Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Deere & Company (NYSE:DE)

F1Q09 Earnings Call

February 18, 2009 10:00 am ET

Executives

Marie Ziegler – Vice President, Investor Relations

Susan Karlix – Investor Relations

Michael Mack – Chief Financial Officer

Analysts

Andrew Obin – Bank of America Securities, Merrill Lynch

Mark Kosnarek – Cleveland Research

Robert Wertheimer – Morgan Stanley

Ann Duignan – J.P. Morgan

David Raso – ISI

Eli Lustgarten – Longbow Securities

Henry Kirn – UBS

Terry Darling – Goldman Sachs

Jamie Cook – Credit Suisse

Daniel Dowd – Bernstein

Meredith Taylor – Barclays Capital

Robert McCarthy – Robert W. Baird

Andrew Casey – Wachovia Capital Markets

Operator

Welcome to the Deere and Company first quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Miss Marie Ziegler, Vice President of Investor Relations.

Marie Ziegler

Good morning. Also on today's call are Mick Mack, our Chief Financial Officer, Susan Karlix and Justin Merrimac, both from the Investor Relations staff. Today, we'll take a closer look at our first quarter earnings, and then spend a few minutes talking about our market and where at this time we see things headed for the remainder of fiscal 2009. After that, we'll open for 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 though a reminder, this call is being broadcast live on the internet and recorded for future transmission and use by Deere and Thompson writers. Any other use, recording or transmission of any portion of this call 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 and all media may be stored and used as part of this earnings call.

The call today includes forward-looking comments concerning the company's projections, plans and objectives for the future that are subject to important risks and uncertainties. Actual results might differ materially from those projected in these forward-looking statements.

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. The company, expect as required by law undertakes no obligation to update or revise its forward-looking information.

The call and the company materials are not an offer to sell or solicitation of offers to buy any of the company's securities.

This call may also include financial measures that are not in conformance with accounting principals generally accepted in the United States of America, GAAP. Additional information concerning these measures including reconciliations to comparable GAAP measures is posted on our web site at www.johndeere.com/financialreports under other financial information.

Call participants should consider the other information on risk factors and uncertainties and non-GAAP measures in addition to the information presented on the call. And now, for a closer look at our results, here is Susan

Susan Karlix

John Deere reported another quarter of solidly profitable performance today and did so despite the impact of the global economic slowdown. Among the highlights, our agricultural equipment operations in the United States and Canada continued on a strong pace. Our construction and forestry division reported a profit in spite of trying market conditions.

Also, our credit operation has maintained access to the credit market. That is helping insure ample financing for our customers.

On the negative side, our results very definitely reflected the impact of the global recession as well as the effect of volatile exchange rates and a further increase in material costs. Let's take a more detailed look at the quarter, starting with Slide 3.

Net income for the quarter was $204 million on first quarter equipment sales of $4.6 billion. Turning to Slide 4, total world wide equipment operations net sales were up about 1% in the quarter versus first quarter 2008. Currency translation on net sales was negative by approximately six points, and there were about six points of positive price realization.

On Slide 5, world wide production tonnage was flat in the quarter compared with our previous forecast of up 12%. This illustrates that all three equipment divisions are not hesitating to step on the brakes, rapidly adjusting to changing market conditions. World wide production tonnage is expected to decrease about 17% in the second quarter of 2009 and be down about 12% for the full year.

As we turn to Slide 6, Ag markets have remained strong in the U.S. and Canada while the remainder of our businesses have seen a dramatic slowdown in the quarter. The forecast we review today, represents our best assessment of the 2009 outlook, but keep in mind; it also reflects a high degree of uncertainty.

Second quarter net sales are expected to be down about 9% compared to the second quarter of 2008. Currency translation on net sales is about a negative six points with about five points of positive price realization.

As the press release states, we have suspended providing quarterly net income guidance for now. Our intent is to revisit this decision when there is less uncertainty in the global economy and evidence of stabilization in foreign currencies.

For the full year, net equipment sales are now forecast to be down about 8% compared with fiscal year 2008. This includes about six points of negative currency translation on net sales and about six points of price realization. The current outlook for net income is approximately $1.5 billion for the full year with risk on the downside.

Turning to a review of our individual businesses, let's start with Agricultural Equipment on Slide 7. Net sales in Ag were up 18% due to higher volume, reflecting strength in the U.S., Canada and Western Europe.

Operating profit was up 5% to $348 million. Price basically offset the impact of higher material costs. Currency had a significant negative impact on Ag Equipment performance for the quarter, basically offsetting the benefit of higher volume. This was due to extremely volatile currency exchange rates and the dollar strengthening against the major currencies we do business in.

Currency movement both translation and transaction, or trade flows reduced operating profit by about $150 million in the first quarter. Slide 8 illustrates the radical decline in foreign currencies versus the U.S. dollar over the last year, but as shown on Slide 9, the biggest part of the change has occurred in the last few months.

Over the course of the year, our trade flows are relatively well balanced, but that may or may not be the case in any reporting period. Where there tends to be annual imbalances, we may hedge our exposure using currency forward contracts or currency risk sharing agreements. That said, the extraordinary volatility of exchange rates and the timing of our trade flows, increased our exposure to currency movements in the first quarter.

In fact, if we look at Ag sales and operating profit on a constant exchange basis, the division would have had a 23% incremental margin in the first quarter.

Now let's move to Slide 10 and take a look at some of the economic assumptions that underlie our Ag forecast. Projected commodity prices for '08/'09 reflect very little change from last quarter. As is our practice, we have included the next crop year's prices on the chart. Although down from last quarter's estimate, they still remain a good level by historic standards.

For a visual perspective, turn to Slide 11. The forecast prices as you can see, though down from recent levels remain higher than the past several years, and as shown on Slide 12, at levels that generally permit our farm customers to earn a good return.

On Slide 13, U.S. farm cash receipts remain at very good levels and are up significantly from most recently as 2007. This supports our expectations that the U.S. farm sector will hold up reasonably well in the year ahead.

Before moving to our retail sales outlook, I'd like to address an issue we are frequently asked about, order cancellations, as seen on Slide 14. The U.S. and Canada as well as Western Europe have seen very few cancellations. South America experienced somewhat higher than normal cancellations in the quarter, while Central Europe and the Commonwealth of Independent States including Russia, have seen a high number of cancellations as market conditions in those areas have deteriorated.

Our outlook for industry sales for agricultural equipment in the U.S. and Canada as shown on Slide 15, is now flat to up 5% in fiscal 2009. We continue to see strength in large tractors and combines in contrast to sales of small tractors and equipment commonly used by livestock producers which has seen further deterioration.

Remember, small tractors tend to be popular with the general customer segment that has been hurt by the economic slump. Livestock producers have taken a sizeable hit to their profitability, largely because of higher feed costs. Cotton equipment sales have also deteriorated since our November outlook.

Our outlook for large equipment remains strong as retail orders in the U.S. and Canada for our many products, extend through much of the year. This includes 8000 and 9000 series tractors, combines, sprayers, tillage and feeding equipments. Transition to a new 8000 series tractor will begin later this year when effective ability on the current series has expired.

For 9000 effective availability is now August. Due to reduced activity in other parts of the world, we are now able to offer earlier availability to our customers in the United States and Canada. The combine early order program closed in early February with nearly 95% of expected 2009 retail sales covered.

As shown on Slide 16, our South America outlook now is for the industry to be down 15% to 25% in fiscal 2009. This outlook is down slightly from last quarter, reflecting drought conditions and a changing tractor mix in Brazil. Brazilian government subsidies on 55 to 75 horsepower tractors has shifted the tractor mix towards sales of smaller units with lower selling prices.

We now expect Western Europe to be down 10% to 15% and Central Europe and the Commonwealth of Independent States including Russia, to be down significantly.

So, putting this all together on Slide 16, the outlook for the sale of John Deere farm machinery and services in 2009 is projected to be down about 2%. Currency translation on net sales is negative by about seven points.

Turning to our Commercial and Consumer Equipment business on Slide 17, reported net sales were down 25% in the quarter. Operating profit was negative $59 million reflecting lower shipment and production volumes and higher raw material costs. The division did benefit from lower SA&G expenses as it continues to make adjustments in the cost structure as recessionary economic conditions persist. Production tonnage was down 20%. Moving to the outlook on Slide 18, for fiscal 2009 net sales are projected to be down about 14%.

Let's focus now on Construction and Forestry on Slide 19 where net sales were down 28% in the quarter. Operating profit was $18 million due to lower shipment and production volumes and higher raw material costs. C&F had positive price realization, a plus in this discouraging market which offset the impact of higher material costs.

The real new though, is the division remained profitable and did so in spite of extremely weak business conditions in a seasonally slow time of year. C&F's performance illustrates rigorous expense control and it lends credence to the divisions' ongoing success in creating a more flexible, sustainable business.

On Slide 20, for the division as a whole, we expect Construction and Forestry net sales to now be down about 24% in 2009. Forestry markets in Europe and Russia weakened dramatically in the quarter. The industry forecast for these markets in 2009 is now down almost 50%.

On the Construction side, the outlook for all geographies weakened in the quarter with the most significant decline occurring in Latin America.

Slide 21 contains information about the American Recovery and Reinvestment Act of 2009, also known as the Stimulus Package which was signed into law yesterday. The good news for Deere, is that the legislation clearly shows the political resolve of the Administration and Congress concerning two important segments in which our company and our customers participate; infrastructure and renewal energy.

Key among the legislation's provision are the following; well over $100 billion in infrastructure funding, extension of bonus depreciation, businesses can write off 50% of the cost of equipment acquired in 2009, extension of Section 179 deduction by an additional year through calendar 2009. Customers who place into service qualifying assets with a value of less than $800,000 will be able to expense the first $250,000 of the asset purchases during 2009.

Also in the legislation is a three year extension of the production tax credit for electricity from wind and biomass among other sources, $4.5 billion for electricity delivery and energy reliability including upgrades to the transmission grids, and programs targeted to help rural development such as more than $7 billion for extending broadband services.

Let's move now to our credit operations on Slide 22. The current provision is running at about the very low 10 year average. This continues to reflect strong farmer cash flows. Ag and C&CE dealer reserves, rigorous underwriting standards, robust collection practices and strong used equipment values.

On Slide 23 we have broken out the first quarter write off activity by collateral type. Results are shown on an annualized basis. The Ag portfolio is in excellent shape. In fact, write offs in Ag are minimal. Write offs in the other two portfolios have increased as you might expect, reflecting the underlying economic condition of those businesses. Bottom line, the portfolio performance is solid, led by the continued strength in Ag.

John Deere Capital Corporations have continued to have access to the global credit market as shown on Slide 24. In the first quarter, JDCC issued $4.7 billion in medium term notes and asset backed securities. That exceeds all John Deere credit 2009 maturities in those two funding classes.

Now let's get to the Federal Deposit Insurance Corporation, FDIC guaranteed debt issuance. On December 16, 2008, JDCC agreed to issue $2 billion of FDIC guaranteed debt under the temporarily liquidity guarantee program, TLGP. Since that issuance, the guidance has evolved and the FDIC published an additional frequently asked questions, FAQ under December 19, 2008 which in pertinent parts, applies to all grandfathered, unitary thrift holding companies such as JDCC.

Consistent with that FAQ, the FDIC has notified Deere and JDCC that JDCC needs additional review and a written determination from the FDIC prior to issuing additional FDIC guaranteed debt. Accordingly, JDCC has submitted the documentation to the FDIC related to this and will continue to see the guidance of the FDIC.

I want to be clear that this has no effect on the December 2008 issuance. That debt continues to carry the FDIC guarantee.

Slide 25 illustrates further evidence of Deere's liquidity. The enterprise cash, cash equivalents and marketable securities balance at January 31, 2009 was $5.2 billion. This mainly reflects John Deere credit success securing funding during the quarter. In addition, Deere and its credit operations continue to access the commercial paper markets on a regular basis, placing commercial paper at various maturities and at very good rates.

Deere's total world wide commercial paper outstanding at January 31 was $2.3 billion. That leaves an incremental $2.2 billion of commercial paper capacity.

Moving back to our world wide credit operations now as seen on Slide 26, first quarter net income was about $45 million. That was down from about $96 million in the first quarter of last year. Factors leading to the decline included narrower financing spreads, lower commissions from crop insurance and a higher provision for credit losses.

As shown on the previous slide, in the current environment our overriding focus is on liquidity. Pre-funding and cash balances come with a price; the cost of negative carry, but it also assures we can provide financing to our customers. These increased costs are reflected in our first quarter results and in our full year forecast. Credit net income for fiscal 2009 is now expected to be about $250 million.

Before moving on to retail sales, let's review receivables and inventory. On Slide 27, consolidated trade receivables and inventory ended the quarter higher than a year ago. The increase was mainly attributable to two factors; one, high rates of production of large tractors and combines in the United States, and two, some product not shipped or materials not yet used in the markets where conditions have softened. In those cases, we expect the build up will be unwound over the course of the year.

Although Ag receivables and inventories were up in the quarter, they are forecast to only be up about $75 million by the end of the year. For the company, the 2009 year end forecast calls for inventories and trade receivables to be down about $250 million. Although trade receivables and inventories have increased year over year, Slide 28 shows they remain well aligned with sales activity.

Now let's discuss the latest on retail sales. Slide 29 presents the product category details for the month of January expressed in units. Utility tractor industry sales were down 15%. Deere sales were down a single digit. Row-Crop industry sales were up 7%. Deere sales were up double digits.

Four wheel drive tractor industry sales were up 15%. Deere sales were up strong double digits. Combine industry sales were up 13%. Deere sales were up in line with the industry.

On Slide 30, you see that for Row-Crop tractors, Deere ended January with inventory with 19% of trailing 12 month sales. Combine inventories were at 8% of sales.

Turning to Slide 31, in Western Europe sales of John Deere tractors were up low double digits with combines down double digits in January. And on Slide 32, Deere's retail sales of Commercial and Consumer equipment in the U.S. and Canada were down low double digits in the month.

Construction and Forestry sales in the U.S. and Canada were down double digits on a first in the dirt basis, and down a low single digit on a settlement basis.

Let's turn to Raw Materials and Logistics on Slide 33, which shows Raw Material and Logistic cost increases of about $270 million in the quarter. Looking ahead, our forecast for the year now calls for material cost increases in the range of $400 million to $500 million, well below the level we were expecting earlier.

With $200 million to $225 million hitting in the second quarter, this implies material costs will be flat to down in the second half of the year versus 2008.

Now let's look at a few housekeeping items. Looking at R&D expense on Slide 34, R&D increased about 7% in the first quarter. Currency translation was negative by about three points. For fiscal 2009 R&D expenses are expected to increase about 3%. Currency translation is forecast to be about a negative three points.

Moving now to Slide 35, SA&G expense for the equipment operations was down about 5% in the quarter. This included about a four point increase associated with global growth and initiatives, primarily in Ag, which was more than offset by currency translation of about four points and a reduction in variable incentive compensation expense of about five points.

It is important to note that everyone on the John Deere team in all geographies and all divisions is taking vigorous action to control costs.

For the year, we project SA&G to be down about four points. The Ag division continues to spend for growth initiatives adding about three points. This however, will be more than offset by currency translation of about four points and reduced incentive compensation expense of about four points. As I pointed out, incentive compensation expense is forecasted to be down about four points in 2009.

Our variable incentive compensation system is designed to align performance around strategy and to flex rewards with business results. Some of you may remember Slide 26 from our marketing deck. This summarizes the variable incentive compensation plan. For those of you running models, this forecasted reduction in incentive compensation will also affect cost of sales.

Moving to the tax rate on Slide 27, during the first quarter, the effective tax rate was approximately 29% due to discrete items. The full year 2009 tax rate continues to be forecast at about 35%.

Turning to Slide 38, for fiscal 2009 we anticipate capital expenditures running about $800 million, $200 million less than the previous forecast. Depreciation and amortization is forecast around $500 million, and we anticipate contributing roughly $180 million to benefit plans.

Financial services CapEx will be about $100 million in 2009, primarily for wind. Actual shares outstanding at January 31, 2009 were 422.7 million and can be found in the appendix on Slide 40. As you see, there was no repurchase activity in the first quarter.

In closing, there is little question that Deere faces a difficult year ahead. However, we're taking vigorous actions to make adjustments in our cost and asset structure and in particular, to keep factory production aligned with demand at the retail level. Also, our number one market, farm machinery in the U.S. and Canada, remains strong while the company as a whole continues to benefit from a sound financial position.

Finally, we still believe that the macro economics are on our side. The positive trends that support our businesses such as global demand for food and infrastructure remain fundamentally intact. In our view, they continue to hold great long range promise for the company and for all who share in its success.

Marie Ziegler

We're now going to open the call for Q&A. As is our usual custom, we ask that you limit yourself to one question and a follow and then get back into the queue to permit others to have the opportunity to ask questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Andrew Obin – Bank of America Securities, Merrill Lynch.

Andrew Obin – Bank of America Securities, Merrill Lynch

Could you comment, one of the surprises was a significant deterioration in Western European Ag outlook. Could you just give us a little bit more color of what you've seen over the past couple of months in that market in terms of access to credit and demand?

Marie Ziegler

Actually, in Western Europe I would say was more of a tweaking. We went from down 5% to 10% to down 15% so it's not a tremendous change. Frankly, the reason for the change in the outlook has to do with the fact that although we have a good order bank, we have seen very few cancellations, we are not seeing a lot of new orders coming in, and so we felt it was appropriate to make an adjustment in our outlook.

Andrew Obin – Bank of America Securities, Merrill Lynch

In terms of thinking about the timing of your internal planning, I think on February 2 you put out a press release saying that one of the employment reductions in one of your construction equipment facilities were consistent with your guidance of down 12% in '09 for construction and forestry. A couple of week's later guidance is reducing significantly. Does that indicate that the guidance was tweaked over the past couple of weeks or does it indicate that you just sort of did not want to change guidance as part of that press release?

Marie Ziegler

I won't comment on the timing of that particular thing, but when we had an outlook that called for our sales volume to be down 12%, we knew that we would be required to make some adjustments in our employment and that's what you saw reflected.

Andrew Obin – Bank of America Securities, Merrill Lynch

I guess what I'm trying to understand you changed the guidance, am I correct to understand that you really got all the facts together over the past couple of weeks or was it work in process throughout the quarter?

Marie Ziegler

I'm not going to comment on that, but the timing of when we actually get our forecast is as you are aware, we have a fairly rapid close, and so we would have had our forecast information, not very many days ago quite candidly before we released.

Operator

Your next question comes from Mark Kosnarek – Cleveland Research.

Mark Kosnarek – Cleveland Research

You usually give the average commodity prices and you didn't this time. I'm just wondering if you could go through those pretty quickly.

Marie Ziegler

Actually they are on, unless something happened to the document you're looking at, but we have them on Slide 10, and I'd be happy to give you them. On Slide 10, for this crop year, '08/'09 crop year, corn is at $4.00, wheat is at $6.85, soybeans are at $9.35.

Mark Kosnarek – Cleveland Research

I see that now. In your North American outlook could you talk about changes that might have occurred between some of the categories within the overall business being a high horsepower tractor versus low horsepower and combines. How do they look versus the prior outlook?

Marie Zeigler

One thing that has happened is that as conditions declined in Central Europe and former Soviet Union, we had availability especially earlier in the year for our U.S. and Canadian customers that we otherwise wouldn't have had. So we've seen an availability shift. So we actually have seen some improvement if you will in the capability of meeting our customer demand there.

If you look though in terms of the slight tweaking of our industry outlook, it had been up 5% and we're now saying flat to up 5%. That really is coming from the small tractors, from hand forge equipment and the deterioration in the outlook for cotton equipment.

Mark Kosnarek – Cleveland Research

So large tractors over 100 horse would be unchanged from your prior forecast?

Marie Zeigler

I don't think they would be materially different. Combines would be improved.

Mark Kosnarek – Cleveland Research

What roughly is the increase for the large horsepower that you're looking for for the market.

Marie Zeigler

That would be a number I'm not able to share with you. I'm sorry.

Operator

Your next question comes from Robert Wertheimer – Morgan Stanley.

Robert Wertheimer – Morgan Stanley

I wanted to ask a little bit of a structural question on your goal to be break even positive on things like C&F. Is this trough just too bad to achieve that goal or is it still something you think you can do no matter the economic situation?

Marie Zeigler

I would like to start and I know Mike would like to make a few comments too. In our current forecast, we do still contemplate the Construction and Forestry equipment division remaining profitable with profitability in the low single digits.

Michael Mack

First of all I want to recognize that this is a very good question because it's quite central to what we've been talking about for awhile, and that is our ability to manage our way through a cycle and reduce our volatility.

This is something as you know we've been working on for quite some time. We talked about this in December 2006 with all the analysts in Waterloo, so we've been focused on it as a company. I think we are extremely low levels on the volume right now so that the target of hitting 12% ORA of the trough right now would be very difficult to achieve this year but certainly much better than we ever have done in the past, and it's our ongoing ambition to try to perform at that level, but I think that's going to be pretty difficult in this year.

Robert Wertheimer – Morgan Stanley

Pricing, I don't know how to ask this exactly. How much pricing do you "achieve" through having a back log and through having priced orders and are you anticipating getting pushed back on that back log?

Marie Ziegler

What I can tell you is that our pricing guidance is six points for the year and that if you think about the large tractors and combines because of the back order position, you've got some comfort in some of those numbers but obviously we're in a difficult market condition in the other segments. I don't have the ability to give you a number of points, nor candidly probably would we.

Operator

Your next question comes from Ann Duignan – J.P. Morgan.

Ann Duignan – J.P. Morgan

I wanted to pick up on the pricing question just a little bit. I saw for full year six points, and you estimate for this coming quarter is four points. Can you talk me through a little bit of what's going on there in terms of the mix? Is it less combines more small lawn tractors, or is there anything structural that we need to be aware that you won't be able to realize the six points for full year then?

Marie Ziegler

Our guidance is the six points so we wouldn't have given guidance of six points if we hadn't expected that. One thing that you do see in the second quarter, that is a seasonally strong quarter for our Commercial and Consumer equipment division, so there is a little bit of mix in there.

Ann Duignan – J.P. Morgan

Could you talk a little bit about your outlook for detrimentals in Construction and Forestry and consumer? As we go through the year, I know you'll have perhaps a tail wind from infra costs. Was there anything specific in Q1 that won't be repeated that the detrimentals should improve as we go forward? I'm trying to understand how to model the operating profit in those divisions.

Marie Ziegler

Again, on an absolute basis for both divisions, both Commercial and Consumer and Construction and Forestry, our current forecast contemplates margins in the low single digits on an absolute basis. I don't have any thing really more specific. Our pricing would get relative to the raw material costs will be a little more of a favorable tail wind.

Michael Mack

I would maybe just comment C&C has quite a seasonal component through the year and the most challenging quarter is the one we just had in the first quarter and then the best two of course are the second and third quarters. So I would anticipate that pattern to hold up this year like it does every year.

Ann Duignan – J.P. Morgan

But the import costs will be more of a tail wind in the back half.

Marie Ziegler

That's certainly what our forecast has, yes.

Operator

Your next question comes from David Raso – ISI.

David Raso – ISI

I wanted to keep the question kind of broad just to get your color. How would you describe the down side risk to guidance that you speak of and which areas in particular are providing that risk in your perspective. And the reason I really ask is, if you look at the production tonnage and what you put up in the first quarter, where you guide in the second quarter and when you look at the full year, it implies that the second half year over year production decline is maybe a little bit less than we'll see in the second quarter. But then you look at your U.S. and Canadian Ag production tonnage guidance it implies, and probably rightfully so the second half of the year your declines get worse. So what's the offset in the second half that's less worse than the second quarter to allow the full year tonnage. Obviously something must be getting a little bit better on a year over year in the second half to let U.S./Canadian Ag get worse, but the total doesn't get worse.

Marie Ziegler

The Commercial and Consumer and the Construction and Forestry divisions were making schedule adjustments as we moved through last year, so they have relatively easier compares, at least in our current forecast.

David Raso – ISI

On a profitability, obviously that's not a great trade off, U.S. and Canadian Ag getting worse on production year over year but CC and CF not getting as bad.

Marie Ziegler

Obviously we made an adjustment in our guidance as well as you know.

Operator

Your next question comes from Eli Lustgarten – Longbow Securities.

Eli Lustgarten – Longbow Securities

Can we talk about pricing to get a clarification? You said 6% for the year, do you still have pricing assumptions by segments and are you still positive in CC and C&F?

Marie Ziegler

I can't give you exact numbers. We no longer do that by division, but I can tell you that all three equipment divisions in the current forecast and in that six points of price realization have positive price realization. Clearly Ag would be stronger and the other two would be somewhat south of the six.

Eli Lustgarten – Longbow Securities

Can we talk about demand in the Ag side. You said 9,000 tractors, but are we past the point where cancellations are really probably in those big tractors given that we're getting into delivery and getting into production cycle? And the more important question, if things hold up this well in 2009 in big Ag, and I know you hate to go out, but are we running from risk in 2010 to be a more difficult year in big Ag stuff?

Marie Ziegler

It is not our custom to comment beyond the current year so I'm not going to be able to answer the second part of your question. The first part of your question regarding cancellations, we would tell you that historically on a retail end in the U.S. and Canada and in Western Europe, because we've been in those markets a very long time, once a customer places an order, we typically have very few cancellations, and in part remember, most of the stuff comes with trade in. The dealer is already working on the trading cycle, so historically we have not seen cancellations.

You are correct in observing that we are getting close to the spring planting season. As we move through the year, we're obviously going to be getting closer to fall work where you again need the tractor and the combine. I can only tell you that historically, we have not had a lot of cancellations.

I might also comment, Susan mentioned earlier that we had had a lot of cancellations in the former Soviet Union, and those really are not customer cancellations per se, those are really because we are simply unable to get financing. So if the financing was available, there is still a very strong demand in that part of the world. It's just simply that we cannot get financing so obviously, we can't make the sale.

Eli Lustgarten – Longbow Securities

How long does that 8000 tractors go out, you said 9000 for August.

Marie Ziegler

It's into the summer and we basically said that the order book was closed. You're no longer able to place an order for the 8000 series tractor because we are over the course of the summer transitioning to a new model.

Operator

Your next question comes from Henry Kirn – UBS.

Henry Kirn – UBS

Dovetailing with Eli's question, could you talk a little bit about what stops a farmer from cancelling an order once it's placed?

Marie Ziegler

They've looked at their crop needs, they've made an assessment of risk of going down if you will in season. They've looked at the technology and productivity that they can gain. And very often, again the dealer knows that there is a trade in coming and the dealer has already worked on that trading cycle.

And remember that, depending on the age of the equipment being traded in, there's usually anywhere from three to five subsequent trades associated with the sale of a new tractor, and so as the dealer is working on that trading cycle that acts also as a factor.

Michael Mack

I would add that the farm cash receipts are still at a high level by any historic comparison and the farmer balance sheets are probably the best they have ever been with debt to asset ratios.

Marie Ziegler

And what we've done with John Deere Capital Corporation, we are able to offer financing and clearly local banks and Federal have cash available to also finance those customers. So access to credit is absolutely not an issue for our farm customers.

Henry Kirn – UBS

In terms of the global fleet, could you maybe talk a little bit about each of the regions where you see the age and how long that Ag fleet could be aged before replacement would need to happen?

Marie Ziegler

If you go into the emerging markets, I really don't have a number but I can tell you that there's enormous demand for the productivity that our new tractors and combines and sprayers etc., offer farm customers. So there it's really not an issue of age of equipment. It's really access to credit.

In the U.S., I think you're all aware that for a very long time we don't have firm industry numbers. We think the average age of a tractor is probably close to 20 years in the U.S., but candidly, nobody is doing high production agriculture with a 20 year old tractor. Usually it's something under 10 years and sometimes under seven years.

Again, over time the reason we talk incessantly about cash receipts is because that has been far and away the most significant driver, or the best correlation to equipment sales, has been farm cash receipts.

Michael Mack

Reflecting back to spring of 2008, I think that's a good example of why people need large productive equipment. Remember the late rains we had, there was basically about a two week planting window for our farmers, and I think that really highlighted requirements to have that capability. So it's not aging fleet and wear out that drives purchases. It's productivity capability.

Operator

Your next question comes from Terry Darling – Goldman Sachs.

Terry Darling – Goldman Sachs

I appreciate you're not giving guidance on 2010, but it is a rather provocative slide on Page 10 with regards to thinking about 2010 with your forecast for the commodity prices down pretty significantly and you're just indicating that crop receipts has been the best indicator of future demand, yet you've also got CapEx still well above depreciation.

I'm trying to calibrate your forecast for commodity prices and history would probably suggest that trend down significantly. You are cutting costs here. Raw materials should help as you move into 2010 and pricing seems to be holding up reasonably well. But can you square off the investment level still running well north of depreciation in that context?

Marie Ziegler

That's a very fair question. I want to first point out that our guidance is approximately $200 million lower than it was last quarter. Last quarter we were looking at about $1 billion, and now we're looking at about $800 million.

I think you are aware that we have projects in the U.S. where we were adding some capacity. Those things are like a harvester. That capacity will be in place by the end of March. Waterloo, there we have slowed down some of the rates of increase. We had talked about that earlier and we are assessing what we might do going forward.

Also, some of that spend relates to Tier-4, and we had talked about that even last year in terms of capital and R&D, and that spend must go forward if we are going to sell tractors that are compliant in 2011. I said Tier-4, I should have said interim Tier-4.

There's a chunk of that. And some of that is we are still investing in infrastructure in some of the emerging parts of the world, even though they may have temporarily slowed down. We still see great opportunity there.

Terry Darling – Goldman Sachs

Mike, I'm wondering if on the credit business you can address two issues; one, how do we handicap what might happen with this FDIC request? Are you confident that it's just a process and you'll get through it and there won't be much change? And if you're unable to handicap that for us, what are the alternative funding plans as you look forward out to 2010?

Michael Mack

Relative to handicapping the FDIC, I don't think I can add very much to what Susan said in the opening remarks so I don't want to speak for the FDIC and we'll have to see how that plays out. It's just not resolved at this time.

I think the most important conclusion relative to this is we have secured liquidity which handles all of our needs for 2009 and the first quarter already. We've had quite a lot of good success accessing the capital markets. We've done that through a variety of funding alternatives, some which we had not had in the past.

For example, this conduit, we had a different kind of conduit before, but this is a new one. We have more capability there. We could also access some other alternatives which we're going to be looking at here in the next few months. So I think we have very good capabilities for accessing the capital markets this year as well as next year, and I think that reduces that risk in that area.

Terry Darling – Goldman Sachs

That other alternatives comment you just made, does that refer to securitization receivables? Is that maybe the AVS markets get some benefits from stimulus and you get more active there, or what do you mean by that comment?

Michael Mack

I don't think it requires any kind of stimulus to get there. We can get there with what we have right now. We have already another $2.2 billion capability in CP. We have more capacity that's available in receivable conduits. We have the ability to access medium term note markets I think in both Europe and the United States.

We have other alternatives on top of that as well, so I think we're in very good shape. Plus, we're starting as you know, this is a record level of cash for our company for all time, right now.

Terry Darling – Goldman Sachs

Can you update us as to where we are with the investment in wind and when we might start to see some profits from those investments coming through?

Marie Ziegler

We are continuing to right now for wind, finish out those things we had commitments on. Actually with last quarter's call we talked about the fact that we had put the breaks on many new projects, so we're just finishing out those projects that we had started. Current guidance for financial services is about $100 million and the bulk of that is wind.

As those projects come on, as we slow frankly putting on some new ones, we will start to see that business turn profitable. It's actually an incremental contributor this year, but I don't have a specific time to share publicly.

Operator

Your next question comes from Jamie Cook – Credit Suisse.

Jamie Cook – Credit Suisse

What's your forecast this year for FX translation on operating income and in terms of what are you forecasting for absorption relative to, I'm just trying to compare that with what you did last quarter.

Marie Ziegler

For translation, now you know there's transaction and translation. Translation, our guidance would be $125 million to $175 million negative impact on operating profit. In terms of absorption, last year we had because of the build in inventories and receivables, we had a favorable $250 million pre-tax benefit.

This year, because we're not looking for a significant decline in inventory and receivables, we're looking for a slight negative and it would $15 million pre-tax.

comes. very little money that get's spent this year, at least that's what people expect, so it will be awhile before that moneyJamie Cook – Credit Suisse

You mentioned in the slides benefits from the stimulus and in particular in Construction and Forestry side, I know it's a depressing year this year, but do you have any anecdotal evidence from your dealers that this at least puts a floor on current things? Do you think this is incremental? I understand it's 2010, but just what you're hearing anecdotally and whether your dealers are positive about this in Construction and Forestry or it's just sort of a, at least things don't get worse.

Marie Ziegler

Anecdotally what we've heard is that they're encouraged. I think they're waiting to see some actual budgeting authority. We have been in communications with our Construction and Equipment dealers about the particulars of the bill and we're providing them with information so that they can make good business decisions in terms of going after some additional things.

But frankly, none of that. There's very little money that get's spent this year, at least that's what people expect, so it will be awhile before that money comes.

Jamie Cook – Credit Suisse

I don't care about 2009. I was just thinking about potential for 2010.

Marie Ziegler

We're hopeful but I think hopeful, things have just gotten passed, and people have yet to see anything. comes. very little money that get's spent this year, at least that's what people expect, so it will be awhile before that money We're just very early.

Jamie Cook – Credit Suisse

Just to understand your Construction and Forestry forecast, you're now saying down 24% and I think in your press release you commented a lot of that was related to Forestry. I just wanted to make sure I understood that correct. I'm just surprised. It's a relatively small part of your Forestry division and that market has been so depressed anyway, unless I misinterpreted it.

Marie Ziegler

Actually, about two-thirds of our Forestry business in outside the U.S. and Canada and our outlook last time was they'd be down for that part of the industry segment, maybe down 5% to 10%, and as Susan said, it's down about 50% so it was really a dramatic change there. But she also said the outlook for every construction geography declined.

Operator

Your next question comes from Daniel Dowd – Bernstein.

Daniel Dowd – Bernstein

I wanted to follow up on the input cost issues. The guidance, if I'm reading this correctly seems to suggest that the incremental input costs in Q3 and Q4 are actually going to be flat year on year.

Marie Ziegler

Flat to down, yes.

Daniel Dowd – Bernstein

Are you seeing something in commodity markets or transport costs that lead you to believe there's no benefit on the back end of the year on input costs?

Marie Ziegler

Our current guidance does take into account transport, a reduction in transport costs, so I think that's already fully factored in.

Michael Mack

If you look at spot prices right now, certainly they're going down but there is a certain amount of lag effect that occurs because of the way commodities are purchased not just by ourselves but by our suppliers or several layers into that. So there's a, I would describe it as having a lag effect that takes place both when prices go up as well as go down, so I think that's what you were seeing more than anything else.

Daniel Dowd – Bernstein

Perhaps I'm misunderstanding from the guidance. It looked to me that you're guiding now to between $400 million and $500 million across the year in incremental input costs. You had $275 million in incremental costs in Q1, and you're guiding I think to between $200 million and $225 million. That implied you're basically flat compared to Q3 and Q4 of '08 and Q3 and Q4 of '09.

Marie Ziegler

Flat to down $100, yes.

Daniel Dowd – Bernstein

Which seems awfully conservative. So you're not seeing anything in particular other than the fact that it takes awhile for these issues to roll through your income statement.

Marie Ziegler

Yes. This number had gotten a significant amount of attention, and that is our best estimate.

Daniel Dowd – Bernstein

A quick question on the balance sheet. Can I ask you to talk strategically where you think you should take the balance sheet for your equipment business and also for the financial services business over the next say 24 months? Are the current leverage ratios the right place to stay or do you see is it appropriate to be changing those things in this context?

Michael Mack

Let me take them one at a time. I think with respect to the equipment operations, our leverage is significantly less than the target would be described at S&P and Moody's relative to a mid single A. In fact if you look across a whole host of operating metrics, where we are, they would suggest we would even be in ranges of double A or better on a lot of these so I think single A is very secure where we are. In fact, at the end of the year, we're basically net net zero for equipment operations. So I think we're in very good shape there with our leverage.

With respect to the financial services, we have reduced our leverage here about a quarter ago with the capital infusion, and it is our plan to not pay dividends from the credit company for the balance of this year, so we've taken our leverage down over the course of the year to I think about 7.5 to 1 for the world wide credit operations by the end of this year.

Having had extensive discussions with the rating agencies on this point as well, we feel quite comfortable and confident relative to that plan for leverage.

Operator

Your next question comes from Meredith Taylor – Barclays Capital.

Meredith Taylor – Barclays Capital

I'm wondering if you can talk a little bit about your expectations for write offs and how others are going to trend going forward by receivables. I see that we're already kind of prior peaks in the CC and C&E business, but if you could talk about what the expectations are for Construction and Forestry, adds clearly trending very attractively.

Marie Ziegler

I'm not at liberty to give it to you by product line. I can tell you that our current estimate is that write offs will run at 57 basis points. Our previous guidance was 49 basis points, and of course that's basically driven by the Construction, Forestry and Commercial Consumer portfolios.

Meredith Taylor – Barclays Capital

Within the Ag business, can you talk a little bit about what you actually saw in the quarter in the regions where you're looking the greatest credit pressures based on credit, particularly in South America and Eastern Europe?

Marie Ziegler

What we actually saw, I'm not sure. In the former Soviet Union, in most of those countries, not all, credit is just very, very difficult to come by and so we were cancelling orders because we simply couldn't get the funding for them.

In South America, it's really a mix of issues. Everyone's well aware at least up to this point the severe drought, and that has affected Argentina and has moved into parts of Brazil and I think it's Uruguay. Credit actually eased, our marketing folks told us eased just a little bit in the quarter, but it's still a very, very difficult situation.

Meredith Taylor – Barclays Capital

I guess I was more wondering if you've seen the cancellations going forward but revenues were still holding better than the estimate for the full year.

Marie Ziegler

We cut our guidance for South America.

Meredith Taylor – Barclays Capital

I guess I'm just wondering what your expectation is indicated through the year for those reasons, whether there was already a steep drop off in the revenue basis or whether the expectation is still to come.

Marie Ziegler

I would say we had a fairly weak first quarter and I guess I don't know exactly how the numbers play out over the rest of the year, but I think the guidance really reflects to a large degree what we were already experiencing.

Michael Mack

I think with respect to CIS the news is baked in right now in terms of the environment relative to tariffs and availability of input financing and so I don't think there's going to be any kind of news in that regard.

Operator

Your next question comes from Robert McCarthy – Robert W. Baird.

Robert McCarthy – Robert W. Baird

We obviously have pretty good detail on Ag inventory levels in the U.S. but could you give us a view on dealer inventory levels and trends internationally? You took your international production forecast down to negative 17%, but it looks like your international retail demand might even be a little worse than that.

Marie Ziegler

When you look at the tonnage numbers, you need to be careful because the tonnage numbers reflect where the goods are manufactured and not where they are sold. So you get a mixed bag of things going across the ocean.

Inventories generally speaking, we've been pretty rapid on the response time so we feel generally pretty good about the level of our inventories.

Robert McCarthy – Robert W. Baird

Was there any special costs related to the shut down of your Canadian facility in the quarter?

Marie Ziegler

Yes. There would have been $11 million in the quarter.

Robert McCarthy – Robert W. Baird

Do you know what segment that was in?

Marie Ziegler

That would be split 60% Ag, 40% Commercial and Consumer.

Operator

Your final question comes from Andrew Casey – Wachovia Capital Markets.

Andrew Casey – Wachovia Capital Markets

Were there any additional fixed cost reduction charges in addition to that plant closures.

Marie Ziegler

There are no other plant closures.

Andrew Casey – Wachovia Capital Markets

The other operating expense increase year over year, is that all currency or is there something else?

Marie Ziegler

It's currency.

Michael Mack

That doesn't reflect every aspect of currency because some of it shows up in cost of sales as well.

Marie Ziegler

Thank you all for participating. As usual, Susan, Justin and I will be around to answer your questions all day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Deere & Company F1Q09 (Qtr End 12/31/08) Earnings Call Transcript
This Transcript
All Transcripts