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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended January 31, 2003, for Deere & Company. The Company operates in two primary segments: Equipment Operations (agricultural, commercial/consumer, and construction/forestry equipment) and Financial Services (credit and health care operations). The filing reflects a return to profitability driven by improved sales volumes, manufacturing efficiencies, and the adoption of new accounting standards regarding goodwill.

Key Financial Metrics

Note: Operating cash flow was negative due to seasonal inventory build-up and working capital adjustments.

Material Changes vs. Prior Period

• Profitability Turnaround: The Company reported a net income of $68.0 million, reversing a net loss of $38.1 million in the prior year. This improvement was driven by a $14 million pretax benefit from the discontinuance of goodwill amortization (FASB 142) and improved operating margins.
• Revenue Growth: Total net sales and revenues increased 11% to $2,793.6 million. Equipment net sales rose 17% to $2,273.7 million, led by a 35% increase in Commercial and Consumer Equipment and a 32% increase in Construction and Forestry.
• Segment Performance:
  • Agricultural Equipment: Sales up 8%; operating profit improved from a $15 million loss to a $6 million profit.
  • Commercial & Consumer: Sales up 35%; operating profit improved from a $43 million loss to a $23 million profit.
  • Construction & Forestry: Sales up 32%; operating profit improved from a $66 million loss to a $16 million profit.
  • Credit: Operating profit decreased 9% to $107 million due to lower gains on retail note sales, partially offset by lower credit loss provisions.
• Cost Structure: The cost of sales to net sales ratio improved to 81.7% from 86.6% in the prior year, aided by manufacturing efficiencies and the cessation of goodwill amortization. However, postretirement benefit costs increased by $75 million pretax.

Guidance, Outlook, and Risks

Management Guidance:

• Q2 2003 Forecast: Net equipment sales expected to be up 10-15% year-over-year; Company-wide net income projected between $200 million and $250 million.
• Full Year 2003 Forecast: Equipment sales expected to rise 7-9%; full-year net income projected in the range of $500 million to $600 million.
• Credit Segment: Expected net income of approximately $300 million for the year.

Key Risks and Contingencies:

• Market Conditions: Economic uncertainties, weather conditions (drought), and delays in U.S. Farm Bill aid signups are impacting agricultural sales. Construction markets remain under pressure due to weak business investment.
• Contingent Liabilities: The Company has guarantees on financing receivables with a maximum exposure of $211 million. Additionally, minority ownership interests in unconsolidated affiliates include put options totaling approximately $170 million to $250 million, exercisable between December 2004 and March 2005.
• Legal Proceedings: Various unresolved legal actions exist regarding product liability (including asbestos), retail credit, and intellectual property, though management does not expect a material effect on financial statements.

Investor Verification Checklist

• Goodwill Accounting Impact: Verify the specific $14 million pretax benefit from FASB 142 adoption to understand the non-cash nature of the profit improvement.
• Postretirement Benefit Costs: Review the $75 million increase in these costs and the $475 million cash contribution made in March 2003 to assess future cash flow obligations.
• Inventory Levels: Confirm the seasonal inventory build-up ($558 million increase) and its impact on working capital and future sales potential.
• Debt Ratings: Monitor credit ratings (currently A3/A-), as a downgrade below Baa3/BBB- could trigger immediate exercise of put options on affiliate interests.
• Argentina Exposure: Assess the impact of currency devaluation in Argentina, which caused a $12 million loss in the prior year and continues to pose a risk.