PART I

 

ITEM 1.                   BUSINESS.

 

Products

 

Deere & Company (Company) and its subsidiaries (collectively called John Deere) have operations which are categorized into four major business segments.

 

The agricultural equipment segment manufactures and distributes a full line of farm equipment and related service parts — including tractors; combine, cotton and sugarcane harvesters; tillage, seeding and soil preparation machinery; sprayers; hay and forage equipment; material handling equipment; and integrated agricultural management systems technology.

 

The commercial and consumer equipment segment manufactures and distributes equipment, products and service parts for commercial and residential uses — including small tractors for lawn, garden, commercial and utility purposes; walk-behind mowers; golf course equipment; utility vehicles (including those commonly referred to as all-terrain vehicles, or “ATVs”); landscape products and irrigation equipment; and other outdoor power products.

 

The construction and forestry segment manufactures, distributes to dealers and sells at retail a broad range of machines and service parts used in construction, earthmoving, material handling and timber harvesting — including backhoe loaders; crawler dozers and loaders; four-wheel-drive loaders; excavators; motor graders; articulated dump trucks; landscape loaders; skid-steer loaders; and log skidders, feller bunchers, log loaders, log forwarders, log harvesters and related attachments.

 

The products and services produced by the segments above are marketed primarily through independent retail dealer networks and major retail outlets.

 

The credit segment primarily finances sales and leases by John Deere dealers of new and used agricultural, commercial and consumer, and construction and forestry equipment. In addition, it provides wholesale financing to dealers of the foregoing equipment, provides operating loans, finances retail revolving charge accounts and plans to offer certain crop risk mitigation products.

 

John Deere also provides managed health care plans. John Deere’s worldwide agricultural equipment; commercial and consumer equipment; and construction and forestry operations are sometimes referred to as the “Equipment Operations.”  The special technologies operations were combined with the agricultural equipment operations in 2004.  The credit, health care and certain miscellaneous service operations are sometimes referred to as “Financial Services.”

 

Additional information is presented in the discussion of business segment and geographic area results on pages 16 and 17. The John Deere enterprise has manufactured agricultural machinery since 1837. The present Company was incorporated under the laws of Delaware in 1958.

 

The Company’s Internet address is http://www.JohnDeere.com. Through that address, the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available free of charge as soon as reasonably practicable after they are filed with the Securities and Exchange Commission. The information contained on the Company’s website is not included in, or incorporated by reference into, this Annual Report on Form 10-K.

 

1

---

 

Market Conditions and Outlook

 

As a result of the factors and conditions outlined below, Company equipment sales for 2005 are expected to increase by 2 to 7 percent with net income forecast to be approximately $1.5 billion. First-quarter equipment sales are currently forecast to be up 20 to 25 percent in comparison with the same period last year. Production levels are expected to increase by 11 to 13 percent for the quarter. Consolidated net income for first-quarter 2005 is forecast to be in a range of $200 million to $225 million.  Beyond the ongoing impact of the company’s business-improvement efforts, a positive customer response to John Deere products is expected to continue driving performance in 2005.

 

Agricultural Equipment . On a worldwide basis, sales of John Deere agricultural equipment are forecast to be up 2 to 5 percent for the year. Despite a downturn in commodity prices, United States farmers are benefiting from record production of corn and soybeans. In addition, the livestock and dairy sectors are strong and government payments are expected to increase substantially in 2005. As a result, United States farm-cash receipts are forecast to be about the same as 2004’s record level. Given these conditions, the Company expects industry retail sales in the United States and Canada to be up about 5 percent for fiscal 2005 in comparison with the very strong levels of the prior year.

 

In other parts of the world, industry retail sales in Western Europe are forecast to be flat to down 5 percent for the year. Farmers in the region have benefited from a good harvest this fall; however, they are expected to see little change in income as a result of lower grain prices, higher input costs and flat government-support payments. In South America, industry sales are forecast to be down 10 to 20 percent on the basis of lower commodity prices, increased input costs and a weaker United States dollar.

 

Commercial & Consumer Equipment . Sales of John Deere commercial and consumer equipment are expected to increase 2 to 5 percent for the year with help from new models of compact tractors, an updated utility-vehicle line, and higher sales of commercial mowing equipment.

 

Construction & Forestry .  Markets are expected to be supported in the coming year by moderate economic growth, relatively low interest rates and a favorable level of housing starts. In this environment, sales of construction and forestry equipment are expected to see further growth as contractors and rental operations continue to replenish their fleets. As a result, division sales are forecast to be up 6 to 9 percent for the year.

 

Financial Services .  Although the Company’s credit operations are expected to benefit from further growth in the loan portfolio, net income for 2005 is forecast to be down primarily due to increased leverage in the portfolio. The credit division is expected to report net income of around $280 million for the year. In its health-care operations, the Company expects net income of about $15 million for 2005 as a result of an improved underwriting margin.

 

2004 Consolidated Results Compared with 2003

 

The Company had net income in 2004 of $1,406 million, or $5.56 per share diluted ($5.69 basic), compared with $643 million, or $2.64 per share diluted ($2.68 basic), in 2004.  Net sales and revenues increased 29 percent to $19,986 million in 2004, compared with $15,535 million in 2003.  Net sales of the Equipment Operations increased 32 percent in 2004 to $17,673 million from $13,349 million last year.  Net sales increased primarily due to higher shipments.  Net sales in the United States and Canada rose 33 percent in 2004.  Outside the United States and Canada, net sales increased by 20 percent for the year, excluding currency translation, and by 30 percent on a reported basis.

 

The Company’s Equipment Operations, which exclude the Financial Services operations, had net income of $1,097 in 2004, compared with $305 million in 2003.  Income increased primarily due to increased

 

2

 

shipments and price realization.  The increase was partially offset by a larger provision for employee bonuses and higher raw material costs. The provision for bonuses was driven by the strong performance in the Equipment Operations.

 

Net income of the Company’s Financial Services operations in 2004 was $309 million, compared with $330 million in 2003.  The decrease was primarily due to higher administrative costs, lower credit margins and increased medical claims costs.  Additional information is presented in the Worldwide Credit Operations and Worldwide Other Operations discussions on page 16.

 

EQUIPMENT OPERATIONS

 

Agricultural Equipment

 

Sales of agricultural equipment, particularly in the United States and Canada, are affected by total farm cash receipts, which reflect levels of farm commodity prices, acreage planted, crop yields and the amount and timing of government payments. Sales are also influenced by general economic conditions, farm land prices, farmers’ debt levels, interest rates, agricultural trends and other input costs associated with farming. Weather and climatic conditions can also affect buying decisions of equipment purchasers.

 

Innovations to machinery and technology also influence buying. For example, larger, more productive equipment is well accepted where farmers are striving for more efficiency in their operations.  The Company has developed a comprehensive agricultural management systems approach using advanced technology and global satellite positioning to enable farmers to better control input costs and yields, to improve environmental management and to gather information.

 

Large, cost-efficient, highly-mechanized agricultural operations account for an important share of worldwide farm output. The large-size agricultural equipment used on such farms has been particularly important to John Deere. A large proportion of the Equipment Operations’ total agricultural equipment sales in the United States is comprised of tractors over 100 horsepower, self-propelled combines, self-propelled cotton pickers, self-propelled forage harvesters and self-propelled sprayers.

 

Seasonality .  Seasonal patterns in retail demand for agricultural equipment result in substantial variations in the volume and mix of products sold to retail customers during various times of the year. Seasonal demand must be estimated in advance, and equipment must be manufactured in anticipation of such demand in order to achieve efficient utilization of manpower and facilities throughout the year. For certain equipment, the Company offers early order discounts to retail customers. Production schedules are based, in part, on these early order programs. The Equipment Operations incur substantial seasonal variation in cash flows to finance production and inventory of equipment.  The Equipment Operations also incur costs to finance sales to dealers in advance of seasonal demand. New combine and cotton harvesting equipment is sold under early order programs with waivers of retail finance charges available to customers to take delivery of machines during off-season periods. Used equipment trade-ins, of which there are typically several transactions for every new combine and cotton harvesting equipment sale, are supported with a fixed pool of funds available to dealers which are then responsible for all associated inventory and sale costs.

 

An important part of the competition within the agricultural equipment industry during the past decade has come from a diverse variety of short-line and specialty manufacturers with differing manufacturing and marketing methods. Because of industry conditions, especially the merger of certain large integrated competitors and the global capability of many competitors, the agricultural equipment business continues to undergo significant change and may become more competitive.

 

3

 

Commercial and Consumer Equipment

 

John Deere commercial and consumer equipment includes front-engine lawn tractors, lawn and garden tractors, compact utility tractors, utility tractors, zero-turning radius mowers, front mowers and small utility vehicles. In the fourth quarter of 2003, the division expanded its offering of utility vehicles with new products focused on residential, commercial, agricultural, and consumer markets. A broad line of associated implements for mowing, tilling, snow and debris handling, aerating, and many other residential, commercial, golf and sports turf care applications are also included. The product line also includes walk-behind mowers and other outdoor power products. Retail sales of these commercial and consumer equipment products are influenced by weather conditions, consumer spending patterns and general economic conditions.  In an effort to increase asset turnover and reduce the average level of field inventories through the year, the Company has recently modified the production and shipment schedules of its product lines to more closely correspond to the seasonal pattern of retail sales.

 

The division manufactures and sells walk-behind mowers in Europe under the SABO brand (as well as the John Deere brand) and a line of commercial mowing equipment, primarily in North America, under the Great Dane brand. The division also builds products for sale by mass retailers. Since 1999, the Company has built products for sale through The Home Depot stores.

 

John Deere Landscapes, Inc., a unit of the division, distributes irrigation equipment, nursery products and landscape supplies primarily to landscape service professionals.

 

In addition to the equipment manufactured by the commercial and consumer division, John Deere purchases certain products from other manufacturers for resale.

 

Seasonality Retail demand for the division’s equipment is higher in the second and third quarters.  The division is pursuing a strategy of building and shipping as close to retail demand as possible.  Consequently, production, shipping and retail sales will be proportionately higher in the second and third quarters of each year.

 

Construction and Forestry

 

John Deere construction, earthmoving, material handling and forestry equipment includes a broad range of backhoe loaders, crawler dozers and loaders, four-wheel-drive loaders, excavators, motor graders, articulated dump trucks, landscape loaders, skid-steer loaders, log skidders, log feller bunchers, log loaders, log forwarders, log harvesters and a variety of attachments.

 

Today, this segment provides sizes of equipment that compete for over 90 percent of the estimated total North American market for those categories of construction, earthmoving and material handling equipment in which it competes. These construction, earthmoving and material handling machines are distributed under the Deere brand name. This segment also provides the most complete line of forestry machines and attachments available in the world. These forestry machines and attachments are distributed under the Deere, Timberjack and Waratah brand names.  In addition to the equipment manufactured by the Construction and Forestry division, John Deere purchases certain products from other manufacturers for resale.

 

The prevailing levels of residential, commercial and public construction and the condition of the forest products industry influence retail sales of John Deere construction, earthmoving, material handling and forestry equipment. General economic conditions, the level of interest rates and certain commodity prices such as those applicable to pulp, paper and saw logs also influence sales.

 

The Company and Hitachi have a joint venture for the manufacture of hydraulic excavators and track log loaders in the United States and Canada.  In May 2002, the Company began distributing Hitachi brands of

 

4

 

construction and mining equipment in North, Central and South America. The Company also has supply agreements with Hitachi under which a range of construction, earthmoving, material handling and forestry products manufactured by John Deere in the United States, Canada, Finland and New Zealand are distributed by Hitachi in certain Far East markets.

 

The division has a number of initiatives in the rent-to-rent, or short-term rental, market for construction, earthmoving and material handling equipment. These include specially designed rental programs for John Deere dealers and expanded cooperation with major, national equipment rental companies.  In November 2003, the Company sold its minority ownership in Sunstate Equipment Co., LLC, a venture engaged in the rent-to-rent business.

 

During the 2003 fiscal year, the Company also had minority ownership interests in Nortrax, Inc., Nortrax Investments, Inc. and Ontrac Holdings, Inc. (collectively called Nortrax). Nortrax is, among other things, an authorized John Deere dealer for construction, earthmoving, material handling and forestry equipment in a variety of markets in the United States and Canada. During the 2004 fiscal year, the Company acquired 100 percent of  Nortrax and it was consolidated.

 

Engineering and Research

 

John Deere makes large expenditures for engineering and research to improve the quality and performance of its products, and to develop new products. Such expenditures were $612 million or 3.5 percent of net sales of equipment in 2004, $577 million, or 4.3 percent in 2003, and $528 million, or 4.5 percent in 2002.

 

Manufacturing

 

Manufacturing Plants . In the United States and Canada, the Equipment Operations own and operate 20 factory locations and lease and operate another three locations, which contain approximately 29.4 million square feet of floor space. Of these 23 factories, twelve are devoted primarily to agricultural equipment, four to commercial and consumer equipment, one to non-forestry construction equipment, one to construction and forestry equipment, one to engines, three to hydraulic and power train components and one to forestry equipment. Outside the United States and Canada, the Equipment Operations own and operate:  agricultural equipment factories in China, France, Germany, Mexico, The Netherlands, Brazil and South Africa; engine factories in Argentina, France and Mexico; a component factory in Spain; commercial and consumer equipment factories in Germany and The Netherlands; an hydraulic component factory in Chile; and forestry equipment factories in Finland and New Zealand. These factories outside the United States and Canada contain approximately 10.6 million square feet of floor space. The Equipment Operations also have financial interests in other manufacturing organizations, which include agricultural equipment manufacturers in China, India and the United States, an industrial truck manufacturer in South Africa, the Hitachi joint venture that builds hydraulic excavators and track log loaders in the United States and Canada and a venture that manufactures transaxles and transmissions used in certain commercial and consumer equipment division products.  In 2004, the Equipment Operations announced plans to build an additional agricultural equipment factory in Brazil.

 

The engine factories referred to above manufacture non-road, heavy duty diesel engines mostly for the Company’s Equipment Operations, but a significant number of these engines are sold to global original equipment manufacturers.

 

John Deere’s facilities are well maintained, in good operating condition and are suitable for their present purposes. These facilities, together with both short-term and long-term planned capital expenditures, are expected to meet John Deere’s manufacturing needs in the foreseeable future.

 

Capacity is adequate to satisfy the Company’s current expectations for retail market demand. The Equipment Operations’ manufacturing strategy involves the implementation of appropriate levels of technology and

 

5

 

automation to allow manufacturing processes to remain viable at varying production levels. Operations are also designed to be flexible enough to accommodate the product design changes required to meet market conditions. Common manufacturing facilities and techniques are employed in the production of components for agricultural, commercial and consumer and construction and forestry equipment.

 

In order to utilize manufacturing facilities and technology more effectively, the Equipment Operations pursue continuous improvements in manufacturing processes. These include steps to streamline manufacturing processes and enhance responsiveness to customers. The Company has implemented flexible assembly lines that can handle a wider product mix and deliver products at the times when dealers and customers require them. Additionally, considerable effort is being directed to manufacturing cost reduction through process improvement, product design, advanced manufacturing technology, enhanced environmental management systems, supply management and compensation incentives related to productivity and organizational structure. The Company has recently experienced an increase in costs of some materials, particularly for certain raw materials. The Company has offset and expects to continue to offset these increased costs through the above-described cost reduction measures and through pricing. Significant cost increases, if they occur, could have an adverse effect on our operating results. The Equipment Operations also pursue external sales of selected parts and components that can be manufactured and supplied to third parties on a competitive basis.

 

Capital Expenditures. The agricultural equipment, commercial and consumer equipment and construction and forestry operations’ capital expenditures totaled $346 million in 2004, compared with $304 million in 2003, and $351 million in 2002. Provisions for depreciation applicable to these operations’ property, plant and equipment during these years were $333 million, $306 million and $296 million, respectively. Capital expenditures for these operations in 2005 are currently estimated to be $480 million. The 2005 expenditures will be related primarily to the modernization and restructuring of key manufacturing facilities and will also be related to the development of new products. Future levels of capital expenditures will depend on business conditions.

 

Patents and Trademarks

 

John Deere owns a significant number of patents, licenses and trademarks which have been obtained over a period of years. The Company believes that, in the aggregate, the rights under these patents, licenses and trademarks are generally important to its operations, but does not consider that any patent, license, trademark or related group of them (other than its house trademarks, which include but are not limited to the “John Deere” mark, the leaping deer logo, the “Nothing Runs Like a Deere” slogan and green and yellow equipment colors) is of material importance in relation to John Deere’s business.

 

Marketing

 

In the United States and Canada, the Equipment Operations distribute equipment and service parts through the following facilities (collectively called sales branches):  one agricultural equipment sales and administration office supported by seven agricultural equipment sales branches; one construction, earthmoving, material handling and forestry equipment sales and administration office; and one commercial and consumer equipment sales and administration office.

 

In addition, the Equipment Operations operate a centralized parts distribution warehouse in coordination with several regional parts depots in the United States and Canada and have an agreement with a third party to operate a high-volume parts warehouse in Indiana.

 

The sales branches in the United States and Canada market John Deere products at approximately 3039 dealer locations, most of which are independently owned. Of these, approximately 1600 sell agricultural equipment, while 542 sell construction, earthmoving, material handling and/or forestry equipment. Nortrax owns some of the 542. Commercial and consumer equipment is sold by most John Deere agricultural

 

6

 

equipment dealers, a few construction, earthmoving, material handling and forestry equipment dealers, and about 897 commercial and consumer equipment dealers, many of whom also handle competitive brands and dissimilar lines of products. In addition, certain lawn and garden product lines are sold through various general and mass merchandisers, including The Home Depot.

 

Outside the United States and Canada, John Deere agricultural equipment is sold to distributors and dealers for resale in over 160 countries.  Sales branches are located in Germany, France, Italy, Poland, Russia, Spain, Switzerland, the United Kingdom, South Africa, Mexico, Brazil, Argentina, Uruguay, Australia and Hong Kong.  Export sales branches are located in Europe and the United States.  Associated companies doing business in China and India also sell agricultural equipment. Commercial and consumer equipment sales occur primarily in Europe and Australia. Construction, earthmoving, material handling and forestry equipment is sold to distributors and dealers primarily by sales offices located in the United States, Brazil, Singapore and Finland.  Some of these dealers are independently owned while the Company owns others.

 

Trade Accounts and Notes Receivable

 

Trade accounts and notes receivable arise from sales of goods to dealers.  Most trade receivables originated by the Equipment Operations are purchased by Financial Services. The Equipment Operations compensate Financial Services at market rates of interest for these receivables. Additional information appears in Note 8 to the Consolidated Financial Statements.

 

FINANCIAL SERVICES

 

Credit Operations

 

United States and Canada .  The Company’s credit subsidiaries (collectively referred to as the Credit Companies) primarily provide and administer financing for retail purchases from John Deere dealers of new equipment manufactured by the Company’s agricultural equipment, commercial and consumer equipment, and construction and forestry divisions and used equipment taken in trade for this equipment. Deere & Company and John Deere Construction & Forestry Company are referred to as the “sales companies.” John Deere Capital Corporation (Capital Corporation), a United States credit subsidiary, purchases retail installment sales and loan contracts (retail notes) from the sales companies. These retail notes are acquired by the sales companies through John Deere retail dealers in the United States. John Deere Credit Inc., a Canadian credit subsidiary, purchases and finances retail notes acquired by John Deere Limited, the Company’s Canadian sales branch.  The terms of retail notes and the basis on which the Credit Companies acquire retail notes from the sales companies are governed by agreements with the sales companies. The Credit Companies also finance and service revolving charge accounts, in most cases acquired from and offered through merchants in the agricultural, commercial and consumer, and construction and forestry markets (revolving charge accounts).  Further, the Credit Companies finance and service operating loans, in most cases offered through and acquired from farm input providers or through direct relationships with agricultural producers (operating loans).  Additionally, the Credit Companies provide wholesale financing for inventories of John Deere engines and John Deere agricultural, commercial and consumer, and construction and forestry equipment owned by dealers of those products (wholesale notes).  The Credit Companies also plan to offer certain crop risk mitigation products.

 

Retail notes acquired by the sales companies are immediately sold to the Credit Companies. The Equipment Operations are the Credit Companies’ major source of business, but many retail purchasers of John Deere products finance their purchases outside the John Deere organization.

 

The Credit Companies offer retail leases to equipment users in the United States. A small number of leases are executed with units of local government. Leases are usually written for periods of two to five years, and frequently contain an option permitting the customer to purchase the equipment at the end of the lease term.

 

7

 

Retail leases are also offered in a generally similar manner to customers in Canada through John Deere Credit Inc. and John Deere Limited.

 

The Credit Companies’ terms for financing equipment retail sales (other than smaller items financed with unsecured revolving charge accounts) provide for retention of a security interest in the equipment financed. The Credit Companies’ guidelines for minimum down payments, which vary with the types of equipment and repayment provisions, are generally not less than 20 percent on agricultural equipment, 10 percent on construction and forestry equipment and 10 percent on lawn and grounds care equipment used for personal use. Finance charges are sometimes waived for specified periods or reduced on certain John Deere products sold or leased in advance of the season of use or in other sales promotions. The Credit Companies generally receive compensation from the sales companies equal to a competitive interest rate for periods during which finance charges are waived or reduced on the retail notes or leases. The cost is accounted for as a deduction in arriving at net sales by the Equipment Operations.

 

The Company has an agreement with the Capital Corporation to make income maintenance payments to the Capital Corporation such that its ratio of earnings before fixed charges to fixed charges is not less than 1.05 to 1 for any fiscal quarter. For 2004 and 2003, the Capital Corporation’s ratios were 2.23 to 1 and 2.17 to 1, respectively, and never less than 2.19 to 1 and 2.05 to 1 for any fiscal quarter of 2004 and 2003, respectively. The Company has also committed to continue to own at least 51 percent of the voting shares of capital stock of the Capital Corporation and to maintain the Capital Corporation’s consolidated tangible net worth at not less than $50 million. The Company’s obligations to make payments to the Capital Corporation under the agreement are independent of whether the Capital Corporation is in default on its indebtedness, obligations or other liabilities.  Further, the Company’s obligations under the agreement are not measured by the amount of the Capital Corporation’s indebtedness, obligations or other liabilities. The Company’s obligations to make payments under this agreement are expressly stated not to be a guaranty of any specific indebtedness, obligation or liability of the Capital Corporation and are enforceable only by or in the name of the Capital Corporation. No payments were necessary under this agreement in 2003 or 2004.

 

Outside the United States and Canada .  The Credit Companies offer equipment financing products in Argentina, Australia, Brazil, Finland, France (through a joint venture), Germany, Italy, Luxembourg, Mexico, New Zealand, Portugal (through a cooperation agreement), Spain, Sweden and the United Kingdom. Retail sales financing outside of the United States and Canada is affected by a diversity of customs and regulations.

 

The Credit Companies also offer to select customers insured international export financing for the purchase of John Deere Products.

 

Additional information on the Credit Companies appears on pages 16, 19 and 20.

 

Health Care

 

In 1985, the Company formed John Deere Health Care, Inc. to commercialize the Company’s expertise in the field of health care benefit management, which had been developed from efforts to manage its own health care costs. John Deere Health Care currently provides health benefit management programs and related administrative services in Illinois, Iowa, Tennessee and Virginia for companies and government entities, either as a third-party administrator or through its health maintenance organization subsidiary, John Deere Health Plan, Inc.. At October 31, 2004, approximately 510,000 individuals were enrolled in these programs, of which approximately 77,000 were John Deere employees, retirees and their dependents.

 

ENVIRONMENTAL MATTERS

 

The Company is subject to a wide variety of state, federal and international environmental laws, rules and regulations. These laws, rules and regulations may affect the way the Company conducts its operations, and failure to comply with these regulations could lead to fines and other penalties. The Company is also

 

8

 

involved in the evaluation and clean-up of a limited number of sites that it owns. Management does not expect that these matters will have a material adverse effect on the consolidated financial position or results of operations of the Company. With respect to acquired properties, the Company cannot be certain that it has identified all adverse environmental conditions. The Company expects that it will acquire additional properties in the future.

 

EMPLOYEES

 

At October 31, 2004, John Deere had approximately 46,500 full-time employees, including approximately 28,500 employees in the United States and Canada. From time to time, John Deere also retains consultants, independent contractors, and temporary and part-time workers.  Unions are certified as bargaining agents for approximately 39 percent of John Deere’s United States employees. Most of the Company’s United States production and maintenance workers are covered by a collective bargaining agreement with the United Auto Workers (UAW), with an expiration date of September 30, 2009.

 

Unions also represent the majority of employees at John Deere manufacturing facilities outside the United States.

 

EXECUTIVE OFFICERS OF THE REGISTRANT

 

Following are the names and ages of the executive officers of the Company, their positions with the Company and summaries of their backgrounds and business experience. All executive officers are elected or appointed by the Board of Directors and hold office until the annual meeting of the Board of Directors following the annual meeting of stockholders in each year.

 

Name, age and office (at December 1, 2004), and year elected to office								Principal occupation during last five years other than office of the Company currently held
Robert W. Lane		55		Chairman, President and Chief Executive Officer		2000		2000 President and Chief Executive Officer; 1999-2000 Division President
Samuel R. Allen		51		Division President		2003		2001-2002 Senior Vice President Global Human Resources and Industrial Relations; 1999-2001 Vice President Region I (Latin America, the Far East, Australia and South Africa)
David C. Everitt		52		Division President		2001		1999-2000 Senior Vice President, Region II (Europe, Africa and the Middle East)
James R. Jenkins		59		Senior Vice President and General Counsel		2000		1999 and prior, Vice President, Secretary and General Counsel, Dow Corning
John J. Jenkins		59		Division President		2000		1997-2000 President, John Deere Health Care; 1999-2000 also Executive Sponsor, SAP*
Nathan J. Jones		48		Senior Vice President and Chief Financial Officer		1998		Has held this position for the last five years
Pierre E. Leroy		56		Division President		1996		Has held this position for the last five years
H. J. Markley		54		Division President		2001		2000-2001 Senior Vice President, Worldwide Human Resources; 1996-2000 Senior Vice President, Construction Division

 

* SAP is a supplier of enterprise resource planning software

 

9

 

ITEM 2.                   PROPERTIES.

 

See “Manufacturing” in Item 1.

 

The Equipment Operations own 16 facilities housing sales branches, one centralized parts depot, regional parts depots, transfer houses and warehouses throughout the United States and Canada. These facilities contain approximately 5.2 million square feet of floor space. The Equipment Operations also own and occupy buildings housing sales branches, one centralized parts depot and regional parts depots in Australia, Brazil, Europe and New Zealand. These facilities contain approximately 1.0 million square feet of floor space.

 

Deere & Company administrative offices, research facilities and certain facilities for health care activities, all of which are owned by John Deere, together contain about 2.5 million square feet of floor space and miscellaneous other facilities total 1.0 million square feet.

 

Overall, the Company owns approximately 49.1 million square feet of facilities and leases approximately 7 million additional square feet in various locations.

 

ITEM 3.                   LEGAL PROCEEDINGS.

 

The Company is subject to various unresolved legal actions which arise in the normal course of its business, the most prevalent of which relate to product liability (including asbestos-related liability), retail credit, software licensing, patent and trademark matters. Although it is not possible to predict with certainty the outcome of these unresolved legal actions or the range of possible loss, the Company believes these unresolved legal actions will not have a material effect on its financial statements.

 

In October 2004, the Company paid $315,000 pursuant to a settlement agreement with the California Air Resources Board (CARB) regarding small engines that did not comply with California emission standards.  These engines were used in certain of the Company’s portable power equipment and walk behind lawn mowers.  CARB executed the settlement agreement on November 1, 2004.

 

ITEM 4.                   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

 

None.

 

PART II

 

ITEM 5.                   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

(a)            The Company’s common stock is listed on the New York Stock Exchange, the Chicago Stock Exchange and the Frankfurt (Germany) Stock Exchange. See the information concerning quoted prices of the Company’s common stock and the number of stockholders in the second table and the sentence following it, and the data on dividends declared and paid per share in the first table, under the caption “Supplemental Information (Unaudited)” in Note 28 to the Consolidated Financial Statements .

 

(b)            Not applicable

 

10

---

 

 

(c)            The Company’s purchases of its common stock during the fourth quarter of 2004 were as follows:

 

Period		Total Number of Shares Purchased(2)(3)		Average Price Paid Per Share			Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)		Approximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs (1)
		(thousands)					(thousands)		(millions)
Aug 1 to Aug 31		198		$	62.25		192		$	80
Sept 1 to Sept 30		644		63.83			589		43
Oct 1 to Oct 31		690		61.77			690
Total		1,532		62.70			1,472

 

(1)    During the fourth quarter of 2004, the Company had one active share purchase plan that was publicly announced in December 1997 (Plan) to purchase up to $1 billion of its common stock.  In fiscal years 1998 and 1999, the Company purchased $808 million of its common stock under the Plan.  As announced on June 15, 2004, the Company continued its purchases under the Plan, and these purchases were completed in the fourth quarter.

(2)    Total shares purchased in August 2004 included approximately 5 thousand shares received from an officer to exercise certain stock option awards and approximately 1 thousand shares to pay the associated payroll taxes.  All the shares were valued at the current market price of $62.02 per share.

(3)    Total shares purchased in September 2004 included approximately 47 thousand shares received from an officer to exercise certain stock option awards and approximately 8 thousand shares to pay the associated payroll taxes.  All the shares were valued at the current market price of $64.27 per share.

 

On December 1, 2004, the Company’s board of directors authorized the repurchase of up to $1 billion of Company common stock.  Repurchases of Company common stock under this new plan will be made from time to time, at the Company’s discretion, in the open market or through privately negotiated transactions.

 

11

 

ITEM 6.                   SELECTED FINANCIAL DATA.

 

Financial Summary

 

(Millions of dollars except per share amounts)		2004			2003			2002*			2001*			2000
For the Year Ended October 31:
Total net sales and revenues		$	19,986		$	15,535		$	13,947		$	13,293		$	13,137
Net income (loss)		$	1,406		$	643		$	319		$	(64	)	$	486
Net income (loss) per share - basic		$	5.69		$	2.68		$	1.34		$	(.27	)	$	2.07
Net income (loss) per share - diluted		$	5.56		$	2.64		$	1.33		$	(.27	)	$	2.06
Dividends declared per share		$	1.06		$	.88		$	.88		$	.88		$	.88
At October 31:
Total assets		$	28,754		$	26,258		$	23,768		$	22,663		$	20,469
Long-term borrowings		$	11,090		$	10,404		$	8,950		$	6,561		$	4,764

 

---

*In 2002 and 2001, the Company had special charges of $46 million, or $.18 per share, and $217 million, or $.91 per share, respectively, related to costs of closing and restructuring certain facilities in both years and a voluntary early-retirement program in 2001.

 

ITEM 7.                   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

See the information under the caption “Management’s Discussion and Analysis” on pages 15 - 23.

 

ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

The Company is exposed to a variety of market risks, including interest rates and currency exchange rates. The Company attempts to actively manage these risks. See the information under “Management’s Discussion and Analysis” on page 23.

 

ITEM 8.                   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

See the consolidated financial statements and notes thereto and supplementary data on pages 24 - 48.

 

ITEM 9.                   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

 

Not applicable.

 

ITEM 9A.               CONTROLS AND PROCEDURES

 

The Company’s principal executive officer and its principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (“the Act”)) were effective as of October 31, 2004, based on the evaluation of these controls and procedures required by Rule 13a-15(b) or 15d-15(b) of the Act.

 

12

---

 

ITEM 9B.                OTHER INFORMATION

 

Not applicable.

 

PART III

 

ITEM 10.                 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

 

The information regarding directors in the proxy statement dated January 13, 2005 (proxy statement), under the captions “Election of Directors,” “Directors Continuing in Office” and in the third paragraph under the caption “Committees - The Audit Review Committee,” is incorporated herein by reference. Information regarding executive officers is presented in Item 1 of this report under the caption “Executive Officers of the Registrant.”

 

The Company has adopted a code of ethics that applies to its principal executive officer, principal financial officer and principal accounting officer.  This code of ethics and the Company’s corporate governance policies are posted on the Company’s website at http://www.JohnDeere.com. The Company intends to satisfy disclosure requirements regarding amendments to or waivers from its code of ethics by posting such information on this website. The charters of the Audit Review, Corporate Governance and Compensation committees of the Company’s Board of Directors are available on the Company’s website as well. This information is also available in print free of charge to any person who requests it.

 

ITEM 11.                 EXECUTIVE COMPENSATION.

 

The information in the proxy statement under the captions “Compensation of Executive Officers” and “Compensation of Directors” is incorporated herein by reference.

 

ITEM 12.                 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

 

(a)            Securities authorized for issuance under equity compensation plans.

 

Equity compensation plan information in the proxy statement, under the caption “Equity Compensation Plan Information,” is incorporated herein by reference.

 

(b)            Security ownership of certain beneficial owners.

 

The information on the security ownership of certain beneficial owners in the proxy statement under the caption “Security Ownership of Certain Beneficial Owners and Management” is incorporated herein by reference.

 

(c)            Security ownership of management.

 

The information on shares of common stock of the Company beneficially owned by, and under option to (i) each director, (ii) certain named executive officers and (iii) the directors and officers as a group, contained in the proxy statement under the captions “Security Ownership of Certain Beneficial Owners and Management,” “Compensation of Executive Officers-Summary Compensation Table” and “Compensation of Executive Officers-Aggregated Option/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option/SAR Values” is incorporated herein by reference.

 

13

---

 

(d)            Change in control.

 

None.

 

ITEM 13.                 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

 

The information in the proxy statement under the caption “Certain Business Relationships” is incorporated herein by reference.

 

ITEM 14.                 PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The information in the proxy statement under the caption “Fees Paid to the External Auditor” is incorporated herein by reference

 

ITEM 15.                 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(1)           Financial StatementsPage

 

	Page
Statement of Consolidated Income for the years ended October 31, 2004, 2003 and 2002	24
Consolidated Balance Sheet, October 31, 2004 and 2003	25
Statement of Consolidated Cash Flows for the years ended October 31, 2004, 2003 and 2002	26
Statement of Changes in Consolidated Stockholders’ Equity for the years ended October 31, 2002, 2003 and 2004	27
Notes to Consolidated Financial Statements	28

 

(2)            Schedule to Consolidated Financial Statements

 

Schedule II - Valuation and Qualifying Accounts for the years ended October 31, 2004, 2003 and 2002

53

 

(3)            Exhibits

 

See the “Index to Exhibits” on pages 54 - 56 of this report .

 

Certain instruments relating to long-term borrowings, constituting less than 10 percent of registrant’s total assets, are not filed as exhibits herewith pursuant to Item 601(b)4(iii)(A) of Regulation S-K. Registrant agrees to file copies of such instruments upon request of the Commission.

 

Financial Statement Schedules Omitted

 

The following schedules for the Company and consolidated subsidiaries are omitted because of the absence of the conditions under which they are required: I, III, IV and V.

 

14

---

 

MANAGEMENT’S DISCUSSION AND ANALYSIS

 

RESULTS OF OPERATIONS FOR THE YEARS ENDED OCTOBER 31, 2004, 2003 AND 2002

 

OVERVIEW

 

Organization

 

The company’s Equipment Operations primarily generate revenues and cash from the sale of equipment to John Deere dealers and distributors. The Equipment Operations manufacture and distribute a full line of agricultural equipment; a variety of commercial and consumer equipment; and a broad range of equipment for construction and forestry. The company’s Financial Services primarily provide credit services and managed health care plans. The credit operations primarily finance sales and leases of equipment by John Deere dealers and trade receivables purchased from the Equipment Operations. The health care operations provide managed health care services for the company and certain outside customers. The information in the following discussion is presented in a format that includes information grouped as the Equipment Operations, Financial Services and consolidated. The company also views its operations as consisting of two geographic areas, the U.S. and Canada, and outside the U.S. and Canada.

 

Trends and Economic Conditions

 

The company’s businesses are currently affected by the following key trends and economic conditions. Farmers are benefiting from record production of corn and soybeans, strong livestock and dairy sectors, and government payments that are expected to increase substantially in 2005. As a result, U.S. farm cash receipts are forecast to be about the same in 2005 as the record level in 2004. The company’s agricultural equipment sales were up 31 percent for 2004 and are forecast to be up approximately 2 to 5 percent in 2005. The company’s commercial and consumer equipment sales increased 16 percent in 2004 and are expected to increase approximately 2 to 5 percent in 2005 due to new products and higher sales of commercial mowing equipment. Construction and forestry markets are expected to be supported in 2005 by moderate economic growth, relatively low interest rates and a favorable level of housing starts. The company’s construction and forestry sales increased 54 percent in 2004 and are forecast to increase 6 to 9 percent in 2005. Although the credit operations are expected to benefit from further growth in the loan portfolio, net income for 2005 is forecast to be down due to increased leverage in the portfolio. The credit operations are expected to report net income of approximately $280 million for the year. The health care operations expect net income to increase to about $15 million for 2005 as a result of an improved underwriting margin.

 

Items of concern include the availability and price of raw materials, including steel and rubber, which have an impact on results of the company’s Equipment Operations. To date, company factories have been able to secure adequate supplies of such materials though prices have risen. In addition, producing engines that continue to meet high performance standards, yet also comply with increasingly stringent emissions regulations, is one of the company’s major priorities. In this regard, the company is making and intends to continue to make the financial and technical investment needed to produce engines in conformance with the U.S. Environmental Protection Agency Tier 3 and Tier 4 emissions rules for off-road diesel engines.

 

Stronger market conditions, combined with a focus on building a better business, have been responsible for much of the company’s success this year. The company’s asset management efforts are continuing to yield positive results, especially in light of the strong increase in sales. Beyond the ongoing impact of the company’s business improvement efforts, a positive customer response to the company’s products is expected to continue driving performance in 2005.

 

2004 COMPARED WITH 2003

 

CONSOLIDATED RESULTS

 

Worldwide net income in 2004 was $1,406 million, or $5.56 per share diluted ($5.69 basic), compared with $643 million, or $2.64 per share diluted ($2.68 basic), in 2003. Net sales and revenues increased 29 percent to $19,986 million in 2004, compared with $15,535 million in 2003. Net sales of the Equipment Operations increased 32 percent in 2004 to $17,673 million from $13,349 million last year. Net sales increased primarily due to higher shipments. Net sales in the U.S. and Canada rose 33 percent in 2004. Outside the U.S. and Canada, net sales increased by 20 percent for the year, excluding currency translation, and by 30 percent on a reported basis.

 

Worldwide Equipment Operations, which exclude the Financial Services operations, had an operating profit of $1,905 million in 2004, compared with $708 million in 2003. Operating profit increased primarily due to increased shipments and price realization. The increase in operating profit was partially offset by a larger provision for employee bonuses and higher raw material costs. The larger provision for bonuses was driven by the strong performance in the Equipment Operations.

 

The Equipment Operations’ net income was $1,097 million in 2004, compared with $305 million in 2003. The same operating factors mentioned above affected these results. In addition, this year’s results benefited from a lower effective tax rate and a decrease in interest expense.

 

Net income of the company’s Financial Services operations in 2004 was $309 million, compared with $330 million in 2003. The decrease was primarily due to higher administrative costs, lower credit margins and increased medical claims costs. Additional information is presented in the following discussion of the credit and “Other” operations.

 

The cost of sales to net sales ratio for 2004 was 76.8 percent, compared to 80.5 percent last year. The decrease in the ratio was primarily due to manufacturing efficiencies related to higher production and sales, and improved price realization. Partially offsetting these factors were the higher employee performance bonus provision and increased costs for raw material, such as steel and rubber.

 

Finance and interest income decreased this year primarily due to a decrease in rental income on operating leases and lower average finance rates. Health care premiums and fees increased, compared to last year, primarily due to higher insured enrollment, while health care claims and costs increased primarily due to higher medical costs and an increase in enrollment. Other income

 

15

 

increased this year primarily due to service income related to Nortrax, Inc., Nortrax Investments, Inc. and Ontrac Holdings, Inc. (collectively called Nortrax), which were consolidated in 2004, and a gain from the sale of the company’s 49 percent ownership in Sunstate Equipment Co., LLC, an equipment rental company. Selling, administrative and general expenses were higher this year primarily due to a higher employee performance bonus provision, the consolidation of Nortrax and foreign currency exchange rate effects. Other operating expenses increased primarily as a result of the consolidation of Nortrax and an increase in service expense.

 

The company has several defined benefit pension plans and defined benefit health care and life insurance plans. The company’s postretirement benefit costs for these plans in 2004 were $596 million, compared to $593 million in 2003. The long-term expected return on plan assets, which is reflected in these costs, was an expected gain of 8.5 percent in both years, or $671 million in 2004, compared to $597 million in 2003. The actual return on postretirement benefit plan assets was a gain of $654 million in 2004, compared to a gain of $1,050 million in 2003. In 2005, the long-term expected return will continue to be 8.5 percent. The total unrecognized losses related to the postretirement benefit plans at October 31, 2004 and 2003 were $5,149 million and $4,794 million, respectively. The company expects the increase in postretirement benefit costs in 2005 to be approximately $40 million pretax, compared with 2004, caused by amortization of unrecognized losses primarily as a result of a decrease in the discount rate assumption and prior years’ asset losses. The company makes any required contributions to the postretirement benefit plan assets under applicable regulations and voluntary contributions from time to time based on the company’s liquidity and ability to make tax-deductible contributions. Total company contributions to the plans were $1,852 million in 2004 and $745 million in 2003, which include direct benefit payments for unfunded plans. These contributions also included voluntary contributions to the U.S. postretirement benefit plan assets of $1,551 million in 2004 and $475 million in 2003. Total company contributions in 2005 are expected to be approximately $810 million, including voluntary contributions to U.S. postretirement plan assets of approximately $500 million. See the following discussion of “Critical Accounting Policies” for postretirement benefit obligations.

 

BUSINESS SEGMENT AND GEOGRAPHIC AREA RESULTS

 

The following discussion relates to operating results by reportable segment and geographic area. Operating profit is income before external interest expense, certain foreign exchange gains or losses, income taxes and corporate expenses. However, operating profit of the credit segment includes the effect of interest expense and foreign exchange gains or losses.

 

Beginning in fiscal 2004, the special technologies group’s results were transferred from the “Other” segment to the agricultural equipment segment due to changes in internal reporting. As a result, the 2003 and 2002 results for the agricultural equipment and “Other” segment were restated for net sales of $41 million and $54 million and operating losses of $8 million and $42 million, respectively, related to the special technologies group. This had no effect on total net sales and operating profit. The “Other” segment now represents primarily the health care operations along with certain miscellaneous service operations added in 2004.

 

Worldwide Agricultural Equipment Operations

 

The agricultural equipment segment had an operating profit of $1,072 million in 2004, compared with $329 million in 2003. Net sales increased 31 percent this year primarily due to higher shipments, reflecting strong retail demand, as well as the translation effect of exchange rates and improved price realization. The operating profit improvement was primarily due to higher worldwide sales, efficiencies related to stronger production volumes, and improved price realization. Offsetting these factors were the higher provision for performance bonuses and increased raw material costs.

 

Worldwide Commercial and Consumer Equipment Operations

 

The commercial and consumer equipment segment had an operating profit of $246 million, compared with $227 million in 2003. Net sales increased 16 percent for the year primarily due to higher volumes. The improved operating profit was primarily due to higher sales and production volumes. Partially offsetting these factors were an increase in the performance bonus provision in addition to higher costs for freight and raw materials.

 

Worldwide Construction and Forestry Operations

 

The construction and forestry segment had an operating profit of $587 million in 2004, compared with $152 million in 2003. Sales increased 54 percent for the year. The increase in sales was primarily due to higher volumes. The operating profit improvement was primarily due to higher sales, efficiencies related to stronger production volumes, and improved price realization. Partially offsetting these factors were a larger performance bonus provision and higher raw material costs. The results also included a $30 million pretax gain from the sale of an equipment rental company.

 

Worldwide Credit Operations

 

The operating profit of the credit operations was $466 million in 2004, compared with $474 million in 2003. Operating profit in 2004 was lower than last year due primarily to higher administrative costs, partly related to a higher provision for performance bonuses in connection with the overall company profitability, and lower margins. Partially offsetting these factors was a lower provision for credit losses, reflecting solid portfolio quality. Total revenues of the credit operations decreased 4 percent in 2004, primarily reflecting lower rental income from operating leases related to the lower level of leases, and lower average finance rates. The average balance of receivables and leases financed was 2 percent higher in 2004, compared with 2003. A decrease in funding rates in 2004 resulted in a 3 percent decrease in interest expense, compared with 2003. The credit operations’ ratio of earnings to fixed charges was 2.12 to 1 in 2004, compared to 2.07 to 1 in 2003.

 

Worldwide Other Operations

 

The company’s other operations,which consisted primarily of the health care operations, had an operating profit of $5 million in 2004, compared with $30 million last year. The decrease was primarily due to increased medical claims costs and a higher performance bonus provision related to overall company profitability.

 

16

 

Equipment Operations in U.S. and Canada

 

The equipment operations in the U.S. and Canada had an operating profit of $1,284 million in 2004, compared with $386 million in 2003. The increase was primarily due to higher sales, efficiencies related to stronger production volumes and improved price realization. Partially offsetting these items was a higher provision for performance bonuses and increased raw material costs. Sales increased primarily due to higher shipments, reflecting strong retail demand, as well as improved price realization. Sales increased 33 percent in 2004 while the physical volume of sales increased 30 percent, compared to 2003.

 

Equipment Operations outside U.S. and Canada

 

The equipment operations outside the U.S. and Canada had an operating profit of $621 million in 2004, compared with $322 million in 2003. The increase was primarily due to higher sales and production volumes of agricultural equipment. Partially offsetting these factors were higher expenses related to stronger foreign exchange rates and an increased provision for performance bonuses. Sales increased mainly from higher volumes, as well as the effect of stronger foreign exchange rates and improvements in price realization. Sales were 30 percent higher than last year, while the physical volume of sales increased 16 percent in 2004, compared with 2003.

 

MARKET CONDITIONS AND OUTLOOK

 

As a result of the factors and conditions outlined below, company equipment sales for 2005 are expected to increase by 2 to 7 percent with net income forecast to be approximately $1.5 billion. First-quarter equipment sales in 2005 are currently forecast to be up 20 to 25 percent in comparison with the same period in 2004. Production levels are expected to increase by 11 to 13 percent for the first quarter of 2005, compared to the same period in 2004. Consolidated net income for the first quarter of 2005 is forecast to be in a range of $200 million to $225 million.

 

Agricultural Equipment: On a worldwide basis, sales of the company’s agricultural equipment are forecast to be up 2 to 5 percent for the year. Despite a downturn in commodity prices, U.S. farmers are benefiting from record production of corn and soybeans. In addition, the livestock and dairy sectors are strong and government payments are expected to increase substantially in 2005. As a result, U.S. farm cash receipts are forecast to be about the same in 2005 as the record level in 2004. Given these conditions, the company expects industry retail sales in the U.S. and Canada to be up about 5 percent for fiscal 2005 in comparison with the very strong levels of 2004.

 

In other parts of the world, industry retail sales in Western Europe are forecast to be flat to down 5 percent in 2005. Farmers in the region have benefited from a good harvest this fall; however, they are expected to see little change in income as a result of lower grain prices, higher input costs and flat government-support payments. In South America, industry sales are forecast to be down 10 to 20 percent on the basis of lower commodity prices, increased input costs and a weaker U.S. dollar.

 

Commercial and Consumer Equipment: Sales of the company’s commercial and consumer equipment are expected to increase 2 to 5 percent in 2005 with help from new models of compact tractors, an updated utility-vehicle line, and higher sales of commercial mowing equipment.

 

Construction and Forestry: Markets are expected to be supported in 2005 by moderate economic growth, relatively low interest rates and a favorable level of housing starts. In this environment, sales of construction and forestry equipment are expected to see further growth as contractors and rental operations continue to replenish their fleets. As a result, segment sales are forecast to be up about 6 to 9 percent for the year.

 

Financial Services: Although the credit operations are expected to benefit from further growth in the loan portfolio, net income for 2005 is forecast to be down primarily due to increased leverage in the portfolio. The credit operations are expected to report net income of around $280 million for the year. In its health care operations, the company expects net income of about $15 million for 2005 as a result of an improved underwriting margin.

 

SAFE HARBOR STATEMENT

 

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: Statements under “Market Conditions and Outlook,” and other statements herein that relate to future operating periods are subject to important risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties could affect particular lines of business, while others could affect all of the company’s businesses.

 

Forward looking statements involve certain factors that are subject to change, including for the company’s agricultural equipment segment the many interrelated factors that affect farmers’ confidence, including worldwide demand for agricultural products, world grain stocks, the growth of non-food uses for some crops, prices realized for commodities and livestock, crop production expenses (most notably fuel and fertilizer costs), weather and soil conditions, real estate values, available acreage for farming, the land ownership policies of various governments, the level, complexity and distribution of government farm programs, international reaction to such programs, animal diseases (including bovine spongiform encephalopathy, commonly known as “mad cow” disease), crop pests and diseases (including Asian rust), harvest yields, availability of transport for crops and the level of farm product exports (including concerns about genetically modified organisms).

 

Factors affecting the outlook for the company’s commercial and consumer equipment segment include general economic conditions in these markets, consumer confidence, consumer borrowing patterns, consumer purchasing preferences, housing starts, spending on behalf of municipalities and golf courses, and weather conditions.

 

The number of housing starts, interest rates and consumer spending patterns are especially important to sales of the company’s construction equipment. The levels of public and non-residential construction also impact the results of the company’s construction and forestry segment. Prices for pulp, lumber and structural panels are important to sales of forestry equipment.

 

All of the company’s businesses and its reported results are affected by general economic conditions in and the political stability of global markets in which the company operates; production and technological difficulties, including capacity and supply constraints, and prices, including supply commodities such as steel and rubber; oil and energy prices and supplies; the availability and cost of freight; monetary and fiscal policies

 

17

 

of various countries, wars and other international conflicts and the threat thereof; actions by the U.S. Federal Reserve Board and other central banks; actions by the U.S. Securities and Exchange Commission; actions by environmental regulatory agencies, including those related to engine emissions and the risk of global warming; actions by other regulatory bodies; actions by rating agencies; capital market disruptions; investor sentiment; inflation and deflation rates, interest rate levels and currency exchange rates; customer borrowing and repayment practices, and the number of customer loan delinquencies and defaults; actions of competitors in the various industries in which the company competes, particularly price discounting; dealer practices especially as to levels of new and used field inventories; labor relations; changes to accounting standards; the effects of terrorism and the response thereto; and legislation affecting the sectors in which the company operates. Company results are also affected by changes in market values of investment assets and the level of interest rates, which impact postretirement benefit costs, and significant changes in health care costs.

 

The company’s outlook is based upon assumptions relating to the factors described above, which are sometimes based upon estimates and data prepared by government agencies. Such estimates and data are often revised. The company, however, undertakes no obligation to update or revise its outlook, whether as a result of new developments or otherwise. Further information concerning the company and its businesses, including factors that potentially could materially affect the company’s financial results, is included in other filings with the Securities and Exchange Commission.

 

2003 COMPARED WITH 2002

 

CONSOLIDATED RESULTS

 

Worldwide net income in 2003 was $643 million, or $2.64 per share diluted ($2.68 basic), compared with $319 million, or $1.33 per share diluted ($1.34 basic), in 2002. The success of new products and ongoing efforts to manage costs and asset intensity were evident in the results for 2003. Improved market conditions also contributed to the stronger performance of the company’s construction and forestry and commercial and consumer equipment segments. Additionally, as a result of disciplined asset management, trade receivables ended 2003 at their lowest level in more than a decade.

 

Net sales and revenues increased 11 percent to $15,535 million in 2003, compared with $13,947 million in 2002. Net sales of the Equipment Operations increased 14 percent in 2003 to $13,349 million from $11,703 million in 2002. Net sales increased primarily due to higher physical volumes of commercial and consumer equipment and construction and forestry equipment. In addition, the increase was due to the translation effect of stronger foreign currency exchange rates and improved price realization. Net sales outside the U.S. and Canada increased 17 percent in 2003. Excluding the impact of changes in currency exchange rates, these sales were up 5 percent for 2003.

 

Worldwide Equipment Operations, which exclude the Financial Services operations, had an operating profit of $708 million in 2003, compared with $401 million in 2002. Operating profit increased primarily due to improved price realization and a higher physical volume of sales. Partially offsetting these factors were an increase in postretirement benefit costs of $306 million in 2003. The results in 2002 were negatively affected by the costs of closing certain facilities and higher costs associated with the company’s minority investments in Nortrax. During 2004, the company acquired a majority interest in Nortrax and it was consolidated.

 

The Equipment Operations’ net income was $305 million in 2003, compared with $78 million in 2002. The same operating factors mentioned above affected these results. In addition, results for 2002 were negatively impacted by a higher effective tax rate.

 

Net income of the company’s Financial Services operations in 2003 was $330 million, compared with $262 million in 2002. The increase was primarily due to lower loan losses, growth in the portfolio and the absence of losses from Argentina related to the peso devaluation in 2002. Additional information is presented in the following discussion of the credit operations.

 

The cost of sales to net sales ratio for 2003 was 80.5 percent, compared to 82.0 percent in 2002. The decrease in the ratio was primarily due to improved price realization, higher production volumes, the discontinuance of the amortization of goodwill, and costs in 2002 from closing certain facilities along with higher costs related to Nortrax. These improvements were partially offset by higher postretirement benefit costs in 2003.

 

Finance and interest income decreased in 2003 primarily due to a decrease in rental income on operating leases caused by a lower level of leases. Health care premiums and fees and related health care claims and costs increased, compared to 2002, primarily due to higher enrollment. Other income decreased in 2003 primarily related to a lower volume of retail notes sold. Research and development costs increased in 2003 due to the higher level of new product development and exchange rate fluctuations. Selling, administrative and general expenses were higher in 2003 primarily due to higher expenses for employee postretirement benefits, exchange rate fluctuations and increased promotional and support costs for new products. Other operating expenses decreased primarily as a result of lower depreciation on operating leases in 2003 due to a lower level of leases, and the absence of losses in 2002 from the Argentine operations related to the peso devaluation. Equity income (loss) of unconsolidated affiliates improved in 2003 primarily due to the results of the Deere-Hitachi Construction Machinery Corporation and Nortrax.

 

The company’s postretirement benefit costs in 2003 were $593 million, compared to $279 million in 2002. The long-term expected return on plan assets, which is reflected in these costs, was an expected gain of 8.5 percent, or $597 million, in 2003, compared to 9.7 percent, or $663 million, in 2002. The actual return on postretirement benefit plan assets was a gain of $1,050 million in 2003, compared to a loss of $522 million in 2002. The total unrecognized losses related to the postretirement benefit plans at October 31, 2003 was $4,794 million. Total company contributions to the plans were $745 million in 2003 and $228 million in 2002, which include direct benefit payments for unfunded plans. The contributions in 2003 included a $475 million voluntary contribution to the U.S. postretirement benefit plan assets. No voluntary contribution was made in 2002.

 

18

See the following discussion of “Critical Accounting Policies” for postretirement benefit obligations.

 

The annual pretax increase in earnings and cash flows from the restructurings in 2001 and 2002 have been approximately $100 million as expected. The restructurings primarily have reduced cost of sales by approximately $300 million and selling, administrative and general expenses by $30 million, partially offset by a reduction in sales of $230 million.

 

BUSINESS SEGMENT RESULTS

 

The agriculture equipment and the “Other” segment discussed below were restated in 2003 and 2002 for the transfer of the special technologies group from the “Other” segment to the agricultural equipment segment (see previous segment discussion for “2004 Compared with 2003”).

 

Worldwide Agricultural Equipment Operations

 

The agricultural equipment segment had an operating profit of $329 million in 2003, compared with $397 million in 2002. Net sales increased 9 percent in 2003 due to the translation effect of stronger exchange rates and improved price realization. The production volumes and physical volume of sales were approximately equal to 2002. The lower operating profit was primarily due to higher postretirement benefit costs of $216 million, higher compensation to the credit operations for financing trade receivables and one-time labor agreement ratification costs. Offsetting these factors was the impact of improved price realization.

 

Worldwide Commercial and Consumer Equipment Operations

 

The commercial and consumer equipment segment had an operating profit of $227 million in 2003, compared with $79 million in 2002. Net sales increased 19 percent in 2003, primarily due to strong retail demand for recently introduced products and the impact of expanded distribution channels. The improved operating profit was primarily due to higher sales and production volumes. Partially offsetting these factors were higher promotional and support costs related to new products, as well as higher postretirement benefit costs of $31 million. Results in 2002 were also negatively affected by restructuring costs related to the closure of certain facilities.

 

Worldwide Construction and Forestry Operations

 

The construction and forestry segment had an operating profit of $152 million in 2003, compared with an operating loss of $75 million in 2002. Sales increased 24 percent in 2003. The increase was primarily due to higher physical volumes, reflecting improved retail activity. The operating profit improvement was primarily due to higher sales and production volumes. Improved price realization also had a favorable impact on the results for 2003. Partially offsetting these factors were higher postretirement benefit costs of $59 million. The results in 2002 were negatively affected by higher costs related to the company’s investment in Nortrax and the costs for a factory closing.

 

Worldwide Credit Operations

 

The operating profit of the credit operations was $474 million in 2003, compared with $386 million in 2002. Operating profit in 2003 was higher than in 2002 due primarily to lower loan losses, growth in the portfolio and the absence of losses in Argentina related to the peso devaluation, partially offset by narrower financing spreads, lower gains from a lower volume of retail note sales and higher selling, administrative and general expenses. Total revenues of the credit operations decreased 2 percent in 2003, primarily reflecting lower rental income from operating leases related to the lower level of leases, and a decrease in gains on a lower volume of retail note sales. The average balance of receivables and leases financed was 12 percent higher in 2003, compared with 2002, primarily due to the increased level of trade receivables. A decrease in financing rates, primarily offset by an increase in average borrowings in 2003, resulted in a 1 percent decrease in interest expense, compared with 2002. The credit operations’ ratio of earnings to fixed charges was 2.07 to 1 in 2003, compared to 1.85 to 1 in 2002.

 

Worldwide Other Operations

 

The company’s other operations, which consisted of the health care operations, had an operating profit of $30 million in 2003 and 2002.

 

FASB STATEMENT NO. 142

 

In 2003, the company adopted FASB Statement No. 142, Goodwill and Other Intangible Assets. In accordance with this Statement, the company did not amortize goodwill related to new acquisitions made after June 30, 2001 and discontinued amortizing goodwill for prior acquisitions as of November 1, 2002. Based on the new standard, goodwill will be written down only for impairments. In 2002, the company had goodwill amortization of $58 million pretax ($53 million after-tax).

 

CAPITAL RESOURCES AND LIQUIDITY

 

The discussion of capital resources and liquidity has been organized to review separately, where appropriate, the company’s Equipment Operations, Financial Services operations and the consolidated totals.

 

EQUIPMENT OPERATIONS

 

The company’s equipment businesses are capital intensive and are subject to large seasonal variations in financing requirements for inventories and certain receivables from dealers. The Equipment Operations sell most of their trade receivables to the company’s credit operations. As a result, the seasonal variations in financing requirements of the Equipment Operations have decreased. To the extent necessary, funds provided from operations are supplemented by external financing sources.

 

Cash provided by operating activities during 2004 was $1,383 million primarily due to net income adjusted for non-cash provisions, and an increase in accounts payable and accrued expenses, which were partially offset by a cash outflow for voluntary contributions to U.S. employee postretirement benefit plans of $1,551 million ($475 million last year) along with an increase in inventories and trade receivables. The operating cash flows, a decrease in cash and cash equivalents of $1,148 million, the proceeds from the issuance of common stock of $251 million (which were the result of the exercise of stock options) and proceeds from sales of businesses of $90 million were used primarily to increase receivables from Financial Services by $1,656 million,

 

19

---

 

fund purchases of property and equipment of $346 million, decrease borrowings by $320 million, pay dividends to stockholders of $247 million, acquire businesses for $193 million and repurchase common stock for $193 million.

 

Over the last three years, operating activities have provided an aggregate of $3,974 million in cash. In addition, proceeds from the issuance of common stock were $473 million and the sales of businesses were $166 million. The aggregate amount of these cash flows was used mainly to increase receivables from Financial Services by $1,576 million, fund purchases of property and equipment of $1,004 million, stockholders’ dividends of $666 million, acquisitions of businesses for $213 million and repurchases of common stock for $195 million. Cash and cash equivalents also increased $1,041 million over the three-year period.

 

Trade receivables held by the Equipment Operations increased by $135 million during 2004. During this time period, the Equipment Operations sold most of its trade receivables to the credit operations (see following consolidated discussion).

 

Inventories increased by $633 million in 2004. Most of these inventories are valued on the last-in, first-out (LIFO) method. The ratios of inventories on a first-in, first-out (FIFO) basis, which approximates current cost, to fiscal year cost of sales were 22 percent at October 31, 2004, and 2003.

 

Total interest-bearing debt of the Equipment Operations was $3,040 million at the end of 2004, compared with $3,304 million at the end of 2003 and $3,387 million at the end of 2002. The ratio of total debt to total capital (total interest-bearing debt and stockholders’ equity) at the end of 2004, 2003 and 2002 was 32 percent, 45 percent and 52 percent, respectively.

 

During 2004, the Equipment Operations retired $250 million of 6.55% notes and other long-term borrowings of $17 million.

 

Capital expenditures for the Equipment Operations in 2005 are estimated to be approximately $480 million.

 

FINANCIAL SERVICES

 

The Financial Services’ credit operations rely on their ability to raise substantial amounts of funds to finance their receivable and lease portfolios. Their primary sources of funds for this purpose are a combination of borrowings and equity capital. Additionally, the credit operations periodically sell substantial amounts of retail notes.

 

Cash flows from the company’s Financial Services operating activities were $653 million in 2004. Cash provided by financing activities totaled $664 million in 2004, representing a $1,264 million increase in borrowings from the Equipment Operations and a $134 million increase in long-term borrowings, partially offset by a $293 million decrease in short-term borrowings and the payment of $444 million of dividends to the Equipment Operations. The cash provided by operating and financing activities was used primarily to increase receivables. Cash used by investing activities totaled $1,437 million in 2004, primarily due to receivable acquisitions exceeding collections by $3,849 million, partially offset by sales of receivables of $2,334 million. Cash and cash equivalents also decreased $109 million.

 

Over the last three years, the Financial Services operating activities have provided $2,118 million in cash. In addition, the sale of receivables of $7,242 million, an increase in borrowings of $752 million and the sale of equipment on operating leases of $1,452 million have provided cash inflows. These amounts have been used mainly to fund receivable and lease acquisitions, which exceeded collections by $10,857 million, and dividends to the Equipment Operations of $1,092 million. Cash and cash equivalents also decreased $309 million over the three-year period.

 

Receivables and leases increased by $1,662 million in 2004, compared with 2003. Acquisition volumes of receivables and leases increased 26 percent in 2004, compared with 2003. The volumes of trade receivables, leases, wholesale notes, retail notes, operating loans and revolving charge accounts increased approximately 37 percent, 23 percent, 22 percent, 17 percent, 16 percent and 10 percent, respectively. The credit operations also sold retail notes receiving proceeds of $2,334 million during 2004, compared with $1,941 million in 2003. At October 31, 2004 and 2003, net receivables and leases administered, which include receivables and leases previously sold but still administered, were $18,620 million and $16,476 million, respectively.

 

Trade receivables held by the credit operations increased by $487 million in 2004 (see following consolidated discussion).

 

Total external interest-bearing debt of the credit operations was $11,508 million at the end of 2004, compared with $11,447 million at the end of 2003 and $10,001 million at the end of 2002. Total external borrowings have increased generally corresponding with the level of the receivable and lease portfolio, the level of cash and cash equivalents and the change in payables owed to the Equipment Operations. The credit subsidiaries’ ratio of total interest-bearing debt to total stockholder’s equity was 6.4 to 1 at the end of 2004 and 5.6 to 1 at the end of 2003 and 2002.

 

During 2004, the credit operations redeemed $150 million of 8-5/8% subordinated debentures due August 2019. The redemption price was equal to the par value plus accrued interest. The credit operations also issued $2,179 million and retired $1,895 million of other long-term borrowings during the year, which were primarily medium-term notes.

 

CONSOLIDATED

 

Sources of liquidity for the company include cash and short-term investments, funds from operations, the issuance of commercial paper and term debt, the securitization and sale of retail notes, and committed and uncommitted, unsecured, bank lines of credit.

 

Because of the multiple funding sources that have been and continue to be available to the company, the company expects to have sufficient sources of liquidity to meet its funding needs. The company’s worldwide commercial paper outstanding at October 31, 2004 and 2003 was approximately $1.9 billion and $2.1 billion, respectively, while the total cash and cash equivalents position was $3.2 billion and $4.4 billion, respectively. The company has for many years accessed diverse funding sources, including short-term and long-term unsecured debt capital markets in the U.S., Canada, Europe and Australia, as well as public and private securitization markets in the U.S. and Canada.

 

The company also has access to unsecured bank lines of credit with various U.S. and foreign banks. Some of the lines are available to both Deere & Company and John Deere Capital Corporation. Worldwide lines of credit totaled $3,190 million at October 31, 2004, $900 million of which were unused. For the purpose of computing unused credit lines, commercial paper and

 

20

 

short-term bank borrowings, excluding the current portion of long-term borrowings, were considered to constitute utilization. Included in the total credit lines at October 31, 2004 was a long-term credit facility agreement totaling $1,250 million, expiring in February 2009.

 

The credit agreement requires the Equipment Operations to maintain a ratio of total debt to total capital (total debt and stockholders’ equity) of 65 percent or less at the end of each fiscal quarter. At October 31, 2004, the ratio was 32 percent. Under this provision, the company’s excess equity capacity and retained earnings balance free of restriction at October 31, 2004 was $4,756 million. Alternatively under this provision, the Equipment Operations had the capacity to incur additional debt of $8,832 million at October 31, 2004.

 

To access public debt capital markets, the company relies on credit rating agencies to assign short-term and long-term credit ratings to the company’s securities as an indicator of credit quality for fixed income investors. A security rating is not a recommendation by the rating agency to buy, sell or hold company securities. A credit rating agency may change or withdraw company ratings based on its assessment of the company’s current and future ability to meet interest and principal repayment obligations. Lower credit ratings generally result in higher borrowing costs and reduced access to debt capital markets.

 

The senior long-term and short-term debt ratings and outlook currently assigned to company securities by the rating agencies engaged by the company are as follows:

 

		Senior Long-Term		Short-Term		Outlook
Moody’s Investors Service, Inc.		A3		Prime-2		Stable
Standard & Poor’s		A-		A-2		Stable

 

Trade accounts and notes receivable primarily arise from sales of goods to dealers. Trade receivables increased by $588 million in 2004. The ratios of trade accounts and notes receivable at October 31 to fiscal year net sales were 18 percent in 2004, compared with 20 percent in 2003. Total worldwide agricultural equipment trade receivables increased $127 million, commercial and consumer equipment receivables increased $110 million and construction and forestry receivables increased $351 million. The collection period for trade receivables averages less than 12 months. The percentage of trade receivables outstanding for a period exceeding 12 months was 2 percent at October 31, 2004, compared with 11 percent at October 31, 2003.

 

Stockholders’ equity was $6,393 million at October 31, 2004, compared with $4,002 million at October 31, 2003. The increase of $2,391 million resulted primarily from net income of $1,406 million, a decrease in the minimum pension liability adjustment of $1,021 million and a decrease in treasury stock of $101 million, partially offset by dividends declared of $262 million.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

The company’s credit operations periodically securitize and sell retail notes to special purpose entities (SPEs) in securitizations of retail notes. The credit operations use these SPEs in a manner consistent with conventional practices in the securitization industry to isolate the retail notes for the benefit of securitization investors. The use of the SPEs enables these operations to access the highly liquid and efficient securitization markets for the sales of these types of financial assets. The amounts of funding from securitizations reflects such factors as capital market accessibility, relative costs of funding sources and assets available for securitization. Based on an assessment of these and other factors, the company received $2,269 million of funding and recognized pretax gains of $48 million related to these securitizations during 2004. The company’s total exposure to recourse provisions related to securitized retail notes was $218 million and the total assets held by the SPEs related to securitizations were $3,441 million at October 31, 2004.

 

At October 31, 2004, the company had guaranteed approximately $40 million of residual values for two operating leases related to an administrative and a manufacturing building. The company is obligated at the end of each lease term to pay to the lessor any reduction in market value of the leased property up to the guaranteed residual value. The company recognizes the expense for these future estimated lease payments over the terms of the operating leases and had accrued expenses of $9 million related to these agreements at October 31, 2004. The leases have terms expiring in 2006 and 2007.

 

At October 31, 2004, the company had approximately $95 million of guarantees issued primarily to banks outside the U.S. related to third-party receivables for the retail financing of John Deere equipment. The company may recover a portion of any required payments incurred under these agreements from repossession of the equipment collateralizing the receivables. At October 31, 2004, the company had accrued losses of approximately $1 million under these agreements. The maximum remaining term of the receivables guaranteed at October 31, 2004 was approximately six years.

 

AGGREGATE CONTRACTUAL OBLIGATIONS

 

Most of the company’s contractual obligations to make payments to third parties are debt obligations. In addition, the company has off-balance sheet obligations for the purchases of raw materials and services along with agreements for future lease payments. The payment schedule for these contractual obligations in millions of dollars is as follows:

 

		Total			Less than 1 year			1-3 years			3-5 years			More than 5 years
Total debt*
Equipment Operations		$	2,958		$	312		$	281		$	8		$	2,357
Financial Services		11,265			3,146			4,393			1,541			2,185
Total		14,223			3,458			4,674			1,549			4,542
Purchase obligations		2,306			2,274			32
Operating leases		367			75			130			59			103
Capital leases		12			2			3			2			5
Contractual obligations		$	16,908		$	5,809		$	4,839		$	1,610		$	4,650

 

*      Principal payments.

 

21

 

CRITICAL ACCOUNTING POLICIES

 

The preparation of the company’s consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues and expenses. Changes in these estimates and assumptions could have a significant effect on the financial statements. The accounting policies below are those management believes are the most critical to the preparation of the company’s financial statements and require the most difficult, subjective or complex judgments. The company’s other accounting policies are described in the Notes to the Consolidated Financial Statements.

 

Sales Incentives

 

At the time a sale to a dealer is recognized, the company records an estimate of the future sales incentive costs for allowances and financing programs that will be due when the dealer sells the equipment to a retail customer. The estimate is based on historical data, announced incentive programs, field inventory levels and settlement volumes. The final cost of these programs and the amount of accrual required for a specific sale is fully determined when the dealer sells the equipment to the retail customer. This is due to numerous programs available at any particular time and new programs that may be announced after the company records the sale. Changes in the mix and types of programs affect these estimates, which are reviewed quarterly.

 

The sales incentive accruals at October 31, 2004, 2003 and 2002 were $540 million, $444 million and $584 million, respectively. The total incentive accruals recorded at the end of 2004 increased compared to the end of 2003 primarily due to an increase in the sales volume discounts to dealers related to the increase in sales in 2004. In 2003, the sales incentive accruals recorded at year-end decreased, compared to 2002 year-end, primarily due to the volume discounts for the agricultural equipment segment being paid quarterly beginning in 2003 versus annually in 2002.

 

The estimation of the sales incentive accrual is impacted by many assumptions. One of the key assumptions is the historical percentage of sales incentive costs to settlements from dealers. Over the last five fiscal years, this percent has varied by approximately plus or minus .5 percent, compared to the average sales incentive costs to settlements percentage during that period. Holding other assumptions constant, if this loss experience percentage were to increase or decrease .5 percent, the sales incentive accrual at October 31, 2004 would increase or decrease by approximately $25 million.

 

Product Warranties

 

At the time a sale to a dealer is recognized, the company records the estimated future warranty costs. The company generally determines its total warranty liability by applying historical claims rate experience to the estimated amount of equipment that has been sold and is still under warranty based on dealer inventories and retail sales. The historical claims rate is primarily determined by a review of five-year claims costs and current quality developments. Variances in claims experience and the type of warranty programs affect these estimates, which are reviewed quarterly.

 

The product warranty accruals at October 31, 2004, 2003 and 2002 were $458 million, $389 million and $332 million, respectively. The increases in 2004 and 2003 were primarily due to the increases in sales volume.

 

Estimates used to determine the product warranty accruals are significantly affected by the historical percentage of warranty claims costs to sales. Over the last five fiscal years, this loss experience percent has varied by approximately plus or minus .15 percent, compared to the average warranty costs to sales percentage during that period. Holding other assumptions constant, if this estimated loss experience percentage were to increase or decrease .15 percent, the warranty accrual at October 31, 2004 would increase or decrease by approximately $30 million.

 

Postretirement Benefit Obligations

 

Pension obligations and other postretirement employee benefit (OPEB) obligations are based on various assumptions used by the company’s actuaries in calculating these amounts. These assumptions include discount rates, health care cost trend rates, expected return on plan assets, compensation increases, retirement rates, mortality rates and other factors. Actual results that differ from the assumptions and changes in assumptions affect future expenses and obligations.

 

The total net pension and OPEB liabilities recognized at October 31, 2004, 2003 and 2002 were $729 million, $3,804 million and $3,660 million, respectively. The decrease in the total net liabilities recognized at October 31, 2004 is primarily due to the decrease in the minimum pension liability related to the increase in pension plan assets. The increase in plan assets was a result of voluntary company contributions and the return on plan assets.

 

The effect of hypothetical changes to selected assumptions on the company’s major U. S retirement benefit plans would be as follows in millions of dollars:

 

October 31, 2004

2005

Increase

Increase

Increase

Percentage

(Decrease)

(Decrease)

(Decrease)

Assumptions

Change

PBO/APBO*

Equity**

Expense

Pension

Discount rate***

+/-.5

$

(389)/417

$

0/(2,436

)

$

(34)/34

Expected return on assets

+/-.5

(39)/39

OPEB

Discount rate***

+/-.5

(353)/394

(52)/57

Health care cost trend rate***

+/-1.0

716/(630

)

170/(148

)

 

*                       Projected benefit obligation (PBO) for pension plans and accumulated postretirement benefit obligation (APBO) for OPEB plans.

**                Pretax minimum pension liability adjustment.

***         Pretax impact on service cost, interest cost and amortization of gains or losses.

 

Allowance for Credit Losses

 

The allowance for credit losses represents an estimate of the losses expected from the company’s receivable portfolio. The level of the allowance is based on many quantitative and qualitative factors, including historical loss experience by product category, portfolio duration, delinquency trends, economic conditions and credit risk quality. The adequacy of the allowance is assessed quarterly.

 

22

 

Different assumptions or changes in economic conditions would result in changes to the allowance for credit losses and the provision for credit losses.

 

The total allowance for credit losses at October 31, 2004, 2003 and 2002 was $201 million, $207 million and $182 million, respectively. The decrease in 2004 was primarily due to improved credit quality and delinquency trends. The increase in 2003 was primarily due to the increase in receivables.

 

The assumptions used in evaluating the company’s exposure to credit losses involve estimates and significant judgment. The historical loss experience on the receivable portfolios represents one of the key assumptions involved in determining the allowance for credit losses. Over the last five fiscal years, the average loss experience has fluctuated between 2 basis points and 15 basis points in any given fiscal year over the applicable prior period. Holding other estimates constant, a 5 basis point increase or decrease in estimated loss experience on the receivable portfolios would result in an increase or decrease of approximately $7 million to the allowance for credit losses at October 31, 2004.

 

Operating Lease Residual Values

 

The carrying value of equipment on operating leases is affected by the estimated fair values of the equipment at the end of the lease (residual values). Upon termination of the lease, the equipment is either purchased by the lessee or sold to a third party, in which case the company may record a gain or a loss for the difference between the estimated residual value and the sales price. The residual values are dependent on current economic conditions and are reviewed quarterly. Changes in residual value assumptions would affect the amount of depreciation expense and the amount of investment in equipment on operating leases.

 

The total operating lease residual values at October 31, 2004, 2003 and 2002 were $803 million, $913 million and $1,092 million, respectively. The decreases in 2004 and 2003 were primarily due to the decreases in the level of operating leases.

 

Estimates used in determining end of lease market values for equipment on operating leases significantly impact the amount and timing of depreciation expense. If future market values for this equipment were to decrease 5 percent from the company’s present estimates, the total impact would be to increase the company’s depreciation on equipment on operating leases by approximately $40 million. This amount would be charged to depreciation expense during the remaining lease terms such that the net investment in operating leases at the end of the lease terms would be equal to the revised residual values. Initial lease terms generally range from three to five years.

 

FINANCIAL INSTRUMENT RISK INFORMATION

 

The company is naturally exposed to various interest rate and foreign currency risks. As a result, the company enters into derivative transactions to manage certain of these exposures that arise in the normal course of business and not for the purpose of creating speculative positions or trading. The company’s credit operations manage the relationship of the types and amounts of their funding sources to their receivable and lease portfolio in an effort to diminish risk due to interest rate and foreign currency fluctuations, while responding to favorable financing opportunities. Accordingly, from time to time, these operations enter into interest rate swap agreements to manage their interest rate exposure. The company also has foreign currency exposures at some of its foreign and domestic operations related to buying, selling and financing in currencies other than the local currencies. The company has entered into agreements related to the management of these currency transaction risks. The credit risk under these interest rate and foreign currency agreements is not considered to be significant.

 

Interest Rate Risk

 

Quarterly, the company uses a combination of cash flow models to assess the sensitivity of its financial instruments with interest rate exposure to changes in market interest rates. The models calculate the effect of adjusting interest rates as follows. Cash flows for financing receivables are discounted at the current prevailing rate for each receivable portfolio. Cash flows for borrowings are discounted at the treasury yield curve plus a market credit spread for similarly rated borrowers. Cash flows for interest rate swaps are projected and discounted using forecasted rates from the swap yield curve at the repricing dates. The net loss in these financial instruments’ fair values which would be caused by decreasing the interest rates by 10 percent from the market rates at October 31, 2004 and 2003 would have been approximately $42 million and $56 million, respectively.

 

Foreign Currency Risk

 

In the Equipment Operations, it is the company’s practice to hedge significant currency exposures. Worldwide foreign currency exposures are reviewed quarterly. Based on the Equipment Operations anticipated and committed foreign currency cash inflows and outflows for the next twelve months and the foreign currency derivatives at year end, the company estimates that a hypothetical 10 percent weakening of the U.S. dollar relative to all other currencies through 2005 would decrease the 2005 expected net cash inflows by $18 million. At last year end, a hypothetical 10 percent strengthening of the U.S. dollar under similar assumptions and calculations indicated a potential $65 million adverse effect on the 2004 net cash inflows.

 

In the Financial Services operations, the company’s policy is to hedge the foreign currency risk if the currency of the borrowings does not match the currency of the receivable portfolio. As a result, a hypothetical 10 percent adverse change in the value of the U.S. dollar relative to all other foreign currencies would not have a material effect on the Financial Services cash flows.

 

23

 

DEERE & COMPANY

STATEMENT OF CONSOLIDATED INCOME

For the Years Ended October 31, 2004, 2003 and 2002

(In millions of dollars except per share amounts)

 

		2004			2003			2002
Net Sales and Revenues
Net sales		$	17,673.0		$	13,349.1		$	11,702.8
Finance and interest income		1,195.7			1,275.6			1,339.2
Health care premiums and fees		766.2			664.5			636.0
Other income		351.2			245.4			269.0
Total		19,986.1			15,534.6			13,947.0
Costs and Expenses
Cost of sales		13,567.5			10,752.7			9,593.4
Research and development expenses		611.6			577.3			527.8
Selling, administrative and general expenses		2,117.4			1,744.2			1,657.3
Interest expense		592.1			628.5			637.1
Health care claims and costs		650.3			536.1			518.4
Other operating expenses		333.5			324.5			410.3
Total		17,872.4			14,563.3			13,344.3
Income of Consolidated Group before Income Taxes		2,113.7			971.3			602.7
Provision for income taxes		708.5			336.9			258.3
Income of Consolidated Group		1,405.2			634.4			344.4
Equity in Income (Loss) of Unconsolidated Affiliates
Credit		.6			.2			(3.8		)
Other		.3			8.5			(21.4		)
Total		.9			8.7			(25.2		)
Net Income		$	1,406.1		$	643.1		$	319.2
Per Share Data
Net income – basic		$	5.69		$	2.68		$	1.34
Net income – diluted		$	5.56		$	2.64		$	1.33
Dividends declared		$	1.06		$	.88		$	.88

 

The notes to consolidated financial statements are an integral part of this statement.

 

24

 

DEERE & COMPANY

CONSOLIDATED BALANCE SHEET

As of October 31, 2004 and 2003

(In millions of dollars except per share amounts)

 

		2004			2003
ASSETS
Cash and cash equivalents		$	3,181.1		$	4,384.5
Marketable securities		246.7			231.8
Receivables from unconsolidated affiliates		17.6			303.2
Trade accounts and notes receivable - net		3,206.9			2,619.3
Financing receivables - net		11,232.6			9,974.2
Other receivables		663.0			428.3
Equipment on operating leases - net		1,296.9			1,381.9
Inventories		1,999.1			1,366.1
Property and equipment - net		2,161.6			2,075.6
Investments in unconsolidated affiliates		106.9			195.5
Goodwill		973.6			872.1
Other intangible assets - net		21.7			252.9
Prepaid pension costs		2,493.1			62.6
Other assets		515.4			534.3
Deferred income taxes		528.1			1,476.1
Deferred charges		109.7			99.6
Total Assets		$	28,754.0		$	26,258.0
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Short-term borrowings		$	3,457.5		$	4,347.2
Payables to unconsolidated affiliates		142.3			87.8
Accounts payable and accrued expenses		3,973.6			3,105.5
Health care claims and reserves		135.9			94.1
Accrued taxes		179.2			226.5
Deferred income taxes		62.6			30.7
Long-term borrowings		11,090.4			10,404.2
Retirement benefit accruals and other liabilities		3,319.7			3,959.9
Total liabilities		22,361.2			22,255.9
STOCKHOLDERS’ EQUITY
Common stock, $1 par value (authorized – 600,000,000 shares; issued – 268,215,602 shares in 2004 and 2003), at stated value		2,043.5			1,987.8
Common stock in treasury, 21,356,458 shares in 2004 and 24,694,170 shares in 2003, at cost		(1,040.4		)	(1,141.4		)
Unamortized restricted stock compensation		(12.7		)	(5.8		)
Retained earnings		5,445.1			4,329.5
Total		6,435.5			5,170.1
Minimum pension liability adjustment		(57.2		)	(1,078.0		)
Cumulative translation adjustment		9.1			(79.2		)
Unrealized loss on derivatives		(6.4		)	(22.4		)
Unrealized gain on investments.		11.8			11.6
Accumulated other comprehensive income (loss)		(42.7		)	(1,168.0		)
Total stockholders’ equity		6,392.8			4,002.1
Total Liabilities and Stockholders’ Equity		$	28,754.0		$	26,258.0

 

The notes to consolidated financial statements are an integral part of this statement.

 

25

 

DEERE & COMPANY

STATEMENT OF CONSOLIDATED CASH FLOWS

For the Years Ended October 31, 2004, 2003 and 2002

(In millions of dollars)

 

		2004			2003			2002
Cash Flows from Operating Activities
Net income		$	1,406.1		$	643.1		$	319.2
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for doubtful receivables		51.4			106.8			160.7
Provision for depreciation and amortization		621.0			631.4			725.3
Undistributed earnings of unconsolidated affiliates		20.7			(5.5		)	22.7
Provision (credit) for deferred income taxes		385.0			33.1			(1.2		)
Changes in assets and liabilities:
Receivables		(477.8		)	182.3			158.2
Inventories		(293.7		)	84.1			85.8
Accounts payable and accrued expenses		872.7			(184.9		)	144.0
Other*		(1,422.9		)	45.3			263.6
Net cash provided by operating activities		1,162.5			1,535.7			1,878.3
Cash Flows from Investing Activities
Collections of receivables		10,233.6			9,077.6			6,987.0
Proceeds from sales of financing receivables		2,333.6			1,941.0			2,967.8
Proceeds from maturities and sales of marketable securities		66.7			76.4			75.4
Proceeds from sales of equipment on operating leases		444.4			514.5			495.2
Proceeds from sales of businesses		90.6			22.5			53.5
Cost of receivables acquired		(13,628.2		)	(11,576.8		)	(9,955.3		)
Purchases of marketable securities		(79.6		)	(118.2		)	(87.8		)
Purchases of property and equipment		(363.8		)	(309.6		)	(358.7		)
Cost of operating leases acquired		(571.1		)	(473.7		)	(487.9		)
Acquisitions of businesses, net of cash acquired		(192.9		)	(10.6		)	(19.0		)
Decrease (increase) in receivables from unconsolidated affiliates		(68.7		)	(6.8		)	14.8
Other		(.1		)	(32.4		)	1.0
Net cash used for investing activities		(1,735.5		)	(896.1		)	(314.0		)
Cash Flows from Financing Activities
Increase (decrease) in short-term borrowings		(356.0		)	126.9			(1,413.2		)
Proceeds from long-term borrowings		2,189.5			3,312.9			4,573.7
Principal payments on long-term borrowings		(2,312.7		)	(2,542.7		)	(2,771.0		)
Proceeds from issuance of common stock		250.8			174.5			48.0
Repurchases of common stock		(193.1		)	(.4		)	(1.2		)
Dividends paid		(246.6		)	(210.5		)	(208.9		)
Other		(.4		)	(1.8		)	(1.5		)
Net cash provided by (used for) financing activities		(668.5		)	858.9			225.9
Effect of Exchange Rate Changes on Cash		38.1			71.1			(5.3		)
Net Increase (Decrease) in Cash and Cash Equivalents		(1,203.4		)	1,569.6			1,784.9
Cash and Cash Equivalents at Beginning of Year		4,384.5			2,814.9			1,030.0
Cash and Cash Equivalents at End of Year		$	3,181.1		$	4,384.5		$	2,814.9

 

The notes to consolidated financial statements are an integral part of this statement.

 

*                                          Primarily related to pension and other postretirement benefits in 2004.

 

26

 

DEERE & COMPANY

STATEMENT OF CHANGES IN CONSOLIDATED STOCKHOLDERS’ EQUITY

For the Years Ended October 31, 2002, 2003 and 2004

(In millions of dollars)

 

		Total Equity			Common Stock			Treasury Stock			Unamortized Restricted Stock			Retained Earnings			Other Comprehensive Income (Loss)
Balance October 31, 2001		$	3,992.2		$	1,948.6		$	(1,405.5	)	$	(16.8	)	$	3,834.8		$	(368.9	)
Comprehensive income (loss)
Net income		319.2												319.2
Other comprehensive income (loss)
Minimum pension liability adjustment		(1,015.9		)													(1,015.9		)
Cumulative translation adjustment		(7.6		)													(7.6		)
Unrealized gain on derivatives		25.0															25.0
Unrealized gain on investments		1.0															1.0
Total comprehensive income (loss)		(678.3		)
Repurchases of common stock		(1.2		)				(1.2		)
Treasury shares reissued		84.5						84.5
Dividends declared		(209.3		)										(209.3		)
Other stockholder transactions		(24.7		)	8.4						(1.0		)	(32.1		)
Balance October 31, 2002		3,163.2			1,957.0			(1,322.2		)	(17.8		)	3,912.6			(1,366.4		)
Comprehensive income
Net income		643.1												643.1
Other comprehensive income (loss)
Minimum pension liability adjustment		(45.9		)													(45.9		)
Cumulative translation adjustment		213.9															213.9
Unrealized gain on derivatives		24.6															24.6
Unrealized gain on investments		5.8															5.8
Total comprehensive income		841.5
Repurchases of common stock		(.4		)				(.4		)
Treasury shares reissued		181.2						181.2
Dividends declared		(211.2		)										(211.2		)
Other stockholder transactions		27.8			30.8						12.0			(15.0		)
Balance October 31, 2003		4,002.1			1,987.8			(1,141.4		)	(5.8		)	4,329.5			(1,168.0		)
Comprehensive income
Net income		1,406.1												1,406.1
Other comprehensive income
Minimum pension liability adjustment		1,020.8															1,020.8
Cumulative translation adjustment		88.3															88.3
Unrealized gain on derivatives		16.0															16.0
Unrealized gain on investments		.2															.2
Total comprehensive income		2,531.4
Repurchases of common stock		(193.1		)				(193.1		)
Treasury shares reissued		294.1						294.1
Dividends declared		(262.2		)										(262.2		)
Other stockholder transactions		20.5			55.7						(6.9		)	(28.3		)
Balance October 31, 2004		$	6,392.8		$	2,043.5		$	(1,040.4	)	$	(12.7	)	$	5,445.1		$	(42.7	)

 

The notes to consolidated financial statements are an integral part of this statement.

 

27