Summary
CAT’s 10-K is a beast to review. Below, we highlight changes and unexpected items, as well as new or broader disclosure on items relevant to earnings. We may yet have more on the filing and still have some questions, but this is our first pass and we have already had a couple of rounds with the company. It seems to us that several reserves/allowances moved to boost earnings – one time even when appropriate (benefit of ~$160 mil for loan loss and warranty). The risk language also moved to better match our view of mining equipment, as it now mentions “industry overcapacity”. Given DRC’s 2014 guide down yesterday*, we may yet see that kind of language applied to Power Systems in the 2014 10-K, a segment where order backlog declined last year.
Highlights
- 2011 & 2012 Revisions: We have read in the 2013 10-Qs that Cash from Operating Activities was revised because of interest payments on Cat Financials bank borrowings being moved from the Financing section ($57 and $53 mil in 2012 and 2011, respectively). However, we got additional revisions in the 10-K:
“We have also revised previously reported balances on Statement 3 as of December 31, 2012 and 2011 to correct for customer advances invoiced but not yet paid. Receivables - trade and other decreased from the amounts previously reported by $386 million and $228 million as of December 31, 2012 and 2011, respectively. Customer advances decreased from the amounts previously reported by $340 million and $204 million as of December 31, 2012 and 2011, respectively. Other (long-term) liabilities also decreased from the amounts previously reported by $46 million and $24 million as of December 31, 2012 and 2011, respectively. Although the revision did not impact Net cash provided by (used for) operating activities on Statement 5, we have revised the impacted operating cash flow line items for the years ended December 31, 2012 and 2011.”
While not overwhelming in magnitude, it continues a trend of revisions and incorrect reporting that can attract unwanted scrutiny and suggest a lack of reporting diligence. Both interest payments and cash from customer advances seem reasonably straightforward to categorize, at least to us.
- New Risk Sounds Familiar: In discussing the risks to CAT’s sales outlook, the following text is inserted “or a weak pricing environment attributable to industry overcapacity.” That addition is consistent with our Resource Industries outlook. (See CAT & The Mining Investment Bubble from July 2012 or subsequent Black Books)
- ASR Timing: While not new, the accelerated stock repurchase is “expected to be completed in March 2014,” which coincides well with the CAT Analyst Day March 4th at ConExpo. Buying $1.7 billion (~3 days volume) in such a short time period seems like a good idea for the presenting management team, but maybe not for long-term investors.
- Warranty Liability Down: CAT’s warranty liability dropped by $110 million, while warranty payments in 2013 increased slightly. The drop may be due to the decline in new warranties vs. previous years because of reduced equipment sales. Nonetheless, it is a nonrecurring earnings benefit, all else equal.
- Loan Loss Reserve Down: While we already covered this one in a historical context here, it’s worth noting that write-offs, TDRs, and total loans and leases increased in 2013. That seems hard to reconcile with a cut in allowance for credit losses to multi-year % of assets low. Even if it is appropriate, it is a non-recurring earnings boost, all else equal. “The allowance for credit losses as of December 31, 2013 was $375 million compared with $423 million as of December 31, 2012. The overall decrease of $48 million in the allowance for credit losses during the year reflects a $55 million decrease associated with the lower allowance rate, partially offset by a $7 million increase due to an increase in Cat Financial's net finance receivables portfolio.”
- Unfriendly IRS?: Perhaps CAT did annoy the Obama administration. The company apparently does not like the preliminary results of its recent IRS field examination: “While we have not yet received a Revenue Agent's Report generally issued at the end of the field examination process, we have received Notices of Proposed Adjustment from the IRS relating to U.S. taxation of certain non-U.S. operations and foreign tax credits. We disagree with these proposed adjustments, and to the extent that adjustments are assessed upon completion of the field examination relating to these matters, we would vigorously contest the adjustments in appeals.”
- No Goodwill Impairment: While the Bucyrus goodwill was not impaired, there is an added disclosure that is a little odd “In addition, only a portion of goodwill for certain acquisitions made in 2011 or later has been allocated to segments.” Not sure on that one, but it will be interesting to see if the BUCY goodwill makes it through 2014.
- Restructuring Can Be Painful: CAT intends to finally do some restructuring this year, but this language begs the question of why one would hold the shares through the whole entire process. CAT restructured during most of the 1980s and it was ugly for shareholders for nearly half a decade. Here is the risk discussion “…we may incur additional charges, including but not limited to asset impairments, employee termination costs, charges for pension and other postretirement contractual benefits, potential additional pension funding obligations, and pension curtailments, any of which could be significant, and could adversely affect our financial condition and results of operations. In addition, we may not realize anticipated savings or benefits from past or future cost reduction actions in full or in part or within the time periods we expect. We are also subject to the risks of labor unrest, negative publicity and business disruption in connection with our cost reduction actions. Failure to realize anticipated savings or benefits from our cost reduction actions could have a material adverse effect on our business, prospects, financial condition, liquidity, results of operations and cash flows.”
- Last Year’s Cost Performance: While not exactly new, this disclosure fails to fill us with optimism on restructuring, since the LIFO liquidation looks like such a significant driver. “Manufacturing costs decreased $167 million. The decrease was primarily due to lower material costs and $115 million ($0.12 per share) of LIFO inventory decrement benefits, partially offset by unfavorable changes in cost absorption resulting from a decrease in inventory during 2013 and an increase in inventory during 2012.”
*This is worth a look just to see a company’s guide-down actually buried in pig manure discussion http://investor.dresser-rand.com/releasedetail.cfm?ReleaseID=826086
