CAT

Caterpillar Inc. Q2 2010 10-Q Summary

Business Context and Reporting Period

This filing is a Quarterly Report (Form 10-Q) for Caterpillar Inc. for the period ended June 30, 2010. The company operates in three principal lines of business: Machinery, Engines, and Financial Products. The reporting period reflects a recovery in global economic conditions, particularly in developing economies, driving increased demand for construction and mining equipment.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total sales increased 31% in Q2 2010 compared to Q2 2009 ($10.4B vs. $8.0B) and 8% for the six-month period ($18.6B vs. $17.2B). Machinery sales volume was the primary driver, up 55% in Q2 due to higher end-user demand and the absence of dealer inventory reductions seen in 2009.
• Profitability Surge: Net profit increased 91% in Q2 2010 ($707M vs. $371M) and 263% for the six-month period ($940M vs. $259M). Operating profit margins improved significantly, doubling as a percentage of sales.
• Cost Management: Manufacturing costs improved by $316 million in Q2. However, this was partially offset by the absence of $110 million in LIFO inventory decrement benefits recorded in Q2 2009.
• Redundancy Costs: Q2 2010 included $20 million in employee separation charges related to corporate streamlining, a significant decrease from the $85 million in redundancy costs incurred in Q2 2009.
• Financial Products: Revenues declined 5% in Q2 due to lower average earning assets, though operating profit remained stable.

Guidance, Outlook, and Risks

2010 Outlook Revision: Management raised its full-year 2010 outlook.

• Sales and Revenues: Revised range of $39 billion to $42 billion (midpoint $40.5B), up from the previous $38B-$42B range.
• Profit Per Share: Revised range of $3.15 to $3.85 (midpoint $3.50), up from the previous $2.50-$3.25 range.

Key Drivers and Risks:

• Positive Factors: Strong growth in developing economies (Asia/Pacific, Latin America), favorable commodity prices (coal, copper, oil), and improved operating efficiencies.
• Negative Factors/Offsets: Unfavorable product mix, higher income taxes (including a $90M deferred tax charge from healthcare legislation), increased incentive compensation costs, and higher R&D expenses for EPA Tier 4 compliance.
• Acquisitions: The company signed a definitive agreement to acquire Electro-Motive Diesel (EMD); however, the 2010 outlook does not include EMD results as the deal had not closed.
• Legal/Environmental: Ongoing negotiations with the EPA and Department of Justice regarding Clean Air Act violations (penalty demand of $3.2M) and a wastewater release incident in Joliet, IL. Management does not believe these will have a material adverse impact.

Investor Verification Checklist

• Dealer Inventory Levels: Verify the sustainability of sales growth given that Q2 2010 benefited from the absence of the significant dealer inventory drawdowns that occurred in 2009.
• LIFO Impact: Confirm the absence of LIFO inventory decrement benefits in 2010 compared to the $300M benefit in 2009, which impacts year-over-year cost comparisons.
• Healthcare Legislation Tax Charge: Review the $90 million deferred tax charge related to the Patient Protection and Affordable Care Act and its impact on the effective tax rate.
• Financial Products Credit Quality: Monitor the allowance for credit losses (1.70% of net finance receivables) and past due rates (5.33%) as economic conditions fluctuate.
• EMD Acquisition: Track the closing status of the Electro-Motive Diesel acquisition and its future impact on the Engines segment.