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Edited Transcript of DE earnings conference call or presentation 21-Aug-15 2:00pm GMT

Q3 2015 Deere & Co Earnings Call

MOLINE Aug 22, 2015 (Thomson StreetEvents) -- Edited Transcript of Deere & Co earnings conference call or presentation Friday, August 21, 2015 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Tony Huegel

Deere & Company - Director of IR

* Susan Karlix

Deere & Company - Manager of Investor Communications

* Raj Kalathur

Deere & Company - CFO

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Conference Call Participants

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* Jamie Cook

Credit Suisse - Analyst

* Steven Fisher

UBS - Analyst

* Adam Uhlman

Cleveland Research Company - Analyst

* Jerry Revich

Goldman Sachs - Analyst

* Tim Thein

Citigroup - Analyst

* Ann Duignan

JPMorgan - Analyst

* Andy Casey

Wells Fargo Securities, LLC - Analyst

* Mike Shlisky

Global Hunter Securities, LLC - Analyst

* Eli Lustgarten

Longbow Research - Analyst

* Mig Dobre

Robert W. Baird & Company, Inc. - Analyst

* David Raso

Evercore ISI - Analyst

* Vishal Shah

Deutsche Bank - Analyst

* Nicole DeBlase

Morgan Stanley - Analyst

* Joel Tiss

BMO Asset Management - Analyst

* Seth Weber

RBC Capital Markets - Analyst

* Ross Gilardi

BofA Merrill Lynch - Analyst

* Kwame Webb

Morningstar - Analyst

* Larry De Maria

William Blair & Company - Analyst

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Presentation

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Operator [1]

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Good morning and welcome to Deere & Company third-quarter earnings conference call.

(Operator Instructions)

I would now like to turn the call over to Mr. Tony Huegel, Director of Investor Relations. Thank you, and you may begin.

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Tony Huegel, Deere & Company - Director of IR [2]

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Thank you. Also on the call today are Raj Kalathur, our Chief Financial Officer, and Susan Karlix, our Manager of Investor Communications. Today we'll take a closer look at Deere's third-quarter earnings then spend some time talking about our markets and our outlook for the remainder of the year. After that we'll respond to your questions. Please note that slides are available to complement the call this morning. They can be accessed on our website at www.johndeere.com.

First a reminder: This call is being broadcast live on the internet and recorded for future transmission and use by Deere & Company. Any other use, recording, or transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited. Participants in the call, including the Q&A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call. This call includes forward-looking comments concerning the Company's plans and projections for the future that are subject to important risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially is contained in the Company's most recent form 8-K and periodic reports filed with the Securities and Exchange Commission.

This call may also include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, or GAAP. Additional information concerning these measures including reconciliations to comparable GAAP measures is included in the release and posted on our website at www.johndeere.com/earnings under other financial information. Susan?

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Susan Karlix, Deere & Company - Manager of Investor Communications [3]

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John Deere announced its third-quarter earnings today, and in our view it was a solid performance in light of the weak conditions in the global agricultural sector. Deere's results reflected the sound execution of our operating plans and the success of efforts to manage costs. Although results were lower than in the same quarter a year ago, all of our businesses remained solidly profitable. As a result the Company continues to be well positioned to meet the needs of customers while funding its growth plans and returning cash to stockholders.

Now let take a closer look at the third quarter in detail beginning on slide 3. Net sales and revenues were down 20% to $7.594 billion. Net income attributable to Deere & Company was $512 million. EPS was $1.53 in the quarter.

On slide 4, total worldwide Equipment Operations net sales were down 22% to $6.8 billion. Price realization in the quarter was positive by 2 points. Currency translation was negative by 6 points.

Turning to a review of our individual businesses, let's start with agriculture and turf on slide 5. Net sales were down 24% in the quarter-over-quarter comparison. Lower sales were recorded in all regions of the world, but the decrease was primarily due to lower shipment volumes of large Ag equipment in the United States and Canada. Also hurting sales was the negative impact of foreign currency exchange. Operating profit was $472 million. The decrease in operating profit was primarily driven by lower shipment volumes, a less favorable product mix, and foreign exchange partially offset by price realizations and lower production costs. The division's decremental margin in the quarter was 28%, quite respectable considering the decrease in large Ag sales.

Before we review the industry sales outlook, let's look at fundamentals affecting the Ag business. Slide 6 outlines US farm cash receipts. Our 2014 forecast calls for cash receipts of about $418 billion, up about 1% from 2013 and the highest level ever recorded. Given the record crop harvest of 2014 and consequently the lower commodity prices we're seeing today, our 2015 forecast calls for cash receipts to be down about 7%. Looking ahead to next year, based on our expectation of above trend line yields for 2015 and declining livestock prices, our very early forecast calls for total cash receipts to be down slightly in 2016.

On slide 7, global grain stocks-to-use ratios remain at somewhat sensitive levels, even after the abundant harvests of the past two years. Global grain and oil seed demand remains strong while supplies are now fully adequate. Even so, unfavorable growing conditions in any key region of the world, as well as unknown impacts from any geopolitical tensions, could disrupt trade, lower production, reduce the stocks-to-use ratio, and result in prices quickly moving higher.

Our economic outlook for the EU 28 is on slide 8. Gradual economic growth continues in the region. While grain prices appear to be stabilizing at levels near the long term average, the dairy sector remains under pressure. As a result farm machinery demand in the EU region is expected to be lower for the year. I should mention we are encouraged by some early indications that this market may be in the early stages of recovery.

On slide 9 you'll see the economic fundamentals outlined for other targeted growth markets. In China the government's continued investment in equipment subsidies and mechanization are supportive of agriculture. However, the economic slowdown and lower commodity prices have led to a decrease in forecast industry sales. Turning to India, positive consumer and investor sentiment are encouraging economic growth. While the government continues to support agriculture, two consecutive below normal monsoon seasons are hurting the farm sector. In the CIS continued deterioration of economic growth and further tightening of credit continue to weigh on equipment sales. Notably, western equipment manufacturers are being heavily affected by the weak Russian currency and geopolitical uncertainties.

Shifting to Brazil, slide 10 illustrates the value of agricultural production, a good proxy for the health of Agri-business. Ag production is expected to decrease about 11% for the year in US dollar terms due to lower global commodity prices. However, with the weak real the value of production is much more attractive in the local currency, up about 10%. That's because Brazilian farmers sell their crops in dollars. Even with the recent drop in prices, Ag fundamentals remain positive for grains. Our early forecast calls for the value of production to be down slightly in 2016.

Slide 11 illustrates eligible finance rates for Ag equipment in Brazil. The 2015/2016 Ag budget affirmed eligible finance rates for Ag equipment are 7.5% and 9% through the end of June 2016 depending on a farmer's revenues, with no change on the required down payment. Though rates have increased they are not considerably higher than they were in 2011, which was a banner year for industry sales in Brazil, and they remain below current market rates of about 14%. Nonetheless, farmer confidence is lower as a result of these rising interest rates, economic uncertainty, and political concerns, all of which are leading to lower equipment sales. Still, long-term fundamentals for the Ag business in Brazil are solid.

Our 2015 Ag & Turf industry outlooks are summarized on slide 12. Lower commodity prices and falling farm incomes are continuing to pressure demand for farm equipment, especially larger models. At the same time conditions in the livestock sector are more positive, providing support to sales of small and mid-sized tractors. We continue to expect industry sales in the US and Canada to be down about 25% for 2015. The EU 28 industry outlook is down about 10%, unchanged from last quarter, due to lower crop prices and farm incomes as well as pressure on the dairy sector. In South America industry sales of tractors and combines are now projected to be down 20% to 25% in 2015, a reflection of the factors already discussed.

Shifting to Asia. We now expect sales to be down moderately with most of the decline in India and China. In the CIS we continue to expect industry sales to be down significantly due to limited credit availability, the weak ruble, and overall economic concerns. Turning to another product category, industry retail sales of turf and utility equipment in the US and Canada are projected to be flat to up 5% in 2015, no change from our prior forecast.

Putting this all together on slide 13, FY15 Deere sales of worldwide Ag & Turf equipment are now forecast to be down about 25% including about 5 points of negative currency translation. Our forecast for the Ag & Turf division's operating margin continues to be approximately 8%.

Now let's focus on Construction & Forestry on slide 14. Net sales were down 13% in the quarter and operating profit was down 34% due to lower shipment volumes and the unfavorable effects of foreign currency. The division's decremental margin was 29%.

Moving to slide 15, looking at the economic indicators on the bottom part of the slide, GDP growth is positive, unemployment is falling, construction hiring is on the increase, and housing starts are expected to exceed 1 million units this year. In spite of these encouraging economic indicators and positive dealer and customer sentiment, we are seeing weakening in our order books. Some contributing factors to the slowdown in demand are the conditions in the energy sector and energy producing regions, wet weather that slowed construction activity this spring and summer, the decline in rental utilization rates, and sluggish economic growth outside the United States. As a result, Deere's Construction & Forestry sales are now forecast to be down about 5% in 2015. Currency translation is forecast to be negative by about 3 points. Global forestry markets are now expected to be flat to up 5% on the heels of a 10% increase in 2014, as gains from the US and Europe are offset by declines in other regions of the world. C&F's full-year operating margin is now projected to be about 10%.

Let's move now to our financial services operations. Slide 16 shows the annualized provision for credit losses as the percentage of the average owned portfolio was 12 basis points at the end of July. This reflects the continued excellent quality of our portfolios. The financial forecast for 2015 now contemplates a loss provision of about 13 basis points versus 9 basis points in 2014. The increase is a reflection of unsustainably low loss levels of the last four years. It remains well below the 10-year average of 26 basis points and the 15-year average of 43 points.

Moving to slide 17. Worldwide financial services net income attributable to Deere & Company was $153 million in the third quarter versus $162 million last year. Lower results for the quarter were primarily due to less favorable financing spreads partially offset by lower selling, administrative, and general expenses. The division's forecast net income attributable to Deere & Company remains at about $630 million for the year.

Slide 18 outlines receivables and inventories. For the Company as a whole receivables and inventories ended the quarter down $1.5 billion. That's equal to 30.6% of prior 12-month sales compared with 29.8% a year ago. We expect to end the year with total receivables and inventories down about $350 million. With this decreased forecast to come entirely from Ag & Turf, the division will have reduced receivables and inventory by almost $2 billion over the last two years. At constant exchange rates the two year decline is about $1.4 billion.

Our 2015 guidance for cost of sales as a percent of net sales shown on slide 19 is about 78%, unchanged from last quarter. When modeling 2015 keep these factors in mind. Price realization of about 1 point. Favorable raw material costs and unfavorable mix of product and tier 4 product costs.

With respect to R&D expense on slide 20, R&D was down 4% in the third quarter, including 4 points of negative currency translation. So essentially flat on a constant exchange basis. Our 2015 forecast now calls for R&D to be down about 2% for the full year, including about 3 points of negative currency translation.

Moving now to slide 21. SA&G expense for the Equipment Operations was down 7% in the third quarter, including 5 points of currency translation. Our 2015 forecast contemplates SA&G expense being down about 11%, with landscapes, water, incentive compensation, and currency accounting for about 9 points of the change.

Turning to slide 22, pension and OPEB expense was up $25 million in the quarter and is forecast to be up about $70 million in 2015. On slide 23, the Equipment Operations tax rate was 31% in the quarter. For the remainder of FY15 the projected effective tax rate is forecast to be in the range of 34% to 36%.

Slide 24 shows our Equipment Operations history of strong cash flow. Cash flow from the Equipment Operations is now forecast to be about $3.2 billion in 2015. The Company's fourth-quarter financial outlook is on slide 25. Net sales for the quarter are forecast to be down about 24% compared with 2014. This includes about 1 point of price realization with unfavorable currency translation of about 5 points.

Turning to slide 26 and the full-year outlook, the forecast now calls for net sales to be down about 21%. Price realization is expected to be positive by about 1 point with negative currency translation of about 4 points. Finally, our forecast now calls for net income attributable to Deere & Company to be about $1.8 billion for the full year.

As a closing thought, John Deere is well on its way to another good year, and doing so in the face of some pretty significant headwinds. Our performance highlights our success establishing a wider range of revenue sources and a more durable business model. As a result the Company is showing great resilience and discipline and performing much better than in previous farm downturns. Longer term we believe our steady investment in new products and geographies will make Deere the provider of choice for a growing global customer base.

What's more we believe the impact of these actions will become increasingly clear as the end markets for our products start moving ahead. These are just some of the reasons we have confidence in the Company's present course and in our ability to deliver significant value to customers and investors well into the future. I'll now turn the call back over to Tony.

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Tony Huegel, Deere & Company - Director of IR [4]

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Thanks, Susan. Now we're ready to begin the Q&A portion of the call. Our operator, David, will instruct you on the calling procedure, but in consideration of others and our hope to allow more of you to participate in the call please limit yourself to one question. If you have additional questions we ask that you rejoin the queue. David?

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Questions and Answers

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Operator [1]

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Thank you.

(Operator Instructions)

Your first question today will be from Jamie Cook with Credit Suisse.

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Jamie Cook, Credit Suisse - Analyst [2]

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Hi, good morning.

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Tony Huegel, Deere & Company - Director of IR [3]

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Hi, Jamie.

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Jamie Cook, Credit Suisse - Analyst [4]

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I guess two questions. One, Tony could you or Susan or Raj speak to where you guys are relative to expectation with regards to inventory in the channel, that's a big concern in the market, and how that impacts 2016 and whether the excess inventory rolls into 2016?

And then I guess my second question is if you could just give some color on the order book, the early order book so far? Thanks.

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Tony Huegel, Deere & Company - Director of IR [5]

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In the spirit of one question I'll go ahead and answer your first one and then we'll pick the second one up hopefully from someone else or ask you to get back in the queue.

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Jamie Cook, Credit Suisse - Analyst [6]

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Okay.

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Tony Huegel, Deere & Company - Director of IR [7]

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So as we think about inventory, I'll split it between new and used inventory. And I'm assuming you're primarily looking at large Ag in the US and Canada?

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Jamie Cook, Credit Suisse - Analyst [8]

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Of course.

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Tony Huegel, Deere & Company - Director of IR [9]

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Okay. As you think about new inventory, and I would say a similar situation to what we've talked about in the past in the sense that we continue to have new inventory well below the competitors. We tend to have 50% or less as you look at inventory as a percent of sales. And that continues to be the case.

We continue to evaluate that of course as we go through the year and see various changes in the market. Used equipment continues to be a challenge. We are making good progress on used equipment.

As you look at some of the factors from a large Ag perspective, we are down about 10% year over year in July, in terms of where we're at with used inventory. Pricing is holding in okay.

If you look at it from a two-year average we would be slightly below that, but believe we continue to maintain a healthy premium versus our competition. And again, we are making progress but it's likely we would expect these efforts will continue into 2016. We continue to coordinate with our dealers to assist with the movement of the used equipment, but it is still, especially on large tractors, continues to be a challenge that we're working on within the market.

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Jamie Cook, Credit Suisse - Analyst [10]

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Okay, thanks, I'll get back in queue.

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Tony Huegel, Deere & Company - Director of IR [11]

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Thank you. Next caller?

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Operator [12]

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Your next question will be from Steven Fisher with UBS.

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Steven Fisher, UBS - Analyst [13]

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Great, thanks, good morning. So I guess I'll pick up on the second half of Jamie's question on how early order programs are trending year over year, and specifically if you could talk also about your approach to incentives year over year on the early order program?

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Tony Huegel, Deere & Company - Director of IR [14]

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One of the challenges that we do have in terms of comparison year over year is there are some timing differences in terms of when -- as you know, we have various phases of the early order programs, and the closing of the first phase is a bit different year over year. Now having said that, I want to make sure I have that clearly out front, but directionally what we're seeing is order activity on those early order programs are off year over year.

And just to be clear what we're talking about is planter, sprayers, and tillage. A lot of people have questions around combine early order programs. I'm guessing, but remember those just started up in early August and candidly it's too early to make any type of conclusions related to where that program is.

One of the challenges we do have, also as you think about the spring seasonal early order programs in where we would think that perhaps in this current environment where they may not be as close of a correlation to...


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