Company Quick10K Filing
Quick10K
Caterpillar Financial Services
10-K 2018-12-31 Annual: 2018-12-31
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
10-Q 2015-09-30 Quarter: 2015-09-30
10-Q 2015-06-30 Quarter: 2015-06-30
10-Q 2015-03-31 Quarter: 2015-03-31
10-K 2014-12-31 Annual: 2014-12-31
10-Q 2014-06-30 Quarter: 2014-06-30
10-Q 2014-03-31 Quarter: 2014-03-31
10-Q 2013-12-31 Quarter: 2013-12-31
10-K 2013-12-31 Annual: 2013-12-31
8-K 2019-03-08 Exhibits
8-K 2019-02-26 Exhibits
8-K 2019-01-28 Earnings, Exhibits
8-K 2019-01-28 Earnings, Exhibits
8-K 2018-12-07 Exhibits
8-K 2018-10-23
8-K 2018-09-07 Exhibits
8-K 2018-09-06 Enter Agreement, Off-BS Arrangement, Exhibits
8-K 2018-08-30 Exhibits
8-K 2018-07-30
8-K 2018-05-16 Exhibits
8-K 2018-04-24
8-K 2018-03-15 Other Events, Exhibits
8-K 2018-01-25
BXP Boston Properties 20,750
LTXB LegacyTexas Financial 1,960
CLS Celestica 1,020
IIIN Insteel Industries 431
KDMN Kadmon Holdings 320
VVUS Vivus 36
HMG HMG Courtland Properties 14
EHIC EHI Car Services 0
CCAA Cala 0
OSMU Original Source Music 0
CFSC 2018-12-31
Part I
Item 1. Business.
Item 1A. Risk Factors.
Item 1B. Unresolved Staff Comments.
Item 2. Properties.
Item 3. Legal Proceedings.
Item 4. Mine Safety Disclosures.
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Item 8. Financial Statements and Supplementary Data.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Item 9A. Controls and Procedures.
Item 9B. Other Information.
Part III
Item 14. Principal Accounting Fees and Services.
Part IV
Item 15. Exhibits and Financial Statement Schedules.
Item 16. Form 10-K Summary
Note 1 - Summary of Significant Accounting Policies
Note 2 - Finance Receivables
Note 3 - Equipment on Operating Leases
Note 4 - Other Assets
Note 5 - Concentration of Credit Risk
Note 6 - Credit Commitments
Note 7 - Short-Term Borrowings
Note 8 - Long-Term Debt
Note 9 - Derivative Financial Instruments and Risk Management
Note 10 - Accumulated Other Comprehensive Income/(Loss)
Note 11 - Commitments and Contingent Liabilities
Note 12 - Income Taxes
Note 13 - Fair Value Measurements
Note 14 - Transactions with Related Parties
Note 15 - Leases
Note 16 - Segment and Geographic Information
Note 17 - Selected Quarterly Financial Data (Unaudited)
EX-23 cfsc-12312018x10kxex23.htm
EX-31.1 cfsc-12312018x10kxex311.htm
EX-31.2 cfsc-12312018x10kxex312.htm
EX-32 cfsc-12312018x10kxex32.htm

Caterpillar Financial Services Earnings 2018-12-31

CFSC 10K Annual Report

Balance SheetIncome StatementCash Flow

10-K 1 cfsc-12312018x10k.htm CFSC FORM 10-K DECEMBER 31, 2018 Document




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
catfincolor3a11.jpg
FORM 10-K
 
(Mark One)
 
 
 
[X]
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
 
 
 
 
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 No. 001-11241 
CATERPILLAR FINANCIAL SERVICES CORPORATION
(Exact name of Registrant as specified in its charter)
 
Delaware
(State or other jurisdiction of incorporation
or organization)
 
37-1105865
(I.R.S. Employer Identification No.)
 
 
2120 West End Ave.,
Nashville, Tennessee
(Address of principal executive offices)
 
37203-0001
(Zip Code)
 
Registrant's telephone number, including area code:  (615) 341-1000

The Registrant is a wholly-owned subsidiary of Caterpillar Inc. and meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K, and is therefore filing this Form with the reduced disclosure format.





 
Securities registered pursuant to Section 12(b) of the Act:
 
 
Title of each class
 
 
Name of each exchange
  on which registered 
 
Medium-Term Notes, Series H,
3.300% Notes Due 2024
 
New York Stock Exchange
 
 
Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    
Yes [ü]   No [    ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [    ]   No [ü]

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 [ü]   No [    ]

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).   
Yes [ü]   No [   ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ü]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer [    ]     Accelerated filer [    ]     Non-accelerated filer [ü
Smaller reporting company [    ] Emerging Growth Company [    ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [    ]

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

As of February 14, 2019, one share of common stock of the registrant was outstanding, which is owned by Caterpillar Inc.



2




TABLE OF CONTENTS
 
 
 
Page
Business
4
 
Risk Factors
6
 
Unresolved Staff Comments
11
 
Properties
12
 
Legal Proceedings
12
 
Mine Safety Disclosures
12
Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
12
 
Management's Discussion and Analysis of Financial
Condition and Results of Operations
13
 
Quantitative and Qualitative Disclosures About Market Risk
28
 
Financial Statements and Supplementary Data
29
 
Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
29
 
Controls and Procedures
29
 
Other Information
29
Principal Accounting Fees and Services
30
Exhibits and Financial Statement Schedules
30
 
Item 16.
Form 10-K Summary
32

3



PART I
 
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
 
Certain statements contained in this Annual Report on Form 10-K may be considered "forward-looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995.  These statements may relate to future events or our future financial performance, which may involve known and unknown risks and uncertainties and other factors that may cause our actual results, levels of activity, performance or achievement to be materially different from those expressed or implied by any forward-looking statements.  From time to time, we may also provide forward-looking statements in oral presentations to the public or in other materials we issue to the public.  Forward-looking statements give current expectations or forecasts of future events about the company.  You may identify these statements by the fact that they do not relate to historical or current facts and may use words such as "believes," "expects," "estimates," "anticipates," "will," "should," "plan," "forecast," "target," "guide," "project," "intend," "could" and similar words or phrases.  These statements are only predictions.  Actual events or results may differ materially due to factors that affect international businesses, including changes in economic conditions, disruptions in the global financial and credit markets, and changes in laws, regulations and political stability, as well as factors specific to Cat Financial and the markets we serve, including the market’s acceptance of our products and services, the creditworthiness of our customers, interest rate and currency rate fluctuations and estimated residual values of leased equipment.  These risk factors may not be exhaustive.  We operate in a continually changing business environment, and new risk factors emerge from time to time.  We cannot predict these new risk factors, nor can we assess the impact, if any, of these new risk factors on our businesses or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those projected in any forward-looking statements.  Accordingly, forward-looking statements should not be relied upon as a prediction of actual results.  All of the forward-looking statements are qualified in their entirety by reference to the factors discussed under the captions "Risk Factors" and "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-K and could cause results to differ materially from those projected in the forward-looking statements.  Cat Financial undertakes no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You may, however, consult any related disclosures we may make in our subsequent Form 10-Q and Form 8-K reports filed with the Securities and Exchange Commission ("SEC").
 
Item 1. 
Business.
 
General

Caterpillar Financial Services Corporation was organized in 1981 in the State of Delaware (together with its subsidiaries, "Cat Financial," "the Company," "we" or "our").  We are a wholly-owned finance subsidiary of Caterpillar Inc. (together with its other subsidiaries, "Caterpillar" or "Cat") and our corporate headquarters is located in Nashville, Tennessee.
 
Nature of Operations

Our primary business is to provide retail and wholesale financing alternatives for Caterpillar products to customers and dealers around the world.  Retail financing is primarily comprised of financing of Caterpillar equipment, machinery and engines.  We also provide financing for vehicles, power generation facilities and marine vessels that, in most cases, incorporate Caterpillar products.  In addition to retail financing, we also provide wholesale financing to Caterpillar dealers and purchase short-term trade receivables from Caterpillar.  The various financing plans offered by Cat Financial are primarily designed to increase the opportunity for sales of Caterpillar products and generate financing income for Cat Financial.  A significant portion of our activity is conducted in North America with additional offices and subsidiaries in Latin America, Asia/Pacific, Europe, Africa and Middle East.  Cat Financial has more than 35 years of experience providing financing for Caterpillar products, contributing to our knowledge of asset values, industry trends, financing structures and customer needs.

The Company’s retail loans (totaling 49 percent*) include:
     
Loans that allow customers and dealers to use their Caterpillar equipment or other assets as collateral to obtain financing (26 percent*).
Installment sale contracts, which are equipment loans that enable customers to purchase equipment with a down payment or trade-in and structure payments over time (23 percent*).

4




The Company’s retail leases (totaling 34 percent*) include:
 
Finance (non-tax) leases, where the lessee for tax purposes is considered to be the owner of the equipment during the term of the lease, that either require or allow the customer to purchase the equipment for a fixed price at the end of the term (21 percent*).
Tax leases that are classified as either operating or finance leases for financial accounting purposes, depending on the characteristics of the lease.  For tax purposes, we are considered the owner of the equipment (12 percent*).
Governmental lease-purchase plans in the U.S. that offer low interest rates and flexible terms to qualified non-federal government agencies (1 percent*).

The Company purchases short-term trade receivables from Caterpillar at a discount (15 percent*).

The Company’s wholesale loans and leases (2 percent*) include inventory/rental programs, which provide assistance to dealers by financing their new Caterpillar inventory and rental fleets.

*Indicates the percentage of total portfolio as of December 31, 2018.  We define total portfolio as finance receivables, net plus equipment on operating leases, less accumulated depreciation.  
 
Competitive Environment
 
We operate in a highly competitive environment, with financing for users of Caterpillar equipment available through a variety of sources, principally commercial banks and finance and leasing companies.  Our competitors include Wells Fargo Equipment Finance and various other banks and finance companies.  In addition, many of the manufacturers that compete with Caterpillar also own financial subsidiaries, such as John Deere Capital Corporation, Komatsu Financial L.P. and Volvo Financial Services, which, in some instances, utilize below-market interest rate programs (funded by the manufacturer) to support machine sales.  We and Caterpillar work together to provide a broad array of financial merchandising programs to compete around the world.
 
We provide financing only when certain criteria are met.  Credit decisions are based on a variety of credit quality factors, including prior payment experience, customer financial information, credit-rating agency ratings, loan-to-value ratios and other internal metrics. We typically maintain a security interest in retail-financed equipment and require physical damage insurance coverage on financed equipment.  We finance a significant portion of Caterpillar dealers' sales and inventory of Caterpillar equipment throughout the world (see Note 16 of Notes to Consolidated Financial Statements for more information regarding our segments and geographic areas).  Our competitive position is improved by marketing programs offered in conjunction with Caterpillar and/or Caterpillar dealers.  Under these programs, Caterpillar, or the dealer, funds an amount at the outset of the transaction, which we then recognize as revenue over the term of the financing.

In certain instances, our operations are subject to supervision and regulation by state, federal and various foreign governmental authorities and may be subject to various laws and judicial and administrative decisions imposing various requirements and restrictions which, among other things, (i) regulate credit granting activities and the administration of loans, (ii) establish maximum interest rates, finance charges and other charges, (iii) require disclosures to customers and investors, (iv) govern secured transactions, (v) set collection, foreclosure, repossession and other trade practices and (vi) regulate the use and reporting of information related to a borrower's credit experience.  Our ability to comply with these and other governmental and legal requirements and restrictions affects our operations.
 
We also have agreements with Caterpillar that are significant to our operations.  These agreements provide us with certain types of operational and administrative support from Caterpillar such as the administration of employee benefit plans, financial support, funding support and various forms of corporate services that are integral to the conduct of our business.  For more information on these agreements, please refer to Note 14 of Notes to Consolidated Financial Statements.
 
Employment
 
As of December 31, 2018, the Company had 1,877 full-time employees, an increase of 1 percent from December 31, 2017.
 

5



Available Information
 
The Company files electronically with the SEC required reports on Form 8-K, Form 10-Q, Form 10-K and registration statements on Form S-3 and other forms or reports as required.  The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.  Copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to these reports filed or furnished with the SEC are available free of charge through Caterpillar Inc.’s website (www.caterpillar.com/secfilings) as soon as reasonably practicable after filing with the SEC.  Copies may also be obtained free of charge by writing to:  Legal Dept., Caterpillar Financial Services Corporation, 2120 West End Ave., Nashville, Tennessee 37203-0001.  In addition, the public may obtain more detailed information about our parent company, Caterpillar Inc., by visiting its website (www.caterpillar.com).  None of the information contained at any time on our website, Caterpillar’s website or the SEC’s website is incorporated by reference into this document.

Item 1A. 
Risk Factors.
 
The statements in this section describe the most significant risks to our business and may contain "forward-looking statements" that are subject to the caption "CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS" presented prior to Item 1 of this report.  The statements in this section should also be considered carefully in conjunction with "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and the "Notes to Consolidated Financial Statements" to this Form 10-K.  The risk factors described below are a cautionary discussion of risks, uncertainties and assumptions that we believe are significant to our business. These are factors that, individually or in the aggregate, we believe could make our actual results differ materially from expected or past results. Because it is impossible to predict or identify all such factors, the following factors should not be considered to be a complete discussion of risks, uncertainties and assumptions.  
 
FINANCIAL RISKS

Disruptions or volatility in global financial markets could adversely impact the industries and markets in which we serve and operate
Continuing to meet our cash requirements over the long-term could require substantial liquidity and access to varied sources of funds, including capital and credit markets.  Global economic conditions may cause volatility and disruptions in the capital and credit markets. While we have continued to maintain access to key global medium-term note and commercial paper markets, there can be no assurance that such markets will continue to represent a reliable source of financing.  If global economic conditions were to deteriorate, we could face materially higher financing costs, become unable to access adequate funding to operate and grow our business and/or meet our debt service obligations as they mature, and we could be required to draw upon contractually committed lending agreements primarily provided by global banks and/or by seeking other funding sources.  However, under extreme market conditions, there can be no assurance that such agreements and other funding sources would be available or sufficient.  Any of these events could negatively impact our business, results of operations and financial condition.
The extent of any impact on our ability to meet our funding or liquidity needs would depend on several factors, including our operating cash flows, the duration of any market disruptions, changes in counterparty credit risk, the impact of government intervention in financial markets, including the effects of any programs or legislation designed to increase or restrict liquidity for certain areas of the market, general credit conditions, the volatility of equity and debt markets, our credit ratings and credit capacity and the cost of financing and other general economic and business conditions.  Market disruption and volatility may also lead to a number of other risks in connection with these events, including but not limited to:
Market developments that may affect the demand for Caterpillar products and/or customer confidence levels and may cause declines in the demand for financing and adverse changes in payment patterns, causing increases in delinquencies and default rates, which could impact our write-offs and provision for credit losses;
The process we use to estimate losses inherent in our credit exposure requires a high degree of management’s judgment regarding numerous subjective, qualitative factors, including forecasts of economic conditions and how economic predictors might impair the ability of our borrowers to repay their loans.  If financial market disruption and volatility is experienced, the accuracy of these judgments may be impacted;
Our ability to engage in routine funding transactions or borrow from other financial institutions on acceptable terms or at all could be adversely affected by disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations; and

6



Because our lending agreements are primarily with financial institutions, their ability to perform in accordance with any of our underlying agreements could be adversely affected by market volatility and/or disruptions in the equity and credit markets.

Failure to maintain our credit ratings would increase our cost of borrowing and could adversely affect our cost of funds, liquidity, competitive position and access to capital markets
Each of Caterpillar and Cat Financial's costs of borrowing and their respective ability to access the capital markets are affected not only by market conditions but also by the short-term and long-term credit ratings assigned to our respective debt by the major credit rating agencies.  These ratings are based, in significant part, on each of Caterpillar's and Cat Financial's performance as measured by financial metrics such as net worth, interest coverage and leverage ratios, as well as transparency with rating agencies and timeliness of financial reporting.   There can be no assurance that Caterpillar or Cat Financial will be able to maintain their credit ratings. We receive debt ratings from the major credit rating agencies. Moody's long- and short-term ratings of Caterpillar and Cat Financial are A3 and Prime-2 ("low-A"), while other major credit rating agencies maintain a "mid-A" debt rating. A downgrade of our credit rating by any of the major credit rating agencies would result in increased borrowing costs and could adversely affect Caterpillar's and our liquidity, competitive position and access to the capital markets, including restricting, in whole or in part, access to the commercial paper market.  There can be no assurance that the commercial paper market will continue to be a reliable source of short-term financing for Cat Financial or an available source of short-term financing for Caterpillar.  An inability to access the capital markets could have a material adverse effect on our cash flows, results of operations and financial condition.
Changes in interest rates, foreign currency exchange rates or market liquidity conditions could adversely affect our earnings and/or cash flows
Changes in interest rates, foreign currency exchange rates and market liquidity conditions could have a material adverse impact on our earnings and cash flows. Because our financial results are reported in U.S. dollars, but our operations are conducted internationally, currency exchange rates can have a significant impact on our business results.  Additionally, because a significant number of our loans are made at fixed interest rates, our business results are subject to fluctuations in interest rates. Certain loans made by us and financing extended to us are made at variable rates that use LIBOR as a benchmark for establishing the interest rate. LIBOR is the subject of recent proposals for reform. On July 27, 2017, the United Kingdom’s Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. These reforms may cause LIBOR to cease to exist, new methods of calculating LIBOR to be established or the establishment of an alternative reference rate(s). These consequences cannot be entirely predicted and could have an adverse impact on the market value for or value of LIBOR-linked securities, loans, and other financial obligations or extensions of credit held by or due to us. Changes in market interest rates may influence our financing costs, returns on financial investments and the valuation of derivative contracts and could reduce our earnings and cash flows.  
In addition, because we make a significant number of loans in currencies other than the U.S. dollar, fluctuations in foreign currency exchange rates could also reduce our earnings and cash flows. There has been, and may continue to be, volatility in currency exchange rates as a result of the United Kingdom’s withdrawal from the European Union (commonly known as “Brexit”), especially between the U.S. dollar and the British pound. We also rely on a number of diversified global debt capital markets and funding programs to provide liquidity for our global operations, including commercial paper, medium-term notes, retail notes, variable denomination floating rate demand notes and bank loans.  Significant changes in market liquidity conditions could impact our access to funding and the associated funding cost and reduce our earnings and cash flows.
We manage interest rate, foreign currency exchange rate and market liquidity risks with a variety of techniques that include a match-funding program that addresses interest rate risk by aligning the interest rate profile (fixed or floating rate and duration) of our debt portfolio with the interest rate profile of our receivables portfolio within predetermined ranges on an ongoing basis, the selective use of derivatives and a broadly diversified funding program. There can be no assurance, however, that fluctuations in interest rates, currency exchange rates and market liquidity conditions will not have a material adverse impact on our earnings and cash flows.  If any of the variety of instruments and strategies we use to hedge our exposure to these various types of risk is ineffective, we may have an adverse impact on our earnings and cash flows.

7



Our business is significantly influenced by the credit risk associated with our customers and an increase in delinquencies, repossessions or net losses could adversely affect our results
Our business is significantly influenced by the credit risk associated with our customers.  The creditworthiness of each customer and the rate of delinquencies, repossessions and net losses on customer obligations are directly impacted by several factors, including, but not limited to, relevant industry (particularly construction-related industries) and economic conditions, the availability of capital, the experience and expertise of the customer's management team, commodity prices, interest rates, political events and the sustained value of the underlying collateral.  Any increase in delinquencies, repossessions and net losses on customer obligations could have a material adverse effect on our earnings and cash flows.
In addition, although we evaluate and adjust our allowance for credit losses related to past due and non-performing receivables on a regular basis, adverse economic conditions or other factors that might cause deterioration of the financial health of our customers could change the timing and level of payments received and necessitate an increase in our estimated losses, which could also have a material adverse effect on our earnings and cash flows.
A decrease in the residual value of the equipment that we finance could adversely affect our results
Declines in the residual value of equipment financed by us may reduce our earnings.  The residual value of leased equipment is determined based on its estimated end-of-term market value at the time of the expiration of the lease term.  We estimate the residual value of leased equipment at the inception of the lease based on a number of factors, including historical wholesale market sales prices, past remarketing experience and any known significant market/product trends.  If estimated end-of-term market values significantly decline due to economic factors, obsolescence or other adverse circumstances, we may not realize such residual value, which could reduce our earnings, either through an increase in depreciation expense or a decrease in finance revenue.
Restrictive covenants in our debt agreements could limit our financial and operating flexibility
Cat Financial and certain subsidiaries have credit agreements under which we borrow or have the ability to borrow funds for use in our respective businesses that are utilized primarily for general corporate purposes.  Certain of these agreements include covenants relating to our financial performance and financial position.  The two most significant financial covenants included in these agreements are: (1) a leverage ratio covenant that requires us to maintain a ratio of consolidated debt to consolidated net worth of not greater than 10 to 1, calculated (i) on a monthly basis as the average of the leverage ratios determined on the last day of each of the six preceding calendar months and (ii) at each December 31; and (2) an interest coverage ratio that requires us to maintain a ratio of (i) profit excluding income taxes, interest expense and net gain/(loss) from interest rate derivatives to (ii) interest expense of not less than 1.15 to 1, in each case, calculated at the end of each calendar quarter for the rolling four-quarter period then most recently ended for us and our subsidiaries on a consolidated basis in accordance with generally accepted accounting principles.  In addition, we are restricted in a number of our agreements from terminating, amending or modifying our support agreement with Caterpillar.  We are also restricted in our ability to incur secured indebtedness or consolidate, merge or sell assets.  Similarly, we are also bound by covenants in various agreements that involve Caterpillar and its obligation to maintain a consolidated net worth of not less than $9 billion at all times during each fiscal year.
Although we do not believe any of these covenants presently materially restrict our operations, our ability to meet any one particular financial covenant may be affected by events that could be beyond our control and could result in material adverse consequences that negatively impact our business, results of operations and financial condition.  These consequences may include the acceleration of repayment of amounts outstanding under certain of our credit agreements, the triggering of an obligation to redeem certain debt securities, the termination of existing unused credit commitments by our lenders, the refusal by our lenders to extend further credit under one or more of our credit agreements or the lowering or modification of our credit ratings, including those of any of our subsidiaries.  We cannot provide assurance that we will continue to comply with each credit covenant, particularly if we were to encounter challenging and volatile market conditions.
MACROECONOMIC RISKS

Changes in government monetary or fiscal policies may negatively impact our results
Most countries where Caterpillar products and services are sold have established central banks to regulate monetary systems and influence economic activities, generally by adjusting interest rates.  Interest rate changes affect overall economic growth, which in turn affects Caterpillar’s sales and our financing activities.  Interest rate changes may also affect customers’ ability to finance machine purchases, can change the optimal time to keep machines in a fleet and can impact the ability of Caterpillar’s suppliers to finance the production of parts and components necessary to manufacture and support Caterpillar products.  Increases in interest rates could negatively impact Caterpillar sales and create supply chain inefficiencies that could in turn adversely impact our business, results of operations and financial condition.

8




Central banks and other policy arms of many countries may take actions to vary the amount of liquidity and credit available in an economy.  The impact from a change in liquidity and credit policies could negatively affect the customers and markets we serve or our suppliers, which could adversely impact our business, results of operations and financial condition.
Government policies on taxes and spending also affect our business.  Throughout the world, government spending finances a significant portion of infrastructure development, such as highways, airports, sewer and water systems and dams.  Tax regulations determine asset depreciation lives and impact the after-tax returns on business activity and investment, both of which influence investment decisions.  Unfavorable developments, such as decisions to reduce public spending or increases in taxes, could negatively impact our results.
Our global operations are exposed to political and economic risks, commercial instability and global events beyond our control in the countries in which we operate
Our global operations are dependent upon products manufactured, purchased, sold and financed in the U.S. and internationally, including in countries with political and economic instability or uncertainty.   This includes, for example, the uncertainty related to Brexit. Some countries have greater political and economic volatility and greater vulnerability to infrastructure and labor disruptions than others.  Operating in different regions and countries exposes us to a number of risks, including:
Multiple and potentially conflicting legal and regulatory requirements that are subject to change, including but not limited to, those legal and regulatory requirements described in Item 1 of this report under the heading Competitive Environment;
Imposition of currency restrictions, restrictions on repatriation of earnings or other restraints;
Imposition of new or additional tariffs or quotas;
Difficulty of enforcing agreements and collecting receivables through foreign legal systems;
Withdrawal from or modification of trade agreements or the negotiation of new trade agreements;
Imposition of new or additional trade and economic sanctions laws imposed by the U.S. or foreign governments;
War or terrorist acts; and
Political and economic instability or civil unrest that may severely disrupt economic activity in affected countries.

The occurrence of one or more of these events may negatively impact our business, results of operations and financial condition.
OPERATIONAL RISKS

The success of our business depends upon the demand for Caterpillar’s products
Our primary business is to provide retail and wholesale financing alternatives for Caterpillar products to customers and dealers and is therefore largely dependent upon the demand for Caterpillar’s products and customers’ willingness to enter into financing or leasing agreements, which may be negatively affected by challenging global economic conditions.  As a result, a significant or prolonged decrease in demand could have a material adverse effect on our business, financial condition, results of operations and cash flows.  The demand for Caterpillar’s products and our products and services is influenced by a number of factors, including:
General world economic conditions and the level of energy, mining, construction and manufacturing activity;
Changes and uncertainties in the monetary and fiscal policies of various governmental and regulatory entities;
Fluctuations in demand and prices for certain commodities;
Fluctuations in currency exchange rates and interest rates;
Political, economic and legislative changes;
Caterpillar’s ability to produce products that meet customers' needs;
Caterpillar’s ability to maintain key dealer relationships;
The ability of Caterpillar dealers to sell Caterpillar products and their practices regarding inventory control; and
Changes in pricing policies by Caterpillar or its competitors.

Any significant adverse changes to these factors could negatively impact our results.


9



Changes in the marketing, operational or administrative support that we receive from Caterpillar could adversely affect our results
We participate in certain marketing programs offered in conjunction with Caterpillar and/or Caterpillar dealers that allow us to offer financing to customers at interest rates that are below market rates.  These marketing programs provide us with a significant competitive advantage in financing Caterpillar products.  Any change in these marketing programs or reduction in our ability to offer competitively priced financing to customers could reduce the percentage of Caterpillar products financed by us, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.  Caterpillar also provides us with other types of operational and administrative support, such as the administration of employee benefit plans, which is integral to the conduct of our business.  Any changes in the levels of support from Caterpillar could also negatively impact our results.
The success of our business depends on our ability to develop, produce and market quality products and services that meet our customers’ needs
We operate in a highly competitive environment, with financing for users of Caterpillar equipment available through a variety of sources, principally commercial banks and finance and leasing companies.  Increasing competition may adversely affect our business if we are unable to match the products and services of our competitors.  Also, as noted above, any changes to the marketing programs offered in conjunction with Caterpillar and/or Caterpillar dealers, which allow us to offer financing to customers at interest rates that are below market rates, could have a materially adverse effect on our business.
Increased information technology security threats and more sophisticated computer crime pose a risk to our systems, networks, products and services
We rely upon information technology systems and networks, some of which are managed by third parties, in connection with a variety of business activities. Additionally, we collect and store data that is sensitive to us and our customers. Operating these information technology systems and networks and processing and maintaining this data, in a secure manner, are critical to our business operations and strategy. Data we collect, store and process is subject to a variety of U.S. and international laws and regulations, such as the European Union's General Data Protection Regulation that became effective in May 2018, which carry, in many cases, significant potential penalties for noncompliance. Information technology security threats -- from user error to cybersecurity attacks designed to gain unauthorized access to our systems, networks and data -- are increasing in frequency and sophistication. Cybersecurity attacks may range from random attempts to coordinated and targeted attacks, including sophisticated computer crime and advanced persistent threats. These threats pose a risk to the security of our systems and networks and the confidentiality, availability and integrity of our data. Cybersecurity attacks could also include attacks targeting customer data or the security, integrity and/or reliability of the hardware and software installed in our products. While, to date, no cybersecurity attack has had a material impact on our financial condition, results of operations or liquidity, we have experienced cybersecurity attacks that have resulted in unauthorized parties gaining access to our information technology systems and networks, and we could in the future experience similar or more serious attacks. While we actively manage information technology security risks within our control, such actions may not be sufficient to mitigate all potential risks to our systems, networks and data. Further, the amount of insurance coverage we maintain may be inadequate to cover claims or liabilities relating to a cybersecurity attack. The potential consequences of a material cybersecurity attack include reputational damage, litigation with third parties, government enforcement actions, penalties, disruption to systems, unauthorized release of confidential or otherwise protected information, corruption of data and increased cybersecurity protection and remediation costs, which in turn could adversely affect our competitiveness, results of operations and financial condition.
LEGAL & REGULATORY RISKS

Our global operations are subject to extensive trade and anti-corruption laws and regulations

Due to the international scope of our operations, we are subject to a complex system of laws and regulations, including U.S. regulations issued by the Office of Foreign Assets Control. Any alleged or actual violations may subject us to government scrutiny, investigation, and civil and criminal penalties and may limit our ability to provide financing outside the United States and/or potentially require us to divest portions of our existing portfolio under certain circumstances.  Furthermore, embargoes and sanctions imposed by the U.S. and other governments prohibiting providing financing to specific persons or countries may expose us to potential criminal and civil sanctions. We cannot predict the nature, scope or effect of future regulatory requirements to which our operations might be subject or in certain locations the manner in which existing laws might be administered or interpreted.

10



In addition, the U.S. Foreign Corrupt Practices Act and similar anti-corruption laws of other countries generally prohibit companies and their intermediaries from making improper payments or providing anything of value to improperly influence foreign government officials for the purpose of obtaining or retaining business or obtaining an unfair advantage. Recent years have seen a substantial increase in the global enforcement of anti-corruption laws. Our continued operation and expansion outside the United States, including in developing countries, could increase the risk of such violations. Violations of anti-corruption laws by our employees or by intermediaries acting on our behalf may result in severe criminal or civil sanctions, could disrupt our business, and could result in an adverse effect on our reputation, business and results of operations or financial condition.
New regulations or changes in financial services regulation could adversely impact our results of operations and financial condition

Our operations are highly regulated by governmental authorities in the locations where we operate, which can impose significant additional costs and/or restrictions on our business. In the U.S. for example, certain of our activities are subject to the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), a comprehensive financial reform act that includes extensive provisions regulating the financial services industry. We have become and could continue to become subject to additional regulatory costs that could be significant and could have an adverse effect on our results of operations and financial condition. Changes in or additional regulations in the U.S. or internationally impacting the financial services industry could also add significant cost or operational constraints that might have an adverse effect on our results of operations and financial condition.

We may incur additional tax expense or become subject to additional tax exposure

We are subject to income taxes in the United States and numerous other jurisdictions. Our future results of operations could be adversely affected by changes in the effective tax rate as a result of a change in the mix of earnings between U.S. and non-U.S. jurisdictions or among jurisdictions with differing statutory tax rates, changes in our overall profitability, changes in tax laws or treaties or in their application or interpretation, changes in tax rates, changes in generally accepted accounting principles, changes in the valuation of deferred tax assets and liabilities, changes in the amount of earnings indefinitely reinvested in certain non-U.S. jurisdictions, the results of audits and examinations of previously filed tax returns and continuing assessments of our tax exposures. We are also subject to the continuous examination of our income tax returns by the U.S. Internal Revenue Service and other tax authorities.  We regularly assess the likelihood of an adverse outcome resulting from these examinations. If our effective tax rates were to increase or if the ultimate determination of our taxes owed is for an amount in excess of amounts previously accrued, our operating results, cash flows and financial condition could be adversely affected.

Changes in accounting guidance could have an adverse effect on our results of operations
Our consolidated financial statements are subject to the application of generally accepted accounting principles in the United States, which is periodically revised and/or expanded.  Accordingly, from time to time we are required to adopt new or revised accounting guidance and related interpretations issued by recognized authoritative bodies, including the Financial Accounting Standards Board and the SEC.  Market conditions have prompted accounting standard setters to issue new guidance, which further interprets or seeks to revise accounting pronouncements related to various transactions, as well as to issue new guidance expanding disclosures.  The impact of accounting pronouncements that have been issued but not yet implemented is disclosed in our annual and quarterly reports on Form 10-K and Form 10-Q.  An assessment of proposed guidance is not provided, as such proposals are subject to change through the exposure process and, therefore, their effects on our financial statements cannot be meaningfully assessed.  It is possible that future accounting guidance we are required to adopt or future changes in accounting principles could change the current accounting treatment that we apply to our consolidated financial statements and that such changes could have a material adverse effect on our business, results of operations and financial condition.
Item 1B. 
Unresolved Staff Comments.
 
None.


11



Item 2.
Properties.
 
Our corporate headquarters are located in Nashville, Tennessee.  We maintain forty-seven offices in total, of which ten are located in North America (nine in the U.S. and one in Canada), twenty-one are located in Europe, one is located in Africa, one is located in the Middle East, nine are located in Asia/Pacific and five are located in Latin America (see Note 16 of Notes to Consolidated Financial Statements for more information regarding our segments and geographic areas).  All of our offices are leased, except for our corporate headquarters building, which was purchased on January 4, 2018.

Item 3. 
Legal Proceedings.

We are involved in unresolved legal actions that arise in the normal course of business. Although it is not possible to predict with certainty the outcome of our unresolved legal actions, we believe that these unresolved legal actions will neither individually nor in the aggregate have a material adverse effect on our consolidated results of operations, financial position or liquidity.

Item 4. 
Mine Safety Disclosures.
 
Not applicable.

PART II
 
Item 5. 
Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.

Our stock is not publicly traded.  Caterpillar Inc. is the owner of our one outstanding share.  Cash dividends of $400 million, $725 million and $275 million were paid to Caterpillar in 2018, 2017 and 2016, respectively.

12



Item 7. 
Management's Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW
 
We reported revenues of $2.85 billion for 2018, an increase of $158 million, or 6 percent, compared with 2017. Profit was $305 million, a $281 million, or 48 percent, decrease from 2017.

The increase in revenues was primarily due to a $107 million favorable impact from higher average financing rates and a $94 million favorable impact from higher average earning assets, partially offset by a $48 million unfavorable impact from lower lending activity with Caterpillar.

Profit before income taxes was $433 million for 2018, compared with $590 million for 2017. The decrease was primarily due to a $222 million increase in provision for credit losses, which was driven by a higher allowance rate and an increase in write-offs, due to continued weakening in the Cat Power Finance portfolio. This decrease was partially offset by a $42 million favorable impact from higher average earning assets and a $36 million increase in net yield on average earning assets primarily due to changes in portfolio mix.

The provision for income taxes reflects an annual tax rate of 25 percent for 2018, compared with negative 1 percent for 2017. The increase in the annual tax rate is primarily due to the overall impact of U.S. tax reform in 2017, along with changes in the geographic mix of profits.
 
Retail new business volume for 2018 was $12.08 billion, an increase of $853 million, or 8 percent, from 2017. The increase was primarily driven by higher volume in Asia/Pacific, Europe and North America, partially offset by a decrease in Cat Power Finance.

At the end of 2018, past dues were 3.55 percent, compared with 2.78 percent at the end of 2017. Write-offs, net of recoveries, were $189 million for 2018, compared with $114 million for 2017. As of December 31, 2018, the allowance for credit losses totaled $511 million, or 1.80 percent of finance receivables, compared with $365 million, or 1.33 percent of finance receivables at December 31, 2017. The increase in past dues, write-offs and allowance for credit losses was primarily due to continued weakening in the Cat Power Finance portfolio.
 



13



2018 COMPARED WITH 2017
 
Consolidated Total Revenues

consrev4q18ytdvs4q17ytd.jpg
The chart above graphically illustrates reasons for the change in Consolidated Total Revenues between 2017 (at left) and 2018 (at right). Items favorably impacting total revenues appear as upward stair steps with corresponding dollar amounts above each bar, while items negatively impacting total revenues appear as downward stair steps with dollar amounts reflected in parentheses above each bar. Management utilizes these charts internally to visually communicate results. 

Retail revenue for 2018 was $1.31 billion, an increase of $73 million from 2017.  The increase was due to a $73 million favorable impact from higher interest rates on retail finance receivables.  For the year ended December 31, 2018, retail average earning assets were $23.10 billion, an increase of $9 million from 2017. The average yield was 5.66 percent for 2018, compared with 5.35 percent in 2017.
 
Operating lease revenue for 2018 was $1.01 billion, an increase of $26 million from 2017. The increase was due to a $27 million favorable impact from higher average rental rates on operating leases, partially offset by a $1 million unfavorable impact from lower average earning assets.
 
Wholesale revenue for 2018 was $415 million, an increase of $108 million from 2017. The increase was due to an $83 million favorable impact from higher average earning assets and a $25 million favorable impact from higher interest rates on wholesale finance receivables. For the year ended December 31, 2018, wholesale average earning assets were $4.85 billion, an increase of $1.04 billion from 2017. The average yield was 8.55 percent for 2018, compared with 8.04 percent in 2017.

Other revenue, net, items were as follows: 
(Millions of dollars)
 
 
 
 
 
 
 
 
2018
 
2017
 
$ Change
Finance receivable and operating lease fees (including late charges)
 
$
71

 
$
80

 
$
(9
)
Fees on committed credit facility extended to Caterpillar
 
40

 
40

 

Interest income on Notes Receivable from Caterpillar
 
30

 
74

 
(44
)
Net loss on returned or repossessed equipment
 
(48
)
 
(48
)
 

Miscellaneous other revenue, net
 
20

 
16

 
4

Total Other revenue, net
 
$
113

 
$
162

 
$
(49
)
 
 
 
 
 
 
 

There was a $2 million favorable impact from currency on revenues in 2018. Currency represents the net translation impact resulting from changes in foreign currency exchange rates versus the U.S. dollar and is included in all financial statement line items and each of the items included in the above analysis.


14



Consolidated Profit Before Income Taxes

conspbt4q18ytdvs4q17ytd.jpg
The chart above graphically illustrates reasons for the change in Consolidated Profit Before Income Taxes between 2017 (at left) and 2018 (at right). Items favorably impacting profit before income taxes appear as upward stair steps with corresponding dollar amounts above each bar, while items negatively impacting profit before income taxes appear as downward stair steps with dollar amounts reflected in parentheses above each bar. Management utilizes these charts internally to visually communicate results. 

Profit before income taxes was $433 million for 2018, compared with $590 million for 2017. The decrease was primarily due to a $222 million increase in provision for credit losses, which was driven by a higher allowance rate and an increase in write-offs, due to continued weakening in the Cat Power Finance portfolio. This decrease was partially offset by a $42 million favorable impact from higher average earning assets and a $36 million increase in net yield on average earning assets primarily due to changes in portfolio mix.

There was a $4 million favorable impact from currency on profit before income taxes in 2018. Currency represents the net translation impact resulting from changes in foreign currency exchange rates versus the U.S. dollar and is included in all financial statement line items and each of the items included in the above analysis.

Provision for Income Taxes
The provision for income taxes reflects an annual tax rate of 25 percent for 2018, compared with negative 1 percent for 2017. The increase in the annual tax rate is primarily due to the overall impact of U.S. tax reform in 2017, along with changes in the geographic mix of profits.

We completed our accounting for the income tax effects of U.S. tax reform legislation with a resulting 2018 measurement period adjustment of $12 million that increased the provisionally estimated net benefit of $151 million recognized during the fourth quarter of 2017. We recorded a $7 million benefit in the third quarter of 2018, resulting from the 2017 tax year return to provision adjustments, which revised the estimated impact of the write-down of U.S. net deferred tax liabilities to reflect the reduction in the U.S. corporate tax rate from 35 percent to 21 percent. In the fourth quarter of 2018, we recorded a $5 million benefit to revise the estimated cost of a mandatory deemed repatriation of non-U.S. earnings.


15



Finance Receivables and Equipment on Operating Leases

New Business Volume
(Millions of dollars)
 
 
 
 
 
 
 
 
2018
 
2017
 
$ Change
New retail financing
 
$
10,600

 
$
9,844

 
$
756

New operating lease activity
 
1,484

 
1,388

 
96

New wholesale financing
 
43,981

 
36,299

 
7,682

Total
 
$
56,065

 
$
47,531

 
$
8,534

 
 
 
 
 
 
 

New retail financing increased primarily due to higher volume in Asia/Pacific, Europe and North America, partially offset by a decrease in Cat Power Finance. New operating lease activity (which is substantially related to retail) increased primarily due to higher rentals of Cat equipment in North America, partially offset by lower rentals in Latin America. New wholesale financing increased primarily due to higher purchases of trade receivables from Caterpillar.

Total Managed Portfolio
We define total portfolio as finance receivables, net plus equipment on operating leases, less accumulated depreciation. We also manage and service receivables and leases that have been sold by us to third parties with limited or no recourse in order to mitigate our concentration of credit risk with certain customers.  These assets are not available to pay our creditors. Total managed portfolio as of December 31, was as follows: 
(Millions of dollars)
 
 
 
 
 
 
 
 
2018
 
2017
 
$ Change
Finance receivables, net
 
$
27,923

 
$
27,126

 
$
797

Equipment on operating leases, less accumulated depreciation
 
3,562

 
3,568

 
(6
)
Total portfolio
 
$
31,485

 
$
30,694

 
$
791

 
 
 
 
 
 
 
Retail installment sale contracts
 
$
107

 
$
74

 
$
33

Retail finance leases
 
100

 
103

 
(3
)
Operating leases
 
25

 
39

 
(14
)
Retail notes receivable
 
23

 
55

 
(32
)
Total off-balance sheet managed assets
 
$
255

 
$
271

 
$
(16
)
 
 
 
 
 
 
 
Total managed portfolio
 
$
31,740

 
$
30,965

 
$
775

 
 
 
 
 
 
 

Total Portfolio Metrics
At the end of 2018, past dues were 3.55 percent, compared with 2.78 percent at the end of 2017. Total non-performing finance receivables, which represent finance receivables currently on non-accrual status, were $885 million and $683 million at December 31, 2018 and 2017, respectively. Total non-performing finance receivables as a percentage of our recorded investment in finance receivables were 3.11 percent and 2.48 percent at December 31, 2018 and 2017, respectively.
 
Our allowance for credit losses as of December 31, 2018 was $511 million or 1.80 percent of our recorded investment in finance receivables compared with $365 million or 1.33 percent as of December 31, 2017. During 2018, our allowance for loan losses (ALLL) estimate increased $146 million, primarily due to a $153 million increase in specific reserves on impaired finance receivables that were individually evaluated. The increase in specific reserves was mainly driven by continued weaknesses in the Cat Power Finance portfolio. The allowance is subject to an ongoing evaluation based on many quantitative and qualitative factors, including past loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of underlying collateral and current economic conditions. We believe our allowance is sufficient to provide for losses inherent in our existing finance receivable portfolio as of December 31, 2018.
 

16



FOURTH QUARTER 2018 VS. FOURTH QUARTER 2017
 
CONSOLIDATED STATEMENTS OF PROFIT (UNAUDITED)
(Dollars in Millions)
 
 
 
Three Months Ended
December 31,
 
 
2018
 
2017
Revenues:
 
 
 
 
Retail finance
 
$
333

 
$
311

Operating lease
 
251

 
248

Wholesale finance
 
111

 
85

Other, net
 
4

 
34

Total revenues
 
699

 
678

 
 
 
 
 
Expenses:
 
 

 
 

Interest
 
199

 
168

Depreciation on equipment leased to others
 
203

 
202

General, operating and administrative
 
97

 
110

Provision for credit losses
 
136

 
50

Other
 
10

 
10

Total expenses
 
645

 
540

 
 
 
 
 
Other income (expense)
 
(8
)
 
(5
)
 
 
 
 
 
Profit before income taxes
 
46

 
133

 
 
 
 
 
Provision (benefit) for income taxes
 
23

 
(141
)
 
 
 
 
 
Profit of consolidated companies
 
23

 
274

 
 
 
 
 
Less:  Profit (loss) attributable to noncontrolling interests
 
5

 
3

 
 
 
 
 
Profit1
 
$
18

 
$
271

 
 
 
 
 
 
 
 

 
 

1 Profit attributable to Caterpillar Financial Services Corporation.

 

17



Consolidated Total Revenues

consrev4q18vs4q17.jpg
The chart above graphically illustrates reasons for the change in Consolidated Total Revenues between fourth quarter 2017 (at left) and fourth quarter 2018 (at right). Items favorably impacting total revenues appear as upward stair steps with corresponding dollar amounts above each bar, while items negatively impacting total revenues appear as downward stair steps with dollar amounts reflected in parentheses above each bar. Management utilizes these charts internally to visually communicate results. 

Retail revenue for the fourth quarter of 2018 was $333 million, an increase of $22 million from the same period in 2017.  The increase was due to a $24 million favorable impact from higher interest rates on retail finance receivables, partially offset by a $2 million unfavorable impact from lower average earning assets.  For the quarter ended December 31, 2018, retail average earning assets were $22.98 billion, a decrease of $102 million from the same period in 2017. The annualized average yield was 5.81 percent for the fourth quarter of 2018, compared with 5.39 percent for the fourth quarter of 2017.
 
Operating lease revenue for the fourth quarter of 2018 was $251 million, an increase of $3 million from the same period in 2017.  The increase was due to a $3 million favorable impact from higher average rental rates on operating leases.

Wholesale revenue for the fourth quarter of 2018 was $111 million, an increase of $26 million from the same period in 2017. The increase was due to a $21 million favorable impact from higher average earning assets and a $5 million favorable impact from higher interest rates on wholesale finance receivables. For the quarter ended December 31, 2018, wholesale average earning assets were $5.15 billion, an increase of $1.04 billion from the same period in 2017. The annualized average yield was 8.61 percent for the fourth quarter of 2018, compared with 8.22 percent for the fourth quarter of 2017.
 
Other revenue, net, items were as follows: 
(Millions of dollars)
 
 
Three Months Ended
 December 31,
 
 
2018
 
2017
 
$ Change
Finance receivable and operating lease fees (including late charges)
 
$
15

 
$
23

 
$
(8
)
Fees on committed credit facility extended to Caterpillar
 
10

 
10

 

Interest income on Notes Receivable from Caterpillar
 
8

 
15

 
(7
)
Net loss on returned or repossessed equipment
 
(34
)
 
(18
)
 
(16
)
Miscellaneous other revenue, net
 
5

 
4

 
1

Total Other revenue, net
 
$
4

 
$
34

 
$
(30
)
 
 
 
 
 
 
 

There was an $11 million unfavorable impact from currency on revenues in the fourth quarter of 2018. Currency represents the net translation impact resulting from changes in foreign currency exchange rates versus the U.S. dollar and is included in all financial statement line items and each of the items included in the above analysis.





18



Consolidated Profit Before Income Taxes

conspbt4q18vs4q17.jpg
The chart above graphically illustrates reasons for the change in Consolidated Profit Before Income Taxes between fourth quarter 2017 (at left) and fourth quarter 2018 (at right). Items favorably impacting profit before income taxes appear as upward stair steps with corresponding dollar amounts above each bar, while items negatively impacting profit before income taxes appear as downward stair steps with dollar amounts reflected in parentheses above each bar. Management utilizes these charts internally to visually communicate results. 

Profit before income taxes was $46 million for the fourth quarter of 2018, compared with $133 million for the fourth quarter of 2017. The decrease was primarily due to an $86 million increase in provision for credit losses, which was driven by a higher allowance rate and an increase in write-offs, due to continued weakening in the Cat Power Finance portfolio.

There was a $4 million unfavorable impact from currency on profit before income taxes in the fourth quarter of 2018. Currency represents the net translation impact resulting from changes in foreign currency exchange rates versus the U.S. dollar and is included in all financial statement line items and each of the items included in the above analysis.

Provision for Income Taxes
The provision for income taxes reflects an effective tax rate of 48 percent in the fourth quarter of 2018, compared with negative 107 percent in the fourth quarter of 2017. The increase in the effective tax rate is primarily due to the overall impact of U.S. tax reform in 2017, along with changes in the geographic mix of profits.

We completed our accounting for the income tax effects of U.S. tax reform legislation with a resulting 2018 measurement period adjustment of $12 million that increased the provisionally estimated net benefit of $151 million recognized during the fourth quarter of 2017. In the fourth quarter of 2018, we recorded a $5 million benefit to revise the estimated cost of a mandatory deemed repatriation of non-U.S. earnings.


19



2017 COMPARED WITH 2016

Consolidated Total Revenues

consrev2017vs2016a01.jpg
The chart above graphically illustrates reasons for the change in Consolidated Total Revenues between 2016 (at left) and 2017 (at right). Items favorably impacting total revenues appear as upward stair steps with corresponding dollar amounts above each bar, while items negatively impacting total revenues appear as downward stair steps with dollar amounts reflected in parentheses above each bar. Management utilizes these charts internally to visually communicate results. 

Retail revenue for 2017 was $1.24 billion, an increase of $15 million from 2016.  The increase was due to a $35 million favorable impact from higher interest rates on retail finance receivables, partially offset by a $20 million unfavorable impact from lower average earning assets.  For the year ended December 31, 2017, retail average earning assets were $23.09 billion, a decrease of $374 million from 2016. The average yield was 5.35 percent for 2017, compared with 5.20 percent in 2016.
 
Operating lease revenue for 2017 was $985 million, a decrease of $30 million from 2016. The decrease was due to a $28 million unfavorable impact from lower average earning assets and a $2 million unfavorable impact from lower average rental rates on operating leases.
 
Wholesale revenue for 2017 was $307 million, an increase of $43 million from 2016. The increase was due to a $36 million favorable impact from higher interest rates on wholesale finance receivables and a $7 million favorable impact from higher average earning assets. For the year ended December 31, 2017, wholesale average earning assets were $3.82 billion, an increase of $93 million from 2016. The average yield was 8.04 percent for 2017, compared with 7.09 percent in 2016.

Other revenue, net, items were as follows: 
(Millions of dollars)
 
 
 
 
 
 
 
 
2017
 
2016
 
$ Change
Finance receivable and operating lease fees (including late charges)
 
$
80

 
$
73

 
$
7

Fees on committed credit facility extended to Caterpillar
 
40

 
40

 

Interest income on Notes Receivable from Caterpillar
 
74

 
30

 
44

Net loss on returned or repossessed equipment
 
(48
)
 
(61
)
 
13

Miscellaneous other revenue, net
 
16

 
14

 
2

Total Other revenue, net
 
$
162

 
$
96

 
$
66

 
 
 
 
 
 
 

There was a $12 million favorable impact from currency on revenues in 2017. Currency represents the net translation impact resulting from changes in foreign currency exchange rates versus the U.S. dollar and is included in all financial statement line items and each of the items included in the above analysis.


20



Consolidated Profit Before Income Taxes

conspbt4q17ytdvs4q16ytdrp.jpg
The chart above graphically illustrates reasons for the change in Consolidated Profit Before Income Taxes between 2016 (at left) and 2017 (at right). Items favorably impacting profit before income taxes appear as upward stair steps with corresponding dollar amounts above each bar, while items negatively impacting profit before income taxes appear as downward stair steps with dollar amounts reflected in parentheses above each bar. Management utilizes these charts internally to visually communicate results. 

Profit before income taxes was $590 million for 2017, compared with $561 million for 2016. The increase was primarily due to a $33 million increase in net yield on average earning assets and a $30 million favorable impact from lending activity with Caterpillar, partially offset by a $38 million increase in general, operating and administrative expenses primarily due to higher incentive compensation.

There was a $3 million favorable impact from currency on profit before income taxes in 2017. Currency represents the net translation impact resulting from changes in foreign currency exchange rates versus the U.S. dollar and is included in all financial statement line items and each of the items included in the above analysis.

Provision for Income Taxes
The provision for income taxes reflects an annual tax rate of negative 1 percent for 2017, compared with 30 percent for 2016. The provision for income taxes for 2017 includes a provisionally estimated net benefit of $151 million due to the enactment of U.S. tax reform legislation on December 22, 2017. The provisionally estimated net benefit includes a $334 million write-down of net deferred tax liabilities to reflect the reduction in the U.S. corporate tax rate from 35 percent to 21 percent beginning January 1, 2018, partially offset by the cost of a mandatory deemed repatriation of non-U.S. earnings. We believe this net benefit is a reasonable estimate that may change as additional required information is prepared and analyzed, interpretations and assumptions are refined, additional guidance is issued, and due to actions we may take as a result of the legislation. The decrease in the annual tax rate is primarily due to this net benefit, an increase in available foreign tax credits and changes in the geographic mix of profits.


21



Finance Receivables and Equipment on Operating Leases

New Business Volume
(Millions of dollars)
 
 
 
 
 
 
 
 
2017
 
2016
 
$ Change
New retail financing
 
$
9,844

 
$
9,260

 
$
584

New operating lease activity
 
1,388

 
1,670

 
(282
)
New wholesale financing
 
36,299

 
30,642

 
5,657

Total
 
$
47,531

 
$
41,572

 
$
5,959

 
 
 
 
 
 
 

New retail financing increased primarily due to higher volume in Asia/Pacific, Europe and North America, partially offset by lower volume in Latin America. New operating lease activity (which is substantially related to retail) decreased primarily due to lower rentals of Cat equipment in North America, Europe and Asia/Pacific. New wholesale financing increased primarily due to higher purchases of trade receivables from Caterpillar.

Total Managed Portfolio
We define total portfolio as finance receivables, net plus equipment on operating leases, less accumulated depreciation. We also manage and service receivables and leases that have been sold by us to third parties with limited or no recourse in order to mitigate our concentration of credit risk with certain customers.  These assets are not available to pay our creditors. Total managed portfolio as of December 31, was as follows: 
(Millions of dollars)
 
 
 
 
 
 
 
 
2017
 
2016
 
$ Change
Finance receivables, net
 
$
27,126

 
$
26,212

 
$
914

Equipment on operating leases, less accumulated depreciation
 
3,568

 
3,708

 
(140
)
Total portfolio
 
$
30,694

 
$
29,920

 
$
774

 
 
 
 
 
 
 
Retail finance leases
 
$
103

 
$
41

 
$
62

Retail installment sale contracts
 
74

 
79

 
(5
)
Retail notes receivable
 
55

 
87

 
(32
)
Operating leases
 
39

 
79

 
(40
)
Total off-balance sheet managed assets
 
$
271

 
$
286

 
$
(15
)
 
 
 
 
 
 
 
Total managed portfolio
 
$
30,965

 
$
30,206

 
$
759

 
 
 
 
 
 
 

Total Portfolio Metrics
At the end of 2017, past dues were 2.78 percent, compared with 2.38 percent at the end of 2016. Total non-performing finance receivables, which represent finance receivables currently on non-accrual status, were $683 million and $579 million at December 31, 2017 and 2016, respectively. Total non-performing finance receivables as a percentage of our recorded investment in finance receivables were 2.48 percent and 2.18 percent at December 31, 2017 and 2016, respectively.
 
Our allowance for credit losses as of December 31, 2017 was $365 million or 1.33 percent of net finance receivables compared with $343 million or 1.29 percent as of December 31, 2016. The allowance is subject to an ongoing evaluation based on many quantitative and qualitative factors, including past loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of underlying collateral and current economic conditions. We believe our allowance is sufficient to provide for losses inherent in our existing finance receivable portfolio as of December 31, 2017.


22



CAPITAL RESOURCES AND LIQUIDITY
 
Capital resources and liquidity provide us with the ability to meet our financial obligations on a timely basis.  Maintaining and managing adequate capital and liquidity resources includes management of funding sources and their utilization based on current, future and contingent needs. Throughout 2018, we experienced favorable liquidity conditions. We ended 2018 with $766 million of cash, an increase of $58 million from year-end 2017. Our cash balances are held in numerous locations throughout the world with approximately $182 million held by our non-U.S. subsidiaries. Amounts held by non-U.S. subsidiaries are available for general corporate use and could be used in the U.S. without incurring significant additional U.S. taxes. We expect to meet our U.S. funding needs without repatriating undistributed profits that are indefinitely reinvested outside the U.S.
 
BORROWINGS
Borrowings consist primarily of medium-term notes and commercial paper, the combination of which is used to manage interest rate risk and funding requirements. (Please refer to Notes 6, 7 and 8 of Notes to Consolidated Financial Statements for additional discussion.)

We receive debt ratings from the major credit rating agencies. Moody’s rates our debt as “low-A”, while Fitch and S&P maintain a “mid-A” debt rating. This split rating has not had a material impact on our borrowing costs or our overall financial health. However, a downgrade of our credit ratings by any of the major credit rating agencies would result in increased borrowing costs and could make access to certain credit markets more difficult. In the event economic conditions deteriorate such that access to debt markets becomes unavailable, we would rely on cash flows from our existing portfolio, existing cash balances, access to our revolving credit facilities and other credit line facilities and potential borrowings from Caterpillar. In addition, Caterpillar maintains a support agreement with us, which requires Caterpillar to remain our sole owner and may, under certain circumstances, require Caterpillar to make payments to us should we fail to maintain certain financial ratios.

Total borrowings outstanding as of December 31, 2018, were $30.06 billion, an increase of $1.48 billion over December 31, 2017, primarily due to increased portfolio funding requirements. Outstanding borrowings as of December 31 were as follows: 
(Millions of dollars) 
 
2018
 
2017
Medium-term notes, net of unamortized discount and debt issuance costs
 
$
22,169

 
$
21,303

Commercial paper, net of unamortized discount
 
4,759

 
3,680

Bank borrowings – long-term
 
646

 
803

Bank borrowings – short-term
 
526

 
675

Variable denomination floating rate demand notes
 
438

 
481

Notes payable to Caterpillar
 
1,518

 
1,638

Total outstanding borrowings
 
$
30,056

 
$
28,580

 
 
 
 
 
 
Medium-term notes
We issue medium-term unsecured notes through securities dealers or underwriters in the U.S., Canada, Europe, Australia, Japan, Hong Kong, and China to both retail and institutional investors. These notes are offered in several currencies and with a variety of maturities. These notes are senior unsecured obligations of the Company. Medium-term notes issued totaled $6.84 billion and redeemed totaled $5.89 billion for the year ended December 31, 2018. Medium-term notes outstanding as of December 31, 2018, mature as follows: 
(Millions of dollars)
 
2019
$
5,577

2020
6,217

2021
4,742

2022
1,990

2023
2,152

Thereafter
1,491

Total
$
22,169

 
 

 

23



Commercial paper
We issue unsecured commercial paper in the U.S., Europe and other international capital markets.  These short-term promissory notes are issued on a discounted basis and are payable at maturity.
 
Revolving credit facilities
We have three global credit facilities with a syndicate of banks totaling $10.50 billion (Credit Facility) available in the aggregate to both Caterpillar and us for general liquidity purposes.  Based on management's allocation decision, which can be revised from time to time, the portion of the Credit Facility available to us as of December 31, 2018 was $7.75 billion. Information on our Credit Facility is as follows:

The 364-day facility of $3.15 billion (of which $2.33 billion is available to us) expires in September 2019.
The three-year facility, as amended in September 2018, of $2.73 billion (of which $2.01 billion is available to us) expires in September 2021.
The five-year facility, as amended in September 2018, of $4.62 billion (of which $3.41 billion is available to us) expires in September 2023. 

At December 31, 2018, Caterpillar’s consolidated net worth was $14.07 billion, which was above the $9.00 billion required under the Credit Facility.  The consolidated net worth is defined in the Credit Facility as the consolidated shareholders' equity including preferred stock but excluding the pension and other postretirement benefits balance within Accumulated other comprehensive income/(loss).

At December 31, 2018, our covenant interest coverage ratio was 1.56 to 1. This is above the 1.15 to 1 minimum ratio, calculated as (1) profit excluding income taxes, interest expense and net gain/(loss) from interest rate derivatives to (2) interest expense, calculated at the end of each calendar quarter for the rolling four quarter period then most recently ended, required by the Credit Facility.

In addition, at December 31, 2018, our six-month covenant leverage ratio was 7.69 to 1 and our year-end covenant leverage ratio was 8.33 to 1.  This is below the maximum ratio of debt to net worth of 10 to 1, calculated (1) on a monthly basis as the average of the leverage ratios determined on the last day of each of the six preceding calendar months and (2) at each December 31, required by the Credit Facility.

In the event that either Caterpillar or we do not meet one or more of our respective financial covenants under the Credit Facility in the future (and are unable to obtain a consent or waiver), the syndicate of banks may terminate the commitments allocated to the party that does not meet its covenants.  Additionally, in such event, certain of our other lenders under other loan agreements where similar financial covenants or cross default provisions are applicable, may, at their election, choose to pursue remedies under those loan agreements, including accelerating the repayment of outstanding borrowings. At December 31, 2018, there were no borrowings under the Credit Facility.
 
Bank borrowings
Available credit lines with banks as of December 31, 2018 totaled $4.58 billion.  These committed and uncommitted credit lines, which may be eligible for renewal at various future dates or have no specified expiration date, are used primarily by our non-U.S. subsidiaries for local funding requirements. As of December 31, 2018, we had $1.17 billion outstanding against these credit lines and were in compliance with all debt covenants under these credit lines. The remaining available credit commitments may be withdrawn any time at the lenders' discretion.
 
Variable denomination floating rate demand notes
We obtain funding from the sale of variable denomination floating rate demand notes, which may be redeemed at any time at the option of the holder without any material restriction.  We do not hold reserves to fund the payment of the demand notes.  The notes are offered on a continuous basis. As of December 31, 2018, there was $438 million of variable denomination floating rate demand notes outstanding. The maximum amount of variable denomination floating rate demand notes that we may have outstanding at any time may not exceed $1.25 billion.

Notes receivable from/payable to Caterpillar
Under our variable amount and term lending agreements and other notes receivable with Caterpillar, we may borrow up to $2.75 billion from Caterpillar and Caterpillar may borrow up to $2.14 billion from us.  The variable amount lending agreements are in effect for indefinite periods of time and may be changed or terminated by either party with 30 days notice.  The term lending agreements have remaining maturities ranging up to ten years. We had notes payable of $1.52 billion and notes receivable of $662 million outstanding under these agreements as of December 31, 2018.

24



 
Committed credit facility
We extended a $2 billion committed credit facility to Caterpillar, which expires in February 2019.  We receive a fee from Caterpillar based on amounts drawn under the credit facility and a commitment fee for the undrawn amounts under the credit facility.  At December 31, 2018, there were no borrowings under this credit facility.
 
OFF-BALANCE SHEET ARRANGEMENTS
We lease all of our facilities except for our corporate headquarters building. In addition, we have potential payment exposure for guarantees issued to third parties totaling $97 million as of December 31, 2018.  Please refer to Notes 11 and 15 of Notes to Consolidated Financial Statements for further information.
 
Managed assets
Certain finance receivables and equipment on operating leases are sold by us to third parties with limited or no recourse in order to mitigate our concentration of credit risk with certain customers.  In 2018, we received $242 million of cash proceeds from the sale of such assets. We typically maintain servicing responsibilities for these assets.

CONTRACTUAL OBLIGATIONS
We have committed cash outflow related to long-term debt, operating lease agreements and purchase obligations.  Minimum payments for these obligations are: 
(Millions of dollars)
 
 
 
 
 
 
 
 
 
 
 
 
2019
 
2020-2021
 
2022-2023
 
After 2023
 
Total
Long-term debt(1)
 
$
5,823

 
$
11,330

 
$
4,224

 
$
1,490

 
$
22,867

Interest payable on long-term debt
 
544

 
676

 
269

 
53

 
1,542

Operating leases
 
8

 
10

 
4

 
2

 
24

Purchase obligations(2)
 
12

 

 

 

 
12

Total contractual obligations
 
$
6,387

 
$
12,016

 
$
4,497

 
$
1,545

 
$
24,445

 
 
 
 
 
 
 
 
 
 
 
(1)Excludes debt issuance costs, unamortized discounts and fair value adjustments.
(2)Represents short-term contractual obligations made in the ordinary course of business for contracted services at December 31, 2018.

These contractual obligations do not include unused commitments for dealers and customers discussed in Note 11 of Notes to Consolidated Financial Statements.

CASH FLOWS
Operating cash flow for 2018 was $1.29 billion, compared with $1.23 billion for 2017. Net cash used for investing activities in 2018 was $2.51 billion, compared with $532 million in 2017. The change was primarily due to the impact of portfolio related activity. Net cash provided by financing activities was $1.28 billion in 2018, compared with net cash used for financing activities of $1.81 billion in 2017. The change was primarily due to higher portfolio funding requirements and a lower dividend payment to Caterpillar.


25



CRITICAL ACCOUNTING POLICIES
 
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts.  The more significant estimates include: residual values for leased assets, allowance for credit losses and income taxes. We have incorporated many years of data into the determination of each of these estimates and we have not historically experienced significant adjustments. These assumptions are reviewed at least annually with the Audit Committee of the Caterpillar Inc. Board of Directors. Following are the methods and assumptions used in determining our estimates and an indication of the risks inherent in each.
 
Residual values for leased assets
Lease residual values are an estimate of the market value of leased equipment at the end of the lease term and are based on an analysis of historical wholesale market sales prices, projected forward on a level trend line without consideration for inflation or possible future pricing action.  At the inception of the lease, residual values are estimated with consideration of the following critical factors: market size and demand, any known significant market/product trends, total expected hours of usage, machine configuration, application, location, model changes, quantities, past remarketing experience, third-party residual guarantees and contractual customer purchase options.  Many of these factors are gathered in an application survey that is completed prior to quotation.  The lease agreement also clearly defines applicable return conditions and remedies for non-compliance, to ensure that the leased equipment will be in good operating condition upon return.  Model changes and updates, as well as market strength and product acceptance, are monitored and adjustments are made to residual values in accordance with the significance of any such changes.  Remarketing sales staff works closely with customers and dealers to manage the sale of lease returns and the recovery of residual exposure.

During the term of the equipment on operating leases, we evaluate our depreciation on a regular basis taking into consideration expected residual values at lease termination.   Adjustments to depreciation expense reflecting revised estimates of expected residual values at the end of the lease terms are recorded prospectively on a straight-line basis. For finance leases, residual value adjustments are recognized through a reduction of finance revenue.

We evaluate the carrying value of equipment on operating leases for potential impairment when we determine a triggering event has occurred. When a triggering event occurs, a test for recoverability is performed by comparing projected undiscounted future cash flows to the carrying value of the equipment on operating leases. If the test for recoverability identifies a possible impairment, the fair value of the equipment on operating leases is measured in accordance with the fair value measurement framework. An impairment charge is recognized for the amount by which the carrying value of the equipment on operating leases exceeds its estimated fair value.

At December 31, 2018, the aggregate residual value of equipment on operating leases was $2.21 billion. Without consideration of other factors such as third-party residual guarantees or contractual customer purchase options, a 10 percent non-temporary decrease in the market value of our equipment subject to operating leases would reduce residual value estimates and result in recognition of approximately $80 million of additional annual depreciation expense.
 
Allowance for credit losses
The allowance for credit losses is an estimate of the losses inherent in our finance receivable portfolio and includes consideration of accounts that have been individually identified as impaired, as well as pools of finance receivables where it is probable that certain receivables in the pool are impaired but the individual accounts cannot yet be identified.   In identifying and measuring impairment, management takes into consideration past loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of underlying collateral and current economic conditions.  

Accounts are identified for individual review based on past-due status and information available about the customer, such as financial statements, news reports and published credit ratings, as well as general information regarding industry trends and the economic environment in which our customers operate. The allowance for credit losses attributable to finance receivables that are individually evaluated and determined to be impaired is based on the present value of expected future cash flows discounted at the receivables' effective interest rate, the fair value of the collateral for collateral-dependent receivables or the observable market price of the receivable.  In determining collateral value, we estimate the current fair market value of the collateral less selling costs. We also consider credit enhancements such as additional collateral and contractual third-party guarantees. The allowance for credit losses attributable to the remaining accounts not yet individually identified as impaired is estimated based on loss forecast models utilizing probabilities of default, our estimate of the loss emergence period and the estimated loss given default.  In addition, qualitative factors not able to be fully captured in our loss forecast models including industry trends, macroeconomic factors and model imprecision are considered in the evaluation of the adequacy of the allowance for credit losses.  These qualitative factors are subjective and require a degree of management judgment.

26




While management believes it has exercised prudent judgment and applied reasonable assumptions, there can be no assurance that in the future, changes in economic conditions or other factors would not cause changes in the financial health of our customers.  If the financial health of our customers deteriorates, the timing and level of payments received could be impacted and therefore, could result in a change to our estimated losses.

Income taxes
We are subject to the income tax laws of the many jurisdictions in which we operate. These tax laws are complex, and the manner in which they apply to our facts is sometimes open to interpretation. In establishing the provision for income taxes, we must make judgments about the application of these inherently complex tax laws. Our income tax positions and analysis are based on currently enacted tax law. Future changes in tax law or related interpretations could significantly impact the provision for income taxes, the amount of taxes payable, and the deferred tax asset and liability balances.

Despite our belief that our tax return positions are consistent with applicable tax laws, we believe that taxing authorities could challenge certain positions. Settlement of any challenge can result in no change, a complete disallowance, or some partial adjustment reached through negotiations or litigation. We record tax benefits for uncertain tax positions based upon management's evaluation of the information available at the reporting date. To be recognized in the financial statements, a tax benefit must be at least more likely than not of being sustained based on technical merits. The benefit for positions meeting the recognition threshold is measured as the largest benefit more likely than not of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. Significant judgment is required in making these determinations and adjustments to unrecognized tax benefits may be necessary to reflect actual taxes payable upon settlement. Adjustments related to positions impacting the effective tax rate affect the provision for income taxes. Adjustments related to positions impacting the timing of deductions impact deferred tax assets and liabilities.

Deferred tax assets generally represent tax benefits for tax deductions or credits available in future tax returns. Certain estimates and assumptions are required to determine whether it is more likely than not that all or some portion of the benefit of a deferred tax asset will not be realized. In making this assessment, management analyzes the trend of U.S. GAAP earnings and estimates the impact of future taxable income, reversing temporary differences and available prudent and feasible tax planning strategies. Should a change in facts or circumstances lead to a change in judgment about the ultimate realizability of a deferred tax asset, we record or adjust the related valuation allowance in the period that the change in facts and circumstances occurs, along with a corresponding increase or decrease in the provision for income taxes.

As a result of U.S. tax reform legislation, distributions of profits from non-U.S. subsidiaries are not expected to cause a significant incremental U.S. tax impact in the future. However, these distributions may be subject to non-U.S. withholding taxes if profits are distributed from certain jurisdictions. We have not recorded a deferred tax liability for withholding taxes in non-U.S. jurisdictions where earnings are considered indefinitely reinvested. If management intentions or U.S. tax law changes in the future, there could be an impact on the provision for income taxes to record an incremental tax liability in the period the change occurs. A deferred tax asset is recognized only if we have definite plans to generate a U.S. tax benefit by repatriating earnings in the foreseeable future.

Income taxes are based on the statutory tax rate of the jurisdiction in which earnings are subject to taxation. That statutory rate may differ from the statutory rate of the jurisdiction in which that entity is incorporated. Taxes are paid in the jurisdictions where earnings are subject to taxation. The effective tax rate differs from the U.S. statutory rate in part due to indefinitely reinvested profits of non-U.S. subsidiaries being subject to statutory tax rates which differ from the U.S. rate of 21 percent.


27



Item 7A. 
Quantitative and Qualitative Disclosures About Market Risk.
 
In the normal course of business, our earnings and cash flow are subject to fluctuations due to changes in foreign currency exchange rates and interest rates. We use derivative financial instruments to manage foreign currency exchange rate and interest rate exposures.  Our Risk Management Policy prevents us from using these instruments for speculative purposes.
 
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 contracts to manage our exposure to interest rate changes.
 
We have a match-funding policy that addresses interest rate risk by aligning the interest rate profile (fixed or floating rate and duration) of our debt portfolio with the interest rate profile of our finance receivable 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 finance receivable portfolio.  This matched funding reduces the volatility of margins between interest-bearing assets and interest-bearing liabilities, regardless of which direction interest rates move.
 
In order to properly manage our sensitivity to changes in interest rates, we measure the potential impact of different interest rate assumptions on pre-tax earnings.  All on-balance sheet positions, including derivative financial instruments, are included in the analysis.  The primary assumptions used in the analysis are that there are no new fixed rate assets or liabilities, the proportion of fixed rate debt to fixed rate assets remains unchanged and the level of floating rate assets and debt remains constant.  An analysis of the December 31, 2018 balance sheet, using these assumptions, estimates the impact of a 100 basis point immediate and sustained adverse change in interest rates to have a $4 million adverse impact on pre-tax earnings.  Last year, similar assumptions and calculations yielded a potential $5 million adverse impact on pre-tax earnings.
 
This analysis does not necessarily represent our current outlook of future market interest rate movement, nor does it consider any actions management could undertake in response to changes in interest rates.  Accordingly, no assurance can be given that actual results would be consistent with the results of our analysis.
 
Foreign currency exchange rate risk
We have balance sheet positions and expected future transactions denominated in foreign currencies, thereby creating exposure to movements in exchange rates. In managing foreign currency risk, our objective is to minimize earnings volatility resulting from conversion and the remeasurement of net foreign currency balance sheet positions and future transactions denominated in foreign currencies.  Our policy allows the use of foreign currency forward, option and cross currency contracts to offset the risk of currency mismatch between our assets and liabilities and exchange rate risk associated with future transactions denominated in foreign currencies. An analysis of the December 31, 2018 balance sheet estimates the net impact of a 10 percent adverse change in the value of the U.S. dollar relative to all other currencies, to have a net impact to pre-tax earnings of less than $1 million. A similar analysis performed on the December 31, 2017 balance sheet resulted in an estimated net impact to pre-tax earnings of less than $2 million.
 
This analysis does not necessarily represent our current outlook for the U.S. dollar relative to all other currencies, nor does it consider any actions management could undertake in response to changes in the foreign currency markets.  Accordingly, no assurance can be given that actual results would be consistent with the results of our analysis.


28



Item 8. 
Financial Statements and Supplementary Data.
 
Information required by Item 8 is included following the Report of Independent Registered Public Accounting Firm.

Item 9. 
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
 
None.
Item 9A.
Controls and Procedures.
 
Evaluation of Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and our Chief Financial Officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, as of December 31, 2018. Based on that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of December 31, 2018.

Management’s Report on Internal Control over Financial Reporting
The management of Cat Financial is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined under Exchange Act Rule 13a-15(f). 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 our assets; (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 our receipts and expenditures are being made only in accordance with authorizations of our management and directors and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our 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 our internal control over financial reporting as of December 31, 2018. 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 (2013). Based on our assessment, we concluded that, as of December 31, 2018, our internal control over financial reporting was effective based on those criteria.

The effectiveness of our internal control over financial reporting as of December 31, 2018 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

Changes in Internal Control over Financial Reporting
There have been no changes in the Company's internal control over financial reporting during the fourth quarter of 2018 covered by this Annual Report on Form 10-K that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B. 
Other Information.
 
None.

29



PART III
 
Item 14. 
Principal Accounting Fees and Services.
 
As a wholly-owned subsidiary of Caterpillar Inc., our principal accounting fees and services are subject to Caterpillar Inc.’s Audit Committee pre-approval policies and procedures described in its Proxy Statement.  This Proxy Statement can be located at Caterpillar Inc.’s Internet site (www.caterpillar.com), under Investors, Financial Information, Proxy Statement.  Other than these policies and procedures, the information contained at that Internet site is not incorporated by reference in this filing.  During 2018, all services provided by the external auditor were pre-approved by Caterpillar’s Audit Committee in accordance with such policy.
 
Fees for professional services provided by our auditors include the following: 
(Millions of dollars)
 
2018
 
2017
Audit fees(1)
 
$
6.6

 
$
5.9

Audit-related fees(2)
 
.3

 
.1

Tax fees(3)
 

 
.1

Total
 
$
6.9

 
$
6.1

 
 
 
 
 
(1) "Audit fees" principally includes audit and review of financial statements (including internal control over financial reporting), statutory and subsidiary audits, SEC registration statements, comfort letters and consents.
(2) "Audit-related fees" principally includes accounting consultations and pre- or post- implementation reviews of processes or systems.
(3) "Tax fees" include, among other things, statutory tax return preparation and review and advising on the impact of changes in local tax laws.

PART IV
 
Item 15. 
Exhibits and Financial Statement Schedules.
The following documents are filed as part of this report.
1

 
Financial Statements:
 
 
·
 
Report of Independent Registered Public Accounting Firm
 
 
·
 
Consolidated Statements of Profit
 
 
·
 
Consolidated Statements of Comprehensive Income
 
 
·
 
Consolidated Statements of Financial Position
 
 
·
 
Consolidated Statements of Changes in Shareholder’s Equity
 
 
·
 
Consolidated Statements of Cash Flows
 
 
·
 
Notes to Consolidated Financial Statements
2

 
Financial Statement Schedules:
 
 
·
 
All schedules are omitted because the required information is shown in the financial statements or the notes thereto or considered to be immaterial.
3

 
Exhibits
3.1
Certificate of Incorporation of the Company, as amended (incorporated by reference from Exhibit 3.1 to the Company’s Form 10 for the year ended December 31, 1984).
3.2
4.1
Indenture, dated as of April 15, 1985, between the Company and Morgan Guaranty Trust Company of New York, as Trustee (incorporated by reference from Exhibit 4.1 to the Company’s Registration Statement on Form S-3, Commission File No. 33-2246).
4.2
First Supplemental Indenture, dated as of May 22, 1986, amending the Indenture dated as of April 15, 1985, between the Company and Morgan Guaranty Trust Company of New York, as Trustee (incorporated by reference from Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q, for the quarter ended June 20, 1986).
4.3
Second Supplemental Indenture, dated as of March 15, 1987, amending the Indenture dated as of April 15, 1985, between the Company and Morgan Guaranty Trust Company of New York, as Trustee (incorporated by reference from Exhibit 4.3 to the Company’s Current Report on Form 8-K, dated April 24, 1987).

30



4.4
Third Supplemental Indenture, dated as of October 2, 1989, amending the Indenture dated as of April 15, 1985, between the Company and Morgan Guaranty Trust Company of New York, as Trustee (incorporated by reference from Exhibit 4.3 to the Company’s Current Report on Form 8-K, dated October 16, 1989).
4.5
Fourth Supplemental Indenture, dated as of October 1, 1990, amending the Indenture dated April 15, 1985, between the Company and Morgan Guaranty Trust Company of New York, as Trustee (incorporated by reference from Exhibit 4.3 to the Company’s Current Report on Form 8-K, dated October 29, 1990).
4.6
Indenture, dated as of July 15, 1991, between the Company and Continental Bank, National Association, as Trustee (incorporated by reference from Exhibit 4.1 to the Company’s Current Report on Form 8-K, dated July 25, 1991).
4.7
4.8
Support Agreement, dated as of December 21, 1984, between the Company and Caterpillar (incorporated by reference from Exhibit 10.2 to the Company’s amended Form 10, for the year ended December 31, 1984).
4.9
 
The registrant hereby undertakes upon request to furnish the Commission with a copy of any instrument with respect to long-term debt where the total amount of securities authorized thereunder does not exceed 10% of the total assets of the registrant and its subsidiaries on a consolidated basis.
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8

31



10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
23
31.1
31.2
32
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document

Item 16. 
Form 10-K Summary
 
Not applicable.


32



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 
 
 
 
Caterpillar Financial Services Corporation
 
 
(Registrant)
 
 
 
 
Date:
February 14, 2019
By:
/s/Leslie S. Zmugg
 
 
 
Leslie S. Zmugg, Secretary
 
 
 
 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
Date
 
Signature
 
Title
 
 
 
 
 
February 14, 2019
 
/s/David T. Walton
 
President, Director and Chief
Executive Officer
 
 
David T. Walton
 
 
 
 
 
 
 
February 14, 2019
 
/s/Andrew R.J. Bonfield
 
Director
 
 
Andrew R.J. Bonfield
 
 
 
 
 
 
 
February 14, 2019
 
/s/Patrick T. McCartan
 
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
 
 
Patrick T. McCartan
 
 
 
 
 
 
 
February 14, 2019
 
/s/Jeffry D. Everett
 
Controller
(Principal Accounting Officer)
 
 
Jeffry D. Everett
 
 
 
 
 
 
 




33



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholder of Caterpillar Financial Services Corporation:

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated statements of financial position of Caterpillar Financial Services Corporation and its subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of profit, comprehensive income, changes in shareholder’s equity and cash flows for each of the three years in the period ended December 31, 2018, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 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, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

Basis for Opinions

The Company's management is responsible for these consolidated 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 the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. 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.

Definition and Limitations of Internal Control over Financial Reporting

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.


34



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
Nashville, Tennessee
February 14, 2019

We have served as the Company’s auditor since 1984.  


35



Caterpillar Financial Services Corporation
CONSOLIDATED STATEMENTS OF PROFIT
For the Years Ended December 31,
(Dollars in Millions)
 
 
 
2018
 
2017
 
2016
Revenues:
 
 
 
 
 
 
Retail finance
 
$
1,308

 
$
1,235

 
$
1,220

Operating lease
 
1,011

 
985

 
1,015

Wholesale finance
 
415

 
307

 
264

Other, net
 
113

 
162

 
96

Total revenues
 
2,847

 
2,689

 
2,595

 
 
 
 
 
 
 
Expenses:
 
 

 
 

 
 

Interest
 
757

 
667

 
611

Depreciation on equipment leased to others
 
819

 
810

 
841

General, operating and administrative
 
423

 
429

 
391

Provision for credit losses
 
354

 
132

 
135

Other
 
38

 
46

 
41

Total expenses
 
2,391

 
2,084

 
2,019

 
 
 
 
 
 
 
Other income (expense)
 
(23
)
 
(15
)
 
(15
)
 
 
 
 
 
 
 
Profit before income taxes
 
433

 
590

 
561

 
 
 
 
 
 
 
Provision (benefit) for income taxes
 
108

 
(4
)
 
171

 
 
 
 
 
 
 
Profit of consolidated companies
 
325

 
594

 
390

 
 
 
 
 
 
 
Less:  Profit attributable to noncontrolling interests
 
20

 
8

 
6

 
 
 
 
 
 
 
Profit1
 
$
305

 
$
586

 
$
384

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 1 Profit attributable to Caterpillar Financial Services Corporation.

See Notes to Consolidated Financial Statements.


36



Caterpillar Financial Services Corporation
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Years Ended December 31,
(Dollars in Millions)

 
 
2018
 
2017
 
2016
 
 
 
 
 
 
 
Profit of consolidated companies
 
$
325

 
$
594

 
$
390

 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
Foreign currency translation, net of tax (expense)/benefit of:
2018-$25; 2017-$106; 2016-$(25)
 
(309
)
 
414

 
(104
)
Derivative financial instruments:
 
 
 
 
 
 
Gains (losses) deferred, net of tax (expense)/benefit of:
2018-$(29); 2017-$28; 2016-$(8)
 
98

 
(49
)
 
15

(Gains) losses reclassified to earnings, net of tax expense/(benefit) of:
2018-$38; 2017-$(27); 2016-$9
 
(129
)
 
45

 
(16
)
Total Other comprehensive income (loss), net of tax
 
(340
)
 
410

 
(105
)
 
 
 
 
 
 
 
Comprehensive income (loss)
 
(15
)
 
1,004

 
285

 
 
 
 
 
 
 
Less: Comprehensive income (loss) attributable to the noncontrolling interests
 
13

 
15

 
(1
)
 
 
 
 
 
 
 
Comprehensive income (loss) attributable to Caterpillar Financial Services
Corporation
 
$
(28
)
 
$
989

 
$
286

 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements.

37



Caterpillar Financial Services Corporation
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
At December 31,
(Dollars in Millions, except share data)
 
 
 
2018
 
2017
Assets:
 
 
 
 
Cash and cash equivalents
 
$
766

 
$
708

Finance receivables, net
 
27,923

 
27,126

Notes receivable from Caterpillar
 
662


559

Equipment on operating leases,
 
 

 
 

less accumulated depreciation
 
3,562

 
3,568

Other assets
 
1,268

 
1,199

Total assets
 
$
34,181

 
$
33,160

 
 
 
 
 
Liabilities and shareholder’s equity:
 
 

 
 

Payable to dealers and others
 
$
117

 
$
190

Payable to Caterpillar – borrowings and other
 
1,601

 
1,723

Accrued expenses
 
259

 
274

Short-term borrowings
 
5,723

 
4,836

Current maturities of long-term debt
 
5,820

 
6,188

Long-term debt
 
16,995

 
15,918

Other liabilities
 
817

 
767

Total liabilities
 
31,332

 
29,896

 
 
 
 
 
Commitments and contingent liabilities (Note 11)
 


 


 
 
 
 
 
Common stock - $1 par value
 
 

 
 

Authorized:  2,000 shares; Issued and
 
 

 
 

outstanding:  one share (at paid-in amount)
 
745

 
745

Additional paid-in capital
 
2

 
2

Retained earnings
 
2,874

 
2,969

Accumulated other comprehensive income/(loss)
 
(925
)
 
(592
)
Noncontrolling interests
 
153

 
140

Total shareholder’s equity
 
2,849

 
3,264

 
 
 
 
 
Total liabilities and shareholder’s equity
 
$
34,181

 
$
33,160

 
 
 
 
 
 See Notes to Consolidated Financial Statements.

38



Caterpillar Financial Services Corporation
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER’S EQUITY
For the Years Ended December 31,
(Dollars in Millions)
 
 
 
Common
stock
 
Additional
paid-in
capital
 
Retained
earnings
 
Accumulated
other
comprehensive
income/(loss)
 
Noncontrolling
interests
 
Total
Balance at December 31, 2015
 
$
745

 
$
2

 
$
2,999

 
$
(897
)
 
$
126

 
$
2,975

Profit of consolidated companies
 
 

 
 

 
384

 
 

 
6

 
390

Dividend paid to Caterpillar
 
 

 
 

 
(275
)
 
 

 
 

 
(275
)
Foreign currency translation, net of tax
 
 

 
 

 
 

 
(97
)
 
(7
)
 
(104
)
Derivative financial instruments, net of tax
 
 

 
 

 
 

 
(1
)
 
 
 
(1
)
Balance at December 31, 2016
 
$
745

 
$
2

 
$
3,108

 
$
(995
)
 
$
125

 
$
2,985

Profit of consolidated companies
 
 

 
 

 
586

 
 

 
8

 
594

Dividend paid to Caterpillar
 
 

 
 

 
(725
)
 
 

 
 

 
(725
)
Foreign currency translation, net of tax
 
 

 
 

 
 

 
407

 
7

 
414

Derivative financial instruments, net of tax
 
 

 
 

 
 

 
(4
)
 
 

 
(4
)
Balance at December 31, 2017
 
$
745

 
$
2

 
$
2,969

 
$
(592
)
 
$
140

 
$
3,264

Profit of consolidated companies
 
 

 
 

 
305

 
 
 
20

 
325

Dividend paid to Caterpillar
 
 

 
 

 
(400
)
 
 
 
 
 
(400
)
Foreign currency translation, net of tax
 
 

 
 

 
 
 
(302
)
 
(7
)
 
(309
)
Derivative financial instruments, net of tax
 
 

 
 

 
 

 
(31
)
 
 
 
(31
)
Balance at December 31, 2018
 
$
745

 
$
2

 
$
2,874

 
$
(925
)
 
$
153

 
$
2,849

 
 
 
 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements.

39



Caterpillar Financial Services Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
 (Dollars in Millions)
 
 
2018
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
 
 
Profit of consolidated companies
 
$
325

 
$
594

 
$
390

Adjustments for non-cash items:
 
 

 
 

 
 

Depreciation and amortization
 
832

 
820

 
851

Amortization of receivables purchase discount
 
(375
)
 
(253
)
 
(207
)
Provision for credit losses
 
354

 
132

 
135

Other, net
 
164

 
61

 
75

Changes in assets and liabilities:
 
 

 
 

 
 

Other assets
 
44

 
60

 
(12
)
Payable to dealers and others
 
(57
)
 
(66
)
 
36

Accrued expenses
 
(6
)
 
31

 
(61
)
Other payables with Caterpillar
 
(10
)
 
36

 
(13
)
Other liabilities
 
16

 
(188
)
 
217

Net cash provided by operating activities
 
1,287

 
1,227

 
1,411

Cash flows from investing activities:
 
 

 
 

 
 

Expenditures for equipment on operating leases
 
(1,451
)
 
(1,362
)
 
(1,628
)
Capital expenditures - excluding equipment on operating leases
 
(108
)
 
(11
)
 
(8
)
Proceeds from disposals of equipment
 
793

 
1,003

 
789

Additions to finance receivables
 
(13,595
)
 
(13,920
)
 
(11,862
)
Collections of finance receivables
 
12,511

 
14,353

 
12,341

Net changes in Caterpillar purchased receivables
 
(1,046
)
 
(732
)
 
399

Proceeds from sales of receivables
 
477

 
127

 
127

Net change in variable lending to Caterpillar
 
(58
)
 
(51
)
 
30

Additions to other notes receivable with Caterpillar
 
(390
)
 
(53
)
 
(146
)
Collections on other notes receivable with Caterpillar
 
345

 
75

 
76

Settlements of undesignated derivatives
 
10

 
45

 
(25
)
Other, net
 

 
(6
)
 
5

Net cash provided by (used for) investing activities
 
(2,512
)
 
(532
)
 
98

Cash flows from financing activities:
 
 

 
 

 
 

Net change in variable lending from Caterpillar
 
(109
)
 
40

 
1,492

Proceeds from borrowings with Caterpillar
 

 

 
253

Payments on borrowings with Caterpillar
 

 
(49
)
 
(1,203
)
Proceeds from debt issued (original maturities greater than three months)
 
8,850

 
8,702

 
5,109

Payments on debt issued (original maturities greater than three months)
 
(7,822
)
 
(6,923
)
 
(6,035
)
Short-term borrowings, net (original maturities three months or less)
 
762

 
(2,854
)
 
(61
)
Dividend paid to Caterpillar
 
(400
)
 
(725
)
 
(275
)
Net cash provided by (used for) financing activities
 
1,281

 
(1,809
)
 
(720
)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
 
(15
)
 
22

 
1

Increase/(decrease) in cash, cash equivalents and restricted cash
 
41

 
(1,092
)
 
790

Cash, cash equivalents and restricted cash at beginning of period (1)
 
732

 
1,824

 
1,034

Cash, cash equivalents and restricted cash at end of period (1)
 
$
773

 
$
732

 
$
1,824

 
 
 
 
 
 
 
Cash paid for interest
 
$
743

 
$
647

 
$
608

Cash (received) paid for taxes
 
$
79

 
$
159

 
$
(61
)
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.
(1) As of December 31, 2018, 2017 and 2016, restricted cash, which is included in Other assets in the Consolidated Statements of Financial Position, was $7 million, $24 million and $29 million, respectively. Restricted cash primarily includes cash related to syndication activities and certain tax deferred transactions which were discontinued in 2018 due to U.S. tax reform legislation.
Non-cash activity: In September 2016, $381 million of medium-term notes with varying interest rates and maturity dates were exchanged for $366 million of 1.93% medium-term notes due in 2021 and $15 million of cash. In addition, a debt exchange premium of $33 million was paid and is included in the operating section of the Consolidated Statements of Cash Flows.
See Notes to Consolidated Financial Statements.

40



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
A. Nature of Operations
 
Caterpillar Financial Services Corporation, a Delaware corporation organized in 1981 (together with its subsidiaries, "Cat Financial," "the Company," "we" and "our"), is a wholly-owned finance subsidiary of Caterpillar Inc. (together with its other subsidiaries, "Caterpillar" or "Cat").  Our primary business is to provide retail and wholesale financing alternatives for Caterpillar products to customers and dealers around the world.  Retail financing is primarily comprised of financing of Caterpillar equipment, machinery and engines.  In addition, we also provide financing for vehicles, power generation facilities and marine vessels that, in most cases, incorporate Caterpillar products.  We also provide wholesale financing to Caterpillar dealers and purchase short-term receivables from Caterpillar. The various financing plans offered by Cat Financial are primarily designed to increase the opportunity for sales of Caterpillar products and generate financing income for Cat Financial.  A significant portion of our activities is conducted in North America.  However, we have additional offices and subsidiaries in Latin America, Asia/Pacific, Europe, Africa and the Middle East.

B. Basis of Presentation
 
The accompanying consolidated financial statements include the accounts of Cat Financial and consolidated variable interest entities (VIEs) in which Cat Financial is the primary beneficiary.  
We consolidate all VIEs where we are the primary beneficiary. For VIEs, we assess whether we are the primary beneficiary as prescribed by the accounting guidance on the consolidation of VIEs. The primary beneficiary of a VIE is the party that has both the power to direct the activities that most significantly impact the entity’s economic performance and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the entity. Please refer to Note 11 for more information.

We have customers and dealers that are VIEs of which we are not the primary beneficiary. Although we have provided financial support to these entities and therefore have a variable interest, we do not have the power to direct the activities that most significantly impact their economic performance. Our maximum exposure to loss from our involvement with these VIEs is limited to the credit risk inherently present in the financial support that we have provided. These risks are evaluated and reflected in our financial statements as part of our overall portfolio of finance receivables and related allowance for credit losses.
Certain amounts for prior years have been reclassified to conform with current-year financial statement presentation.
C. Revenue Recognition
 
Finance revenue is recorded over the life of the related finance receivable using the interest method, including the accretion of purchased receivables discount and certain direct origination costs that are deferred. Revenue from rental payments received on operating leases is recognized on a straight-line basis over the term of the lease.

Recognition of finance revenue and operating lease revenue is suspended and the account is placed on non-accrual status when management determines that collection of future income is not probable (generally after 120 days past due).  Recognition is resumed, and previously suspended income is recognized, when the account becomes current and collection of remaining amounts is considered probable.
 
We participate in certain marketing programs offered in conjunction with Caterpillar and/or Caterpillar dealers that allow us to periodically offer financing to customers at interest rates that are below market rates.  Under these marketing programs, Caterpillar and/or the dealer funds an amount at the outset of the transaction, which we then recognize as revenue over the term of the financing.  The funds we receive from Caterpillar and/or the dealer equal an amount that when combined with the customer’s contractual interest provides us with a market interest rate.

Other revenue includes: (1) late charges, (2) fee revenue, primarily commitment fees and fees on committed lines of credit or letters of credit, (3) gains and losses on sales of returned or repossessed equipment, (4) impairments on returned or repossessed equipment held for sale, (5) gains and losses on loan and lease sales and (6) other miscellaneous revenues. Other revenue items are recognized in accordance with relevant authoritative pronouncements.



41



D. Depreciation
 
Depreciation for equipment on operating leases is recognized using the straight-line method over the lease term, typically one to seven years.  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.
 
E. Residual Values
 
The residuals for leases classified as operating leases are included in Equipment on operating leases.  The residuals for leases classified as finance leases, in accordance with lease accounting, are included in finance receivables.

During the term of the equipment on operating leases, we evaluate our depreciation on a regular basis taking into consideration expected residual values at lease termination.   Adjustments to depreciation expense reflecting revised estimates of expected residual values at the end of the lease terms are recorded prospectively on a straight-line basis. For finance leases, residual value adjustments are recognized through a reduction of finance revenue.

We evaluate the carrying value of equipment on operating leases for potential impairment when we determine a triggering event has occurred. When a triggering event occurs, a test for recoverability is performed by comparing projected undiscounted future cash flows to the carrying value of the equipment on operating leases. If the test for recoverability identifies a possible impairment, the fair value of the equipment on operating leases is measured in accordance with the fair value measurement framework. An impairment charge is recognized for the amount by which the carrying value of the equipment on operating leases exceeds its estimated fair value.
 
F. Derivative Financial Instruments
 
Our earnings and cash flow are subject to fluctuations due to changes in foreign currency exchange rates and interest rates.  Our Risk Management Policy (policy) allows for the use of derivative financial instruments to manage foreign currency exchange rate and interest rate exposures.  Our policy specifies that derivatives are not to be used for speculative purposes.  Derivatives that we use are primarily foreign currency forward, option and cross currency contracts and interest rate contracts.  All derivatives are recorded at fair value. See Note 9 for additional information.
 
G. Allowance for Credit Losses
 
The allowance for credit losses is an estimate of the losses inherent in our finance receivable portfolio and includes consideration of accounts that have been individually identified as impaired, as well as pools of finance receivables where it is probable that certain receivables in the pool are impaired but the individual accounts cannot yet be identified.   In identifying and measuring impairment, management takes into consideration past loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of underlying collateral and current economic conditions.  

Accounts are identified for individual review based on past-due status and information available about the customer, such as financial statements, news reports and published credit ratings, as well as general information regarding industry trends and the economic environment in which our customers operate. The allowance for credit losses attributable to finance receivables that are individually evaluated and determined to be impaired is based on the present value of expected future cash flows discounted at the receivables' effective interest rate, the fair value of the collateral for collateral-dependent receivables or the observable market price of the receivable.  In determining collateral value, we estimate the current fair market value of the collateral less selling costs. We also consider credit enhancements such as additional collateral and contractual third-party guarantees. The allowance for credit losses attributable to the remaining accounts not yet individually identified as impaired is estimated based on loss forecast models utilizing probabilities of default, our estimate of the loss emergence period and the estimated loss given default.  In addition, qualitative factors not able to be fully captured in our loss forecast models including industry trends, macroeconomic factors and model imprecision are considered in the evaluation of the adequacy of the allowance for credit losses.  These qualitative factors are subjective and require a degree of management judgment.

Receivable balances, including accrued interest, are written off against the allowance for credit losses when, in the judgment of management, they are considered uncollectible (generally upon repossession of the collateral). The amount of the write-off is determined by comparing the fair value of the collateral, less cost to sell, to the recorded investment. Subsequent recoveries, if any, are credited to the allowance for credit losses when received.


42



H. Income Taxes
 
The provision for income taxes is determined using the asset and liability approach taking into account guidance related to uncertain tax positions.  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.
 
We join Caterpillar in the filing of a consolidated U.S. Federal income tax return and certain state income tax returns.  In accordance with our tax sharing agreement with Caterpillar, we generally pay to or receive from Caterpillar our allocated share of income taxes or credits reflected in these consolidated filings. This amount is calculated on a separate return basis by taking taxable income times the applicable statutory tax rate and includes payment for certain tax attributes earned during the year.
 
I. Foreign Currency Translation
 
The functional currency for most of our subsidiaries is the respective local currency. Gains and losses resulting from the remeasurement of foreign currency amounts to the functional currency are included in Other income (expense) in the Consolidated Statements of Profit. Gains and losses resulting from translating assets and liabilities from the functional currency to U.S. dollars are included in Accumulated other comprehensive income/(loss) in the Consolidated Statements of Financial Position.
 
J. Use of Estimates in the Preparation of Financial Statements
 
The preparation of financial statements, in conformity with generally accepted accounting principles in the United States of America, requires management to make estimates and assumptions that affect the reported amounts.  Significant estimates include residual values for leased assets, allowance for credit losses and income taxes. Actual results may differ from these estimates.

K. New Accounting Pronouncements
 
Revenue recognition – In May 2014, the Financial Accounting Standards Board (FASB) issued new revenue recognition guidance to provide a single, comprehensive revenue recognition model for all contracts with customers. Under the new guidance, an entity will recognize revenue to depict the transfer of promised goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. A five step model has been introduced for an entity to apply when recognizing revenue. The new guidance also includes enhanced disclosure requirements. The guidance was effective January 1, 2018, and was applied on a modified retrospective basis. The adoption did not have a material impact on our financial statements.

Recognition and measurement of financial assets and financial liabilities – In January 2016, the FASB issued accounting guidance that affects the accounting for equity investments, financial liabilities accounted for under the fair value option and the presentation and disclosure requirements for financial instruments. Under the new guidance, all equity investments in unconsolidated entities (other than those accounted for using the equity method of accounting) will generally be measured at fair value through earnings. There will no longer be an available-for-sale classification for equity securities with readily determinable fair values. For financial liabilities when the fair value option has been elected, changes in fair value due to instrument-specific credit risk will be recognized separately in other comprehensive income. In addition, the FASB clarified guidance related to the valuation allowance assessment when recog