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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-Q

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2010

 

OR

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                    to                   

 

Commission File Number:  1-768

 

CATERPILLAR INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(309) 675-1000

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yeso   No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

	Large accelerated filer		x		Accelerated filer		o
	Non-accelerated filer		o		Smaller reporting company		o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No  x

 

At June 30, 2010, 630,472,409 shares of common stock of the registrant were outstanding.

 

 

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Table of Contents

 

Part I. Financial Information
Item 1.		Financial Statements		3
Item 2.		Management’s Discussion and Analysis		43
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		81
Item 4.		Controls and Procedures		81
Part II. Other Information
Item 1.		Legal Proceedings		81
Item 1A.		Risk Factors		*
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		82
Item 3.		Defaults Upon Senior Securities		*
Item 4.		Removed and Reserved		*
Item 5.		Other Information		*
Item 6.		Exhibits		83

 

* Item omitted because no answer is called for or item is not applicable.

 

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Part I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

Caterpillar Inc.

Consolidated Statement of Results of Operations

(Unaudited)

(Dollars in millions except per share data)

 

		Three Months Ended June 30,
		2010		2009
Sales and revenues:
Sales of Machinery and Engines		$9,723		$7,254
Revenues of Financial Products		686		721
Total sales and revenues		10,409		7,975
Operating costs:
Cost of goods sold		7,372		5,752
Selling, general and administrative expenses		1,059		914
Research and development expenses		450		351
Interest expense of Financial Products		234		272
Other operating (income) expenses		317		339
Total operating costs		9,432		7,628
Operating profit (loss)		977		347
Interest expense excluding Financial Products		81		109
Other income (expense)		50		163
Consolidated profit (loss) before taxes		946		401
Provision (benefit) for income taxes		209		40
Profit (loss) of consolidated companies		737		361
Equity in profit (loss) of unconsolidated affiliated companies		(4)		(1)
Profit (loss) of consolidated and affiliated companies		733		360
Less: Profit (loss) attributable to noncontrolling interests		26		(11)
Profit (loss) 1		$707		$371
Profit (loss) per common share		$1.12		$0.61
Profit (loss) per common share — diluted 2		$1.09		$0.60
Weighted-average common shares outstanding (millions)
- Basic		629.8		611.8
- Diluted 2		647.0		619.8
Cash dividends declared per common share		$0.86		$0.84

 

1      Profit (loss) attributable to common stockholders.

2      Diluted by assumed exercise of stock-based compensation awards using the treasury stock method.

 

 

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Consolidated Statement of Results of Operations

(Unaudited)

(Dollars in millions except per share data)

 

		Six Months Ended June 30,
		2010		2009
Sales and revenues:
Sales of Machinery and Engines		$17,274		$15,764
Revenues of Financial Products		1,373		1,436
Total sales and revenues		18,647		17,200
Operating costs:
Cost of goods sold		13,266		12,779
Selling, general and administrative expenses		1,991		1,796
Research and development expenses		852		739
Interest expense of Financial Products		467		551
Other operating (income) expenses		586		1,163
Total operating costs		17,162		17,028
Operating profit (loss)		1,485		172
Interest expense excluding Financial Products		183		210
Other income (expense)		113		227
Consolidated profit (loss) before taxes		1,415		189
Provision (benefit) for income taxes		440		(40)
Profit (loss) of consolidated companies		975		229
Equity in profit (loss) of unconsolidated affiliated companies		(6)		—
Profit (loss) of consolidated and affiliated companies		969		229
Less: Profit (loss) attributable to noncontrolling interests		29		(30)
Profit (loss) 1		$940		$259
Profit (loss) per common share		$1.50		$0.43
Profit (loss) per common share — diluted 2		$1.46		$0.42
Weighted-average common shares outstanding (millions)
- Basic		628.1		607.6
- Diluted 2		645.2		614.0
Cash dividends declared per common share		$0.86		$0.84

 

1      Profit (loss) attributable to common stockholders.

2      Diluted by assumed exercise of stock-based compensation awards using the treasury stock method.

 

 

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Caterpillar Inc.

Consolidated Statement of Financial Position

(Unaudited)

(Dollars in millions)

 

		June 30, 2010		December 31, 2009
Assets
Current assets:
Cash and short-term investments		$3,597		$4,867
Receivables – trade and other		6,348		5,611
Receivables – finance		8,086		8,301
Deferred and refundable income taxes		1,041		1,216
Prepaid expenses and other current assets		965		862
Inventories		7,339		6,360
Total current assets		27,376		27,217
Property, plant and equipment – net		11,763		12,386
Long-term receivables – trade and other		1,150		971
Long-term receivables – finance		11,585		12,279
Investments in unconsolidated affiliated companies		154		105
Noncurrent deferred and refundable income taxes		2,464		2,714
Intangible assets		485		465
Goodwill		2,292		2,269
Other assets		1,524		1,632
Total assets		$58,793		$60,038
Liabilities
Current liabilities:
Short-term borrowings:
Machinery and Engines		$217		$433
Financial Products		3,430		3,650
Accounts payable		3,975		2,993
Accrued expenses		3,083		3,351
Accrued wages, salaries and employee benefits		1,182		797
Customer advances		1,404		1,217
Dividends payable		277		262
Other current liabilities		936		888
Long-term debt due within one year:
Machinery and Engines		434		302
Financial Products		4,846		5,399
Total current liabilities		19,784		19,292
Long-term debt due after one year:
Machinery and Engines		4,828		5,652
Financial Products		15,398		16,195
Liability for postemployment benefits		6,977		7,420
Other liabilities		2,102		2,179
Total liabilities		49,089		50,738
Commitments and contingencies (Notes 10 and 12)
Redeemable noncontrolling interest		432		477
Stockholders’ equity
Common stock of $1.00 par value:
Authorized shares: 900,000,000 Issued shares: (6/30/10 and 12/31/09 – 814,894,624) at paid-in amount		3,636		3,439
Treasury stock (6/30/10 – 184,422,215 shares; 12/31/09 – 190,171,905 shares) at cost		(10,539)		(10,646)
Profit employed in the business		20,133		19,711
Accumulated other comprehensive income (loss)		(4,045)		(3,764)
Noncontrolling interests		87		83
Total stockholders’ equity		9,272		8,823
Total liabilities, redeemable noncontrolling interest and stockholders’ equity		$58,793		$60,038

 

 

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Consolidated Statement of Changes in Stockholders’ Equity

(Unaudited)

(Dollars in millions)

		Common stock		Treasury stock		Profit employed in the business		Accumulated other comprehensive income (loss)		Noncontrolling interests		Total		Comprehensive income (loss)
Six Months Ended June 30, 2009
Balance at December 31, 2008		$3,057		$(11,217)		$19,826		$(5,579)		$103		$6,190
Profit (loss) of consolidated and affiliated companies		—		—		259		—		(30)		229		$229
Foreign currency translation, net of tax of $16		—		—		—		166		1		167		167
Pension and other postretirement benefits
Current year actuarial gain (loss), net of tax of $801		—		—		—		55		—		55		55
Amortization of actuarial (gain) loss, net of tax of $54		—		—		—		95		2		97		97
Current year prior service cost, net of tax of $1971		—		—		—		236		—		236		236
Amortization of prior service cost, net of tax of $1		—		—		—		2		—		2		2
Amortization of transition (asset) obligation, net of tax of $0		—		—		—		1		—		1		1
Derivative financial instruments
Gains (losses) deferred, net of tax of $57		—		—		—		92		—		92		92
(Gains) losses reclassified to earnings, net of tax of $12		—		—		—		(15)		—		(15)		(15)
Retained interests
Gains (losses) deferred, net of tax of $122		—		—		—		(22)		—		(22)		(22)
(Gains) losses reclassified to earnings, net of tax of $10		—		—		—		18		—		18		18
Available-for-sale securities
Gains (losses) deferred, net of tax of $14		—		—		—		26		—		26		26
(Gains) losses reclassified to earnings, net of tax of $10		—		—		—		19		—		19		19
Change in ownership for noncontrolling interest		—		—		—		—		(6)		(6)		—
Dividends declared		—		—		(513)		—		—		(513)		—
Common shares issued from treasury stock for stock-based compensation:  1,286,806		(6)		37		—		—		—		31		—
Common shares issued from treasury stock for benefit plans:  18,480,0953		224		435		—		—		—		659		—
Stock-based compensation expense		74		—		—		—		—		74		—
Excess tax benefits from stock-based compensation		(2)		—		—		—		—		(2)		—
Cat Japan share redemption4		—		—		7		—		30		37		—
Balance at June 30, 2009		$3,347		$(10,745)		$19,579		$(4,906)		$100		$7,375		$905
Six Months Ended June 30, 2010
Balance at December 31, 2009		$3,439		$(10,646)		$19,711		$(3,764)		$83		$8,823
Adjustment to adopt consolidation of variable interest entities5		—		—		(6)		3		—		(3)
Balance at January 1, 2010		$3,439		$(10,646)		$19,705		$(3,761)		$83		$8,820
Profit (loss) of consolidated and affiliated companies		—		—		940		—		29		969		$969
Foreign currency translation, net of tax of $153		—		—		—		(428)		(7)		(435)		(435)
Pension and other postretirement benefits
Amortization of actuarial (gain) loss, net of tax of $91		—		—		—		152		6		158		158
Amortization of prior service cost, net of tax of $6		—		—		—		(7)		—		(7)		(7)
Amortization of transition (asset) obligation, net of tax of $0		—		—		—		1		—		1		1
Derivative financial instruments
Gains (losses) deferred, net of tax of $29		—		—		—		(50)		—		(50)		(50)
(Gains) losses reclassified to earnings, net of tax of $19		—		—		—		33		—		33		33
Available-for-sale securities
Gains (losses) deferred, net of tax of $11		—		—		—		15		—		15		15
Change in ownership from noncontrolling interests		(17)		—		—		—		(12)		(29)		—
Dividends declared		—		—		(542)		—		—		(542)		—
Common shares issued from treasury stock for stock-based compensation:  4,716,874		(2)		86		—		—		—		84		—
Common shares issued from treasury stock for benefit plans:  1,032,8163		41		21		—		—		—		62		—
Stock-based compensation expense		138		—		—		—		—		138		—
Excess tax benefits from stock-based compensation		37		—		—		—		—		37		—
Cat Japan share redemption4		—		—		30		—		(12)		18		—
Balance at June 30, 2010		$3,636		$(10,539)		$20,133		$(4,045)		$87		$9,272		$684

 

1    Changes in amounts due to plan re-measurements. See Note 9 for additional information.

2    Includes noncredit component of other-than-temporary impairment losses on securitized retained interest of ($10) million, net of tax of $5 million, for the six months ended June 30, 2009. See Note 15 for additional information.

3    See Note 9 regarding shares issued for benefit plans.

4    See Note 16 regarding the Cat Japan share redemption.

5    See Note 15 for additional information.

 

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Consolidated Statement of Cash Flow

(Unaudited)

(Millions of dollars)

 

		Six Months Ended June 30,
		2010		2009
Cash flow from operating activities:
Profit (loss) of consolidated and affiliated companies		$969		$229
Adjustments for non-cash items:
Depreciation and amortization		1,116		1,072
Other		176		59
Changes in assets and liabilities:
Receivables – trade and other		(1,096)		3,133
Inventories		(1,020)		1,631
Accounts payable		1,151		(2,181)
Accrued expenses		(91)		(536)
Customer advances		171		(338)
Other assets – net		288		168
Other liabilities – net		79		(434)
Net cash provided by (used for) operating activities		1,743		2,803
Cash flow from investing activities:
Capital expenditures – excluding equipment leased to others		(484)		(443)
Expenditures for equipment leased to others		(372)		(441)
Proceeds from disposals of property, plant and equipment		755		454
Additions to finance receivables		(4,017)		(3,800)
Collections of finance receivables		4,161		5,119
Proceeds from sale of finance receivables		5		93
Investments and acquisitions (net of cash acquired)		(170)		—
Proceeds from sale of available-for-sale securities		90		170
Investments in available-for-sale securities		(81)		(251)
Other – net		6		(53)
Net cash provided by (used for) investing activities		(107)		848
Cash flow from financing activities:
Dividends paid		(527)		(505)
Common stock issued, including treasury shares reissued		84		31
Excess tax benefit from stock-based compensation		39		2
Acquisitions of noncontrolling interests		(26)		(6)
Proceeds from debt issued (original maturities greater than three months):
– Machinery and Engines		126		872
– Financial Products		4,125		8,157
Payments on debt (original maturities greater than three months):
– Machinery and Engines		(889)		(915)
– Financial Products		(5,582)		(6,655)
Short-term borrowings – net (original maturities three months or less)		(136)		(3,365)
Net cash provided by (used for) financing activities		(2,786)		(2,384)
Effect of exchange rate changes on cash		(120)		(12)
Increase (decrease) in cash and short-term investments		(1,270)		1,255
Cash and short-term investments at beginning of period		4,867		2,736
Cash and short-term investments at end of period		$3,597		$3,991

 

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:

During 2010 and 2009, we contributed 1.0 and 18.4 million shares of company stock with a fair value of $62 and $659 million to our U.S. benefit plans, respectively.

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.             A.  Basis of Presentation

 

In the opinion of management, the accompanying financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of (a) the consolidated results of operations for the three and six month periods ended June 30, 2010 and 2009, (b) the consolidated financial position at June 30, 2010 and December 31, 2009, (c) the consolidated changes in stockholders’ equity for the six month periods ended June 30, 2010 and 2009, and (d) the consolidated statement of cash flow for the six month periods ended June 30, 2010 and 2009.  The financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America (U.S. GAAP) and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).  Certain amounts for prior periods have been reclassified to conform to the current period financial statement presentation.

 

Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with the audited financial statements and notes thereto included in our Company’s annual report on Form 10-K for the year ended December 31, 2009 (2009 Form 10-K).

 

The December 31, 2009 financial position data included herein is derived from the audited consolidated financial statements included in the 2009 Form 10-K but does not include all disclosures required by U.S. GAAP.

 

B.  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, underground mining equipment, tunnel boring equipment 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, 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 10 to 21,800 horsepower (8 to over 16 000 kilowatts).  Turbines range from 1,600 to 30,000 horsepower (1 200 to 22 000 kilowatts).

 

(3)           Financial Products - A principal line of business consisting primarily of Caterpillar Financial Services Corporation (Cat Financial), Caterpillar Insurance Holdings, Inc. (Cat Insurance) 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.

 

Our Machinery and Engines operations are highly integrated.  Throughout the Notes, Machinery and Engines represents the aggregate total of these principal lines of business.

 

C.  Accumulated Other Comprehensive Income (Loss)

 

Comprehensive income (loss) and its components are presented in Consolidated Statement of Changes in Stockholders’ Equity.   Accumulated other comprehensive income (loss), net of tax, consisted of the following:

 

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(Millions of dollars)		June 30, 2010		June 30, 2009
Foreign currency translation		$175		$427
Pension and other postretirement benefits		(4,293)		(5,460)
Derivative financial instruments		43		172
Retained interests		—		(11)
Available-for-sale securities		30		(34)
Total accumulated other comprehensive income (loss)		$(4,045)		$(4,906)

 

2.             New Accounting Guidance

 

Fair value measurements - In September 2006, the Financial Accounting Standards Board (FASB) issued accounting guidance on fair value measurements, which 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, this guidance expands disclosures about fair value measurements. In February 2008, the FASB issued additional guidance that (1) deferred the effective date of the original guidance for one year for certain nonfinancial assets and nonfinancial liabilities and (2) removed certain leasing transactions from the scope of the original guidance.  We applied this guidance to financial assets and liabilities effective January 1, 2008 and nonfinancial assets and liabilities effective January 1, 2009. The adoption of this guidance did not have a material impact on our financial statements.  See Note 17 for additional information.

 

In January 2010, the FASB issued new accounting guidance that requires the gross presentation of activity within the Level 3 fair value measurement roll forward and details of transfers in and out of Level 1 and 2 fair value measurements.  It also clarifies existing disclosure requirements regarding the level of disaggregation of fair value measurements and disclosures on inputs.  We adopted this new accounting guidance for the quarterly period ended March 31, 2010.  The adoption of this guidance did not have a material impact on our financial statements.  See Note 17 for additional information.

 

Business combinations and noncontrolling interests in consolidated financial statements - In December 2007, the FASB issued accounting guidance on business combinations and noncontrolling interests in consolidated financial statements.  The guidance on business combinations requires the acquiring entity in a business combination to recognize the assets acquired and liabilities assumed. Further, it changes the accounting for acquired in-process research and development assets, contingent consideration, partial acquisitions and transaction costs.  Under the guidance on noncontrolling interests, 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 are treated as equity transactions.  We adopted this new guidance on January 1, 2009.  As required, the guidance on noncontrolling interests was adopted through retrospective application.  The adoption of this guidance did not have a material impact on our financial statements.  See Note 19 for further details.

 

Disclosures about derivative instruments and hedging activities - In March 2008, the FASB issued accounting guidance on disclosures about derivative instruments and hedging activities.  This guidance expands disclosures for derivative instruments by requiring entities to disclose the fair value of derivative instruments and their gains or losses in tabular format.  It also requires disclosure of information about credit risk-related contingent features in derivative agreements, counterparty credit risk, and strategies and objectives for using derivative instruments.  We adopted this new guidance on January 1, 2009.  The adoption of this guidance did not have a material impact on our financial statements.  See Note 4 for additional information.

 

Employers’ disclosures about postretirement benefit plan assets - In December 2008, the FASB issued accounting guidance on employers’ disclosures about postretirement benefit plan assets. This guidance expands the disclosure set forth in previous guidance by adding required disclosures about (1) how investment allocation decisions are made by management, (2) major categories of plan assets, and (3) significant concentration of risk. Additionally, this guidance requires an employer to disclose information about the valuation of plan assets similar to that required under the accounting guidance on fair value measurements.  We adopted this guidance for our financial statements for the annual period ended December 31, 2009.  The adoption of this guidance did not have a material impact on our financial statements.

 

Recognition and presentation of other-than-temporary impairments - In April 2009, the FASB issued accounting guidance on the recognition and presentation of other-than-temporary impairments.  This new guidance amends the existing impairment guidance relating to certain debt securities and requires a company to assess the likelihood of selling the security prior to recovering its cost basis.  When a security meets the criteria for impairment, the impairment charges related to credit losses would be recognized in earnings, while noncredit losses would be reflected in other comprehensive income. Additionally, it requires a more detailed, risk-oriented breakdown of major security types and related information.

 

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We adopted this guidance on April 1, 2009.  The adoption of this guidance did not have a material impact on our financial statements.  See Note 8 for additional information.

 

Subsequent events - In May 2009, the FASB issued accounting guidance on subsequent events that establishes standards of accounting for and disclosure of subsequent events.  In addition, it requires disclosure of the date through which an entity has evaluated subsequent events and the basis for that date.  This new guidance was adopted for our financial statements for the quarterly period ended June 30, 2009.  The adoption of this guidance did not have a material impact on our financial statements.

 

In February 2010, the FASB issued new accounting guidance that amends the May 2009 subsequent events guidance described above to (1) eliminate the requirement for an SEC filer to disclose the date through which it has evaluated subsequent events, (2) clarify the period through which conduit bond obligors must evaluate subsequent events, and (3) refine the scope of the disclosure requirements for reissued financial statements.  We adopted this new accounting guidance for our financial statements for the quarterly period ended March 31, 2010.  The adoption of this guidance did not have a material impact on our financial statements.

 

Accounting for transfers of financial assets - In June 2009, the FASB issued accounting guidance on accounting for transfers of financial assets.  This guidance amends previous guidance and includes: the elimination of the qualifying special-purpose entity (QSPE) concept; a new participating interest definition that must be met for transfers of portions of financial assets to be eligible for sale accounting; clarifications and changes to the derecognition criteria for a transfer to be accounted for as a sale; and a change to the amount of recognized gain or loss on a transfer of financial assets accounted for as a sale when beneficial interests are received by the transferor.  Additionally, the guidance requires extensive new disclosures regarding an entity’s involvement in a transfer of financial assets.  Finally, existing QSPEs (prior to the effective date of this guidance) must be evaluated for consolidation by reporting entities in accordance with the applicable consolidation guidance upon the elimination of this concept.  We adopted this new guidance on January 1, 2010.  The adoption of this guidance did not have a material impact on our financial statements.  See Note 15 for additional information.

 

Consolidation of variable interest entities - In June 2009, the FASB issued accounting guidance on the consolidation of variable interest entities (VIEs). This new guidance revises previous guidance by eliminating the exemption for QSPEs, by establishing a new approach for determining who should consolidate a VIE and by changing when it is necessary to reassess who should consolidate a VIE.  We adopted this new guidance on January 1, 2010.  The adoption of this guidance resulted in the consolidation of QSPEs related to Cat Financial’s asset-backed securitization program that were previously not recorded on our consolidated financial statements.  The adoption of this guidance did not have a material impact on our financial statements.  See Note 15 for additional information.

 

3.             Stock-Based Compensation

 

Accounting for stock-based compensation requires that the cost resulting from all stock-based payments be recognized in the financial statements based on the grant date fair value of the award.  Stock-based compensation primarily consists of stock-settled stock appreciation rights (SARs), restricted stock units (RSUs) and stock options.  We recognized pretax stock-based compensation cost in the amount of $97 million and $138 million for the three and six months ended June 30, 2010, respectively; and $41 million and $74 million for the three and six months ended June 30, 2009, respectively.  Included in the second quarter of 2010 pretax stock-based compensation cost was $17 million relating to the modification of awards resulting from separations due to the streamlining of our corporate structure as announced in the second quarter.

 

The following table illustrates the type and fair value of the stock-based compensation awards granted during the six month periods ended June 30, 2010 and 2009, respectively:

 

		2010				2009
		# Granted		Fair Value Per Award		# Granted		Fair Value Per Award
SARs		7,125,210		$22.31		6,260,647		$7.10
RSUs		1,711,771		53.35		2,185,674		20.22
Stock options		431,271		22.31		562,580		7.10

 

The stock price on the date of grant was $57.85 and $22.17 for 2010 and 2009, respectively.

 

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The following table provides the assumptions used in determining the fair value of the stock-based awards for the six month periods ended June 30, 2010 and 2009, respectively:

 

		Grant Year
		2010		2009
Weighted-average dividend yield		2.32%		3.07%
Weighted-average volatility		36.4%		36.0%
Range of volatilities		35.2-51.8%		35.8-61.0%
Range of risk-free interest rates		0.32-3.61%		0.17-2.99%
Weighted-average expected lives		7 years		8 years

 

As of June 30, 2010, the total remaining unrecognized compensation cost related to nonvested stock-based compensation awards was $224 million, which will be amortized over the weighted-average remaining requisite service periods of approximately 2.3 years.

 

4.             Derivative Financial Instruments and Risk Management

 

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, commodity forward and option contracts, and stock repurchase 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.

 

All derivatives are recognized on the Consolidated Statement of 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 asset or 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 asset or 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 Accumulated other comprehensive income (loss) (AOCI) on the Consolidated Statement of Financial Position until they are reclassified to earnings in the same period or periods during which the hedged transaction affects earnings.  Changes in the fair value of undesignated derivative instruments and the ineffective portion of designated derivative instruments are reported in current earnings. Cash flow from designated derivative financial instruments are classified within the same category as the item being hedged on the Consolidated Statement of Cash Flow.  Cash flow 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 assets and liabilities on the Consolidated Statement of 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 designated derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flow of hedged items.  When a derivative is determined not to be highly effective as a hedge or the underlying hedged transaction is no longer probable, we discontinue hedge accounting prospectively, in accordance with the derecognition criteria for hedge accounting.

 

Foreign Currency Exchange Rate Risk

 

Foreign currency exchange rate movements create a degree of risk by affecting the U.S. dollar value of sales made and costs incurred in foreign currencies. Movements in foreign currency rates also affect our competitive position as these changes may affect business practices and/or pricing strategies of non-U.S.-based competitors. Additionally, we have balance sheet positions denominated in foreign currencies, thereby creating exposure to movements in exchange rates.

 

Our Machinery and Engines operations purchase, manufacture and sell products in many locations around the world. As we have a diversified revenue and cost base, we manage our future foreign currency cash flow exposure on a net basis. We use

 

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foreign currency forward and option contracts to manage unmatched foreign currency cash inflow and outflow. Our objective is to minimize the risk of exchange rate movements that would reduce the U.S. dollar value of our foreign currency cash flow. Our policy allows for managing anticipated foreign currency cash flow for up to five years.

 

We generally designate as cash flow hedges at inception of the contract any Australian dollar, Brazilian real, British pound, Canadian dollar, Chinese yuan, euro, Japanese yen, Mexican peso, Singapore dollar or Swiss franc forward or option contracts that meet the requirements for hedge accounting and the maturity extends beyond the current quarter-end. Designation is performed on a specific exposure basis to support hedge accounting. The remainder of Machinery and Engines foreign currency contracts are undesignated, including any hedges designed to protect our competitive exposure.  Periodically we also designate as fair value hedges specific euro forward contracts used to hedge firm commitments.

 

As of June 30, 2010, $27 million of deferred net gains, net of tax, included in equity (Accumulated other comprehensive income (loss) in the Consolidated Statement of Financial Position), are expected to be reclassified to current earnings (Other income (expense) in the Consolidated Statement of Results of Operations) over the next twelve months when earnings are affected by the hedged transactions.  The actual amount recorded in Other income (expense) will vary based on exchange rates at the time the hedged transactions impact earnings.

 

In managing foreign currency risk for our Financial Products operations, our objective is to minimize earnings volatility resulting from conversion and the remeasurement of net foreign currency balance sheet positions. Our policy allows the use of foreign currency forward and option contracts to offset the risk of currency mismatch between our receivables and debt. All such foreign currency forward and option contracts are undesignated.

 

Interest Rate Risk

 

Interest rate movements create a degree of risk by affecting the amount of our interest payments and the value of our fixed-rate debt. Our practice is to use interest rate derivatives to manage our exposure to interest rate changes and, in some cases, lower the cost of borrowed funds.

 

Machinery and Engines operations generally use fixed-rate debt as a source of funding.  Our objective is to minimize the cost of borrowed funds.  Our policy allows us to enter into fixed-to-floating interest rate swaps and forward rate agreements to meet that objective with the intent to designate as fair value hedges at inception of the contract all fixed-to-floating interest rate swaps.  Designation as a hedge of the fair value of our fixed-rate debt is performed to support hedge accounting.

 

Financial Products operations have a match-funding policy that addresses interest rate risk by aligning the interest rate profile (fixed or floating rate) of Cat Financial’s debt portfolio with the interest rate profile of their receivables portfolio within predetermined ranges on an ongoing basis. In connection with that policy, we use interest rate derivative instruments to modify the debt structure to match assets within the receivables portfolio. This matched funding reduces the volatility of margins between interest-bearing assets and interest-bearing liabilities, regardless of which direction interest rates move.

 

Our policy allows us to use fixed-to-floating, floating-to-fixed, and floating-to-floating interest rate swaps to meet the match-funding objective.  We designate fixed-to-floating interest rate swaps as fair value hedges to protect debt against changes in fair value due to changes in the benchmark interest rate.  We designate most floating-to-fixed interest rate swaps as cash flow hedges to protect against the variability of cash flows due to changes in the benchmark interest rate.

 

As of June 30, 2010, $20 million of deferred net losses, net of tax, included in equity (Accumulated other comprehensive income (loss) in the Consolidated Statement of Financial Position), related to Financial Products floating-to-fixed interest rate swaps, are expected to be reclassified to current earnings (Interest expense of Financial Products in the Consolidated Statement of Results of Operations) over the next twelve months.  The actual amount recorded in Interest expense of Financial Products will vary based on interest rates at the time the hedged transactions impact earnings.

 

We have, at certain times, liquidated fixed-to-floating and floating-to-fixed interest rate swaps at both Machinery and Engines and Financial Products.  The gains or losses associated with these swaps at the time of liquidation are amortized into earnings over the original term of the underlying hedged item.

 

Commodity Price Risk

 

Commodity price movements create a degree of risk by affecting the price we must pay for certain raw material. Our policy is to use commodity forward and option contracts to manage the commodity risk and reduce the cost of purchased materials.

 

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Our Machinery and Engines operations purchase aluminum, copper, lead, nickel and rolled coil steel embedded in the components we purchase from suppliers.  Our suppliers pass on to us price changes in the commodity portion of the component cost. In addition, we are also subject to price changes on natural gas and diesel fuel purchased for operational use.

 

Our objective is to minimize volatility in the price of these commodities. Our policy allows us to enter into commodity forward and option contracts to lock in the purchase price of a portion of these commodities within a five-year horizon. All such commodity forward and option contracts are undesignated.

 

The location and fair value of derivative instruments reported in the Consolidated Statement of Financial Position are as follows:

 

(Millions of dollars)
				Asset (Liability) Fair Value
		Statement of Financial Position Location		June 30, 2010		December 31, 2009
Designated derivatives
Foreign exchange contracts
Machinery and Engines		Receivables – trade and other		$50		$27
Machinery and Engines		Long-term receivables – trade and other		38		125
Machinery and Engines		Accrued expenses		(13)		(22)
Machinery and Engines		Other liabilities		—		(3)
Interest rate contracts
Machinery and Engines		Receivables – trade and other		1		1
Machinery and Engines		Accrued expenses		(1)		(1)
Financial Products		Receivables – trade and other		24		18
Financial Products		Long-term receivables – trade and other		218		127
Financial Products		Accrued expenses		(35)		(100)
				$282		$172
Undesignated derivatives
Foreign exchange contracts
Machinery and Engines		Receivables – trade and other		$7		$—
Machinery and Engines		Long-term receivables – trade and other		58		66
Machinery and Engines		Accrued expenses		—		—
Machinery and Engines		Other liabilities		(1)		(3)
Financial Products		Receivables – trade and other		9		20
Financial Products		Accrued expenses		(5)		(18)
Interest rate contracts
Machinery and Engines		Accrued expenses		—		(7)
Financial Products		Receivables – trade and other		—		1
Financial Products		Long-term receivables – trade and other		—		1
Financial Products		Accrued expenses		(2)		(6)
Commodity contracts
Machinery and Engines		Receivables – trade and other		3		10
				$69		$64

 

The effect of derivatives designated as hedging instruments on the Consolidated Statement of Results of Operations is as follows:

 

Fair Value Hedges
(Millions of dollars)
				Three Months Ended June 30, 2010				Six Months Ended June 30, 2010
		Classification		Gains (Losses) on Derivatives		Gains (Losses) on Borrowings		Gains (Losses) on Derivatives		Gains (Losses) on Borrowings
Interest rate contracts
Machinery and Engines		Other income (expense)		$(1)		$1		$—		$—
Financial Products		Other income (expense)		88		(83)		141		(134)
				$87		$(82)		$141		$(134)

 

				Three Months Ended June 30, 2009				Six Months Ended June 30, 2009
		Classification		Gains (Losses) on Derivatives		Gains (Losses) on Borrowings		Gains (Losses) on Derivatives		Gains (Losses) on Borrowings
Interest rate contracts
Financial Products		Other income (expense)		$(160)		$155		$(220)		$234
				$(160)		$155		$(220)		$234

 

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