Document
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
caterpillarlogo09302017a03.jpg 
 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, 2017
OR
[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                    to
Commission File Number:  1-768
CATERPILLAR INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation)
 
37-0602744
(IRS Employer I.D. No.)
 
 
 
100 NE Adams Street, Peoria, Illinois
(Address of principal executive offices)
 
61629
(Zip Code)
 
Registrant’s telephone number, including area code: (309) 675-1000 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x    No  ¨
Indicate by check mark whether the registrant 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, smaller reporting company, or an emerging growth company.  See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.  (Check one):
Large accelerated filer
x
Accelerated filer
o
 
 
 
 
Non-accelerated filer
o
(Do not check if a smaller reporting company)
 
 
 
 
 
 
 
Smaller reporting company
o
 
 
 
 
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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, 2017, 594,933,582 shares of common stock of the registrant were outstanding.
 

Table of Contents

Table of Contents
 
 
 
 
 
 
 
 
Item 1A.
Risk Factors
*
Item 3.
Defaults Upon Senior Securities
*
Item 4.
Mine Safety Disclosures
*
Item 5.
Other Information
*
 
* 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
 
2017
 
2016
Sales and revenues:
 
 
 
Sales of Machinery, Energy & Transportation
$
10,713

 
$
8,463

Revenues of Financial Products
700

 
697

Total sales and revenues
11,413

 
9,160

 
 
 
 
Operating costs:
 

 
 

Cost of goods sold
7,633

 
6,527

Selling, general and administrative expenses
1,237

 
992

Research and development expenses
455

 
453

Interest expense of Financial Products
163

 
147

Other operating (income) expenses
348

 
560

Total operating costs
9,836

 
8,679

 
 
 
 
Operating profit
1,577

 
481

 
 
 
 
Interest expense excluding Financial Products
118

 
126

Other income (expense)
64

 
28

 
 
 
 
Consolidated profit before taxes
1,523

 
383

 
 
 
 
Provision (benefit) for income taxes
470

 
96

Profit of consolidated companies
1,053

 
287

 
 
 
 
Equity in profit (loss) of unconsolidated affiliated companies
8

 
(4
)
 
 
 
 
Profit of consolidated and affiliated companies
1,061

 
283

 
 
 
 
Less: Profit (loss) attributable to noncontrolling interests
2

 
—

 
 
 
 
Profit 1
$
1,059

 
$
283

 
 
 
 
Profit per common share
$
1.79

 
$
0.48

 
 
 
 
Profit per common share – diluted 2
$
1.77

 
$
0.48

 
 
 
 
Weighted-average common shares outstanding (millions)
 

 
 

– Basic
592.9

 
584.7

– Diluted 2
600.1

 
589.6

 
 
 
 
Cash dividends declared per common share
$
—

 
$
—

 
1    Profit attributable to common shareholders.
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
 
2017
 
2016
 
 
 
 
Profit of consolidated and affiliated companies
$
1,061

 
$
283

Other comprehensive income (loss), net of tax:
 
 
 
   Foreign currency translation, net of tax (provision)/benefit of: 2017 - $28; 2016 - $4
248

 
137

 
 
 
 
   Pension and other postretirement benefits:

 
 
        Current year prior service credit (cost), net of tax (provision)/benefit of: 2017 - $0; 2016 - $0
—

 
2

        Amortization of prior service (credit) cost, net of tax (provision)/benefit of: 2017 - $2; 2016 - $5
(4
)
 
(10
)
 
 
 
 
   Derivative financial instruments:
 
 
 
        Gains (losses) deferred, net of tax (provision)/benefit of: 2017 - $2; 2016 - $16
(4
)
 
(28
)
        (Gains) losses reclassified to earnings, net of tax (provision)/benefit of: 2017 - $(5); 2016 - $(2)
11

 
6

 
 
 
 
   Available-for-sale securities:
 
 
 
        Gains (losses) deferred, net of tax (provision)/benefit of: 2017 - $(8); 2016 - $(1)
11

 
5

        (Gains) losses reclassified to earnings, net of tax (provision)/benefit of: 2017 - $12; 2016 - $3
(24
)
 
(6
)
 
 
 
 
Total other comprehensive income (loss), net of tax
238

 
106

Comprehensive income
1,299

 
389

Less: comprehensive income attributable to the noncontrolling interests
(2
)
 
—

Comprehensive income attributable to shareholders
$
1,297

 
$
389

 
 
 
 

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
 
2017
 
2016
Sales and revenues:
 
 
 
Sales of Machinery, Energy & Transportation
$
30,482

 
$
26,888

Revenues of Financial Products
2,084

 
2,075

Total sales and revenues
32,566

 
28,963

 
 
 
 
Operating costs:
 

 
 

Cost of goods sold
22,160

 
20,768

Selling, general and administrative expenses
3,571

 
3,203

Research and development expenses
1,326

 
1,429

Interest expense of Financial Products
484

 
447

Other operating (income) expenses
1,780

 
1,356

Total operating costs
29,321

 
27,203

 
 
 
 
Operating profit
3,245

 
1,760

 
 
 
 
Interest expense excluding Financial Products
362

 
385

Other income (expense)
88

 
112

 
 
 
 
Consolidated profit before taxes
2,971

 
1,487

 
 
 
 
Provision (benefit) for income taxes
921

 
372

Profit of consolidated companies
2,050

 
1,115

 
 
 
 
Equity in profit (loss) of unconsolidated affiliated companies
8

 
(7
)
 
 
 
 
Profit of consolidated and affiliated companies
2,058

 
1,108

 
 
 
 
Less: Profit (loss) attributable to noncontrolling interests
5

 
4

 
 
 
 
Profit 1
$
2,053

 
$
1,104

 
 
 
 
Profit per common share
$
3.48

 
$
1.89

 
 
 
 
Profit per common share – diluted 2
$
3.44

 
$
1.88

 
 
 
 
Weighted-average common shares outstanding (millions)
 
 
 

– Basic
590.3

 
583.8

– Diluted 2
596.5

 
588.7

 
 
 
 
Cash dividends declared per common share
$
1.55

 
$
1.54


1    Profit attributable to common shareholders.
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
 
2017
 
2016
 
 
 
 
Profit of consolidated and affiliated companies
$
2,058

 
$
1,108

Other comprehensive income (loss), net of tax:
 
 
 
   Foreign currency translation, net of tax (provision)/benefit of: 2017 - $86; 2016 - $16
719

 
442

 
 
 
 
   Pension and other postretirement benefits:
 
 
 
        Current year prior service credit (cost), net of tax (provision)/benefit of: 2017 - $(4); 2016 - $(69)
8

 
119

        Amortization of prior service (credit) cost, net of tax (provision)/benefit of: 2017 - $6; 2016 - $16
(12
)
 
(29
)
 
 
 
 
   Derivative financial instruments:
 
 
 
        Gains (losses) deferred, net of tax (provision)/benefit of: 2017 - $(3); 2016 - $21
6

 
(37
)
        (Gains) losses reclassified to earnings, net of tax (provision)/benefit of: 2017 - $(41); 2016 - $(8)
77

 
16

 
 
 
 
   Available-for-sale securities:
 
 
 
        Gains (losses) deferred, net of tax (provision)/benefit of: 2017 - $(17); 2016 - $(9)
29

 
21

        (Gains) losses reclassified to earnings, net of tax (provision)/benefit of: 2017 - $11; 2016 - $12
(21
)
 
(24
)
 
 
 
 
Total other comprehensive income (loss), net of tax
806

 
508

Comprehensive income
2,864

 
1,616

Less: comprehensive income attributable to the noncontrolling interests
(5
)
 
(4
)
Comprehensive income attributable to shareholders
$
2,859

 
$
1,612

 
 
 
 

See accompanying notes to Consolidated Financial Statements.




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Caterpillar Inc.
Consolidated Statement of Financial Position
(Unaudited)
(Dollars in millions) 
 
September 30,
2017
 
December 31,
2016
Assets
 
 
 
Current assets:
 

 
 

Cash and short-term investments
$
9,591

 
$
7,168

Receivables – trade and other
6,691

 
5,981

Receivables – finance
8,984

 
8,522

Prepaid expenses and other current assets
1,707

 
1,682

Inventories
10,212

 
8,614

Total current assets
37,185

 
31,967

 
 
 
 
Property, plant and equipment – net
14,187

 
15,322

Long-term receivables – trade and other
969

 
1,029

Long-term receivables – finance
13,192

 
13,556

Noncurrent deferred and refundable income taxes
2,845

 
2,790

Intangible assets
2,175

 
2,349

Goodwill
6,196

 
6,020

Other assets
1,811

 
1,671

Total assets
$
78,560

 
$
74,704

 
 
 
 
Liabilities
 

 
 

Current liabilities:
 

 
 

Short-term borrowings:
 

 
 

Machinery, Energy & Transportation
$
11

 
$
209

Financial Products
5,459

 
7,094

Accounts payable
6,113

 
4,614

Accrued expenses
3,114

 
3,003

Accrued wages, salaries and employee benefits
2,333

 
1,296

Customer advances
1,510

 
1,167

Dividends payable
—

 
452

Other current liabilities
1,744

 
1,635

Long-term debt due within one year:
 

 
 

Machinery, Energy & Transportation
5


507

Financial Products
5,614

 
6,155

Total current liabilities
25,903

 
26,132

 
 
 
 
Long-term debt due after one year:
 

 
 

Machinery, Energy & Transportation
8,820

 
8,436

Financial Products
16,015

 
14,382

Liability for postemployment benefits
8,973

 
9,357

Other liabilities
3,152

 
3,184

Total liabilities
62,863

 
61,491

Commitments and contingencies (Notes 10 and 13)


 


Shareholders’ equity
 

 
 

Common stock of $1.00 par value:
 

 
 

Authorized shares: 2,000,000,000
Issued shares: (9/30/17 and 12/31/16 – 814,894,624) at paid-in amount
5,460

 
5,277

Treasury stock (9/30/17 – 219,961,042 shares; 12/31/16 – 228,408,600 shares) at cost
(17,130
)
 
(17,478
)
Profit employed in the business
28,530

 
27,377

Accumulated other comprehensive income (loss)
(1,233
)
 
(2,039
)
Noncontrolling interests
70

 
76

Total shareholders’ equity
15,697

 
13,213

Total liabilities and shareholders’ equity
$
78,560

 
$
74,704

 
See accompanying notes to Consolidated Financial Statements.

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Caterpillar Inc.
Consolidated Statement of Changes in Shareholders’ 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, 2016
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
$
5,238

 
$
(17,640
)
 
$
29,246

 
$
(2,035
)
 
$
76

 
$
14,885

Profit of consolidated and affiliated companies
—

 
—

 
1,104

 
—

 
4

 
1,108

Foreign currency translation, net of tax
—

 
—

 
—

 
442

 
—

 
442

Pension and other postretirement benefits, net of tax
—

 
—

 
—

 
90

 
—

 
90

Derivative financial instruments, net of tax
—

 
—

 
—

 
(21
)
 
—

 
(21
)
Available-for-sale securities, net of tax
—

 
—

 
—

 
(3
)
 
—

 
(3
)
Dividends declared
—

 
—

 
(900
)
 
—

 
—

 
(900
)
Distribution to noncontrolling interests
—

 
—

 
—

 
—

 
(10
)
 
(10
)
Common shares issued from treasury stock for stock-based compensation:  2,750,695
(150
)
 
96

 
—

 
—

 
—

 
(54
)
Stock-based compensation expense
187

 
—

 
—

 
—

 
—

 
187

Net excess tax benefits from stock-based compensation
(18
)
 
—

 
—

 
—

 
—

 
(18
)
Other
9

 
—

 
—

 
—

 
—

 
9

Balance at September 30, 2016
$
5,266

 
$
(17,544
)
 
$
29,450

 
$
(1,527
)
 
$
70

 
$
15,715

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
 

 
 

 
 

 
 

 
 

 
 

Balance at December 31, 2016
$
5,277

 
$
(17,478
)
 
$
27,377

 
$
(2,039
)
 
$
76

 
$
13,213

Adjustment to adopt stock-based compensation guidance1
—

 
—

 
15

 
—

 
—

 
15

Balance at January 1, 2017
$
5,277

 
$
(17,478
)
 
$
27,392

 
$
(2,039
)
 
$
76

 
$
13,228

Profit of consolidated and affiliated companies
—

 
—

 
2,053

 
—

 
5

 
2,058

Foreign currency translation, net of tax
—

 
—

 
—

 
719

 
—

 
719

Pension and other postretirement benefits, net of tax
—

 
—

 
—

 
(4
)
 
—

 
(4
)
Derivative financial instruments, net of tax
—

 
—

 
—

 
83

 
—

 
83

Available-for-sale securities, net of tax
—

 
—

 
—

 
8

 
—

 
8

Change in ownership from noncontrolling interests
4

 
—

 
—

 
—

 
(3
)
 
1

Dividends declared
—

 
—

 
(915
)
 
—

 
—

 
(915
)
Distribution to noncontrolling interests
—

 
—

 
—

 
—

 
(8
)
 
(8
)
Common shares issued from treasury stock for stock-based compensation: 8,447,558
5

 
348

 
—

 
—

 
—

 
353

Stock-based compensation expense
165

 
—

 
—

 
—

 
—

 
165

Other
9

 
—

 
—

 
—

 
—

 
9

Balance at September 30, 2017
$
5,460

 
$
(17,130
)
 
$
28,530

 
$
(1,233
)
 
$
70

 
$
15,697

 
 
 
 
 
 
 
 
 
 
 
 
1 See Note 2 for additional information.
 
 
 
 
 
 
 
 
 
 
 
 
 
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
 
2017
 
2016
Cash flow from operating activities:
 
 
 
Profit of consolidated and affiliated companies
$
2,058

 
$
1,108

Adjustments for non-cash items:
 

 
 

Depreciation and amortization
2,153

 
2,255

Other
592

 
640

Changes in assets and liabilities, net of acquisitions and divestitures:
 

 
 

Receivables – trade and other
(455
)
 
1,128

Inventories
(1,489
)
 
331

Accounts payable
1,371

 
(163
)
Accrued expenses
121

 
(153
)
Accrued wages, salaries and employee benefits
962

 
(727
)
Customer advances
310

 
(24
)
Other assets – net
(137
)
 
(141
)
Other liabilities – net
(325
)
 
(279
)
Net cash provided by (used for) operating activities
5,161

 
3,975

 
 
 
 
Cash flow from investing activities:
 

 
 

Capital expenditures – excluding equipment leased to others
(566
)
 
(807
)
Expenditures for equipment leased to others
(1,071
)
 
(1,393
)
Proceeds from disposals of leased assets and property, plant and equipment
864

 
572

Additions to finance receivables
(8,246
)
 
(6,911
)
Collections of finance receivables
8,532

 
6,968

Proceeds from sale of finance receivables
98

 
55

Investments and acquisitions (net of cash acquired)
(47
)
 
(72
)
Proceeds from sale of businesses and investments (net of cash sold)
93

 
—

Proceeds from sale of securities
431

 
304

Investments in securities
(594
)
 
(339
)
Other – net
38

 
5

Net cash provided by (used for) investing activities
(468
)
 
(1,618
)
 
 
 
 
Cash flow from financing activities:
 

 
 

Dividends paid
(1,367
)
 
(1,348
)
Distribution to noncontrolling interests
(7
)
 
(8
)
Common stock issued, including treasury shares reissued
353

 
(54
)
Proceeds from debt issued (original maturities greater than three months):
 

 
 

        Machinery, Energy & Transportation
362

 
6

        Financial Products
6,972

 
4,424

Payments on debt (original maturities greater than three months):
 

 
 

        Machinery, Energy & Transportation
(506
)
 
(525
)
        Financial Products
(5,714
)
 
(5,077
)
Short-term borrowings – net (original maturities three months or less)
(2,403
)
 
(111
)
Net cash provided by (used for) financing activities
(2,310
)
 
(2,693
)
Effect of exchange rate changes on cash
40

 
(11
)
Increase (decrease) in cash and short-term investments
2,423

 
(347
)
Cash and short-term investments at beginning of period
7,168

 
6,460

Cash and short-term investments at end of period
$
9,591

 
$
6,113


 All short-term investments, which consist primarily of highly liquid investments with original maturities of three months or less, are considered to be cash equivalents.
Non-cash activities: In September 2016, $381 million of medium-term notes with varying interest rates and maturity dates were exchanged for $366 million of
1.93% medium-term notes due in 2021 and $15 million of cash. In addition, a debt exchange premium of $33 million was paid and is included in the operating
activities section of the Consolidated Statement of Cash Flow.
See accompanying notes to Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1.
A.  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.

B.  Basis of presentation
 
In the opinion of management, the accompanying unaudited 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 months ended September 30, 2017 and 2016, (b) the consolidated comprehensive income for the three and nine months ended September 30, 2017 and 2016, (c) the consolidated financial position at September 30, 2017 and December 31, 2016, (d) the consolidated changes in shareholders’ equity for the nine months ended September 30, 2017 and 2016 and (e) the consolidated cash flow for the nine months ended September 30, 2017 and 2016.  The financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America (U.S. GAAP) and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).

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, 2016 (2016 Form 10-K).
 
The December 31, 2016 financial position data included herein is derived from the audited consolidated financial statements included in the 2016 Form 10-K but does not include all disclosures required by U.S. GAAP.  Certain amounts for prior periods have been reclassified to conform to the current period financial statement presentation. See Note 2 for more information.

Unconsolidated Variable Interest Entities (VIEs)

We have affiliates, suppliers and dealers that are VIEs of which we are not the primary beneficiary. Although we have provided financial support, we do not have the power to direct the activities that most significantly impact the economic performance of each entity.

Our maximum exposure to loss from VIEs for which we are not the primary beneficiary was as follows:

 
 
 
 
 
 
(Millions of dollars)
 
September 30, 2017
 
December 31, 2016
 
Receivables - trade and other
 
$
18

 
$
55

 
Receivables - finance
 
161

 
174

 
Long-term receivables - finance
 
218

 
246

 
Investments in unconsolidated affiliated companies
 
38

 
31

 
Guarantees
 
270

 
210

 
Total
 
$
705

 
$
716

 
 
 
 
 
 
 


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In addition, Cat Financial has end-user customers that are VIEs of which we are not the primary beneficiary. Although we have provided financial support to these entities and therefore have a variable interest, we do not have the power to direct the activities that most significantly impact their economic performance. Our maximum exposure to loss from our involvement with these VIEs is limited to the credit risk inherently present in the financial support that we have provided. These risks are evaluated and reflected in our financial statements as part of our overall portfolio of finance receivables and related allowance for credit losses.

2.                                    New accounting guidance
 
Revenue recognition - In May 2014, the Financial Accounting Standards Board (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, 2018. 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 Shareholders' Equity. We will adopt the new guidance effective January 1, 2018 under the modified retrospective approach. We have completed our evaluation of the impact of the new standard. Under the new guidance, sales of certain turbine machinery units will change to a point-in-time recognition model. Under current guidance, we account for these sales under an over-time model following the percentage-of-completion method as the product is manufactured. In addition, under the new guidance we will begin to recognize an asset for the value of expected replacement part returns and will discontinue lease accounting treatment for certain product sales containing residual value guarantees. We are currently in the process of updating our accounting policies and internal controls over financial reporting. The actual impact from adoption on our financial statements will be based on the specific revenue contracts existing as of January 1, 2018, however we have not identified any impacts to our financial statements or disclosures that we believe will be material in the year of adoption.

Simplifying the measurement of inventory – In July 2015, the FASB issued accounting guidance which requires that inventory be measured at the lower of cost or net realizable value. Prior to the issuance of the new guidance, inventory was measured at the lower of cost or market. Replacing the concept of market with the single measurement of net realizable value is intended to create efficiencies for preparers. Inventory measured using the last-in, first-out (LIFO) method and the retail inventory method are not impacted by the new guidance. The guidance was effective January 1, 2017, and was applied prospectively. The adoption did not have a material impact on our financial statements.

Recognition and measurement of financial assets and financial liabilities – In January 2016, the FASB issued accounting guidance that affects the accounting for equity investments, financial liabilities accounted for under the fair value option and the presentation and disclosure requirements for financial instruments. Under the new guidance, all equity investments in unconsolidated entities (other than those accounted for using the equity method of accounting) will generally be measured at fair value through earnings. There will no longer be an available-for-sale classification for equity securities with readily determinable fair values. For financial liabilities when the fair value option has been elected, changes in fair value due to instrument-specific credit risk will be recognized separately in other comprehensive income. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The new guidance is effective January 1, 2018, with the cumulative effect adjustment from initially applying the new guidance recognized in the Consolidated Statement of Financial Position as of the beginning of the year of adoption. The impact on our financial statements at the time of adoption will primarily be based on changes in the fair value of our available-for-sale equity securities subsequent to January 1, 2018, which will be recorded through earnings.

Lease accounting – In February 2016, the FASB issued accounting guidance that revises the accounting for leases. Under the new guidance, lessees are required to recognize a right-of-use asset and a lease liability for all leases. The new guidance will continue to classify leases as either financing or operating, with classification affecting the pattern of expense recognition. The accounting applied by a lessor under the new guidance will be substantially equivalent to current lease accounting guidance. The new guidance is effective January 1, 2019, with early adoption permitted. The new standard is required to be applied with a modified retrospective approach to each prior reporting period presented and provides for certain practical expedients. We have formed an implementation team and are in the process of evaluating the effect of the new guidance on our financial statements.

Stock-based compensation – In March 2016, the FASB issued accounting guidance to simplify several aspects of the accounting for share-based payments. The new guidance changes how reporting entities account for certain aspects of

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share-based payments, including the accounting for income taxes and the classification of the tax impact on the Consolidated Statement of Cash Flow. Under the new guidance all excess tax benefits and deficiencies during the period are recognized in income (rather than equity) on a prospective basis. The guidance removes the requirement to delay recognition of excess tax benefits until it reduces income taxes currently payable. This change was required to be applied on a modified retrospective basis, resulting in a cumulative-effect adjustment to opening retained earnings in the period of adoption. In addition, Cash flows related to excess tax benefits are now included in Cash provided by operating activities and will no longer be separately classified as a financing activity. This change was adopted retrospectively. The guidance was effective January 1, 2017, and did not have a material impact on our financial statements.

Measurement of credit losses on financial instruments – In June 2016, the FASB issued accounting guidance to introduce a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The new guidance will apply to loans, accounts receivable, trade receivables, other financial assets measured at amortized cost, loan commitments and other off-balance sheet credit exposures. The new guidance will also apply to debt securities and other financial assets measured at fair value through other comprehensive income. The new guidance is effective January 1, 2020, with early adoption permitted beginning January 1, 2019. We are in the process of evaluating the effect of the new guidance on our financial statements.

Classification for certain cash receipts and cash payments – In August 2016, the FASB issued accounting guidance related to the presentation and classification of certain transactions in the statement of cash flows where diversity in practice exists. The guidance is effective January 1, 2018, with early adoption permitted. We do not expect the adoption to have a material impact on our financial statements.

Tax accounting for intra-entity asset transfers – In October 2016, the FASB issued accounting guidance that will require the tax effects of intra-entity asset transfers to be recognized in the period when the transfer occurs. Under current guidance, the tax effects of intra-entity sales of assets are deferred until the transferred asset is sold to a third party or otherwise recovered through use. The new guidance does not apply to intra-entity transfers of inventory. The guidance is effective January 1, 2018, and is required to be applied on a modified retrospective basis through a cumulative effect adjustment to retained earnings as of the beginning of the period of adoption. Based on our current assessment, we do not expect the adoption to have a material impact on our financial statements.

Classification of restricted cash – In November 2016, the FASB issued accounting guidance related to the presentation and classification of changes in restricted cash on the statement of cash flows where diversity in practice exists. The new standard is required to be applied with a retrospective approach. The guidance is effective January 1, 2018, with early adoption permitted. We do not expect the adoption to have a material impact on our financial statements.

Clarification on the definition of a business – In January 2017, the FASB issued accounting guidance to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance is effective January 1, 2018, with early adoption permitted. We adopted the guidance effective January 1, 2017, and the adoption did not have a material impact on our financial statements.

Simplifying the measurement for goodwill – In January 2017, the FASB issued guidance to simplify the accounting for goodwill impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The new guidance will be applied prospectively and is effective January 1, 2020, with early adoption permitted beginning January 1, 2017. We adopted the guidance effective January 1, 2017. The adoption did not have a material impact on our financial statements.

Presentation of net periodic pension costs and net periodic postretirement benefit costs – In March 2017, the FASB issued accounting guidance that will require that an employer disaggregate the service cost component from the other components of net benefit cost. Service cost is required to be reported in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net periodic benefit cost are required to be reported outside the subtotal for income from operations. Additionally, only the service cost component of net benefit costs are eligible for capitalization. The guidance is effective January 1, 2018, with early adoption permitted. We will adopt this guidance on January 1, 2018, and apply the presentation changes retrospectively and the capitalization change prospectively. The impact on our financial statements at the time of adoption will primarily be reclassification of other components of net periodic benefit cost outside of Operating profit in the Consolidated Statement of Results of Operations.

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Premium amortization on purchased callable debt securities – In March 2017, the FASB issued accounting guidance related to the amortization period for certain purchased callable debt securities held at a premium. Securities held at a premium will be required to be amortized to the earliest call date rather than the maturity date. The new standard is required to be applied with a modified retrospective approach through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The guidance is effective January 1, 2019, with early adoption permitted. We do not expect the adoption to have a material impact on our financial statements.

Clarification on stock-based compensation – In May 2017, the FASB issued accounting guidance to clarify which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The new standard is required to be applied prospectively. The guidance is effective January 1, 2018, with early adoption permitted. We do not expect the adoption to have a material impact on our financial statements.

Derivatives and hedging – In August 2017, the FASB issued accounting guidance to better align hedge accounting with a company’s risk management activities, simplify the application of hedge accounting and improve the disclosures of hedging arrangements. The new guidance is required to be applied on a modified retrospective basis, resulting in a cumulative-effect adjustment to opening retained earnings in the period of adoption. The guidance is effective January 1, 2019, with early adoption permitted. We are in the process of evaluating the effect of the new guidance 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.  Our stock-based compensation primarily consists of stock options, restricted stock units (RSUs), performance-based restricted stock units (PRSUs) and stock-settled stock appreciation rights (SARs).

Upon separation from service, if the participant is 55 years of age or older with more than five years of service, the participant meets the criteria for a "Long Service Separation." Award terms for awards granted in 2016 allow for immediate vesting upon separation of all outstanding options and RSUs with no requisite service period for employees who meet the criteria for a "Long Service Separation." Compensation expense was fully recognized immediately on the grant date for these employees. Award terms for the 2017 grant allow for continued vesting as of each vesting date specified in the award document for employees who meet the criteria for a "Long Service Separation" and fulfill a requisite service period of six months. Compensation expense for eligible employees for the 2017 grant is recognized over the period from the grant date to the end date of the six-month requisite service period. For employees who become eligible for a "Long Service Separation" subsequent to the end date of the six-month requisite service period and prior to the completion of the vesting period, compensation expense is recognized over the period from the grant date to the date eligibility is achieved.

Prior to 2017, all outstanding PRSU awards granted to employees eligible for a "Long Service Separation" may vest at the end of the performance period based upon achievement of the performance target. Compensation expense for the 2016 PRSU grant was fully recognized immediately on the grant date for these employees. For PRSU awards granted in 2017, only a prorated number of shares may vest at the end of the performance period based upon achievement of the performance target, with the proration based upon the number of months of continuous employment during the three-year performance period. Employees with a "Long Service Separation" must also fulfill a six-month requisite service period in order to be eligible for the prorated vesting of outstanding PRSU awards granted in 2017. Compensation expense for the 2017 PRSU grant is recognized on a straight-line basis over the three-year performance period for all participants.

During the second quarter of 2017, the 2014 Long-Term Incentive Plan (the Plan) was amended and restated. The Plan initially provided that up to 38,800,000 Common Shares would be reserved for future issuance under the Plan, subject to adjustment in certain events. Upon shareholder approval of the amendment and restatement of the Plan, an additional 36,000,000 Common Shares became available for all awards under the Plan.

We recognized pretax stock-based compensation expense of $48 million and $165 million for the three and nine months ended September 30, 2017, respectively and $41 million and $187 million for the three and nine months ended September 30, 2016, respectively.


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The following table illustrates the type and fair value of the stock-based compensation awards granted during the nine months ended September 30, 2017 and 2016, respectively:

 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
 
Shares Granted
 
Weighted-Average Fair Value Per Share
 
Weighted-Average Grant Date Stock Price
 
Shares Granted
 
Weighted-Average Fair Value Per Share
 
Weighted-Average Grant Date Stock Price
Stock options
2,701,644

 
$
25.01

 
$
95.66

 
4,243,272

 
$
20.64

 
$
74.77

RSUs
924,421

 
$
90.11

 
$
96.01

 
1,085,505

 
$
68.04

 
$
74.77

PRSUs
437,385

 
$
86.78

 
$
95.66

 
614,347

 
$
64.71

 
$
74.77

 
 
 
 
 
 
 
 
 
 
 
 
 
The following table provides the assumptions used in determining the fair value of the stock-based awards for the nine months ended September 30, 2017 and 2016, respectively:
 
 
 
 
 
 
Grant Year
 
2017
 
2016
Weighted-average dividend yield
3.42%
 
3.23%
Weighted-average volatility
29.2%
 
31.1%
Range of volatilities
22.1-33.0%
 
22.5-33.4%
Range of risk-free interest rates
0.81-2.35%
 
0.62-1.73%
Weighted-average expected lives
8 years
 
8 years
 
 
 
 
 
As of September 30, 2017, the total remaining unrecognized compensation expense related to nonvested stock-based compensation awards was $188 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 contracts 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 (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 flows from designated derivative financial instruments are classified within the same category as the item being hedged on the Consolidated Statement of Cash Flow.  Cash flows 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

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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. As of September 30, 2017, the maximum term of these outstanding contracts was approximately 51 months.
 
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, Norwegian krona, Singapore dollar or Thailand baht 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.  
 
As of September 30, 2017, $4 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 assets and liabilities, and exchange rate risk associated with future transactions denominated in foreign currencies. Our foreign currency forward, option and cross currency contracts are primarily undesignated. We designate fixed-to-fixed cross currency contracts as cash flow hedges to protect against movements in exchange rates on foreign currency fixed rate assets and liabilities.
 
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 contracts to manage our exposure to interest rate changes.
 
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 contracts and forward rate agreements to meet that objective. We designate fixed-to-floating interest rate contracts 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.

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.

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Our policy allows us to use fixed-to-floating, floating-to-fixed and floating-to-floating interest rate contracts to meet the match-funding objective.  We designate fixed-to-floating interest rate contracts 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 contracts as cash flow hedges to protect against the variability of cash flows due to changes in the benchmark interest rate.
 
We have, at certain times, liquidated fixed-to-floating and floating-to-fixed interest rate contracts at both Machinery, Energy & Transportation and Financial Products.  The gains or losses associated with these contracts 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, 2017
 
December 31, 2016
Designated derivatives
 
 
 
 
 
Foreign exchange contracts
 
 
 

 
 

Machinery, Energy & Transportation
Receivables – trade and other
 
$
14

 
$
13

Machinery, Energy & Transportation
Long-term receivables – trade and other
 
3

 
—

Machinery, Energy & Transportation
Accrued expenses
 
(8
)
 
(93
)
Machinery, Energy & Transportation
Other liabilities
 
(5
)
 
(36
)
Financial Products
Long-term receivables – trade and other
 
8

 
29

Financial Products
Accrued expenses
 
(41
)
 
(3
)
Interest rate contracts
 
 
 
 
 

Financial Products
Long-term receivables – trade and other
 
3

 
4

Financial Products
Accrued expenses
 
(1
)
 
(1
)
 
 
 
$
(27
)
 
$
(87
)
Undesignated derivatives
 
 
 

 
 

Foreign exchange contracts
 
 
 

 
 

Machinery, Energy & Transportation
Receivables – trade and other
 
$
11

 
$
—

Machinery, Energy & Transportation
Accrued expenses
 
(2
)
 
(30
)
Financial Products
Receivables – trade and other
 
42

 
39

Financial Products
Accrued expenses
 
(8
)
 
(4
)
Commodity contracts
 
 
 
 
 

Machinery, Energy & Transportation
Receivables – trade and other
 
12

 
10

 
 
 
$
55

 
$
15

 
 
 
 
 
 






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

 
 
 
 
 
(Millions of dollars)
 
September 30, 2017
 
December 31, 2016
 
 
 
 
 
Machinery, Energy & Transportation
 
$
2,081

 
$
2,530

Financial Products
 
$
3,560

 
$
2,626

 
 
 
 
 

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
 
 
 
 
 
 
 
 
 
Three Months Ended
September 30, 2017
 
Three Months Ended
September 30, 2016
 
 (Millions of dollars)
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)
 
$
—

 
$
—

 
$
(11
)
 
$
11

 
 
 
 
$
—

 
$
—

 
$
(11
)
 
$
11

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
September 30, 2017
 
Nine Months Ended
September 30, 2016
 
 
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)
 
$
(1
)
 
$
1

 
$
(11
)
 
$
10

 
 
 
 
$
(1
)
 
$
1

 
$
(11
)
 
$
10

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



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Cash Flow Hedges
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2017
 
 
 
 
Recognized in Earnings
 
 (Millions of dollars)
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
$
16

 
Other income (expense)
 
$
4

 
$
—

 
Financial Products
(21
)
 
Other income (expense)
 
(20
)
 
—

 
Interest rate contracts
 
 
 
 
 
 
 
 
Machinery, Energy & Transportation
—

 
Interest expense excluding Financial Products
 
(2
)
 
—

 
Financial Products
(1
)
 
Interest expense of Financial Products
 
2

 
—


 
$
(6
)
 
 
 
$
(16
)
 
$
—

 
 
Three Months Ended September 30, 2016
 
 
 
 
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
$
(29
)
 
Other income (expense)
 
$
4

 
$
—

 
Financial Products
(17
)
 
Other income (expense)
 
(10
)
 
—

 
Interest rate contracts
 

 
 
 
 

 
 

 
Machinery, Energy & Transportation
—

 
Interest expense excluding Financial Products
 
(2
)
 
—

 
Financial Products
2

 
Interest expense of Financial Products
 
—

 
—


 
$
(44
)
 
 
 
$
(8
)
 
$
—

 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
 
 
 
 
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
$
72

 
Other income (expense)
 
$
(49
)

$
—

 
Financial Products
(62
)
 
Other income (expense)
 
(69
)
 
—

 
Interest rate contracts
 
 
 
 
 

 
 

 
Machinery, Energy & Transportation
—

 
Interest expense excluding Financial Products
 
(5
)
 
—

 
Financial Products
(1
)
 
Interest expense of Financial Products
 
5

 
—


 
$
9

 
 
 
$
(118
)
 
$
—

 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2016
 
 
 
 
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
$
(35
)
 
Other income (expense)
 
$
—


$
—

 
Financial Products
(23
)
 
Other income (expense)
 
(16
)
 
—

 
Interest rate contracts
 

 
 
 
 

 
 

 
Machinery, Energy & Transportation
—

 
Interest expense excluding Financial Products
 
(5
)
 
—

 
Financial Products
—

 
Interest expense of Financial Products
 
(3
)
 
—


 
$
(58
)
 
 
 
$
(24
)
 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


18
Table of Contents

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, 2017
 
Three Months Ended
September 30, 2016
Foreign exchange contracts
 
 
 
 
 
Machinery, Energy & Transportation
Other income (expense)
 
$
15

 
$
2

Financial Products
Other income (expense)
 
11

 
(5
)
Commodity contracts
 
 
 

 
 
Machinery, Energy & Transportation
Other income (expense)
 
11

 
3

 
 
 
$
37

 
$
—

 
 
 
 
 
 
 
Classification of Gains (Losses)
 
Nine Months Ended
September 30, 2017
 
Nine Months Ended
September 30, 2016
Foreign exchange contracts
 
 
 
 
 
Machinery, Energy & Transportation
Other income (expense)
 
$
67

 
$
24

Financial Products
Other income (expense)
 
21

 
(33
)
Commodity contracts
 
 
 
 
 
Machinery, Energy & Transportation
Other income (expense)
 
12

 
9

 
 
 
$
100

 
$
—

 
 
 
 
 
 
 
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, 2017 and December 31, 2016, no cash collateral was received or pledged under the master netting agreements.


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Table of Contents

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:

 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2017
 
 
 
 
 
 
 
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
 
$
40

 
$
—

 
$
40

 
$
(14
)
 
$
—

 
$
26

Financial Products
 
53

 
—

 
53

 
(8
)
 
—

 
45

 Total
 
$
93

 
$
—

 
$
93

 
$
(22
)
 
$
—

 
$
71

September 30, 2017
 
 
 
 
 
 
 
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
 
$
(15
)
 
$
—

 
$
(15
)
 
$
14

 
$
—

 
$
(1
)
Financial Products
 
(50
)
 
—

 
(50
)
 
8

 
—

 
(42
)
 Total
 
$
(65
)
 
$
—

 
$
(65
)
 
$
22

 
$
—

 
$
(43
)
December 31, 2016
 
 
 
 
 
 
 
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
 
$
23

 
$
—

 
$
23

 
$
(21
)
 
$
—

 
$
2

Financial Products
 
72

 
—

 
72

 
(7
)
 
—

 
65

 Total
 
$
95

 
$
—

 
$
95

 
$
(28
)
 
$
—

 
$
67

December 31, 2016
 
 
 
 
 
 
 
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
 
$
(159
)
 
$
—

 
$
(159
)
 
$
21

 
$
—

 
$
(138
)
Financial Products
 
(8
)
 
—

 
(8
)
 
7

 
—

 
(1
)
 Total
 
$
(167
)
 
$
—

 
$
(167
)
 
$
28

 
$
—

 
$
(139
)
 
 
 
 
 
 
 
 
 
 
 
 
 


20
Table of Contents

5.                                     Inventories
 
Inventories (principally using the last-in, first-out (LIFO) method) are comprised of the following:
 
 
 
 
 
(Millions of dollars)
September 30,
2017
 
December 31,
2016
Raw materials
$
2,777

 
$
2,102

Work-in-process
2,241

 
1,719

Finished goods
4,990

 
4,576

Supplies
204

 
217

Total inventories
$
10,212

 
$
8,614

 
 
 
 

During the first nine months of 2017, there was a liquidation of LIFO inventory resulting from closure of our facility in Gosselies, Belgium. The liquidated inventory was carried at lower costs prevailing in prior years as compared with current costs. The effect of this reduction of inventory decreased Cost of goods sold by approximately $62 million and increased Profit by approximately $45 million or $0.07 per share.

6.                                     Investments in unconsolidated affiliated companies
 
Investments in unconsolidated affiliated companies, included in Other assets in the Consolidated Statement of Financial Position, were as follows:

 
 
 
 
(Millions of dollars)
September 30,
2017
 
December 31,
2016
Investments in equity method companies
$
219

 
$
192

Plus: Investments in cost method companies
33

 
57

Total investments in unconsolidated affiliated companies
$
252

 
$
249

 
 
 
 

In May 2017, we sold our equity interest in IronPlanet Holdings Inc. for $93 million. We recognized a pretax gain of $85 million (included in Other income (expense)) and derecognized the carrying value of our noncontrolling interest, which was included in Other assets in the Consolidated Statement of Financial Position. The gain on the disposal is included as a reconciling item between Segment profit and Consolidated profit before taxes.


21
Table of Contents

7.                                     Intangible assets and goodwill
 
A.  Intangible assets
 
Intangible assets are comprised of the following:
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2017
(Millions of dollars)
Weighted
Amortizable
Life (Years)
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Customer relationships
15
 
$
2,433

 
$
(1,077
)
 
$
1,356

Intellectual property
11
 
1,529

 
(812
)
 
717

Other
13
 
191

 
(89
)
 
102

Total finite-lived intangible assets
14
 
$
4,153

 
$
(1,978
)
 
$
2,175

 
 
 
December 31, 2016
 
Weighted
Amortizable
Life (Years)
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Customer relationships
15
 
$
2,378

 
$
(934
)
 
$
1,444

Intellectual property
11
 
1,496

 
(706
)
 
790

Other
14
 
192

 
(77
)
 
115

Total finite-lived intangible assets
14
 
$
4,066

 
$
(1,717
)
 
$
2,349

 
 
 
 
 
 
 
 

Amortization expense for the three and nine months ended September 30, 2017 was $82 million and $241 million, respectively. Amortization expense for the three and nine months ended September 30, 2016 was $82 million and $246 million, respectively. Amortization expense related to intangible assets is expected to be:

(Millions of dollars)
 
 
 
 
 
 
 
 
 
 
 
Remaining Three Months of 2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
$81
 
$319
 
$313
 
$302
 
$284
 
$876
 
 
 
 
 
 
 
 
 
 
 
 
B.  Goodwill
 
No goodwill was impaired during the three or nine months ended September 30, 2017 or 2016.
 

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Table of Contents

The changes in carrying amount of goodwill by reportable segment for the nine months ended September 30, 2017 were as follows: 

 
 
 
 
 
 
 
(Millions of dollars)
 
December 31,
2016
 
Other Adjustments 1
 
September 30,
2017
Construction Industries
 
 
 
 
 


Goodwill
 
$
296

 
$
10

 
$
306

Impairments
 
(22
)
 
—

 
(22
)
Net goodwill
 
274

 
10

 
284

Resource Industries
 
 
 
 
 
 
Goodwill
 
4,110

 
111

 
4,221

Impairments
 
(1,175
)
 
—

 
(1,175
)
Net goodwill
 
2,935

 
111

 
3,046

Energy & Transportation
 
 
 
 
 
 
Goodwill
 
2,756

 
54

 
2,810

All Other 2