強鹿 (DE) 2008 Q2 法說會逐字稿

Welcome to the Deere & Company second quarter earnings conference call.

Your lines have been placed on listen only until we open up for questions and answers.

I'd now like to turn the conference over to Ms.

Marie Ziegler, Vice President Investor Relations.

Please go ahead.

Good morning.

Also on today;s call are Mike Mack, our Chief Financial Officer, as well as Susan Karlix, Karen [Thompson] and Bill Ratzburg, from our IR team.

Today we'll take a closer look at Deere's second quarter earnings and then spend a few minutes talking about our markets and where things are headed for the rest of the year.

And after that we'll respond to your questions.

First though, a reminder that this call is being broadcast live on the internet and recorded for future transmission and use by Deere, Thomson Reuters, and third parties.

Participants in the call including the Q&A session agree their likeness and remarks and all media may be stored and used as part of the earnings call.

This call includes forward-looking comments concerning the company's projections, plans, and objectives for the future that are subject to important risks and uncertainties.

Actual results might differ materially from those projected in these forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially is contained in the company's most recent Form 8-K and periodic reports filed with the Securities and Exchange Commission.

The Company, except as required by law, undertakes no obligation to update or revise its forward-looking information.

The call and the company materials are not an offer to sell or a solicitation of offers to buy any of the company's securities.

This call also may include financial measures that are not in conformance with GAAP -- that would be Accounting Principles Generally Accepted in the United States of America.

Additional information concerning these measures including reconciliations to comparable GAAP measures is posted on our website at www.deere.com/financialreports under Second Quarter 2008 Reports.

Call participants should consider the other information on risks and uncertainties and non-GAAP measures in addition to the information presented on today's call.

Now before we turn to the details of the quarter, let's have Mike Mack make a few remarks and please start with Slide 3.

Earlier this morning, we reported terrific results for the second quarter, in fact the highest sales and earnings for any quarter in our company's history.

While the present is great, our future is even better.

In the second quarter we made three strategic announcements to strengthen that future.

First, in Waterloo, Iowa, we plan to increase large tractor production capacity by about 25% to better serve farmers not only in the United States and Canada but in countries like Brazil, Kazakhstan, and Ukraine.

Second, in the Kaluga region of Russia, we are developing an operation center for parts and complete goods distribution along with the training facility.

We believe this new 98 acre site represents one of the largest single investment projects by a non-Russian farm and forestry equipment manufacturer.

The site can accommodate future expansion into local assembly and manufacturing.

Third, in Xuchou, China, we intend to expand our construction equipment business by entering into a joint venture with Xuchou Xuwa Excavator Machinery Company.

While we have long had a presence in the Chinese agricultural equipment market, this will be our first manufacturing operation in the Chinese construction equipment market.

These three join many other efforts to help our customers productively meet the world's growing need for food, fiber, shelter and infrastructure.

And reflecting global magnitude of this need for productive equipment, this year for the first time, our agricultural equipment sales outside the United States and Canada are projected to surpass those in the U.S.

and Canada.

And that is true even excluding currency changes.

Truly historic.

Another important point is that while the thriving farm sector is a headline item at present, the news that John Deere goes beyond farm machinery.

Our construction in forestry and commercial and consumer equipment businesses remains solidly profitable.

This is a notable feat -- I'd say unprecedented -- in a difficult U.S.

economic environment, with growth anemic and housing starts at the lowest levels since World War II.

We are clearly demonstrating the power of the shareholder value-added model.

While we remain on track for another record performance in 2008, we do face cost pressures.

These are reflected in our earnings guidance, specifically in the second half of the year.

Raw material costs, especially for vital commodities like steel, are racing ahead, well beyond what we had anticipated when we set prices for model year 2008.

We've recently announced a number of price increases and we are aggressively pursuing continuous improvement projects that will help us offset higher costs, but the effect of these efforts won't have much impact before next year.

And while our suppliers are doing a great job keeping up with sometimes dramatic volume increases this year, spot shortages of various parts and components are cropping up from time to time.

Specifically and certainly not a surprise to any of you, agricultural tires have become more challenging.

These near term challenges in no way detract from the great promise of our businesses and the tremendous opportunity that promise represents for our customers, our employees, our suppliers, our communities, and our investors.

Now for a closer look at the second quarter, here is Bill.

Thank you, Mike.

Turning to Slide 4, this morning Deere reported second quarter net income of $763 million on equipment operations net sales of approximately $7.5 billion.

Net income increased 22% and diluted earnings per share rose 28%.

On Slide 5, total worldwide equipment operations net sales were up 19% compared to the second quarter of 2007.

About 6 points related to positive currency translation.

LESCO added about another 3 points and there were about 2 points of price realization.

The remainder is primarily from increased volume.

On Slide 6, you you can see our second quarter production tonnage was up 17%.

For the third quarter, worldwide production tonnage is expected to increase 14%.

For the full fiscal year, 2008 worldwide production tonnage is now forecast to be up 17% versus our previous forecast of up 15%.

Both are driven by a very strong global market in agriculture.

Regarding our company outlook, let's turn to Slide 7.

For the third quarter of 2008, we expect companywide equipment operations net sales to be up about 20%.

Currency is forecasted to account for about 4 points.

Net income is expected to be $550 million to $575 million in the quarter.

For the full year, we are you now forecasting equipment net sales to be up about 20% compared with fiscal year 2007.

This includes about 5 points of currency and about 2 points of price realization.

The 2008 net income forecast remains at approximately $2.2 billion.

Let's turn to a review of our individual businesses starting with Agricultural Equipment on Slide 8.

While the press release describes the major items affecting financial results, let me mention that of the 34% net sales increase in the second quarter, currency translation accounted for about 8 points.

Operating profit increased 61% to $782 million, with currency translation contributing about $50 million.

Looking ahead, global ag fundamentals are really encouraging.

Worldwide stocks to use ratios remain at very low levels, particularly for corn and wheat, and Slide 9 highlights the exceptional strength of the futures market for the important commodities of corn, wheat, and soybeans.

Deere's forecasted commodity prices are on Slide 10.

The strong market for crops drive good levels of farm income globally and as shown on Slide 11, please note that our forecast for total U.S.

farm cash receipts for 2008 and 2009 are higher than our outlook from just one quarter ago and have dramatically increased levels from those of just a few years ago.

In addition, although the United States Farm Bill has not yet been passed by Congress and enacted into law, with commodity prices as high as they are, the bill would have minimal impact on 2008 and 2009 U.S.

farm cash receipts.

All of this translates into a strong outlook at John Deere, not only for tractors and combines but also for products like sprayers and seeding equipment, and provides solid support for our outlook for industry sales of agricultural equipment in the U.S.

and Canada as shown on Slide 12, which is now up about 20% from 2007.

In addition, our industry outlook for South America is now up about 30%.

Note, however, that uncertainties exist regarding the status of loan payments due in 2008 by farmers in Brazil as well as over the impact of Argentina's export taxes, both of which could affect agricultural equipment sales in those regions.

The increased industry forecast for South America is complemented by Slide 13, which demonstrates solid farm incomes in Brazil and Argentina.

Slide 14 highlights the strength of the European agricultural market as well.

As shown on Slide 15, our outlook for 2008 for Western Europe for industry sales remains up 3 to 5% for the fiscal year and very strong growth is expected to continue in central Europe and the Commonwealth of Independent States countries, including Russia.

Australia is recovering from its severe drought and we are seeing excellent growth in emerging markets like China and India, though from a very small base.

So putting this all together, Slide 16 depicts a stronger worldwide outlook for the sale of John Deere farm machinery and services.

Net sales are now projected to be up about 35% with currency translation accounting for about 7 points of the increase.

Just as currency translation will affect net sales, it will also affect forecasted operating profit, adding about $150 million for the full year.

The forecast now anticipates a fiscal year 2008 ag division incremental margin to be about 20%.

Let's move now to our commercial and consumer equipment business on Slide 17 where reported net sales were up 8% in the quarter.

LESCO accounted for about 12 points.

New product introductions continued to drive excellent customer interest, helping to offset market conditions that have become more challenging.

Operating profit increased 3% in the quarter.

Turning to the commercial and consumer equipment outlook on Slide 18, for Fiscal 2008 we now anticipate sales to be up about 4% with LESCO contributing about 6 points.

Portions of the business continue to be affected by the housing slowdown and general economic conditions.

We also have exciting new product offerings in the market this year, including the Precision Cut Fairway Mowers, Select Series homeowner models and utility vehicles.

The integration of LESCO into our landscapes operations is proceeding.

We have begun to merge retail centers where we have redundant footprints.

The rapid rise in fertilizer prices has caused business to slow a bit as is reflected in the slightly lower sales guidance.

Let's focus now on construction and forestry on Slide 19, where sales were down 7% in the quarter and production tonnage off 8%.

Operating profit was lower as well but the division remains strongly profitable with a margin of 12%.

Given today's difficult market conditions, the decrease in the 2008 net sales forecast is quite modest as seen on Slide 20.

Indeed, construction and forestry's solid performance in a sluggish market is due in no small part to the company's actions to make the results of every business more consistent and less volatile under all types of market conditions.

What we're seeing is exactly how our shareholder value-added model is designed to work.

In many respects, construction and forestry has lead the way in production discipline.

It was, you may recall, the first Deere division to adopt a build to order production model.

By aligning supply chain order fulfillment and manufacturing processes, the business gained flexibility in adjusting to changes in the retail market.

As a result, last year the division was able to make rapid and deep production cuts in response to the softening U.S.

market conditions in construction.

This year, it is essentially producing in step with retail demand.

Over the last few years, construction and forestry has expanded its product lineup to include both larger and smaller models and broadened its customer base to serve as an example more large customers.

Along these lines, the division enlarged its global forestry platform, creating even more balance in terms of products sold and markets served.

C&F is doing a good job on the cost side as well, carefully managing R&D and SA&G and putting capital expenditures on hold wherever appropriate.

As a result of these steps, Deere's construction and forestry business is performing quite well in light of the severe downturn that has engulfed the U.S.

housing market.

Based on our present outlook, we expect it to remain solidly profitable for the year with only a small downturn in sales.

Moving now to our credit operations, as you see on Slide 21, credit losses continue to remain low with the current provision running well below its 10 year average.

And as further evidence of the quality of John Deere Credit's portfolio, turn to Slide 22.

As mentioned last quarter, we received the support of rating agencies to increase the company's leverage, from the previous 8.5 to 1 to 10 to 1 and we began implementing the change during the second quarter with a special dividend of $318 million paid to the Deere parent.

Very importantly, SVA for both John Deere Credit and the enterprise will increase due to the change in leverage.

The increased leverage affected quarterly results and is part of the reason credit reported net income in quarter of about $84 million as can be seen on Slide 23.

Our forecasted credit net income for fiscal 2008 is now about $350 million versus the previous forecast of $365 million, with the bulk of this change coming from lower revenues due to slower than expected commissioning of wind projects.

This is just a timing issue and you'll see a related reduction in the 2008 wind capital expenditures as well.

Given the turmoil in the financial markets, Slide 24 highlights our continuing access to the capital markets with some of our recent activities.

Last year, our short-term debt rating was increased to A1/P1.

During the second quarter, we increased our credit facility to $4.5 billion and have a considerable amount of unused capacity.

We consistently were active in the capital markets as well.

We issued $1.6 billion in medium term notes with both issuances being oversubscribed and upsized and the last one being oversubscribed by four times.

Before moving on to retail sales, let's review receivables and inventory.

Looking at the quarter, on Slide 25, you will note that reported trade receivables in inventory were about $1.2 billion higher than a year ago, with currency translation accounting for about one-third of that increase.

The ag division came in $1.1 billion higher, of which currency translation accounted for about $300 million of the change.

The majority, however, is supporting the growing global agricultural business.

Although you have seen trade receivables and inventories increase year-over-year, Slide 26 clearly demonstrates that the increase is driven by the growing level of sales.

As seen on Slide 27, our 2008 year-end forecast calls for flat inventories in trade receivables and C&CE and C&F.

The increase in the ag division is consistent with their larger global footprint and currency accounts for the change from the previous forecast.

Before turning to housekeeping, let's discuss the latest on retail sales.

While we do not have the information available in slide, here is the product category detail from the month of April expressed in units.

For utility trackers, the industry was down 6%.

Deere was down double digits.

For row-crop tractors, the industry was up 15%, Deere was up a single digit.

For 4-wheel drive tractors, the industry was down 10% and Deere was down in line with the industry.

For combines, the industry was up 47%, Deere was up more than the industry.

Dealer inventories in the U.S.

and Canada remain in very good shape as Deere inventories at the end of April remain below industry levels in each of the categories just cited, except 4-wheel drive tractors where they were in line with the industry.

On Slide 28, you see that for row-crop tractors, Deere ended April with inventories at 18% of trailing 12 month sales.

Combine inventories were low at 12% of trailing 12 month sales.

Turning to Slide 29, in Western Europe, sales of John Deere tractors and combines were both up double digits in April.

Moving to Slide 30, Deere's retail sales of commercial and consumer equipment in the U.S.

and Canada were down double digits in April.

Construction and forestry sales in the U.S.

and Canada were down double digits on both the first in the dirt and the settlement basis.

Now let's touch on a few housekeeping items.

I'll let Bill have a moment to recover his voice here.

Regarding material cost in freight, let's move on to Slide 31.

In the second quarter, these costs rose approximately $60 million versus last year, which brings our year-to-date increase to about $110 million.

For the full year, we now expect these costs to increase to a range of $400 million to $500 million, so they're obviously backend loaded.

With price realization running about 2 points in our full year guidance, this means there will be pressure on margins in the second half of 2008, with the impact being most pronounced in the ag and construction and forestry divisions.

Looking at R&D expense on Slide 32, for the full year, R&D is now expected to increase about 13% and the currency accounts for the change in the guidance.

Moving now to Slide 33, SA&G expense for the equipment operations was up about 18% in the second quarter with about 13 points of that increase coming from global growth initiatives and currency translation.

Our fiscal year 2008 forecast now includes SA&G expense increases of about 15% over 2007, with about 9 points of the expected increase coming from global growth initiatives and currency translation.

Regarding the tax rate on Slide 34, during the second quarter, the effective tax rate was approximately 35%, the same as the rate projected for the full year.

Actual shares outstanding at the end of the quarter were about 431 million as shown on Slide 35.

You can also see the history of share repurchases since 2004.

Our cumulative cost of repurchases since we started in 2004 is about $4.9 billion.

22.9 million shares remain under the current $40 million share repurchase program.

Slide 36 provides some additional information related to fiscal year 2008.

For equipment operations, capital expenditures are now forecast to be about $800 million.

Depreciation and amortization is now expected to be about $475 million and we continue to anticipate funding about $425 million in pension and OPEB contributions over the year.

For Financial Services, capital expenditures relating to wind are now expected to total about $375 million in 2008.

Looking ahead, 2008 looks to be a year of exceptional financial results and excellent cash generation.

We continue to consistently execute on our plans for building, growing, and sustaining a great business and we're looking forward to delivering superior results in 2008.

Thank you, Bill.

We're now ready to begin the Q&A portion of this call.

Laura will instruct you on the polling procedure, but as a reminder, I know I ask this every quarter -- in consideration of others please limit yourself to one question with a related follow-up.

If you have additional questions, you are welcome to get back into the queue.

Laura?

(OPERATOR INSTRUCTIONS) Our first question comes from Ann Duignan.

Please state your company name.

Good morning, everybody.

As I've been saying recently, still Bear Stearns.

My question is around your input cost outlook.

My third quarter net income is significantly higher than you're forecasting and I'm trying to figure out if it's just the input cost.

Can you walk us through the back half of the year what you're anticipating in third quarter and what you're anticipating fourth quarter at least directionally if you can't get an actual?

And my related follow-up then is how much of the increase have you already seen versus how much are you just baking in just in case?

Ann, we have a fairly large range on our raw material costs for the full year, $400 million to $500 million, given that we're halfway through the year.

Year-to-date we have seen $110 million, so you're looking for approximately $300 million plus in the second half of the year.

This is a rapidly evolving situation and somewhere in the range of $400 million to $500 million is our best estimate at this point.

I can't give you more precise guidance.

But can you tell us where exactly have you seen the ramp up as you've gone through this quarter?

I'm trying to get a sense of -- are we going to see it ramp up slowly in Q3 into Q4?

Or have you seen it already and it's going to be a big step function in Q3 and then stable in Q4?

Our forecast would assume that we would see some ramp up in the third quarter and maybe a little bit more in the fourth quarter.

And as you know, it's coming from really a variety of commodity groups.

So primarily raw materials?

Well, it's tied in into the components, Ann, as well and the logistics costs because of what's happened with oil, so it's really across-the-board.

Okay, is that my follow-up there or do I have another follow-up?

You're done.

Okay, I'll get back in line.

Thanks.

Thank you.

Our next question comes from Andrew Obin and please state your company name.

Yes, Merrill Lynch.

Just a question on the impact of FX in agricultural equipment.

A, if you could give me the number and if you can't, just -- I'm just trying to figure out if the fact that you are selling a lot of stuff in Europe offsetting the fact that you're shipping a lot of stuff from Mannheim worldwide and being negatively impacted by the Euro.

The currency impact for the company are very balanced in terms of the trade flows.

What's coming from the United States into Europe is fairly well offset by what's coming from Mannheim and Zweibruecken back into the U.S.

But there is still a currency translation impact because the foreign currency denominated sales and operating profit translate into higher dollars, and that amount for the ag division is about $60 million in the second quarter, and just as Bill alluded to in our remarks, in his opening remarks about $150 million right now is anticipated in the forecast for the full year.

And just sort of a follow-up.

You can only ask one.

Looking at the tonnage number for construction and forestry, it seems that you still were able to get positive pricing in the quarter and the segment.

Is that a fair estimate?

Yes.

Price realization was slightly positive in the quarter for that division.

That is true.

Thank you very much.

Thank you, Andrew.

Next?

Thank you.

Our next question comes from Jamie Cook and please state your company name.

Hi, good morning, Credit Suisse.

Good morning, Jamie.

Marie, if you could just talk a little bit about your margins on the overseas front.

If you back into it, it looks like it was about 12%, which was a little lower than I thought.

Are there any issues over there?

Can you talk about sort of what you're seeing on the Brazil tractor, the new facility in Brazil, whether that's ramping up according to plan or whether there are any other issues that I should be aware of?

Actually, our overseas operations are performing very well and the Montenegro is quote fully ramped up.

Obviously with very strong market conditions we're looking at what we might do going forward, but they're operating at where we had anticipated.

They would be.

When you look at the margins though overseas, you do have to bear in mind that overseas is where a lot of our growth opportunities are occurring in the near term and so they are probably somewhat disproportionally hit by higher SA&G as we are working to develop future opportunities in these markets.

Okay, and then I guess just a follow-up question, I think you said in your prepared remarks that the ag incremental margins are now expected to be about 20%.

I think last quarter you were saying 20 to 25.

I mean, I understand the issues this year, but I mean as you look at the ag incrementals, is that a number that you would be happy with on a longer term basis?

Would you continue, is there any other efficiencies that you think you can gain and will you continue to invest at the same level?

I'm just trying to get a feel for how I should think about it on a longer term basis.

That's an excellent point.

I think one of the things very candidly that's happened is we had a very strong backorder position, which is a very good thing.

It gives us great comfort and confidence in our production schedules, but that is also price protected.

We have, as you know, instituted some interim price increases in the ag division, which candidly because of the backorder position, will not have much impact on fiscal 2008, but which will be more evident in fiscal 2009.

And it is our intention to longer term improve those incremental margins.

All right, thanks, I'll get back in queue.

Thank you, Jamie.

Thank you our next question comes from Terry Darling and please state your company name.

Thanks, Goldman Sachs.

Marie, can you follow-up on sort of order of magnitude price increases we're talking about?

I'm just trying to think about in the second half of the year that price raw material balance will go negative for you, and there's some sort of a reversion the other way as we move into fiscal '09.

I'm trying to think about what kind of order of magnitude that might be.

What we've announced so far for large tractors for example, would be 3% in the United States.

And we have not made any comments yet on several other product lines, but -- because basically, for example, on the combines we're pretty much fully ordered out because of the early order program.

So that's all that we have announced at this point, Terry, but we would have the ability to watch what's happening in the markets.

The other point that we want to talk about is the technology that we're putting into our products that really adds value and to our customers, makes them more productive -- just even this morning we heard an anecdote of a customer who believed that by using our AutoTrack system, they were able to actually get in more acres than they otherwise would have, and that's really important as you know with the weather conditions.

While as you think about those, that technology that delivers great value to our customers and allows us to reap some benefit ourselves as well.

Just to be clear, this 2% price that you're talking about, is that net of raw materials or just on a year-over-year basis net of discounts?

That's correct.

It's priced net of discounts and we always treat those things separately.

Okay, so it sounds like maybe if you're pushing price another 3% which on a half year basis would be $300 million or $400 million, as we move into '09 you go from a negative trade off to a neutral trade off -- is that how we should think of it?

Excluding all your efficiency initiatives and new technology and all that sort of thing?

Or would you actually see yourself getting ahead of the curve?

I think that's probably a degree of speculation we shouldn't enter into.

I would go back and point out that over time our objective is the 30% incremental margin and we are certainly working to deliver that.

Over a long period of time.

Okay.

Lastly --

I'd comment that 2% is all of the divisions blended average.

Yes.

So we're certainly going to expect to do better than that in the ag side of the business.

Just lastly, can you share with us what your guidance for the balance, the second half of fiscal '08 assumes for C&F decremental margins?

Actually, no, I would not be able to do that, but I can tell you that we are saying that their absolute margin should be in the range -- or at least our current forecast assumes the range will be -- or their absolute margin will be in the range of about 10%.

Thank you.

Thank you, Terry.

Next question?

Thank you, our next question comes from Andy Casey, and please state your company name.

Wachovia Securities.

Good morning, everybody.

Good morning, Andy.

Just a different question on the pricing actions.

Can you talk about any resistance that you may be seeing in North American construction equipment?

I'm not sure what the you're referring to.

Again, our pricing realization has been slightly positive.

We talked about last quarter and this quarter.

We've certainly helped ourselves by managing our inventories very tightly and there's not a lot of excess equipment floating around in the system.

And actually, we've even seen with used equipment margins stabilizing, which -- really over the last several months, which is very encouraging to us as well.

I guess the point of the question is basically as Mike indicated, you might have better pricing ability in some of the stronger markets like ag.

Are the competitors that you see in construction equipment all doing the same thing as you are?

I really can't speak for our competitors.

I can tell you that our forecast for the year -- what's in our financial forecast assumes that the construction equipment division is basically in a flattish environment overall for the full year.

That's what's in the current forecast.

And beyond that, I really can't speculate.

Okay.

Last one, the ag receivables for the year in terms of year-over-year increase is quite a bit lower than what you saw at the end of the quarter.

Is that a function of the comps for Q4 last year, or does it imply that you're producing a little bit closer to whatever the end market demand is?

For the second half.

That's a very fair question.

As you know in the fourth quarter of last year, we were really full bore, full press ahead.

And so really, the ending inventory guidance reflects the fact that you were up against a fourth quarter end that was higher, reflecting general business conditions.

This year, you would have Montenegro at full bore, which you didn't have last year.

You would have additional parts inventories as we're building our sales in new markets.

You need to prepare for that.

Okay, thank you.

Thank you.

Thank you.

Our next question comes from David Raso.

Please state your company name.

Citigroup.

I have a few thoughts I'm trying to put together here.

I'm trying to think to risk in the second half of the year on your cost.

First thing, can you help me understand on the raw material increases, particularly steel, are you seeing it more from surcharges being put on to your current contracts or contracts coming up that you're seeing obvious ramp we've seen of roughly 50% from March to June?

That level of detail, David, I understand your interest in the issue, but that level of detail we are not prepared to discuss.

I guess asked a different way, the variability in your $400 million to $500 million -- obviously the more it's already an agreed upon new contract gives you some assuredness around that number, but we're seeing surcharges and new quotes out for June going up every day.

So we're just trying to get a better understanding offer your handle on the $400 million to $500 million.

Is it a moving target versus new contracted numbers?

Just a percentage or some scope of security around that $400 million to $500 million number?

It comes from many commodities, not only steel, and the contracts all have different options.

And really David again, $400 million to $500 million is our best estimate at this time and we have no further comment.

I think your comment about moving target is probably more accurately describes the situation that's been very dynamic just in the last 90 days.

So you try to project ahead through the rest of the year with knowing what's happened in that last short period and it's a more challenging estimate than normal.

Is there any just bigger than a bread basket idea of -- are these numbers being based off of new agreed upon prices or truly the majority of this is we don't know what the surcharge will be a month from now, this is what we're seeing and guessing?

We're just trying to get a feel for -- if it's pure surcharge that number can move dramatically still.

If it's somewhat of a new contract you're taking a hit, but your arms release a little bit around it.

Can you give any clarity around that?

We are not prepared to discuss our contracting strategy.

Okay, I guess related to the idea of the margins then, if I'm doing my numbers correctly, your incremental margins domestically were 62% in the second quarter while your incremental internationally were lower than I would have thought, like 13%.

Can you help me understand -- I appreciate Waterloo and so forth shipping with the weak dollar, but given the way the scrap prices are going up dramatically in the U.S.

given the weak dollar and demand overseas, I'm trying to understand why were the margins so strong domestically?

Or is that the delta that's coming that yes, they were strong but wait until the new steel prices kick in and that's the second half hit?

Well, I think the impact will be more pronounced in the North American operations, or the U.S.

and Canadian Operations in the second half of the year.

I think that's a fair observation.

Okay that's helpful.

I appreciate it.

Thank you.

Thank you, David.

Next?

Thank you, our next question comes from Seth Weber.

Please state your company name.

Hi, B of A.

Good morning, Seth.

Just going back to the pricing commentary for a second.

On the interim price increases, is that just for the ag space or do you expect to also put increases on the other two businesses over the balance of the year?

I can not speculate about what we might do with pricing actions.

Our current forecast is for those divisions would not contemplate further pricing actions.

That doesn't preclude us perhaps from doing something, but again I can only say about what is in the forecast and that is what's baked in.

Just ag is baked in currently?

And there again, there's very little benefit from the incremental, from that interim price increase because of the backorder position.

You're really looking at something that will benefit model year 2009.

Right, okay.

And on the C&F business, can you give us, can you characterize any of the pricing, the positive pricing you saw there.

Was it up in both construction and forestry and can you give us any color whether it was up domestically versus internationally?

So in other words --

We normally would not drill into that level of granularity.

And so again, I'm sorry, but I'm going to stick with the fact that we're somewhat positive in the second quarter and the guidance for the full year is flat and again, a remarkable achievement in the current environment.

Okay.

Thank you.

Thank you, Seth.

Thank you.

Our next question comes from Daniel Dowd, and please state your company name.

Bernstein.

Good morning.

I really just want to touch base on some of the international investments.

So the investment you mentioned in Kaluga, and you seem to indicate earlier on the call that capacity expansion in Brazil is probably being considered.

When do you think incremental revenues -- it would be realistic to expect to see them?

Is that an '09 or is it later in '09 or beyond that?

Well, from those existing projects, the incremental revenues will kick in fairly rapidly.

But I don't know what actions we may choose to take in the future that would overall affect the incremental margin that's being generated.

Again, as we see opportunities to invest in these very good markets, our model says that this is the time that we should be investing, as we have high value-added projects to add.

Okay.

And then just on the margin, so it seems reasonable to expect given what our probably explosive growth opportunity is that the issue of higher than usual SA&G is likely to linger for a while.

This is not likely to get straightened out in the next four quarters or so.

Is that correct, or do you actually think the overseas margins are likely to pretty rapidly close in on the domestic margins?

I think on the SA&G, I wouldn't use the terminology straightened out.

We're making some deliberate choices to invest for the future, and I do expect that we will continue to be in an investment mode in some of those growth markets for a period of time.

And that's really consistent with the opportunities we see in the future in some of those countries.

Okay.

Thank you.

Thank you.

Thank you, our next question comes from Barry Bannister.

Please state your company name.

Hi, Barry Bannister, Stifel Nicolaus, how are you?

Good morning, Barry, fine.

I noticed that in the international side, your sales growth has gone from 32% to 37 to 46% in the last three quarters, but your incremental margin in international has gone from 30% to 26 to 14%, so it's basically cut in half.

Are raw materials and component issues far more of a problem overseas than in North America, perhaps due to the fragmentation of those markets?

I haven't heard real significant differentiation between the challenges in any one country or any one geographic market.

I don't know, Mike, if you've had a chance?

I don't think that's it.

I think it has to do maybe with the mix of products, where they produced or where the absorption occurs in the factories versus where the revenues are accounted.

An example, large tractors made in Waterloo have good incremental margin absorption.

The manufacturing impact that accrues in the North American operations with revenues occurring overseas.

And so I think that when you do the segmentation of the domestic versus international, you get a certain distortion because of that.

So you kind of need to look at maybe the whole I think to get a better picture.

And is Deere channeling some incentives in other market share and expansion costs through SG&A, especially internationally?

In other words, is it a strategy of Deere to spend as it were some of the strong EPS gains on market expansion, thereby capping the upside to EPS?

No.

When we talk about SA&G investments, we're not talking about discounts.

And we suggest we're again -- in our pricing we're looking at the value that we're delivering to our overall customer.

Our SA&G takes more the form of when you have a new -- when you're building a new factory, you're going to have people in position who would not bringing in machine tools, doing the market development, maybe strengthening a dealer network, when you may not have revenue to offset that.

And a lot of our SA&G comes in the form of what I would generally call dealer development, and in market development.

We've got people on the ground helping to develop trade finance for example, and banking relationships.

We are investing in the Kaluga facility for example as parts distribution.

Parts is very important.

We're setting up those networks.

But that kind of expenditure.

Okay, thanks.

Thank you, Barry.

Thank you.

Our next question comes from Mark Koznarek.

Please state your company name.

It's Cleveland Research, good morning.

Good morning, Mark.

A question on the ag equipment capacity, you're expanding Waterloo 25% and I don't imagine that's all going to be on by next year.

No, in fact in the release we said that we expect it would be fully implemented in 2010.

Okay, well, the question is the incremental increase that we would expect to get in 2009 with a partial expansion of Waterloo, a full year benefit of Montenegro and then I know at Harvester Works you're going through a rolling upgrade there, but if we look at year-over-year production capacity increase, would we be talking about potentially something in the range of 10%, or is it more incremental than that?

I certainly appreciate your interest and the reason for your questions, but we are unable to provide guidance, really, is what you're asking for 2009 at this time.

But I understand the reason for your question, Mark.

Well then, maybe just to clarify the Waterloo statement, is that an all-or-nothing in 2010?

Is it we flip a switch and we get --

I'm sorry I interrupted you, but there will be some rolling benefit in 2009.

Okay.

And then a follow-up question then would be on the North American construction equipment business.

What would you expect the underlying market retail sales outlook to be down?

How much percent this year?

What underpins your segment forecast?

Well, I think we're down on the retail end for United States and Canadian retail construction, we're down in that 15 to 20% range I think as we would in terms of sales.

And again we're being helped by the fact that last year, we had taken $250 million out of our inventories.

And the other area that we haven't focused very much on is that we are -- even though the United States and Canadian markets are weak, we are seeing growth in forestry markets outside the U.S.

and Canada and even although off a very small base, even some activity in our construction equipment markets outside the U.S.

and Canada.

Okay.

Thanks very much.

Thank you.

Next question?

Thank you.

Our next question comes from Robert McCarthy.

Please state your company name.

Yes, it's Robert W.

Baird.

Good morning, everybody.

Good morning, Rob.

I wanted to ask about your South American forecast on Slide 12.

Forecasting retail up 30% now instead of 15.

So much more positive, yet you identify especially in the case of Argentina two significant risk factors.

What exactly are you assuming here in your upgraded forecast?

Is this, does this represent a case that could get better if these risk factors are relieved, or is this a forecast based on sort of steady state conditions?

Or can you help with that?

Well, let me clarify the risk factors.

One was cited for Brazil in terms of the payments and then the other one was the status of the payments under (inaudible), and the other one -- it's really not the status but the impact of the export tax on commodities, principally soybeans, that's been discussed although it's on other agricultural commodities as well.

30% represents our best estimate and assessment of what will happen in the next six months.

We felt though that there were these two big issues that were looming.

And ultimately how they play out we don't know, but the 30% is our best estimate and I'm not sure, I would be reluctant to speculate whether there's upside or downside.

This is our best estimate.

But you're not specifically making a call on whether Argentinian farmers are going to quit protesting and go back to work?

As it were?

I would not presume that to try to make the call one way or the other.

This is based on what our own order positions are what we're hearing from Mark, customers in the market, etc.

And again that up 30% is an industry look for all of South America.

Understood, right.

Okay, and then the other question I wanted to ask was about the agricultural tire situation that you mentioned.

How is this impacting your outlook?

Is this a, does it have a bigger effect on revenue?

In other words, making it more difficult to get products shipped?

Or is it more a margin issue that you're having to go to non-traditional suppliers, maybe inbound transport costs were higher than they otherwise would be.

I think the situation has tightened certainly in the last 90 days, and I would also to be fair point out that we have increased our production outlook for worldwide ag, and of course tractors would be part of that.

Right.

Our suppliers are doing a very good job of meeting our needs, but in the face of such a significant increase, we felt that it would be appropriate to point out that we may have some spot issues in terms of availability.

Again, our forecast reflects our best estimate of our availability of materials, so we're not trying to game the system so to speak, but just make you aware that things are tighter than they were.

So if I'm inferring correctly, your concern is more revenue opportunity than it is profitability related specifically to tires?

It would be both.

And I mean obviously all commodities are up.

We're seeing pressure in as you mentioned steel and tires, and all kinds of oil related commodities.

So there's pressure on that end, but additionally, with this very rapid increase in the schedule, really not only from us but really for the industry, there's a fair amount of pressure on our suppliers who are again working very hard to meet our needs.

But what's in the face of such big increases, sometimes it gets more exciting.

Yes.

Okay, thank you.

Thank you.

Thank you, our next question comes from Alex Blanton.

Please state your company name.

It's Ingalls and Schneider.

Thanks for asking that question.

I was going to ask about the tires.

But on the currency, Marie, in looking at the second half and your forecast, are you basically just assuming that the currency levels stay where they are?

Yes.

Okay, so you're talking about the year-over-year impact of the current currency levels?

Yes.

Okay, so if the dollar went up, for example, then that currency effect might be less than you're forecasting?

You are correct.

Okay.

Now on the -- I want a clarification if I can get it on your incremental margin statement 30% -- which line are you talking about, gross profit or operating?

Operating profit, and net sales.

And we're looking at the change year-over-year in net sales and the change year-over-year in operating profit.

And the 30% is an objective that we have for the construction equipment and -- construction and forestry equipment and the agricultural divisions on average over time.

That's not a projection for any one quarter.

So this includes -- this is after you subtracted SG&A allocation?

Yes.

That is correct.

So my question is this: the 30% can only be achieved within a given, within a small volume range because obviously, if you achieve that over time, your operating margin would approach 30% asymptotically.

That's true, because you're assuming that --

So what is that volume range and are we close to the top of it or the bottom of it?

Well, I think it would depend on when we see growth opportunities and when we choose to make investments.

When we look at the future of our ag business, the fact that we are putting a new facility in Russia, we are adding capacity at Waterloo, you see a pretty good level candidly of capital expenditures as we're looking at opportunities really in many product lines in many countries.

And we see a very bright future that -- we would not be making these investments if we didn't see very good return opportunities as we move over time.

Right, but the 30% as you said is construction and forestry target.

On average, in ag.

I said ag.

Oh, and ag.

And on average over time.

But what would you expect to hit as an operating margin if you get to the 30% within a certain volume range?

You can't obviously continue that for too long or you're going to run into capacity problems.

So what would be your average target?

I mean, it's not, it can't be 30%.

Our incremental margin?

No, no.

Operating margin.

Oh, we don't aspire to an absolute margin, you are correct, of 30%.

And our margin targets, we don't have specific margin targets per se.

We are instead looking at the returns on invested capital and our business with the intention of growing them over time.

Our measure for that is SVA and our aspiration is to grow that on average over time, 7% annually.

Thank you, Alex.

Okay, I'll take you offline then.

I have time for one more question.

Thank you.

Our final question comes from Robert Wertheimer and please state your company name.

Morgan Stanley.

Thanks everybody, good morning.

I wanted to follow-up on the components question.

I'm not sure I understand.

You took up the production volumes and the revenues 5% in the guidance, and you mentioned this is a hinderance to achieving results.

Does that mean it would have been up more ex the components this year, or does that mean it's a hinderance more in Q3 and you have confidence it's getting better in Q4?

You mean the availability?

Well, I guess what I'm saying is on the ag, you talk about the components as being in short supply and hindering your ability to achieve good results, and yet you take the volume up 5%.

So I'm just trying to figure out if it would have been up more or if it's a temporary shortage in 3Q.

Does that make sense?

I think that we expected that we will continue to see challenges off and on throughout the year.

I think it's -- we're very pleased with the fact that we were able to take our production up from the worldwide ag from up 23 to up 28, which is the 5 points I presume that you're alluding to.

And I think we're just pointing out that in any given -- on any given day, we may have some issues as we are working to deliver that.

But we are, I mean our forecast assumes that we will deliver this.

I'm not really sure what else to say.

That's fair.

Maybe I'll say it a slightly different way.

Is there any particular pinch point we're seeing in Q3 or is it just generally tight?

Again, Mike alluded to the fact that, very candidly tires are an exciting commodity.

Our tire suppliers have been working very hard with us, but again in the face of pretty significant increases, that has been a bit of a challenge.

And those things aren't substitutable between like construction where you may be able to get more bearings or something because the construction business is a little lighter.

You can't do that with agricultural tires -- they're very specific.

But again, I want to emphasize our suppliers are working with us and we actually were able to take up our projected volume.

Yes.

Okay, and just to wrap it up with a final question on pricing.

I mean versus materials, if you had been able to forecast this extraordinary rise in steel, are you confident you could have gotten the pricing to offset it this year?

Or was it just not able to guess which way the commodities were going or was it competitive pressure?

No, I would not say it was competitive pressure.

When we actually do our pricing, we certainly take a look at what's happening in the commodity markets but we're looking overall at a value picture in terms of the productivity, the features we're delivering to our customers.

And we're looking at things that are long term sustainable for us and that makes sense in terms of value proposition we're delivering to our customers.

Okay.

I'll leave it at that, thank you.

Thank you so much to all participating in today's call, and as usual we'll be around the rest of the day to answer your questions.

Thanks.

Thank you.

This concludes today's conference call.

We thank you for your participation and you may now disconnect your lines.