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  • Operator

  • Good morning and welcome to the Deere & Company third quarter earnings conference.

  • At this time your lines have been placed in a listen-only mode until the question and answer session of the conference.

  • Today's call is being recorded.

  • If you should have any objections, please disconnect at this time.

  • I will now like to turn the conference over to Mr. Greg Derrick, Manager of Investor Communications, sir, you may begin.

  • Greg Derrick - Directot of Investor Relations

  • Thank you.

  • Good morning.

  • Marie Ziegler and Susan Carlix are also participating in this morning's conference call.

  • Now before getting started, a reminder that our call today 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 media may be stored and used as part 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 risks and uncertainties.

  • Actual results may 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 S.E.C. filings, including the most recent form 10-Q and in the press release being filed today on form 8-K.

  • In today's call, we will take a closer look at third quarter earnings then respond to your questions.

  • This morning Deere reported third quarter net income of $248 million on sales of $3.8 billion.

  • Compared with last year earnings were up 68% or $100 million on a sales gain of 12% or $423 million.

  • Now, a couple of points about the quarter.

  • First, most of the improvement came from construction and forestry and commercial and consumer equipment.

  • Credit had higher net income as well.

  • Second, results for agricultural equipment you may have noted were lower, this is due in large part to production shut downs which were carried out as planned.

  • Now let's review the quarter by individual business line.

  • In ag equipment, performance for the quarter was hurt by extensive shut-downs in North America which contributed to a lower physical volume of sales.

  • Worldwide agricultural sales were up 4% but down on the basis of physical volume alone by about 5 points.

  • Of the 9-point difference, the difference between reported sales and physical volume of sales. price realization was 3 points reflecting improvement both overseas and in North America and currency was 6 points.

  • We're continuing to get some benefit from currency translation primarily due to the strengthening in the euro.

  • On the operating profit side, third quarter ag operating profit was down 38% to $127 million.

  • The factors that have negatively affected our ag profit included the shut downs, which I mentioned, as planned these represented about 16% of the available days for the quarter.

  • The division also saw higher post-retirement benefit and pension expense of $52 million.

  • Earlier we mentioned price realization, this also helped ag profits in the quarter.

  • Now, before moving ahead, let's review the retail sales picture in farm machinery for July.

  • And this is expressed in -- these are in units for the U.S. and Canada.

  • In utility tractors, Deere was up for the month double digit.

  • Row crops;

  • Deere down double digit, but low double digit.

  • Four wheel drives, Deere down slightly.

  • Combines, unit sales for July for John Deere up a strong double digit.

  • As for inventories, the production cuts we've mentioned are having a positive effect.

  • Deere ended July with combine inventories. this is for the U.S. and Canada, at 18% of trailing 12 month sales of 18%.

  • Eighteen percent, this is in reference to a figure last year at the same time of 21%.

  • Row crop tractor inventories at the end of the month were 30%, which is where they were last year.

  • Let's turn to Western Europe where July sales were hurt by extremely dry weather and widespread drought throughout the region.

  • Sales of both John Deere tractors and combines were down double digit for the month.

  • On a year-to-date basis tractor sales were down by single digit, combines down by a double digit.

  • Turning to the industry outlook, we have made a slight upward revision to our industry sales outlook for North American farm machinery.

  • We now expect sales to be flat to down 5% for the year, we were saying down 5, now we're saying flat to down, so a slight upward revision there.

  • Retail sales have increased somewhat in recent weeks due to improved farmer cash flow, better crop conditions than last year and the continuation of overall positive fundamentals.

  • U.S. farm cash flow is expected to increase by 11% this year to a record level of $226 billion.

  • That's a very slight increase of a billion dollars or so from where our previous estimate was.

  • This improvement in cash flow is based on sharply higher livestock receipts, a modest increase on the crop side and higher government payments and based on early projections, farmer cash flow should continue at record levels next year.

  • We believe these positive factors, as well as benefits from new tax legislation, will help sales in coming months.

  • Now our outlook for sales in Europe is weakened in relation to what were very strong levels last year.

  • The drought and hot weather I mentioned are having a negative effect on grain production and contributing to lower European farm income.

  • As a result, we now see industry sales in Europe down 5 to 7% for the year, earlier we'd been saying down 3 to 5%, now down 5 to 7, so a slight downward revision there.

  • Turning to South America, the outlook has improved due to a much stronger market in Brazil versus extremely weak conditions there last year.

  • We now see industry sales -- excuse me, in Argentina, much stronger market in Argentina versus extremely weak levels there in Argentina last year.

  • The outlook now for South America, the industry sales there we see being up 5% and previously the outlook was down 5%.

  • So quite a turnaround in the outlook there.

  • Now as far as Deere is concerned, we've upped our own ag sales forecast and are now projecting an increase of 7 to 9% for the full year worldwide.

  • However, we continue to see physical volume down slightly for the year which is consistent with our earlier forecast.

  • Now, in keeping with our strategy of holding down assets, ag production will be lower in the fourth quarter, specifically North American ag production is forecast to be down by 7% in the fourth quarter.

  • Factory shut-downs in our North American ag operations are projected at 22% of available days for the quarter, 22%, that is in reference to 19% last year in the fourth quarter.

  • Now, low sales have obviously hurt our ag results this year but just how low are they in comparison with normal?

  • Well, we believe that normal row crop tractor sales in the U.S. and Canada, we believe normal unit volumes are about 22,000 and that compares with 12 month sales on a rolling 12 through June, of 17,600, so that's about 22% below normal.

  • Pretty much the same story on the combine side where we see normal volumes of about 7,000 and through June they were 5,800 on an R-12.

  • Now, what that means is that this year's sales are well below what we consider to be a normal level and they're certainly far from what we would regard as a potential peak.

  • Moving to other areas, Deere's commercial and consumer equipment business continues to perform strongly as a result of new products and an improving ability to match production with retail demand.

  • For the quarter, sales rose 18%, operating profit increased 70% to $104 million.

  • New products are helping results.

  • These include small tractors, commercial mowers, and, of course, the 100-series lawn tractors being sold through dealers and the Home Depot.

  • The division also had higher selling general and administrative expense for the quarter this was mostly in regard to advertising and promotion for the new products and last year results from the division included charges of $24 million, this was mostly related to the closing of a utility vehicle factory in Williamsburg, Virginia.

  • The retail picture has been strong all year in our commercial and consumer operations and that carried over into July.

  • Dealer and mass channel sales rose by a strong double digit for July and are also up double digit year to date.

  • Dealer sales alone were up by double digits for July and for nine months.

  • Regarding the outlook for this business, CC&E, full year sales are now seen as being up over 15%.

  • This is a little stronger than what we had said before but it's basically in line with our previous guidance, last quarter we were saying up 13 to 15.

  • CC&E factory and production levels, however, will be down significantly for the fourth quarter in line with the division's efforts to better align production with retail activity, we think those production levels will be down more than 25% for the quarter.

  • And our Horicon factory, our Horicon, Wisconsin factory, which is a maker of high-margin premium riding lawn equipment will be most affected by these shut-downs.

  • This lower production likely means a larger loss in the fourth quarter for our commercial and consumer equipment operations than we saw last year, and last year's loss in CC&E was 19 million on an operating basis.

  • Let's look now at our construction and forestry operations.

  • This business has seen a dramatic turnaround the last few months and that story continues to be evident in the July retail totals.

  • Deere's first in the dirt activity was up by a strong double digit in July.

  • First in the dirt up strong double digit.

  • Settlements were also up by a double digit.

  • For the quarter as a whole, Deere first in the dirt, year bids we were up by 30%, settlements were up 25%.

  • Now, following up on these encouraging retail numbers Deere's shipments have risen sharply as well.

  • Third quarter sales were up 29% to $788 million.

  • That includes $36 million of incremental sales from the consolidation of Deere and Hitachi marketing operations.

  • Now, while volume was clearly the driving force in the sales increase price and currency each accounted for 3 points of the change.

  • Volume and price helped produce a big swing in operating profit in this business.

  • This quarter our C&F operations on an operating basis earned $59 million that is in comparison with a loss of $10 million last year, so plus 59 versus minus 10.

  • Also in the quarter, construction and forestry add lower Nortrax accrual.

  • It was $7 million in the third quarter.

  • That is in reference to $33 million last year and for the year it looks like the Nortrax accrual will be in the ball park of $30 million and it was in the lower 60's last year.

  • Now, bear in mind that construction and forestry net sales, though sharply higher, are tracking closely with the retail situation.

  • Total system inventory, which is a comprehensive measure that includes everything on the dealer lot, fresh, new, plus rental machines ended the quarter flat with last year and little changed from the end of the second quarter.

  • In other words, construction and forestry has achieved this dramatic sales improvement with flat inventories.

  • Now, as far as the outlook is concerned, we've stepped up both our outlook for the industry and also for Deere's own sales in this business.

  • The industry outlook is improved, we think it's now up 5 to 10% for the year, we had been saying flat to down 5.

  • So, up 5 to 10 for the year is where we see industry construction activity for the year.

  • Deere's own sales forecast has moved up as well.

  • We now see division sales being up 18% for the year and in the call three months ago we were saying up 7%.

  • So, a big improvement there and this sales increase is widespread, there are no particular pockets. it extends to most all of our construction and forestry markets and this includes $127 million from the consolidation of Deere and Hitachi marketing operations.

  • Without Hitachi, C&F sales, our forecast to be up 13% for the year.

  • So, up 18 on a reported basis, up 13 without Hitachi.

  • Let's turn now to our credit operations.

  • Credit had good quarter.

  • Net income was $86 million versus $57 million in the third quarter a year ago.

  • Looking at the details, one of the things this quarter did not have were last year's incremental bad debt charges of $12 million.

  • We also had higher receivable sale gains of $12 million on an after-tax basis for the quarter, though again the A B.S. sale gains are way down on a year-to-date basis but they were up for the quarter.

  • Also the portfolio quality in this business remains very high, past due's and write-offs are improved for the quarter and this is in comparison with some very favorable levels of last year.

  • We continue to see net income for credit this year at about $300 million.

  • Our outlook there has not changed.

  • Now let's look at some housekeeping items.

  • Total worldwide sales as reported for the quarter were up 12%.

  • Of that amount, currency was 4 points and price was 2, so volume was basically half of the increase for the quarter.

  • Selling, general and administrative expense was $45 million higher for the quarter.

  • The largest single factor there being higher advertising and promotional expenses in commercial and consumer equipment associated with the new products.

  • For the year, we're expecting moderate increases in SG&A and in R&D, this is consistent with our previous comments.

  • We talked a lot about higher pension and post-retirement benefit expenses this year, that increase company-wide was $68 million for the quarter, and this is mainly reflected in cost of goods.

  • We had previously forecast a full-year increase in pension and opeb expense of 275 million and that figure still looks good.

  • Currency translation added $14 million to our third quarter operating profit and brings the year to date benefit to $43 million.

  • Ag equipment accounted for all the third-quarter increase and virtually all of it for the year-to-date period.

  • Our balance sheet shows the clear impact of our asset management efforts.

  • Despite higher sales volumes, trade receivables and inventories are about the same as last year on a constant exchange basis.

  • They're up about $150 million on the balance sheet as reported but pretty much the same if you strip out the currency effect.

  • We continue to forecast no change in trade receivable and inventory levels for the full year, that is, the end of the year in '03 should look a lot like it did in '02 in these categories.

  • I note on capital spending, capex is likely to be lower than we thought for the year.

  • We had been saying around $425 million for the year it now seems more likely to be in the ballpark of $375 million.

  • The difference has to do with timing and with this year's underspend carrying over to next year and in that case, that would put our 2004 capital spending total in a range of $450 to $500 million.

  • Now, looking ahead, Deere's financial results will be under pressure in the fourth quarter due to low rates of production particularly in North American ag and in our commercial and consumer operations.

  • Reported sales for the quarter are forecast to be up 5%, however, physical volume will be down slightly.

  • This will be the first quarter of the year when overall production volume, for the company as a whole, actually declined.

  • Now, on a full-year basis, it looks like sales will come in at a little over $13 billion.

  • We think this is about 90% of what we would consider normal for all of our businesses on a combined basis.

  • Our net income range for the year has been revised upward, it now stands from $575 million to $625 million.

  • We had been saying for the first part of the year we have been saying $500 to $600 million, now 575 to 625.

  • This implies fourth quarter earnings of roughly break-even to $50 million.

  • Which, in turn, suggests that fourth quarter in our equipment divisions will very likely have an operating loss in the fourth quarter and we consider that to be very realistic in light of the low production levels we're planning for the period.

  • So, the fourth quarter looks challenging but 2003 is turning out to be a solid year.

  • We're having a lot of success bringing the John Deere brand to a wider audience.

  • Our commercial and consumer business has shown double digit profitable growth.

  • Construction and forestry is showing very definite signs of recovery and North American ag sales have improved of late.

  • In addition, we're realizing significant benefits from our ongoing focus on cost control and asset management which we think are the keys to achieving a sustainably higher level of operating efficiency.

  • And our key measures of operating efficiency are looking better.

  • Take SVA, for example, shareholder value added, it's a metric we use to evaluate operating profit relative to an implied cost of capital.

  • Through nine months, enterprise SVA showed a positive swing of over $380 million and this improvement is mainly due to a notable change on the positive side in construction and forestry and better performance in our commercial and consumer equipment business.

  • In summary then, our performance to date has been pretty good but that doesn't mean we're satisfied, far from it.

  • We have aggressive targets in place for asset turnover and operating margin as reflected in our objective of a 20% operating return on operating assets at normal sales volumes and while we're making very definite progress and we're proud of the progress we've made to date, we know there is still work to be done.

  • We're now ready for discussion, for the Q&A period.

  • In fairness to others, please limit yourself to one question with a related follow-up, if needed.

  • You can get back in the queue to ask more questions as time permits.

  • The operator will now give instructions on the polling procedure for the Q&A.

  • Operator

  • Thank you.

  • At this time if you would like to ask a question please press star followed by 1 on your touch-tone phone.

  • You will be announced by name prior to asking your question.

  • To withdraw your question you may press star 2.

  • Once again, to ask a question, please press star, followed by 1.

  • Your first question comes from Alex Blanton.

  • Please state your company name.

  • Alex Blanton - Analyst

  • Good morning.

  • That was an excellent rundown.

  • I wonder if you could comment on the price increase.

  • It's 3% year-over-year in which divisions and I think you said a 2% overall and comment on whether you have run into any resistance to that, because this is sort of unusual these days, these price increases.

  • Greg Derrick - Directot of Investor Relations

  • Yeah, hi, Alex.

  • For the quarter, we had about 3 points in ag and in the ballpark of 3 points in construction and forestry, roughly 2 points overall.

  • Alex Blanton - Analyst

  • Yes.

  • But any resistance to these at all?

  • Greg Derrick - Directot of Investor Relations

  • Well, I don't -- these are being passed through.

  • I mean, I think that's evident in the sales tones.

  • The markets, particularly on the construction side, I think the market are a little stronger.

  • On the ag side, the retails have been up somewhat of late.

  • Our feeling is that if you provide, you know, a lot of new equipment and features that customers find of value, they're going to be willing to pay for it.

  • If we had seen a lot of resistance, I don't think we'd have the kind of price realization we have.

  • Alex Blanton - Analyst

  • All right.

  • Second question is, could you tell us what your sales to the big rental fleets are doing as opposed to sales to your dealers, how are they versus last year?

  • Marie Ziegler - Vice President of Investor Relations

  • Alex, this is Marie.

  • Our sales really across the board are up over last year's levels and that would include sales to independent rental houses as well as our regular sales to dealers.

  • Alex Blanton - Analyst

  • I'm really talking on the construction side.

  • So the sales to the rental.

  • Marie Ziegler - Vice President of Investor Relations

  • That's what I'm talking about, too.

  • Alex Blanton - Analyst

  • Are up in line with the total?

  • Marie Ziegler - Vice President of Investor Relations

  • I don't have a percentage breakdown by the different markets but they are all up.

  • All areas of the business.

  • Alex Blanton - Analyst

  • Because the rental fleets really haven't been buying a lot recently, so, this is a change since earlier in the year?

  • Marie Ziegler - Vice President of Investor Relations

  • For rental, yes.

  • We have seen rental houses come back and also our dealer activity.

  • That's reflected in the strong retail pass-through that you saw with our first in the dirt activity up 30% in the quarter on a settlement basis up 25%.

  • Thank you very much.

  • Alex Blanton - Analyst

  • Okay.

  • Thanks.

  • Operator

  • Thank you.

  • Your next question comes from Mark Koznarek, please state your company name.

  • Mark Koznarek - Analyst

  • Hi, it is Midwest Research.

  • Good morning.

  • Greg Derrick - Directot of Investor Relations

  • Hi, Mark.

  • Mark Koznarek - Analyst

  • One clarification, Greg.

  • On the foreign exchange, did you say you made 14 million in the quarter that was income?

  • Greg Derrick - Directot of Investor Relations

  • The benefit to operating profit was $14 million for the quarter and all that was in ag equipment and this is attributable to converting the profits in the strengthening euro into dollars.

  • Mark Koznarek - Analyst

  • Now, my main question involves inventory.

  • Where are we trying to get inventories and receivables by year end and then sort of I'll ask the follow-on right now, which is why is there -- are you trying to clear out certain models to get ready for new models to be introduced next year?

  • Greg Derrick - Directot of Investor Relations

  • Basically the goal is to end the year where we started the year.

  • Mark Koznarek - Analyst

  • Okay.

  • Greg Derrick - Directot of Investor Relations

  • So, based on our projections and we're certainly headed in that direction, we will have flat trade receivables and inventories on year-over-year bay and I don't know that there's any particular focus or area, this is a pretty general strategy, and really it's in concert with the whole asset management philosophy that we've had over the last few years.

  • Marie Ziegler - Vice President of Investor Relations

  • Maybe I could just step in and add one other clarification.

  • You do note in that commercial and consumer equipment, tonnage will be down about 25% versus a year ago and that has nothing to do with inventory positions that are of concern.

  • Last year in the fourth quarter we ramped up because we were anticipating a very good level of retail sell-through which we had.

  • This year, we've improved our build-to-order capabilities over the course of the year and we do not need to have that ramp up in the fourth quarter.

  • It will happen in the first quarter next year.

  • Mark Koznarek - Analyst

  • Okay.

  • Is there any major ag roll-outs planned for next year in terms of models?

  • Greg Derrick - Directot of Investor Relations

  • Well, we're bringing out new products, in fact, they're basically being introduced to our dealers now.

  • It's not a particularly large year in terms of new products but there are some significant new products coming out but that's not the rationale, at least that I'm aware of, for reducing inventory.

  • Operator

  • Thank you, your next question comes from Andrew Casey.

  • Please state your company name.

  • Andrew Casey - Analyst

  • Prudential Equity Group.

  • Good morning.

  • Greg Derrick - Directot of Investor Relations

  • Hi, Andy.

  • Andrew Casey - Analyst

  • Just a follow-up question to Mark's, I guess.

  • If you are looking at the normal levels to be above where they were for the last 12 months, are you seeing the trends in place to get back to normal?

  • Marie Ziegler - Vice President of Investor Relations

  • What normal level are you referring to?

  • Greg Derrick - Directot of Investor Relations

  • Yeah, what's normal?

  • Andrew Casey - Analyst

  • Ag equipment, Greg.

  • You went through normal levels.

  • Greg Derrick - Directot of Investor Relations

  • We were talking there about industry, you know, what the industry sales were at par and basically what we were saying is that this year, based on combines and row crops, we're about 20% below par.

  • Marie Ziegler - Vice President of Investor Relations

  • And your question is regarding our outlook, and certainly when we take a look at the strong cash receipts that we have in place for this year and which are at record level, and we expect that to continue into next year, it certainly sets the stage for some improvement.

  • You have the potential of some added buying, which would us be fiscal 2004 as people consider their tax situations in November and December.

  • So, the fundamentals certainly look encouraging, we don't have an outlook officially yet for 2004 and won't until we release earnings in November.

  • Andrew Casey - Analyst

  • Sure and then when you look at your cash position, is there any usage for that in the near term?

  • Greg Derrick - Directot of Investor Relations

  • I think we're comfortable with where our cash position is now and we plan to maintain it at roughly these levels for the foreseeable future.

  • Andrew Casey - Analyst

  • Thank you.

  • Greg Derrick - Directot of Investor Relations

  • You're welcome.

  • Operator

  • Your next question comes from David Raso.

  • Please state your company name.

  • David Raso

  • Smith Barney, good morning.

  • Regarding the production schedule for North American ag in the fourth quarter, if you look at a year ago it was shut down pretty significantly.

  • Go back two years ago, shut down even more.

  • I'm trying to understand, given the comments about some improving fundamental back-drops you spoke of, the depreciation, tax planning, the cash receipts why would it be necessary to have production down more this year on a shutdown -- percent of days shut down than we saw last year and even almost down equivalent to what we saw two years ago when you were shut down 24%.

  • Correct me if I'm wrong, those shut-downs are largely in Waterloo and East Moline?

  • Marie Ziegler - Vice President of Investor Relations

  • I will take a shot at this, yes, they are in Waterloo and at the Harvester.

  • Some of the Harvester work related to changes in our build-to-order plan.

  • We had extensive shut downs, you may recall.

  • In the first quarter we were only producing about 50% of available days there and that's because nobody needs a brand-new combine after the harvest, so, some of what you are seeing in the first and the fourth quarters, a good chunk of what you're seeing there simply relates to the fact that we are skewing production, or moving it into the second and third quarters when it's right ahead of the season.

  • In the case of Waterloo there would be some build to order elements there as well.

  • Waterloo had some higher elements of production in the early part of this year, in the first and second quarter, and they have -- they are just producing at slightly lower levels.

  • If you will recall from our previous guidance we had said that North American tonnage in both the third and the fourth quarters would be down more, 10% or more, so this actually does reflect an improvement from our previous outlook.

  • David Raso

  • I'm trying to understand.

  • The inventory appears to be lower than a year ago or at a minimum, equivalent to a year ago.

  • Marie Ziegler - Vice President of Investor Relations

  • Without exchanges, it's flat, that's right.

  • David Raso

  • I'm just trying to understand the positive outlook on the big tractors, which you're citing and then combines citing as being furthest below normal with positive fundamental from your perspective on improving demand.

  • Why do you need to underproduce retail again in the fourth quarter or is that not the case?

  • That's what I'm implying, that you are going to underproduce retail again in the fourth quarter.

  • I know you're skewing production more and more towards the second/third quarter.

  • That's been going on for a couple of years, I'm just trying to understand -- maybe I should ask the question point blank: How is the production going to be versus retail for the big tractors and combines in the fourth quarter?

  • Marie Ziegler - Vice President of Investor Relations

  • In combines, by the end of the quarter we would probably be under producing but you know, David, I don't have a point-blank comparison.

  • I can only tell you that as we look at things year-over-year our expectation is that we will end with our inventories basically in a similar position to what they were a year ago.

  • David Raso

  • Positive labor.

  • But if inventory is already where it was last year or lower, if inventory is now just going to be equal year-over-year and I'm assuming those two product are consistent.

  • Marie Ziegler - Vice President of Investor Relations

  • Row crops, when we give an inventory number, David, we're giving you an inventory number that looks at inventories at a worldwide level.

  • It's definitely conceivable that those row crop tractor inventories could be a bit lower than they were.

  • I think that's the issue, you're looking at a rolled up number.

  • David Raso

  • Thank you.

  • We'll talk more off-line, I appreciate it

  • Operator

  • Thank you.

  • Your next question comes from Joel Tiss.

  • Please state your company name.

  • Joel Tiss - Analyst

  • Hi, still at Lehman Brothers, how are you doing, guys?

  • Can you help us a little bit?

  • The free cash flow has come down quite a bit in the quarter and I just wondered if your inventories are in shape, your net income is up a lot, can you just give us some of the pieces that would have caused that?

  • Marie Ziegler - Vice President of Investor Relations

  • I'm turning to my sheet here.

  • Hang on.

  • I don't have a quarterly number.

  • I will have to get back to you.

  • I can't think of anything off the top of my head that would have made a big change.

  • Joel Tiss - Analyst

  • Okay.

  • And also can you just give us a sense about sustainability of this rebound that we're feeling in the construction industry?

  • And I'm thinking into '04, '05, not anything specific, just kind of where are we in the cycle?

  • Greg Derrick - Directot of Investor Relations

  • Well, I think the kinds of increases you've seen lately, I don't think it's reasonable to think that you're going to see increases like that but I think, at least in terms of our sales but generally speaking, it looks like that business is headed in the right direction.

  • We do think a lot of the replacement we've seen to date has been or the buying we've seen has been along the lines of a replacement cycle type thing as opposed to any type of organic need for new machines but it definitely looks like that business is going the right way.

  • Joel Tiss - Analyst

  • So a lot of that replacement demand is being satisfied in the nearer term, do you think?

  • Marie Ziegler - Vice President of Investor Relations

  • It's up, but from very, very low levels.

  • So we think that there is some potential for sustainability here.

  • Again, you're dealing with very low levels.

  • Remember, this equipment has been working throughout this downturn in our own equipment sales and industry equipment sales and the equipment has aged out, so there is some opportunity here for replacement.

  • It's not a one-quarter or two-quarter phenomena, but you're looking at changes from extremely low levels of activity.

  • Operator

  • Your next question comes from Steve Volkmann.

  • Please state your company name.

  • Steve Volkmann - Analyst

  • Morgan Stanley.

  • Greg Derrick - Directot of Investor Relations

  • Hi, Steve.

  • Steve Volkmann - Analyst

  • Hi, guys.

  • Most of it, I think has, been answered.

  • In the subsidiary income the other income was stronger than what I was looking for in my model and sort of stronger than the recent run rate.

  • What happenedthere and how should we look at that going forward?

  • Marie Ziegler - Vice President of Investor Relations

  • I think there you are seeing some of the improved market conditions that we're seeing in construction equipment because that would reflect the subsidiary income and would include income from Nortrax and our Hitachi joint venture.

  • Steve Volkmann - Analyst

  • Is 10 million reasonable going forward, or, any color on that?

  • Marie Ziegler - Vice President of Investor Relations

  • Let me just take a quick peek at that.

  • Steve Volkmann - Analyst

  • While you are at it, when does the Nortrax thing go away?

  • Marie Ziegler - Vice President of Investor Relations

  • Just a second, Steve .

  • We would not, Susan just found the number here.

  • For the fourth quarter, that probably does seem to be a bit -- probably 10 million is not a good run rate in the fourth quarter and I guess now that I think about it that would reflect the fact that the market is usually seasonally a little slower.

  • Hitachi would have seasonal production for example, so you would not see a 10 million run rate, something less than that.

  • In terms of the Nortrax accrual that, will depend on whether or not we exercise our call options which the first one, our first opportunity would be in December.

  • So for planning purposes I can't tell you for sure what we will do but that's the earliest opportunity for it to end.

  • Steve Volkmann - Analyst

  • Okay.

  • And then is it too early to get an early look at pension in '04?

  • Marie Ziegler - Vice President of Investor Relations

  • Our current thinking is that the incremental cost on pensions and on opeb together, next year the incremental impact would be $150 million.

  • Our previous talk had been an increase of 50 to 100 million and that really reflected the fact that interest rates are lower in the market.

  • Last year we valued those pensions at a discount rate and the opeb, at a discount rate of 6.75% and, of course, interest rates have moved down since that time.

  • The reason for the change in guidance from 50 to 100 up to 150 really reflect the fact that medical inflation has continued into this year so we're anticipating that we might have some higher expenses.

  • As you know, a lot of these valuations are done just on the 31st of October and so a lot of what we're going to be accruing for next year will depend on how interest rates look at the time.

  • But our best estimate is an incremental impact of 150 million.

  • Steve Volkmann - Analyst

  • That's great.

  • Thanks very much.

  • Operator

  • Thank you, your next question comes from David Bleustein and please state your company name.

  • David Bleustein - Analyst

  • Good morning.

  • UBS.

  • Just to clarify, you mentioned that ag sales had improved in the last few weeks but it didn't look like it in the July numbers.

  • Does that mean August retail improved or are your dealers placing more orders with you?

  • Greg Derrick - Directot of Investor Relations

  • In general the retail activity in the last several months has been better than what it had been before.

  • I don't know that anybody is saying that it's at a particularly high level but particularly if you look at the overall units, say in tractors, there very definitely is some improvement occurring there.

  • Marie Ziegler - Vice President of Investor Relations

  • David we were up double digits in both utility tractors and in combines, so you saw a good level of activity there.

  • David Bleustein - Analyst

  • Fair enough.

  • There's still an excess of 3 billion of cash on the balance sheet.

  • Can you walk through how management prioritizes its use of funds and how you think about cash when calculating return on assets?

  • Marie Ziegler - Vice President of Investor Relations

  • We continue to hold on to that cash because of our credit rating, this gives us some cushion.

  • As you know, we are rated A 2-P 2 on the commercial end of the market.

  • This gives us some liquidity in the near term.

  • Looking out a bit longer, management of course does continue to see opportunities to invest in the business.

  • With a 20% operating return on asset target, we're unlikely to be able to find a lot of acquisitions that makes a lot of sense there, so we anticipate future growth will be more of the type of things like with the 100 series you saw, reaching new customers with niche-type acquisitions, like landscape.

  • Then finally, as we look at our cash position, we do have some opportunities, we think to return it to shareholders and I should also note that we do expect to, over the next few years, put in, in the range of $300 million a year on pension.

  • So that would use a little bit of that cash as well.

  • In terms of our formal calculation of operating return on assets, cash would not be included in that calculation.

  • David Bleustein - Analyst

  • All righty.

  • Terrific.

  • Thanks.

  • Operator

  • Thank you.

  • Your next question comes from Steve Hagerty Please state your company name.

  • Steve Hagerty

  • Good morning.

  • It's Merrill Lynch.

  • Two quick questions, related.

  • The first is, if I think about how you've adjust your outlook for net income for the full year from 500 million to 600 million to 575 to 625, is all that increase occurring in construction and forestry because it sounds like you've kept your outlook the same for financial services, you've got a slightly weaker outlook for commercial and consumer and I'm not sure about ag?

  • Marie Ziegler - Vice President of Investor Relations

  • Slightly weaker for construction consumer?

  • That would not be the case.

  • Steve Hagerty

  • Where is the increase coming from the change in outlook, which of the business divisions?

  • Greg Derrick - Directot of Investor Relations

  • As far as net income, really whatever the profit calculation is based on, the biggest shift would be in construction.

  • I mean that's where we have a 7% sales change.

  • Marie Ziegler - Vice President of Investor Relations

  • Then commercial consumer.

  • Greg Derrick - Directot of Investor Relations

  • Yeah, CC&E is up marginally

  • Steve Hagerty

  • None of it in ag?

  • Marie Ziegler - Vice President of Investor Relations

  • A little improvement in ag but not to the same degree.

  • Steve Hagerty

  • As a follow-on, in terms of the financial services performance in the quarter, I just wanted to understand how much of that improvement is sort of sustainable going forward?

  • The incremental bad debt charges that you mentioned, Greg, of 12 million, that's a one-off that occurred last year that didn't occur this year so that's out of the system now?

  • Greg Derrick - Directot of Investor Relations

  • That's right.

  • Steve Hagerty

  • Then the A B.S. sales gain of 12 million, remind me how often you're doing these asset backed securitizations and when you tend to do them in the course of the year.

  • Should we expect another one of those in the fourth fiscal quarter?

  • Greg Derrick - Directot of Investor Relations

  • I don't think we're looking for significantly more this year on A.B.S..

  • The A B.S. totals moving around from year to year.

  • Last year, just for reference we had about $100 million last year and this is pre-tax and pre-tax gains this year will probably be about half that.

  • We're pretty much, I think, where we're going to be for the year.

  • Marie Ziegler - Vice President of Investor Relations

  • Steve, let me just chime in here.

  • We tend to be opportunistic on our use of that market and our current plans would have very modest level of activity in the fourth quarter.

  • Really, maybe just slightly higher than what we had last year.

  • Again, we're opportunistic.

  • Steve Hagerty

  • Thank you very much.

  • Operator

  • Your next question comes from Joanna Shatney.

  • Please state your company name.

  • Joanna Shatney - Analyst

  • Good morning, Goldman Sachs.

  • Can you guys talk about production versus retail in '04, are we implementing at some point the inventory management process or is that still further away?

  • Marie Ziegler - Vice President of Investor Relations

  • We've actually, we are gradually implementing it in ag.

  • I would say at this time we would expect that our production would be in line with retail, generally speaking, across all three businesses.

  • Again, we do not have a formal outlook for 2004 yet but, generally speaking, that would be the case.

  • Joanna Shatney - Analyst

  • Okay.

  • And at the end of the year you've got your union contract coming up.

  • Can you just kind of give us the dates and what we should be watching for and kind of -- I'm sure health care is going to be the big issue.

  • It's the big issue for everybody.

  • Just give us some color on what to expect in the next couple of months for that?

  • Greg Derrick - Directot of Investor Relations

  • The contract expires on 1st of October, so we will be going into talks soon but we're really not going to comment on what the issues are.

  • Joanna Shatney - Analyst

  • Did we realize any of those savings that we had talked about because part of that involved hiring a lot of new people in under the old contract.

  • Did we get any real incremental savings you should the prior five-year daily?

  • Greg Derrick - Directot of Investor Relations

  • I don't know that we can quantify it but there's absolutely improvement because I think about a third of the UAW force now

  • Marie Ziegler - Vice President of Investor Relations

  • Just to correct, one-seventh.

  • Greg Derrick - Directot of Investor Relations

  • So about a thousand.

  • Joanna Shatney - Analyst

  • Is under new contract.

  • Marie Ziegler - Vice President of Investor Relations

  • Under the new contract.

  • Joanna Shatney - Analyst

  • Thanks.

  • Operator

  • Thank you.

  • Your next question comes from John Mcginty.

  • Please state your company name.

  • John Mcginty - Analyst

  • Credit Suisse First Boston.

  • Good morning.

  • I want to get back to the thing that David Bleustein was touching on.

  • I'm a little bit confused.

  • It's very un-Deere like to make a statement that retail sales of machinery in the U.S. have moved up in recent weeks which implies not only a kind of recent time frame and admittedly, it was just June was when it started but also implies that -- are you saying anything about what's continued through August?

  • I wondered if -- you said row crops were down double digits.

  • Can you talk about things like orders, showroom activity, in other words is this just based on the EMI data that you're looking at or does it transcend it a little bit based on what you're hearing back from the dealers, the regions and everything else in terms of the implications for higher retail sales?

  • Greg Derrick - Directot of Investor Relations

  • Basically, I don't know that there are any implications there.

  • We're commenting specifically on what the AAM data is showing.

  • We had a couple of pretty decent months on the retail side.

  • We had said we thought things, the sales would be a little better in the second half of the year and so far that has proven to be the case.

  • Marie Ziegler - Vice President of Investor Relations

  • John, just to let me add to what Greg said, we are hearing, you know, in the midst of meeting with some of our dealers as we speak and we are detecting a little better mood in the field.

  • John Mcginty - Analyst

  • Can you give us a quantification to the fact that you were saying down 5, you're now saying flat to down 5, what that means specifically for the fourth quarter now versus where you were a quarter ago in terms of the forecast?

  • Greg Derrick - Directot of Investor Relations

  • I don't think we can refine it that much, John.

  • The only place I can see where that might come out is that the production that we were anticipating in ag for the fourth quarter we had said it would be down, I think in excess of 10%, we were saying 3, in North America three months ago, and now we're saying 7.

  • So at the margin, that's a little better but I can't really give you a better analysis of that.

  • Other than the fact that the market is, you know, incrementally, it has improved a little bit.

  • John Mcginty - Analyst

  • I guess kind of the follow-up to that, you mentioned quite -- I would agree that the tax legislation on depreciation, write-off and so on is likely to be beneficial.

  • Are you seeing that now or is this more likely to be a November/December kind of a most people's, you know, taxpayer's year end rather than a Deere fiscal year end, in other words, are you expecting that in the fourth quarter or is that going to be, for Deere a first quarter event?

  • Marie Ziegler - Vice President of Investor Relations

  • It will be more of a first quarter event for Deere in terms of translating to retail activity because of course our fiscal 2004 begins in November.

  • We are certainly hearing a lot of chatter anecdotally and a lot of enthusiasm and we have provided a lot of materials to our farm customers.

  • We've done this in commercial, on the commercial end of the business, too, to make sure that people understand the potential opportunities there to say that we're cautioning them to consult with a tax adviser but there is opportunity.

  • John Mcginty - Analyst

  • Then just a final follow-up, not to be cynical but the way your SVA works, what's the trade-off for someone running that division in terms of keeping the inventories low therefore getting assets out but suffering a lower level of earnings in the fourth quarter but getting assets out?

  • Is there any reason that the move to that is, in fact, bringing assets down at the same time that retail sales look like they're starting to get better since your investors are more of less where you want them now, looking better but if the retail goes up they're actually going to be too low?

  • Marie Ziegler - Vice President of Investor Relations

  • Well, John, one point, remember October is really the end of the new season.

  • John Mcginty - Analyst

  • Yep.

  • Marie Ziegler - Vice President of Investor Relations

  • So we have the benefit, or the luxury, if you will, with lower inventories because you've got a period of time when that equipment is not going to be used heavily.

  • We certainly plan to make sure that we have adequate supplies to take advantage of anybody's potential tax needs but we still think there's opportunity.

  • John Mcginty - Analyst

  • Fair enough.

  • Thank you.

  • Operator

  • Your next question comes from Barry Bannister.

  • Please state your company name.

  • Barry Bannister - Analyst

  • Legg Mason.

  • Hi, Marie.

  • Marie Ziegler - Vice President of Investor Relations

  • Hi, Barry.

  • Barry Bannister - Analyst

  • Maybe Greg knows the answer to this as well but you've mentioned the tax law changing helping with the retail sales number for the quarter.

  • Could you discuss some of those changes and whether they're working from both the used equipment side, from the bottom up and the new equipment side from the top down, in the tax credits may be available to buyers at the first and second tier among farmers, whatever type of equipment they choose to buy from a dealer?

  • Greg Derrick - Directot of Investor Relations

  • Basically, you know, what we would see on this is that you've got benefits on both sides.

  • You've got it on the new side, got it on the used side.

  • Theoretically, you could argue that that's been the case for the last several years but what's happened is that these features have been enhanced in the form of the most recently passed tax legislation and basically on the new side with the 50% depreciation bonus you can now expense about 55% of the value of a new piece of farm machinery and I think it's even a little bit higher than that in construction.

  • That would be applicable to new equipment.

  • On the used side, we think there could be some benefits from the section 179 credit which is of particular benefit to smaller operators.

  • That had been operating -- that's been around for awhile, but the threshold has been $25,000 and now that's been elevated to $100,000, so that should be a help on the used side.

  • So our belief is that via the enhanced depreciation and the expanded 179 credit that this should be beneficial to sales on both sides.

  • Barry Bannister - Analyst

  • And, Greg, just as a follow-on, since you were talking generally about the effect on price, could you talk about the 3% ag worldwide price increase and break it down between North America and overseas because I was operating under the impression that the North American pricing improvement anniversaried around May 1st in terms of reductions of discounting and that that did not continue in this quarter.

  • So I'm trying to derive where you managed to achieve a 300-basis point increase in pricing in ag.

  • Greg Derrick - Directot of Investor Relations

  • We're looking at that.

  • Marie Ziegler - Vice President of Investor Relations

  • I could take a shot at this.

  • Actually we saw a little more strength coming out of our overseas market in terms of that 3-point pricing but we still got some increase in North America.

  • Obviously, you'd have to, to get 3 points.

  • Barry Bannister - Analyst

  • With weakening sales in overseas you managed to see a strengthening in pricing power?

  • Marie Ziegler - Vice President of Investor Relations

  • Yes.

  • Barry Bannister - Analyst

  • Okay.

  • Marie Ziegler - Vice President of Investor Relations

  • New product, new features, broader distribution.

  • Barry Bannister - Analyst

  • Thanks, guys.

  • Operator

  • Thank you.

  • Your next question comes from Robert McCarthy, and please state your company name.

  • Robert McCarthy

  • Robert W. Baird.

  • Good morning, everyone.

  • Marie Ziegler - Vice President of Investor Relations

  • Good morning.

  • Robert McCarthy

  • You've made some, what, call them preliminary optimistic comments about the potential for North American ag retail next year.

  • Could you say or address what your sense is of prospects for European market particularly given recent weakness and issues of drought and changes in cap?

  • Greg Derrick - Directot of Investor Relations

  • I don't know that we've necessarily forecast anything on the European side.

  • That market has been pretty hot though, of late and it's probably, certainly on a long-term basis, probably operating at above an equilibrium point but to my knowledge, we have not commented about what it might look like next year.

  • Marie Ziegler - Vice President of Investor Relations

  • We would view the extreme dryness and the impact that's going to have on farm income, so a little bit of concern, I'm sure we would be cautious certainly in our outlook for 2004 but we don't have an official number yet and unfortunately won't until November.

  • Robert McCarthy

  • Right, okay.

  • Separately, small housekeeping item, could you give us the pension and opeb impact for each of the three segments in the quarter?

  • Greg Derrick - Directot of Investor Relations

  • Sure.

  • Marie Ziegler - Vice President of Investor Relations

  • Actually, Rob, that -- we can pull it right out.

  • For worldwide ag --

  • Greg Derrick - Directot of Investor Relations

  • Are you talking about the incremental pension and opeb expense, right, Rob?

  • Robert McCarthy

  • Yes.

  • Greg Derrick - Directot of Investor Relations

  • 52 for ag.

  • Marie Ziegler - Vice President of Investor Relations

  • It's in the press release.

  • It's 7 million for commercial and consumer and for construction, it's 10.

  • Robert McCarthy

  • Sorry for putting you through that.

  • Marie Ziegler - Vice President of Investor Relations

  • That's okay.

  • Robert McCarthy

  • Thank you.

  • Operator

  • Thank you.

  • Your next questions comes from Antonio Antozano and please state your company name.

  • Antonio Antozano

  • Good morning.

  • Bear Stearns.

  • What is your number for Brazil from a product and channel standpoint what product are you focusing on there?

  • Marie Ziegler - Vice President of Investor Relations

  • In Brazil, well, we our biggest opportunities have been and continue to be in combines and in tractors.

  • In tractors in particular simply because we don't -- we were not in the market prior to 1996.

  • We've added tractor lines and continued to build on that.

  • Antonio Antozano

  • And then follow-up, looking at the equipment operations P&L, the older operating expense was lower than year ago and lower than prior quarters.

  • What should we expect going forward?

  • Marie Ziegler - Vice President of Investor Relations

  • That really related to exchange, which an exchange gain that benefited last year -- or the exchange impact last year that we didn't have this year.

  • I would use the fourth quarter rate -- or the third quarter rate and assume that that goes into the fourth quarter.

  • Antonio Antozano

  • Thank you.

  • Operator

  • Thank you.

  • Your next question comes from Robert Bradalara and please state your company name.

  • Robert Rizzalara - Analyst

  • First Trust.

  • I'm just confused about one aspect.

  • I don't understand, if things are looking up in most of your businesses, including the most important aspect of the ago agricultural cultural business relative to farm payments and livestock prices and the benefits of the new tax legislation, why is production being reduced?

  • I don't understand it.

  • It just doesn't seem to come together for me.

  • Can you try again and see if you can get it across to me?

  • Greg Derrick - Directot of Investor Relations

  • A lot of it has do with the very seasonal nature of our business and the fact that there's not a lot of demand in the wintertime and as we migrate to a build to order system, which we've done particularly successfully in construction and we're trying to extend that to our businesses, you know, you probably going to be in an ideal sense you're going to produce the products as close to the time of use or as close to the time of sale as you possibly can.

  • Marie Ziegler - Vice President of Investor Relations

  • In addition, last quarter we had anticipated that production in North American ag would be down 10% or more in the fourth quarter and we're now saying down 7%, so we have improved the outlook.

  • Robert Rizzalara - Analyst

  • All right.

  • Okay.

  • Thank you very much.

  • Marie Ziegler - Vice President of Investor Relations

  • Thank you.

  • Operator

  • Thank you.

  • Your next question comes from Alex Blanton and please state your company name.

  • Alex Blanton - Analyst

  • It's Ingalls & Snyder.

  • Marie, could you comment on the change in the capital spending figure?

  • You're spending 50 million less than you had planned but for next year, the increase is a range of 20 to 33%.

  • So that kind of goes along with what we're seeing in general.

  • There's an increase in capital spending in the economy in general just starting up and it's affecting you because your customers are doing the same thing.

  • So what is bringing that about?

  • Marie Ziegler - Vice President of Investor Relations

  • That would not be the case.

  • Think about spending range of about 425 million improved for both 2003 and 2004 and what's happening is at the rate of spend for this year we're going to come in at about 375 instead of 425, and that 50 million, then, is just simply being deferred into 2004.

  • It really has to do more with the timing of the spend.

  • Alex Blanton - Analyst

  • What happened there?

  • Marie Ziegler - Vice President of Investor Relations

  • You know, a project may not be progressing quite as fast as people anticipated.

  • They may have decided that a project could be done at a later time.

  • This is a very typical occurrence for us as you move through the year you make refinements in what you're actually going to tackle.

  • Alex Blanton - Analyst

  • So you really got more cautious about this year.

  • Earlier in the year slowed down the project.

  • Marie Ziegler - Vice President of Investor Relations

  • I think it has to do more with planning the work flows, what needs to be done when.

  • Greg Derrick - Directot of Investor Relations

  • Also, even with 375, that's higher -- that's more than we spent last year, Alex.

  • Alex Blanton - Analyst

  • Thank you.

  • Operator

  • Thank you.

  • Your next question comes from David Raso.

  • Please state your company name.

  • David Raso

  • Smith Barney.

  • Quick question on ag profits.

  • If you play around with the three moving parts, the pension, $52 million hit, the $56 million price benefit, and the $14 million FX benefit, pulling out those three it implies core profits were down $96 million in ag year-over-year on a 5% volume decline which is only $94 million.

  • And I understand that shut-downs were in your high leveraged plans.

  • I'm just trying to understand the leverage over 100%.

  • Can you help me understand?

  • Was there anything unique going on during the quarter, why the ag profits were that low?

  • Not to discredit getting pricing, I understand that getting it was horrific, I'm just trying to understand the inherent nature of the leverage.

  • Can you help us there?

  • Marie Ziegler - Vice President of Investor Relations

  • I'm just reaching for my forecasted production.

  • Where did I put that?

  • Or the tonnage page.

  • The issue may be better explained if we tell you that production in North American factories, the weight of what we produced was down 14% in the third quarter and that's comparing against that 5% total for the worldwide division.

  • So you had an unfavorable mix, if you will.

  • David Raso

  • Not to be skeptical on the price increase, but fundamentally over 100% decremental margin just seems a little bit extreme if I believe the price increase and everything else.

  • Can you help me understand, is that the inherent leverage that, I mean, generally it's not that high, so I know it's not the inherent leverage but if something changed or something changed that explains that weak profit performance?

  • Marie Ziegler - Vice President of Investor Relations

  • Again, you have a significant impact from a 14% tonnage cut in our North American operations and a lot of that came out of Waterloo because Waterloo was shut down for parts of the third quarter.

  • David Raso

  • I'll follow up.

  • It just seems a bit extreme, down 14 on tonnage.

  • Marie Ziegler - Vice President of Investor Relations

  • Waterloo would be a very significant, as you know, plant for us.

  • David Raso

  • I appreciate that.

  • Thank you.

  • Operator

  • Your next question comes from Andrew Casey.

  • Please state your company name.

  • Andrew Casey - Analyst

  • Prudential Equity Group.

  • Just a follow-up on Bob Brazalere's question.

  • If you -- can I go back and assume that ag in North America has gotten a little bit better in the outlook?

  • Are you just not building into your forecast any of the improvement that you've seen lately?

  • Marie Ziegler - Vice President of Investor Relations

  • Well, again, our forecast had North American production in the fourth quarter down 10% or more and we improved it to now down about 7%, so we have tweaked it upwards and that is being reflected.

  • We made a modest improvement in our guidance for the full year outlook from down 5 to flat to down 5.

  • So there's been a very modest improvement but you're still looking at a market that's been a little bit sloppy and you are seeing improvement but coming off of a very low base and again you end the year at a time when there's not a lot of seasonal demand for equipment.

  • Andrew Casey - Analyst

  • And then if we can go back to David Raso's question, I think it probably ties into the question before, if you look at Waterloo and the ongoing efficiency improvement, am I to look at the 14% reduction in tonnage in addition to the costs associated with the efficiency improvements, do those potentially go away towards the end of next year or get better?

  • So the incremental profit, going forward, should be much higher, is that a correct way to read this?

  • Marie Ziegler - Vice President of Investor Relations

  • Yes.

  • Andrew Casey - Analyst

  • Thank you.

  • Operator

  • Thank you, your next question comes from the line of Steve Hagerty and please state your company name.

  • Steve Hagerty

  • It is Merrill Lynch, I just wanted to follow up on something Greg mentioned earlier in the presentation about, I think you said, Greg, your view that the improved outlook for farmers' cash flow, the early indications are that you expect that to continue, did you say into '04 and is that based on an internal forecast if it '04 or is that based just on a U.S.D.A. outlook?

  • Greg Derrick - Directot of Investor Relations

  • It is based on our forecast and what we are seeing now is with that cash receipt number which is the top line number, we would be a little better next year.

  • It is still early but that's the best of our evaluation at this point.

  • Alex Blanton - Analyst

  • Okay, thank you.

  • Operator

  • Thank you, your next question comes from Barry Bannister and please state your company name.

  • Barry Bannister - Analyst

  • Legg Mason.

  • Greg, or Marie, could you give us, just to follow up on the two Davids questions earlier, if we finish this fiscal year at about 26 DSOs on the equipment side for trade receivables and about 7.6 turns in inventory, given that you have made quite a bit of progress in this down turn unlike some of your competitors in terms of producing working capital.

  • Can you just empirically give us an idea of what your long term goals will be for inventory turnover and DSOs if we look out over several years rather than just the myopic next quarter or even next year view?

  • Marie Ziegler - Vice President of Investor Relations

  • I don't have a DSO calculation, I can tell you that when we look in total at our assets which would include valuing inventories at a pre-life or in other words a FICO plus standard type or basis, we are looking to achieve 2 turns and that would be true in all three of our equipment divisions and we are not there yet in ag this year and, frankly, I don't know about the other two divisions but we have some upside opportunities.

  • Barry Bannister - Analyst

  • That recalculation of the two is versus what currently?

  • Marie Ziegler - Vice President of Investor Relations

  • We have got a charge...

  • Greg Derrick - Directot of Investor Relations

  • Last year was 1.6 and this year, I don't know if we will be 2 but we won't be far from it.

  • Barry Bannister - Analyst

  • Okay, we are talking this year but what about long term has there been any discussion about long term goals or is this an ongoing thing, can we look forward to you producing under retail for quite a long time or is it more of an event related to this fiscal year?

  • Greg Derrick - Directot of Investor Relations

  • If you look at our objectives for asset turns and margins which yields that 20% figure at normal, that assumes two turns and the two doesn't vary too much across the cycle, it pretty much delivers if you look at the continuum the margin is really the variable there, more so than the asset turns but we think two turns is about right and we won't quite be there this year but we certainly are getting close.

  • Inventories return more than assets.

  • Barry Bannister - Analyst

  • That is good to hear, thanks.

  • Marie Ziegler - Vice President of Investor Relations

  • We have got time for one more question.

  • Operator

  • Thank you and our final question comes from Steve Goldsmith, please state your company name.

  • Stephen Altman

  • Marie, I wonder if you could comment on this, obviously I think people are having trouble squaring your slightly better outlook with the fact that you are under producing, could you comment on how much more shorter, maybe your cycle times are now than they were five or ten years ago and your ability to react more quickly than you have in the past to changes in retail demand could that be why you feel like you can afford to be more cautious with the build schedule than some of us think you might ought to be given the realities of the market?

  • Marie Ziegler - Vice President of Investor Relations

  • We have significantly, of course, shortened our bill times on tractors, it wasn't that long ago that you would look at something in excess of three months and at the time we started the Waterloo development we were at 40-some days and by the time we were done, remember, we are only 3 years into it, we will be somewhere around a 7 day reaction time.

  • The other factor, though, that we have at play here is simply reflecting the seasonal nature of our business which is something that in our traditional sales models we tended to operate the factories at more level production levels and we have changed that so we have different, if you will, different daily build rates as you approach the use season and that is done, of course, to lower the overall inventories to make sure that we get the right products to customers at the right time but what happened in the past in a more level build schedule is that you would build a tractor assuming that we knew what the options were that the customer wanted, this way we could make sure that the customer gets exactly what he or she wants .

  • Stephen Altman

  • And how much flexibility do you have with your workforce or various other costs in order to sort of minimize the margin impact or are we just going to have, obviously real big second/third quarter and losses for the first?

  • Marie Ziegler - Vice President of Investor Relations

  • You are going to have very attractive second and third quarters because the production will be concentrated in there, frankly, for all three businesses and then softer first and fourth quarters.

  • I might also add that a lot of our variations, if you will, are done with shut downs, a week here, a week there and you have the opportunity as you see the markets changing to take away, for example, a shut down if it is necessary.

  • So you do have some flexibility there.

  • Stephen Altman

  • Great, thank you.

  • Marie Ziegler - Vice President of Investor Relations

  • Thank you all for participating in today's call.

  • Operator

  • Thank you, this does conclude today's conference call, we thank your for your participation.