Deere & Company — Q3 2016 Form 10-Q
Business context and reporting period. The unaudited quarter ended July 31, 2016, and comprised 13 weeks; the filing also reports the first nine months of fiscal 2016. Deere operates Agriculture and Turf, Construction and Forestry, and Financial Services businesses. Unless noted otherwise, amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total net sales and revenues | $6,724 | $7,594 | $20,124 | $22,148 |
| Equipment net sales | $5,861 | $6,840 | $17,737 | $19,843 |
| Net income attributable to Deere | $489 | $512 | $1,239 | $1,589 |
| Diluted EPS | $1.55 | $1.53 | $3.91 | $4.67 |
| Operating cash flow | Not separately provided | Not separately provided | $1,320 | $1,192 |
- Q3 revenue fell 11% and equipment sales fell 14%; nine-month revenue fell 9% and equipment sales fell 11%. Equipment sales included 2% price realization and a 2% unfavorable currency effect in both periods.
- Q3 Deere-attributable net income declined 4%, while diluted EPS increased from $1.53 to $1.55, supported by lower average diluted shares (315.7 million versus 334.1 million). Nine-month net income declined 22% and diluted EPS declined 16%.
- Equipment cost of sales was 76.7% of equipment net sales in Q3 versus 78.3% a year earlier; for nine months it was 78.2% versus 78.0%.
- Q3 segment operating profit: Agriculture and Turf $571 (up 21%); Construction and Forestry $54 (down 58%); Financial Services $191 (down 20%). Nine-month segment operating profit was $1,329 (down 4%), $197 (down 58%), and $545 (down 26%), respectively.
- Operating cash flow for nine months rose to $1,320 from $1,192. Investing used $362, financing used $806, and cash increased $159 to $4,321.
- At July 31, cash and marketable securities totaled $4,790; total assets were $58,606 and stockholders’ equity was $7,440. Reported borrowings comprised $7,362 short-term, $5,729 short-term securitization, and $24,128 long-term. Securitization borrowings are secured by restricted receivables.
- Worldwide bank credit lines totaled $7,278, of which $5,350 was unused. Commercial paper outstanding was $1,650. The company reported meeting its credit agreement requirements.
Material changes and unusual items
- Equipment sales and operating profit were pressured by lower shipment volumes, especially in construction and forestry, unfavorable currency effects, and weaker product mix. Agriculture and Turf Q3 profit improved on pricing, lower production costs, and lower selling and administrative expenses.
- Financial Services profit declined amid less favorable financing spreads, higher credit-loss provisions, and increased lease residual-value losses. Interest expense increased 24% in Q3 and 12% year to date, primarily due to higher average borrowing rates.
- A partial sale of Deere’s SiteOne interest generated a $75 pretax ($47 after-tax) gain in Q2 2016; Deere retained approximately 24%. Prior-year results included a $42 pretax gain from the Crop Insurance business sale, affecting comparisons.
- Deere acquired Monosem and an 80% interest in Hagie during 2016. The filing reports approximately $199 of cash outflow for business acquisitions, net of cash acquired.
- In August 2016, the U.S. Department of Justice sued to block Deere’s proposed $190 acquisition of Precision Planting; Deere said it would contest the action and the closing date was uncertain.
Outlook, risks, and contingencies
- Management forecast fiscal 2016 equipment sales down about 10% and Q4 equipment sales down about 8% year over year; the full-year forecast included an approximately 2% unfavorable currency effect. Fiscal 2016 Deere-attributable net income was projected at approximately $1,350.
- Agriculture and Turf sales were forecast down about 8% for fiscal 2016; Construction and Forestry sales down about 18%. Financial Services net income was forecast at approximately $480.
- Management cited the continuing global farm recession and weak construction conditions, while emphasizing cost reductions and operational efficiency. Industry forecasts included U.S./Canada agricultural equipment declines of 15–20% and South American tractor and combine declines of 15–20%.
- Key risks include farm income and commodity prices, construction demand, used-equipment values, credit quality and customer access to financing, financing spreads, interest and currency rates, funding-market access, geopolitical and trade developments, regulation, supply-chain constraints, and product acceptance.
- Legal matters arise in the ordinary course, including product liability, intellectual property, credit, and environmental matters; management stated the reasonably possible losses beyond amounts accrued were not expected to materially affect consolidated financial statements. Deere also reported $160 of equipment-financing guarantees, $260 of property and equipment commitments, and approximately $30 of miscellaneous contingent liabilities considered substantially remote.
- Moody’s affirmed A2 long-term and Prime-1 short-term ratings but changed the outlook to negative on August 15, 2016; S&P ratings were A and A-1 with a stable outlook.
Important facts for investors to verify
- Whether full-year net income guidance of approximately $1,350 and segment sales forecasts remained achievable as farm and construction markets evolved.
- How much of Q3 Agriculture and Turf profit improvement was recurring versus attributable to the SiteOne gain, and how segment margins respond to continued volume declines.
- Trends in Financial Services credit-loss provisions, delinquencies, lease residual values, financing spreads, and funding costs.
- The scale and implications of securitization funding and restricted assets, alongside the company’s liquidity, debt maturities, and rating outlook.
- The outcome and timing of the DOJ action concerning Precision Planting, and any material developments in legal or other contingencies.