DEERE & CO - Quarter Report: 2015 July (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C.  20549

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FORM 10-Q

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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended July 31, 2015

 

Commission file no: 1-4121

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DEERE  &  COMPANY

(Exact name of registrant as specified in its charter)

 

One John Deere Place

Moline, Illinois 61265

(Address of principal executive offices)

Telephone Number:  (309) 765-8000

 

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Indicate by check mark whether the registrant:   (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes    X    No          

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes    X    No          

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes           No    X   

 

At July 31, 2015,  328,166,270 shares of common stock, $1 par value, of the registrant were outstanding.

 

 

 

Index to Exhibits: Page 50

 

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PART I.  FINANCIAL INFORMATION

 

See Condensed Notes to Interim Consolidated Financial Statements.

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See Condensed Notes to Interim Consolidated Financial Statements.

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See Condensed Notes to Interim Consolidated Financial Statements.

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See Condensed Notes to Interim Consolidated Financial Statements.

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See Condensed Notes to Interim Consolidated Financial Statements.

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See Condensed Notes to Interim Consolidated Financial Statements.

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See Condensed Notes to Interim Consolidated Financial Statements.

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Condensed Notes to Interim Consolidated Financial Statements (Unaudited)

(1)  The information in the notes and related commentary are presented in a format which includes data grouped as follows:

Equipment Operations - Includes the Company’s agriculture and turf operations and construction and forestry operations with financial services reflected on the equity basis.

Financial Services - Includes primarily the Company’s financing operations.

Consolidated - Represents the consolidation of the equipment operations and financial services.  References to "Deere & Company" or "the Company" refer to the entire enterprise.

 

(2)  The consolidated financial statements of Deere & Company and consolidated subsidiaries have been prepared by the Company, without audit, pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC).  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the U.S. have been condensed or omitted as permitted by such rules and regulations.  All adjustments, consisting of normal recurring adjustments, have been included.  Management believes that the disclosures are adequate to present fairly the financial position, results of operations and cash flows at the dates and for the periods presented.  It is suggested that these interim financial statements be read in conjunction with the consolidated financial statements and the notes thereto appearing in the Company’s latest annual report on Form 10-K.  Results for interim periods are not necessarily indicative of those to be expected for the fiscal year.

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts and related disclosures.  Actual results could differ from those estimates.

Cash Flow Information

All cash flows from the changes in trade accounts and notes receivable are classified as operating activities in the Statement of Consolidated Cash Flows as these receivables arise from sales to the Company’s customers.  Cash flows from financing receivables that are related to sales to the Company’s customers are also included in operating activities.  The remaining financing receivables are related to the financing of equipment sold by independent dealers and are included in investing activities.

The Company had the following non-cash operating and investing activities that were not included in the Statement of Consolidated Cash Flows.  The Company transferred inventory to equipment on operating leases of approximately $468 million and $499 million in the first nine months of 2015 and 2014, respectively.  The Company also had accounts payable related to purchases of property and equipment of approximately $42 million and $50 million at July 31, 2015 and 2014, respectively.

 

(3)  New accounting standards to be adopted are as follows:

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in Accounting Standards Codification (ASC) 605, Revenue Recognition.  This ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract.  In August 2015, the FASB issued ASU No. 2015-14, Deferral of the Effective Date, which amends ASU No. 2014-09.  As a result, the effective date will be the first quarter of fiscal year 2019 with early adoption permitted in the first quarter of fiscal year 2018.  The adoption will use one of two retrospective application methods.  The Company has not determined the potential effects on the consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period, which amends ASC 718, Compensation - Stock Compensation.  This ASU requires that a performance target

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that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.  Therefore, the performance target should not be reflected in estimating the grant-date fair value of the award.  Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered.  The total compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest.  The effective date will be the first quarter of fiscal year 2017.  The adoption will not have a material effect on the Company’s consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which amends ASC 835-30, Interest - Imputation of Interest.  This ASU requires that debt issuance costs related to borrowings be presented in the balance sheet as a direct deduction from the carrying amount of the borrowing.  This treatment is consistent with debt discounts.  The ASU does not affect the amount or timing of expenses for debt issuance costs.  The effective date will be the first quarter of fiscal year 2017 and will be applied retrospectively.  The adoption will not have a material effect on the Company’s consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, which amends ASC 350-40, Intangibles-Goodwill and Other-Internal-Use Software.  This ASU provides guidance to customers about whether a cloud computing arrangement includes a software license.  If an arrangement includes a software license, the accounting for the license will be consistent with licenses of other intangible assets.  If the arrangement does not include a license, the arrangement will be accounted for as a service contract.  The effective date will be the first quarter of fiscal year 2017 and will be adopted prospectively.  The adoption will not have a material effect on the Company’s consolidated financial statements.

In May 2015, the FASB issued ASU No. 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), which amends ASC 820, Fair Value Measurement.  This ASU removes the requirement to categorize within the fair value hierarchy investments without readily determinable fair values in entities that elect to measure fair value using net asset value per share or its equivalent.  The ASU requires that these investments continue to be shown in the investment disclosure amount to allow the disclosure to reconcile to the investment amount presented in the balance sheet.  The ASU will be early adopted in the fourth quarter of fiscal year 2015 and will be applied retrospectively.  The adoption will not have a material effect on the Company’s consolidated financial statements.

In May 2015, the FASB issued ASU No. 2015-09, Disclosures about Short-Duration Contracts, which amends ASC 944, Financial Services - Insurance.  This ASU requires disclosure of additional information about unpaid claims and claims adjustment expenses, including a rollforward of the liability of the claims adjustment liability.  The effective date will be the fourth quarter of fiscal year 2017.  The adoption will not have a material effect on the Company’s consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, which amends ASC 330, Inventory.  This ASU simplifies the subsequent measurement of inventory by using only the lower of cost or net realizable value.  The ASU does not apply to inventory measured using last-in, first-out method.  The effective date will be the first quarter of fiscal year 2018 with early adoption permitted.  The adoption will not have a material effect on the Company’s consolidated financial statements.

In August 2015, the FASB issued ASU No. 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, which amends ASC 835-30, Interest - Imputation of Interest.  This ASU clarifies the presentation and subsequent measurement of debt issuance costs associated with lines of credit.  These costs may be presented as an asset and amortized ratably over the term of the line of credit arrangement, regardless of whether there are outstanding borrowings on the arrangement.  The effective date will be the first quarter of fiscal year 2017 and will be applied retrospectively.  The adoption will not have a material effect on the Company’s consolidated financial statements.

 

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(4)  The after-tax changes in accumulated other comprehensive income (loss) in millions of dollars follow:

 

* Represents the accumulated translation adjustments related to the foreign subsidiaries of the Water operations that were sold (see Note 18).

 

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Following are amounts recorded in and reclassifications out of other comprehensive income (loss), and the income tax effects, in millions of dollars:

 

* These accumulated other comprehensive income amounts are included in net periodic postretirement costs.  See Note 7 for additional detail.

 

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* These accumulated other comprehensive income amounts are included in net periodic postretirement costs.  See Note 7 for additional detail.

 

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* Represents the accumulated translation adjustments related to the foreign subsidiaries of the Water operations that were sold (see Note 18).

** These accumulated other comprehensive income amounts are included in net periodic postretirement costs.  See Note 7 for additional detail.

In the third quarter of 2015 and 2014, the noncontrolling interests’ comprehensive income was none and $.2 million, respectively, which consisted of net income of $.1 million and $.2 million and cumulative translation adjustments of $(.1) million and none, respectively.

 

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* Represents the accumulated translation adjustments related to the foreign subsidiaries of the Water operations that were sold (see Note 18).

** These accumulated other comprehensive income amounts are included in net periodic postretirement costs.  See Note 7 for additional detail.

In the first nine months of 2015 and 2014, the noncontrolling interests’ comprehensive income was $.2 million and $1.0 million, respectively, which consisted of net income of $.6 million and $1.0 million and cumulative translation adjustments of $(.4) million and none, respectively.

 

(5)  Dividends declared and paid on a per share basis were as follows:

 

 

 

 

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(6)  A  reconciliation of basic and diluted net income per share attributable to Deere & Company follows in millions, except per share amounts:

 

 

All stock options outstanding were included in the above per share computation for both periods in 2015.  During the third quarter and first nine months of 2014, 2.4 million shares in both periods were excluded from the computation because the incremental shares under the treasury stock method would have been antidilutive.

 

(7)  The Company has several defined benefit pension plans and defined postretirement health care and life insurance plans covering its U.S. employees and employees in certain foreign countries.

The worldwide components of net periodic pension cost consisted of the following in millions of dollars:

 

The worldwide components of net periodic postretirement benefits cost (health care and life insurance) consisted of the following in millions of dollars:

 

During the first nine months of 2015, the Company contributed approximately $61 million to its pension plans and $22 million to its other postretirement benefit plans.  The Company presently anticipates contributing an additional $16 million to its pension plans and $5 million to its other postretirement benefit plans during the remainder of fiscal year 2015.  These contributions include payments from Company funds to either increase plan assets or make direct payments to plan participants.

 

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(8)  The Company’s unrecognized tax benefits at July 31, 2015 were $236 million, compared to $213 million at October 31, 2014.  The liability at July 31, 2015 consisted of approximately $80 million, which would affect the effective tax rate if it was recognized.  The remaining liability was related to tax positions for which there are offsetting tax receivables, or the uncertainty was only related to timing.  The changes in the unrecognized tax benefits for the first nine months of 2015 were not significant.  The Company expects that any reasonably possible change in the amounts of unrecognized tax benefits in the next 12 months would not be significant.

 

(9)  Worldwide net sales and revenues, operating profit and identifiable assets by segment in millions of dollars follow:

 

 

 

* Operating profit is income from continuing operations before corporate expenses, certain external interest expense, certain foreign exchange gains and losses and income taxes.  Operating profit of the financial services segment includes the effect of interest expense and foreign exchange gains and losses.

** Reconciling items are primarily corporate expenses, certain external interest expense, certain foreign exchange gains and losses and net income attributable to noncontrolling interests.

 

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(10)  Past due balances of financing receivables still accruing finance income represent the total balance held (principal plus accrued interest) with any payment amounts 30 days or more past the contractual payment due date.  Non-performing financing receivables represent loans for which the Company has ceased accruing finance income.  These receivables are generally 120 days delinquent and the estimated uncollectible amount, after charging the dealer’s withholding account, if any, has been written off to the allowance for credit losses.  Finance income for non-performing receivables is recognized on a cash basis.  Accrual of finance income is generally resumed when the receivable becomes contractually current and collections are reasonably assured.

An age analysis of past due financing receivables that are still accruing interest and non-performing financing receivables in millions of dollars follows:

 

 

 

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An analysis of the allowance for credit losses and investment in financing receivables in millions of dollars during the periods follows:

 

 

 

* Individual allowances were not significant.

** Remainder is collectively evaluated.

Financing receivables are considered impaired when it is probable the Company will be unable to collect all amounts due according to the contractual terms.  Receivables reviewed for impairment generally include those that are either past due, or have provided bankruptcy notification, or require significant collection efforts.  Receivables that are impaired are generally classified as non-performing.

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An analysis of the impaired financing receivables in millions of dollars follows:

 

*   Finance income recognized was not material.

**  Primarily retail notes.

***   Primarily retail notes and wholesale receivables.

**** Primarily wholesale receivables, retail notes and operating loans.

A troubled debt restructuring is generally the modification of debt in which a creditor grants a concession it would not otherwise consider to a debtor that is experiencing financial difficulties.  These modifications may include a reduction of the stated interest rate, an extension of the maturity dates, a reduction of the face amount or maturity amount of the debt, or a reduction of accrued interest.  During the first nine months of 2015, the Company identified 76 financing receivable contracts, primarily retail notes, as troubled debt restructurings with aggregate balances of $2.2 million pre-modification and $1.7 million post-modification.  During the first nine months of 2014, there were 51 financing receivable contracts, primarily retail notes, identified as troubled debt restructurings with aggregate balances of $1.4 million pre-modification and $1.2 million post-modification.  During these same periods, there were no significant troubled debt restructurings that subsequently defaulted and were written off.  At July 31, 2015, the Company had no commitments to lend additional funds to borrowers whose accounts were modified in troubled debt restructurings.

 

(11)  Securitization of financing receivables:

The Company, as a part of its overall funding strategy, periodically transfers certain financing receivables (retail notes) into variable interest entities (VIEs) that are special purpose entities (SPEs), or a non-VIE banking operation, as part of its asset-backed securities programs (securitizations).  The structure of these transactions is such that the transfer of the retail notes does not meet the criteria of sales of receivables, and is, therefore, accounted for as a secured borrowing.  SPEs utilized in securitizations of retail notes differ from other entities included in the Company’s consolidated statements because the assets they hold are legally isolated.  Use of the assets held by the SPEs or the non-VIE is restricted by terms of the documents governing the securitization transactions.

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In securitizations of retail notes related to secured borrowings, the retail notes are transferred to certain SPEs or to a non-VIE banking operation, which in turn issue debt to investors.  The resulting secured borrowings are recorded as “Short-term securitization borrowings” on the balance sheet.  The securitized retail notes are recorded as “Financing receivables securitized – net” on the balance sheet.  The total restricted assets on the balance sheet related to these securitizations include the financing receivables securitized less an allowance for credit losses, and other assets primarily representing restricted cash.  For those securitizations in which retail notes are transferred into SPEs, the SPEs supporting the secured borrowings are consolidated unless the Company does not have both the power to direct the activities that most significantly impact the SPEs’ economic performance and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the SPEs.  No additional support to these SPEs beyond what was previously contractually required has been provided during the reporting periods.

In certain securitizations, the Company consolidates the SPEs since it has both the power to direct the activities that most significantly impact the SPEs’ economic performance through its role as servicer of all the receivables held by the SPEs, and the obligation through variable interests in the SPEs to absorb losses or receive benefits that could potentially be significant to the SPEs.  The restricted assets (retail notes securitized, allowance for credit losses and other assets) of the consolidated SPEs totaled $2,639 million, $3,011 million and $2,402 million at July 31, 2015, October 31, 2014 and July 31, 2014, respectively.  The liabilities (short-term securitization borrowings and accrued interest) of these SPEs totaled $2,534 million, $2,942 million and $2,308 million at July 31, 2015, October 31, 2014 and July 31, 2014 respectively.  The credit holders of these SPEs do not have legal recourse to the Company’s general credit.

In certain securitizations, the Company transfers retail notes to a non-VIE banking operation, which is not consolidated since the Company does not have a controlling interest in the entity.  The Company’s carrying values and interests related to the securitizations with the unconsolidated non-VIE were restricted assets (retail notes securitized, allowance for credit losses and other assets) of $284 million, $368 million and $425 million at July 31, 2015, October 31, 2014 and July 31, 2014, respectively.  The liabilities (short-term securitization borrowings and accrued interest) were $265 million, $351 million and $398 million at July 31, 2015, October 31, 2014 and July 31, 2014, respectively.

In certain securitizations, the Company transfers retail notes into bank-sponsored, multi-seller, commercial paper conduits, which are SPEs that are not consolidated.  The Company does not service a significant portion of the conduits’ receivables, and, therefore, does not have the power to direct the activities that most significantly impact the conduits’ economic performance.  These conduits provide a funding source to the Company (as well as other transferors into the conduit) as they fund the retail notes through the issuance of commercial paper.  The Company’s carrying values and variable interests related to these conduits were restricted assets (retail notes securitized, allowance for credit losses and other assets) of $1,923 million, $1,331 million and $1,539 million at July 31, 2015, October 31, 2014 and July 31, 2014 respectively.  The liabilities (short-term securitization borrowings and accrued interest) related to these conduits were $1,798 million, $1,267 million and $1,438 million at July 31, 2015, October 31, 2014 and July 31, 2014, respectively.

The Company’s carrying amount of the liabilities to the unconsolidated conduits, compared to the maximum exposure to loss related to these conduits, which would only be incurred in the event of a complete loss on the restricted assets, was as follows in millions of dollars:

 

The total assets of unconsolidated VIEs related to securitizations were approximately $54 billion at July 31, 2015.

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The components of consolidated restricted assets related to secured borrowings in securitization transactions follow in millions of dollars:

 

The components of consolidated secured borrowings and other liabilities related to securitizations follow in millions of dollars:

 

The secured borrowings related to these restricted securitized retail notes are obligations that are payable as the retail notes are liquidated.  Repayment of the secured borrowings depends primarily on cash flows generated by the restricted assets.  Due to the Company’s short-term credit rating, cash collections from these restricted assets are not required to be placed into a restricted collection account until immediately prior to the time payment is required to the secured creditors.  At July 31, 2015, the maximum remaining term of all restricted securitized retail notes was approximately six years.

 

(12)  Most inventories owned by Deere & Company and its U.S. equipment subsidiaries and certain foreign equipment subsidiaries are valued at cost on the “last-in, first-out” (LIFO) method.  If all of the Company’s inventories had been valued on a “first-in, first-out” (FIFO) method, estimated inventories by major classification in millions of dollars would have been as follows:

 

 

 

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(13)  The changes in amounts of goodwill by operating segments were as follows in millions of dollars:

 

* Accumulated impairment losses were reduced by $60 million related to the divestiture of the Water operations, which occurred in May 2014 (see Note 18).

 

The components of other intangible assets were as follows in millions of dollars:

 

*  Weighted-averages

** Accumulated amortization at July 31, 2015, October 31, 2014 and July 31, 2014 for customer lists and relationships totaled $10 million, $9 million and $9 million, respectively, and technology, patents, trademarks and other totaled $42 million, $36 million and $34 million, respectively.

*** Licenses were reduced by $4 million related to the divestiture of the Crop Insurance operations, which occurred in March 2015 (see Note 19).

The amortization of other intangible assets in the third quarter and the first nine months of 2015 was $3 million and $8 million and for 2014 was $3 million and $8 million, respectively.  The estimated amortization expense for the next five years is as follows in millions of dollars:  remainder of 2015 - $2, 2016 - $10, 2017 - $9, 2018 - $5 and 2019 - $5.

 

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(14)  Commitments and contingencies:

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.

The premiums for extended warranties are primarily recognized in income in proportion to the costs expected to be incurred over the contract period.  These unamortized extended warranty premiums (deferred revenue) included in the following table totaled $439 million and $389 million at July 31, 2015 and 2014, respectively.

A reconciliation of the changes in the warranty liability and unearned premiums in millions of dollars follows:

 

At July 31, 2015, the Company had approximately $183 million of guarantees issued primarily to banks outside the U.S. and Canada 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 July 31, 2015, the Company had accrued losses of approximately $7 million under these agreements.  The maximum remaining term of the receivables guaranteed at July 31, 2015 was approximately five years.

At July 31, 2015, the Company had commitments of approximately $221 million for the construction and acquisition of property and equipment.  Also, at July 31, 2015, the Company had restricted assets of $82 million, primarily as collateral for borrowings and restricted other assets.  See Note 11 for additional restricted assets associated with borrowings related to securitizations.

The Company also had other miscellaneous contingent liabilities totaling approximately $37 million at July 31, 2015, for which it believes the probability for payment is substantially remote.  The accrued liability for these contingencies was not material at July 31, 2015.

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, trademark and environmental matters.  The Company believes the reasonably possible range of losses for these unresolved legal actions in addition to the amounts accrued would not have a material effect on its consolidated financial statements.

 

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(15)  The fair values of financial instruments that do not approximate the carrying values in millions of dollars follow:

 

* Fair value measurements above were Level 3 for all financing receivables and Level 2 for all borrowings.

Fair values of financing receivables that were issued long-term were based on the discounted values of their related cash flows at interest rates currently being offered by the Company for similar financing receivables.  The fair values of the remaining financing receivables approximated the carrying amounts.

Fair values of long-term borrowings and short-term securitization borrowings were based on current market quotes for identical or similar borrowings and credit risk, or on the discounted values of their related cash flows at current market interest rates.  Certain long-term borrowings have been swapped to current variable interest rates.  The carrying values of these long-term borrowings included adjustments related to fair value hedges.

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Assets and liabilities measured at fair value on a recurring basis in millions of dollars follow:

 

*  Measurements above were Level 2 measurements except for Level 1 measurements of the international equity securities of $8 million at July 31, 2015; the equity fund of $35 million, $45 million and $32 million at July 31, 2015, October 31, 2014 and July 31, 2014; the fixed income fund of $10 million at both October 31, 2014 and July 31, 2014; and the U.S. government debt securities of $37 million, $741 million and $1,041 million at July 31, 2015, October 31, 2014 and July 31, 2014, respectively.  In addition, $31 million of the international debt securities were Level 3 measurements at July 31, 2015.  There were no transfers between Level 1 and Level 2 during the first nine months of 2015 or 2014.

** Primarily issued by U.S. government sponsored enterprises.

***  Excluded from this table are the Company’s cash equivalents, which were carried at cost that approximates fair value.  The cash equivalents consist primarily of money market funds that were Level 1 measurements.

The contractual maturities of debt securities at July 31, 2015 in millions of dollars are shown below.  Actual maturities may differ from those scheduled as a result of prepayments by the issuers.  Because of the potential for prepayment on mortgage-backed securities, they are not categorized by contractual maturity.

 

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Fair value, recurring, Level 3 measurements from available for sale marketable securities in millions of dollars follow:

Fair value,  nonrecurring, Level 3 measurements from impairments in millions of dollars follow: 

 

* See financing receivables with specific allowances in Note 10.  Losses were not significant.

** Does not include costs to sell (see Note 18).

The fair value measurement and impairment losses shown above were the result of changes in circumstances that indicate it was probable the future cash flows would not cover the carrying amounts of certain long-lived assets.  The non-cash charge of $26 million pretax and after-tax was recognized in the first quarter of 2014 in cost of sales.  The impairment was associated with the Company’s John Deere Water operations, which were included in the agriculture and turf operating segment.  The impairment was due to a decline in forecasted financial performance and a review of strategic options for the business, which was sold in May 2014.

Level 1 measurements consist of quoted prices in active markets for identical assets or liabilities.  Level 2 measurements include significant other observable inputs such as quoted prices for similar assets or liabilities in active markets; identical assets or liabilities in inactive markets; observable inputs such as interest rates and yield curves; and other market-corroborated inputs.  Level 3 measurements include significant unobservable inputs.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  In determining fair value, the Company uses various methods including market and income approaches.  The Company utilizes valuation models and techniques that maximize the use of observable inputs.  The models are industry-standard models that consider various assumptions including time values and yield curves as well as other economic measures.  These valuation techniques are consistently applied.

The following is a description of the valuation methodologies the Company uses to measure certain financial instruments on the balance sheet at fair value:

Marketable Securities – The portfolio of investments, except for the Level 3 measurement international debt securities, is primarily valued on a market approach (matrix pricing model) in which all significant inputs are observable or can be derived from or corroborated by observable market data such as interest rates, yield curves, volatilities, credit risk and prepayment speeds.  Funds are primarily valued using the fund’s net asset value, based on the fair value of the underlying securities.  The Level 3 measurement international debt

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securities are primarily valued using an income approach based on discounted cash flows using yield curves derived from limited, observable market data.

Derivatives – The Company’s derivative financial instruments consist of interest rate swaps and caps, foreign currency futures, forwards and swaps, and cross-currency interest rate swaps.  The portfolio is valued based on an income approach (discounted cash flow) using market observable inputs, including swap curves and both forward and spot exchange rates for currencies.

Financing Receivables – Specific reserve impairments are based on the fair value of collateral, which is measured using a market approach (appraisal values or realizable values).  Inputs include a selection of realizable values.

Property and Equipment – Net – The impairments were measured at the lower of the carrying amount, or fair value.  The valuations were based on an income approach using probability weighted cash flows of potential outcomes of the ongoing strategic option review.  The inputs included estimates of the cash flow related to each of the alternatives being considered and management’s estimate of the likelihood of each alternative.

Assets Held for Sale – Water Operations – The impairment of the disposal group was measured at the lower of the carrying amount, or fair value less cost to sell.  Fair value was based on the probable sale price.  The inputs included estimates of the final sale price.

Other Assets – The impairments are measured at the lower of the carrying amount or fair value.  The valuations were based on a market approach.  The inputs include sales of comparable assets.

 

(16)  It is the Company’s policy that derivative transactions are executed only to manage exposures arising in the normal course of business and not for the purpose of creating speculative positions or trading.  The Company’s financial services 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.  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 functional currencies.

All derivatives are recorded at fair value on the balance sheet.  Cash collateral received or paid is not offset against the derivative fair values on the balance sheet.  Each derivative is designated as a cash flow hedge, a fair value hedge, or remains undesignated.  All designated hedges are formally documented as to the relationship with the hedged item as well as the risk-management strategy.  Both at inception and on an ongoing basis the hedging instrument is assessed as to its effectiveness.  If and when a derivative is determined not to be highly effective as a hedge, or the underlying hedged transaction is no longer likely to occur, or the hedge designation is removed, or the derivative is terminated, hedge accounting is discontinued.  Any past or future changes in the derivative’s fair value, which will not be effective as an offset to the income effects of the item being hedged, are recognized currently in the income statement.

Cash flow hedges

Certain interest rate and cross-currency interest rate contracts (swaps) were designated as hedges of future cash flows from borrowings.  The total notional amounts of the receive-variable/pay-fixed interest rate contracts at July 31, 2015,  October 31, 2014 and July 31, 2014 were $2,800 million, $3,050 million and $3,650 million, respectively.  The notional amounts of cross-currency interest rate contracts at July 31, 2015, October 31, 2014 and July 31, 2014 were $65 million, $70 million, and $70 million, respectively.  The effective portions of the fair value gains or losses on these cash flow hedges were recorded in other comprehensive income (OCI) and subsequently reclassified into interest expense or other operating expenses (foreign exchange) in the same periods during which the hedged transactions affected earnings.  These amounts offset the effects of interest rate or foreign currency changes on the related borrowings.  Any ineffective portions of the gains or losses on all cash flow interest rate contracts designated as hedges were recognized currently in interest expense or other operating expenses (foreign exchange) and were not material during any periods presented.  The cash flows from these contracts were recorded in operating activities in the statement of consolidated cash flows.

The amount of loss recorded in OCI at July 31, 2015 that is expected to be reclassified to interest expense or other operating expenses in the next twelve months if interest rates or exchange rates remain unchanged is

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approximately $5 million after-tax.  These contracts mature in up to 38 months.  There were no gains or losses reclassified from OCI to earnings based on the probability that the original forecasted transaction would not occur.

Fair value hedges

Certain interest rate contracts (swaps) were designated as fair value hedges of borrowings.  The total notional amounts of these receive-fixed/pay-variable interest rate contracts at July 31, 2015, October 31, 2014 and July 31, 2014 were $8,694 million, $8,798 million and $8,847 million, respectively.  The effective portions of the fair value gains or losses on these contracts were offset by fair value gains or losses on the hedged items (fixed-rate borrowings).  Any ineffective portions of the gains or losses were recognized currently in interest expense.  The ineffective portions were none and a loss of $1 million during the third quarter of 2015 and 2014, respectively, and were a gain of $1 million and a loss of $2 million during the first nine months of 2015 and 2014, respectively.  The cash flows from these contracts were recorded in operating activities in the statement of consolidated cash flows.

The gains (losses) on these contracts and the underlying borrowings recorded in interest expense follow in millions of dollars:

 

* Includes changes in fair values of interest rate contracts excluding net accrued interest income of $42 million and $44 million during the third quarter of 2015 and 2014, respectively, and $131 million and $121 million during the first nine months of 2015 and 2014, respectively.

** Includes adjustments for fair values of hedged borrowings excluding accrued interest expense of $68 million and $69 million during the third quarter of 2015 and 2014, respectively, and $207 million and $194 million during the first nine months of 2015 and 2014, respectively.

Derivatives not designated as hedging instruments

The Company has certain interest rate contracts (swaps and caps), foreign exchange contracts (futures, forwards and swaps) and cross-currency interest rate contracts (swaps), which were not formally designated as hedges.  These derivatives were held as economic hedges for underlying interest rate or foreign currency exposures primarily for certain borrowings and purchases or sales of inventory.  The total notional amounts of these interest rate swaps at July 31, 2015, October 31, 2014 and July 31, 2014 were $5,912 million, $6,317 million and $6,303 million, the foreign exchange contracts were $3,040 million, $3,524 million and $3,578 million and the cross-currency interest rate contracts were $80 million, $98 million and $78 million, respectively.  At July 31, 2015, October 31, 2014 and July 31, 2014, there were also $1,190 million, $1,703 million and $1,858 million, respectively, of interest rate caps purchased and the same amounts sold at the same capped interest rate to facilitate borrowings through securitization of retail notes.  The fair value gains or losses from the interest rate contracts were recognized currently in interest expense and the gains or losses from foreign exchange contracts in cost of sales or other operating expenses, generally offsetting over time the expenses on the exposures being hedged.  The cash flows from these non-designated contracts were recorded in operating activities in the statement of consolidated cash flows.

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Fair values of derivative instruments in the condensed consolidated balance sheet in millions of dollars follow:

 

 

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The classification and gains (losses) including accrued interest expense related to derivative instruments on the statement of consolidated income consisted of the following in millions of dollars:

 

* Includes interest and foreign exchange gains (losses) from cross-currency interest rate contracts.

** The amount is not significant.

Counterparty Risk and Collateral

Certain of the Company’s derivative agreements contain credit support provisions that may require the Company to post collateral based on the size of the net liability positions and credit ratings.  The aggregate fair value of all derivatives with credit-risk-related contingent features that were in a net liability position at July 31, 2015, October 31, 2014 and July 31, 2014, was $60 million, $57 million and $76 million, respectively.  The Company, due to its credit rating and amounts of net liability position, has not posted any collateral.  If the credit-risk-related contingent features were triggered, the Company would be required to post collateral up to an amount equal to this liability position, prior to considering applicable netting provisions.

Derivative instruments are subject to significant concentrations of credit risk to the banking sector.  The Company manages individual counterparty exposure by setting limits that consider the credit rating of the counterparty, the credit default swap spread of the counterparty and other financial commitments and exposures between the Company and the counterparty banks.  All interest rate derivatives are transacted under International Swaps and Derivatives Association (ISDA) documentation.  Some of these agreements include credit support provisions.  Each master agreement permits the net settlement of amounts owed in the event of default or termination.

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Derivatives are recorded without offsetting for netting arrangements or collateral.  The impact on the derivative assets and liabilities related to netting arrangements and any collateral received or paid follows:

 

 

 

 

 

 

 

(17)  In December 2014, the Company granted stock options to employees for the purchase of 3.0 million shares of common stock at an exercise price of $88.19 per share and a binomial lattice model fair value of $19.67 per share at the grant date.  At July 31, 2015, options for 14.9 million shares were outstanding with a weighted-average exercise price of $77.38 per share.  The Company also granted 237 thousand restricted stock units to employees and non-employee directors in the first nine months of 2015, of which 111 thousand are subject to service based only conditions, 63 thousand are subject to performance/service based conditions and 63 thousand are subject to market/service based conditions.  The fair value of the service based only units at the grant date was $88.69 per unit based on the market price of a share of underlying common stock.  The fair value of the performance/service based units at the grant date was $81.78 per unit based on the market price of a share of underlying common stock excluding dividends.  The fair value of the market/service based units at the grant date was $113.97 per unit based on a lattice valuation model excluding dividends.  At July 31, 2015, the Company was authorized to grant an additional 16.9 million shares related to stock option and restricted stock awards.

 

(18)  In May 2014, the Company closed the sale of the stock and certain assets of the entities that compose the Company’s Water operations to FIMI Opportunity Funds.  At April 30, 2014, the total assets of $85 million and liabilities of $50 million were classified as held for sale in the consolidated financial statements, which consisted of $57 million of trade receivables, $10 million of other receivables, $49 million of inventories, $5 million of other assets less a $36 million asset impairment.  The related liabilities held for sale consisted of accounts payable and accrued expenses of $47 million and retirement benefits and other liabilities of $3 million.

The total amount of proceeds from the sale was approximately $35 million with a loss of $10 million, pretax and after-tax, in addition to the impairment discussed below.  The Company provided certain business services for a fee during a transition period.

In the second quarter of 2014, the Company recorded a non-cash charge in other operating expenses of $36 million pretax or $4 million after-tax for an impairment to write the Water operations down to fair value less costs to sell.  The tax benefits recognized from the sale resulted primarily from a change in valuation allowances of the Water operations.  These operations were included in the Company’s agriculture and turf segment.

 

 

 

 

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(19)  In March 2015, the Company closed the sale of all of the stock of its wholly-owned subsidiaries, John Deere Insurance Company and John Deere Risk Protection, Inc. (collectively the Crop Insurance operations) to Farmers Mutual Hail Insurance Company of Iowa.  These operations were included in the Company’s financial services operating segment.  At January 31, 2015, the total assets of $381 million and liabilities of $267 million were classified as held for sale in the consolidated financial statements, which consisted of the following:

 

 

The total amount of proceeds from the sale was approximately $154 million, including $5 million of cash and cash equivalents sold, with a gain recorded in other income of $42 million pretax and $40 million after-tax. The tax expense was partially offset by a change in a valuation allowance on a capital loss carryforward. The Company will provide certain business services for a fee during a transition period.