Highlights from DE's Q3 Conference Call: Highest Q3 Earnings in Company History, Sales Were Second Highest

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August 18, 2010 1:06 PM EDT

This morning, Deere & Company (NYSE: DE) reported Q3 EPS of $1.44, 23 cents better than the analyst estimate of $1.21. Revenue for the quarter was $6.84 billion, and net sales were $6.22 billion, which compares to the estimate of $6.49 billion. Shares are down 2.19% today.

Highlights from DE's Q3 Conference Call:

(Susan Karlix, Manager, Investor Communications) Income was up 47% on a sales increase of 18%. Earnings were the highest for any third quarter in the company's history and sales were the second highest.
The gain was led by Ag and Turf, which had another blockbuster quarter.
Construction and Forestry had its highest profit in seven quarters and our credit operations had another solid performance.
The company is being helped by somewhat improved business conditions, but tailwinds are only part of the story. After all, Construction markets are still weak by historical standards and some Ag markets such as Europe and the CIS remain under pressure.
Net sales and revenues were up 16% to $6.8 billion in the quarter.
Net income attributable to Deere & Company was 617 million, and as just mentioned, up 47% compared with Q3 last year and our highest ever income for a third quarter.
Total worldwide equipment operations net sales were up 18% to $6.2 billion.
Currency translation on net sales was flat versus our May forecast for currency to be up about 2 points in the third quarter. Price realization in the quarter was positive by 2 points.
Worldwide production tonnage was up 31% in the quarter.
The exception was outside the U.S. and Canada where tonnage came in lower than anticipated due to continued weakness in western Europe. For the full year, worldwide production tonnage is now forecast to be up about 14.
Q4 sales are expected to be down to approximately 32% compared with the fourth quarter of 2009. Currency translation on net sales is expected to be negative by about 1 point.
Net income attributable to DE is forecast to be approximately $375 million in the fourth quarter.
For the full year, net equipment sales are forecast to be up about 12% compared with fiscal year 2009. This includes about 2 points of positive currency translation and approximately 2 points of positive price realizations.
Turning to a review of our individual businesses, let's start with Agriculture and Turf. Production tonnage was up 24% in the quarter, on a 12% increase in sales. Operating profits, however, jumped by nearly $345 million or 72% to $824 million. The increase was primarily due to higher shipment and production volume and improved price realization partially offset by higher post retirement benefit costs.
On the heels of the recent commodity price increases, the outlook for most crop prices is up considerably for the 2010, '11 crop year.
Corn prices are being helped by increasing global demand and have moved in sympathy with the poor grain crop in many areas of the world. We project that 2009, 2010 stock in the U.S. and Canada will end 250 million bushels below a year ago and fall another 150 million bushels in the coming year.
Soybean exports have remained strong. Growing global consumption is expected to keep soybean prices at extremely favorable levels for the '10, '11 crop.
Global wheat stocks have tightened with lower winter wheat plantings as well as yield losses in Western Europe and to an even greater extent in the CIS. 2010, '11 cotton prices remain well above the '08, '09 levels, driven by the recovery in global demands and a reduction in the global cotton supply.
2010 U.S. farm cash receipts are now forecast to be up about 6% from 2009 to about $317 billion. That's about $4 billion higher than our last forecast and is driven by increased crop receipts. 2011 farm cash receipts are forecasted to be slightly above the 2010 levels.
The recent movement in upward grain prices might seem as odd with our rather subdued 2010 industry sales outlook for Western Europe. No doubt some customers are locking in crop sales at attractive prices, which should provide support for 2011.
Farm net income in Brazil and Argentina: We continue to see good farm income from soybeans and sugarcane, the two crops that drive the bulk of the equipment purchases in Brazil. Other positive factors include strong global demand for Brazilian commodities, a 5 to 10% decrease in input costs and strong government-sponsored low rate finance programs that run through at least the end of calendar year 2010.
We have increased our forecast for 2010 farm net income in Argentina with milk and beef prices high we continue to see increased demand for tractors, combines, sprayers and forage equipment.
Although too early to predict, we are closely monitoring the developments of a La Nia weather pattern that could result in lower production and yield in 2011.
Our 2010 industry outlooks: Sales of agriculture equipment in the U.S. and Canada are forecast to be up 5 to 10%.
The 8R series tractor introduced last year has been very well received and we have continued to add schedules throughout the year. We are just now introducing the interim Tier 4 compliant 8R to our dealers and are encouraged by the initial orders of over 1,000 units, well over half our retail sold with customer names on the order.
Earlier we touched on the conditions in Western Europe. While fundamentals are promising as we enter 2011, current market conditions are weak and we are therefore lowering our industry forecast. We now expect Ag sales to be down 15 to 20% in the year.
Turning to another product category, we expect retail sales of Turf and utility equipment in the U.S. and Canada to be up 10 to 15% in 2010 from the very low levels of a year ago. We have seen an uptick in the commercial mowing, riding lawn equipment and golf market.
Deere sales were worldwide Ag and Turf are now projected to be up about 8% in the year. Currency translation on net sales is projected to be positive, about 2 points.
Construction and Forestry: Deere's net sales were up 59% in the quarter while production tonnage nearly doubled, being up 96%. The division reported operating profit of $66 million.
Meanwhile, global Forestry markets are up significantly from the very low levels of last year, and our factories have responded quickly to the increased demand. We are now forecasting Construction and Forestry sales to dealers to be up about 35% in 2010 from the very low levels of 2009.
Worldwide credit operations provision for credit losses as a percent of the total average owned portfolio. Year-to-date on an annualized basis, the provision is 49 basis points. Write offs in the Construction and Forestry portfolios continue to improve. Recovery rates are improving steadily.
The full year provision for John Deere credit is forecasted to run around 55 basis points, an improvement over our prior forecast of about 71 basis points.
Worldwide credit operations net income attributable to Deere & Company was $95 million in the quarter versus 99 million last year.
Looking ahead, we are now projecting worldwide credit operations net income attributable to Deere & Company of about 325 million in 2010.
For the company as a whole, receivables and inventories were up roughly $450 million in the third quarter versus Q3 2009. Keep in mind we ended fiscal 2009 with receivables and inventories at rock bottom levels. In fact, they were $1.3 billion lower than at the end of fiscal 2008.
Retail sales: Category detail in the U.S. and Canada for the month of July expressed in units. Utility tractor industry seams were up 3%. Deere sales were up double digits. Grow crop industry tractor seams were down 10%.
Looking at Deere dealer inventories in the bottom chart, for row crop tractors, Deere ended July with inventories at 18% of trailing 12-month sales. Combine inventories were at 19% of sales.
Raw material and logistics costs up about $10 million in the quarter. We now forecast material cost decreases of approximately $150 million for the year. By division, the Ag and Turf savings are forecasted about $175 million. For Construction and Forestry, we continue to forecast a material cost increase of about $25 million.
Looking at R&D expense: R&D was up about 5% in the third quarter with currency translation accounting for negative approximately 2 points. Year-to-date, R&D expenses up about 6%. For the full year, R&D expense is expected to be up about 10%.
We expect R&D spending to increase in the fourth quarter as we approach significant product launches with interim Tier 4 engines and remain at high levels over the next three years as we approach the final Tier 4 emissions standards.
Pension and OPEB expense in the third quarter was up about $100 million. The 2010 forecast calls for an increase of about $350 million in pension and OPEB expense, unchanged from our previous forecast.
SA&G expense for the equipment operations was up about 17% in the quarter. Variable incentive compensation accounted for about 8 points and currency translation added about 3 points. For fiscal 2010, we project SA&G to be up about 9 points, unchanged from our previous forecast.
Strong cash flow from our equipment operations even in ears of tough market conditions like last year. This reflects in large part our success managing assets and controlling working capital levels. We anticipate cash flow from equipment operations of about $2.4 billion for the year, a $1 billion increase over 2009. Such strong cash flow is further testament to our successful execution of the FDA model.
Depreciation and amortization is projected to be about $550 million. Our forecast currently includes about $700 million of pension and OPEB contributions in he year.
(Q&A) My first question is on the near term, your fourth quarter outlook. Particularly on the Ag and Turf side, you noted that margins would be about 13%. That would imply much lower margin in Q4 than I have been forecasting and much lower than Q3. Marie, I think you guys addressed knit the call, but I just wanted to make sure. Are you anticipating a significant hit on gross margins because of the build-up of pre-Tier 4 interim engines? Is that what maybe I was missing in my forecast? (A) Not directly, Ann. In fact, instead of just addressing Ag and Turf, let me look at it for the full company in relation to our full guidance and just give you some of the numbers that are implicit in our guidance. With the increased profitability for the company incentive compensation is rising, and in the fourth quarter over last year, it will be about a $90 million expense. Again, very low levels of activity in the fourth quarter last year. Materials, which has been either a neutral or a tailwind for us in the first three quarters of this year, will be an expense in our projection. It's $75 million. R&D, we have a pretty significant jump. That's why Susan called out the fact that year to date we're up 6% for the forecast we're up about 10%. That's about $55 million in the fourth quarter. That is a lot of money and that is very much impacted by iT4 as we're getting ready to enter into this very significant launch phase. And remember, we've got final Tier 4 following on the heels in just like three years. Another factor is overhead absorption, and we estimate that at about $50 million. I shouldn't say overhead absorption. It's overhead expense. We have a very significant spend in R&D. Likewise, we have a very significant spend in capital expenditures ahead of us in the fourth quarter, and that is disruptive to the factory efficiency as you bring new machine tooling in, use train operators, and so we have provisioned for that in our outlook. And then the only other thing of note would be SA&G is a little higher as well.
Okay. That's very helpful. I just wasn't sure what I was missing there. And then longer term, I know you won't talk specifically about your outlook for 2011. I know better than to ask directly. But could you talk a little bit about the overall global impact with a negative impact in Russia because of the drought, what that might do to protein sector in Europe, and their input costs versus the positive impact it may have for U.S. farmers and South America farmers? How are you looking at putting all of these pieces together as you look into 2011 and the health of global agriculture as we step forward? (A) There's no question that the recent run in commodity prices driven by the events in the CIS and even in Eastern Europe certainly has supported the prospect for crop farmer incomes. You correctly note that livestock sector is a little more concerned obviously with what's happened, especially just having come out of two years of very, very difficult financial situations. It is not as likely, there, you will have much crop herd expansion globally in the face of these rising feed costs. But overall for the farm sector, it would appear to be very positive as you look into 2011. Some of the other factors, though, Ann that we are considering as we ourselves look into the future, obviously with the events of the last couple of weeks regarding the global economy, which seems to vary day by day, people are perhaps a little less certain than they were, and that does raise a note of caution especially a lot of talk about the U.S. economy which would affect certainly our Construction equipment business and our Turf and utility. And frankly even the small Ag sector, because a lot of that is economically sensitive because it goes into homeowners and large property owners, et cetera. The other thing that you would want to think about is rising materials-rising commodity costs affecting our materials as we go into 2011.
I mentioned in the first question that I was answering of yours that we had had a tailwind or neutral in the first three quarters of the year. That's worth about $250 million. If raw material costs just stay where they are today, obviously that's something that would not be repeated. And the other thing I would just note is that we are going to be in the midst of this iT4 transition. We are very encouraged by the early results on it, but none- you know, we've got some good orders as Susan mentioned on the 8,000s, but it's very early, so you're really looking at a very small base. So we'll see how that plays out as we look ahead.