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Operator
Good morning, and welcome to the Deere & Company first quarter fiscal year earnings conference.
At this time your lines have been placed in a listen-only mode until the question and answer session.
This call is being recorded on behalf of Deere & Company.
If you have objections, please disconnect at this time.
I will turn the call over to Ms. Marie Ziegler, vice president of investor relations.
Thank you, you may begin.
Marie Ziegler - Vice President of Investor Relations
Good morning.
Susan Carlick (ph) and Greg Derreck (ph) join me on today's call.
This call is being broadcast live on the Internet and recorded for future transmission and use by Deere, CCBN and third parties.
Participants in the call including the q &a session agree that their likeness and remarks in all mediums may be stored and used as parts of the earnings call.
Comments made during this conference call that state management expects, our outlook, we project, or otherwise state the company's predictions for the future are forward-looking statements subject to important risk and uncertainties.
Actual results might differ materially from those projected in the forward looking statements.
Additional information concerning factors that could cause actual results to differ materially is contained in the company's SEC filings, including the most recent form 10-K and in the press release being filed today on form 8K.
I will start with five key observations about this quarter.
First, clearly, we benefited from higher production levels.
Second, we achieved a turnaround in profitability despite a 75 million dollar pre-tax increase in post retirement benefit costs.
Third, we had significantly better operating results in the commercial and consumer equipment division and in the construction and forestry division.
Four, the U.S. and Canadian AG retail markets were somewhat softer than we had expected.
And five, we saw continued strength in our own European AG retail activity.
Now, let's look at the results by individual division and we will start as usual with worldwide AG.
Sales in this division were up 8% in the quarter.
Price realization accounts for about half of the 8% gain.
The stronger Euro compared to the U.S. dollar also increases reported sales in Europe.
Currency changes account for about another 3 points of the 8-point gain.
So volume is up, but virtually all of the gain comes from Europe.
In fact, the United States and Canadian sales to dealers were down and our factories were shut down 17% of available days, this is as planned, compared to 11% of shutdowns of available days last year.
When you look at operating profits, the division did have its share of increase in post-employment benefits expense.
Operating profit for the AG division now includes $49 million of incremental expense, but still, the division improved its operating results to a $6 million operating profit from an operating loss of $15 million a year ago.
Looking now at retail activity in the month of January, the association of equipment manufacturers industry numbers are not available yet for the month of January, so I can comment only on Deere.
In the United States and Canada, in units we saw sales of utility tractors and row crop tractors down a single digit.
Four wheel drive tractors and sales of combines were down double-digits in the month of January.
On inventories we ended the month with combine inventories at 6% of trailing 12-month sales compared to 9% a year ago.
Row crop tractor inventories ended at 39%.
Now, a year ago recall that we were transitioning to new row crop tractor models so we had very low field inventories on row crops at about 27% of trailing 12-month sales.
This year inventories at -- are at a more normal level.
In Western Europe, our retail activity in the month of January on tractors was up double-digits, and combines down double-digits, but this is off a very low base since it is now off season for combines and actually we had very good levels of activity in November and December.
Let's move on now to the outlook.
We will start with the United States and Canada.
Our previous forecast of industry activity contemplated a slow start to retail sales during the winter months, with sales picking up during the spring planting season.
And our forecast also contemplated the tough comparisons we had in November and December because of the 2001 closeout on the 8010 and 9010 series tractors.
However, the first quarter retail activity was quieter than we expected.
And as a result we are revising our industry projections from up 5% to now flat in 2003.
Some of the factors that we're looking at -- clearly we had anticipated some calendar year end tax-driven buying that did not materialize.
Second factor, it's dry.
There is severe dryness continuing in much of the Wheat Belt and as we are moving closer to the time when the crop resumes growing, concerns are building that winter wheat crop will not reach its potential.
Also, a large part of the Corn Belt is dry.
Now, it's early, but these concerns are weighing on the market.
A third factor has been the farm bill.
I think most of you would be aware of the fact that signups have been slower than expected and as of the end of January, only 1/3 of eligible farmers have signed up and this also appears to be weighing on farmers' minds.
As we look ahead, though, throughout the balance of 2003, farm bill signings will get caught up and cash payments made to farmers as we move through the year.
Second factor are commodity prices.
They have come off their highs of last fall, but we still expect prices for corn, beans and wheat to range from 20 to 30% higher than a year ago.
So when we put it all together, retail activity got off to a slower start than we expected in the first quarter, and we have revised our industry retail outlook to flat, and we do still expect retail activity to pick up as we move through the year.
Moving now to Europe, for Deere, we expect to continue benefiting from the significant new product introductions for the 2002 model year and from our dealers' increased capacity.
However, the industry outlook has softened slightly as we have seen dryness in Germany from last fall and the completion of the hoof and mouth disaster payments in the U.K.
Both of these appear to have affected the market a bit more than expected.
So we're going to soften our industry outlook a bit.
Our previous outlook had been down 3% for sales of tractors in Western Europe.
We're now saying down 3 to 5%.
What does this mean now for Deere's worldwide AG division?
We now project net sales to increase 7 to 9% in 2003.
But as you consider this estimate, recall that at first in 2002 we underproduced retail demand.
We have some upside just from producing to retail.
Second, our estimate does include some improved pricing.
And third, currency.
Our previous estimate called for about an 8% sales increase in worldwide AG.
But since we made that estimate, several currencies have further strengthened relative to the dollar.
And so our new estimate includes an estimated 2 points of gain, that wasn't in our previous estimate.
So in other words, had currency relationships not changed, you would see worldwide AG division sales projections going to an increase of 5 to 7% instead of the 7 to 9.
Again this is an estimated impact of currency, but gives you a feel for what's happened in the numbers.
Let's move on now to the commercial and consumer equipment division.
Here, production tonnage in the quarter rose 109%.
But there are two main factors accounting for this.
First, of course were the major production cuts last year as the division lowered field and company owned inventory.
Last year in the first quarter, production tonnage was down 39%.
This year we are producing more in line with projected retail.
A second factor would be the new 100 series riding lawn tractors that we are now producing for John Deere dealers and the Home Depot -- we have been in heavy production throughout the first quarter to be ready to ship during the second quarter for the start of the spring selling season.
I just would add there was very little shipping on these new models during the first quarter.
So the higher sales and production volumes are the primary factors that turned last year's operating loss of 43 million into an operating income this year of 23 million for the first quarter.
Division also continues to benefit from the major restructuring activity it's under taken in the last year and a half, this would include exiting lines of business, selling off Homelite (ph) division, et cetera.
I would point out too that the division achieved this turnaround despite absorbing $10 million of incremental pre tax hire, post employment benefits expense and last year in the first quarter, they benefited from an insurance settlement from a warehouse fire and that was a $11 million pre-tax benefit that they had last year that they do not have this year.
Dealer retail activity for the division in the month of January was at the same level as a year ago.
And the division continues to expect that its sales to dealers for 2003 will rise 13 to 15%, this is unchanged from the previous estimate.
And this increase is based on the new relationship with the Home Depot and the 100 series, it's based on full availability of new products introduced for model year 2002, recall last year we were in start-up.
And three, again, being able to produce to retail for the first time since 2000.
In construction and forestry, retail activity in the month of January on a first in the dirt and settlements basis was down double-digits.
But interestingly the first in the dirt activity, which can be a leading indicator during the month of November and December was higher than a year ago.
Last year our dealers were aggressively reducing their own inventory and this situation now appears to have stabilized.
As a result of this activity, we actually had sales that were a bit stronger in the first quarter than we had anticipated.
We have a 32% increase for total sales of 512 million dollars, this does include $37 million of incremental sales from the consolidation of the Deere and Hitachi marketing operations, and as you recall, that consolidation began in the third quarter of last year.
Volume accounts for the biggest piece of the $82 million improvement in operating profit from a loss last year of $66 million to profit of $16 million.
Also supporting the higher operating profit is price realization and it accounts for about 3 points of the 32-point net sales gain.
There are two other factors that benefited the quarter.
Last year we had a 16 million dollar pre-tax charge for closing the Skidsteer (ph) factory in Tennessee and secondly, in these results you can see the ongoing aggressive cost control active in this division.
As in the commercial and consumer equipment division and the AG division, construction and forestry achieved the turnaround despite higher post retirement benefits expense, which was $16 million incrementally pre-tax in the quarter.
Secondly, the Nortrack (ph) accrual expected profit of about 10 million pre-tax in the quarter, and this was in line with our estimate.
Moving on to construction outlook, at the margin, the best news I think is the pricing conditions may be improving slightly.
As you know, this industry has been very price competitive for about four years.
We had an opportunity on the first of January to take a modest price increase and last week we announced that we would be taking a second price increase effective the fourth of March.
Between the two announced price increases this division is taking an average list price increase of just over 2%.
Although pricing seems to be improving a bit, and our first quarter dealer purchases were stronger than expected, we still have January retail activity down double-digits and the economic factors have not improved from what we were seeing at the end of the fourth quarter.
So our outlook remains cautious for this division.
Industry outlook is unchanged at flat to down 5% and management's estimates of its own sales are also unchanged, up slightly, which includes an incremental 110 million dollar benefit from the consolidation of Deere and Hitachi marketing operations -- without this, sales would be down slightly.
Turning now to credit, net income here was 69 million dollars compared to 76 million a year ago.
As expected, we sold significantly fewer receivables in the first quarter this year than we did last year.
To compare, last year we sold -- excuse me, we sold 1.75 billion dollars of receivables in the quarter, this year we sold $288 million.
So you can see a very significant difference.
This of course led to a lower gain on receivables, the aftertax impact of that would be 14 million.
We were able to partially offset this loss of income, if you will, on the receivables sales with lower credit write-offs that generated an aftertax benefit of about $7 million.
I would point out that past dues in the portfolio continue to be low.
Projected net income for credit operations is unchanged at about $300 million for 2003, this compares to a year ago's $243 million net income.
Let's look for a moment now at the equipment operations balance sheet.
Asset management is a key focus of our company and frankly it's critical if we are to succeed in our drive to create improved shareholder value.
But ending assets are affected by changes in currency relationships.
At the end of January, the Euro was 23% higher than the dollar compared to January of 2002.
So we see higher currency affecting our reported ending balances.
For example, on consolidated trade receivables, that would be the total of dealer receivables held by the equipment operations and by the credit company, consolidated trade receivables increased 233 million dollars over a year ago, but currency accounts for $100 million of that increase.
Company inventories also increased for the same reason, about 100 million versus last year, but currency explains about 5 million of this increase.
That leaves about a $200 billion real increase, about half of this is CNCE, and the remainder is worldwide AG.
For both divisions, the increase reflects lower production and sales levels of last year, verse sauce a more typical production pattern this year.
Additionally in commercial and consumer equipment, the increase also reflects the high first quarter production required to support the new 100 series riding lawn tractors in both the Mack and the dealer channels.
For the year, we still expect that our consolidated trade receivables and inventories will end in October at approximately the same level they were in October of 2002.
Let's look now at forecasted income.
There probably hasn't been a quarter that's gone by that we don't cite economic uncertainty or talk about facts that could cause things to change.
But the ramifications of military action in Iraq are adding to the uncertainty in our outlook this year and are very difficult to quantify.
Projected equipment sales for the total company as you see in the press release are up 7 to 9%, our previous guidance was up 8 to 10%.
Here again, currency changes since last November do add a couple of points to the sales increase.
One final thought on sales, as you think about how sales split between the quarters, with sales up 17% in the first quarter and up 10 to 15% in the second quarter, but projected sales for the year up 7 to 9%, this certainly implies that the rate of gain will slow considerably in the second half of the year.
The reason again is the easy comparison we have in the early part of 2002 when we had low production to accomplish our targeted inventory and dealer receivable reductions.
And we had relatively stronger production than in the second half of 2002.
The forecast also impacted by higher incremental OPEC and tension expenses -- we're expecting about an incremental 300 million dollars pre-tax cost this year and it's roughly evenly distributed between all four quarters.
We also have made a modest change in the tax rate -- you'll notice in the first quarter the applied rate is about 35% for the full-year, we're using 35 to 36% and our previous guidance had been 33 to 34%.
So putting this all together, then, you have AG retail sales beginning the year a bit slower than we expected.
We have lowered our projection of Deere's net sales for the year, but we are still holding our forecast net income in a range of 500 and $600 million.
This represents a significantly improved profitability in 2003.
And we will generate this improvement despite a $300 million pre-tax increase in post employment benefits expense.
Clearly our business improvement initiatives are powerful and they are working.
One final comment before we open for q &a -- we have talked a lot about shareholder value added, SVA, and operating return on assets, OROA, in the last few years.
In the 2002 annual report on pages 6 and 7 and in note 27 of the 10-K, we describe these metrics.
We use them to evaluate the performance of our operating divisions, and we use them to help drive significantly improved value creation for our shareholders.
With today's earnings report, we begin quarterly updates of these key operating metrics.
The details are attached to the press release sent today in a table entitled additional financial information.
You can also find this table on our website at www.deere.com/oroa.
We are now ready for q &a.
The operator will give us instruction on the polling procedure and to give everyone an equal opportunity to participate, we ask that you limit yourself to one question with the related follow up if needed, and you are certainly welcome to get back into the queue to ask questions as time permits.
Operator
Thank you.
At this time we are ready to begin the question and answer session.
If you would like to ask a question, please press star followed by 1 on your touch tone phone, you will be announced prior to asking your question.
To withdraw your question, you may press star followed by 2.
Once again, to ask a question, please press star followed by 1.
Your first question comes from John McGinty (ph), and please state your company name.
+++ q-and-a.
John McGinty
Credit Suisse First Boston.
Good morning, Marie.
A question of trying to understand exactly the change and the guidance versus the previous.
I'm looking at last quarter's guidance and we're now saying 300 million for post-retirement and previously saying 250 to 300 million.
Marie Ziegler - Vice President of Investor Relations
Yes, it's a round number, but yes.
John McGinty
So in essence, that is a change or is that like a fine tuning?
It's basically -- at the midpoint. it's a 25 million dollar bigger hit that you're overcoming, or was it just all pluses and minuses?
Marie Ziegler - Vice President of Investor Relations
I would say it's just, it's a refinement of the range.
And that range has the potential to be refined as we move further, move along further through the year.
John McGinty
Further refined up?
Marie Ziegler - Vice President of Investor Relations
Or down.
John McGinty
Okay.
And then one other kind of follow up, on the adjustment and everything, you're saying that the sales are essentially the same, 7 to 9 versus 8 to 10 but currency adds 2 points to the sales which it didn't before.
So in essence you're forecasting somewhat lower sales.
What isn't clear to me is was there a positive or negative currency impact to earnings in the quarter?
And will they be for the year?
And does that change from where the guidance was before?
Marie Ziegler - Vice President of Investor Relations
That's a very fair question.
Our -- the principle strengthening has been in the Euro and the relationship between the trade flows into the United States from Europe and vice versa is fairly well balanced.
So we tend, although the Euro will influence the reported sales numbers, by the time you watch all the way through the income statement, it tends to wash itself out.
So it has very little impact in the bottom line operating profit reported.
John McGinty
Thanks very much.
I'll get back in queue.
Operator
Thank you.
Your next question comes from (inaudible).
Please state your company name.
Unidentified
From Lehman Brothers.
How you doing?
Marie Ziegler - Vice President of Investor Relations
Hi, Joel.
Unidentified
I wonder if you could give us more detail on why the construction business seems so strong in the quarter?
Marie Ziegler - Vice President of Investor Relations
We believe that it really has to do with the fact that last year, not only were we working to lower assets overall as a company, but our dealers in construction were also lowering theirs that they carry onsite.
We think based on our conversations with our dealers, what has happened is there seems to have stabilized, here not cutting things anymore and this was something we had not expected would happen in the first quarter.
We want to be very careful, though, to say that we think this may be an action limited to the first quarter.
You'll notice we did not change our sales estimates for the full-year because we still look at the economic factors and remain very cautious.
But we think that's the main reason for the change.
Unidentified
Okay.
Then just a follow-up, if, can you give us any help on understanding if you're very strong in commercial consumer in 2003, how can you keep that momentum going in to '04?
How do we not have a hiccup because you are filling out a lot of different product lines and product channels?
Marie Ziegler - Vice President of Investor Relations
Well, we always have a few new production that will be coming out and I don't think that in a single year we'll get the full benefit of the 100 series tractors, I think we'll benefit from some exposure that we will have in 2003.
But we think that we still have plenty of upside and we have announced new relations with Bombardier (ph), for example, on some new utility vehicle that will be available in the line in 2004.
So again, there are new products coming.
Unidentified
Thank you very much.
Operator
Thank you.
Your next question comes from Joanna Shatney (ph), please state your company name.
Joanna Shatney
Goldman Sachs, good morning.
Marie Ziegler - Vice President of Investor Relations
Good morning.
Joanna Shatney
Can you just go through each of the businesses and where production was versus retail in the current quarter?
And then do it for the expectation for the full year?
Marie Ziegler - Vice President of Investor Relations
Where production is versus retail?
Well, in the first quarter, relative to last year?
Joanna Shatney
Just trying to get a feel, you said in AG you have some help from producing more in line with retail than you did a year ago.
Marie Ziegler - Vice President of Investor Relations
That's true.
Joanna Shatney
And then you said the same thing was true in consumer commercial -- I know we expect that for the full-year but it sounds like it was true in construction equipment as well.
So I'm just trying to see how much came in the first quarter versus the rest of the year.
Marie Ziegler - Vice President of Investor Relations
Maybe the issue is that last year we took huge cuts, basically we accomplished most of our inventory in receivable reduction, which our target was 400 million and you'll recall we had some currency issues - and if you strip out currency, we basically got 375 million of it.
Most of that was done by very low levels of production in the first quarter.
Joanna Shatney
So the issue this year is that you're producing to more normal levels?
So you may have produced above retail, but that's more normal for your first quarter than say a year ago when you were trying to right-size all the inventories.
Marie Ziegler - Vice President of Investor Relations
That's correct, there would be a little of seasonal build and the example would be, for example, the 100 series that we have to produce ahead of the season.
Joanna Shatney
Okay.
Can you just go through some of the detail that your economist provides in terms of the expectation for farm income -- what is his row crop forecast for '03 in and whatever data you have available on the corn price, wheat price and soybean price?
Marie Ziegler - Vice President of Investor Relations
On the -- let's start with that.
On the wheat prices, which I just need to pull out.
Let's see.
Okay.
In our own forecasts we are saying that -- let me pull the other sheet.
I'm sorry, I don't have them here.
Okay.
For soybeans, we'll start there.
Farm price for soybeans for 2002-2003, current crop year, is $5.42 compared to $4.56.
For corn, $2.37 compared to $1.94. $1.94.
And wheat, $3.70 compared to $2.82.
Joanna Shatney
You don't have the next year out yet, right?
Marie Ziegler - Vice President of Investor Relations
We have an estimate and I would be happy to provide it.
For the next crop year, it would be 3.27 for wheat, price settling back a bit.
For corn, it would be 2.20, which is down slightly from this weir's 2.37.
And soybeans at 5.24 again down slightly from 5.42 this year.
Joanna Shatney
Does that translate to higher income?
Marie Ziegler - Vice President of Investor Relations
Then, Joanna, we need to move along to provide someone else with an opportunity to talk.
And the cash receipts, and there is an interesting story here.
Cash receipts in 2001 were 223.5 billion dollars.
In 2002, our best estimate says that they were $207.5 billion.
We have them recovering in 2003 to $222.3 billion.
And I will go ahead and give you the details because I think many folks are interested in that.
If you go back to 2001 for crops, that would have been a 96.4 billion dollar cash receipt. 2002 it's 98.1.
In 2003, 103.4. (inaudible) stock in 2001 is 100.4, 96.0 for 2002 and in 2003, 100.5.
Government payment, 20.7 in 2001, 13.4 in 2002, and then recovering to 18.4 in 2003.
Joanna Shatney
Thanks, Marie.
Marie Ziegler - Vice President of Investor Relations
Thank you.
Operator
Your next question comes from David Rossow (ph), and please state your company name.
David Rossow
Salomon Smith Barney.
Hi.
The question on the outlook for AG, where the change took place, if you strip out the fx, the slightly slower sales outlook...
Marie Ziegler - Vice President of Investor Relations
I'm sorry.
If you strip out -- I couldn't hear that word.
David Rossow
If you strip out the fx...
Marie Ziegler - Vice President of Investor Relations
Currency, okay.
David Rossow
Currency, if you look at where the sales outlook is diminished, where is it taking place given the industry outlook for Europe and North America were both lowered, but where is it taking place geographically and in which product categories?
Marie Ziegler - Vice President of Investor Relations
The outlook has been lowered more in North America, consistent with the bigger change in the outlook there, and a little bit in Europe.
In terms of the markets in Europe, I can only cite Germany and the U.K. as being a little weaker than expected, and Germany again, it has to do with dryness last year, U.K., the ending of the hoof and mouth disaster payments.
In terms of payments we have seen, you can see it in the numbers that tractor sales will be a little weaker than expected.
One very interesting observation is that our combine sales, early order program just ended at the end of January and traditionally we target a 80% orders to our forecasted sales ratio and we actually came very close to that number.
So that again gives us a little bit of comfort that activity is going to pick up as we move through the year.
David Rossow
And lastly, in the commercial and consumer, the series 100 comment you made about large production, but not much in the way of shipments.
Marie Ziegler - Vice President of Investor Relations
Correct.
David Rossow
What should we be thinking for the second quarter on the sales year over year given book to sales shipped and how should we expect that to fall to the bottom line?
I'm having a tough time figuring out manufacturing efficiencies you got in the first quarter by the heavy production, but you didn't get the shipment.
What should we be thinking on CNCE second quarter sales increase and thinking through the margin year over year?
Marie Ziegler - Vice President of Investor Relations
Last year in the second quarter they had already, they were catching up on the production of the new models so the bigger impact in the second quarter really comes from shipping the new products.
And they should have a pretty reasonable percentage gain in the second quarter.
And in terms of profitability, they should see some improvements in terms of the operating margins, as well.
David Rossow
And sales gain, just quantify it a little more.
Marie Ziegler - Vice President of Investor Relations
No, I really can't go beyond what we have done in the press release.
David Rossow
Okay, appreciate it.
Thank you.
Marie Ziegler - Vice President of Investor Relations
Thank you.
Operator
Thank you.
Your next question comes from Alex Blanton (ph), and please state your company name.
Alex Blanton
It's Ingalls and Snyder.
Hi, Marie.
Marie Ziegler - Vice President of Investor Relations
Hi, Alex.
Alex Blanton
You mentioned the inventory change year over year was -- 25% of that was currency, is that correct?
Marie Ziegler - Vice President of Investor Relations
Yes.
Alex Blanton
And how much was it quarter over quarter?
It was an increase of about 558 million in dollars quarter over quarter.
And...
Marie Ziegler - Vice President of Investor Relations
I could tell you that the spot rate increased about 10% between the U.S. and the Euro, but Alex, I'm sorry, I do not have that detail.
Alex Blanton
Okay.
I wonder if you could get back to me on that.
The quarter over quarter.
Marie Ziegler - Vice President of Investor Relations
That would not be in the analysis that we would normally do.
I'll see what I can find and I would be happy to get back to you if I have it.
Alex Blanton
Okay.
And at year end you expect inventory to be about flat with last year?
Marie Ziegler - Vice President of Investor Relations
The combination of inventory and receivables would be about flat.
Alex Blanton
What about the inventory separately?
Marie Ziegler - Vice President of Investor Relations
Don't have a separate comment on them.
We have chosen to look at them together.
Alex Blanton
And those two then would incorporate some currency portion, right, for the year?
Marie Ziegler - Vice President of Investor Relations
That is correct, although it's very hard to know exactly what will happen.
Alex Blanton
Right.
Marie Ziegler - Vice President of Investor Relations
In terms of the currency and we'll have a better understanding of this as we move through the year.
Alex Blanton
But if it were positive, if it added to the totals, then in actual fact without the currency, you would be forecasting, they would be lower.
Marie Ziegler - Vice President of Investor Relations
Correct.
Alex Blanton
Adjusted for currency.
Marie Ziegler - Vice President of Investor Relations
That's correct.
Alex Blanton
Okay.
And then one more thing.
Did you mention how much the Hitachi consolidation added to the construction sales in the first quarter?
If you did, I missed that.
Marie Ziegler - Vice President of Investor Relations
That's okay, it's 37 million.
Alex Blanton
37 million.
Okay.
Marie Ziegler - Vice President of Investor Relations
Okay, Alex, I will see if I can get an answer for you.
Alex Blanton
On the currency quarter over quarter.
Great, thanks.
Operator
Thank you.
Your next question comes from Ann Dugman (ph) and please state your company name.
Ann Dugman
Hi, Marie.
Sanford Bernstein.
My question is around your net income guidance of 500 to 600 million for the year, if you back out financial services guidance of 300 million, then your guidance for equipment income is about 200 million to 300 million.
Can you just give us guidance on what market conditions would drive you to the lower end of that forecast?
And under what market conditions would you expect to achieve the higher guidance?
Marie Ziegler - Vice President of Investor Relations
Well, I guess it really depends in some part on what we see happening with sales, because sales, as you know, are in a range, although a fairly narrow range of 7 to 9%.
Clearly, if we're able to achieve the higher end of the range, that should imply perhaps some improved price realizations in that estimate and it would certainly suggest that we see the markets in -- especially in the AG moving up as we move through the year.
Is that specific enough?
Ann Dugman
Well, at what point in the year might you be comfortable that the 9% or the 300 million might be more achievable than the 7% or the 200 million?
Marie Ziegler - Vice President of Investor Relations
Well, we have, you know, the businesses are somewhat seasonal, you have two main selling seasons in AG.
You have a spring selling season and clearly what happens in the spring selling season will be very important, but you do have a subsequent fall season.
In commercial and consumer, we will know based on what happens in April, May, June and July, those are the four key selling months in the account for the whole of the retail activity.
In construction equipment, that's also somewhat seasonal, they start picking up in about March and they stay pretty active in through August and then things start to slow down ahead of their fall and winter.
So it will be awhile, but we should have a pretty good idea based on what we see happening in the spring selling season for AG, that will certainly have a major impact.
Ann Dugman
Okay.
And just one follow-up question our buildup of inventory this past quarter, is this contrary to your build to order policy where you stated that when you received a order you will build, therefore inventory levels would not accumulate?
Marie Ziegler - Vice President of Investor Relations
Well, in the commercial and consumer equipment division, that business is very seasonal and it's a product to homeowner side that you must have in the channel when the customer goes to see it.
So that product, the build to order definition there is not going to be the traditional one you will have seen.
That one is going to be doing more with logistics on the homeowner side to make sure we can distribute inventory better, and that's something that we have, we actually started working on in, I think it was 1997, 1998 in materials of the distribution logistics.
In terms of AG, recall that last year we were -- this is unusual -- but we were transitioning production last year on the 8th and on the 9000 series tractors so we actually had taken very significant schedule cuts and this also helped us achieve our inventory goals, but we were transitioning and so you didn't have very high levels of production.
Today we are doing a more normalized level of production.
Also, the AG division is still in the process of implementing build to order -- they are not -- it's not the same theme, if you will, as it would be in the construction equipment division where they are able to implement more of a actual build to order.
Many of the AG division products are seasonal.
Maybe an example of what they're doing in the AG division will help.
We talked about the shutdown levels that we had in the first quarter, they were about 17% compared to 11% a year ago.
The reason for that, the primary driver was the fact that we had taken additional shutdown days at the combine factory in East Moline (ph), the reason is that these, nobody really needs a combine to work in the field at this time of the year.
So we're shifting what would be normal scheduled shutdown days into a seasonally slow time and then putting more production closer to the main selling season.
You'll see more activity like that that.
This is a long-winded answer to your question but I hope it gives you some background.
Ann Dugman
Thanks, Marie.
Operator
Thank you.
Your next question comes from Robert McCarthy (ph), please state your company name.
Robert McCarthy
It's Robert W. Baird.
Good morning, Marie.
Your forecast for North American industry has been reduced and obviously influenced by what you saw in the first quarter, would the first quarter results retail wise relative to expectations explain the majority of your reduction in the industry outlook?
Marie Ziegler - Vice President of Investor Relations
Yes.
Robert McCarthy
Good.
And is there any implicit change in your market share assumptions in either your forecast for North American AG or western European AG?
Marie Ziegler - Vice President of Investor Relations
No.
Robert McCarthy
The other thing I was going to ask about was operating income performance, I mean clearly volume and construction and forestry was better than expected and that would help drive better than expected results there.
But could you characterize overall operating income performance relative to expectations given the realized sales levels?
I mean my sense is that you did a little better than you thought you would.
Marie Ziegler - Vice President of Investor Relations
Well, I think that's very fair.
Pricing was something that we would not have been certain of in November, we didn't know we were going to be able to take the first price increase, those price increases we have taken per se don't really impact the quarter because there's a period of delay.
But it does indicate a little better pricing environment.
Robert McCarthy
But that would be -
Marie Ziegler - Vice President of Investor Relations
That went a little better.
And then they are just experiencing very, very tight expense control and they have been very aggressive in reducing costs in this division and so I think you see a little bit of potential there.
But again, they remain very cautious in terms of the market outlook because the economic fundamentals don't appear to have changed.
Robert McCarthy
Right, okay.
Thanks.
Marie Ziegler - Vice President of Investor Relations
Thank you.
Operator
Your next question comes from Gary McManus (ph) and please state your company name.
Gary McManus
JP Morgan.
Hi, Marie.
In your outlook statement under the AG equipment, let me quote, sales activity expected to pick up in the spring as farmers prepare for planning and start receiving government payments.
Two questions there.
To what degree do you see a pickup in the spring?
Secondly, you said that maybe a third of the farmers are -- now only a third of the farmers getting government payments.
How quickly will that be resolved?
Do you see that being kind of an issue for the entire year?
Or do you think it will get resolved by the spring?
Marie Ziegler - Vice President of Investor Relations
That's a tough one to answer.
The signup for the government programs ends the first of April.
And the USDA recently affirmed it will end the first of April.
If you talk to folks in the industry, they're saying there's no way and this thing could drag out a couple more months.
So it's possible that it would, that things won't turn around immediately in April but we think over the next few months after that they will.
Kind of interestingly, this may help you understand things, I have got direct government payments, a comparison to last year, and probably the most interesting one is what happens in the second quarter because we do expect the second quarter and this would be I think a major factor, last year, first quarter payments, government payments were about 6.1 billion.
This year they're about 5.5 billion.
Last year, both 2002, they were about .1 billion.
This year we think about 1.8 billion.
The third quarter, a little higher, 1.1 billion versus 1.9 billion this year.
And then in the fourth quarter, 6.1 versus 9.2, so you see just basically almost the next three-quarters benefiting from higher government payments.
And that should be positive because it will indicate this issue has been resolved in the farmers' minds and they're able to move on.
Gary McManus
Just as a follow up, looking at both your SG&A and R&D, they appear to be down year over year.
You had like 17% sales growth, so very good performance as a percent of sales.
And that, I assume in the SG&A, there's higher pension and health care in that number that wasn't in last year, right?
I'm wondering, sustainability of still having those two expenses trending down for the entire year.
Marie Ziegler - Vice President of Investor Relations
I think that's a very good question.
Last year regarding SG&A specifically, we still had some unrealized benefit, if you will from the early retirement programs because we didn't have everybody out, so we do have that benefit that will be coming, it's about a $30 million benefit and you really saw that in the first quarter.
In other words, some of those folks were still working.
Gary McManus
Right.
I got you.
Marie Ziegler - Vice President of Investor Relations
So we are saying if you look for the full-year, we see SG&A and R&D, we project they will increase moderately.
Gary McManus
In absolute terms?
Marie Ziegler - Vice President of Investor Relations
In absolute, in an absolute term.
Gary McManus
Okay.
Great.
Thank you.
Operator
Your next question comes from Barry Bannister (ph) and please state your company name.
Barry Bannister
Hi, Marie.
Can you hear me?
Marie Ziegler - Vice President of Investor Relations
Hi, Barry, yes.
Barry Bannister
Hi.
Your worldwide AG price was up 4% in the quarter.
Could you break that down possibly between changes in discounting practices, change in financing terms and changes perhaps in actual price realization on equipment?
Marie Ziegler - Vice President of Investor Relations
I can't break it down that fine.
And I can only give you very round estimates.
We would tell you about half comes from price increases and about half from lowered discounts.
But I don't, I can't, we don't have the ability to break it down any further.
Barry Bannister
Okay.
Just on a related note, you begin to anniversary the cessation of discounting around April, if I recall versus a year ago.
That's when we first started to see this 200 basis point swing.
Marie Ziegler - Vice President of Investor Relations
In the second quarter.
Barry Bannister
Yes.
I'm just wondering, how you have any confidence in the last two quarters of the year that you can continue any sort of decent price realization.
Are you just counting on volume follow through and perhaps additional price increases?
Marie Ziegler - Vice President of Investor Relations
Well, we actually did take price increases in both Europe and in the United States and Canada.
In rounds numbers you're looking at a point and a half to 2 points of price increase, so there's, we are hopeful that that will stick as you move through the rest of the year.
And then...
Barry Bannister
So it's basically roughly 4% price increase in the first half, 2 points in the second half and then we'll just derive a full-year number?
Marie Ziegler - Vice President of Investor Relations
Right.
Barry Bannister
Thank you.
Operator
Thank you.
Your next question comes from Steve Hagerty (ph), please state your company name.
Steve Hagerty
Good morning, Merrill Lynch.
Marie Ziegler - Vice President of Investor Relations
Hi, Steve.
Steve Hagerty
Quick question back to inventories, Marie.
Look at the sequential change from October to January this year versus last year, looks like inventories rose about 557 million this year versus 325.
You said part was currency and I'm assuming another chunk of it was probably billed to commercial and consumer.
Marie Ziegler - Vice President of Investor Relations
Specifically for the 100 series, you are correct.
Steve Hagerty
That would be a fairly big piece of that inventory swing?
Marie Ziegler - Vice President of Investor Relations
Well, it would be a piece of it.
I cannot quantify.
Steve Hagerty
And to finish this up, to get to flat inventory by year end, I'm assuming we won't see these incremental increases in inventory like the first quarter.
Marie Ziegler - Vice President of Investor Relations
You may see, there always are seasonal impact and that's something I don't have a good forecast on quarter by quarter.
It wouldn't surprise me or necessarily concern me if you even had an increase in the second quarter.
But then you should start seeing it trending down.
Typically there's a pretty good seasonal reduction between the third quarter and fourth quarter.
Steve Hagerty
Thanks a lot.
Operator
Thank you.
Your next question comes from Shannon Collins (ph).
Shannon Collins
Falcon Fund.
Good morning.
Marie Ziegler - Vice President of Investor Relations
Hi, Shannon.
Shannon Collins
How you doing?
Marie Ziegler - Vice President of Investor Relations
Fine.
How are you?
Shannon Collins
: I'm fine, thanks.
Could you tell us what it the balance was in the reserves and liabilities for special items?
I know that at the end of the year, it was 78 million, just curious what it was at the end of the first quarter.
Marie Ziegler - Vice President of Investor Relations
That's something I don't have with me in all my notes, and I would be happy to get back to you after the call.
Shannon Collins
Okay.
Great.
Marie Ziegler - Vice President of Investor Relations
Do you want to -- would you want to just put a call in?
Shannon Collins
Sure.
Marie Ziegler - Vice President of Investor Relations
Thank you.
Shannon Collins
Let me ask you another question.
This operating return on assets is a fascinating report, this one that's on the website.
I noticed that despite having 68 million in profitability, it shows for the first quarter, the shareholder value added was negative 147 million, just curious if you have an estimate for that number, for the year.
Marie Ziegler - Vice President of Investor Relations
No, we actually do not have -- I mean we do have internal forecasts, but nothing that we'll publicly be able to talk about.
You could make some educated assumptions based on what we are telling you our projected income.
Shannon Collins
Right.
Marie Ziegler - Vice President of Investor Relations
And I would point out that I really, I chose not to make a lot of comment, not to make any comments other than the fact we provided it simply because with one quarter's worth of data in what is typically a seasonally weak quarter, it's hard to read much comparison year over year.
Shannon Collins
Sure.
I think it's a fantastic report.
Can you comment as to where, I know the compensation committee targets bonuses and stock options and what have you.
Based on this shareholder value added, can you comment on where the targets are for the year for the management team?
Marie Ziegler - Vice President of Investor Relations
That is in the process of being rolled out to employees and we will have a comment, we'll be able to make in the future time, but I can't right now because I haven't rolled it out to employees.
Shannon Collins
Good deal.
Marie Ziegler - Vice President of Investor Relations
Thank you.
Shannon Collins
Thank you.
Operator
Thank you.
Your next question comes from Ron Fisher (ph) and please state your company name.
Ron Fisher
Ron Fisher, Stein Row (ph).
Good morning.
Marie Ziegler - Vice President of Investor Relations
Hi, Ron.
Ron Fisher
Question for you.
The cash flow at the equipment operation and financial services individually was higher than the year before.
Looking at the cash from operating activities but on a consolidated basis it was lower by a couple hundred million.
I wondered, and there's no detail specifically within the cash flow from operating activities.
I wondered if you could comment as to what was basically a 200 million dollar shortfall in cash flow and why it was higher, and higher at the units and lower on the consolidate it basis.
Do you follow me?
Marie Ziegler - Vice President of Investor Relations
Yes, I can, that's something I didn't even think to look at.
I will be very happy to get back to you with that.
Ron Fisher
Okay.
Thank you.
Marie Ziegler - Vice President of Investor Relations
I suspect it has something to do with receivables.
Ron Fisher
That would be my guess.
Marie Ziegler - Vice President of Investor Relations
Yeah, I would have to confirm that.
Ron Fisher
Thank you, Marie.
Operator
Thank you.
Your next question comes from David Bleustein (ph) and please state your company name.
David Bleustein
UBS Warburg.
Good morning, Marie.
Marie Ziegler - Vice President of Investor Relations
Hi, Dave.
David Bleustein
Following up on John McGinty's question, what Euro-dollar exchange rate have you assumed for the balance of the year?
Marie Ziegler - Vice President of Investor Relations
I put that report away.
We would assume that the rate, I can answer it.
We would assume it's the rate we are seeing today would be similar to the rate that we would have going forward.
David Bleustein
Okay.
And if it's not that, will you get back to me?
Marie Ziegler - Vice President of Investor Relations
Absolutely.
David Bleustein
I know these things are impossible to predict but do you have a thought or thoughts on the 3.1 billion of potential disaster payments that did go through the Senate, may not yet be in the House bill?
What are your thoughts on that?
Marie Ziegler - Vice President of Investor Relations
Well, actually, in our farmer cash estimates, we actually only put in about 2 billion, trying to hedge our risk.
The company doesn't, won't, will not make a comment, publicly, about the pros and cons of this payment or the way it's being structured.
But we decided it might be prudent to not put the full 3.1 billion in, so we're hedging our bets.
David Bleustein
Following up on Joanna's question, the forecasts you gave are farm prices, not CBOT prices, right?
The 5.42 and 5.24 for soybeans?
Marie Ziegler - Vice President of Investor Relations
That's correct.
Operator
Your next question comes from Michael Harris (ph) and please state your company name.
Mr. Harris, your line is now open.
Michael Harris
Yes, good morning, Marie.
Marie Ziegler - Vice President of Investor Relations
Hi, Michael.
Michael Harris
Quick question.
Housekeeping items: Have you had any change in your outlook from, say, cap-ex prospective, tax rate?
Marie Ziegler - Vice President of Investor Relations
The capital expenditures outlook is unchanged.
We said it would be approximately 400 million dollars approved capital expenditures.
We last year underspent a little bit of our budget, as you may recall we came in closer to 350.
So there would be another 25 million or so that could spill over to this year.
So total it would be about 425.
The tax rate did change, we are now saying it will be 35 to 36% and we had been saying 30, 34%.
Michael Harris
I'm sorry, what was that, Marie?
Marie Ziegler - Vice President of Investor Relations
The tax rate?
Michael Harris
Yeah, what was it previously?
Marie Ziegler - Vice President of Investor Relations
33 to 34%.
Michael Harris
Okay.
Marie Ziegler - Vice President of Investor Relations
And then no substantive changes on depreciation.
Michael Harris
Okay.
I'm easy this morning.
I'll get back in the queue.
Operator
Your next question comes from Chet Lee (ph), please state your company name.
Chet Lee
Barclay's Capital.
My question has to do with your cash balance.
What is your forecast for, what should we do with that, will it stay or will it be used to pay down debt?
Where is it going to go?
Marie Ziegler - Vice President of Investor Relations
Right now we think it's prudent to maintain a pretty healthy cash balance given the uncertainties out in the market and the fact that we frankly are an issuer, we think it's a good idea.
I would expect that we would continue to have a pretty healthy balance on that cash position, as we move frankly throughout the calendar year.
I wouldn't see major -- a major decline at this time.
Chet Lee
Great, thanks.
Operator
Thank you.
Your next question comes from Bob Shanosky.
Bob Shanosky
CIBC.
Good morning, Marie.
Marie Ziegler - Vice President of Investor Relations
Hi, Bob.
Bob Shanosky
One, to follow up on Gary's, you noted that R&D will actually be up for the year.
Marie Ziegler - Vice President of Investor Relations
Yes, and that's driven in part by the OPEC.
Bob Shanosky
Right.
So with it being down actually year over year by 10 million in the first quarter, how should we think about it the balance of the year?
Ramp up sequentially, are there any quarters related to specific projects that we need to be concerned about?
Marie Ziegler - Vice President of Investor Relations
I don't have that level of detail.
I would take the forecast and just prorate that up moderately through the balance of the remaining three-quarters.
Bob Shanosky
Great, thanks.
As a follow-up, in terms of the construction segment relative to the dealer inventories, given that industrial construction was off 35% in December, non-residential down 14%, can you offer any color on a geographic basis where dealers have been willing to take to inventory in the quarter?
If any of that was non-U.S.?
Thanks.
Marie Ziegler - Vice President of Investor Relations
My comment would not refer to anybody outside the United States.
I was looking at the U.S.
But I do not have a geographic breakdown.
Bob Shanosky
Okay.
Thank you.
Operator
Thank you.
Your next question comes from Elias Lusgarten (ph), and please state your company name.
Elias Lusgarten
H.C.
Wainwright & Company.
Good morning, Marie.
Marie Ziegler - Vice President of Investor Relations
Hi, Eli.
Elias Lusgarten
Couple quick questions, we talk about pricing, can you give us pricing assumption by division as to this year, price realization for this year?
Marie Ziegler - Vice President of Investor Relations
We said again, that we hope over the balance of the year for worldwide AG to get a, you know, a couple points would be nice.
In AG, in commercial and consumer equipment we would really tend to be pretty price neutral there, that would be consistent with division strategy.
Construction has remained pretty cautious in their forecast because they just made the decision to take this additional price increase.
So they would have, they would be looking for maybe a point of pricing.
Elias Lusgarten
You just matched a price increase actually.
Can you talk about down days of production for the rest of the year versus last year?
Marie Ziegler - Vice President of Investor Relations
I only would have that comment available for the AG division and for, I have the total.
As soon as I find it.
For the year, we expect to have total shut downs in North America of about 11%.
This compares to about 10% a year ago.
Elias Lusgarten
This is just AG?
Marie Ziegler - Vice President of Investor Relations
This is just North American AG.
I don't have any other similar numbers.
Elias Lusgarten
Okay.
I assume there's no shutdown in the second quarter at this point anyway.
Marie Ziegler - Vice President of Investor Relations
There could be a very modest -- there actually would be a very modest shutdown in the second quarter, we're actually taking one week on our 8000 series tractors and that's all that I know of.
Elias Lusgarten
Okay.
Nothing in the other divisions?
Marie Ziegler - Vice President of Investor Relations
They don't have shut downs the same way, measurable, that they would in the AG division.
However, because this is the primary selling season, I would be very surprised that there would be shut downs in any of the other two.
Elias Lusgarten
One final question.
Do you have any estimate of cash flow for the cash flow conversions for the year versus 500, 600 million in net income that you predicted?
Marie Ziegler - Vice President of Investor Relations
We typically don't comment on that.
We provide a comment on the change in receivables and inventories which we have, comment on cash, on capital expenditures, depreciation and then that's the extent of what we -
Elias Lusgarten
That's the SG&A forecast for the year?
Marie Ziegler - Vice President of Investor Relations
About 350, 375.
Elias Lusgarten
Thank you.
Operator
Thank you.
Your next question comes from John McGinty, please state your company name.
John McGinty
Credit Suisse First Boston.
Marie, a couple of follow ups.
The 4% worldwide AG is, it's 2 and 2, the two discounting, two increases, round numbers.
Was that the same in Europe as the States, or more heavily weighted toward the States versus Europe?
Marie Ziegler - Vice President of Investor Relations
Currency makes this a more interesting calculation, John, as you might imagine.
But more likely weighted towards North America than Europe.
John McGinty
You said in combines where you have an early order program, you came awfully close to hitting your target, you wanted 80%, came very close.
And you said in answer to somebody else's question that there was no change in your market share.
Does that imply that all of the decline in the large farm equipment is in row crop tractors, if combines are about what you thought?
Marie Ziegler - Vice President of Investor Relations
No.
It would effect other implements and some of the other tractor lines as well.
John McGinty
But combines are in fact what you thought they were going to be?
Marie Ziegler - Vice President of Investor Relations
They're very close.
John McGinty
Okay.
Final question, you had said, I believe, I had it in my knows, that you all were looking for construction and forestry division to break-even before Nortracks, which that will be like a 10 million a quarter.
You make a lot of money in the first quarter relative to that even with the 10 million in Nortracks.
Then you raise prices another percent.
Would we assume that you would now be looking for at least a break-even for the year in construction and forestry?
Since you really haven't changed the top line, you have the good cost, you have more price, you had a heck of a good first quarter.
Marie Ziegler - Vice President of Investor Relations
I would say that they're pretty conservative.
If you -- but I would say that break-even is certainly looks like it's possible, absolutely.
John McGinty
Okay.
Thank you very much.
Operator
Your next question comes from Joanna Shatney, please state your company name.
Joanna Shatney
Goldman Sachs.
Marie, we -- I don't know if you did this in the conference call or talked off-line about it, you were planning on moving some receivable from Europe to the finance sub, did that happen in the first quarter?
Marie Ziegler - Vice President of Investor Relations
Yes, we did.
We had moved about 250 prior to year end and I think we moved about another 100, 150 in the first quarter.
Joanna Shatney
Okay.
And are we done moving those out?
Marie Ziegler - Vice President of Investor Relations
Basically, there could be a few incremental changes on the way, but that's the majority of what we intended to move at this time.
Joanna Shatney
Great, thanks.
Marie Ziegler - Vice President of Investor Relations
Thank you.
Operator
Your next question comes from Barry Bannister, please state your company name.
Barry Bannister
Hi, Marie, Barry Bannister of Mason.
Question about John Deere health care.
It made 4.3 million versus 4.6.
Could you give me the revenues on that?
And secondly, is the plan or the intention, even subliminally, to run John Deere health care close to break even to contain these massive OPEB liabilities or is that company pretty much run as a profit center in its own right?
Marie Ziegler - Vice President of Investor Relations
A dual answer.
The reason we are in the health care business is to contain our OPEB costs and we have been very successful at this - we've run several points below the industry's rate of increase.
Last year we estimated the increase in medical inflation was around 16%, we think we were more like in the 11, 12% range.
So we have been very successful with that.
The book of business that is run for Deere & Company is run not as a profit center, but basically to cover costs only.
And that's because employees, as you know, cost share and the premiums of salaried employees (inaudible).
The outside business, the outside business is about 80%, round numbers, of the total enrollment and that's has to do with the fact that we have geographic concentrations. (inaudible) Anyway, that piece of business is run for profit.
Barry Bannister
Okay.
Thank you.
Marie Ziegler - Vice President of Investor Relations
Does that answer your question?
Thank you.
That was actually it for questions in the queue, so I thank you all very much for participating in the call and look forward to talking with some of you as we move through the day.
Good day.
Operator
Thank you.
This does conclude today's conference call.
We thank you for your participation.