EX-13 6 ex_13.htm GENERAL AND FINANCIAL INFORMATION FOR 2007 ex_13.htm

EXHIBIT 13


 
CATERPILLAR INC.
GENERAL AND FINANCIAL INFORMATION
2007





A-1

 
 
TABLE OF CONTENTS
 
A-2


 
INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Caterpillar Inc. (company) is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
Management assessed the effectiveness of the company's internal control over financial reporting as of December 31, 2007. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on our assessment we concluded that, as of December 31, 2007, the company's internal control over financial reporting was effective based on those criteria.
 
The effectiveness of the company's internal control over financial reporting as of December 31, 2007 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm. Their report appears on page A-4.
 
     
        /s/ James W. Owens     
       
James W. Owens
Chairman of the Board
and Chief Executive Officer
 
   
     
        /s/ David B. Burritt     
       
David B. Burritt
Vice President and
Chief Financial Officer
 
   
       
 
February 21, 2008
   
 
A-3

 
 
 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 
To the Board of Directors and Stockholders of Caterpillar Inc.:
 
In our opinion, the accompanying consolidated statement of financial position and the related statements of consolidated results of operations, changes in stockholders' equity, and cash flow, including pages A-5 through A-39, present fairly, in all material respects, the financial position of Caterpillar Inc. and its subsidiaries at December 31, 2007, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America.  Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control Over Financial Reporting appearing on page A-3.  Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits.  We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects.  Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

As discussed in Note 1L to the consolidated financial statements, the Company changed the manner in which it accounts for uncertainty in income taxes in 2007.  As discussed in Note 1N and 1L, respectively, the Company changed the manner in which it accounts for stock-based compensation in 2006 and the manner in which it accounts for defined benefit pension and other postretirement plans, effective December 31, 2006.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP
Peoria, Illinois
February 21, 2008
 
A-4

 
STATEMENT 1
Caterpillar Inc.
Consolidated Results of Operations for the Years Ended December 31
(Dollars in millions except per share data)
 
 
2007
 
2006
 
2005
Sales and revenues:
                     
 
Sales of Machinery and Engines
$
41,962
   
$
38,869
   
$
34,006
 
 
Revenues of Financial Products
 
2,996
     
2,648
     
2,333
 
 
Total sales and revenues
 
44,958
     
41,517
     
36,339
 
                         
Operating costs:
                     
 
Cost of goods sold
 
32,626
     
29,549
     
26,558
 
 
Selling, general and administrative expenses
 
3,821
     
3,706
     
3,190
 
 
Research and development expenses
 
1,404
     
1,347
     
1,084
 
 
Interest expense of Financial Products
 
1,132
     
1,023
     
768
 
 
Other operating expenses
 
1,054
     
971
     
955
 
 
Total operating costs
 
40,037
     
36,596
     
32,555
 
                         
Operating profit
 
4,921
     
4,921
     
3,784
 
                         
 
Interest expense excluding Financial Products
 
288
     
274
     
260
 
 
Other income (expense)
 
320
     
214
     
377
 
                         
Consolidated profit before taxes
 
4,953
     
4,861
     
3,901
 
                         
 
Provision for income taxes
 
1,485
     
1,405
     
1,120
 
 
Profit of consolidated companies
 
3,468
     
3,456
     
2,781
 
                         
 
Equity in profit (loss) of unconsolidated affiliated companies
 
73
     
81
     
73
 
                       
Profit
$
3,541
   
$
3,537
   
$
2,854
 
                         
                       
Profit per common share
$
5.55
   
$
5.37
   
$
4.21
 
                         
Profit per common share – diluted 1
$
5.37
   
$
5.17
   
$
4.04
 
                         
Weighted-average common shares outstanding (millions)
                     
 
- Basic
 
638.2
     
658.7
     
678.4
 
 
- Diluted 1
 
659.5
     
683.8
     
705.8
 
                       
Cash dividends declared per common share
$
1.38
   
$
1.15
   
$
.96
 
 
1
Diluted by assumed exercise of stock-based compensation awards, using the treasury stock method.
 
See accompanying notes to Consolidated Financial Statements.
 
A-5

 
 
STATEMENT 2
Caterpillar Inc.
Consolidated Financial Position at December 31
(Dollars in millions)
 
 
2007
 
2006
 
2005
Assets
                     
 
Current assets:
                     
   
Cash and short-term investments
$
1,122
   
$
530
   
$
1,108
 
   
Receivables – trade and other
 
8,249
     
8,607
     
7,906
 
   
Receivables – finance
 
7,503
     
6,804
     
6,442
 
   
Deferred and refundable income taxes
 
816
     
733
     
255
 
   
Prepaid expenses and other current assets
 
583
     
638
     
2,250
 
   
Inventories
 
7,204
     
6,351
     
5,224
 
 
Total current assets
 
25,477
     
23,663
     
23,185
 
                         
 
Property, plant and equipment – net
 
9,997
     
8,851
     
7,988
 
 
Long-term receivables – trade and other
 
685
     
860
     
1,037
 
 
Long-term receivables – finance
 
13,462
     
11,531
     
10,301
 
 
Investments in unconsolidated affiliated companies
 
598
     
562
     
565
 
 
Noncurrent deferred and refundable income taxes
 
1,553
     
1,949
     
857
 
 
Intangible assets
 
475
     
387
     
424
 
 
Goodwill
 
1,963
     
1,904
     
1,451
 
 
Other assets
 
1,922
     
1,742
     
1,745
 
Total assets
$
56,132
   
$
51,449
   
$
47,553
 
                       
Liabilities
                     
 
Current liabilities:
                     
   
Short-term borrowings:
                     
     
Machinery and Engines
$
187
   
$
165
   
$
871
 
     
Financial Products
 
5,281
     
4,990
     
4,698
 
   
Accounts payable
 
4,723
     
4,085
     
3,412
 
   
Accrued expenses
 
3,178
     
2,923
     
2,617
 
   
Accrued wages, salaries and employee benefits
 
1,126
     
938
     
1,601
 
   
Customer advances
 
1,442
     
921
     
454
 
   
Dividends payable
 
225
     
194
     
168
 
   
Other current liabilities
 
951
     
1,145
     
1,012
 
   
Long-term debt due within one year:
                     
     
Machinery and Engines
 
180
     
418
     
340
 
     
Financial Products
 
4,952
     
4,043
     
4,159
 
 
Total current liabilities
 
22,245
     
19,822
     
19,332
 
                         
 
Long-term debt due after one year:
                     
   
Machinery and Engines
 
3,639
     
3,694
     
2,717
 
   
Financial Products
 
14,190
     
13,986
     
12,960
 
 
Liability for postemployment benefits
 
5,059
     
5,879
     
3,161
 
 
Other liabilities
 
2,116
     
1,209
     
951
 
Total liabilities
 
47,249
     
44,590
     
39,121
 
Commitments and contingencies (Notes 22 and 23)
                     
Stockholders’ equity
                     
 
Common stock of $1.00 par:
                     
   
Authorized shares:  900,000,000
Issued shares:  (2007, 2006 and 2005 – 814,894,624) at paid-in amount
 
2,744
     
2,465
     
1,859
 
 
Treasury stock (2007 – 190,908,490 shares; 2006 – 169,086,448 shares
an
d 2005 – 144,027,405 shares) at cost
 
(9,451
)
   
(7,352
)
   
(4,637
)
 
Profit employed in the business
 
17,398
     
14,593
     
11,808
 
 
Accumulated other comprehensive income
 
(1,808
)
   
(2,847
)
   
(598
)
Total stockholders’ equity
 
8,883
     
6,859
     
8,432
 
Total liabilities and stockholders’ equity
$
56,132
   
$
51,449
   
$
47,553
 
 
See accompanying notes to Consolidated Financial Statements.
 
A-6

 
 
STATEMENT 3
Caterpillar Inc.
Changes in Consolidated Stockholders’ Equity for the Years Ended December 31
(Dollars in millions)
                   
             
Accumulated other comprehensive income
   
 
Common stock  
 
Treasury stock 
 
Profit
employed in
the business
 
Foreign currency translation
 
Pension & other post- retirement benefits1
 
Derivative financial instruments
 
Available-for-sale securities
 
Total
Balance at December 31, 2004
$
1,231
   
$
(3,277
)
 
$
9,937
   
$
489
   
$
(1,041
)
 
$
110
   
$
18
   
$
7,467
 
Profit
 
     
     
2,854
     
     
     
     
     
2,854
 
Foreign currency translation
 
     
     
     
(187
)
   
     
     
     
(187
)
Minimum pension liability adjustment,
net of tax of $36
 
     
     
     
     
107
     
     
     
107
 
Derivative financial instruments
                                                             
 
Gains (losses) deferred, net of tax of $1
 
     
     
     
     
     
(3
)
   
     
(3
)
 
(Gains) losses reclassified to earnings,
net of tax of $46
 
     
     
     
     
     
(89
)
   
     
(89
)
Available-for-sale securities
                                                             
 
Gains (losses) deferred, net of tax of $3
 
     
     
     
     
     
     
3
     
3
 
 
(Gains) losses reclassified to earnings,
net of tax of $1
 
     
     
     
     
     
     
(5
)
   
(5
)
   
Comprehensive income
                                                         
2,680
 
Dividends declared
 
     
     
(645
)
   
     
     
     
     
(645
)
Common shares issued from treasury stock
for stock-based compensation:  18,912,521
 
156
     
324
     
     
     
     
     
     
480
 
Tax benefits from stock-based compensation
 
134
     
     
     
     
     
     
     
134
 
Shares repurchased:  33,919,200
 
     
(1,684
)
   
     
     
     
     
     
(1,684
)
Impact of 2–for–1 stock split
 
338
     
     
(338
)
   
     
     
     
     
 
Balance at December 31, 2005
 
1,859
     
(4,637
)
   
11,808
     
302
     
(934
)
   
18
     
16
     
8,432
 
Profit
 
     
     
3,537
     
     
     
     
     
3,537
 
Foreign currency translation
 
     
     
     
169
     
     
     
     
169
 
Minimum pension liability adjustment,
net of tax of $97
 
     
     
     
     
229
     
     
     
229
 
Derivative financial instruments
                                                             
 
Gains (losses) deferred, net of tax of $40
 
     
     
     
     
     
73
     
     
73
 
 
(Gains) losses reclassified to earnings,
net of tax of $26
 
     
     
     
     
     
(43
)
   
     
(43
)
Available-for-sale securities
                                                             
 
Gains (losses) deferred, net of tax of $8
 
     
     
     
     
     
     
17
     
17
 
 
(Gains) losses reclassified to earnings,
net of tax of $12
 
     
     
     
     
     
     
(23
)
   
(23
)
   
Comprehensive income
 
     
     
     
     
     
     
     
3,959
 
Incremental adjustment to adopt SFAS 158,
net of tax of $1,494
 
     
     
     
     
(2,671
)
   
     
     
(2,671
)
Dividends declared
 
     
     
(752
)
   
     
     
     
     
(752
)
Common shares issued from treasury stock for
stock-based compensation:  15,207,055
 
73
     
341
     
     
     
     
     
     
414
 
Stock-based compensation expense
 
137
     
     
     
     
     
     
     
137
 
Tax benefits from stock-based compensation
 
170
     
     
     
     
     
     
     
170
 
Shares repurchased:  45,608,000
 
     
(3,208
)
   
     
     
     
     
     
(3,208
)
Share issued for Progress Rail Services, Inc.
acquisition: 5,341,902
 
226
     
152
     
     
     
     
     
     
378
 
Balance at December 31, 2006
$
2,465
   
$
(7,352
)
 
$
14,593
   
$
471
   
$
(3,376
)
 
$
48
   
$
10
   
$
6,859
 
 
(Continued)
A-7

 
STATEMENT 3
Caterpillar Inc.
Changes in Consolidated Stockholders’ Equity for the Years Ended December 31  (Continued)
(Dollars in millions)
 
 
           
Accumulated other comprehensive income
   
 
Common stock
 
Treasury stock
 
Profit employed in the business
 
Foreign currency translation
 
Pension & other post- retirement benefits1
 
Derivative financial instruments
 
Available-for-sale securities
 
Total
Balance at December 31, 2006
$
2,465
   
$
(7,352
)
 
$
14,593
   
$
471
   
$
(3,376
)
 
$
48
   
$
10
   
$
6,859
 
Adjustment to adopt FIN 48
 
     
     
141
     
     
     
     
     
141
 
Balance at January 1, 2007
 
2,465
     
(7,352
)
   
14,734
     
471
     
(3,376
)
   
48
     
10
     
7,000
 
Profit
 
     
     
3,541
     
     
     
     
     
3,541
 
Foreign currency translation
 
     
     
     
278
     
     
     
     
278
 
Pension and other postretirement benefits
                                                             
 
Current year actuarial gain/(loss), net of tax of $271
 
     
     
     
     
537
     
     
     
537
 
 
Amortization of actuarial (gain)/loss, net of tax of $123
 
     
     
     
     
228
     
     
     
228
 
 
Current year prior service cost, net of tax of $1
 
     
     
     
     
(2
)
   
     
     
(2
)
 
Amortization of prior service cost, net of tax of $10
 
     
     
     
     
17
     
     
     
17
 
 
Amortization of transition asset/obligation, net of tax of $1
 
     
     
     
     
2
     
     
     
2
 
Derivative financial instruments
                                                             
 
Gains (losses) deferred, net of tax of $27
 
     
     
     
     
     
51
     
     
51
 
 
(Gains) losses reclassified to earnings, net of tax of $45
 
     
     
     
     
     
(80
)
   
     
(80
)
Available-for-sale securities
                                                             
 
Gains (losses) deferred, net of tax of $8
 
     
     
     
     
     
     
14
     
14
 
 
(Gains) losses reclassified to earnings, net of tax of $3
 
     
     
     
     
     
     
(6
)
   
(6
)
   
Comprehensive income
                                                         
4,580
 
Dividends declared
 
     
     
(877
)
   
     
     
     
     
(877
)
Common shares issued from treasury stock for stock-based compensation:  11,710,958
 
22
     
306
     
     
     
     
     
     
328
 
Stock-based compensation expense
 
146
     
     
     
     
     
     
     
146
 
Tax benefits from stock-based compensation
 
167
     
     
     
     
     
     
     
167
 
Shares repurchased:  33,533,000
 
     
(2,405
)
   
     
     
     
     
     
(2,405
)
Stock repurchase derivative contracts
 
(56
)
   
     
     
     
     
     
     
(56
)
Balance at December 31, 2007
$
2,744
   
$
(9,451
)
 
$
17,398
   
$
749
   
$
(2,594
)
 
$
19
   
$
18
   
$
8,883
 
                                                                 
 
1
Pension and other postretirement benefits includes net adjustments for unconsolidated companies of $(9) million, $(6) million and $11 million, and the ending balances of $(52) million,  $(43) million and $(37) million for the years 2007, 2006 and 2005, respectively.
 
See accompanying notes to Consolidated Financial Statements.
 
A-8

 
 
STATEMENT 4
Caterpillar Inc.
Consolidated Statement of Cash Flow for the Years Ended December 31
(Millions of dollars)
 
 
2007
 
2006
 
2005
Cash flow from operating activities:
                     
 
Profit
$
3,541
   
$
3,537
   
$
2,854
 
 
Adjustments for non-cash items:
                     
   
Depreciation and amortization
 
1,797
     
1,602
     
1,477
 
   
Other
 
199
     
197
     
(20
)
 
Changes in assets and liabilities:
                     
   
Receivables trade and other
 
899
     
(148
)
   
(970
)
   
Inventories
 
(745
)
   
(827
)
   
(568
)
   
Accounts payable and accrued expenses
 
618
     
670
     
532
 
   
Customer advances
 
576
     
511
     
(26
)
   
Other assets – net
 
66
     
(262
)
   
(882
)
   
Other liabilities – net
 
984
     
519
     
716
 
Net cash provided by (used for) operating activities
 
7,935
     
5,799
     
3,113
 
Cash flow from investing activities:
                     
 
Capital expenditures excluding equipment leased to others
 
(1,700
)
   
(1,593
)
   
(1,201
)
 
Expenditures for equipment leased to others
 
(1,340
)
   
(1,082
)
   
(1,214
)
 
Proceeds from disposals of property, plant and equipment
 
408
     
572
     
637
 
 
Additions to finance receivables
 
(13,946
)
   
(10,522
)
   
(10,334
)
 
Collections of finance receivables
 
10,985
     
8,094
     
7,057
 
 
Proceeds from sale of finance receivables
 
866
     
1,067
     
900
 
 
Investments and acquisitions (net of cash acquired)
 
(229
)
   
(513
)
   
(13
)
 
Proceeds from release of security deposit
 
290
     
     
530
 
 
Proceeds from sale of available-for-sale securities
 
282
     
539
     
257
 
 
Investments in available-for-sale securities
 
(485
)
   
(681
)
   
(338
)
 
Other – net
 
461
     
323
     
194
 
Net cash provided by (used for) investing activities
 
(4,408
)
   
(3,796
)
   
(3,525
)
Cash flow from financing activities:
                     
 
Dividends paid
 
(845
)
   
(726
)
   
(618
)
 
Common stock issued, including treasury shares reissued
 
328
     
414
     
482
 
 
Payment for stock repurchase derivative contracts
 
(56
)
   
     
 
 
Treasury shares purchased
 
(2,405
)
   
(3,208
)
   
(1,684
)
 
Excess tax benefit from stock-based compensation
 
155
     
169
     
 
 
Proceeds from debt issued (original maturities greater than three months):
                     
   
— Machinery and Engines
 
224
     
1,445
     
574
 
   
— Financial Products
 
10,815
     
9,824
     
14,000
 
 
Payments on debt (original maturities greater than three months):
                     
   
— Machinery and Engines
 
(598
)
   
(839
)
   
(654
)
   
— Financial Products
 
(10,290
)
   
(9,536
)
   
(10,966
)
 
Short-term borrowings (original maturities three months or less) net
 
(297
)
   
(136
)
   
19
 
Net cash provided by (used for) financing activities
 
(2,969
)
   
(2,593
)
   
1,153
 
Effect of exchange rate changes on cash
 
34
     
12
     
(78
)
Increase (decrease) in cash and short-term investments
 
592
     
(578
)
   
663
 
Cash and short-term investments at beginning of period
 
530
     
1,108
     
445
 
Cash and short-term investments at end of period
$
1,122
   
$
530
   
$
1,108
 
 
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:
 
 
On June 19, 2006, Caterpillar acquired 100 percent of the equity in Progress Rail Services, Inc.  A portion of the acquisition was financed with 5.3 million shares of Caterpillar stock with a fair value of $379 million as of the acquisition date.  See Note 25 for further discussion.
 
 
In 2005, $116 million of 9.375% debentures due in 2021 and $117 million of 8.00% debentures due in 2023 were exchanged for $307 million of 5.30% debentures due in 2035 and $23 million of cash. The $23 million of cash is included in payments on debt.
 
See accompanying notes to Consolidated Financial Statements.
 
 
A-9

 
 

1.
Operations and summary of significant accounting policies
 
A.
 
Nature of Operations
 
 
We operate in three principal lines of business:
 
 
(1)
 
Machinery— A principal line of business which includes the design, manufacture, marketing and sales of construction, mining and forestry machinery—track and wheel tractors, track and wheel loaders, pipelayers, motor graders, wheel tractor-scrapers, track and wheel excavators, backhoe loaders, log skidders, log loaders, off-highway trucks, articulated trucks, paving products, skid steer loaders and related parts. Also includes logistics services for other companies and the design, manufacture, remanufacture, maintenance and services of rail-related products.
 
 
(2)
 
Engines A principal line of business including the design, manufacture, marketing and sales of engines for Caterpillar machinery; electric power generation systems; on-highway vehicles and locomotives; marine, petroleum, construction, industrial, agricultural and other applications; and related parts.  Also includes remanufacturing of Caterpillar engines and a variety of Caterpillar machine and engine components and remanufacturing services for other companies.  Reciprocating engines meet power needs ranging from 5 to 21,500 horsepower (4 to over 16 000 kilowatts).  Turbines range from 1,600 to 20,500 horsepower (1 200 to 15 000 kilowatts).
 
 
(3)
 
Financial Products— A principal line of business consisting primarily of Caterpillar Financial Services Corporation (Cat Financial), Caterpillar Insurance Holdings, Inc. (Cat Insurance), Caterpillar Power Ventures Corporation (Cat Power Ventures) and their respective subsidiaries.  Cat Financial provides a wide range of financing alternatives to customers and dealers for Caterpillar machinery and engines, Solar gas turbines as well as other equipment and marine vessels.  Cat Financial also extends loans to customers and dealers.  Cat Insurance provides various forms of insurance to customers and dealers to help support the purchase and lease of our equipment.  Cat Power Ventures is an investor in independent power projects using Caterpillar power generation equipment and services.
 
 
Our Machinery and Engines operations are highly integrated. Throughout the Notes, Machinery and Engines represents the aggregate total of these principal lines of business.
 
Our products are sold primarily under the brands "Caterpillar," "Cat," "Solar Turbines," "MaK," "Perkins," "FG Wilson" and "Olympian."
 
We conduct operations in our Machinery and Engines lines of business under highly competitive conditions, including intense price competition. We place great emphasis on the high quality and performance of our products and our dealers' service support. Although no one competitor is believed to produce all of the same types of machines and engines that we do, there are numerous companies, large and small, which compete with us in the sale of each of our products.
 
Machines are distributed principally through a worldwide organization of dealers (dealer network), 53 located in the United States and 128 located outside the United States. Worldwide, these dealers serve 182 countries and operate 3,645 places of business, including 1,606 dealer rental outlets. Reciprocating engines are sold principally through the dealer network and to other manufacturers for use in products manufactured by them. Some of the reciprocating engines manufactured by Perkins are also sold through a worldwide network of 132 distributors located in 181 countries along with 3,500 supporting dealers. The FG Wilson branded electric power generation systems are sold through a worldwide network of 200 dealers located in 180 countries. Our dealers do not deal exclusively with our products; however, in most cases sales and servicing of our products are the dealers' principal business. Turbines and large medium speed reciprocating engines are sold through sales forces employed by the company. At times, these employees are assisted by independent sales representatives.
 
Manufacturing activities of the Machinery and Engines lines of business are conducted in 95 plants in the United States; 12 in the United Kingdom; nine in Italy; eight in Mexico; seven in China; five in France; four in Canada; three each in Australia, Brazil, India, The Netherlands, Northern Ireland and Poland; two each in Germany, Indonesia and Japan; and one each in Belgium, Hungary, Malaysia, Nigeria, Russia, Scotland, South Africa, Switzerland and Tunisia. Thirteen parts distribution centers are located in the United States and 14 are located outside the United States.
 
The Financial Products line of business also conducts operations under highly competitive conditions. Financing for users of Caterpillar products is available through a variety of competitive sources, principally commercial banks and finance and leasing companies. We emphasize prompt and responsive service to meet customer requirements and offer various financing plans designed to increase the opportunity for sales of our products and generate financing income for our company. Financial Products activity is conducted primarily in the United States, with additional offices in Asia, Australia, Canada, Europe and Latin America.
 
B.
 
Basis of consolidation
 
The financial statements include the accounts of Caterpillar Inc. and its subsidiaries. Investments in companies that are owned 20% to 50% or are less than 20% owned and for which we have significant influence are accounted for by the equity method (see Note 11). We consolidate all variable interest entities where Caterpillar Inc. is the primary beneficiary.
 
Certain amounts for prior years have been reclassified to conform with the current-year financial statement presentation.
 
Shipping and handling costs are included in Cost of goods sold in Statement 1.  Other operating expense primarily includes Cat Financial's depreciation of equipment leased to others, Cat Insurance’s underwriting expenses, gains (losses) on disposal of long-lived assets and long-lived asset impairment charges.
 
Prepaid expenses and other current assets in Statement 2 include prepaid rent, prepaid insurance and other prepaid items.  In addition, at December 31, 2006, this line included a security deposit of $249 million related to a deposit obligation due in 2007 (see Note 16 for further discussion).  At December 31, 2005 prepaid expenses related to our pension plans of $1.95 billion were also included in this line.  No such prepaid pension asset existed at December 31, 2007 or 2006 as a result of our adoption of SFAS 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans." See Notes 1L and 14 for further discussion.
 
A-10

 
C.
 
Sales and revenue recognition
 
Sales of Machinery and Engines are generally recognized when title transfers and the risks and rewards of ownership have passed to customers or independently owned and operated dealers.  Typically, where product is produced and sold in the same country, title and risk of ownership transfer when the product is shipped.  Products that are exported from a country for sale typically pass title and risk of ownership at the border of the destination country.
 
No right of return exists on sales of equipment.  Replacement part returns are estimable and accrued at the time a sale is recognized.
 
We provide discounts to dealers and original equipment manufacturers (OEM) through merchandising programs that are administered by our marketing profit centers.  We have numerous programs that are designed to promote the sale of our products.  The most common dealer programs provide a discount when the dealer sells a product to a targeted end user.  OEM programs provide discounts designed to encourage the use of our engines. The cost of these discounts is estimated based on historical experience and known changes in merchandising programs and is reported as a reduction to sales when the product sale is recognized.   
 
Our standard invoice terms are established by marketing region. When a sale is made to a dealer, the dealer is responsible for payment even if the product is not sold to an end customer and must make payment within the standard terms to avoid interest costs. Interest at or above prevailing market rates is charged on any past due balance. Our policy is to not forgive this interest. In 2007, 2006 and 2005 terms were extended to not more than one year for $219 million, $49 million and $287 million of receivables, respectively. For 2007, 2006 and 2005, these amounts represent less than 1% of consolidated sales.
 
 
Sales with payment terms of two months or more were as follows:
 
   
     
(Dollars in millions)
     
2007
 
2006
 
2005
 
Payment Terms (months)
 
Sales
 
Percent
of Sales
 
Sales
 
Percent
of Sales
 
Sales
 
Percent
of Sales
 
2
 
$
1,747
     
4.2
%
 
$
1,481
     
3.8
%
 
$
261
     
0.8
%
 
3
   
2,047
     
4.9
%
   
636
     
1.6
%
   
548
     
1.6
%
 
4
   
524
     
1.2
%
   
336
     
0.9
%
   
262
     
0.8
%
 
5
   
964
     
2.3
%
   
1,228
     
3.2
%
   
916
     
2.7
%
 
6
   
4,499
     
10.7
%
   
8,516
     
21.9
%
   
8,147
     
23.9
%
 
7-12
   
240
     
0.6
%
   
272
     
0.7
%
   
345
     
1.0
%
     
$
10,021
     
23.9
%
 
$
12,469
     
32.1
%
 
$
10,479
     
30.8
%
                                                   
 
 
 
We establish a bad debt allowance for Machinery and Engines receivables when it becomes probable that the receivable will not be collected. Our allowance for bad debts is not significant.  In 2006, we wrote off approximately $70 million of receivables in conjunction with settlement of various legal disputes with Navistar International Corporation.  No significant write-offs of Machinery and Engines receivables were made during 2007 or 2005.
 
 
Revenues of Financial Products primarily represent the following Cat Financial revenues:
 
 
·
Retail (end-customer) finance revenue on finance leases and installment sale contracts is recognized over the term of the contract at a constant rate of return on the scheduled outstanding principal balance.  Revenue on retail notes is recognized based on the daily balance of retail receivables outstanding and the applicable effective interest rate.
 
 
·
Operating lease revenue is recorded on a straight-line basis in the period earned over the life of the contract.
 
 
·
Wholesale (dealer) finance revenue on installment contracts and finance leases is recognized over the term of the contract at a constant rate of return on the scheduled outstanding principal balance.  Revenue on wholesale notes is recognized based on the daily balance of wholesale receivables outstanding and the applicable effective interest rate.
 
 
·
Loan origination and commitment fees are deferred and then amortized to revenue using the interest method over the life of the finance receivables.
 
 
Recognition of income is suspended when collection of future income is not probable. Accrual is resumed, and previously suspended income is recognized, when the receivable becomes contractually current and/or collection doubts are removed. Cat Financial provides wholesale inventory financing to dealers. See Notes 7 and 8 for more information.
 
Sales and revenue recognition items are presented net of sales and other related taxes.
 
D.
 
Inventories
 
Inventories are stated at the lower of cost or market. Cost is principally determined using the last-in, first-out (LIFO) method. The value of inventories on the LIFO basis represented about 75% of total inventories at December 31, 2007 and 2006, and about 80% of total inventories at December 31, 2005.
 
If the FIFO (first-in, first-out) method had been in use, inventories would have been $2,617 million, $2,403 million and $2,345 million higher than reported at December 31, 2007, 2006 and 2005, respectively.
 
E.
 
Securitized receivables
 
We periodically sell finance receivables in securitization transactions. When finance receivables are securitized, we retain interests in the receivables in the form of interest-only strips, servicing rights, cash reserve accounts and subordinated certificates. The retained interests are recorded in “Other assets” at fair value. We estimate fair value based on the present value of future expected cash flows using key assumptions for credit losses, prepayment speeds and discount rates. See Note 8 for more information.
 
F.
 
Depreciation and amortization
 
Depreciation of plant and equipment is computed principally using accelerated methods. Depreciation on equipment leased to others, primarily for Financial Products, is computed using the straight-line method over the term of the lease. The depreciable basis is the original cost of the equipment less the estimated residual value of the equipment at the end of the lease term. In 2007, 2006 and 2005, Cat Financial depreciation on equipment leased to others was $671 million, $631 million and $615 million, respectively, and was included in "Other operating expenses" in Statement 1. In 2007, 2006 and 2005 consolidated depreciation expense was $1,725 million, $1,554 million and $1,444 million, respectively. Amortization of purchased intangibles is computed principally using the straight-line method, generally not to exceed a period of 20 years.
 
 
A-11

 
G.
 
Foreign currency translation
 
The functional currency for most of our Machinery and Engines consolidated companies is the U.S. dollar. The functional currency for most of our Financial Products and equity basis companies is the respective local currency. Gains and losses resulting from the translation of foreign currency amounts to the functional currency are included in "Other income (expense)" in Statement 1. Gains and losses resulting from translating assets and liabilities from the functional currency to U.S. dollars are included in "Accumulated other comprehensive income" in Statement 2.
 
H.
 
Derivative financial instruments
 
Our earnings and cash flow are subject to fluctuations due to changes in foreign currency exchange rates, interest rates and commodity prices.  In addition, the amount of Caterpillar stock that can be repurchased under our stock repurchase program is impacted by movements in the price of the stock.  Our Risk Management Policy (policy) allows for the use of derivative financial instruments to prudently manage foreign currency exchange rate, interest rate, commodity price and Caterpillar stock price exposures.  Our policy specifies that derivatives are not to be used for speculative purposes.  Derivatives that we use are primarily foreign currency forward and option contracts, interest rate swaps 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.
 
Payments for stock repurchase derivatives are accounted for as a reduction in stockholders’ equity. All other derivatives are recognized on the Consolidated Financial Position at their fair value. On the date the derivative contract is entered, we designate the derivative as (1) a hedge of the fair value of a recognized liability ("fair value" hedge), (2) a hedge of a forecasted transaction or the variability of cash flow to be paid ("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 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 other comprehensive income until earnings are affected by the forecasted transaction or the variability of cash flow and are then reported in current 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 designated as fair value hedges to specific liabilities on the Consolidated 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 derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flow of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, we discontinue hedge accounting prospectively, in accordance with Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities."  See Note 3 for more information.
 
I.
 
Impairment of available-for-sale securities
 
Available-for-sale securities are reviewed monthly to identify market values below cost of 20% or more. If a decline for a debt security is in excess of 20% for six months, the investment is evaluated to determine if the decline is due to general declines in the marketplace or if the investment has been impaired and should be written down to market value pursuant to Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities."  After the six-month period, debt securities with declines from cost in excess of 20% are evaluated monthly for impairment. For equity securities, if a decline from cost of 20% or more continues for a 12-month period, an other than temporary impairment is recognized without continued analysis.
 
J.
 
Income taxes
 
The provision for income taxes is determined using the asset and liability approach for accounting for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes."  Tax laws require items to be included in tax filings at different times than the items are reflected in the financial statements. A current liability is recognized for the estimated taxes payable for the current year. Deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. Deferred taxes are adjusted for enacted changes in tax rates and tax laws. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.
 
K.
 
Estimates in financial statements
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts. The more significant estimates include: residual values for leased assets, fair market values for goodwill impairment tests, warranty liability, stock-based compensation and reserves for product liability and insurance losses, postemployment benefits, post-sale discounts, credit losses and income taxes.
 
L.
 
New accounting standards
 
SFAS 155 – In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155 (SFAS 155), “Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140.”  SFAS 155 allows financial instruments that have embedded derivatives to be accounted for as a whole, eliminating the need to separate the derivative from its host, if the holder elects to account for the whole instrument on a fair value basis.  This new accounting standard was effective January 1, 2007.  The adoption of SFAS 155 did not have a material impact on our financial statements.
 
 
A-12

 
 
SFAS 156 – In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156 (SFAS 156), “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140.”  SFAS 156 requires that all separately recognized servicing rights be initially measured at fair value, if practicable.  In addition, this Statement permits an entity to choose between two measurement methods (amortization method or fair value measurement method) for each class of separately recognized servicing assets and liabilities.  This new accounting standard was effective January 1, 2007.  The adoption of SFAS 156 did not have a material impact on our financial statements.
 
FIN 48 – In July 2006, the FASB issued FIN 48  “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies that a tax position must be more likely than not of being sustained before being recognized in the financial statements. As required, we adopted the provisions of FIN 48 as of January 1, 2007.  The following table summarizes the effect of the initial adoption of FIN 48. See Note 5 for additional information.
 
   
 
Initial adoption of FIN 48
         
  (Millions of dollars)
January 1, 2007
Prior to FIN 48 Adjustment
 
FIN 48 Adjustment
 
January 1, 2007
Post FIN 48 Adjustment
 
Deferred and refundable income taxes
$
733
   
$
82
   
$
815
 
 
Noncurrent deferred and refundable income taxes
 
1,949
     
211
     
2,160
 
 
Other current liabilities
 
1,145
     
(530
)
   
615
 
 
Other liabilities
 
1,209
     
682
     
1,891
 
 
Profit employed in the business
 
14,593
     
141
     
14,734
 
                         
 
 
SFAS 157 – In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (SFAS 157), “Fair Value Measurements.” SFAS 157 provides a common definition of fair value and a framework for measuring assets and liabilities at fair values when a particular standard prescribes it. In addition, the Statement expands disclosures about fair value measurements. In February 2008, the FASB issued final Staff Positions that will (1) defer the effective date of this Statement for one year for certain nonfinancial assets and nonfinancial liabilities and (2) remove certain leasing transactions from the scope of the Statement.  We will apply this new accounting standard to all other fair value measurements effective January 1, 2008. We do not expect the adoption to have a material impact on our financial statements.
 
SFAS 158 – In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (SFAS 158), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106 and 132(R).”  SFAS 158 requires recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet.  Under SFAS 158, gains and losses, prior service costs and credits and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost are recognized in accumulated other comprehensive income (loss), net of tax effects, until they are amortized as a component of net periodic benefit cost. Also, the measurement date – the date at which the benefit obligation and plan assets are measured – is required to be the company’s fiscal year-end.
 
As required by SFAS 158, we adopted the balance sheet recognition provisions at December 31, 2006, and will adopt the year-end measurement date in 2008.  We do not expect the adoption of the year-end measurement date will have a material impact on our financial statements. SFAS 87 required the recognition of an additional minimum liability (AML) if the market value of plan assets was less than the accumulated benefit obligation at the end of the measurement date.  The AML was eliminated upon the adoption of SFAS 158.  The following summarizes the effect of the required changes in the AML, as well as the impact of the initial adoption of SFAS 158, as of December 31, 2006. See Note 14 for additional information regarding postemployment benefits.
 
   
 
Initial adoption of SFAS 158
 
(Millions of dollars)
December 31, 2006
 Prior to AML and SFAS 158 Adjustments
 
AML Adjustment
per SFAS 87
 
SFAS 158 Adjustment
 
December 31, 2006
Post AML and SFAS 158 Adjustments
 
Prepaid expenses and other current assets
$
2,467
   
$
   
$
(1,829
)
 
$
638
 
 
Investments in unconsolidated affiliated companies
 
568
     
     
(6
)
   
562
 
 
Deferred income taxes
 
552
     
(97
)
   
1,494
     
1,949
 
 
Intangible assets
 
639
     
(60
)
   
(192
)
   
387
 
 
Accrued wages, salaries and employee  benefits
 
1,440
     
     
(502
)
   
938
 
 
Liability for postemployment benefits
 
3,625
     
(386
)
   
2,640
     
5,879
 
 
Accumulated other comprehensive income
 
(405
)
   
229
     
(2,671
)
   
(2,847
)
                                 
 

 
SFAS 159 – In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 (SFAS 159), “The Fair Value Option for Financial Assets & Financial Liabilities – including an amendment of SFAS No. 115.” SFAS 159 will create a fair value option under which an entity may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities on a contract by contract basis, with changes in fair values recognized in earnings as these changes occur. SFAS 159 will become effective for fiscal years beginning after November 15, 2007. We will adopt this new accounting standard on January 1, 2008.  We do not expect the adoption to have a material impact on our financial statements.

 
SFAS 141R  & SFAS 160  – In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007) (SFAS 141R), “Business Combinations,” and No. 160 (SFAS 160), “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51”. SFAS 141R requires the acquiring entity in a business combination to recognize the assets acquired and liabilities assumed. Further, SFAS 141R also changes the accounting for acquired in-process research and development assets, contingent consideration, partial acquisitions and transaction costs.  Under SFAS 160, all entities are required to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements. In addition, transactions between an entity and noncontrolling interests will be treated as equity transactions. SFAS 141R and SFAS 160 will become effective for fiscal years beginning after December 15, 2008. We will adopt these new accounting standards on January 1, 2009.  We are currently reviewing the impact of SFAS 141R and SFAS 160 on our financial statements and expect to complete this evaluation in 2008.
 
A-13


 
M.
 
Goodwill
 
Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired.  We account for goodwill in accordance with Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets," which requires that we test goodwill for impairment annually and when events or circumstances indicate the fair value of a reporting unit may be below its carrying value.  We perform our annual goodwill impairment testing in September.  Goodwill is reviewed for impairment utilizing a two-step process.  The first step requires us to identify the reporting units and compare the fair value of each reporting unit, which we compute using a discounted cash flow analysis, to the respective carrying value, which includes goodwill.  If the carrying value is higher than the fair value, there is an indication that an impairment may exist.  In step two, the implied fair value of goodwill is calculated as the excess of the fair value of a reporting unit over the fair values assigned to its assets and liabilities.  If the implied fair value of goodwill is less than the carrying value of the reporting unit’s goodwill, the difference is recognized as an impairment loss.
 
N.
 
Stock-based compensation
 
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004) (SFAS 123R), “Share-Based Payment” using the modified prospective transition method. SFAS 123R requires all stock–based payments to be recognized in the financial statements based on the grant date fair value of the award.  Under the modified prospective transition method, we are required to record stock-based compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards outstanding as of the date of adoption. In accordance with the modified prospective transition method, our Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R.  See Note 2 for additional information regarding stock-based compensation.
 
 
Prior to the adoption of SFAS 123R, we used the intrinsic value method of accounting for stock-based employee compensation in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Under the intrinsic value method no compensation expense was recognized in association with our stock awards. The following table illustrates the effect on profit and profit per share if we had applied SFAS 123R for the 2005 grant using the lattice-based option-pricing model: 
 
   
   
Year ended December 31,
 
(Dollars in millions except per share data)
2005
 
Profit, as reported
$
2,854
 
 
Deduct:  Total stock-based compensation expense determined
under fair value based method for all awards, net of related tax effects
 
(135
)
 
Pro forma profit
$
2,719
 
         
 
Profit per share of common stock:
     
   
As reported: