Edgar Filing: CATERPILLAR INC

CAT_10Q_3.31.2014

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2014

[ ] 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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	o

Non-accelerated filer	o	Smaller reporting company	o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

At March 31, 2014, 624,233,901 shares of common stock of the registrant were outstanding.

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Part I. Financial Information
Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	48
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	74
Item 4.	Controls and Procedures	74

Part II. Other Information
Item 1.	Legal Proceedings	75
Item 1A.	Risk Factors	*
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	75
Item 3.	Defaults Upon Senior Securities	*
Item 4.	Mine Safety Disclosures	76
Item 5.	Other Information	*
Item 6.	Exhibits	76

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

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Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Caterpillar Inc.

Consolidated Statement of Results of Operations

(Unaudited)

(Dollars in millions except per share data)



	Three Months Ended March 31,
	2014		2013
Sales and revenues:
Sales of Machinery, Energy & Transportation	$	12,493	$	12,484
Revenues of Financial Products	748		726
Total sales and revenues	13,241		13,210

Operating costs:
Cost of goods sold	9,437		9,639
Selling, general and administrative expenses	1,292		1,390
Research and development expenses	508		562
Interest expense of Financial Products	160		189
Other operating (income) expenses	446		212
Total operating costs	11,843		11,992

Operating profit	1,398		1,218

Interest expense excluding Financial Products	110		120
Other income (expense)	54		29

Consolidated profit before taxes	1,342		1,127

Provision (benefit) for income taxes	418		246
Profit of consolidated companies	924		881

Equity in profit (loss) of unconsolidated affiliated companies	1		1

Profit of consolidated and affiliated companies	925		882

Less: Profit (loss) attributable to noncontrolling interests	3		2

Profit ¹	$	922	$	880

Profit per common share	$	1.47	$	1.34

Profit per common share – diluted ²	$	1.44	$	1.31

Weighted-average common shares outstanding (millions)
– Basic	626.7		656.2
– Diluted²	639.3		671.6

Cash dividends declared per common share	$	—	$	—

¹ Profit attributable to common stockholders.

² Diluted by assumed exercise of stock-based compensation awards using the treasury stock method.

See accompanying notes to Consolidated Financial Statements.

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Caterpillar Inc.

Consolidated Statement of Comprehensive Income

(Unaudited)

(Dollars in millions)



	Three Months Ended March 31,
	2014			2013

Profit of consolidated and affiliated companies	$	925		$	882
Other comprehensive income (loss), net of tax:
Foreign currency translation, net of tax (provision)/benefit of: 2014 - $0; 2013 - $(21)	39			(366		)

Pension and other postretirement benefits:
Current year actuarial gain (loss), net of tax (provision)/benefit of: 2014 - $0; 2013 - $(10)	—			15
Amortization of actuarial (gain) loss, net of tax (provision)/benefit of: 2014 - $(44); 2013 - $(67)	86			129
Amortization of prior service (credit) cost, net of tax (provision)/benefit of: 2014 - $3; 2013 - $5	(6		)	(9		)
Amortization of transition (asset) obligation, net of tax (provision)/benefit of: 2014 - $0; 2013 - $0	—			1

Derivative financial instruments:
Gains (losses) deferred, net of tax (provision)/benefit of: 2014 - $10; 2013 - $18	(16		)	(31		)
(Gains) losses reclassified to earnings, net of tax (provision)/benefit of: 2014 - $3; 2013 - $(7)	(5		)	11

Available-for-sale securities:
Gains (losses) deferred, net of tax (provision)/benefit of: 2014 - $(3); 2013 - $(8)	8			15
(Gains) losses reclassified to earnings, net of tax (provision)/benefit of: 2014 - $4; 2013 - $0	(10		)	(1		)

Total other comprehensive income (loss), net of tax	96			(236		)
Comprehensive income	1,021			646
Less: comprehensive income attributable to the noncontrolling interests	(2		)	(2		)
Comprehensive income attributable to stockholders	$	1,019		$	644

See accompanying notes to Consolidated Financial Statements.

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Caterpillar Inc.

Consolidated Statement of Financial Position

(Unaudited)

(Dollars in millions)



	March 31, 2014			December 31, 2013
Assets
Current assets:
Cash and short-term investments	$	5,345		$	6,081
Receivables – trade and other	8,565			8,413
Receivables – finance	8,834			8,763
Deferred and refundable income taxes	1,401			1,553
Prepaid expenses and other current assets	935			900
Inventories	12,888			12,625
Total current assets	37,968			38,335

Property, plant and equipment – net	16,716			17,075
Long-term receivables – trade and other	1,284			1,397
Long-term receivables – finance	15,206			14,926
Investments in unconsolidated affiliated companies	266			272
Noncurrent deferred and refundable income taxes	700			594
Intangible assets	3,509			3,596
Goodwill	6,986			6,956
Other assets	1,762			1,745
Total assets	$	84,397		$	84,896

Liabilities
Current liabilities:
Short-term borrowings:
Machinery, Energy & Transportation	$	18		$	16
Financial Products	4,497			3,663
Accounts payable	6,731			6,560
Accrued expenses	3,454			3,493
Accrued wages, salaries and employee benefits	1,475			1,622
Customer advances	2,500			2,360
Dividends payable	—			382
Other current liabilities	1,845			1,849
Long-term debt due within one year:
Machinery, Energy & Transportation	759			760
Financial Products	6,016			6,592
Total current liabilities	27,295			27,297
Long-term debt due after one year:
Machinery, Energy & Transportation	7,998			7,999
Financial Products	18,803			18,720
Liability for postemployment benefits	6,715			6,973
Other liabilities	3,217			3,029
Total liabilities	64,028			64,018
Commitments and contingencies (Notes 10 and 13)
Stockholders’ equity
Common stock of $1.00 par value:
Authorized shares: 2,000,000,000 Issued shares: (3/31/14 and 12/31/13 – 814,894,624) at paid-in amount	4,773			4,709
Treasury stock (3/31/14 – 190,660,723 shares; 12/31/13 – 177,072,282 shares) at cost	(13,442		)	(11,854		)
Profit employed in the business	32,775			31,854
Accumulated other comprehensive income (loss)	(3,801		)	(3,898		)
Noncontrolling interests	64			67
Total stockholders’ equity	20,369			20,878
Total liabilities and stockholders’ equity	$	84,397		$	84,896

See accompanying notes to Consolidated Financial Statements.

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Caterpillar Inc.

Consolidated Statement of Changes in Stockholders’ Equity

(Unaudited)

(Dollars in millions)



	Common stock			Treasury stock			Profit employed in the business			Accumulated other comprehensive income (loss)			Noncontrolling interests			Total
Three Months Ended March 31, 2013
Balance at December 31, 2012	$	4,481		$	(10,074	)	$	29,558		$	(6,433	)	$	50		$	17,582
Profit of consolidated and affiliated companies	—			—			880			—			2			882
Foreign currency translation, net of tax	—			—			—			(366		)	—			(366		)
Pension and other postretirement benefits, net of tax	—			—			—			136			—			136
Derivative financial instruments, net of tax	—			—			—			(20		)	—			(20		)
Available-for-sale securities, net of tax	—			—			—			14			—			14
Distribution to noncontrolling interests	—			—			—			—			(8		)	(8		)
Common shares issued from treasury stock for stock-based compensation: 2,436,453	(61		)	69			—			—			—			8
Stock-based compensation expense	49			—			—			—			—			49
Net excess tax benefits from stock-based compensation	41			—			—			—			—			41
Balance at March 31, 2013	$	4,510		$	(10,005	)	$	30,438		$	(6,669	)	$	44		$	18,318

Three Months Ended March 31, 2014
Balance at December 31, 2013	$	4,709		$	(11,854	)	$	31,854		$	(3,898	)	$	67		$	20,878
Profit of consolidated and affiliated companies	—			—			922			—			3			925
Foreign currency translation, net of tax	—			—			—			40			(1		)	39
Pension and other postretirement benefits, net of tax	—			—			—			80			—			80
Derivative financial instruments, net of tax	—			—			—			(21		)	—			(21		)
Available-for-sale securities, net of tax	—			—			—			(2		)	—			(2		)
Change in ownership from noncontrolling interests	—			—			—			—			2			2
Dividends declared	—			—			(1		)	—			—			(1		)
Distribution to noncontrolling interests	—			—			—			—			(7		)	(7		)
Common shares issued from treasury stock for stock-based compensation: 4,522,294	(58		)	150			—			—			—			92
Stock-based compensation expense	53			—			—			—			—			53
Net excess tax benefits from stock-based compensation	69			—			—			—			—			69
Common shares repurchased: 18,110,735 ¹	—			(1,738		)	—			—			—			(1,738		)
Balance at March 31, 2014	$	4,773		$	(13,442	)	$	32,775		$	(3,801	)	$	64		$	20,369


¹	See Note 11 regarding shares repurchased.

See accompanying notes to Consolidated Financial Statements.

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Caterpillar Inc.

Consolidated Statement of Cash Flow

(Unaudited)

(Millions of dollars)



	Three Months Ended March 31,
	2014			2013
Cash flow from operating activities:
Profit of consolidated and affiliated companies	$	925		$	882
Adjustments for non-cash items:
Depreciation and amortization	781			723
Other	115			98
Changes in assets and liabilities, net of acquisitions and divestitures:
Receivables – trade and other	(37		)	209
Inventories	(270		)	308
Accounts payable	403			118
Accrued expenses	27			(121		)
Accrued wages, salaries and employee benefits	(152		)	(742		)
Customer advances	145			(47		)
Other assets – net	26			41
Other liabilities – net	(66		)	(45		)
Net cash provided by (used for) operating activities	1,897			1,424

Cash flow from investing activities:
Capital expenditures – excluding equipment leased to others	(454		)	(896		)
Expenditures for equipment leased to others	(285		)	(336		)
Proceeds from disposals of leased assets and property, plant and equipment	184			176
Additions to finance receivables	(2,634		)	(2,715		)
Collections of finance receivables	2,215			2,219
Proceeds from sale of finance receivables	20			66
Investments and acquisitions (net of cash acquired)	(5		)	—
Proceeds from sale of businesses and investments (net of cash sold)	13			98
Proceeds from sale of available-for-sale securities	115			98
Investments in available-for-sale securities	(105		)	(123		)
Other – net	(12		)	(46		)
Net cash provided by (used for) investing activities	(948		)	(1,459		)

Cash flow from financing activities:
Dividends paid	(383		)	—
Distribution to noncontrolling interests	(7		)	(8		)
Contribution from noncontrolling interests	2			—
Common stock issued, including treasury shares reissued	92			8
Treasury shares purchased	(1,738		)	—
Excess tax benefit from stock-based compensation	69			41
Proceeds from debt issued (original maturities greater than three months):
Machinery, Energy & Transportation	6			54
Financial Products	2,146			2,665
Payments on debt (original maturities greater than three months):
Machinery, Energy & Transportation	(9		)	(26		)
Financial Products	(2,773		)	(2,576		)
Short-term borrowings – net (original maturities three months or less)	944			387
Net cash provided by (used for) financing activities	(1,651		)	545
Effect of exchange rate changes on cash	(34		)	(18		)
Increase (decrease) in cash and short-term investments	(736		)	492
Cash and short-term investments at beginning of period	6,081			5,490
Cash and short-term investments at end of period	$	5,345		$	5,982

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)


1.	A. Basis of Presentation

In the opinion of management, the accompanying financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of (a) the consolidated results of operations for the three month periods ended March 31, 2014 and 2013, (b) the consolidated comprehensive income for the three month periods ended March 31, 2014 and 2013, (c) the consolidated financial position at March 31, 2014 and December 31, 2013, (d) the consolidated changes in stockholders’ equity for the three month periods ended March 31, 2014 and 2013, and (e) the consolidated cash flow for the three month periods ended March 31, 2014 and 2013. 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. 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, 2013 (2013 Form 10-K).

The December 31, 2013 financial position data included herein is derived from the audited consolidated financial statements included in the 2013 Form 10-K but does not include all disclosures required by U.S. GAAP.

B. Nature of Operations

Information in our financial statements and related commentary are presented in the following categories:

Machinery, Energy & Transportation – Represents the aggregate total of Construction Industries, Resource Industries, Energy & Transportation, and All Other operating segments and related corporate items and eliminations.

Financial Products – Primarily includes the company’s Financial Products Segment. This category includes Caterpillar Financial Services Corporation (Cat Financial), Caterpillar Financial Insurance Services (Insurance Services) and their respective subsidiaries.

2. New Accounting Guidance

Joint and several liability arrangements – In February 2013, the Financial Accounting Standards Board (FASB) issued accounting guidance on the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements. The guidance requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. The entity is also required to disclose the nature and amount of the obligation as well as any other information about those obligations. This guidance was effective January 1, 2014, with retrospective application required. The guidance did not have a material impact on our financial statements.

Parent's accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity – In March 2013, the FASB issued accounting guidance on the parent's accounting for the cumulative translation adjustment (CTA) upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. The new standard clarifies existing guidance regarding when the CTA should be released into earnings upon various deconsolidation and consolidation transactions. This guidance was effective January 1, 2014. The guidance did not have a material impact on our financial statements.

Presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists – In July 2013, the FASB issued accounting guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance requires an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward

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in the financial statements if available under the applicable tax jurisdiction. The guidance was effective January 1, 2014. The guidance did not have a material impact on our financial statements.

Reporting discontinued operations and disclosures of disposals of components of an entity – In April 2014, the FASB issued accounting guidance for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. The guidance defines a discontinued operation as a disposal of a component or group of components that is disposed of or is classified as held for sale and represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results. This guidance is effective January 1, 2015. We do not expect the adoption to have a material impact on our financial statements.

3. Stock-Based Compensation

Accounting for stock-based compensation 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, restricted stock units (RSUs) and stock-settled stock appreciation rights (SARs). We recognized pretax stock-based compensation cost in the amount of $53 million and $49 million for the three months ended March 31, 2014 and 2013, respectively.

The following table illustrates the type and fair value of the stock-based compensation awards granted during the three month periods ended March 31, 2014 and 2013, respectively:



	2014			2013
	Shares Granted	Fair Value Per Award		Shares Granted	Fair Value Per Award
Stock options	4,448,218	$	29.52	4,276,060	$	28.34
RSUs	1,429,512	$	89.18	1,614,870	$	84.05

The stock price on the date of grant was $96.31 and $89.75 for 2014 and 2013, respectively.

The following table provides the assumptions used in determining the fair value of the stock-based awards for the three month periods ended March 31, 2014 and 2013, respectively:



	Grant Year
	2014	2013
Weighted-average dividend yield	2.15%	2.13%
Weighted-average volatility	28.2%	30.6%
Range of volatilities	18.4-36.2%	23.4-40.6%
Range of risk-free interest rates	0.12-2.60%	0.16-1.88%
Weighted-average expected lives	8 years	8 years

As of March 31, 2014, the total remaining unrecognized compensation cost related to nonvested stock-based compensation awards was $395 million, which will be amortized over the weighted-average remaining requisite service periods of approximately 2.4 years.

4. Derivative Financial Instruments and Risk Management

Our earnings and cash flow are subject to fluctuations due to changes in foreign currency exchange rates, interest rates and commodity prices. Our Risk Management Policy (policy) allows for the use of derivative financial instruments to prudently manage foreign currency exchange rate, interest rate and commodity price exposures. Our policy specifies that derivatives are not to be used for speculative purposes. Derivatives that we use are primarily foreign currency forward, option, and cross currency 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.

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All derivatives are recognized on the Consolidated Statement of Financial Position at their fair value. On the date the derivative contract is entered into, we designate the derivative as (1) a hedge of the fair value of a recognized asset or liability (fair value hedge), (2) a hedge of a forecasted transaction or the variability of cash flow to be paid (cash flow hedge), or (3) an undesignated instrument. Changes in the fair value of a derivative that is qualified, designated and highly effective as a fair value hedge, along with the gain or loss on the hedged recognized asset or liability that is attributable to the hedged risk, are recorded in current earnings. Changes in the fair value of a derivative that is qualified, designated and highly effective as a cash flow hedge are recorded in Accumulated other comprehensive income (loss) (AOCI), to the extent effective, on the Consolidated Statement of Financial Position until they are reclassified to earnings in the same period or periods during which the hedged transaction affects earnings. Changes in the fair value of undesignated derivative instruments and the ineffective portion of designated derivative instruments are reported in current earnings. Cash flow from designated derivative financial instruments are classified within the same category as the item being hedged on the Consolidated Statement of Cash Flow. Cash flow from undesignated derivative financial instruments are included in the investing category on the Consolidated Statement of Cash Flow.

We formally document all relationships between hedging instruments and hedged items, as well as the risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair value hedges to specific assets and liabilities on the Consolidated Statement of Financial Position and linking cash flow hedges to specific forecasted transactions or variability of cash flow.

We also formally assess, both at the hedge’s inception and on an ongoing basis, whether the designated derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flow of hedged items. When a derivative is determined not to be highly effective as a hedge or the underlying hedged transaction is no longer probable, we discontinue hedge accounting prospectively, in accordance with the derecognition criteria for hedge accounting.

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 currencies, thereby creating exposure to movements in exchange rates.

Our Machinery, Energy & Transportation 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, Indian rupee, Japanese yen, Mexican peso, Singapore dollar or Swiss franc forward or option contracts that meet the requirements for hedge accounting and the maturity extends beyond the current quarter-end. Designation is performed on a specific exposure basis to support hedge accounting. The remainder of Machinery, Energy & Transportation foreign currency contracts are undesignated, including any hedges designed to protect our competitive exposure.

As of March 31, 2014, $12 million of deferred net gains, net of tax, included in equity (AOCI 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 twelve months when earnings are affected by the hedged transactions. The actual amount recorded in Other income (expense) will vary based on exchange rates at the time the hedged transactions impact earnings.

In managing foreign currency risk for our Financial Products operations, our objective is to minimize earnings volatility resulting from conversion and the remeasurement of net foreign currency balance sheet positions, and future transactions denominated in foreign currencies. Our policy allows the use of foreign currency forward, option and cross currency contracts to offset the risk of currency mismatch between our receivables and debt, and exchange rate risk associated with future transactions denominated in foreign currencies. Substantially all such foreign currency forward, option and cross currency contracts are undesignated.

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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 derivatives to manage our exposure to interest rate changes and, in some cases, lower the cost of borrowed funds.

Our Machinery, Energy & Transportation 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. We designate fixed-to-floating interest rate swaps as fair value hedges at inception of the contract, and we designate certain forward rate agreements as cash flow hedges at inception of the contract.

As of March 31, 2014, $3 million of deferred net losses, net of tax, included in equity (AOCI in the Consolidated Statement of Financial Position), related to Machinery, Energy & Transportation forward rate agreements, are expected to be reclassified to current earnings (Other income (expense) in the Consolidated Statement of Results of Operations) over the next twelve months. The actual amount recorded in Other income (expense) will vary based on interest rates at the time the hedged transactions impact earnings.

Financial Products operations has 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 ongoing 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 matched 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. We designate fixed-to-floating interest rate swaps as fair value hedges to protect debt against changes in fair value due to changes in the benchmark interest rate. We designate most floating-to-fixed interest rate swaps as cash flow hedges to protect against the variability of cash flows due to changes in the benchmark interest rate.

As of March 31, 2014, $3 million of deferred net losses, net of tax, included in equity (AOCI 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 twelve months. The actual amount recorded in Interest expense of Financial Products will vary based on interest rates at the time the hedged transactions impact earnings.

We have, at certain times, liquidated fixed-to-floating and floating-to-fixed interest rate swaps at both Machinery, Energy & Transportation and Financial Products. The gains or losses associated with these swaps at the time of liquidation are amortized into earnings over the original term of the previously designated hedged item.

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, Energy & Transportation operations purchase base and precious metals 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 subject to price changes on energy products such as natural gas and diesel fuel 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 five-year horizon. All such commodity forward and option contracts are undesignated.

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The location and fair value of derivative instruments reported in the Consolidated Statement of Financial Position are as follows:



(Millions of dollars)
	Consolidated Statement of Financial	Asset (Liability) Fair Value
	Position Location	March 31, 2014			December 31, 2013
Designated derivatives
Foreign exchange contracts
Machinery, Energy & Transportation	Receivables – trade and other	$	38		$	54
Machinery, Energy & Transportation	Accrued expenses	(19		)	(39		)
Interest rate contracts
Machinery, Energy & Transportation	Accrued expenses	(38		)	—
Financial Products	Receivables – trade and other	11			7
Financial Products	Long-term receivables – trade and other	97			115
Financial Products	Accrued expenses	(6		)	(6		)
		$	83		$	131
Undesignated derivatives
Foreign exchange contracts
Machinery, Energy & Transportation	Receivables – trade and other	$	12		$	19
Machinery, Energy & Transportation	Accrued expenses	(2		)	(1		)
Financial Products	Receivables – trade and other	4			7
Financial Products	Long-term receivables – trade and other	7			9
Financial Products	Accrued expenses	(6		)	(4		)
Commodity contracts
Machinery, Energy & Transportation	Receivables – trade and other	1			—
Machinery, Energy & Transportation	Accrued expenses	(2		)	—
		$	14		$	30

The total notional amounts of the derivative instruments are as follows:



(Millions of dollars)
	March 31, 2014		December 31, 2013

Machinery, Energy & Transportation	$	4,493	$	3,565
Financial Products	$	6,517	$	6,743

The notional amounts of the derivative financial instruments do not represent amounts exchanged by the parties. The amounts exchanged by the parties are calculated by reference to the notional amounts and by other terms of the derivatives, such as foreign currency exchange rates, interest rates, or commodity prices.

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The effect of derivatives designated as hedging instruments on the Consolidated Statement of Results of Operations is as follows:



Fair Value Hedges (Millions of dollars)
		Three Months Ended March 31, 2014					Three Months Ended March 31, 2013
	Classification	Gains (Losses) on Derivatives			Gains (Losses) on Borrowings		Gains (Losses) on Derivatives			Gains (Losses) on Borrowings
Interest rate contracts
Financial Products	Other income (expense)	$	(13	)	$	15	$	(29	)	$	30
		$	(13	)	$	15	$	(29	)	$	30



Cash Flow Hedges (Millions of dollars)
	Three Months Ended March 31, 2014
				Recognized in Earnings
	Amount of Gains (Losses) Recognized in AOCI (Effective Portion)			Classification of Gains (Losses)	Amount of Gains (Losses) Reclassified from AOCI to Earnings			Recognized in Earnings (Ineffective Portion)
Foreign exchange contracts
Machinery, Energy & Transportation	$	13		Other income (expense)	$	10		$	—
Interest rate contracts
Machinery, Energy & Transportation	(37		)	Other income (expense)	(1		)	—
Financial Products	(2		)	Interest expense of Financial Products	(1		)	—
	$	(26	)		$	8		$	—



	Three Months Ended March 31, 2013
				Recognized in Earnings
	Amount of Gains (Losses) Recognized in AOCI (Effective Portion)			Classification of Gains (Losses)	Amount of Gains (Losses) Reclassified from AOCI to Earnings				Recognized in Earnings (Ineffective Portion)
Foreign exchange contracts
Machinery, Energy & Transportation	$	(49	)	Other income (expense)	$	(17	)	¹	$	—
Interest rate contracts
Financial Products	—			Interest expense of Financial Products	(1		)		—
	$	(49	)		$	(18	)		$	—


¹	Includes $3 million loss reclassified from AOCI to Other income (expense) in 2013 as certain derivatives were dedesignated as the related transactions are no longer probable to occur.

The effect of derivatives not designated as hedging instruments on the Consolidated Statement of Results of Operations is as follows:



(Millions of dollars)
	Classification of Gains (Losses)	Three Months Ended March 31, 2014			Three Months Ended March 31, 2013
Foreign exchange contracts
Machinery, Energy & Transportation	Other income (expense)	$	11		$	(20	)
Financial Products	Other income (expense)	(5		)	(15		)
Commodity contracts
Machinery, Energy & Transportation	Other income (expense)	(1		)	(1		)
		$	5		$	(36	)

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We enter into International Swaps and Derivatives Association (ISDA) master netting agreements within Machinery, Energy & Transportation and Financial Products that permit the net settlement of amounts owed under their respective derivative contracts. Under these master netting agreements, net settlement generally permits the company or the counterparty to determine the net amount payable for contracts due on the same date and in the same currency for similar types of derivative transactions. The master netting agreements generally also provide for net settlement of all outstanding contracts with a counterparty in the case of an event of default or a termination event.

Collateral is generally not required of the counterparties or of our company under the master netting agreements. As of March 31, 2014 and December 31, 2013, no cash collateral was received or pledged under the master netting agreements.

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The effect of the net settlement provisions of the master netting agreements on our derivative balances upon an event of default or termination event is as follows:



March 31, 2014							Gross Amounts Not Offset in the Statement of Financial Position
(Millions of dollars)	Gross Amount of Recognized Assets		Gross Amounts Offset in the Statement of Financial Position		Net Amount of Assets Presented in the Statement of Financial Position		Financial Instruments			Cash Collateral Received		Net Amount of Assets
Derivatives
Machinery, Energy & Transportation	$	51	$	—	$	51	$	(39	)	$	—	$	12
Financial Products	119		—		119		(7		)	—		112
Total	$	170	$	—	$	170	$	(46	)	$	—	$	124



March 31, 2014									Gross Amounts Not Offset in the Statement of Financial Position
(Millions of dollars)	Gross Amount of Recognized Liabilities			Gross Amounts Offset in the Statement of Financial Position		Net Amount of Liabilities Presented in the Statement of Financial Position			Financial Instruments		Cash Collateral Pledged		Net Amount of Liabilities
Derivatives
Machinery, Energy & Transportation	$	(61	)	$	—	$	(61	)	$	39	$	—	$	(22	)
Financial Products	(12		)	—		(12		)	7		—		(5		)
Total	$	(73	)	$	—	$	(73	)	$	46	$	—	$	(27	)



December 31, 2013							Gross Amounts Not Offset in the Statement of Financial Position
(Millions of dollars)	Gross Amount of Recognized Assets		Gross Amounts Offset in the Statement of Financial Position		Net Amount of Assets Presented in the Statement of Financial Position		Financial Instruments			Cash Collateral Received		Net Amount of Assets
Derivatives
Machinery, Energy & Transportation	$	73	$	—	$	73	$	(32	)	$	—	$	41
Financial Products	138		—		138		(9		)	—		129
Total	$	211	$	—	$	211	$	(41	)	$	—	$	170



December 31, 2013									Gross Amounts Not Offset in the Statement of Financial Position
(Millions of dollars)	Gross Amount of Recognized Liabilities			Gross Amounts Offset in the Statement of Financial Position		Net Amount of Liabilities Presented in the Statement of Financial Position			Financial Instruments		Cash Collateral Pledged		Net Amount of Liabilities
Derivatives
Machinery, Energy & Transportation	$	(40	)	$	—	$	(40	)	$	32	$	—	$	(8	)
Financial Products	(10		)	—		(10		)	9		—		(1		)
Total	$	(50	)	$	—	$	(50	)	$	41	$	—	$	(9	)

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5. Inventories

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



(Millions of dollars)	March 31, 2014		December 31, 2013
Raw materials	$	3,031	$	2,966
Work-in-process	2,760		2,589
Finished goods	6,801		6,785
Supplies	296		285
Total inventories	$	12,888	$	12,625

6. Investments in Unconsolidated Affiliated Companies

Combined financial information of the unconsolidated affiliated companies accounted for by the equity method (generally on a lag of 3 months or less) was as follows:



Results of Operations of unconsolidated affiliated companies: (Millions of dollars)	Three Months Ended March 31,
	2014			2013
Sales	$	390		$	258
Cost of sales	301			205
Gross profit	$	89		$	53

Profit (loss)	$	(14	)	$	(3	)



Financial Position of unconsolidated affiliated companies: (Millions of dollars)	March 31, 2014		December 31, 2013
Assets:
Current assets	$	695	$	683
Property, plant and equipment – net	686		710
Other assets	582		608
	1,963		2,001
Liabilities:
Current liabilities	466		437
Long-term debt due after one year	890		900
Other liabilities	216		262
	1,572		1,599
Equity	$	391	$	402



Caterpillar’s investments in unconsolidated affiliated companies: (Millions of dollars)	March 31, 2014		December 31, 2013
Investments in equity method companies	$	256	$	262
Plus: Investments in cost method companies	10		10
Total investments in unconsolidated affiliated companies	$	266	$	272

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7. Intangible Assets and Goodwill

A. Intangible assets

Intangible assets are comprised of the following:



		March 31, 2014
(Millions of dollars)	Weighted Amortizable Life (Years)	Gross Carrying Amount		Accumulated Amortization			Net
Customer relationships	15	$	2,643	$	(575	)	$	2,068
Intellectual property	11	1,752		(459		)	1,293
Other	11	239		(109		)	130
Total finite-lived intangible assets	14	4,634		(1,143		)	3,491
Indefinite-lived intangible assets - In-process research & development		18		—			18
Total intangible assets		$	4,652	$	(1,143	)	$	3,509



		December 31, 2013
	Weighted Amortizable Life (Years)	Gross Carrying Amount		Accumulated Amortization			Net
Customer relationships	15	$	2,653	$	(539	)	$	2,114
Intellectual property	11	1,821		(495		)	1,326
Other	10	274		(136		)	138
Total finite-lived intangible assets	13	4,748		(1,170		)	3,578
Indefinite-lived intangible assets - In-process research & development		18		—			18
Total intangible assets		$	4,766	$	(1,170	)	$	3,596

Amortization expense for the three months ended March 31, 2014 and 2013 was $92 million and $94 million, respectively. Amortization expense related to intangible assets is expected to be:



(Millions of dollars)
2014	2015	2016	2017	2018	Thereafter
$365	$357	$335	$333	$329	$1,882

B. Goodwill

We test goodwill for impairment annually and whenever events or circumstances make it more likely than not that an impairment may have occurred. We perform our annual goodwill impairment test as of October 1 and monitor for interim triggering events on an ongoing basis. Goodwill is reviewed for impairment utilizing a qualitative assessment or a two-step process. We have an option to make a qualitative assessment of a reporting unit's goodwill for impairment. If we choose to perform a qualitative assessment and determine the fair value more likely than not exceeds the carrying value, no further evaluation is necessary. For reporting units where we perform the two-step process, the first step requires us to compare the fair value of each reporting unit, which we primarily determine using an income approach based on the present value of discounted cash flows, to the respective carrying value, which includes goodwill. If the fair value of the reporting unit exceeds its carrying value, the goodwill is not considered impaired. If the carrying value is higher than the fair value, there is an indication that an impairment may exist and the second step is required. In step two, the implied fair value of goodwill is calculated as the excess of the fair value of a reporting unit over the fair values assigned to its assets and liabilities. If the implied fair value of goodwill is less than the carrying value of the reporting unit's goodwill, the difference is recognized as an impairment loss. No goodwill for reporting units was impaired during the three months ended March 31, 2014 or 2013.

As discussed in Note 15, effective January 1, 2014, we revised our reportable segments in line with the changes to our organizational structure. Our reporting units did not significantly change as a result of the changes to our reportable segments. The segment information for 2013 has been retrospectively adjusted to conform to the 2014 presentation.

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The changes in carrying amount of goodwill by reportable segment for the three months ended March 31, 2014 were as follows:



(Millions of dollars)
	December 31, 2013			Acquisitions		Held for Sale and Business Divestitures ¹			Other Adjustments ²		March 31, 2014
Construction Industries
Goodwill	$	291		$	—	$	—		$	15	$	306
Resource Industries
Goodwill	4,468			—		(2		)	10		4,476
Impairments	(580		)	—		—			—		(580		)
Net goodwill	3,888			—		(2		)	10		3,896
Energy & Transportation
Goodwill	2,600			3		—			4		2,607
All Other ³
Goodwill	199			—		—			—		199
Impairments	(22		)	—		—			—		(22		)
Net goodwill	177			—		—			—		177
Consolidated total
Goodwill	7,558			3		(2		)	29		7,588
Impairments	(602		)	—		—			—		(602		)
Net goodwill	$	6,956		$	3	$	(2	)	$	29	$	6,986

¹ See Note 18 for additional details.

² Other adjustments are comprised primarily of foreign currency translation.

³ Includes All Other operating segments (See Note 15).

8. Available-For-Sale Securities

We have investments in certain debt and equity securities, primarily at Insurance Services, that have been classified as available-for-sale and recorded at fair value based upon quoted market prices. These investments are primarily 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.

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	March 31, 2014						December 31, 2013
(Millions of dollars)	Cost Basis		Unrealized Pretax Net Gains (Losses)		Fair Value		Cost Basis		Unrealized Pretax Net Gains (Losses)			Fair Value
Government debt
U.S. treasury bonds	$	10	$	—	$	10	$	10	$	—		$	10
Other U.S. and non-U.S. government bonds	117		1		118		119		1			120

Corporate bonds
Corporate bonds	629		22		651		612		21			633
Asset-backed securities	76		1		77		72		—			72

Mortgage-backed debt securities
U.S. governmental agency	326		—		326		322		(1		)	321
Residential	17		1		18		18		—			18
Commercial	70		6		76		87		6			93

Equity securities
Large capitalization value	164		74		238		173		81			254
Smaller company growth	24		24		48		25		24			49
Total	$	1,433	$	129	$	1,562	$	1,438	$	132		$	1,570

During the three months ended March 31, 2014 and 2013, there were no charges for other-than-temporary declines in the market values of securities.

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Investments in an unrealized loss position that are not other-than-temporarily impaired:

	March 31, 2014
	Less than 12 months¹				12 months or more ¹				Total
(Millions of dollars)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Corporate bonds
Corporate bonds	$	159	$	1	$	1	$	—	$	160	$	1
Asset-backed securities	5		—		17		1		22		1
Mortgage-backed debt securities
U.S. governmental agency	98		2		105		4		203		6
Equity securities
Large capitalization value	20		1		1		—		21		1
Total	$	282	$	4	$	124	$	5	$	406	$	9



	December 31, 2013
	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
Corporate bonds
Corporate bonds	$	159	$	2	$	1	$	—	$	160	$	2
Asset-backed securities	6		—		20		1		26		1
Mortgage-backed debt securities
U.S. governmental agency	140		4		65		2		205		6
Total	$	305	$	6	$	86	$	3	$	391	$	9

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

Corporate Bonds. The unrealized losses on our investments in corporate bonds and asset-backed securities relate to changes in interest rates and credit-related yield spreads since time of purchase. We do not intend to sell the investments and it is not likely that we will be required to sell the investments before recovery of their amortized cost basis. We do not consider these investments to be other-than-temporarily impaired as of March 31, 2014.

Mortgage-Backed Debt Securities. The unrealized losses on our investments in mortgage-backed securities relate to changes in interest rates and credit-related yield spreads since time of purchase. We do not intend to sell the investments and it is not likely that we will be required to sell these investments before recovery of their amortized cost basis. We do not consider these investments to be other-than-temporarily impaired as of March 31, 2014.

Equity Securities. Insurance Services maintains a well-diversified equity portfolio consisting of two specific mandates: large capitalization value stocks and smaller company growth stocks. U.S. equity valuations were generally higher during the first quarter of 2014 on generally favorable economic data. The unrealized losses on our investments in equity securities relate to inherent risks of individual holdings and/or their respective sectors. We do not consider these investments to be other-than-temporarily impaired as of March 31, 2014.

The cost basis and fair value of the available-for-sale debt securities at March 31, 2014, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay and creditors may have the right to call obligations.

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	March 31, 2014
(Millions of dollars)	Cost Basis		Fair Value
Due in one year or less	$	155	$	156
Due after one year through five years	614		635
Due after five years through ten years	33		35
Due after ten years	30		30
U.S. governmental agency mortgage-backed securities	326		326
Residential mortgage-backed securities	17		18
Commercial mortgage-backed securities	70		76
Total debt securities – available-for-sale	$	1,245	$	1,276



Sales of Securities:
	Three Months Ended March 31,
(Millions of dollars)	2014		2013
Proceeds from the sale of available-for-sale securities	$	115	$	98
Gross gains from the sale of available-for-sale securities	$	14	$	1
Gross losses from the sale of available-for-sale securities	$	—	$	—

9. Postretirement Benefits

A. Pension and postretirement benefit costs



(Millions of dollars)	U.S. Pension Benefits				Non-U.S. Pension Benefits				Other Postretirement Benefits
	March 31,				March 31,				March 31,
	2014		2013		2014		2013		2014		2013
For the three months ended:
Components of net periodic benefit cost:
Service cost	$	39	$	49	$	28	$	31	$	20	$	24
Interest cost	162