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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, 2004
Business Overview: 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 Company reported record net income for the period, driven by strong retail demand, higher shipments, and improved price realization across all equipment segments.

Key Financial Metrics

Note: Debt figures represent the sum of Short-term borrowings and Long-term borrowings from the Consolidated Balance Sheet.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated net sales and revenues increased 34% in Q2 and 30% year-to-date (YTD) compared to the prior year. Equipment net sales rose 37% in Q2 and 34% YTD.
• Profitability Surge: Net income increased 86% in Q2 and 99% YTD. Equipment Operations operating profit jumped 114% in Q2 and 142% YTD, driven by volume and price realization.
• Segment Performance:
  • Agricultural Equipment: Sales up 29% (Q2) and 28% (YTD); Operating profit up 122% (Q2) and 161% (YTD).
  • Construction and Forestry: Sales up 67% (Q2) and 58% (YTD); Operating profit up 311% (Q2) and 356% (YTD). Results included a $30 million pretax gain from the sale of a rental company.
  • Commercial and Consumer: Sales up 33% (Q2) and 28% (YTD); Operating profit up 38% (Q2) and 30% (YTD).
  • Credit: Operating profit remained relatively flat (-1% Q2, +4% YTD) due to lower gains on receivable sales offsetting portfolio growth.
• Cash Flow: Net cash used for operating activities was $908.5 million for the six months ended April 30, 2004, primarily due to $1.025 billion in pension plan contributions and increased inventory/receivables.
• Balance Sheet: Inventories increased $860 million YTD, reflecting seasonal buildup and the consolidation of Nortrax. Total debt decreased compared to the prior year due to lower external borrowings in the credit operations.

Guidance, Outlook, and Risks

Management Outlook (Fiscal 2004):

• Sales: Expected to increase 24% to 26% for the full year.
• Net Income: Forecast to be approximately $1.2 billion for the year.
• Q3 2004 Forecast: Sales expected up 25% to 27%; Net income forecast at approximately $350 million.
• Segment Forecasts: Agricultural equipment sales up 24-26%; Commercial/Consumer up 15-17%; Construction/Forestry up 35-37%.

Key Risks and Contingencies:

• Raw Materials: Rising costs for steel and rubber impact margins, though supply remains adequate.
• Regulatory: Compliance with EPA Tier 3 and Tier 4 emissions rules requires significant investment.
• Legal: Unresolved actions include product liability (including asbestos), retail credit, and intellectual property matters. Management believes these will not have a material effect.
• Guarantees: Maximum exposure to losses on recourse obligations for sold receivables is $215 million; residual value guarantees on operating leases total $40 million.
• Health Care: Higher medical claims costs are expected to keep health care operations near breakeven for the year.

Investor Verification Checklist

• Inventory Levels: Verify the sustainability of the $860 million inventory increase and its impact on future working capital needs.
• Pension Contributions: Confirm the $1.025 billion cash outflow for pension plans and the anticipated $40 million additional contribution for the remainder of the fiscal year.
• Acquisition Impact: Assess the long-term profitability of the Nortrax consolidation, which had an unfavorable operating profit impact of $18 million in Q2.
• Credit Portfolio Quality: Monitor the ratio of earnings to fixed charges (2.08 to 1 in Q2) and delinquency rates given the growth in the loan portfolio.
• Foreign Currency: Evaluate the sensitivity of the 34% revenue growth to foreign exchange rates, as organic growth outside the U.S./Canada was 18% in Q2 excluding currency effects.