial Products		271		232
	Other operating expenses		239		262

	Total operating costs		8,876		8,174

Operating profit			1,140		1,218

	Interest expense excluding Financial Products		79		68
	Other income (expense)		111		43

Consolidated profit before taxes			1,172		1,193

	Provision for income taxes		375		370

	Profit of consolidated companies		797		823

	Equity in profit (loss) of unconsolidated affiliated companies		19		17

Profit		$	816	$	840


Profit per common share		$	1.27	$	1.25

Profit per common share - diluted ¹		$	1.23	$	1.20

Weighted-average common shares outstanding (millions)
	- Basic		643.9		672.0
	- Diluted ¹		665.2		699.1

Cash dividends declared per common share		$	—	$	—

¹ Diluted by assumed exercise of stock-based compensation awards using the treasury stock method.
See accompanying notes to Consolidated Financial Statements.

Page 2

Caterpillar Inc. Consolidated Statement of Financial Position (Unaudited) (Dollars in millions)
					March 31, 2007			December 31, 2006

Assets
	Current assets:
		Cash and short-term investments			$	607		$	530
		Receivables - trade and other				8,016			8,607
		Receivables - finance				6,700			6,804
		Deferred and refundable income taxes				847			733
		Prepaid expenses and other current assets				657			638
		Inventories				7,131			6,351

	Total current assets					23,958			23,663

	Property, plant and equipment - net					8,892			8,851
	Long-term receivables - trade and other					705			860
	Long-term receivables - finance					11,799			11,531
	Investments in unconsolidated affiliated companies					554			562
	Noncurrent deferred and refundable income taxes					2,121			1,949
	Intangible assets					460			387
	Goodwill					1,940			1,904
	Other assets					1,819			1,742

Total assets					$	52,248		$	51,449

Liabilities
	Current liabilities:
		Short-term borrowings:
				Machinery and Engines	$	649		$	165
				Financial Products		5,592			4,990
		Accounts payable				4,044			4,085
		Accrued expenses				2,883			2,923
		Accrued wages, salaries and employee benefits				704			938
		Customer advances				1,081			921
		Dividends payable				—			194
		Other current liabilities				899			1,145
		Long-term debt due within one year:
				Machinery and Engines		442			418
				Financial Products		3,656			4,043

	Total current liabilities					19,950			19,822

	Long-term debt due after one year:
			Machinery and Engines			3,679			3,694
			Financial Products			13,338			13,986
	Liability for postemployment benefits					5,873			5,879
	Other liabilities					1,916			1,209

Total liabilities						44,756			44,590

Commitments and contingencies (Notes 10 and 12)
Stockholders' equity
	Common stock of $1.00 par value:
			Authorized shares: 900,000,000 Issued shares: (3/31/07 and 12/31/06 - 814,894,624) at paid-in amount			2,518			2,465
	Treasury stock (3/31/07 - 174,498,725; 12/31/06 - 169,086,448) at cost					(7,789	)		(7,352	)
	Profit employed in the business					15,550			14,593
	Accumulated other comprehensive income					(2,787	)		(2,847	)

Total stockholders' equity						7,492			6,859

Total liabilities and stockholders' equity					$	52,248		$	51,449

See accompanying notes to Consolidated Financial Statements.

Page 3

Caterpillar Inc.

Consolidated Statement of Changes in Stockholders' Equity

(Unaudited)

(Dollars in millions)

											Accumulated other comprehensive income

			Common stock			Treasury stock			Profit employed in the business		Foreign currency translation		Pension & other post- retirement benefits¹			Derivative financial instruments			Available-for-sale securities			Total

Three Months ended March 31, 2006
Balance at December 31, 2005			$	1,859		$	(4,637	)	$	11,808	$	302	$	(934	)	$	18		$	16		$	8,432
Profit				—			—			840		—		—			—			—			840
Foreign currency translation				—			—			—		14		—			—			—			14
Minimum pension liability adjustment, net of tax of $0				—			—			—		—		1			—			—			1
Derivative financial instruments
	Gains (losses) deferred, net of tax of $7			—			—			—		—		—			19			—			19
	(Gains) losses reclassified to earnings, net of tax of $6			—			—			—		—		—			8			—			8
Available-for-sale securities
	Gains (losses) deferred, net of tax of $2			—			—			—		—		—			—			3			3
	(Gains) losses reclassified to earnings, net of tax of $2			—			—			—		—		—			—			(3	)		(3	)

		Comprehensive Income																					882

Common shares issued from treasury stock for stock-based compensation: 9,212,797				68			182			—		—		—			—			—			250
Stock-based compensation expense				34			—			—		—		—			—			—			34
Tax benefits from stock-based compensation				102			—			—		—		—			—			—			102
Shares repurchased: 10,450,000				—			(738	)		—		—		—			—			—			(738	)

Balance at March 31, 2006			$	2,063		$	(5,193	)	$	12,648	$	316	$	(933	)	$	45		$	16		$	8,962

Three Months ended March 31, 2007
Balance at December 31, 2006			$	2,465		$	(7,352	)	$	14,593	$	471	$	(3,376	)	$	48		$	10		$	6,859
Adjustment to adopt FIN 48				—			—			141		—		—			—			—			141

Balance at January 1, 2007				2,465			(7,352	)		14,734		471		(3,376	)		48			10			7,000
Profit				—			—			816		—		—			—			—			816
Foreign currency translation				—			—			—		16		—			—			—			16
Amortization of pension and other postretirement benefits losses, net of tax of $33				—			—			—		—		62			—			—			62
Derivative financial instruments
	Gains (losses) deferred, net of tax of $1			—			—			—		—		—			2			—			2
	(Gains) losses reclassified to earnings, net of tax of $12			—			—			—		—		—			(22	)		—			(22	)
Available-for-sale securities
	Gains (losses) deferred, net of tax of $2			—			—			—		—		—			—			4			4
	(Gains) losses reclassified to earnings, net of tax of $1			—			—			—		—		—			—			(2	)		(2	)

		Comprehensive Income																					876

Common shares issued from treasury stock for stock-based compensation: 2,645,723				(1	)		74			—		—		—			—			—			73
Stock-based compensation expense				27			—			—		—		—			—			—			27
Tax benefits from stock-based compensation				27			—			—		—		—			—			—			27
Shares repurchased: 8,058,000				—			(511	)		—		—		—			—			—			(511	)

Balance at March 31, 2007			$	2,518		$	(7,789	)	$	15,550	$	487	$	(3,314	)	$	28		$	12		$	7,492

¹	Pension and other postretirement benefits includes the aggregate adjustment for unconsolidated companies of $0 million and $1 million for the three months ended March 31, 2007 and 2006, respectively. The ending balances were $43 million and $36 million at March 31, 2007 and 2006, respectively.
See accompanying notes to Consolidated Financial Statements.

Page 4

Caterpillar Inc. Consolidated Statement of Cash Flow (Unaudited) (Millions of dollars)
			Three Months Ended
			March 31,
			2007			2006

Cash flow from operating activities:
	Profit		$	816		$	840
	Adjustments for non-cash items:
		Depreciation and amortization		412			400
		Other		1			10
	Changes in assets and liabilities:
		Receivables - trade and other		739			(463	)
		Inventories		(734	)		(618	)
		Accounts payable and accrued expenses		(141	)		216
		Other assets - net		(71	)		(4	)
		Other liabilities - net		327			126

Net cash provided by (used for) operating activities				1,349			507

Cash flow from investing activities:
	Capital expenditures - excluding equipment leased to others			(252	)		(233	)
	Expenditures for equipment leased to others			(252	)		(252	)
	Proceeds from disposals of property, plant and equipment			106			208
	Additions to finance receivables			(2,553	)		(2,346	)
	Collections of finance receivables			2,359			2,220
	Proceeds from sales of finance receivables			40			17
	Investments and acquisitions (net of cash acquired)			(153	)		(4	)
	Proceeds from sale of available-for-sale securities			62			76
	Investments in available-for-sale securities			(124	)		(118	)
	Other - net			140			117

Net cash provided by (used for) investing activities				(627	)		(315	)

Cash flow from financing activities:
	Dividends paid			(193	)		(168	)
	Common stock issued, including treasury shares reissued			73			253
	Treasury shares purchased			(511	)		(738	)
	Excess tax benefit from stock-based compensation			26			101
	Proceeds from debt issued (original maturities greater than three months):
	- Machinery and Engines			26			29
	- Financial Products			1,849			2,055
	Payments on debt (original maturities greater than three months):
	- Machinery and Engines			(28	)		(7	)
	- Financial Products			(3,000	)		(2,823	)
	Short-term borrowings - net (original maturities three months or less)			1,107			806

Net cash provided by (used for) financing activities				(651	)		(492	)

Effect of exchange rate changes on cash				6			(2	)

Increase (decrease) in cash and short-term investments				77			(302	)

Cash and short-term investments at beginning of period				530			1,108

Cash and short-term investments at end of period			$	607		$	806

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.
See accompanying notes to Consolidated Financial Statements.

Page 5

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 month periods ended March 31, 2007 and 2006, (b) the consolidated financial position at March 31, 2007 and December 31, 2006, (c) the consolidated changes in stockholders' equity for the three month periods ended March 31, 2007 and 2006, and (d) the consolidated statement of cash flow for the three month periods ended March 31, 2007 and 2006. 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, 2006 (2006 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 pension and other postretirement benefits. Total comprehensive income for the three months ended March 31, 2007 and 2006 was $876 million and $882 million, respectively.

The December 31, 2006 financial position data included herein is derived from the audited consolidated financial statements included in the 2006 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, skid steer loaders and related parts. Also includes logistics services for other companies and the design, manufacture, remanufacture, maintenance and service of rail-related products.
	(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. Also includes remanufacturing of Caterpillar engines and a variety of Caterpillar machine and engine components and remanufacturing services for other companies. 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 6

New Accounting Pronouncements

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 was effective January 1, 2007. The adoption of SFAS 155 did not have a material 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 was effective January 1, 2007. The adoption of SFAS 156 did not 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 No. 109” to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies that a tax position must be more likely than not of being sustained before being recognized in the financial statements. As required, we adopted the provisions of FIN 48 as of January 1, 2007. The following table summarizes the effect of the initial adoption of FIN 48. (See Note 14 for additional information.)

Initial adoption of FIN 48
	January 1, 2007 Prior to FIN 48 Adjustment		FIN 48 Adjustment			January 1, 2007 Post FIN 48 Adjustment

(Millions of dollars)
Deferred and refundable income taxes	$	733	$	82		$	815
Noncurrent deferred and refundable income taxes		1,949		211			2,160
Other current liabilities		1,145		(530	)		615
Other liabilities		1,209		682			1,891
Profit employed in the business		14,593		141			14,734

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.

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 - an amendment of FASB Statements No. 87, 88, 106 and 132(R).” SFAS 158 requires 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 are 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 adopted the balance sheet recognition provisions at December 31, 2006, and will adopt the year-end measurement date in 2008 using the prospective method.

SFAS 159 - In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 (SFAS 159), “The Fair Value Option for Financial Assets & Financial Liabilities - Including an Amendment of SFAS No. 115.” SFAS 159 will create a fair value option under which an entity may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities on a contract by contract basis, with changes in fair values recognized in earnings as these changes occur. SFAS 159 will become effective for fiscal years beginning after November 15, 2007. We are currently reviewing the impact of SFAS 159 on our financial statements and expect to complete this evaluation in 2007. We will adopt this new accounting standard on January 1, 2008.

Page 7

Stock-Based Compensation

We adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), effective January 1, 2006. SFAS 123R requires that the cost resulting from all stock-based payments be recognized in the financial statements based on the grant date fair value of the award. Stock-based compensation primarily consists of stock options, stock-settled stock appreciation rights (SARs) and restricted stock units (RSUs). We recognized pretax stock-based compensation cost in the amount of $27 million and $34 million in the first quarter of 2007 and 2006, respectively.

The following table illustrates the type and fair market value of the stock-based compensation awards granted during the first quarter of 2007 and 2006, respectively:


	2007				2006

	# Granted		Fair Value Per Award		# Granted		Fair Value Per Award

SARs		4,193,401	$	20.73		9,388,534	$	23.44
Stock options		231,615		20.73		331,806		23.44
RSUs		1,282,020		59.94		—		—

As of March 31, 2007, the total remaining unrecognized compensation cost related to nonvested stock-based compensation awards was $240 million, which will be amortized over the weighted-average remaining requisite service periods of approximately 2.5 years.

Our long-standing practices and policies specify all stock-based compensation 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-based compensation awards included in an individual’s award is determined based on the methodology approved by the Committee. Prior to 2007, the terms of the 1996 Stock Option and Long-Term Incentive Plan (which expired in April of 2006) provided for the exercise price methodology to be the average of the high and low price of our stock on the date of grant. In 2007, under the terms of the Caterpillar Inc. 2006 Long-Term Incentive Plan (approved by stockholders in June of 2006), the Compensation Committee approved the exercise price methodology to be the closing price of the Company stock on the date of grant.

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.” In the third quarter of 2006, we elected 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.

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.

Page 8

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, New Zealand dollar or Swiss franc forward or option contracts that meet the standard 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. We designate as fair value hedges specific euro forward contracts used to hedge firm commitments.

As of March 31, 2007, $10 million of deferred net gains (net of tax) 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 affected by the hedged transactions. The actual amount recorded in Other income (expense) will vary based on exchange rates at the time the hedged transactions impact earnings.

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 March 31,
(Millions of dollars)		2007			2006

Machinery and Engines:
	On undesignated contracts	$	4		$	11

Financial Products:
	On undesignated contracts		(6	)		5

		$	(2	)	$	16

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 ($7 million at March 31, 2007) 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 Cat Financial’s debt portfolio with the interest rate profile of their receivables portfolio within predetermined 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.

Page 9

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 swap 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 the 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 and 2004, which resulted in deferred net gains. These gains ($7 million at March 31, 2007) are being amortized to earnings ratably over the remaining life of the hedged debt.

Gains (losses) included in current earnings [Other income (expense)]:
			Three Months Ended March 31,
(Millions of dollars)			2007			2006

Fixed-to-floating interest rate swaps
	Machinery and Engines:
		Gain (loss) on designated interest rate derivatives	$	—		$	—
		Gain (loss) on hedged debt		(1	)		—
		Gain (loss) on liquidated swaps - included in interest expense		1			1
	Financial Products:
		Gain (loss) on designated interest rate derivatives		12			(50	)
		Gain (loss) on hedged debt		(12	)		50
		Gain (loss) on liquidated swaps - included in interest expense		—			2

			$	—		$	3

As of March 31, 2007, $11 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.

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. There were no gains or losses on undesignated contracts for the three months ended March 31, 2007 or 2006.

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


(Millions of dollars)	March 31,		December 31,
	2007		2006

Raw materials	$	2,477	$	2,182
Work-in-process		1,098		977
Finished goods		3,288		2,915
Supplies		268		277

Total inventories	$	7,131	$	6,351

Page 10

6.	Investments in Unconsolidated Affiliated Companies
	Our investments in affiliated companies accounted for by the equity method consist primarily of a 50% 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 December 31) was as follows:

Results of Operations of unconsolidated affiliated companies:
	Three Months Ended
(Millions of dollars)	March 31,
	2007		2006

Sales	$	1,022	$	1,025
Cost of sales		823		815

Gross profit	$	199	$	210

Profit (loss)	$	50	$	39

Caterpillar's profit (loss)	$	19	$	17

Sales from SCM to Caterpillar for the three months ended March 31, 2007 and March 31, 2006 of approximately $379 million and $417 million, respectively, are included in the affiliated company sales. In addition, SCM purchased $65 million and $71 million of products from Caterpillar during the three months ended March 31, 2007 and March 31, 2006, respectively.

Financial Position of unconsolidated affiliated companies:
		March 31,		December 31,
(Millions of dollars)		2007		2006

Assets:
	Current assets	$	1,717	$	1,807
	Property, plant and equipment - net		1,043		1,119
	Other assets		156		176

			2,916		3,102

Liabilities:
	Current liabilities		1,251		1,394
	Long-term debt due after one year		265		309
	Other liabilities		148		145

			1,664		1,848

Ownership		$	1,252	$	1,254

Caterpillar's investments in unconsolidated affiliated companies:
(Millions of dollars)
	Investments in equity method companies	$	529	$	542
	Plus: Investments in cost method companies		25		20

	Total investments in unconsolidated affiliated companies	$	554	$	562

On February 15, 2007, we signed a nonbinding memorandum of understanding with Mitsubishi Heavy Industries Ltd. (MHI) and SCM to conclude a plan that would result in a new ownership structure for SCM. The companies are in discussions with the intention of reaching definitive agreements that would result in Caterpillar owning a majority stake in SCM. When complete, SCM will proceed with the execution of a share redemption for a portion of SCM’s shares held by MHI. In conjunction with the plan, we agreed to discuss with MHI the creation of a new comprehensive joint venture agreement as well as certain definitive agreements for implementation of the plan. These definitive agreements would be subject to applicable regulatory approvals.

Page 11

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


(Dollars in millions)	Weighted Amortizable Life (Years)	March 31, 2007		December 31, 2006

Customer relationships	20	$	324	$	242
Intellectual property	11		197		211
Other	13		75		73

Total finite-lived intangible assets - gross	16		596		526
Less: Accumulated amortization			136		139

Intangible assets - net		$	460	$	387

Amortization expense for the three months ended March 31, 2007 and March 31, 2006 was $11 million and $6 million, respectively. Amortization expense related to intangible assets is expected to be:

(Millions of dollars)
2007		2008		2009		2010		2011		Thereafter

$	41	$	40	$	40	$	39	$	37	$	274

During the first quarter 2007, we acquired finite-lived intangible assets of $82 million due to the purchase of Franklin Power Products. (See Note 15 for acquisition details.)

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.

No goodwill was impaired or disposed of during the first quarter of 2007. 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. The declining outlook of this business resulted from the MG Rover’s cessation of vehicle production and warranties resulting from bankruptcy in 2005. Although the MG Rover parts business continues to provide parts to the existing population of vehicles, the unit’s sales will continue to decline in the future as production of new vehicles has ceased. In determining if there was impairment, we first compared the fair value of the reporting unit (calculated by discounting projected cash flows) to the carrying value. Because the carrying value exceeded the fair value, we allocated the fair value to the assets and liabilities of the unit and determined the fair value of the implied goodwill was zero. 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" category during the first quarter of 2006.

During the first quarter of 2007, we acquired assets with related goodwill of $36 million as part purchase of Franklin Power Products (See Note 15 for details on the acquisition of these assets.)

The changes in carrying amount of the goodwill by reportable segment for the quarter ended March 31, 2007 were as follows:


(Millions of dollars)	Heavy Construction & Mining		Electric Power		Large Power Products		All Other¹		Consolidated Total

Balance at December 31, 2006	$	20	$	203	$	628	$	1,053	$	1,904

Acquisitions		—		—		—		36		36

Balance at March 31, 2007	$	20	$	203	$	628	$	1,089	$	1,940


¹All Other includes operating segments included in “All Other” category (See Note 13).

Page 12

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 (SFAS 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.


	March 31, 2007							December 31, 2006

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

Government debt	$	350	$	(3	)	$	347	$	355	$	(5	)	$	350
Corporate bonds		608		(4	)		604		541		(6	)		535
Equity securities		157		25			182		154		26			180

Total	$	1,115	$	18		$	1,133	$	1,050	$	15		$	1,065

Investments in an unrealized loss position that are not other-than-temporarily impaired:
	March 31, 2007

	Less than 12 months¹				12 months or more¹				Total

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

Government debt	$	77	$	—	$	181	$	3	$	258	$	3
Corporate bonds		144		1		135		4		279		5
Equity securities		13		1		22		—		35		1

Total	$	234	$	2	$	338	$	7	$	572	$	9

¹Indicates length of time that individual securities have been in a continuous unrealized loss position.

Investments in an unrealized loss position that are not other-than-temporarily impaired:
	December 31, 2006

	Less than 12 months¹				12 months or more¹				Total

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

Government debt	$	116	$	—	$	199	$	4	$	315	$	4
Corporate bonds		198