CAT

Caterpillar Inc. Q2 2004 10-Q Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2004, and the six months ended on that date. Caterpillar Inc. operates in three principal lines of business: Machinery, Engines, and Financial Products. The company reported record results in the second quarter, driven by surging global demand across major industries and geographic markets. Management noted a strategic decision to satisfy unprecedented customer demand despite increased operating costs related to material surcharges and expediting.

Key Financial Metrics

Note: Operating cash flow for the six months ended June 30, 2004, decreased to $571 million from $977 million in the prior year, primarily due to higher working capital requirements and a $500 million voluntary contribution to U.S. pension plans.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated sales increased 27% in Q2 and 30% year-to-date compared to 2003. Machinery sales rose 32% in Q2, driven by a 27% volume increase, improved price realization, and favorable currency impacts. Engines sales increased 23% in Q2.
• Profitability: Net profit increased 38% in Q2 and 83% year-to-date. Operating profit margins improved due to volume leverage and price increases, partially offset by higher core operating costs.
• Cost Drivers: Core operating costs increased due to steel surcharges, freight/expediting costs to meet demand, and higher incentive compensation. Retirement benefit costs also increased due to amortization of actuarial losses.
• Non-Conformance Penalties (NCP): Operating profit was favorably impacted by $47 million in Q2 and $96 million year-to-date due to the absence of EPA Non-Conformance Penalties that were recorded in 2003. Caterpillar achieved full compliance with emission standards by the end of 2003.
• Segment Performance: Machinery operating profit rose 30% in Q2; Engines operating profit rose 57%; Financial Products operating profit rose 10%.

Guidance, Outlook, and Risks

• 2004 Outlook: Management projects full-year sales and revenues to increase approximately 25% (up from a previous 20% estimate). Profit per share is expected to increase 80% to 85% from 2003 levels. Return on Sales and Revenues is expected to be about 7%.
• Regional Outlook: North America sales expected to rise ~35%; EAME ~10%; Latin America ~25%; Asia/Pacific ~25%. Growth is expected to be supported by strong housing demand, mining recovery, and infrastructure spending.
• Labor Relations: A ratification vote on a new 6-year labor agreement with the United Auto Workers (UAW) was scheduled for August 15, 2004. Management noted that a prolonged work stoppage would negatively impact sales and profits.
• Legal and Regulatory Risks:
  • WTO Tariffs: The EU began imposing retaliatory tariffs on U.S. goods in March 2004, starting at 5% and increasing monthly. Management does not believe this will materially impact results due to global production capabilities, but legislative changes in the U.S. could affect the 2004 tax provision.
  • Navistar Litigation: Caterpillar is pursuing a lawsuit against Navistar regarding fuel injector pricing and contract breaches, with $139 million in past-due receivables as of June 30, 2004.
• Environmental: The company is cleaning up hazardous waste at several locations, but accrued costs are not material. Compliance with environmental laws has not had a material impact on capital expenditures or earnings.

Investor Verification Checklist

• Volume vs. Price: Verify the sustainability of the 27% volume increase in Machinery sales and the ability to maintain price realization in a competitive market.
• Cost Inflation: Monitor the impact of steel surcharges and raw material costs on future margins, as these are expected to remain high.
• Labor Agreement: Confirm the outcome of the UAW contract ratification vote and assess the risk of potential work stoppages.
• Pension Funding: Review the impact of the $500 million voluntary pension contribution on future cash flow and the assumptions regarding the discount rate and return on assets.
• China Exposure: Assess the impact of government curbs on development in China, which caused a 38% drop in dealer deliveries in that region during Q2.
• Financial Products Credit Quality: Monitor the allowance for credit losses (1.47% of receivables) and delinquency rates (2.6% past due over 30 days) in the Financial Products segment.