Edgar Filing: CATERPILLAR INC

form10q_3q07.htm

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, 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 September 30, 2007, 635,960,246 shares of common stock of the Registrant were outstanding.

Page 1

Table of Contents
			Page
Part I – Financial Information
	Item 1.	Financial Statements	3
	Item 2.	Management’s Discussion and Analysis	26
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	59
	Item 4.	Controls and Procedures	59

Part II – Other Information
	Item 1.	Legal Proceedings	60
	Item 1A.	Risk Factors	*
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	60
	Item 3.	Defaults Upon Senior Securities	*
	Item 4.	Submission of Matters to a Vote of Security Holders	*
	Item 5.	Other Information	*
	Item 6.	Exhibits	61

* Item omitted because no answer is called for or item is not applicable.

Page 2

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,
		2007		2006
Sales and revenues:
	Sales of Machinery and Engines	$	10,668	$	9,842
	Revenues of Financial Products		774		675
	Total sales and revenues		11,442		10,517

Operating costs:
	Cost of goods sold		8,270		7,610
	Selling, general and administrative expenses		938		988
	Research and development expenses		357		329
	Interest expense of Financial Products		289		266
	Other operating expenses		275		246
	Total operating costs		10,129		9,439

Operating profit			1,313		1,078

	Interest expense excluding Financial Products		69		72
	Other income (expense)		51		72

Consolidated profit before taxes			1,295		1,078

	Provision for income taxes		395		334
	Profit of consolidated companies		900		744

	Equity in profit (loss) of unconsolidated affiliated companies		27		25

Profit		$	927	$	769


Profit per common share		$	1.45	$	1.18

Profit per common share – diluted ¹		$	1.40	$	1.14

Weighted average common shares outstanding (millions)
	- Basic		638.3		653.2
	- Diluted ¹		660.0		677.2

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 3

Caterpillar Inc. Consolidated Statement of Results of Operations (Unaudited) (Dollars in millions except per share data)
		Nine Months Ended
		September 30,
		2007		2006
Sales and revenues:
	Sales of Machinery and Engines	$	30,602	$	28,541
	Revenues of Financial Products		2,212		1,973
	Total sales and revenues		32,814		30,514

Operating costs:
	Cost of goods sold		23,706		21,578
	Selling, general and administrative expenses		2,796		2,690
	Research and development expenses		1,047		979
	Interest expense of Financial Products		839		754
	Other operating expenses		760		738
	Total operating costs		29,148		26,739

Operating profit			3,666		3,775

	Interest expense excluding Financial Products		228		206
	Other income (expense)		232		165

Consolidated profit before taxes			3,670		3,734

	Provision for income taxes		1,155		1,153
	Profit of consolidated companies		2,515		2,581

	Equity in profit (loss) of unconsolidated affiliated companies		51		74

Profit		$	2,566	$	2,655


Profit per common share		$	4.00	$	4.01

Profit per common share – diluted ¹		$	3.87	$	3.86

Weighted average common shares outstanding (millions)
	- Basic		641.0		662.4
	- Diluted ¹		662.7		688.5

Cash dividends declared per common share		$	.66	$	.55

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

Page 4

Caterpillar Inc. Consolidated Statement of Financial Position (Unaudited) (Dollars in millions)
				September 30, 2007			December 31, 2006
Assets
	Current assets:
		Cash and short-term investments		$	910		$	530
		Receivables – trade and other			8,089			8,607
		Receivables – finance			6,991			6,804
		Deferred and refundable income taxes			892			733
		Prepaid expenses and other current assets			853			638
		Inventories			7,187			6,351
	Total current assets				24,922			23,663

	Property, plant and equipment – net				9,436			8,851
	Long-term receivables – trade and other				784			860
	Long-term receivables – finance				12,917			11,531
	Investments in unconsolidated affiliated companies				551			562
	Noncurrent deferred and refundable income taxes				1,954			1,949
	Intangible assets				456			387
	Goodwill				1,937			1,904
	Other assets				1,842			1,742
Total assets				$	54,799		$	51,449

Liabilities
	Current liabilities:
		Short-term borrowings:
			Machinery and Engines	$	132		$	165
			Financial Products		5,254			4,990
		Accounts payable			4,426			4,085
		Accrued expenses			3,080			2,923
		Accrued wages, salaries and employee benefits			1,022			938
		Customer advances			1,435			921
		Dividends payable			—			194
		Other current liabilities			808			1,145
		Long-term debt due within one year:
			Machinery and Engines		425			418
			Financial Products		4,491			4,043
	Total current liabilities				21,073			19,822

	Long-term debt due after one year:
		Machinery and Engines			3,725			3,694
		Financial Products			13,428			13,986
	Liability for postemployment benefits				5,910			5,879
	Other liabilities				2,055			1,209
Total liabilities					46,191			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: (9/30/07 and 12/31/06 – 814,894,624) at paid-in amount			2,759			2,465
	Treasury stock (9/30/07 – 178,934,378; 12/31/06 – 169,086,448) at cost				(8,547	)		(7,352	)
	Profit employed in the business				16,877			14,593
	Accumulated other comprehensive income (loss)				(2,481	)		(2,847	)
Total stockholders' equity					8,608			6,859
Total liabilities and stockholders' equity				$	54,799		$	51,449

See accompanying notes to Consolidated Financial Statements.

Page 5

Caterpillar Inc.
Consolidated Statement of Changes in Stockholders' Equity
(Unaudited)
(Dollars in millions)
											Accumulated other comprehensive income (loss)
			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
Nine Months ended September 30, 2006
Balance at December 31, 2005			$	1,859	$	(4,637	)	$	11,808		$	302	$	(934	)	$	18		$	16		$	8,432
Profit				—		—			2,655			—		—			—			—			2,655
Foreign currency translation				—		—			—			117		—			—			—			117
Derivative financial instruments
	Gains (losses) deferred, net of tax of $27			—		—			—			—		—			54			—			54
	(Gains) losses reclassified to earnings, net of tax of $27			—		—			—			—		—			(47	)		—			(47	)
Available-for-sale securities
	Gains (losses) deferred, net of tax of $4			—		—			—			—		—			—			10			10
	(Gains) losses reclassified to earnings, net of tax of $9			—		—			—			—		—			—			(18	)		(18	)
		Comprehensive Income																					2,771
Dividends declared				—		—			(363	)		—		—			—			—			(363	)
Common shares issued from treasury stock for stock-based compensation: 14,180,353				71		312			—			—		—			—			—			383
Stock-based compensation expense				123		—			—			—		—			—			—			123
Tax benefits from stock-based compensation				161		—			—			—		—			—			—			161
Shares repurchased: 39,855,000				—		(2,858	)		—			—		—			—			—			(2,858	)
Shares issued for Progress Rail Services, Inc. acquisition: 5,341,902				227		152			—			—		—			—			—			379
Balance at September 30, 2006			$	2,441	$	(7,031	)	$	14,100		$	419	$	(934	)	$	25		$	8		$	9,028

Nine Months ended September 30, 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				—		—			2,566			—		—			—			—			2,566
Foreign currency translation				—		—			—			190		—			—			—			190
Amortization of pension and other postretirement benefits losses, net of tax of $99				—		—			—			—		186			—			—			186
Derivative financial instruments
	Gains (losses) deferred, net of tax of $19			—		—			—			—		—			34			—			34
	(Gains) losses reclassified to earnings, net of tax of $30			—		—			—			—		—			(52	)		—			(52	)
Available-for-sale securities
	Gains (losses) deferred, net of tax of $9			—		—			—			—		—			—			14			14
	(Gains) losses reclassified to earnings, net of tax of $3			—		—			—			—		—			—			(6	)		(6	)
		Comprehensive Income																					2,932
Dividends declared				—		—			(423	)		—		—			—			—			(423	)
Common shares issued from treasury stock for stock-based compensation: 11,052,070				21		290			—			—		—			—			—			311
Stock-based compensation expense				125		—			—			—		—			—			—			125
Tax benefits from stock-based compensation				148		—			—			—		—			—			—			148
Shares repurchased: 20,900,000				—		(1,485	)		—			—		—			—			—			(1,485	)
Balance at September 30, 2007			$	2,759	$	(8,547	)	$	16,877		$	661	$	(3,190	)	$	30		$	18		$	8,608

¹	Pension and other postretirement benefits include the aggregate adjustment for unconsolidated companies of $(3) million for the nine months ended September 30, 2007. The ending balances were $40 million and $37 million at September 30, 2007 and 2006, respectively.
See accompanying notes to Consolidated Financial Statements.

Page 6

Caterpillar Inc. Condensed Consolidated Statement of Cash Flow (Unaudited) (Millions of dollars)
			Nine Months Ended
			September 30,
			2007			2006
Cash flow from operating activities:
	Profit		$	2,566		$	2,655
	Adjustments for non-cash items:
		Depreciation and amortization		1,301			1,220
		Other		38			110
	Changes in assets and liabilities:
		Receivables – trade and other		850			(165	)
		Inventories		(715	)		(902	)
		Accounts payable and accrued expenses		268			327
		Other assets – net		(89	)		(345	)
		Other liabilities – net		1,211			666
Net cash provided by (used for) operating activities				5,430			3,566

Cash flow from investing activities:
	Capital expenditures – excluding equipment leased to others			(969	)		(905	)
	Expenditures for equipment leased to others			(971	)		(798	)
	Proceeds from disposals of property, plant and equipment			302			440
	Additions to finance receivables			(9,797	)		(7,817	)
	Collections of finance receivables			7,908			6,204
	Proceeds from sales of finance receivables			800			1,004
	Investments and acquisitions (net of cash acquired)			(130	)		(512	)
	Proceeds from sales of available-for-sale securities			196			255
	Investments in available-for-sale securities			(286	)		(357	)
	Other – net			336			201
Net cash provided by (used for) investing activities				(2,611	)		(2,285	)

Cash flow from financing activities:
	Dividends paid			(617	)		(531	)
	Common stock issued, including treasury shares reissued			311			383
	Treasury shares purchased			(1,485	)		(2,858	)
	Excess tax benefit from stock-based compensation			143			159
	Proceeds from debt issued (original maturities greater than three months)			7,506			8,629
	Payments on debt (original maturities greater than three months)			(7,923	)		(8,517	)
	Short-term borrowings (original maturities three months or less) – net			(374	)		905
Net cash provided by (used for) financing activities				(2,439	)		(1,830	)
Effect of exchange rate changes on cash				—			(6	)
Increase (decrease) in cash and short-term investments				380			(555	)

Cash and short-term investments at beginning of period				530			1,108
Cash and short-term investments at end of period			$	910		$	553

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 accompanying notes to Consolidated Financial Statements.

Page 7

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 month periods ended September 30, 2007 and 2006, (b) the consolidated financial position at September 30, 2007 and December 31, 2006, (c) the consolidated changes in stockholders' equity for the nine month periods ended September 30, 2007 and 2006, and (d) the consolidated statement of cash flow for the nine month periods ended September 30, 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 September 30, 2007 and 2006 was $1,067 million and $764 million, respectively. Total comprehensive income for the nine months ended September 30, 2007 and 2006 was $2,932 million and $2,771 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 more than 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 8

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. We do not expect the adoption to have a material impact on our financial statements.

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 (loss), net of tax effects, until they are amortized as a component of net periodic benefit 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.

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 will adopt this new accounting standard on January 1, 2008. We do not expect the adoption to have a material impact on our financial statements.

Page 9

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 $43 million and $125 million for the three and nine months ended September 30, 2007, respectively; and $31 million and $123 million for the three and nine months ended September 30, 2006, respectively.

The following table illustrates the type and fair market value of the stock-based compensation awards granted during the nine month periods ended September 30, 2007 and 2006, respectively:



	2007				2006
	# Granted		Fair Value Per Award		# Granted		Fair Value Per Award
SARs		4,195,188	$	20.73		9,479,534	$	23.44
Stock options		231,615		20.73		331,806		23.44
RSUs		1,282,020		59.94		—		—

The following table provides the assumptions used in determining the fair value of the stock-based awards for the nine month periods ended September 30, 2007 and 2006, respectively:


	Grant Year
	2007		2006
Weighted-average dividend yield		1.68%		1.79%
Weighted-average volatility		26.04%		26.79%
Range of volatilities		26.03-26.62%		26.56-26.79%
Range of risk-free interest rates		4.40-5.16%		4.34-4.64%
Weighted-average expected lives		8 years		8 years

As of September 30, 2007, the total remaining unrecognized compensation cost related to nonvested stock-based compensation awards was $142 million, which will be amortized over the weighted-average remaining requisite service period of approximately 2.0 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.

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. In addition, the amount of Caterpillar stock that can be repurchased under our stock repurchase program is impacted by movements in the price of the stock. Our Risk Management Policy (policy) allows for the use of derivative financial instruments to prudently manage foreign currency exchange rate, interest rate, commodity price and Caterpillar stock price exposures. 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 10

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 five years.

We generally designate as cash flow hedges at inception of the contract any Australian dollar, Brazilian real, British pound, Canadian dollar, Chinese yuan, 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 September 30, 2007, $23 million of deferred net gains (net of tax) included in equity ("Accumulated other comprehensive income (loss)" 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 the 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 September 30,						Nine Months Ended September 30,
(Millions of dollars)		2007			2006			2007			2006
Machinery and Engines:
	On undesignated contracts	$	14		$	(3	)	$	22		$	16
Financial Products:
	On undesignated contracts		(42	)		(3	)		(52	)		(4	)
		$	(28	)	$	(6	)	$	(30	)	$	12

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 existing fixed-to-floating interest rate swaps. The gain ($5 million at September 30, 2007) is being amortized to earnings ratably over the remaining life of the hedged debt. Since 2006, we have entered into a total of $400 million of interest rate swaps designated as fair value hedges of our fixed-rate long-term debt.

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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.

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 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 ($6 million remaining at September 30, 2007) are being amortized to earnings ratably over the remaining life of the hedged debt. Financial Products liquidated floating-to-fixed interest rate swaps during 2007 that resulted in deferred net gains that are being amortized to earnings ratably over the remaining life of the hedged debt. The unamortized balance of $1 million as of September 30, 2007 will be amortized into Interest expense over the next 12 months.


Gains (losses) included in current earnings [Other income (expense)]:
			Three Months Ended September 30,						Nine Months Ended September 30,
(Millions of dollars)			2007			2006			2007			2006
Fixed-to-floating interest rate swaps
	Machinery and Engines:
		Gain (loss) on designated interest rate derivatives	$	14		$	—		$	9		$	—
		Gain (loss) on hedged debt		(2	)		—			—			—
		Gain (loss) on liquidated swaps – included in interest expense		1			1			2			3
	Financial Products:
		Gain (loss) on designated interest rate derivatives		62			79			31			(7	)
		Gain (loss) on hedged debt		(64	)		(79	)		(33	)		7
		Gain (loss) on liquidated swaps – included in interest expense		1			2			2			6
			$	12		$	3		$	11		$	9

As of September 30, 2007, $7 million, net of tax, of deferred net gains included in equity ("Accumulated other comprehensive income (loss)"), 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 and nine months ended September 30, 2007. 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.

Stock Repurchase Risk

In February 2007, the Board of Directors authorized a $7.5 billion stock repurchase program, expiring on December 31, 2011. The amount of Caterpillar stock that can be repurchased under the authorization is impacted by movements in the price of the stock. In August 2007, the Board of Directors authorized the use of derivative contracts to reduce stock repurchase price volatility. No stock repurchase derivative contracts had been executed as of September 30, 2007.

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


(Millions of dollars)	September 30,		December 31,
	2007		2006
Raw materials	$	2,464	$	2,182
Work-in-process		1,186		977
Finished goods		3,236		2,915
Supplies		301		277
Total inventories	$	7,187	$	6,351

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:


Results of Operations of unconsolidated affiliated companies:
	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(Millions of dollars)	2007		2006		2007		2006
Sales	$	859	$	1,158	$	2,931	$	3,291
Cost of sales		697		931		2,367		2,625
Gross profit		162		227		564		666

Profit (loss)	$	23	$	61	$	113	$	169

Caterpillar's profit (loss)	$	27	$	25	$	51	$	74


Financial Position of unconsolidated affiliated companies:		September 30,		December 31,
(Millions of dollars)		2007		2006
Assets:
	Current assets	$	1,666	$	1,807
	Property, plant and equipment – net		1,180		1,119
	Other assets		170		176
			3,016		3,102
Liabilities:
	Current liabilities		1,215		1,394
	Long-term debt due after one year		264		309
	Other liabilities		325		145
			1,804		1,848
Ownership		$	1,212	$	1,254

Caterpillar's investments in unconsolidated affiliated companies:
(Millions of dollars)
	Investments in equity method companies	$	535	$	542
	Plus: Investments in cost method companies		16		20
	Total investments in unconsolidated affiliated companies	$	551	$	562

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Sales from SCM to Caterpillar for the three months ended September 30, 2007 and September 30, 2006 of $460 million and $488 million, respectively, and for the nine months ended September 30, 2007 and September 30, 2006 of $1,232 million and $1,379 million, respectively, are included in the affiliated company sales. In addition, SCM purchases of Caterpillar products were $69 million and $70 million for the three months ended September 30, 2007 and September 30, 2006, respectively, and $202 million and $213 million for the nine months ended September 30, 2007 and September 30, 2006, respectively.

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.

During the second quarter of 2007, a $13 million after tax charge for net adjustments related to revenue recognition, deferred tax valuation allowances and environmental liabilities that were identified during our due diligence procedures was included in Equity in profit of unconsolidated affiliated companies. These adjustments have since been recorded by SCM and are reflected in the tables above.

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


(Dollars in millions)	Weighted Amortizable Life (Years)	September 30, 2007		December 31, 2006
Customer relationships	19	$	340	$	242
Intellectual property	11		195		211
Other	13		76		73
Total finite-lived intangible assets – gross	16		611		526
Less: Accumulated amortization			155		139
Intangible assets – net		$	456	$	387

Amortization expense on intangible assets for the three and nine months ended September 30, 2007 was $10 million and $30 million, respectively. Amortization expense for the three and nine months ended September 30, 2006 was $10 million and $23 million, respectively. Amortization expense related to intangible assets is expected to be:


(Millions of dollars)
2007		2008		2009		2010		2011		Thereafter
$	41	$	41	$	40	$	39	$	37	$	288

During the first quarter 2007, we acquired finite-lived intangible assets of $89 million as part of the purchase of Franklin Power Products. (See Note 16 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.

Page 14

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 in Note 13 during the first quarter of 2006. No other goodwill was impaired or disposed of during the three or nine months ended September 30, 2007 and 2006.

During the first quarter of 2007, we acquired assets with related goodwill of $33 million as part of the purchase of Franklin Power Products (See Note 16 for acquisition details.)

The changes in carrying amount of the goodwill by reportable segment for the nine months ended September 30, 2007 were as follows:


(Millions of dollars)	Heavy Construction & Mining		Electric Power		Large Power Products		All Other¹		Consolidated Total
Balance at December 31, 2006	$	14	$	203	$	628	$	1,059	$	1,904
Acquisitions		—		—		—		33		33
Balance at September 30, 2007	$	14	$	203	$	628	$	1,092	$	1,937

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

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 (loss)" 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, 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	$	346	$	(1	)	$	345	$	355	$	(5	)	$	350
Corporate bonds		676		(5	)		671		541		(6	)		535
Equity securities		166		35			201		154		26			180
Total	$	1,188	$	29		$	1,217	$	1,050	$	15		$	1,065

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Investments in an unrealized loss position that are not other-than-temporarily impaired:
	September 30, 2007
	Less than 12 months ¹				12 months or more ¹					Total
(Millions of dollars)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Government debt	$	68	$	—	$	141	$	2		$	209	$	2
Corporate bonds		258		4		175		4			433		8
Equity securities		36		3		—		—			36		3
Total	$	362	$	7	$	316	$	6		$	678	$	13

	December 31, 2006
	Less than 12 months ¹				12 months or more ¹					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		1		233			5		431		6
Equity securities		22		1		1