Edgar Filing: CATERPILLAR INC

CAT_10Q_9.30.2014

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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 September 30, 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 September 30, 2014, 605,398,874 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	60
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	93
Item 4.	Controls and Procedures	93

Part II. Other Information
Item 1.	Legal Proceedings	94
Item 1A.	Risk Factors	*
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	94
Item 3.	Defaults Upon Senior Securities	*
Item 4.	Mine Safety Disclosures	*
Item 5.	Other Information	*
Item 6.	Exhibits	95

* 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 September 30,
	2014		2013
Sales and revenues:
Sales of Machinery, Energy & Transportation	$	12,758	$	12,678
Revenues of Financial Products	791		745
Total sales and revenues	13,549		13,423

Operating costs:
Cost of goods sold	9,634		9,774
Selling, general and administrative expenses	1,446		1,319
Research and development expenses	533		469
Interest expense of Financial Products	157		178
Other operating (income) expenses	387		282
Total operating costs	12,157		12,022

Operating profit	1,392		1,401

Interest expense excluding Financial Products	128		116
Other income (expense)	117		(24		)

Consolidated profit before taxes	1,381		1,261

Provision (benefit) for income taxes	364		310
Profit of consolidated companies	1,017		951

Equity in profit (loss) of unconsolidated affiliated companies	4		(1		)

Profit of consolidated and affiliated companies	1,021		950

Less: Profit (loss) attributable to noncontrolling interests	4		4

Profit ¹	$	1,017	$	946

Profit per common share	$	1.66	$	1.48

Profit per common share – diluted ²	$	1.63	$	1.45

Weighted-average common shares outstanding (millions)
– Basic	611.5		639.3
– Diluted²	622.8		651.9

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 September 30,
	2014			2013

Profit of consolidated and affiliated companies	$	1,021		$	950
Other comprehensive income (loss), net of tax:
Foreign currency translation, net of tax (provision)/benefit of: 2014 - $(44); 2013 - $33	(710		)	291

Pension and other postretirement benefits:
Current year actuarial gain (loss), net of tax (provision)/benefit of: 2014 - $(2); 2013 - $2	4			(3		)
Amortization of actuarial (gain) loss, net of tax (provision)/benefit of: 2014 - $(44); 2013 - $(67)	86			129
Current year prior service credit (cost), net of tax (provision)/benefit of: 2014 - $(1); 2013 - $0	—			—
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 - $(1)	—			—

Derivative financial instruments:
Gains (losses) deferred, net of tax (provision)/benefit of: 2014 - $17; 2013 - $(15)	(30		)	26
(Gains) losses reclassified to earnings, net of tax (provision)/benefit of: 2014 - $1; 2013 - $(5)	—			9

Available-for-sale securities:
Gains (losses) deferred, net of tax (provision)/benefit of: 2014 - $5; 2013 - $(6)	(5		)	9
(Gains) losses reclassified to earnings, net of tax (provision)/benefit of: 2014 - $7; 2013 - $0	(13		)	(1		)

Total other comprehensive income (loss), net of tax	(674		)	451
Comprehensive income	347			1,401
Less: comprehensive income attributable to the noncontrolling interests	(4		)	(4		)
Comprehensive income attributable to stockholders	$	343		$	1,397

See accompanying notes to Consolidated Financial Statements.

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Caterpillar Inc.

Consolidated Statement of Results of Operations

(Unaudited)

(Dollars in millions except per share data)



	Nine Months Ended September 30,
	2014		2013
Sales and revenues:
Sales of Machinery, Energy & Transportation	$	38,642	$	39,048
Revenues of Financial Products	2,298		2,206
Total sales and revenues	40,940		41,254

Operating costs:
Cost of goods sold	29,268		30,186
Selling, general and administrative expenses	4,175		4,130
Research and development expenses	1,557		1,579
Interest expense of Financial Products	470		552
Other operating (income) expenses	1,205		631
Total operating costs	36,675		37,078

Operating profit	4,265		4,176

Interest expense excluding Financial Products	358		356
Other income (expense)	236		(79		)

Consolidated profit before taxes	4,143		3,741

Provision (benefit) for income taxes	1,201		943
Profit of consolidated companies	2,942		2,798

Equity in profit (loss) of unconsolidated affiliated companies	6		(1		)

Profit of consolidated and affiliated companies	2,948		2,797

Less: Profit (loss) attributable to noncontrolling interests	10		11

Profit ¹	$	2,938	$	2,786

Profit per common share	$	4.73	$	4.30

Profit per common share – diluted ²	$	4.64	$	4.21

Weighted-average common shares outstanding (millions)
– Basic	620.6		647.6
– Diluted²	632.7		661.3

Cash dividends declared per common share	$	1.30	$	1.12

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)



	Nine Months Ended September 30,
	2014			2013

Profit of consolidated and affiliated companies	$	2,948		$	2,797
Other comprehensive income (loss), net of tax:
Foreign currency translation, net of tax (provision)/benefit of: 2014 - $(52); 2013 - $41	(643		)	(255		)

Pension and other postretirement benefits:
Current year actuarial gain (loss), net of tax (provision)/benefit of: 2014 - $(7); 2013 - $(14)	14			24
Amortization of actuarial (gain) loss, net of tax (provision)/benefit of: 2014 - $(132); 2013 - $(201)	258			388
Current year prior service credit (cost), net of tax (provision)/benefit of: 2014 - $(1); 2013 - $0	1			—
Amortization of prior service (credit) cost, net of tax (provision)/benefit of: 2014 - $10; 2013 - $14	(18		)	(27		)
Amortization of transition (asset) obligation, net of tax (provision)/benefit of: 2014 - $0; 2013 - $(1)	—			1

Derivative financial instruments:
Gains (losses) deferred, net of tax (provision)/benefit of: 2014 - $33; 2013 - $(2)	(57		)	2
(Gains) losses reclassified to earnings, net of tax (provision)/benefit of: 2014 - $7; 2013 - $(24)	(10		)	42

Available-for-sale securities:
Gains (losses) deferred, net of tax (provision)/benefit of: 2014 - $(6); 2013 - $(8)	18			14
(Gains) losses reclassified to earnings, net of tax (provision)/benefit of: 2014 - $11; 2013 - $0	(23		)	(1		)

Total other comprehensive income (loss), net of tax	(460		)	188
Comprehensive income	2,488			2,985
Less: comprehensive income attributable to the noncontrolling interests	(9		)	(13		)
Comprehensive income attributable to stockholders	$	2,479		$	2,972

See accompanying notes to Consolidated Financial Statements.

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Caterpillar Inc.

Consolidated Statement of Financial Position

(Unaudited)

(Dollars in millions)



	September 30, 2014			December 31, 2013
Assets
Current assets:
Cash and short-term investments	$	6,082		$	6,081
Receivables – trade and other	7,705			8,413
Receivables – finance	9,307			8,763
Deferred and refundable income taxes	1,370			1,553
Prepaid expenses and other current assets	1,250			900
Inventories	13,328			12,625
Total current assets	39,042			38,335

Property, plant and equipment – net	16,431			17,075
Long-term receivables – trade and other	1,473			1,397
Long-term receivables – finance	14,691			14,926
Investments in unconsolidated affiliated companies	265			272
Noncurrent deferred and refundable income taxes	761			594
Intangible assets	3,210			3,596
Goodwill	6,801			6,956
Other assets	1,814			1,745
Total assets	$	84,488		$	84,896

Liabilities
Current liabilities:
Short-term borrowings:
Machinery, Energy & Transportation	$	7		$	16
Financial Products	4,429			3,663
Accounts payable	6,778			6,560
Accrued expenses	3,466			3,493
Accrued wages, salaries and employee benefits	2,230			1,622
Customer advances	2,165			2,360
Dividends payable	—			382
Other current liabilities	1,848			1,849
Long-term debt due within one year:
Machinery, Energy & Transportation	509			760
Financial Products	6,157			6,592
Total current liabilities	27,589			27,297
Long-term debt due after one year:
Machinery, Energy & Transportation	9,498			7,999
Financial Products	18,682			18,720
Liability for postemployment benefits	6,539			6,973
Other liabilities	3,284			3,029
Total liabilities	65,592			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: (9/30/14 and 12/31/13 – 814,894,624) at paid-in amount	4,968			4,709
Treasury stock (9/30/14 – 209,495,750 shares; 12/31/13 – 177,072,282 shares) at cost	(15,765		)	(11,854		)
Profit employed in the business	33,977			31,854
Accumulated other comprehensive income (loss)	(4,357		)	(3,898		)
Noncontrolling interests	73			67
Total stockholders’ equity	18,896			20,878
Total liabilities and stockholders’ equity	$	84,488		$	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
Nine Months Ended September 30, 2013
Balance at December 31, 2012	$	4,481		$	(10,074	)	$	29,558		$	(6,433	)	$	50		$	17,582
Profit of consolidated and affiliated companies	—			—			2,786			—			11			2,797
Foreign currency translation, net of tax	—			—			—			(257		)	2			(255		)
Pension and other postretirement benefits, net of tax	—			—			—			386			—			386
Derivative financial instruments, net of tax	—			—			—			44			—			44
Available-for-sale securities, net of tax	—			—			—			13			—			13
Change in ownership from noncontrolling interests	(6		)	—			—			—			14			8
Dividends declared	—			—			(730		)	—			—			(730		)
Distribution to noncontrolling interests	—			—			—			—			(10		)	(10		)
Common shares issued from treasury stock for stock-based compensation: 4,792,341	(83		)	160			—			—			—			77
Stock-based compensation expense	196			—			—			—			—			196
Net excess tax benefits from stock-based compensation	69			—			—			—			—			69
Common shares repurchased: 23,484,843 ¹	—			(2,000		)	—			—			—			(2,000		)
Balance at September 30, 2013	$	4,657		$	(11,914	)	$	31,614		$	(6,247	)	$	67		$	18,177

Nine Months Ended September 30, 2014
Balance at December 31, 2013	$	4,709		$	(11,854	)	$	31,854		$	(3,898	)	$	67		$	20,878
Profit of consolidated and affiliated companies	—			—			2,938			—			10			2,948
Foreign currency translation, net of tax	—			—			—			(642		)	(1		)	(643		)
Pension and other postretirement benefits, net of tax	—			—			—			255			—			255
Derivative financial instruments, net of tax	—			—			—			(67		)	—			(67		)
Available-for-sale securities, net of tax	—			—			—			(5		)	—			(5		)
Change in ownership from noncontrolling interests	—			—			—			—			4			4
Dividends declared	—			—			(815		)	—			—			(815		)
Distribution to noncontrolling interests	—			—			—			—			(7		)	(7		)
Common shares issued from treasury stock for stock-based compensation: 9,338,857	(109		)	327			—			—			—			218
Stock-based compensation expense	207			—			—			—			—			207
Net excess tax benefits from stock-based compensation	161			—			—			—			—			161
Common shares repurchased: 41,762,325 ¹	—			(4,238		)	—			—			—			(4,238		)
Balance at September 30, 2014	$	4,968		$	(15,765	)	$	33,977		$	(4,357	)	$	73		$	18,896


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)



	Nine Months Ended September 30,
	2014			2013
Cash flow from operating activities:
Profit of consolidated and affiliated companies	$	2,948		$	2,797
Adjustments for non-cash items:
Depreciation and amortization	2,368			2,263
Other	327			377
Changes in assets and liabilities, net of acquisitions and divestitures:
Receivables – trade and other	244			992
Inventories	(859		)	1,911
Accounts payable	667			157
Accrued expenses	(44		)	(227		)
Accrued wages, salaries and employee benefits	648			(500		)
Customer advances	(132		)	(230		)
Other assets – net	(104		)	(74		)
Other liabilities – net	123			145
Net cash provided by (used for) operating activities	6,186			7,611

Cash flow from investing activities:
Capital expenditures – excluding equipment leased to others	(1,072		)	(1,862		)
Expenditures for equipment leased to others	(1,310		)	(1,301		)
Proceeds from disposals of leased assets and property, plant and equipment	681			593
Additions to finance receivables	(8,464		)	(8,339		)
Collections of finance receivables	7,264			6,790
Proceeds from sale of finance receivables	154			110
Investments and acquisitions (net of cash acquired)	(18		)	(193		)
Proceeds from sale of businesses and investments (net of cash sold)	196			168
Proceeds from sale of securities	347			297
Investments in securities	(769		)	(312		)
Other – net	(12		)	(29		)
Net cash provided by (used for) investing activities	(3,003		)	(4,078		)

Cash flow from financing activities:
Dividends paid	(1,197		)	(730		)
Distribution to noncontrolling interests	(7		)	(10		)
Contribution from noncontrolling interests	2			—
Common stock issued, including treasury shares reissued	218			77
Treasury shares purchased	(4,238		)	(2,000		)
Excess tax benefit from stock-based compensation	162			70
Proceeds from debt issued (original maturities greater than three months):
Machinery, Energy & Transportation	1,991			145
Financial Products	7,112			6,854
Payments on debt (original maturities greater than three months):
Machinery, Energy & Transportation	(779		)	(1,134		)
Financial Products	(7,114		)	(7,636		)
Short-term borrowings – net (original maturities three months or less)	791			1,736
Net cash provided by (used for) financing activities	(3,059		)	(2,628		)
Effect of exchange rate changes on cash	(123		)	(38		)
Increase (decrease) in cash and short-term investments	1			867
Cash and short-term investments at beginning of period	6,081			5,490
Cash and short-term investments at end of period	$	6,082		$	6,357

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 and nine month periods ended September 30, 2014 and 2013, (b) the consolidated comprehensive income for the three and nine month periods ended September 30, 2014 and 2013, (c) the consolidated financial position at September 30, 2014 and December 31, 2013, (d) the consolidated changes in stockholders’ equity for the nine month periods ended September 30, 2014 and 2013, and (e) the consolidated cash flow for the nine month periods ended September 30, 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.

We have revised previously reported amounts on the Consolidated Statement of Cash Flow for the nine months ended September 30, 2013 to correct for customer advances invoiced but not yet paid and to correct for certain non-cash transactions impacting Receivables - trade and other and Accounts payable. Although these revisions did not impact Net cash provided by operating activities, cash provided by Receivables - trade and other decreased by $173 million, cash provided by Accounts payable increased by $116 million and cash used for Customer advances decreased by $57 million from the amounts previously reported for the nine month period ended September 30, 2013. Management has concluded that the impact was not material to any period presented.

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

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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 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.

Revenue recognition – In May 2014, the FASB issued new revenue recognition guidance to provide a single, comprehensive revenue recognition model for all contracts with customers. Under the new guidance, an entity will recognize revenue to depict the transfer of promised goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. A five step model has been introduced for an entity to apply when recognizing revenue. The new guidance also includes enhanced disclosure requirements, and is effective January 1, 2017. Entities have the option to apply the new guidance under a retrospective approach to each prior reporting period presented, or a modified retrospective approach with the cumulative effect of initially applying the new guidance recognized at the date of initial application within the Consolidated Statement of Changes in Stockholders' Equity. We are in the process of evaluating the application and implementation of the new guidance.

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 $70 million and $207 million for the three and nine months ended September 30, 2014, respectively; and $64 million and $196 million for the three and nine months ended September 30, 2013, respectively.

The following table illustrates the type and fair value of the stock-based compensation awards granted during the nine month periods ended September 30, 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 nine month periods ended September 30, 2014 and 2013, respectively:

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	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 September 30, 2014, the total remaining unrecognized compensation cost related to nonvested stock-based compensation awards was $236 million, which will be amortized over the weighted-average remaining requisite service periods of approximately 1.9 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.

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

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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 September 30, 2014, $17 million of deferred net losses, 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.

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 September 30, 2014, $4 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 (Interest expense excluding Financial Products in the Consolidated Statement of Results of Operations) over the next twelve months.

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 September 30, 2014, $4 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.

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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.

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	September 30, 2014			December 31, 2013
Designated derivatives
Foreign exchange contracts
Machinery, Energy & Transportation	Receivables – trade and other	$	36		$	54
Machinery, Energy & Transportation	Long-term receivables – trade and other	2			—
Machinery, Energy & Transportation	Accrued expenses	(63		)	(39		)
Machinery, Energy & Transportation	Other liabilities	(4		)	—
Interest rate contracts
Financial Products	Receivables – trade and other	12			7
Financial Products	Long-term receivables – trade and other	71			115
Financial Products	Accrued expenses	(9		)	(6		)
		$	45		$	131
Undesignated derivatives
Foreign exchange contracts
Machinery, Energy & Transportation	Receivables – trade and other	$	3		$	19
Machinery, Energy & Transportation	Accrued expenses	(41		)	(1		)
Financial Products	Receivables – trade and other	10			7
Financial Products	Long-term receivables – trade and other	12			9
Financial Products	Accrued expenses	(22		)	(4		)
Commodity contracts
Machinery, Energy & Transportation	Receivables – trade and other	1			—
Machinery, Energy & Transportation	Accrued expenses	(4		)	—
Machinery, Energy & Transportation	Other liabilities	(1		)	—
		$	(42	)	$	30

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

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(Millions of dollars)
	September 30, 2014		December 31, 2013

Machinery, Energy & Transportation	$	4,178	$	3,565
Financial Products	$	5,573	$	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.

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 September 30, 2014						Three Months Ended September 30, 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)	$	(19	)	$	1	¹	$	(9	)	$	12
		$	(19	)	$	1		$	(9	)	$	12

		Nine Months Ended September 30, 2014						Nine Months Ended September 30, 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)	$	(38	)	$	24	¹	$	(87	)	$	92
		$	(38	)	$	24		$	(87	)	$	92


¹	The Other income (expense) line has been reduced by $18 million and $14 million for the three and nine months ended September 30, 2014, respectively, for the cumulative correction of immaterial errors related to prior periods, of which $14 million related to prior years.

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Cash Flow Hedges (Millions of dollars)
	Three Months Ended September 30, 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	$	(45	)	Other income (expense)	$	4		$	—
Interest rate contracts
Machinery, Energy & Transportation	—			Interest expense excluding Financial Products	(1		)	—
Financial Products	(2		)	Interest expense of Financial Products	(2		)	—
	$	(47	)		$	1		$	—



	Three Months Ended September 30, 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	$	44		Other income (expense)	$	(12	)	$	—
Interest rate contracts
Machinery, Energy & Transportation	—			Other income (expense)	(1		)	—
Financial Products	(3		)	Interest expense of Financial Products	(1		)	—
	$	41			$	(14	)	$	—




	Nine Months Ended September 30, 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	$	(20	)	Other income (expense)	$	24			$	—
Interest rate contracts
Machinery, Energy & Transportation	(63		)	Interest expense excluding Financial Products	(3		)		—
Financial Products	(7		)	Interest expense of Financial Products	(4		)		—
	$	(90	)		$	17			$	—

	Nine Months Ended September 30, 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	$	4		Other income (expense)	$	(60	)	¹	$	—
Interest rate contracts
Machinery, Energy & Transportation	—			Other income (expense)	(2		)		—
Financial Products	—			Interest expense of Financial Products	(4		)		—
	$	4			$	(66	)		$	—


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.

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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 September 30, 2014			Three Months Ended September 30, 2013
Foreign exchange contracts
Machinery, Energy & Transportation	Other income (expense)	$	(44	)	$	15
Financial Products	Other income (expense)	(19		)	3
Interest rate contracts
Financial Products	Other income (expense)	—			(1		)
Commodity contracts
Machinery, Energy & Transportation	Other income (expense)	(6		)	2
		$	(69	)	$	19

	Classification of Gains (Losses)	Nine Months Ended September 30, 2014			Nine Months Ended September 30, 2013
Foreign exchange contracts
Machinery, Energy & Transportation	Other income (expense)	$	(35	)	$	7
Financial Products	Other income (expense)	(36		)	4
Interest rate contracts
Financial Products	Other income (expense)	—			(1		)
Commodity contracts
Machinery, Energy & Transportation	Other income (expense)	(3		)	(2		)
		$	(74	)	$	8

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 September 30, 2014 and December 31, 2013, no cash collateral was received or pledged under the master netting agreements.

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:

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September 30, 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	$	42	$	—	$	42	$	(42	)	$	—	$	—
Financial Products	105		—		105		(15		)	—		90
Total	$	147	$	—	$	147	$	(57	)	$	—	$	90



September 30, 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	$	(113	)	$	—	$	(113	)	$	42	$	—	$	(71	)
Financial Products	(31		)	—		(31		)	15		—		(16		)
Total	$	(144	)	$	—	$	(144	)	$	57	$	—	$	(87	)



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)	September 30, 2014		December 31, 2013
Raw materials	$	3,221	$	2,966
Work-in-process	2,983		2,589
Finished goods	6,832		6,785
Supplies	292		285
Total inventories	$	13,328	$	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 September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Sales	$	453		$	349		$	1,253		$	916
Cost of sales	357			284			974			722
Gross profit	$	96		$	65		$	279		$	194

Profit (loss)	$	(7	)	$	(6	)	$	(17	)	$	(31	)



Financial Position of unconsolidated affiliated companies: (Millions of dollars)	September 30, 2014		December 31, 2013
Assets:
Current assets	$	707	$	683
Property, plant and equipment – net	673		710
Other assets	580		608
	1,960		2,001
Liabilities:
Current liabilities	502		437
Long-term debt due after one year	872		900
Other liabilities	229		262
	1,603		1,599
Equity	$	357	$	402



Caterpillar’s investments in unconsolidated affiliated companies: (Millions of dollars)	September 30, 2014		December 31, 2013
Investments in equity method companies	$	255	$	262
Plus: Investments in cost method companies	10		10
Total investments in unconsolidated affiliated companies	$	265	$	272

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7. Intangible Assets and Goodwill

A. Intangible assets

Intangible assets are comprised of the following:



		September 30, 2014
(Millions of dollars)	Weighted Amortizable Life (Years)	Gross Carrying Amount		Accumulated Amortization			Net
Customer relationships	15	$	2,525	$	(635	)	$	1,890
Intellectual property	11	1,732		(545		)	1,187
Other	11	238		(123		)	115
Total finite-lived intangible assets	14	4,495		(1,303		)	3,192
Indefinite-lived intangible assets - In-process research & development		18		—			18
Total intangible assets		$	4,513	$	(1,303	)	$	3,210



		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

Gross customer relationship intangibles of $46 million and related accumulated amortization of $9 million were reclassified from Intangible assets to assets held for sale and/or divested during 2014, and are not included in the September 30, 2014 balances in the table above. These transactions were related to the divestiture of portions of the Bucyrus distribution business. See Note 19 for additional information on divestitures.

Amortization expense for the three and nine months ended September 30, 2014 was $91 million and $276 million, respectively. Amortization expense for the three and nine months ended September 30, 2013 was $91 million and $276 million, respectively. Amortization expense related to intangible assets is expected to be:



(Millions of dollars)
2014	2015	2016	2017	2018	Thereafter
$356	$348	$326	$325	$320	$1,811

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,

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the difference is recognized as an impairment loss. No goodwill for reporting units was impaired during the three and nine months ended September 30, 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.

The changes in carrying amount of goodwill by reportable segment for the nine months ended September 30, 2014 were as follows:



(Millions of dollars)
	December 31, 2013			Acquisitions		Held for Sale and Business Divestitures ¹			Other Adjustments ²			September 30, 2014
Construction Industries
Goodwill	$	291		$	—	$	—		$	7		$	298
Resource Industries
Goodwill	4,468			—		(15		)	(109		)	4,344
Impairments	(580		)	—		—			—			(580		)
Net goodwill	3,888			—		(15		)	(109		)	3,764
Energy & Transportation
Goodwill	2,600			7		—			(45		)	2,562
All Other ³
Goodwill	199			—		—			—