Caterpillar Inc. — Q3 2017 Form 10-Q
Business context and reporting period. Caterpillar’s unaudited quarterly report covers the three and nine months ended September 30, 2017. Its principal businesses are Construction Industries, Resource Industries, Energy & Transportation, and Financial Products.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 |
|---|---|---|
| Sales and revenues | $11.413 billion | $9.160 billion |
| Operating profit | $1.577 billion | $481 million |
| Profit attributable to common shareholders | $1.059 billion | $283 million |
| Diluted earnings per share | $1.77 | $0.48 |
- Q3 operating margin was approximately 13.8%, versus 5.3% a year earlier; net margin was approximately 9.3%, versus 3.1%.
- For the first nine months, revenue rose 12% to $32.566 billion; operating profit increased 84% to $3.245 billion; net profit increased 86% to $2.053 billion; and diluted EPS rose to $3.44 from $1.88.
- Nine-month operating cash flow was $5.161 billion, compared with $3.975 billion in 2016. Investing activities used $468 million and financing activities used $2.310 billion. Cash and short-term investments increased to $9.591 billion from $7.168 billion at year-end 2016.
- At September 30, total debt was approximately $35.9 billion, down $859 million from year-end 2016. ME&T’s debt-to-capital ratio improved to 36.1% from 41.0%. Available credit was $9.303 billion; no borrowings were outstanding under the global credit facilities. Current assets were $37.185 billion and current liabilities $25.903 billion.
- Nine-month dividends paid were $1.367 billion. Caterpillar reported no common-stock repurchases in the first nine months; approximately $5.47 billion remained under the repurchase authorization.
Material changes versus the prior comparable period
- Management attributed Q3 revenue growth mainly to higher volume: roughly half from stronger end-user demand and half from favorable dealer-inventory changes. Growth spanned all regions and most end markets; Construction Industries had the largest segment increase. Financial Products revenue was roughly flat.
- Q3 profit improvement reflected higher volume, favorable pricing, lower restructuring costs and improved variable manufacturing costs, partly offset by higher period costs. Short-term incentive compensation was about $400 million in Q3 versus none in the prior-year quarter.
- For the first nine months, restructuring costs were $1.011 billion, versus $624 million a year earlier. Excluding restructuring costs and the IronPlanet sale gain, adjusted diluted EPS was $4.72 for 2017 versus $2.58 for 2016; this is a company-defined non-GAAP measure.
- Reported cash flow benefited from higher profit and non-cash restructuring charges, while working capital was a partial offset. Inventory increased by $1.489 billion in the first nine months.
Outlook, management commentary, risks and unusual items
- Management expected full-year 2017 restructuring costs of about $1.3 billion and approximately $450 million of 2017 cost benefits from restructuring actions versus 2016. The Gosselies, Belgium facility closure affects about 2,000 employees; production ended in Q2 2017, with remaining site operations expected to phase out by the end of Q2 2018.
- Management anticipated higher material costs, particularly steel, and higher period costs during the remainder of 2017, including targeted digital and product-technology investment. It also expected 2017 short-term incentive compensation to be significantly above 2016 and above target levels.
- Firm order backlog was approximately $15.4 billion at quarter-end, up about $600 million sequentially and $3.8 billion year over year; $2.6 billion was not expected to ship within the following 12 months. Management cautioned that some China construction demand may have been pulled forward into 2017, potentially weighing on 2018 demand.
- A Gosselies-related LIFO inventory liquidation reduced nine-month cost of goods sold by about $62 million and increased profit by about $45 million, or $0.07 per share. Caterpillar also recorded an $85 million pretax gain on its IronPlanet equity sale.
- Based on September 30 market conditions, management estimated a possible year-end increase of about $650 million in underfunded retirement obligations and a pretax mark-to-market loss of similar size, or about $0.75 per share after tax. The final amount depended on year-end actuarial assumptions and asset returns.
- The IRS proposed approximately $2 billion of additional tax and penalties for 2005 and 2007–2012 related to certain parts transactions involving Caterpillar SARL. Caterpillar is contesting the proposed adjustments and said it did not expect a material adverse effect. The company could not predict the outcome or estimate a potential loss for a separate ongoing U.S. grand jury investigation involving tax and export matters.
- Other disclosed exposures include a Brazilian antitrust investigation and a criminal investigation concerning Progress Rail. The company said it was cooperating and did not expect these matters to have a material adverse effect. Total maximum potential payments under reported guarantees were $2.213 billion, although the recorded related liability was $8 million; some guarantees have no stated payment cap.
- Key operating risks include cyclical demand and commodity-price exposure, dealer inventory decisions, steel and other input costs, currency and interest-rate movements, Cat Financial credit losses, pension funding, legal and tax matters, and access to credit markets. Cat Financial’s reported past-dues rate was 2.73%; net write-offs were $47 million in Q3, up from $29 million.
Important facts for investors to verify
- Whether revenue growth and backlog convert to end-user demand, rather than being primarily driven by dealer restocking or demand pulled forward, particularly in China.
- Delivery and cash costs of the Gosselies closure and other restructuring, and whether expected savings materialize; reconcile adjusted EPS with GAAP results and the reported LIFO benefit.
- Year-end pension assumptions and any resulting remeasurement charge, as well as the status and potential consequences of the IRS, grand jury, Brazil antitrust and Progress Rail matters.
- Cash-flow sustainability as inventory and production rise, and debt, liquidity and covenant headroom across ME&T and Financial Products.
- Cat Financial delinquencies, charge-offs, impaired receivables and allowance adequacy, especially in Latin America and marine-related portfolios.