Deere & Company (DE) F3Q13 Earnings Call August 14, 2013 10:00 AM ET
Tony Huegel - Director of Investor Relations
Susan Karlix - Manager of Investor Communications
Raj Kalathur - Chief Financial Officer
Marie Ziegler - Deputy Financial Officer
Ross Gilardi - Bank of America
Andrew Kaplowitz - Barclays
Jerry Revich - Goldman Sachs
David Raso - ISI Group
Andy Casey - Wells Fargo
Jamie Cook - Credit Suisse
Rob Wertheimer - Vertical Research Partners
Mircea Dobre - Robert W. Baird
Steven Fisher - UBS
Eli Lustgarten - Longbow Research
Larry DeMaria - William Blair
Adam Fleck - Morningstar
Ann Duignan - JP Morgan
Ashish Gupta - CLSA
Seth Weber - RBC Capital Markets
Good morning, and welcome to Deere’s 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. You may begin.
Hello. Also on the call today are Raj Kalathur, our chief financial officer; Marie Ziegler, deputy financial officer; and Susan Karlix, 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 how we expect to end the fiscal year. After that, we will 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 and NASDAQ OMX. 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 also may 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/financialreports under Other Financial Information.
Thank you, Tony. John Deere’s strong performance continued in the third quarter of 2013. Earnings jumped 26% on a sales increase of 4%. Both earnings and sales were the highest of any third quarter in the company’s history and it marked our 13th quarter in a row of record profits.
The game was led by ag and turf, which had another terrific quarter, with operating margins of about 17%. Financial services also made a major contribution, while construction and forestry kept profits in line with last year in spite of a slump in sales.
No doubt, John Deere is being helped by a strong market for large farm machinery in North and South America. However, our results showed disciplined execution of our business plans too, plans focused on winning new customers around the world while keeping a close watch on costs and asset levels. In all, it was a productive quarter, putting John Deere well on the way to another very good year.
Now let’s take a look at the third quarter in detail, beginning on slide three. Net sales and revenues were up 4% in the quarter, to $10 billion. Net income attributable to Deere & Company was $997 million. As noted, both sales and income were the best ever third quarter results recorded by the company.
On slide four, total worldwide equipment [operator] net sales were $9.3 billion, up 4% quarter over quarter, including an unfavorable impact from currency translation of about 1 point. Price realization in the quarter was positive by 3 points.
Turning to a review of our individual businesses, let’s start with agriculture and turf on slide five. Sales were up 8% in the quarter, on continuing strength in the global ag economy, especially North and South America. Operating profit was $1.3 billion, up 32%.
The division’s results included an impairment charge for long lived assets related to John Deere Water of approximately $50 million pretax, $44 million after tax. Before we review the industry sales outlook, let’s look at some of the fundamentals [affecting] the ag business.
Slide six outlines U.S. farm cash receipts. For the year ahead, crop yields are forecast to be higher than in 2012, and much closer to normal, but prices will be somewhat lower. This reflects recovery from last year’s drought conditions.
Conversely, livestock receipts are forecast to be higher in 2013 than 2012. As a result of these factors, our forecast calls for 2013 cash receipts to be about $390 billion, the second highest on record, and a solid level of income.
On slide seven, with forecasts of a bumper crop, lower crop prices, and an increase in stock [unintelligible] ratios, our initial outlook for 2014 U.S. farm cash receipts is down modestly, but remains at a historically high level, approximately $380 billion. 2014 cash receipts, the number one predictor of farm equipment sales, are expected to remain at an excellent level, helping keep farmers in a financially sound position.
Our economic outlook for the E.U. 28 is on slide eight. We continue to see offsetting trends in the E.U. on the one hand, ag fundamentals remain positive and production is expected to increase about 7%. Above average commodity prices are driving supportive farm income. Beef prices are leveling off at historic highs while pork and milk prices are favorable.
On the other hand, farm machinery demand is expected to be lower in 2013, as the financial crisis continues to weigh on farmer sentiment and softness in the U.K. continues. On slide nine, you’ll see the economic fundamentals outlined for a few of our other targeted growth markets. Of note is the decline in our outlook for the CIS countries.
The market is softer than our previous forecast, as import duties continue affecting combine demand in Russia, Kazakhstan, and Belarus. Hot, dry weather has impacted crop prospects in southern Russia and Ukraine, and credit availability is also hurting equipment demand.
Slide 10 illustrates the value of agricultural production, a good proxy for the health of agribusiness in Brazil. With expectations for a strong soybean crop due to an increase in acres planted, higher yields, and sustained high crop prices, the 2013 value of ag production in Brazil is expected to increase about 6% over the 2012 level.
Our 2013 ag and turf industry outlook is summarized on slide 11. In the U.S. and Canada, we continue to see strength in demand, especially for high horse power tractors and combines. We continue to project industry sales to be up about 5% in relation to the healthy levels of 2012. The E.U. 28 industry outlook is down about 5%, no change from our prior forecast.
Throughout fiscal 2013, we have, each quarter, raised the industry outlook for South America, and we have done so again. Based on a combination of positive farm fundamentals, plus supportive financing programs in Brazil, we now expect industry sales of tractors and combines in South America to be up about 20% in 2013.
South America continues to grow in importance for Deere. Our tractor market share has grown considerably, but our strong presence in combines, sugarcane harvesters, and feeding equipment should not go unnoticed.
Shifting to the CIS, as we noted earlier, our 2013 industry outlook is now moderately lower, a decrease from a quarter ago. In Asia, we continue to forecast little change in industry sales from 2012.
Turning to another product category, we now expect industry retail sales of turf and utility equipment in the U.S. and Canada to be up about 5% in 2013, as favorable summer weather has driven much stronger demand. Deere is seeing strength in commercial mowing equipment, utility vehicles, and zero track mowers.
Putting all of this together on slide 12, fiscal year 2013 Deere sales of worldwide ag and turf equipment continue to be forecast to be up about 7%, including about 1 point of negative currency translation. 2013 operating margin for the ag and turf division is forecast at about 16%, a point increase since our last forecast.
As we have discussed all year, last year’s fourth quarter sales were particularly strong. Production schedules were higher to accommodate the interim tier 4 transition at a time when the factories were running at very high rates to catch up with customer orders.
Consequently, sales for ag in the fourth quarter of 2013 are expected to be lower than the fourth quarter a year ago. This reflects a tough comparison. It does not indicate any change in our outlook for demand or global ag fundamentals.
Let’s focus now on construction and forestry on slide 13. Net sales were down 11% in the quarter, and operating profit was down 5% due to lower shipment volumes. That $190 million decline in sales was only a $6 million reduction in operating profit is a reflection of price realization, good execution, and lever pulling to control costs in response to slow demand.
On slide 14, looking at the economic indicators on the bottom part of the slide, the outlooks for GDP and government spending have softened since last quarter. Although overall economic growth continues at a sluggish pace, we are beginning to see some positive indicators.
While moving very slowly, residential investment is growing, home sales and prices are increasing, and there are reports that the number of build-ready lots are dwindling. Global forestry markets are now expected to be up 5-10% in 2013, as weakness in Europe and Russia is more than offset by improvement in North America. Forestry markets in the U.S. are considerably higher due to the year over year increase in housing starts.
Fiscal 2013 net sales in construction and forestry are now forecast to be down about 8%. Our previous outlook was down about 5%. The year over year sales decline is reflected in lower inventory and receivable numbers, and it has had an impact on mix as we reduce shipments of high margin equipment. C&F full year operating margin is now projected to be about 6%, a 1 point improvement from last quarter, as the division is pulling levers and cutting costs to meet its operating goals.
Let’s move now to our financial services operations. Slide 15 shows the financial services provision for credit losses at 3 basis points, based on the percentage of the total average owned portfolio at the end of the quarter. This reflects the excellent quality of our portfolios and recoveries from prior year’s writeoff.
Our 2013 financial forecast now contemplates a loss provision of about 5 basis points as a percentage of the average owned portfolio. This is well below the 10-year average of about 28 basis points.
Moving to slide 16, worldwide financial services net income attributable to Deere & Company was $150 million in the third quarter, versus $110 million last year. The increased provision for credit losses cited in the press release is a function of small reductions taken in the third quarter of 2012. The loss experienced on the portfolio remains at an extremely low level.
For the full year, net income attributable to Deere & Company is now forecast to be about $560 million. Slide 17 outlines receivables and inventory. For the company as a whole, receivables and inventories ended the quarter up about $20 million, or equal to approximately 30% of prior 12-month sales, compared with 32.3% a year ago.
The year over year forecasted downward tweak in ag is due to the impact of currency and reflects no real change in absolute inventory levels. C&F is now projected to be down about $175 million as we respond to slowing demand and a reduction in Canadian confined inventories.
We expect to end 2013 with receivables and inventory up about $50 million. Our guidance for cost of sales as a percentage of net sales, shown on slide 18, remains at approximately 74% for the full year. Factors affecting cost of sales include price realization, production or manufacturing costs, raw material costs, engine emissions product costs, absorption, and effects of foreign currency.
When modeling the full year, keep in mind the following: price realizations: we are forecasting about 3 points in 2013; favorable year over year raw material costs; the impact on cost of sales of new employees; interim tier four product costs; absorption due to the low levels of inventory compared to 2012; and an unfavorable mix of product in C&F, as we talked about earlier.
Looking at R&D expense on slide 19, R&D was down about 8% in the third quarter, compared with the same period last year. This is consistent with our earlier guidance that the increase in R&D spending for 2013 would occur in the first half of the year. Our 2013 forecast continues to call for R&D expense to be up about 3% for the full year.
Moving now to slide 20, SA&G expense for the equipment operations was up about 4% in the third quarter. Very much like R&D, the quarter over quarter increases for SA&G were heavily weighted to the first half of the year. SA&G expense is forecast to be up about 7% in 2013, no change from our previous guidance.
On slide 21, pension and OPEB was up about $15 million in the quarter, compared with last year.
Turning to slide 22, the equipment operations tax rate was about 36% in the third quarter. For full year 2015 the effective tax rate is forecast to be in the range of 34-36%, representing no change from our previous forecast.
On slide 23, UCR equipment operations’ history of strong cash flow: our forecast for cash flow from equipment operations is now about $3.8 billion in 2013. Of note is a $700 million Deere & Company debt maturity in April 2014.
On slide 24, we outline our 2013 outlook for the fourth quarter and full year. Our net sales forecast for the fourth quarter is down about 5% compared with 2012, due to the extremely tough comparison discussed earlier. This includes about 3 points of price realization.
The full year forecast calls for net sales to be up about 5%, with 1 point of unfavorable exchange. Thus, the forecast at constant currency up about 6% represents no change from our last forecast. Price realization is expected to be positive by about 3 points. Finally, our full year 2013 net income forecast has increased to about $3.45 billion.
In closing, John Deere is well on the road to another year of impressive performance. Even with a difficult comparison in store for the fourth quarter, our financial guidance implies a healthy level of income, helping us wrap up a third consecutive year of record results.
Also, it is significant to note that Deere has been consistently setting new performance records despite facing some significant headwinds, including a sluggish global economy, political gridlock in Washington, and a host of major product changeovers associated with more stringent emissions rules.
As for the longer term picture, it remains extremely bright. Indeed, the broad trends we’ve been talking about, based on a growing, richer, more urban population appear to have plenty of staying power, staying power that we believe will help the company deliver substantial value to its customers and investors for years to come.
Thank you, Susan. Now we’re ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedures, but as a reminder, in consideration of others, please limit yourself to one question and one related follow up. If you have additional questions, we ask that you rejoin the queue. Operator?
Earnings Call Part 2: