Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  
TRANSCRIPT SPONSOR
Wall Street Breakfast

Deere & Co. (NYSE:DE)

F3Q07 Earnings Call

August 15, 2007 10:00 am ET

Executives

Marie Ziegler - IR

Bill Ratzburg - IR

Mike Mack - CFO

Analysts

Steve Wharton – JP Morgan

Andrew Casey - Wachovia Capital Markets

Ann Duignan - Bear Stearns

David Raso - Citigroup

Andrew Obin - Merrill Lynch

Terry Darling - Goldman Sachs

Heiko Ihle - Gabelli

Barry Bannister - Stifel Nicolaus

Mark Koznarek - Cleveland Research

Jamie Cook - Credit Suisse

Daniel Dowd - Sanford Bernstein

Charlie Rentschler - Wall Street Access

Seth Weber - Banc of America Securities

David Bluestein - UBS

Robert McCarthy - Robert W Baird

Presentation

Operator

Good morning and welcome to the Deere & Company third quarter earnings conference call. (Operator Instructions) I will now turn the call over to Ms. Marie Ziegler, Vice President of Investor Relations. Please go ahead.

Marie Ziegler

Good morning. Also on today's call are Mike Mack, our Chief Financial Officer, as well as Susan Karlix and Bill Ratzburg from our investor relations staff.

Today we'll take a closer look at Deere's third quarter earnings and then spend a few minutes talking about our markets and where things are headed for the rest of the year, and after that, we'll respond to your questions. Please note that slides are available to complement the call this morning and they can be accessed on our website at www.deere.com.

First, a reminder. This call is being broadcast live on the Internet and recorded for future transmission and use by Deere, Thomson, and third parties. 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 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 our periodic reports filed with the Securities and Exchange Commission. The company, except as required by law, undertakes no obligation to update or revise its forward-looking information.

This call also may include financial measures that are not in conformance with generally accepted accounting principles. Additional information concerning these measures including reconciliations to comparable GAAP measures are posted on our website at www.deere.com/financialreports, under third quarter 2007 reports. Call participants should consider the other information on risks and uncertainties and non-GAAP measures in addition to the information presented on the call.

Now for a closer look at the quarter, here's Bill.

Bill Ratzburg

Thanks, Marie. This morning Deere reported record third quarter net income of $537 million on equipment operations net sales of almost $6 billion as shown on slide 3 of the presentation. On a continuing operations basis, income increased 23% and diluted earnings per share rose 28%. On slide 4, third quarter total worldwide equipment operations net sales were up 5% compared to the prior year quarter. There were about 3 points related to positive currency translation; price realization was about 2 points. In fact, all three equipment divisions had positive price realization in the quarter. This is particularly gratifying given the difficulty in the construction and forestry markets. LESCO, our newest growth opportunity, added about another 2 points. It is worth noting that physical volume in our equipment businesses was down slightly in the quarter, making the bottom line performance all the more impressive.

On slide 5, we have provided a table with production tonnage data. For the full fiscal year, worldwide production tonnage is now forecast to be up 4% verses our previous forecast of up 2%. You'll note that fourth quarter 2007 tonnage for the worldwide equipment operations is expected to be up 19%. Within the U.S. and Canada, while construction and forestry tonnage is anticipated to decrease 22%, ag tonnage is forecast to increase 63%.

Regarding our company outlook, let's turn to slide 6. For the fourth quarter of 2007, we expect company-wide equipment operations net sales to be up about 16%, with sales from LESCO and positive currency translation accounting for about half of that increase. For the full year, we are now forecasting net equipment sales to be up about 7% compared with fiscal year 2006, 1 percentage point higher than our previous guidance. This includes about 2 points of net price realization and about 2 points of positive currency translation. The estimated net income is about $1.70 billion for the year compared to our previous guidance of around $1.55 billion.

Let's turn now to a review of our individual businesses starting with agricultural equipment on slide 7. For the third quarter, Deere's worldwide ag sales were up 16%, including approximately 3 points of positive currency translation. Operating profit rose 73% in the quarter to $431 million, with incremental margins of approximately 40%.

The quarter benefited from 15% higher production tonnage contributing to improved operating efficiencies and the strength in large tractors as well as positive price realization. Somewhat offsetting these factors were higher raw material costs of $24 million and higher research and development expense in the quarter relating to advance new products, just ahead of a major product launch.

Looking ahead, global ag fundamentals are very encouraging, as reflected in strong farm income. Worldwide stocks-to-use ratios remain at very low levels for corn and wheat; in fact at the lowest levels in over 30 years. This supports crop prices which in turn supports good levels of farm income in all geographies, and as shown in the U.S. for slide 8, with total cash receipts for 2007 increasing to about $282 million, a rise of over $22 million compared to 2006, driven primarily by the combination of crops and livestock. The current Deere U.S. commodity price assumptions from these farm income forecasts are on slide 9.

Our outlook for industry sales of agricultural equipment in the U.S. and Canada as shown on slide 10 remains up about 5% for fiscal year 2007 versus fiscal year 2006, reflecting continued strength in large tractors. In addition, our outlook for South America increased to up 30% from up about 20% last quarter. A strong recovery continues in Brazil, certainly helped by the proposed resolution on 2007 Benami payments. There are high level details of the proposed Benami financing plan on slide 11. Customers widely anticipate that this will be approved by Congress. It is very important because this clears up a major area of uncertainty and is reflected in our improved outlook.

In Western Europe, shown on slide 12, our current outlook is for industry sales to be up about 2% for the fiscal year compared to our previous outlook of flat to up 2%, with strength in the overall farm sector primarily due to higher crop and dairy prices. When we last spoke, there were concerns about emerging drought conditions. Since then, excessive rains have fallen in some areas. Despite this, generally the mood of farmers is more positive, which we find encouraging. We continue to see good sales, but from a small base in Eastern Europe and the commonwealth of independent states countries, including Russia and continue to be optimistic about the future. In Australia, rains have come, alleviating some of the severe drought conditions. While they occurred late and will not help 2007 retail activity, it bodes well for 2008.

So putting this all together, slide 13 depicts a stronger worldwide outlook for the sale of John Deere farm machinery. We now project 2007 Deere agricultural equipment sales to be up approximately 16%, including about 3 points of currency translation versus our previous outlook of up about 13%. Production tonnage is expected to be about 14% higher this year compared to our previous projection of up about 11%, reflecting the strengthening in all global markets and our plan to prebuild some components to support what we believe will be better markets in 2008.

Let's move now to our commercial and consumer equipment business on slide 14, where reported net sales were up 15% for the quarter with $125 million coming from LESCO; however, operating profit rose 63%. In the third quarter performance, we clearly see the benefit of new offerings like the residential zero-turn radius mowers, utility vehicles and compact tractors with their positive contribution to price realization, volume and mix in an otherwise difficult market.

Slide 15 has the key details relating to LESCO. LESCO is in the process of being integrated into John Deere Landscapes and the integration pace is proceeding as plan. In fact, while still very early, LESCO was slightly profitable in the third quarter and for their first six months as part of Deere, instead of generating a small loss we now anticipate it to be slightly profitable.

Turning to the full year commercial and consumer equipment outlook on slide 16, we continue to anticipate sales up about 11% for 2007, or up just about 2% excluding LESCO and conclude by pointing out once more that despite the difficult market conditions, the marketplace is valuing the new products and this in turn is supporting our results.

Let's focus now on construction and forestry on slide 17, where sales were down 20% for the quarter, with weakness in the U.S. and Canada being offset somewhat by strength in sales outside the region. Despite 14% lower production volumes, quarterly operating profit was relatively strong at $150 million with some positive price realization more than offset by raw material increases of approximately $45 million.

Turning to slide 18, our net sales of construction and forestry equipment are now forecast to be down about 12% for the year versus our previous outlook of down about 11%. Both construction and forestry equipment sales in the U.S. and Canada are projected lower and more than offset strengths in markets in the rest of the world. Spending from independent rental companies in the U.S. and Canada on our types of equipment is down significantly this year.

Lest we end on too gloomy of a note, this is a challenging environment with U.S. housing starts falling to 1.4 million from 2.1 million less than two years ago. Despite this, construction and forestry earned operating margins of approximately 12% in the third quarter. With incremental margins for the full year likely to be in the range of 35% to 40%, an improvement from our previously expected approximate 45%. Our sales guidance suggests sales of around $5 billion this fiscal year. This is excellent operating performance and it reflects successful broadening of construction and forestry product offerings, its diversification of end markets and the power of Deere's overall SVA efforts.

Moving now to our credit operations as you see on slide 19, credit reported net income for the quarter of approximately $91 million, up from approximately $89 million a year ago. Our forecasted credit net income for the full year remains at about $355 million. As slide 20 shows, John Deere Credit’s provision for losses remains at very low rates.

Turning to slide 21, on our statement of cash flows for the equipment operations, you'll note a significant change in the undistributed earnings of unconsolidated subsidiaries and affiliates between 2007 and 2006. This change is largely due to higher dividends of about $448 million paid by credit so far during 2007. As a reminder, this includes a $230 million special dividend paid during the second quarter of 2007. This dividend is a result of support for higher leverage in our credit operations from the rating agencies.

Before moving on to retail sales, let's look at receivables and inventory. This marks the 29th consecutive quarter where we have reduced trade receivables and inventories as a percent of sales but compared to the same quarter in the prior year. This data is shown graphically on slide 22.

Slide 23 lists the change in receivables and inventories at the end of the third quarter of 2007 versus the third quarter of 2006 by division. You'll note that reported trade receivables and inventory at 31 July were $37 million lower than a year ago. On a constant exchange basis, this reduction is an impressive $234 million. Our fiscal year 2007 forecast on slide 24 now calls for a $250 million increase in inventories and receivables versus our previous estimate of about $150 million increase. By division, ag now anticipates an increase of about $375 million, about one-third of which is from currency translation compared to the previous estimate of $175 million, and virtually all of the $200million change being in company-owned inventory as we build up raw material and components in anticipation of better markets in 2008. In fact, while still very early, customer response in the corn belt to early order programs for products in seeding, tillage, and sprayers has been strong.

C&CE’s increase of about $100 million is solely due to the acquisition of LESCO, which added about $150 million. Construction and forestry now expects to reduce receivables in inventory by about $225 million compared to $125 million last quarter, continuing the divisions and dealers disciplined approach to challenging market conditions in the United States and Canada.

Before turning to housekeeping, let's look at the latest in retail sales. Slide 25 shows the product category detail for the month of July expressed in units. For utility tractors, the industry was flat and Deere was down a single-digit. For row crop tractors, the industry was up 20% and Deere was flat. For four-wheel drive tractors, the industry was up 4% and Deere was down double-digits. For combines, the industry was up 3%, Deere was down a single-digit. Retail activity for agricultural equipment in the United States and Canada for the quarter was up a single-digit on a current dollar basis and we expect that retail momentum will continue to build as we move into the fourth quarter.

Deere dealer inventories in the U.S. and Canada remain in very good shape as Deere inventories at the end of June remain below industry levels in each of the categories just cited except for four-wheel drive tractors, where Deere inventories were in line with the industry. On slide 26, you'll see that for row crop tractors, Deere ended July with inventories at 19% of trailing 12-month sales versus 22% a year ago. Combine inventories remain at low levels at 16% of trailing 12-month sales versus 13% at the same time last year.

Turning to slide 27, in Western Europe, sales of John Deere tractors and combines were up double-digits in July. Moving to slide 28, Deere's retail sales of commercial and consumer equipment in the U.S. and Canada were flat in July. Construction and forestry sales in the U.S. and Canada were down double-digits on both first in the dirt and a settlement basis.

Now let’s touch on a few housekeeping items. Regarding raw material and freight, let's move to slide 29. In the third quarter, these costs rose approximately $75 million versus last year. Our fiscal year 2007 forecast continues to include an increase in raw material and freight of about $200 million. By division, the break down is now about $80 million for ag, about $20 million for C&CE and about $100 million for construction and forestry.

Looking at research and development expense on slide 30, spending was up 16% in the third quarter, just ahead of upcoming new product launches. We are forecasting an increase of around 12% for 2007. This increased spending relates to our continued emphasis on advanced new products and technology to drive future growth and ever increasing productivity to our customers.

Now moving to slide 31, selling, administrative and general expenses. SA&G for the equipment operations was up 9% in the third quarter with all of it explained by global growth initiatives and currency translation. Our fiscal year 2007 forecast now includes SA&G increases of about 14%, including about 10 points related to growth in currency. This includes about $100 million for LESCO.

Regarding the tax rate on slide 32, for fiscal year 2007 our forecast still assumes a full year tax rate of approximately 33%. Before we leave housekeeping, we wanted to note that currency translation added about $16 million to operating profit in the quarter and about $52 million on a year-to-date basis, mostly in the ag division.

Actual shares outstanding at the end of the quarter were 221.9 million and average diluted shares outstanding for the quarter were 226.8 million as shown on slide 33. On May 30 of this year, Deere's board of directors authorized a new 20 million share repurchase program. With the 2005 program almost complete at the end of July, it is likely that during the fourth quarter of 2007 we will conclude that program and begin to repurchase shares under the new authorization.

Slide 34 highlights the share repurchases as part of our publicly announced plans by quarter for fiscal years 2007 and 2006. During the third quarter of 2007, we repurchased 4.3 million shares with an expenditure of about $500 million. Slide 35 provides some additional information related to our fiscal year 2007 forecast.

For equipment operations, capital expenditures are currently forecast to be about $600 million. Depreciation and amortization is expected to range from $400 million to $450 million. We now anticipate about $525 million in pension and OPEB contributions for the year. For financial services, capital expenditures for wind investments are expected to total about $500 million in 2007. Slide 36 provides the 2006 information on discontinued operations and special items by quarter.

Looking ahead, Deere is on track for another year of outstanding financial performance including exceptional cash generation, demonstrating the power of our SVA discipline. The company is well-positioned to benefit from powerful global, secular economic trends. We at John Deere are looking forward to exciting times in the years ahead.

Marie Ziegler

Thank you, Bill. We are now ready to begin the Q&A portion of the call. The operator will instruct us on the polling procedure. But as a reminder, in consideration of others and we do actually get feedback on that, please limit yourself to one question and a related follow-up. You are welcome to get back into the queue. As time permits, we will get through the second round of questions.

Question-and-Answer Session

Operator

Your first question comes from Steven Wharton – JP Morgan.

Steve Wharton - JP Morgan

Good morning. A question on ag margins. First, maybe I just wasn't looking at this quite right, but it sounded to me like in the last quarter call you were giving us a few things that we ought to be cognizant of in terms of some headwinds on margins in the quarter. Margins came out in ag much better than I had expected. Either I misforecast that or things went a little better there than you had expected. Can you give me a sense of that?

Marie Ziegler

Absolutely. Well, it's true that our financial performance is better than what we had anticipated, frankly in all of our equipment operations. But the headwinds do continue in SA&G and R&D, and just as a reminder for those who may not have heard this last time, this again is true in all of our businesses, but particularly in ag as we are investing to grow our businesses in places like Brazil and Russia and China, we are encountering higher SA&G and some higher R&D as we continue to develop products for those markets as well as our existing major markets. We think we have some real opportunities in the years ahead. We do expect and that's consistent in the guidance that Bill just shared with you for the overall company in R&D and SA&G, that we will continue to see some headwinds. That said, ag clearly performed very well in the quarter.

Steve Wharton - JP Morgan

Just where are we with respect to sort of normal volumes in ag?

Marie Ziegler

There's a fair amount of upside in ag without giving a point-blank answer. But there's some upside.

Steve Wharton - JP Morgan

So if we're doing 14% margins now with still a fair amount of upside in volume, it seems like maybe we ought to be thinking about margin potential in this business being bigger than it has been historically? Does that follow?

Marie Ziegler

Mike, do you want to take that?

Mike Mack

I think a couple things. I would answer that we're probably very near our normal volumes in ag right now. As we increase as a percent of normal volumes, we do experience operating leverage in each of our businesses. Certainly that's the case in ag, as you get more absorption in the factories. They are running, I think efficient. We've benefited in the last quarter from pricing and volume in that business, as well.

Operator

Your next question comes from Andrew Casey - Wachovia.

Andrew Casey - Wachovia

A question on agricultural equipment market. Your two comments you expected 63% Q4 U.S. and Canada tonnage increase, and the decision to prebuild components indicate pretty high expectations for future demand. Likely you already stepped up production in August. So what, if any, supply chain constraints have you encountered or are you concerned about?

Marie Ziegler

Well, it's true that we are working with our supply chain. With planning you can do a number of things. At this point, we don't have anything really to discuss in terms of supply chain constraints. We have added, I think you're aware, even in our own operations, we've added a little bit of capital. We've talked about this at Waterloo, that'll come online, machine tooling. We also added some machine tooling down in Brazil to help accommodate that market. So we're really not at this point aware of anything that we would need to discuss. But certainly, a lot of work to make sure that we can meet customer demand.

Andrew Casey - Wachovia

You're modestly reversing a multi-year inventory reduction in North American ag equipment. Does that mean this level of field inventory is pretty much the bottom as a percentage of trailing sales?

Marie Ziegler

I would say that over time we will continue to strive to lower that ratio as a percent of sales. But I would also tell you that everything that we know that we can do, we are doing. We've talked in the past that there may be things with logistics. There may be things in terms of some of the processes, the way we run our operations. We have flexible workforce arrangements, so we are looking at other things that will permit us, in the longer term, to potentially run with lower levels. At this point, this is about where we think we can support our customer demand.

Mike Mack

I would just add, every time we've looked at the reductions in assets, we always think about the context of making sure we're going to have our order fill and the fill rate metrics consistent with providing the fill rates for both customers and dealers that we want to have. It is a balancing act.

Operator

Your next question comes from Ann Duignan – Bear Stearns.

Ann Duignan - Bear Stearns

Could you give us a little bit more color on your investments in Brazil? Also an update on your proposed acquisition in China? How is the ramp-up expected to take place in Brazil, in particular, and whether you're comfortable with your distribution there? In China, if and when that deal does close, will either of these or both of these be detrimental to margins?

Marie Ziegler

Let's start with China first. China, we are waiting still for government approvals. We have said that we expect that acquisition to create positive income in its second full year of ownership. Between now and the time we get there, it would be slightly negative in terms of its income. Very, very immaterial, quite candidly.

Looking on to Brazil, there are we are in a limited build mode in the new factory. The first two models that go into production will not be products that have been produced in Horizontina. So we're going to ramp up that first and then we will transition production from the existing factory in Horizontina into Montenegro. All things are on track. We expect to start ramping up regular production over the course of the fall and into winter.

Actually as it gets up and gets going, we would anticipate it would start to reverse what has been a bit of a margin drag right now, because basically you've got a lot of people in the factory with no production to speak of. You've got people being trained, establishing supply relationships, et cetera, et cetera. So as we move through 2008, we would expect that would become less of a drag as you move through the year.

Ann Duignan - Bear Stearns

Just for clarification on China, you said it will overall be losing money or it will be detrimental to current margins?

Marie Ziegler

The operation itself between now and the second full year of ownership -- once we get approval, of course to buy it -- would be slightly negative, but Ann it's going to be so small, you won't see it in our margin.

Operator

Your next question comes from David Raso - Citigroup.

David Raso - Citigroup

A question on construction. The further reduction of receivables and inventory at the end of the year and now forecast, how much of that do you have already in the third quarter?

Mike Mack

It's really done. If you look at where we are with our year-over-year, we're basically there.

David Raso - Citigroup

So you were able to do that with, again, your pricing was up in construction in the quarter.

Marie Ziegler

It was positive.

David Raso - Citigroup

Looking into '08. Just kind of get a feel philosophically about your construction inventory. If you're already done and you feel essentially you don't need to reduce it further in the fourth quarter, if retail hypothetically was flat next year, are we no longer thinking we have to under produce retail in '08 given the comments you just made about you completed essentially your full year '07 inventory and receivable reduction already?

Marie Ziegler

Based on what we know about the market, it would appear and we would tell you that we feel very good about the position of our inventories and receivables. I would have to answer your question, yes. But time will tell.

Operator

Your next question comes from Andrew Obin – Merrill Lynch.

Andrew Obin - Merrill Lynch

Just on the financials, are you expecting any impact on performance going into '08 due to widening spreads?

Mike Mack

No, Andrew, we don't at all. The way we run our credit company, we have a very tight management for interest rate risk management. I wouldn't anticipate any impact on that at all, really.

Andrew Obin - Merrill Lynch

So that should just be a function of volumes that you sell, right?

Mike Mack

That’s right.

Andrew Obin - Merrill Lynch

In terms of farmer behavior, historically we’ve looked at interest rate as a component of farmer behavior, and interest rates have been so low for so long. Are you seeing any impact on farmer behavior or any potential impact from the recent turmoil in credit prices and accessibility of credits?

Marie Ziegler

There has been no impact whatsoever on that. Now granted, events are rapidly developing, but we did check with our credit people. The other thing I want to point out is many farmers have cash and pay cash for their product.

Mike Mack

I would just like to chime in that the past dues and writeoffs in total on the credit company are really very good levels still, and almost about the same as they were last yea and compared to our historical levels, a very clean portfolio right now.

Operator

Your next question comes from Terry Darling – Goldman Sachs.

Terry Darling - Goldman Sachs

I wanted to follow-up on the ag incremental margin discussion. If I'm translating or extrapolating some of the things you said about 4Q profitability for construction and forestry and C&CE, my extrapolation of those comments would suggest that the farm equipment incrementals targeted within the guidance is more like a low 30%. The question is, can you be more direct about where you see on a full year basis looking out the incrementals? Should we think of 40% this quarter as sustainable?

Marie Ziegler

Things do bounce around quite a bit. I will tell you that typically our second quarter is a strong quarter in terms of our production. Fourth quarter in contrast would not typically be so strong. Some of that production tonnage increase you're seeing is not going to actually be reflected fully in margins because it's going to be a little bit going into inventory.

For the full year, the majority of what will affect our incremental profit for the full year has already occurred because we're three quarters into that. So you're probably looking at something in the range 25% plus or minus for the full year, if that helps you.

Terry Darling - Goldman Sachs

I'm not sure how that math works into the mid 20s, I think it's got to be low 30s. I could follow-up offline. The follow-up question is on other income, that number's bouncing around a lot, as well. Should we think of this quarter as a trend line or sort of the average of the last couple of quarters? Thinking about that $21.8 million other operating expense which was versus $48 million last year.

Marie Ziegler

The other operating expense is just a whole host of little items that affected it. Conversely in the fourth quarter and by its very nature you understand this is somewhat hard to predict because it is miscellaneous. Our forecast would have it actually flipping around. The fact that you're a little light versus a year ago in the third quarter will be made up in the fourth quarter. I don't really have any more insight, frankly than the similar comment in terms of our other income, as well.

Operator

Your next question comes from Heiko Ihle - Gabelli.

Heiko Ihle - Gabelli

A quick question on the slight 20, you show the provision for the credit losses, which seem to be going off slightly and still low on historical levels. What segments do you see those losses in?

Marie Ziegler

We have had extremely low levels in all of our businesses. It would be true that we would be keeping maybe a little closer eye on CNS and on consumer, as well. They continue to remain comfortably below historic levels. There's really no story there.

Heiko Ihle - Gabelli

There's no story. Can you maybe elaborate on where these losses are?

Marie Ziegler

I don't have anything more than what we just said. We're keeping a little closer eye on the construction and forestry and on the consumer. One thing -- maybe, the most important thing -- is this is very consistent with what we actually went into the year with. So we've seen no deterioration from what our expectations were.

Operator

Our next question comes from Barry Bannister – Stifel Nicolaus.

Barry Bannister - Stifel Nicolaus

You bumped up your ag segment trade receivable inventories by a couple hundred million. It accounted for 80% of the full year change. What I'm curious about is since you're increasing your production tonnage in North American ag by 63% in Q4 against a minus 17% a year ago,, how much of that build is subassemblies that have not yet made it to the finished goods stage? Or is it a production issue all the way to the finished good where you're getting the equipment ready for final sale?

Marie Ziegler

It's really raw materials and components. There's really very little in the way of finished goods that would be in that $200 million change from our previous guidance.

Barry Bannister - Stifel Nicolaus

When you measure tonnage, though, you're talking about things that are not yet to the finished goods stage.

Marie Ziegler

So that could include finished goods, as well.

Barry Bannister - Stifel Nicolaus

It would not necessarily have the same incremental margin?

Marie Ziegler

That is absolutely true.

Barry Bannister - Stifel Nicolaus

Related to your production, which I presume your production is somewhat in line with both your market growth forecast and your market share forecast. I've noticed that your market share has slipped versus the industry. Would you comment on the market conditions and why Deere share is down this year and what's caused that?

Marie Ziegler

You're talking specifically in North America?

Barry Bannister - Stifel Nicolaus

Yes, North American agriculture.

Marie Ziegler

As you know, you've heard this repeatedly. We've talked about that market shares need to be looked at over a long period of time in any given month you can have an awful lot of flexibility. When we went into the year, knowing if you'll recall that we've seen commodity prices run pretty dramatically in October, which is right ahead of the end of our previous fiscal year. We talked about the fact that we expect we would get off to a relatively slow start on a retail basis in the first part of the year and build momentum as we moved through the year. That has certainly played out. We again, expect to continue to build momentum as we move through the year and in any given month market shares just somewhat of noise in terms of what happens one way or the other. So we'll see.

Mike Mack

I just looked at market share data across basically all of our products over the last five years, I think you can conclude that for most products most of the time, we've had a nice gradual trend in terms of the market share gains.

Barry Bannister - Stifel Nicolaus

I'm just curious why your row crop and combines year-to-date are somewhat lagging the AEM numbers. I don’t understand the reason.

Marie Ziegler

Let's see how we look as we continue to move through the year and see if you have some differences in timing of shipments. I don't really have anything else to add. Again, the year is playing out as we had anticipated with the acceleration of retail activity as we move through the year.

Barry Bannister - Stifel Nicolaus

So if I were to look at this as kind of a battlefield, your fourth quarter looks like you're planning a large assault here?

Marie Ziegler

You have such a way with words.

Barry Bannister - Stifel Nicolaus

Thank you.

Operator

Your next question comes from Mark Koznarek – Cleveland Research.

Mark Koznarek - Cleveland Research

Just some clarifications. The discussion we were just having about the $200 million of extra ag inventory and receivables, is there an earnings impact to that buildup of components? Does that contribute at all to your bottom line?

Marie Ziegler

Yes, but you get some absorption on that change, if you will. And again, it's about $200 million, but you don't get the margin from selling it. The benefit, if you will, in our fourth quarter for our ag operations would be in round numbers about $20 million.

Mark Koznarek - Cleveland Research

$20 million of operating income?

Marie Ziegler

Yes.

Mark Koznarek - Cleveland Research

The other clarification has to do with Brazil. I thought I heard you say that as you're starting up, you're going to be transitioning production between the two facilities that in '08 we'll clearly have production volume to offset the expenses you've been incurring down there.

Marie Ziegler

To start off, that is correct.

Mark Koznarek - Cleveland Research

What I'm looking for is whether we actually get into positive contribution to earnings in '08 based on the ramp-up that you're expecting or is it less of an expense?

Marie Ziegler

I think at this time our forecast is less of an expense because you're still looking at pretty low levels of production volume as you even start into fiscal '08 as you're transitioning. Remember, you've got a lot of training, brand new factory, new people, a lot of activity down there.

Mark Koznarek - Cleveland Research

So what does the overall start-up schedule look like? When do you expect to be up, I don't know if there's a normal level of volume production that you're targeting. How should we look at the ramp-up period?

Marie Ziegler

Again, we've said we we'll start in the fall and then continue to ramp up through the northern hemisphere winter. We have some flexibility depending on what happens with market conditions, Mark. So we don't have a firm date that we will be complete with that ramp-up.

Mark Koznarek - Cleveland Research

In '08 are you going to be at a full production level appropriate to the market or are there still things that are being staged in order to get to full production?

Marie Ziegler

By the time you would get to the latter part of our fiscal year, we will of course be at regular levels of production.

Operator

Your next question comes from Jamie Cook – Credit Suisse.

Jamie Cook - Credit Suisse

Marie, my first question, you talked that little bit about your ability to get pricing. I was surprised. Could you give a little more color by segment in North American ag? I was hearing some people were being more aggressive. If you could comment in what you're so seeing in North American and overseas. Or rank order by segment where you've been most successful on the pricing front?

Marie Ziegler

In the quarter, 2 points of price realization. We have talked quite a bit about the difficult conditions in the construction and forestry. It would be fair to assume that there was a slight increase and there was a bit of an increase in the commercial and consumer. We don't provide guidance or breakout by product line. But that would imply you actually had something north of 2 points in our ag division. I don't have anymore geographic comments.

Jamie Cook - Credit Suisse

Getting back to the construction and forestry business, you did mention that the commercial construction business or non-res was up 8%. How are you looking at that going forward? We're hearing some commentary from other people to suggest we might have seen the best in commercial construction. Do you expect that to follow residential? How are you looking at that internally?

Marie Ziegler

By the way that was an industry forecast for U.S. spend. We have it up about 8% this year. We have it up about 2% next year. So the rate of growth would slow, but we still see positive growth there and you heard that we see housing stabilizing at about 1.4% in 2008.

Jamie Cook - Credit Suisse

But you didn't see anything in the quarter to suggest the commercial construction was slowing?

Marie Ziegler

Again, just the rate of growth is slowing. But our most current estimate is the 2% increase. Jamie, maybe just before you leave. Just to go back on that pricing. I do want to point out that we have helped ourselves with our price realization through an extensive array of new products over the years through our very strong dealer distributions through our discipline in terms of the amount of product that we are providing into the marketplace. So we've done an awful lot over the last several years to help support the kind of pricing that we're achieving in this environment. Thanks. Next question.

Operator

Your next question comes from Daniel Dowd – Sanford Bernstein.

Daniel Dowd - Sanford Bernstein

I wanted to touch base on your U.S. commodity price estimates. I noticed that your '07/'08 previous forecasts and your updated forecasts show a good deal of volatility. You're projecting corn to be down quite a bit from where you were three months ago, but you're also predicting wheat and soybeans to be up a good deal. Can you talk about the things you're seeing in the marketplace that are leading you to move these estimates around?

Marie Ziegler

They'd be the same sorts of things that you guys would be looking at. We've seen nearby futures come in just a little bit. But you still see extremely good levels of the overall, they're still at extremely good levels. You get into '09 and you're seeing corn over $4 in the futures market. So we're taking a look at basically the same sorts of things that you are in terms of trying to adjust what we see in our forecast. Not sure where you're going with that.

Daniel Dowd - Sanford Bernstein

I guess my question here is any of this based on your insights into farm yield or acreage dedicated to corn or other kinds of things? Perhaps the demand side on ethanol or other sources of demand for corn?

Marie Ziegler

Well, I think you're aware in terms of ethanol, the USDA just increased its projection of ethanol production for the '07/'08 crop; they had been at 3.2, they're at 3.4 billion bushels. In our own internal forecasts, we're still at 3.2. Again, I don't really have any other insight in terms of yields you saw what the USDA did last Friday. Our own internal yield forecast is 152.5, the USDA is 152.8. So we turned out to be very similar.

Daniel Dowd - Sanford Bernstein

So essentially that change is being driven purely by the futures market, not anything you're seeing in the real agricultural economy? Is that right?

Marie Ziegler

They're linked. They're not disconnected. As you know, what's in the futures market, there's always a clip as to what actually gets into farmers' hands. But no, again I'm sorry, I'm not sure where you're headed.

Mike Mack

I think there's a lot of momentum in the demand side for these commodities. You've got the investments that have already occurred for ethanol, and you’ve got those which are online in the next 12months and those together I think are about 13 billion gallons of ethanol, and if you get to say 15 billion, that's going to translate to about 5 billion bushels of corn demand. So it's up substantially from where we are now. I think that's what the futures are reacting to.

Daniel Dowd - Sanford Bernstein

Your total farm cash receipts estimates. So your '08 estimate is basically flat from your '07 estimate which is, to be honest, I would have assumed that '08 would have been better than '07. Do you have any other commentary on that other than just your view of corn prices here?

Marie Ziegler

We would say that's flat at pretty darn good levels of activity. There may be a little bit of play to some degree it depends on how much crop gets sold when. You actually could have a little bit of the '07 slide into '08. Some of that will be driven quite candidly by timing. We're making some assessments or assumptions as to when people sell crops. Clearly a very healthy outlook.

Daniel Dowd - Sanford Bernstein

Clearly, it is a very healthy outlook for sure. Thank you.

Operator

Your next question comes from Charlie Rentschler – Wall Street Access.

Charlie Rentschler - Wall Street Access

Can you give us some more detail on new products you alluded to being released here in the near future?

Marie Ziegler

We will be announcing them to our dealers starting next week. Until that time, we really are not in a position to make comments about those products. There'll be a rollout.

Charlie Rentschler - Wall Street Access

Going back to the last couple of questions. The upturn that we're talking about here in North America, what kind of legs does this have under it? Do you see this thing? You are clearly suggesting that your fiscal '08 is going to be very strong. But do you see this thing going on a couple three years more? Is there a case that could be made for that?

Marie Ziegler

It appears to be what the futures markets are telling you. Again, that's not a guarantee. But futures for corn as I mentioned a few moments ago, up over $4. You've got soybean futures into '09 going over $9. You look at wheat prices, again into '09 well over $5.50 to $5.85 so really pretty good levels of prices. So the futures markets are giving you one neutral or one not company-biased indication that the expectation is quite good. We are in the midst of people being able to upgrade our diets. This is something we've talked about for a very long time. But you're really seeing it get some legs here. People know they can eat better. They have the income growing to support improved diets. On top of that, you layer on what's happening with interest and renewable energy. The fundamentals look to be very encouraging.

Charlie Rentschler - Wall Street Access

Thank you, you're truly setting the table.

Marie Ziegler

Correct. Nice way to put it. Next question.

Operator

Your next question comes from Seth Weber – Banc of America Securities.

Seth Weber - Banc of America Securities

Most of my questions have been answered. But on the raw material impact, Marie, you left that number the same $200 million or so even though the production number is going higher, the tonnage number is going higher. Can you talk about where you might be seeing some pressure still and what might be getting better there on the material side?

Marie Ziegler

Let me start by saying we try to adjust that increase for volumes so it's volume neutral. We are taking a look at, had we had the same rates of spend last year as this year. That does not take into account the fact that you're going to have higher levels of production. Do you understand what I'm saying on how that's calculated?

Seth Weber - Banc of America Securities

Yes, thanks.

Marie Ziegler

Now, regarding where we're seeing pressure, we've said steel was up about 2% for the year. If you look at maybe in the quarter we may have just tweaked our guidance slightly down. You are seeing a little bit of relief on the sheet steel side. On the other hand, at the very margin, tires are maybe a little bit more costly than they were a quarter ago. But basically, the year is playing out pretty much as we had anticipated.

Operator

Your next question comes from David Bluestein - UBS.

David Bluestein - UBS

The $200 million increase in your ag inventories, how much of that is Brazil? Just expected ramp?

Marie Ziegler

Really, the bulk of that increase is probably more directed at North America. We're talking about the change in the guidance from 175 up to 375 up.

David Bluestein - UBS

Right so the bulk of that big tractor is North America?

Marie Ziegler

Would be in several product categories, but certainly big tractors would be a part of it.

David Bluestein - UBS

Somewhere in the press release or prepared remarks you mentioned rental channel customers buying significantly less. Do you think we're done with that in 2007? Do they snap back next year? A flattish environment you've laid out for the housing starts and nonresidential construction activity. How do you peg their demand?

Marie Ziegler

I'm not prepared to comment on that at this time. They were down last year, as well. They're at fairly low levels of volume as we would go into 2008. I just do not have a comment on 2008 at this time.

David Bluestein - UBS

A final question just on fourth quarter with the revenues you've given us, your guidance would imply some fairly low incremental margins, but you've got a big ramp in production. What else is slowing you down in Q4 from blowing up the number?

Marie Ziegler

We will have some higher raw material costs and it goes really back to this R&D and SA&G that we talked about. In addition, when you look at the sales guidance, I know we said it, but I think it's worth repeating. Although we're up 16%, you've got ex-LESCO and currency we're up 8% so the gain is really half of that. The LESCO, which is $225 million of sales in the quarter, actually we come in with a slight operating loss in the fourth quarter. Again a change for the year.

The other thing to think about is taxes. Last year in the fourth quarter, our effective tax rate was 27.5%, and of course our guidance for the full year which would imply the fourth quarter would be at 33%. That's a chunk of money.

Operator

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

Robert McCarthy - Robert W Baird

I just have a couple quick follow-ups. First related to your comments about price realization, would it be fair to assume that in the quarter seeing much stronger growth internationally than domestically that similarly price realization would have been stronger internationally?

Marie Ziegler

No, I don't think you can assume that. In fact, you should not assume that. I don't want to imply it was bad overseas either.

Robert McCarthy - Robert W Baird

Would you mind sharing with us your acreage assumptions for corn and soybeans for '07/'08 and '08/'09?

Marie Ziegler

I certainly have those, but not committed to memory. I presume you want corn?

Robert McCarthy - Robert W Baird

Right.

Marie Ziegler

For the '08/’09 marketing year, we think we will plant about 87 million acres, this is compared to the 92.9 million acres planted in the U.S. We have a yield of 156.7. For beans plan about 70 million acres up from 64 million and that's the interesting dynamic between what's happening with corn and bean prices with bean prices up so significantly and a yield there of about 43.3 million. Do you want wheat, as well?

Robert McCarthy - Robert W Baird

As long as you're at it.

Marie Ziegler

Wheat planted acres about 59.5 million compared to 60.5 million this year and then the '08/'09 yield of 44 bushels per acre.

Robert McCarthy - Robert W Baird

I'm sorry just for reference, the bean number for this year?

Marie Ziegler

Sure. Bean number in terms of yield was 42. And again the planted acres this year 64.1. There's quite a jump in soybean plantings next year. That'll be something that'll be interesting to watch as we move into next year and what the dynamics are between corn and bean markets.

I think we're ready for our last question now.

Operator

Our final question comes from Barry Bannister – Stifel Nicolaus.

Barry Bannister - Stifel Nicolaus

I am trying to reconcile slides 11 and 20 with regard to your receivable exposure in Brazil. As we bear down on a rewrite of the agricultural financing regime down there, what percent of your average owned portfolio is Brazilian receivables? Could you put a dollar amount around it also?

Marie Ziegler

Sure. I'm not sure exactly how you're trying to reconcile. We are very well-provisioned in the event of any potential losses. The first thing I should say is that even though farmers have not yet been required to make the 2007 payments, we've collected about 68% of what is already due. The current deadline is the 31st of August., but as you know, the Congress has not yet approved this proposed program. It's expected that that deadline might actually slide just a little bit. In terms of what we have for our Brazilian portfolio overall, July in dollars it's about $800 million.

Barry Bannister - Stifel Nicolaus

What is your own portfolio total worldwide?

Marie Ziegler

You mean in the credit operations?

Barry Bannister - Stifel Nicolaus

Yes.

Marie Ziegler

Worldwide 14, 15, I'd have to look at it up. I don't have anything that has that handy. I will get back to you on that.

Barry Bannister - Stifel Nicolaus

One last sort of housekeeping question to tie it together. Historically, at least in the last three years, and even beyond that, about 80% of the year's profits was made in the first three quarters. If you would just annualize that, your earnings would be somewhere in the 775 range for the year, not the 750-ish range that you're guiding to. I wonder if, perhaps, the fact that two-thirds of the beat from this quarter was from non-ag operations where housing and consumer durable spending might be at risk has led you to be a little more cautious on your forecast.

Marie Ziegler

Well, no, again when we take a look at that specifically it's the raw material, it's the R&D, and it's the SA&G and the taxes. The tax effect is about $45 million alone between last year and the presumption for the fourth quarter of this year. So that's where it is.

Thank you all for participating in the call. The numbers. Portfolio owned net receivables would be actually about $20 billion. Thank you all. Bye.

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 & Co. F3Q07 (Qtr End 7/31/07) Earnings Call Transcript
This Transcript
All Transcripts