Edgar Filing: CATERPILLAR INC

form10q_3q08.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, 2008 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, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer”, “accelerated filer" and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

	Large accelerated filer	X	Accelerated filer

	Non-accelerated filer		Smaller reporting company

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, 2008, 603,233,837 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	30
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	62
	Item 4.	Controls and Procedures	62

Part II – Other Information
	Item 1.	Legal Proceedings	63
	Item 1A.	Risk Factors	63
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	68
	Item 3.	Defaults Upon Senior Securities	*
	Item 4.	Submission of Matters to a Vote of Security Holders	*
	Item 5.	Other Information	*
	Item 6.	Exhibits	69

* 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,
				2008		2007
Sales and revenues:
	Sales of Machinery and Engines			$	12,148	$	10,668
	Revenues of Financial Products				833		774
	Total sales and revenues				12,981		11,442

Operating costs:
	Cost of goods sold				9,704		8,270
	Selling, general and administrative expenses				1,061		938
	Research and development expenses				437		357
	Interest expense of Financial Products				291		289
	Other operating expenses				315		275
	Total operating costs				11,808		10,129

Operating profit					1,173		1,313

	Interest expense excluding Financial Products				59		69
	Other income (expense)				138		51

Consolidated profit before taxes					1,252		1,295

	Provision for income taxes				395		395
	Profit of consolidated companies				857		900

	Equity in profit (loss) of unconsolidated affiliated companies				11		27

Profit				$	868	$	927


Profit per common share				$	1.43	$	1.45

Profit per common share – diluted			1	$	1.39	$	1.40

Weighted average common shares outstanding (millions)
	- Basic				607.0		638.3
	- Diluted	1			624.8		660.0

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,
				2008		2007
Sales and revenues:
	Sales of Machinery and Engines			$	35,924	$	30,602
	Revenues of Financial Products				2,477		2,212
	Total sales and revenues				38,401		32,814

Operating costs:
	Cost of goods sold				28,349		23,706
	Selling, general and administrative expenses				3,094		2,796
	Research and development expenses				1,221		1,047
	Interest expense of Financial Products				854		839
	Other operating expenses				892		760
	Total operating costs				34,410		29,148

Operating profit					3,991		3,666

	Interest expense excluding Financial Products				203		228
	Other income (expense)				325		232

Consolidated profit before taxes					4,113		3,670

	Provision for income taxes				1,249		1,155
	Profit of consolidated companies				2,864		2,515

	Equity in profit (loss) of unconsolidated affiliated companies				32		51

Profit				$	2,896	$	2,566


Profit per common share				$	4.72	$	4.00

Profit per common share – diluted			1	$	4.57	$	3.87

Weighted average common shares outstanding (millions)
	- Basic				613.2		641.0
	- Diluted	1			633.2		662.7

Cash dividends declared per common share				$	.78	$	.66

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, 2008			December 31, 2007
Assets
	Current assets:
		Cash and short-term investments		$	2,138		$	1,122
		Receivables – trade and other			9,580			8,249
		Receivables – finance			8,094			7,503
		Deferred and refundable income taxes			839			816
		Prepaid expenses and other current assets			583			583
		Inventories			9,290			7,204
	Total current assets				30,524			25,477

	Property, plant and equipment – net				11,817			9,997
	Long-term receivables – trade and other				685			685
	Long-term receivables – finance				15,024			13,462
	Investments in unconsolidated affiliated companies				100			598
	Noncurrent deferred and refundable income taxes				1,337			1,553
	Intangible assets				536			475
	Goodwill				2,234			1,963
	Other assets				1,972			1,922
Total assets				$	64,229		$	56,132

Liabilities
	Current liabilities:
		Short-term borrowings:
			Machinery and Engines	$	1,858		$	187
			Financial Products		6,315			5,281
		Accounts payable			5,149			4,723
		Accrued expenses			3,668			3,178
		Accrued wages, salaries and employee benefits			1,115			1,126
		Customer advances			1,946			1,442
		Dividends payable			—			225
		Other current liabilities			1,112			951
		Long-term debt due within one year:
			Machinery and Engines		353			180
			Financial Products		5,844			4,952
	Total current liabilities				27,360			22,245

	Long-term debt due after one year:
		Machinery and Engines			4,265			3,639
		Financial Products			15,529			14,190
	Liability for postemployment benefits				4,796			5,059
	Other liabilities				2,170			2,116
Total liabilities					54,120			47,249
Commitments and contingencies (Notes 10 and 12)
Redeemable noncontrolling interest (Note 16)					464			—
Stockholders' equity
	Common stock of $1.00 par value:
		Authorized shares: 900,000,000 Issued shares: (9/30/08 and 12/31/07 – 814,894,624) at paid-in amount			2,993			2,744
	Treasury stock (9/30/08 – 211,660,787; 12/31/07 – 190,908,490) at cost				(11,109	)		(9,451	)
	Profit employed in the business				19,673			17,398
	Accumulated other comprehensive income (loss)				(1,912	)		(1,808	)
Total stockholders' equity					9,645			8,883
Total liabilities, redeemable noncontrolling interest and stockholders' equity				$	64,229		$	56,132

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		Treasury			Profit employed in the			Foreign currency			Pension & other post- retirement			Derivative financial instruments			Available- for-sale
Nine Months Ended September 30, 2007				stock		stock			business			translation			benefits		1	and other			securities			Total
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
Pension and other postretirement benefits
	Amortization of actuarial (gain) loss, net of tax of $91				—		—			—			—			171			—			—			171
	Amortization of prior service cost, net of tax of $7				—		—			—			—			13			—			—			13
	Amortization of transition asset/obligation, net of tax of $1				—		—			—			—			2			—			—			2
Derivative financial instruments and other
	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 (loss)																							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

Nine Months Ended September 30, 2008
Balance at December 31, 2007				$	2,744	$	(9,451	)	$	17,398		$	749		$	(2,594	)	$	19		$	18		$	8,883
Adjustment to adopt measurement date
provisions of FAS 158, net of tax			2		—		—			(33	)		—			17			—			—			(16	)
Balance at January 1, 2008					2,744		(9,451	)		17,365			749			(2,577	)		19			18			8,867
Profit					—		—			2,896			—			—			—			—			2,896
Foreign currency translation, net of tax of $107					—		—			—			(234	)		(3	)		—			—			(237	)
Pension and other postretirement benefits
	Amortization of actuarial (gain) loss, of FAS 158, net of tax of $61				—		—			—			—			113			—			—			113
	Amortization of prior service cost, net of tax of $0				—		—			—			—			1			—			—			1
	Amortization of transition asset/obligation, net of tax of $1				—		—			—			—			1			—			—			1
Derivative financial instruments and other
	Gains (losses) deferred, net of tax of $63				—		—			—			—			—			90			—			90
	(Gains) losses reclassified to earnings, net of tax of $16				—		—			—			—			—			(18	)		—			(18	)
Available-for-sale securities
	Gains (losses) deferred, net of tax of $39				—		—			—			—			—			—			(72	)		(72	)
	(Gains) losses reclassified to earnings, net of tax of $1				—		—			—			—			—			—			1			1
		Comprehensive income (loss)																							2,775
Dividends declared					—		—			(475	)		—			—			—			—			(475	)
Common shares issued from treasury stock for stock-based compensation: 4,514,729					8		120			—			—			—			—			—			128
Stock-based compensation expense					163		—			—			—			—			—			—			163
Tax benefits from stock-based compensation					54		—			—			—			—			—			—			54
Shares repurchased: 25,267,026			3		—		(1,778	)		—			—			—			—			—			(1,778	)
Stock repurchase derivative contracts					24		—			—			—			—			—			—			24
Cat Japan share redemption			4		—		—			(113	)		—			—			—			—			(113	)
Balance at September 30, 2008				$	2,993	$	(11,109	)	$	19,673		$	515		$	(2,465	)	$	91		$	(53	)	$	9,645

1	Pension and other postretirement benefits include net adjustments for Caterpillar Japan Limited (Cat Japan) of $1 million and $(3) million for the nine months ended September 30, 2008 and 2007, respectively. The ending balances were $53 million and $40 million at September 30, 2008 and 2007, respectively. See Note 16 regarding the Cat Japan share redemption.
2	Adjustments to profit employed in the business and pension and other postemployment benefits were net of tax of $(17) million and $9 million, respectively.
3	Amount consists of $1,716 million of cash-settled purchases and $62 million of derivative contracts.
4	See Note 16 regarding the Cat Japan share redemption.
	See accompanying notes to Consolidated Financial Statements.

Page 6

Caterpillar Inc. Consolidated Statement of Cash Flow (Unaudited) (Dollars in millions)
			Nine Months Ended
			September 30,
			2008			2007
Cash flow from operating activities:
	Profit		$	2,896		$	2,566
	Adjustments for non-cash items:
		Depreciation and amortization		1,453			1,301
		Other		84			38
	Changes in assets and liabilities:
		Receivables – trade and other		(676	)		850
		Inventories		(1,380	)		(715	)
		Accounts payable and accrued expenses		790			268
		Customer advances		321			541
		Other assets – net		154			(89	)
		Other liabilities – net		(372	)		670
Net cash provided by (used for) operating activities				3,270			5,430

Cash flow from investing activities:
	Capital expenditures – excluding equipment leased to others			(1,362	)		(969	)
	Expenditures for equipment leased to others			(1,082	)		(971	)
	Proceeds from disposals of property, plant and equipment			754			302
	Additions to finance receivables			(11,168	)		(9,797	)
	Collections of finance receivables			7,402			7,908
	Proceeds from sales of finance receivables			710			800
	Investments and acquisitions (net of cash acquired)			(139	)		(130	)
	Proceeds from sales of available-for-sale securities			292			196
	Investments in available-for-sale securities			(270	)		(286	)
	Other – net			116			336
Net cash provided by (used for) investing activities				(4,747	)		(2,611	)

Cash flow from financing activities:
	Dividends paid			(700	)		(617	)
	Common stock issued, including treasury shares reissued			128			311
	Payment for stock repurchase derivative contracts			(38	)		—
	Treasury shares purchased			(1,716	)		(1,485	)
	Excess tax benefit from stock-based compensation			55			143
	Proceeds from debt issued (original maturities greater than three months)
	- Machinery and Engines			49			125
	- Financial Products			13,971			7,381
	Payments on debt (original maturities greater than three months)
	- Machinery and Engines			(173	)		(169	)
	- Financial Products			(10,715	)		(7,754	)
	Short-term borrowings (original maturities three months or less) – net			1,646			(374	)
Net cash provided by (used for) financing activities				2,507			(2,439	)
Effect of exchange rate changes on cash				(14	)		—
Increase (decrease) in cash and short-term investments				1,016			380

Cash and short-term investments at beginning of period				1,122			530
Cash and short-term investments at end of period			$	2,138		$	910

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.

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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, 2008 and 2007, (b) the consolidated financial position at September 30, 2008 and December 31, 2007, (c) the consolidated changes in stockholders' equity for the nine month periods ended September 30, 2008 and 2007, and (d) the consolidated statement of cash flow for the nine month periods ended September 30, 2008 and 2007. The financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America (U.S. 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 the audited financial statements and notes thereto included in our Company's annual report on Form 10-K for the year ended December 31, 2007 (2007 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, 2008 and 2007 was $571 million and $1,067 million, respectively. Total comprehensive income for the nine months ended September 30, 2008 and 2007 was $2,775 million and $2,932 million, respectively.

The December 31, 2007 financial position data included herein is derived from the audited consolidated financial statements included in the 2007 Form 10-K, but does not include all disclosures required by U.S. GAAP.

	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 services 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 30,000 horsepower (1 200 to 22 000 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.

New Accounting Pronouncements

FIN 48 – In July 2006, the Financial Accounting Standards Board (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.

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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. In February 2008, the FASB issued final Staff Positions that (1) deferred the effective date of this Statement for one year for certain nonfinancial assets and nonfinancial liabilities (see below) and (2) removed certain leasing transactions from the scope of the Statement. We applied this new accounting standard to all other fair value measurements effective January 1, 2008. The adoption of SFAS 157 did not have a material impact on our financial statements. See Note 15 for additional information.

FSP 157-2 – In February 2008, the FASB issued FASB Staff Position on Statement 157 "Effective Date of FASB Statement No. 157" (FSP 157-2). FSP 157-2 delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed on a recurring basis, to fiscal years beginning after November 15, 2008. Our significant nonfinancial assets and liabilities that could be impacted by this deferral include assets and liabilities initially measured at fair value in a business combination and goodwill tested annually for impairment. The adoption of FSP 157-2 is not expected to have a significant impact on our financial statements.

FSP 157-3 – In October 2008, the FASB issued FASB Staff Position on Statement 157 "Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (FSP 157-3). FSP 157-3 clarifies how FAS 157 should be applied when valuing securities in markets that are not active by illustrating key considerations in determining fair value. It also reaffirms the notion of fair value as the exit price as of the measurement date. FSP 157-3 was effective upon issuance, which included periods for which financial statements have not yet been issued. This new accounting standard has been adopted for our financial statements ended September 30, 2008. The adoption of FSP157-3 did not 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. 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. We adopted the balance sheet recognition provisions at December 31, 2006, and adopted the year-end measurement date effective January 1, 2008 using the “one measurement” approach. Under the one measurement approach, net periodic benefit cost for the period between any early measurement date and the end of the fiscal year that the measurement provisions are applied are allocated proportionately between amounts to be recognized as an adjustment of retained earnings and net periodic benefit cost for the fiscal year. Previously, we used a November 30th measurement date for our U.S. pension and other postretirement benefit plans and September 30th for our non-U.S. plans. The following summarizes the effect of adopting the year-end measurement date provisions as of January 1, 2008. See Note 9 for additional information.

Adoption of SFAS 158 year-end measurement date
	January 1, 2008 Prior to SFAS 158 Adjustment			SFAS 158 Adjustment			January 1, 2008 Post SFAS 158 Adjustment
(Millions of dollars)
Noncurrent deferred and refundable income taxes	$	1,553		$	8		$	1,561
Liability for postemployment benefits		5,059			24			5,083
Accumulated other comprehensive income (loss)		(1,808	)		17			(1,791	)
Profit employed in the business		17,398			(33	)		17,365

Page 9

SFAS 159 – In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 (SFAS 159), “The Fair Value Option for Financial Assets and Financial Liabilities – including an amendment of SFAS No. 115.” SFAS 159 creates 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. We adopted this new accounting standard on January 1, 2008. We have not elected to measure any financial assets or financial liabilities at fair value which were not previously required to be measured at fair value. Therefore, the adoption of SFAS 159 did not have a material impact on our financial statements.

SFAS 141R & SFAS 160 – In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007) (SFAS 141R), “Business Combinations,” and No. 160 (SFAS 160), “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51.” SFAS 141R requires the acquiring entity in a business combination to recognize the assets acquired and liabilities assumed. Further, SFAS 141R also changes the accounting for acquired in-process research and development assets, contingent consideration, partial acquisitions and transaction costs. Under SFAS 160, all entities are required to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements. In addition, transactions between an entity and noncontrolling interests will be treated as equity transactions. SFAS 141R and SFAS 160 will become effective for fiscal years beginning after December 15, 2008. We will adopt these new accounting standards on January 1, 2009. We do not expect the adoption to have a material impact on our financial statements.

SFAS 161 – In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161 (SFAS 161), “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133.” SFAS 161 expands disclosures for derivative instruments by requiring entities to disclose the fair value of derivative instruments and their gains or losses in tabular format. SFAS 161 also requires disclosure of information about credit risk-related contingent features in derivative agreements, counterparty credit risk, and strategies and objectives for using derivative instruments. SFAS 161 will become effective for fiscal years beginning after November 15, 2008. We will adopt this new accounting standard on January 1, 2009. We do not expect the adoption to have a material impact on our financial statements.

SFAS 162 – In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162 (SFAS 162), “The Hierarchy of Generally Accepted Accounting Principles.” SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with U.S. GAAP. SFAS 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” This statement is not expected to result in a change in our current practice.

SFAS 163 – In May 2008, the FASB issued Statement of Financial Accounting Standards No. 163 (SFAS 163), “Accounting for Financial Guarantee Insurance Contracts – an interpretation of FASB Statement No. 60.” SFAS 163 requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. It also requires disclosure about (1) the risk-management activities used by an insurance enterprise to evaluate credit deterioration in its insured financial obligations and (2) the insurance enterprise’s surveillance or watch list. SFAS 163 will become effective for fiscal years beginning after December 15, 2008. We will adopt this new accounting standard on January 1, 2009. We do not expect the adoption to have a material impact on our financial statements.

Stock-Based Compensation

Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (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. Our 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 $56 million and $163 million for the three and nine months ended September 30, 2008, respectively; and $43 million and $125 million for the three and nine months ended September 30, 2007, 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, 2008 and 2007, respectively:

	2008				2007
	# Granted		Fair Value Per Award		# Granted		Fair Value Per Award
SARs		4,476,095	$	22.32		4,195,188	$	20.73
Stock options		410,506		22.32		231,615		20.73
RSUs		1,511,523		69.17		1,282,020		59.94

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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, 2008 and 2007, respectively:

	Grant Year
	2008		2007
Weighted-average dividend yield		1.89%		1.68%
Weighted-average volatility		27.14%		26.04%
Range of volatilities		27.13-28.99%		26.03-26.62%
Range of risk-free interest rates		1.60-3.64%		4.40-5.16%
Weighted-average expected lives		8 years		8 years

As of September 30, 2008, the total remaining unrecognized compensation cost related to nonvested stock-based compensation awards was $167 million, which will be amortized over the weighted-average remaining requisite service periods 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. In 2007, under the terms of the Caterpillar Inc. 2006 Long-Term Incentive Plan (approved by stockholders in June of 2006), the Committee approved the exercise price methodology to be the closing price of the Company stock on the date of grant.

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 not be used for speculative purposes. Derivatives that we use are primarily foreign currency forward and option contracts, interest rate swaps, commodity forward and option contracts and stock repurchase 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 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 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 is undesignated. We designate as fair value hedges specific euro forward contracts used to hedge firm commitments.

As of September 30, 2008, $46 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. The actual amount recorded in “Other income (expense)” will vary based on the exchange rates at the time the hedged transactions impact earnings.

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In managing foreign currency risk for our Financial Products operations, our objective is to minimize earnings volatility resulting from conversion and the remeasurement 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)	2008		2007			2008		2007
Machinery and Engines	$	33	$	14		$	32	$	22
Financial Products		151		(42	)		45		(52	)
	$	184	$	(28	)	$	77	$	(30	)

Gains and losses on the Financial Products contracts above are designed to offset 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.

Since 2006, we entered into $400 million (notional amount) of interest rate swaps designated as fair value hedges of our fixed rate long-term debt. During the first quarter 2008, our Machinery and Engines operations liquidated all of these fixed-to-floating interest rate swaps. The gain ($18 million remaining at September 30, 2008) 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.

Our policy allows us to use fixed-to-floating, floating-to-fixed 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 the inception of the swap contract.

Financial Products liquidated fixed-to-floating interest rate swaps during 2006, 2005 and 2004, which resulted in deferred net gains. These gains ($4 million remaining at September 30, 2008) 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 September 30,						Nine Months Ended September 30,
(Millions of dollars)			2008			2007			2008			2007
Fixed-to-floating interest rate swaps
	Machinery and Engines:
		Gain (loss) on designated interest rate derivatives	$	—		$	14		$	18		$	9
		Gain (loss) on hedged debt		—			(2	)		(9	)		—
		Gain (loss) on liquidated swaps – included in interest expense		1			1			3			2

	Financial Products:
		Gain (loss) on designated interest rate derivatives		66			62			(2	)		31
		Gain (loss) on hedged debt		(55	)		(64	)		11			(33	)
		Gain (loss) on liquidated swaps – included in interest expense		—			1			1			2
			$	12		$	12		$	22		$	11

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As of September 30, 2008, $12 million of deferred net losses included in equity ("Accumulated other comprehensive income (loss)" in the Consolidated Statement of Financial Position), 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 material. 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 subject 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 net gains or losses on undesignated contracts for the three or nine months ended September 30, 2007, and no contracts were outstanding during 2008.

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 the movements in the price of the stock. In August 2007, the Board of Directors authorized the use of derivative contracts to reduce stock repurchase volatility.

In connection with our stock repurchase program, we entered into capped call transactions (“call”) with a major bank for an aggregate of 6.0 million shares. During 2008, we paid the bank premiums of $38 million for the establishment of calls for 2.5 million shares, which was accounted for as a reduction to stockholders’ equity. A call permits us to reduce share repurchase price volatility by providing a floor and cap on the price at which the shares can be repurchased. The floor, cap and strike prices for the calls were based upon the average purchase price paid by the bank to purchase our common stock to hedge these transactions. Each call will mature and be exercisable within one year after the call was established. If we exercise a call, we can elect to settle the transaction with the bank by physical settlement (paying cash and receiving shares), cash settle (receiving a net amount of cash) or net share settlement (receiving a net amount of shares). We will continue to use open market purchases in conjunction with capped call transactions to repurchase our stock.

During the three and nine months ended September 30, 2008, $119 million and $219 million of cash were used to repurchase 2.2 million shares and 4.0 million shares, respectively, pursuant to calls exercised under this program. Premiums previously paid associated with these exercised calls were $34 million and $62 million, respectively. The following table summarizes the call contracts outstanding as of September 30, 2008:

Stock repurchase derivative contracts outstanding at September 30, 2008
						per share
Contract Date	Number of Shares		Expiration Date	Net Premiums Paid (Millions)		Lower Strike Price		Upper Strike Price
October 2007		1,000,000	October 2008	$	17	$	58.00	$	88.00
January 2008		1,000,000	December 2008		16		50.00		80.00
Total Outstanding		2,000,000		$	33		54.00		84.00

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

(Millions of dollars)	September 30,		December 31,
	2008		2007
Raw materials	$	3,051	$	2,474
Work-in-process		1,739		1,379
Finished goods		4,205		3,066
Supplies		295		285
Total inventories	$	9,290	$	7,204

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Investments in Unconsolidated Affiliated Companies

Our investments in affiliated companies accounted for by the equity method have historically consisted primarily of a 50 percent interest in Shin Caterpillar Mitsubishi Ltd. (SCM) located in Japan. On August 1, 2008, SCM redeemed half of Mitsubishi Heavy Industries Ltd.’s (MHI’s) shares in SCM. As a result, Caterpillar now owns 67 percent of the renamed entity, Caterpillar Japan Ltd. (Cat Japan). Because Cat Japan is accounted for on a lag, Cat Japan’s August 1, 2008 financial position was consolidated on September 30, 2008. Cat Japan’s results of operations will be consolidated in the fourth quarter. See Note 16 for details on this share redemption. In February 2008, we sold our 23 percent equity investment in A.S.V. Inc. (ASV) resulting in a $60 million pretax gain. Accordingly, the September 30, 2008 financial position and equity investment amounts noted below do not include ASV or Cat Japan.

Combined financial information of the unconsolidated affiliated companies accounted for by the equity method (generally on a lag) was as follows:

Results of Operations of unconsolidated affiliated companies:	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(Millions of dollars)	2008		2007		2008		2007

Sales	$	1,285	$	859	$	3,455	$	2,931
Cost of sales		1,063		697		2,863		2,367
Gross profit		222		162		592		564

Profit (loss)	$	16	$	23	$	53	$	113

Caterpillar's profit (loss)	$	11	$	27	$	32	$	51

Sales from SCM to Caterpillar for the three months ended September 30, 2008 and September 30, 2007 of $437 million and $460 million, respectively, and for the nine months ended September 30, 2008 and September 30, 2007 of $1,669 million and $1,232 million, respectively, are included in the affiliated company sales. In addition, SCM purchases of Caterpillar products were $95 million and $69 million for the three months ended September 30, 2008 and September 30, 2007, respectively, and $353 million and $202 million for the nine months ended September 30, 2008 and September 30, 2007, respectively.

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

Financial Position of unconsolidated affiliated companies:		September 30,		December 31,
(Millions of dollars)		2008		2007
Assets:
	Current assets	$	238	$	2,062
	Property, plant and equipment – net		225		1,286
	Other assets		29		173
			492		3,521
Liabilities:
	Current liabilities		222		1,546
	Long-term debt due after one year		105		269
	Other liabilities		24		393
			351		2,208
Ownership		$	141	$	1,313

Caterpillar's investments in unconsolidated affiliated companies:
(Millions of dollars)
	Investments in equity method companies	$	70	$	582
	Plus: Investments in cost method companies		30		16
	Total investments in unconsolidated affiliated companies	$	100	$	598

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

(Dollars in millions)	Weighted Amortizable Life (Years)	September 30, 2008			December 31, 2007
Customer relationships	18	$	407		$	366
Intellectual property	11		212			195
Other	11		113			81
Total finite-lived intangible assets – gross	15		732			642
Less: Accumulated amortization			(196	)		(167	)
Intangible assets – net		$	536		$	475

During the third quarter of 2008, the Cat Japan share redemption resulted in additional finite-lived intangible assets of $55 million. During the second quarter of 2008, we acquired finite-lived intangible assets of $17 million due to the purchase of Lovat Inc. See Note 16 for details on these business combinations. Also during the second quarter of 2008, we acquired finite-lived intangible assets of $32 million from other acquisitions.

Amortization expense on intangible assets for the three and nine months ended September 30, 2008 was $12 million and $44 million, respectively. Amortization expense for the three and nine months ended September 30, 2007 was $10 million and $30 million, respectively. Amortization expense related to intangible assets is expected to be:

(Millions of dollars)
2008		2009		2010		2011		2012		Thereafter
$	57	$	60	$	58	$	49	$	43	$	313

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 nine months ended September 30, 2008.

During the third quarter of 2008, the Cat Japan share redemption resulted in $199 million of goodwill. Also during the third quarter of 2008, we acquired net assets with related goodwill of $41 million as part of the purchase of Gremada Industries, Inc. During the second quarter of 2008, we acquired net assets with related goodwill of $22 million as part of the purchase of Lovat Inc. See Note 16 for details on these business combinations. Also during the second quarter of 2008, we acquired net assets with related goodwill of $8 million from other acquisitions.

The changes in carrying amount of the goodwill by reportable segment for the nine months ended September 30, 2008 were as follows:

Building

Construction

EAME

Electric

Heavy

Construction

Industrial

Power

Infrastructure

Large

Power

Marine &

Petroleum

All

Consolidated

(Millions of dollars)

Products

Operations

Power

& Mining

Systems

Development

Systems