Business Context and Reporting Period
Company: DEERE & CO
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and nine months ended July 31, 2006
Business Overview: Deere & Company manufactures and distributes agricultural, commercial, consumer, and construction/forestry equipment. It also provides financial services (credit and leasing) to support equipment sales. The company recently sold its health care operations, which are now reported as discontinued operations.
Key Financial Metrics
| Metric (in millions) | Q3 2006 | Q3 2005 | 9M 2006 | 9M 2005 |
|---|---|---|---|---|
| Net Sales and Revenues | $6,266.7 | $5,823.4 | $17,030.3 | $16,198.7 |
| Net Income | $436.0 | $387.1 | $1,416.5 | $1,213.9 |
| Income from Continuing Ops | $435.7 | $378.8 | $1,176.6 | $1,193.2 |
| Diluted EPS (Total) | $1.85 | $1.58 | $5.96 | $4.89 |
| Operating Cash Flow (9M) | Net cash used: $(337.9) vs $(127.1) | |||
| Total Assets | $34,767.8 | $33,052.0 | (As of July 31) | |
| Stockholders' Equity | $7,569.3 | $6,937.0 | (As of July 31) | |
| Short-term Borrowings | $8,100.2 | $6,115.9 | (As of July 31) | |
| Long-term Borrowings | $11,240.3 | $11,738.2 | (As of July 31) |
Material Changes vs. Prior Period
- Revenue Growth: Total net sales and revenues increased 8% in Q3 and 5% in the first nine months of 2006 compared to the prior year. Equipment sales were essentially unchanged excluding currency and price effects.
- Profitability: Net income rose 13% in Q3 and 17% for the nine-month period. However, income from continuing operations for the nine months decreased slightly (1%) due to higher expenses and tax rates, offset by a significant gain from discontinued operations.
- Discontinued Operations: The sale of the health care business resulted in a $239.9 million gain in the first nine months of 2006, compared to $20.7 million in the prior year. This is the primary driver of the increase in total net income for the nine-month period.
- Segment Performance:
- Agricultural Equipment: Sales up 1% in Q3, down 4% for nine months. Operating profit declined due to lower volumes.
- Construction & Forestry: Sales up 13% in both periods. Operating profit increased 44% in Q3 and 30% for nine months.
- Credit: Operating profit increased 5% in Q3 and 7% for nine months, driven by portfolio growth.
- Cash Flow: Net cash used for operating activities increased to $(337.9) million for the nine months ended July 31, 2006, compared to $(127.1) million in the prior year, largely due to increased receivables and inventory levels.
Guidance, Outlook, and Risks
- Full Year Guidance:
- Net Income: Forecast at approximately $1,625 million for fiscal 2006.
- Q4 Net Income: Forecast at approximately $200 million.
- Equipment Sales: Projected to increase 2-3% for the full year.
- Production: Expected to be down 5% for the year and 10% in Q4 due to asset management initiatives.
- Market Outlook:
- Agricultural: Global farm conditions are solid, but higher input costs and dry weather in key regions (U.S. Plains, South America, Australia) are pressuring sales. Industry retail sales in the U.S./Canada are forecast down 5%.
- Construction: Markets are gaining due to increased spending; sales forecast up 12% for the year.
- Credit: Net income forecast at $340 million for the year, reflecting strong credit quality and portfolio growth.
- Risks and Contingencies:
- Raw Materials: Rising costs for steel and other materials impact margins.
- Restructuring: Closure of a forestry facility in Canada is expected to result in total expenses of approximately $55 million pretax.
- Debt Repurchase: A cash tender offer resulted in a $70 million pretax expense in the first nine months.
- Accounting Changes: Adoption of FASB 123(R) added $64 million in pretax share-based compensation expense for the nine months.
- Legal: Various unresolved legal actions exist (product liability, asbestos, etc.), but management does not expect a material effect.
Investor Verification Checklist
- Discontinued Operations Impact: Verify the sustainability of earnings by analyzing results excluding the $240 million gain from the sale of the health care business.
- Operating Cash Flow: Investigate the significant increase in cash used for operating activities (driven by receivables and inventory build-up) and its impact on liquidity.
- Debt Levels: Review the increase in short-term borrowings to $8.1 billion and the total debt-to-capital ratio to assess leverage.
- Share-Based Compensation: Confirm the impact of the new FASB 123(R) standard on future earnings, noting the $64 million expense recognized in the first nine months.
- Restructuring Costs: Monitor the execution of the Canadian facility closure and the associated $55 million expense estimate.
- Segment Mix: Assess the divergence between declining agricultural sales and growing construction/forestry sales to understand future revenue drivers.