Deere & Company — Q2 FY2016 Form 10-Q
Reporting period: Quarter ended April 30, 2016; the company notes its fiscal quarter actually ended May 1. Quarter and year-to-date comparisons cover 13-week quarters and the six months ended April 30, respectively. All financial amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and performance
Deere manufactures and distributes agricultural, turf, construction and forestry equipment, and provides equipment financing through Financial Services. Management attributed weaker results to the ongoing global farm downturn and further weakness in construction equipment.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total net sales and revenues | $7,875 | $8,171 | $13,400 | $14,554 |
| Net sales, equipment operations | $7,107 | $7,399 | $11,876 | $13,004 |
| Net income attributable to Deere | $495 | $691 | $750 | $1,077 |
| Diluted EPS | $1.56 | $2.03 | $2.36 | $3.14 |
| Operating profit, segments combined | $848 | $1,093 | $1,256 | $1,740 |
Quarterly revenue fell 4% and Deere-attributable net income fell 28%; six-month revenue fell 8% and net income fell 30%. Lower shipment volumes, unfavorable currency effects and less favorable product mix pressured equipment results. Price realization, lower production costs and lower selling, administrative and general expenses partly offset these factors. Average diluted shares declined to 316.5 million from 339.7 million in Q2, and to 317.1 million from 342.8 million year to date.
Segments and margins
- Agriculture and turf: Sales were approximately flat in Q2 and down 5% year to date. Operating profit was $614 million for Q2, down 4%, and $759 million year to date, down 16%.
- Construction and forestry: Sales fell 16% in Q2 and 20% year to date. Operating profit declined 61% to $74 million in Q2 and 57% to $143 million year to date, reflecting lower volumes, higher sales incentives and product mix.
- Financial Services: Operating profit fell 40% to $160 million in Q2 and 29% to $354 million year to date. Deere-attributable segment net income was $103 million and $232 million, respectively. Higher lease residual losses, less favorable financing spreads and higher credit-loss provisions weighed on results; year-to-date results also included unfavorable currency translation.
Equipment cost of sales was 77.8% of net sales in Q2 versus 77.0% a year earlier, and 78.9% year to date versus 77.8%. The filing does not provide a clear consolidated operating margin. Interest expense was $191 million in Q2 versus $166 million, and $364 million year to date versus $346 million.
Cash flow, debt and liquidity
- Consolidated operating cash flow was negative $312 million for the first six months, compared with negative $155 million in 2015. Management cited seasonal increases in sales-related receivables and inventories and lower accounts payable and accrued expenses.
- Investing cash flow was positive $210 million, down from $1,152 million, with lower proceeds from securities and $199 million of net business acquisitions. Financing cash flow was positive $21 million, versus negative $325 million; borrowing inflows were partly offset by dividends and share repurchases.
- Cash and cash equivalents were $4,133 million at April 30, 2016, and marketable securities were $476 million. Together they totaled $4,609 million. Commercial paper outstanding was $3,006 million. Worldwide credit lines totaled $7,220 million, of which $3,994 million was unused. The company reported compliance with its credit agreement requirements.
- Balance-sheet borrowings were $8,576 million short term, $4,642 million short-term securitization borrowings and $24,648 million long term. Equipment Operations’ interest-bearing debt was $4,803 million, with debt-to-capital of 40%. Financial Services’ external interest-bearing debt was $33,063 million, with debt-to-equity of 7.7 to 1.
- Financing receivables, net, were $28,150 million, including securitized receivables. Past-due financing receivables were $505 million and non-performing receivables were $196 million at April 30, 2016. The credit-loss allowance was $165 million.
Outlook, risks and unusual items
- For FY2016, Deere forecast equipment sales down about 9% and net income attributable to Deere of approximately $1.2 billion. Equipment sales were expected to be about 12% lower in Q3 than in the prior-year quarter.
- Agriculture and turf sales were forecast down about 8% for FY2016; construction and forestry sales down about 13%. Financial Services net income was forecast at approximately $480 million.
- Industry agricultural equipment sales were forecast down 15–20% in the U.S. and Canada and South America; EU28 sales were expected flat to down 5%. Key stated uncertainties include commodity prices and farm income, used-equipment demand and pricing, interest and currency rates, customer credit quality, capital-market access, geopolitical events, trade policy, weather, supply constraints and emissions regulation.
- In May 2016, after quarter-end, Deere sold part of its interest in SiteOne Landscapes and terminated a service agreement, recording a $76 million pretax gain ($48 million after tax); management included the gain in its FY2016 earnings forecast. The company also declared a $0.60-per-share dividend payable August 1, 2016.
- During the first half, Deere acquired Monosem and an 80% interest in Hagie for approximately $199 million combined, net of cash acquired. The acquisitions added $14 million of redeemable noncontrolling interest for Hagie. A proposed Precision Planting acquisition, estimated at $190 million net of cash acquired, remained subject to customary closing conditions and regulatory approvals.
- First-half impairment charges were $49.7 million. Legal matters included product liability, retail credit, intellectual property and environmental issues; management said reasonably possible additional losses were not expected to materially affect the consolidated financial statements. Guarantees of third-party retail financing totaled about $172 million, with $4 million accrued. Commitments for property and equipment were approximately $218 million.
- The FY2015 comparison benefited from a $41 million pretax gain on the sale of the Crop Insurance operations. Deere also said a 2016 change in pension and postretirement cost estimation reduced FY2016 service and interest costs by approximately $175 million versus the prior method.
Most important facts for investors to verify
- Whether the forecast of approximately $1.2 billion FY2016 net income, including the May SiteOne gain, is achieved.
- Whether agricultural and construction market declines, shipment volumes and used-equipment values develop as assumed.
- Whether Financial Services’ lease residual losses, credit provisions and financing spreads stabilize; monitor delinquencies and non-performing receivables.
- Liquidity and funding conditions for Financial Services, including commercial paper, securitization funding, debt levels and covenant headroom.
- Integration and final purchase accounting for Monosem and Hagie, and the status and terms of the proposed Precision Planting acquisition.
- Working-capital cash use, particularly seasonal receivables and inventories, and the impact of currency movements and pension-cost methodology.