Caterpillar Inc. — 2018 Second-Quarter Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Amounts are U.S. dollars; financial statement amounts are in millions except per-share data. Comparisons are with the corresponding 2017 periods unless noted.
Business context and results
Caterpillar operates in Construction Industries, Resource Industries, Energy & Transportation, and Financial Products. Second-quarter growth reflected stronger demand across the three equipment-related segments, with the largest sales increase in Construction Industries. Currency, mainly a stronger euro and Chinese yuan, also lifted sales.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Sales and revenues | $14.011 billion | $11.331 billion | $26.870 billion | $21.153 billion |
| Operating profit | $2.167 billion | $1.184 billion | $4.275 billion | $1.564 billion |
| Profit attributable to common shareholders | $1.707 billion | $802 million | $3.372 billion | $994 million |
| Diluted earnings per share | $2.82 | $1.35 | $5.56 | $1.67 |
| Operating profit margin | 15.5% | 10.4% | 15.9% | 7.4% |
| Adjusted operating profit margin | 16.3% | 11.9% | 16.6% | 11.6% |
| Adjusted diluted EPS | $2.97 | $1.49 | $5.79 | $2.77 |
Adjusted measures are non-GAAP and exclude restructuring costs; 2017 adjusted EPS also excludes a gain on the IronPlanet investment sale. Q2 revenue rose 24%, and six-month revenue rose 27%. Profit growth reflected higher sales volume, a lower effective tax rate, and lower restructuring costs versus the prior year. Favorable pricing was partly offset by higher manufacturing costs, especially freight and materials.
Cash flow, financial position, and capital allocation
- First-half consolidated operating cash flow was $3.083 billion, down from $3.924 billion. Management cited higher working-capital needs to support production and higher incentive-compensation payments, partly offset by higher profit. ME&T operating cash flow was $3.032 billion, versus $3.553 billion.
- First-half investing cash outflow was $2.068 billion, compared with $159 million; financing cash outflow was $573 million, compared with $694 million. Investing outflows included finance-receivable growth, acquisitions, and higher capital spending.
- At June 30, cash and short-term investments were $8.654 billion, up $393 million from year-end 2017. Total debt was approximately $36.17 billion, up $1.29 billion; most of the increase was in Financial Products debt as its portfolio grew. Shareholders’ equity was $14.942 billion and total assets were $78.987 billion.
- Available credit was $8.652 billion, including $2.750 billion allocated to ME&T; there were no borrowings under the global credit facilities. The company reported compliance with applicable credit-facility covenants.
- First-half dividends paid were $933 million and share repurchases were $1.250 billion. The board raised the quarterly dividend 10% to $0.86 per share and, in July, approved a new $10 billion repurchase authorization effective January 1, 2019.
Material changes and segment trends
- Q2 ME&T sales increased 25%; Construction Industries sales rose 24%, Resource Industries 38%, and Energy & Transportation 20%. Financial Products revenue increased 6% on the consolidated statement, while its segment revenue increased 7%.
- Q2 segment profit increased in all three equipment-related segments. Financial Products segment profit fell to $134 million from $191 million, primarily because of higher credit-loss provisions.
- Restructuring costs were $114 million in Q2 and $183 million in the first half, versus $169 million and $921 million, respectively, in 2017. The sharply lower year-to-date costs helped lift reported operating profit and earnings.
- Dealer machine and engine inventories increased about $1.3 billion in the first half, compared with a decrease of about $100 million in the prior-year period. Management said the increase reflected current end-user demand, but noted that inventory also depends on dealer expectations and delivery times.
- Cat Financial past dues were 3.16% at Q2-end versus 2.71% a year earlier. Q2 net write-offs were $80 million versus $26 million, primarily reflecting a small number of Cat Power Finance customers and Latin America collection experience. The allowance for credit losses was $416 million, or 1.48% of finance receivables.
Outlook, commentary, and risks
- The filing does not provide a clear full-year revenue, profit, or EPS forecast. Management expected about $400 million of 2018 restructuring costs, including approximately $150 million more for its large-scale plan, and expected restructuring actions to benefit 2018 operating costs by about $120 million versus 2017.
- Management expected second-half 2018 tariffs to add approximately $100–$200 million to material costs and supply-chain constraints to continue pressuring freight costs. Mid-year price increases were expected to benefit second-half price realization. Full-year short-term incentive compensation was expected to be about $1.4 billion, nearly the same as 2017.
- ME&T capital expenditures were expected to be $1.0–$1.5 billion in 2018; full-year pension and postretirement contributions were expected to be about $365 million. Management expected second-half share repurchases in a range similar to the first half, subject to cash priorities and market conditions.
- Firm order backlog was approximately $17.7 billion at quarter-end, about flat sequentially and $2.9 billion above Q2 2017; approximately $3.1 billion was not expected to ship within the next 12 months. Management noted mining customers had not yet begun full-scale fleet replacements.
- Key risks include global demand and commodity-price changes, material availability and costs, trade policies and tariffs, currency and interest-rate movements, dealer inventory decisions, supply-chain constraints, and credit losses at Cat Financial. Cat Financial debt and receivables are substantial and should be evaluated separately from ME&T.
- The company is cooperating with a U.S. grand jury investigation involving tax and export matters and cannot estimate any potential loss; management believed it would not have a material adverse effect. Caterpillar is also contesting approximately $2.3 billion of proposed U.S. tax and penalties for 2007–2012 related to transactions involving Caterpillar SARL; management likewise stated it did not expect a material adverse effect. U.S. tax reform’s provisional charge was $2.371 billion, unchanged from year-end 2017, but further analysis could materially affect tax expense, cash taxes, and deferred tax balances.
- Other contingencies include a Brazilian antitrust investigation and guarantees with maximum potential undiscounted payments of $2.174 billion; recorded guarantee liability was $8 million, and management said no significant guarantee loss was anticipated. Environmental remediation accruals and other unresolved legal exposures were described as not material by management.
Important facts for investors to verify
- Whether sales growth and margins persist after accounting for dealer inventory accumulation, currency, pricing, and the unusually low prior-year restructuring comparison.
- Whether supply-chain constraints, steel costs, tariffs, and freight pressures are offset by pricing and productivity in the second half.
- Cat Financial credit quality: rising past dues and write-offs, allowance adequacy, and concentration of impaired or non-accrual receivables.
- Cash conversion and working-capital requirements, particularly inventory, receivables, and incentive-compensation payments; distinguish consolidated cash flow from ME&T cash flow.
- Developments in the IRS dispute and U.S. investigation, and any resulting changes to tax exposure, contingencies, or management’s materiality assessment.
- Execution of restructuring plans, capital spending, dividend and repurchase plans, and the timing and conversion of the $17.7 billion backlog into revenue and cash.
- Effects of adopting revenue recognition guidance: it reduced Q2 2018 sales by $51 million and profit by $8 million versus prior guidance; comparative periods were not recast.