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Business Context and Reporting Period

Company: DEERE & CO
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended April 30, 2005
Business Overview: The Company operates through Equipment Operations (agricultural, commercial/consumer, and construction/forestry equipment) and Financial Services (credit and health care). The Company is an accelerated filer with 242,211,084 shares of common stock outstanding as of April 30, 2005.

Key Financial Metrics

Note: Debt figures derived from Balance Sheet short-term borrowings ($5,364.0M) and long-term borrowings ($11,324.3M) as of April 30, 2005.

Material Changes vs. Prior Period

• Revenue Growth: Total net sales and revenues increased 13% in Q2 and 15% for the six months compared to the prior year. Equipment net sales rose 14% in Q2 and 16% for the six months.
• Profitability: Net income increased 27% in Q2 and 28% for the six months. Operating profit grew 19% in Q2 and 20% for the six months.
• Segment Performance:
  • Agricultural Equipment: Sales up 17% (Q2) and 20% (6 months); Operating profit up 13% (Q2) and 26% (6 months).
  • Construction and Forestry: Sales up 28% (Q2) and 30% (6 months); Operating profit up 62% (Q2) and 41% (6 months).
  • Commercial and Consumer: Sales declined 6% (Q2) and 7% (6 months) due to unseasonably cold, wet weather affecting lawn equipment sales.
• Cost Structure: Cost of sales to net sales ratios increased slightly to 75.5% (Q2) and 76.6% (6 months) due to higher raw material costs, partially offset by manufacturing efficiencies and improved price realization.
• Balance Sheet: Total assets increased to $31.7 billion from $26.0 billion a year ago, driven by growth in financing receivables and inventories.

Guidance, Outlook, and Risks

Management Guidance

• Full Year 2005 Net Income: Projected between $1.55 billion and $1.6 billion.
• Q3 2005 Net Income: Projected between $450 million and $475 million.
• Sales Outlook: Equipment sales expected to increase 9-11% for the full year (excluding currency) and 13-15% for Q3. Currency expected to add ~2-3 percentage points.
• Production: Expected to decline 7-9% in the second half of the year to manage inventory levels ahead of 2006 product introductions.
• Financial Services: Full year net income expected to be approximately $315 million.

Risks and Contingencies

• Raw Materials: Rising prices for steel and rubber impact margins, though supply remains adequate.
• Regulatory: Compliance with increasingly stringent global emissions regulations for off-road diesel engines requires significant investment.
• Agricultural Risks: Uncertainty regarding Asian rust and aphids affecting U.S. soybean crops; drought conditions in South America (Brazil) impacting sales.
• Legal: Unresolved legal actions regarding product liability (including asbestos), retail credit, and intellectual property. Management believes these will not have a material effect.
• Accounting Changes: Reclassification of cash flows in 2004 to eliminate non-cash intercompany transactions. Adoption of FASB 123(R) in fiscal 2006 expected to increase expenses by ~$40 million after-tax.

Investor Verification Checklist

• Inventory Levels: Verify the impact of the $891 million inventory increase (seasonal vs. demand-driven) and the LIFO reserve valuation.
• Raw Material Costs: Monitor steel and rubber price trends and their effect on the cost of sales ratio.
• Production Cuts: Confirm the execution of planned production reductions in H2 2005 to align with inventory targets.
• Financial Services Leverage: Review the credit operations' debt-to-equity ratio (7.3 to 1) and the status of the $2 billion revolving conduit facility.
• Foreign Currency: Assess the impact of exchange rate fluctuations on reported sales growth, particularly in South America and Western Europe.