Deere & Company — Q2 FY2018 Form 10-Q
Business context and reporting period
Unaudited quarterly filing for the 13 weeks ended April 29, 2018, with six-month comparisons to April 30, 2017. Deere reports Agriculture and Turf, Construction and Forestry, and Financial Services. The December 2017 Wirtgen acquisition materially expanded Construction and Forestry.
Financial performance and position
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Net sales and revenues | $10.720B | $8.287B | $17.634B | $13.912B |
| Net sales, equipment operations | $9.747B | $7.260B | $15.721B | $11.958B |
| Net income attributable to Deere | $1.208B | $809M | $673M | $1.008B |
| Diluted EPS | $3.67 | $2.50 | $2.05 | $3.14 |
- Quarterly operating profit across segments was $1.494B, up 17%; six-month segment operating profit was $2.130B, up 25%. Segment measures are before corporate and other reconciling items.
- Cost of sales was 75.2% of net sales in Q2 versus 74.8% a year earlier, and 76.6% for six months versus 77.0%. Quarterly pressure reflected Wirtgen purchase accounting and higher production costs; lower warranty costs partly offset this.
- Six-month operating cash flow was negative $1.222B, compared with negative $164M. Investing cash flow was negative $5.153B, primarily including $5.171B for acquisitions. Financing cash flow was positive $1.095B. Cash declined $5.134B to $4.201B.
- At April 29, cash and marketable securities totaled $4.681B. Short-term borrowings were $10.895B, short-term securitization borrowings $4.401B, and long-term borrowings $26.279B. Worldwide credit lines totaled $8.073B, of which $4.019B was unused.
- Deere stockholders’ equity was $10.410B. Equipment operations’ debt-to-capital ratio was 38%; Financial Services’ interest-bearing debt-to-equity ratio was 7.8:1.
- Financial Services six-month net income attributable to Deere was $529M, versus $218M. Results benefited from a higher average portfolio and lower credit-loss provisions and lease residual losses, partly offset by less favorable financing spreads and higher interest expense.
Material changes and unusual items
- Wirtgen contributed $873M of Q2 and $1.127B of six-month sales and revenues. Its reported operating profit was $41M for Q2 and an operating loss of $51M for six months, reflecting purchase-accounting effects and acquisition costs. The acquisition added $2.060B of goodwill; purchase price, net of acquired cash, was $5.130B.
- Tax reform substantially affected reported earnings: Q2 included a provisional $174M tax benefit, while the first six months included $803M of provisional tax expense. The six-month provision also reflects provisional deferred-tax remeasurement and deemed repatriation tax estimates; adjustments remained subject to the measurement period.
- Deere approved a voluntary $1.000B contribution to U.S. pension and postretirement plans. It had contributed $50M of the voluntary amount in Q2 and anticipated most of the remainder in Q3.
- Cash and marketable securities fell sharply from fiscal year-end, primarily due to the Wirtgen acquisition. Inventory and trade receivables also rose, reflecting acquisition effects, seasonality, higher production and demand.
Outlook, commentary and risks
- FY2018 net income attributable to Deere was forecast at approximately $2.3B, including $803M of provisional tax expense; the prior forecast was $2.1B with $977M of provisional tax expense. Net sales and revenues were expected to rise about 26%.
- Equipment sales were projected to increase about 30% for FY2018 and 35% in Q3 year over year. Agriculture and Turf sales were forecast up about 14%; Construction and Forestry up about 83%, including Wirtgen’s estimated 56% contribution to that segment’s annual sales.
- FY2018 Financial Services net income was forecast at approximately $800M, including a provisional $229M tax benefit; first-quarter guidance had been $840M, including a $262M tax benefit.
- Management cited strengthening farm and construction demand and progress increasing supplier production, while noting higher raw-material and freight costs. Risks include commodity and used-equipment prices, weather, foreign exchange, interest rates, trade policy and tariffs, supply constraints, customer credit conditions, funding access, and acquisition integration.
- Unrecognized tax benefits were $421M, up from $221M at fiscal year-end. A reduction of approximately $160M, with an estimated $55M positive effective-tax-rate impact, was considered reasonably possible within 12 months. The filing says unresolved legal matters are not expected to have a material financial-statement effect; it also describes an Iowa emissions notice and a Brazil oil-spill fine under administrative defense.
Investor verification points
- Verify the assumptions and subsequent adjustments behind the provisional tax-reform expense and the unusually high six-month effective tax burden.
- Assess the durability of the FY2018 earnings and sales outlook, especially demand, production ramp-up, input and freight costs, and Wirtgen integration and purchase-accounting impacts.
- Track seasonal working-capital needs, inventory and receivables growth, post-acquisition cash levels, and the planned pension and postretirement contributions.
- Review Financial Services’ funding costs, leverage, credit quality and delinquencies, lease residual values, and reliance on capital markets and securitization.
- Confirm final Wirtgen purchase-price allocations, tax exposures, and the status of disclosed legal and environmental matters.