強鹿 (DE) 2010 Q2 法說會逐字稿

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  • Operator

  • Good morning and welcome to the Deere's second quarter earnings conference call. Your lines have been placed on listen-only until the question and answer session of today's conference. I would now like to turn the call over to Ms. Marie Ziegler, Vice President Investor Relations. Please go ahead.

  • Marie Ziegler - VP-Investor Relations

  • Good morning. Also on today's call are Jim Field, our Chief Financial Officer as well as Susan Karlix, and Justin Marovec from the Deere Investor Relations staff. Today we'll take a closer look at Deere's second quarter earnings and then spend some time talking about our markets and how we see the second half of the year shaping up. After that, we'll respond to your questions. Please note that slides are available to complement the call this morning and they can be accessed on our website at www.JohnDeere.com.

  • First as usual, a reminder. This call is being broadcast live on the Internet and recorded for future transmission and use by Deere and Thomson Reuters. Any other use, recording or transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited. Participants in today's 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. The 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 accompanying materials not are an offer to sell or a solicitation of offers to buy any of the Company's security. And finally, this call will include financial measures that are not in conformance with Accounting Principles Generally Accepted in the United States of America, known as GAAP.

  • Additional information concerning these measures, including reconciliations to comparable GAAP measures, is posted on our website at www.JohnDeere.com under financial reports, other financial information. Call participants should consider the other information on risks and uncertainties and non-GAAP measures in addition to the information presented on the call. And now for a closer look at the second quarter, here is Susan.

  • Susan Karlix - Manager - Investor Communications

  • Thanks, Marie. John Deere's strong performance continued in the second quarter of 2010. Earnings were up 16% on a sales increase of 6%. Results would have been higher without a charge related to the recent enactment of US healthcare legislation. The quarter's improvement was broad-based. The gain was led by Ag & Turf, but all three divisions had higher profits. Among the highlights our Construction & Forestry business saw its first year-over-year profit increase in nine quarters. Solid execution of our business plans was again a big story for the quarter as was disciplined cost and asset management. Trade receivables and inventories declined by some $900 million.

  • Finally, in line with improved business conditions, our full year earnings forecast has been increased and now totals approximately $1.6 billion. All in all, it was a productive quarter and John Deere seems well on its way to a very good year. Now let's look at the quarter in more detail starting with slide three. This is a supplemental slide illustrating the impact of the tax charge for US healthcare legislation taken in the quarter, excluding the approximately $130 million charge net income attributable to Deere & Company would have been $677 million or $1.58 per share.

  • On slide four, we show that net income attributable to Deere & Company on a reported basis was $547 million. As we mentioned that was a 16% increase in profit on a 6% increase in net sales and revenues. Turning to slide five. Total worldwide equipment operations net sales were up 6% to $6.5 billion, Deere's second highest sales on record in a second quarter. Currency translation on net sales was positive by 4 points and price realization was positive by 2 points. Both equipment divisions had positive price realization in the quarter.

  • Turning to slide six. Worldwide production tonnage was up 7% in the quarter. Construction & Forestry tonnage was up considerably, in large part due to easy comparisons with the second quarter of 2009 when tonnage was down 62% from the previous year's level. In addition, improving global economic conditions, better pulp prices, and low field inventories are benefiting the Forestry segment in 2010. Tonnage outside the US and Canada increased due to strength in Argentina and Brazil, China, India, and Mexico. For the full year, worldwide production tonnage is now forecast to be up about 11%.

  • Let's turn to the Company outlook on slide seven. Third quarter sales are expected to be up 21% to 23% compared with the third quarter of 2009. In the financial forecast, currency translation on net sales is expected to be positive by about 2 points. For the full year, net equipment sales are forecast to be up 11% to 13% compared with fiscal year 2009. This includes about 3 points of positive currency translation and approximately 1.5 points of positive price realization. This is in line with our previous guidance of 1 point to 2 points. Net income attributable, to Deere & Company, is now forecast to be about $1.6 billion for the year versus our prior guidance of about $1.3 billion. That includes the second quarter tax charge of approximately $130 million for US healthcare legislation.

  • Turning to a review of our individual businesses, let's start with Ag & Turf on slide eight. In the quarter net, sales were up 1% and so was production tonnage. Operating profit, however, improved by nearly $250 million or 35% to $952 million. The increase was primarily due to improved price realization, higher production volumes, the favorable effects of foreign exchange, and lower raw material costs.

  • These factors were partially offset by higher post-retirement benefit costs. You might notice we didn't include the A&T incremental margin this quarter. It calculates at about 498% due to the very large swing in operating profit on the small increase in sales. A&T executed well with an operating margin in the quarter of about 17%. The Division is benefiting again this year from strong sales of large Ag equipment in the United States and Canada. Compared with a normal year, a favorable mix contributed 1 point of margin in the quarter.

  • Before we review the sales outlook, let's look at some of the fundamentals affecting the Ag business starting on slide nine. Commodity prices for the 2009 to 2010 crop have remained steady at attractive levels since our last forecast with soybeans seeing an improvement. Soybean exports have remained at good levels despite a strong South American crop and the good weather we have been experiencing here in the US tends to favor more corn planting. Cotton prices remain well above year ago levels driven by strong Chinese demand and a reduction in the global cotton supply.

  • On slide ten, we have included Deere's estimate of US acres planted for 2010, 2011. They are the same as the USDA estimates. Corn acreage is expected to increase 2.3 million acres to 88.8 million in order to meet growing demand for feed, exports, and ethanol. Turning to slide 11, 2010 US farm cash receipts are now forecast to be up about 5% from 2009 levels, a slight improvement from our last forecast. Livestock is driving the increase in 2010 cash receipts. The industry should finally expect profits this year after two years of losses. As you can see, 2011 farm cash receipts are expected to be up slightly from 2010 levels.

  • Deere's outlook for the EU-27 is shown on slide 12. We are beginning to see stabilization in this market but at very low levels. We don't expect any real recovery in 2010. Farmers' sentiment in the region remains negative. Small grain, pork, and beef prices are expected to remain under pressure and used equipment inventories remain at high levels due to the lack of product going to Central Europe. The industry forecast for 2010 unit tractor sales is slightly below levels seen during the last recession in the early 1990s.

  • Slide 13 highlights farm net income in Brazil and Argentina. Income from two main crops, soybeans and sugarcane, drive the bulk of equipment purchases in Brazil. So going forward, we will provide a breakout of these two crops when discussing farm net income. Corn, paddy rice and cotton make up the other category. 2010 farm net income is driven by the strength in sugar due to a drastic drought-driven reduction in output from India and China. Demand for sugar though is only part of the story in Brazil. Other positive factors include demand for Brazilian commodities globally as well as government-sponsored low rate finance programs like [Finame] and Mas Alimentos. These are all contributing to positive producer attitudes which translate into higher spending on farm equipment.

  • In April, the Brazilian government announced the Finame financing program would be extended through the end of December for loans taken through the end of June, the interest rate will remain at 4.5%. For loans taken from July through December, the interest rate will be 5.5%. Still, an extremely attractive rate in the Brazilian market. Argentina is recovering from the severe 2009 drought with Ag commodity production up over 40% in 2010. With farm net income about $6 billion higher than 2009, we are seeing increased demand for tractors, combines, sprayers and forage equipment. Clearly, the markets are improving and there's a lot of good news out of Brazil.

  • The next two slides illustrate the long term potential we see in the country. Slide 14 shows Deere estimates for planted acres and production of soybeans in Brazil over the next eight years. Planted acres are expected to increase about 45% and production about 60%. The story is similar for sugarcane. On slide 15, you can see we expect sugarcane planted acres to increase about 65% and production about 55%. To take advantage of this opportunity, Deere opened a tractor factory in Brazil in 2007 to complement our combine factory and in 2008 we announced an $80 million expansion adding capacity to both factories. Of course, we didn't undertake this without the buy-in of our dealers who are committed to representing John Deere and willing to invest in their own businesses.

  • Moving to slide 16, you can see we've added almost 70 dealer locations in the last six years and on slide 17, we have expanded our product offerings to meet the needs of our customers. In fact, in 2010 and 2011, we will add 50 new or updated products to our line-up, covering a broad array of categories from tractors and combines to turf equipment and precision technology. It's an exciting picture for Brazil and it's clear why Deere and its dealers are looking forward to the opportunity that lies ahead and to serving our growing customer base there. Turning to another great opportunity for John Deere, as you can see on slide 18. On the heels of a slight pick-up in activity and loosening of liquidity in Russia, John Deere celebrated the grand opening of its Domodedovo manufacturing and parts center outside of Moscow last month. We began limited assembly of large tractors, combines, motor graders and four-wheel drive loaders.

  • Slide 19 highlights our 2010 industry outlooks. Sales of agricultural equipment in the US and Canada are now forecasted to be up 5% to 10%. That's quite a change from our February forecast of comparable to 2009 and our November 2009 forecast of down about 10%. We continue to see our order book strengthen, especially for large Ag equipment. Remember the Combine Early Order Program ended in January with a significantly higher than expected response rate. Demand for large tractors has been higher than expected as well. The new 8R Series Tractor has been very well received in the marketplace. We have continued to add schedule throughout the first half of the year and effective availability is November 2010. Effective availability for the 9000 Series Tractors is September 2010.

  • Conditions in Western Europe remain weak with Ag sales there still expected to be down 10% to 15% in the year. Although Russia is up slightly, other countries in the region remain down. Sales in Central Europe and the CIS are expected to remain under pressure and based on the factors we covered earlier, South America is now projected to increase about 25%. Turning to another product category, we expect retail sales of Turf Equipment and Compact Utility Tractors in the US and Canada to be up 5% to 10% in the year. We remain cautiously optimistic for this market as we have witnessed a slow steady movement in the right direction. Economic indicators are improving. Weather has been favorable for sales and we have had a very good start to the all important spring selling season.

  • Putting this all together on slide 20. Deere sales for worldwide Ag & Turf are now projected to be up 9% to 11% in the year versus our previous forecast of up 4% to 6%. Currency translation on net sales is projected to be positive about 3 points. For the year, the A&T division's operating margin is forecast to be around 12% to 13%. Let's focus now on Construction & Forestry on slide 21. With dealers replenishing their fleets and global forestry markets strengthening from a very low base, Deere's net sales were up 52% in the quarter. Production tonnage was up 82%. The division reported an operating profit of $36 million. Due to the very large volume increases from last year's very low base and positive price realization, C&F's incremental margin was about 36%.

  • On slide 22, although we are forecasting the US construction industry to be down about 5% for the full year, we feel the market has reached its bottom. We are encouraged by a number of positive developments, independent rental companies are in talks and in some cases beginning to purchase earth moving equipment. Also, Deere dealers are starting to see an improvement in rental utilization and used equipment turns. As mentioned earlier, global forestry markets are improving with pulp prices up significantly from last year and US lumber production increasing. On slide 23, Construction & Forestry sales are now expected to be up about 30% in 2010 from the very low levels of 2009. Our previous forecast was up about 21%. Our forecast now has C&F operating margin slightly above break-even for the year. Previously the division had been forecasted to lose money. Let's move now to our Credit Operations.

  • Slide 24 shows the Worldwide Credit Operations provision for credit losses as a percent of the total average portfolio. Year-to-date on an annualized basis, the provision is 52 basis points. In the first half of the year, write-offs in the Construction & Forestry portfolio have been considerably lower than expected. We are encouraged by improvement in recovery rates and increased pricing on repossessions. However, we do continue to have high levels of repossessions and delinquent accounts. Consequently, we remain conservative in our forecast provision. The full year provision for John Deere Credit is forecast to run around 71 basis points, which is an improvement over our prior forecast of about 88 basis points.

  • On slide 25, past dues for the Worldwide Credit Operations are about flat with last year. Another promising sign is the C&F revolving charge and financing lease past dues are all lower than a year ago. Annualized write-offs continue to reflect the excellent performance of our Ag portfolio coupled with improvements in the other portfolios. Moving to slide 26, Worldwide Credit Operations net income attributable to Deere & Company was $84 million in the quarter versus $68 million last year. The biggest factors were an improvement in financing spreads, a lower provision for credit losses, growth in the portfolio, and higher commissions from crop insurance. These were partially offset by lower tax credits related to wind energy projects and higher SA&G. Looking ahead, we are now projecting Worldwide Credit Operations net income attributable to Deere & Company, of about $300 million in 2010.

  • Now, let's turn our focus back to the equipment operations and take a look at receivables and inventory on slide 27. For the Company as a whole, receivables and inventories were down roughly $900 million in the second quarter versus second quarter 2009. We are now forecasting receivables and inventories to be up about $700 million for the year. The increase of $250 million from our outlook last quarter is a result of increasing production levels, especially in the fourth quarter. Now let's discuss the latest on retail sales.

  • On slide 28 you see the product categories for US and Canada for the month of April expressed in units. For utility tractors, industry sales were down 6%. Deere was down low double digits. Row-crop tractor industry sales were up 6% and Deere was up less than the industry. Four-wheel drive tractor industry sales were up 40%. Deere was up more than the industry and for combines, the industry was up 21%, Deere was up a single digit. Looking at Deere dealer inventories in the bottom chart, for row-crop tractors, Deere ended April with inventories at 18% of trailing 12 month sales. Combine inventories were at 8% of sales.

  • Turning to slide 29. In Western Europe, sales of John Deere tractors were down a single digit and combines were down double digits in April. Deere's retail sales of selected Turf and Utility equipment in the US and Canada were up double digits in the month. Construction & Forestry sales in the US and Canada on both a First-in-the-Dirt and Settlement basis were up double digits in the month. Slide 30 shows raw material and logistics costs down about $70 million in the quarter. We now forecast material cost decreases of approximately $100 million for the year. This is slightly lower than our previous forecast reflecting higher commodity price projections for inputs like steel. By division, the Ag & Turf savings are forecast at about $125 million. For Construction & Forestry, we are now forecasting a material cost increase of about $25 million. This is due to the currency impact on partner products and higher steel prices.

  • Now let's look at a few housekeeping items. Looking at R&D expense on slide 31. R&D was up about 4% in the quarter, with currency translation accounting for about 1 point. Year-to-date, R&D expense is up about 6%. For the full year, R&D expense is expected to be up about 13%. We expect R&D to ramp up in the second half of the year due to Interim Tier 4 durability builds and feasibility testing on products that have Interim Tier 4 production dates after 2011. Moving now to slide 32. Pension expense in the second quarter was up about $70 million. The 2010 forecast calls for an increase of about $350 million in pension and OPEB expense which is down from our previous forecast of about $400 million. Of the $350 million, about $300 million will hit cost of sales leaving about $50 million in SA&G. Approximately $275 million of the additional expense is attributable to the Ag & Turf division while the increase for C&F is about $75 million.

  • On slide 33, SA&G expense for the equipment operations was up about 8% in the quarter. Variable incentive compensation accounted for about 5 points and currency translation added about 3 points. For fiscal 2010, we now project SA&G to be up about 9 points. Variable incentive compensation is expected to contribute about 4 points of the change as profitability improves. In fiscal 2009, when profitability was lower, variable incentive compensation was about 6 points lower than it was in 2008. Pension and OPEB accounts for about 2 points and currency translation about 2 points.

  • Moving to the tax rate on slide 34. The second quarter tax rate includes the charge for US healthcare legislation of about $130 million. For 2010, the full year effective tax rate is expected to be about 40%. This includes the $130 million charge. Excluding the charge, the forecast effective tax rate for 2010 is 34% to 35%. Before touching on cash flow, currency movements, both translation and transaction or trade flows, increased operating profit by about $80 million in the second quarter, predominantly in Ag & Turf.

  • On slide 35, you see the strong cash flow from our equipment operations even in years of tough market conditions like 2009. This reflects in large part our success managing assets and controlling working capital levels. We anticipate strong cash flow from the equipment operations in 2010, about $2.5 billion, up from last year's $1.4 billion. Such strong cash flow is further testament to the successful execution of the SVA model. On slide 36, Capital Expenditures are expected to be about $900 million for the year, primarily driven by Interim Tier 4. Depreciation and amortization is projected to be about $550 million. Our forecast currently includes about $600 million of pension and OPEB contributions in the year.

  • In closing, John Deere has reached the halfway mark of 2010 on a strong pace. We're looking forward to delivering a solid second half of the year. Our performance, no doubt, reflects some improvement in overall economic conditions. It certainly reflects strong demand for large farm machinery in the United States and other key markets. By the same token, we are benefiting from the solid execution of our operating and marketing plans, allowing us to quickly capitalize on these positive moves in the marketplace. We've been quite successful extending our competitive position as well, increasing capacity and adding productive new models of equipment to serve an expanding global customer base. As a result, we believe our Company is well positioned to benefit from a growing worldwide economy and to continue delivering value to our customers and investors for the long haul. Marie?

  • Marie Ziegler - VP-Investor Relations

  • Thank you, Susan. We are now ready to begin the Q&A portion of this call. The Operator is going to instruct us on the polling procedure. As usual, however, I ask that you respect the rest of the audience participants and ask two questions, a limit of two questions, with no follow-ups in that limit. If you have additional questions you are of course welcome to get back into the queue. Laura? We're ready.

  • Operator

  • Thank you. (Operator Instructions) Our first question comes from Robert Wertheimer. And please state your company name.

  • Robert Wertheimer - Analyst

  • It's Morgan Stanley. Good morning everybody.

  • Marie Ziegler - VP-Investor Relations

  • Good morning.

  • Robert Wertheimer - Analyst

  • Two questions is tough on such a good quarter. So let me see, on the Ag margin, I wanted to ask first is there anything particularly abnormal in price cost? Or is this just where the lower materials flow through and you got the pricing so that would erode? Or is maybe some of the old commercial consumer margins coming up?

  • Marie Ziegler - VP-Investor Relations

  • Are you talking about in the quarter or in our guidance?

  • Robert Wertheimer - Analyst

  • In the quarter, I beg your pardon.

  • Marie Ziegler - VP-Investor Relations

  • In the quarter, we are experiencing some improvement obviously in market conditions for the old Turf, but you're absolutely right, that pricing was positive. We talked about 2 points for the Company and raw materials was also a positive.

  • Robert Wertheimer - Analyst

  • Let me ask in Brazil then for the second one. Your share has been very good in the past couple years. It was a little less good in the past three months or four months on high horsepower tractors is what I'm talking about. I know that's lumpy but has there been any production issues? And when are the new models all launching that should help that as well?

  • Marie Ziegler - VP-Investor Relations

  • There have not been any production issues, but you are correct that we are in the process of a transition. I don't have the exact dates on the individual models and a couple actually come in from other markets. But you need, Rob as you well know, you need to look at market share over a long period of time. You have normal ebbs and flows and we feel very good about the positioning of our product line especially now that we have these new products available.

  • Robert Wertheimer - Analyst

  • All right. Thank you.

  • Marie Ziegler - VP-Investor Relations

  • Thank you, next?

  • Operator

  • Thank you. Our next question comes from Jerry Revich. Please state your company name.

  • Jerry Revich - Analyst

  • Good morning. It's Goldman Sachs.

  • Marie Ziegler - VP-Investor Relations

  • Good morning, Jerry.

  • Jerry Revich - Analyst

  • Marie, can you please talk about the drivers of the production ramp in your international Ag facilities? How much of that is to support the transition to Tier 4 Interim versus stronger production for North America, Brazil and Russia? Thank you.

  • Marie Ziegler - VP-Investor Relations

  • For international factories, in terms of producing for the US, there would be some with medium size tractors in particular. They're coming from markets like Mexico and Mannheim, so there would be some activity there. Most of those products though, I think, virtually all would not be subject to IT4 requirements until starting in 2012 because of the horsepower breaks and if you recall the IT4 breaks at 175 [horsepower] for 2011 and then below 175 [horsepower] in 2012. Does that answer your question, Jerry?

  • Jerry Revich - Analyst

  • Absolutely. And Marie, on the R&D side, Susan alluded to the step up in investment in the back half of the year. Should we look at a similar pace of investment going forward until the full Tier 4 Interim product rollout is complete?

  • Marie Ziegler - VP-Investor Relations

  • Yes, I would not see any reason why those numbers will rollback because there's just an enormous number of launches ahead of us.

  • Jerry Revich - Analyst

  • Thank you very much.

  • Marie Ziegler - VP-Investor Relations

  • Thank you, Jerry.

  • Operator

  • Thank you. Our next question comes from David Raso and please state your company name.

  • David Raso - Analyst

  • ISI. My question relates to the guidance. The first half of the year you had sales of $10.8 billion and the second half you're guiding to $12.6 billion. So you got $1.8 billion of sales growth, sequentially I'm talking. And on the segment profits, the first half you did about $1.3 billion, the back half guidance roughly implies $1.2 billion, so again we're saying sales are going up of $1.8 billion, sequentially but profits go down hundred. Now I could see the R&D first half and second half does go up a hundred.

  • You get a little D & A help, a little pension help but let's call that hundred, I understand the $1.3 billion going to $1.2 billion. But on the revenue growth of $1.8 billion, if I think of a typical incremental margin of 25% that you would get that you're saying we're not going to get it all. Sequentially, not year-over-year, sequentially that's implying your price versus costs in the back half of the year is like negative 3%.

  • Marie Ziegler - VP-Investor Relations

  • Our raw materials in the back half of the year are expected to be a negative approximately $170 million. That's what's implied in the guidance in the final six months.

  • David Raso - Analyst

  • Well, that's a year-over-year though. I'm talking sequentially do we think price versus cost is that negative?

  • Marie Ziegler - VP-Investor Relations

  • Yes, because we've had favorable price and favorable raw materials cost in both the first quarter and the second quarters. We had 2 points of positive price realization for the Company in both the first quarter and the second quarters in our guidance, David, as Susan pointed out is unchanged. We're looking at for the full year about a 1.5 points and that implies to be a little less in the second half of the year. You have higher SA&G as we move into the back half of the year, too.

  • David Raso - Analyst

  • But again, sequential is different than the year-over-year. In the channel, we learned that you did raise price in April and depends how quickly you can ship what is under the old price with the new pricing. Can you help me understand price versus cost? Are there pricing actions that you're taking including we heard where you weren't price protecting orders from dealers for their inventory but you are protecting of course customer invoice? Can you help me understand the price versus cost better on the pricing action?

  • Marie Ziegler - VP-Investor Relations

  • At the time that we announced the price increases, we pretty much had a full order book for tractors and as you know, we were long since done with the Combine Early Order Program.

  • David Raso - Analyst

  • Sure.

  • Marie Ziegler - VP-Investor Relations

  • So there are very modest benefits to us in the fourth quarter in terms of price realization from those actions. So they will be more evident as you move through 2011.

  • David Raso - Analyst

  • That's helpful. Okay, thank you very much.

  • Marie Ziegler - VP-Investor Relations

  • Thank you, David.

  • Operator

  • Thank you. Our next question comes from Steve Volkman. Please state your company name.

  • Steve Volkmann - Analyst

  • Hello, good morning. It's Jeffries.

  • Marie Ziegler - VP-Investor Relations

  • Good morning.

  • Steve Volkmann - Analyst

  • So I'm wondering if we need to rethink I guess earnings power, particularly in the Ag & Turf Division. I guess I'm assuming that the Turf margins are still well below the Ag margins. And so it looks to me like this was actually a record quarter for Ag margins going back as far as my model actually back to 1985. But where do you think we are on percent of normal in Ag? And is there any reason we shouldn't be thinking of this business as getting close to 20% at the peak in terms of EBIT margins?

  • Marie Ziegler - VP-Investor Relations

  • You might be surprised when I tell you where we think we are relative to normal and worldwide Ag & Turf. We think we're actually below average. Where we are very strong is in the United States and Canada, specifically in large Ag equipment. But in many other areas, we are very low as we've talked about in Europe and in Russia for example, and although recovering in the smaller products like Compact Utility Tractors and the Turf, et cetera. And you have Brazil recovering or I should say maybe more broadly South America recovering, but still not to the very high levels or the good levels they would have been. So as we think about where we are relative to our total opportunity, we would tell you that we're again below our "average" sales opportunity. That said, Susan did point out that we are benefiting in the quarter and actually this would be true for the full year by about 1 point because of the heavy mix of large Ag equipment.

  • We also have good pricing, as we talked about in the quarter, and a tailwind on raw materials that will slip in the second half of the year. You're right, by our calculations going back, that 17% is very, very strong and compares against, we think as we calculate our previous peak in the second quarter would have been about 15%. So I would say there is additional upside certainly in terms of volumes to summarize, but you do need to bear in mind that we have a very favorable mix of large equipment and it's worth about a point. Again I want to emphasize that point is not year-over-year. We've seen this favorable mix release in 2008 to some degree and certainly 2009 and this year. Does that help?

  • Steve Volkmann - Analyst

  • It does, but just to push you a little bit, if we can get all these markets recovering globally, won't that be enough to more than offset the 1 point of mix that we have here and margins should be structurally higher?

  • Marie Ziegler - VP-Investor Relations

  • Well, I would tell you that we are aspiring in this business to get ourselves to about a 14.5% margin. That would be over a full year, obviously not in each quarter, and so we have a little bit of work to do. But we are very focused on improving that return.

  • Steve Volkmann - Analyst

  • Okay, thank you.

  • Operator

  • Thank you. Our next question comes from Ann Duignan. Please state your company name.

  • Greg Williams - Analyst

  • Good morning, it's JPMorgan and it's Greg Williams sitting in for Ann Duignan. Hello.

  • Marie Ziegler - VP-Investor Relations

  • Good morning, Greg.

  • Greg Williams - Analyst

  • Good morning. You guys have $3.6 billion in cash this quarter versus about $3.4 billion last quarter. What are your priorities for that cash going forward?

  • Jim Field - CFO

  • Yes, I'll take that. We have for some period of time, had a very well articulated and consistent use of cash policy, which is, number one, we're firmly committed to the single-A rating. Number two ,we're going to continue to make the requisite investments in the business to continue the long term viability and sustainability of the business and extend our competitive advantage. And number three is, we will look then once we've appropriately satisfied the first two. And once we're comfortable that we are carrying enough liquidity given what's going on in the external market environment particularly in the capital markets, that we will look from time to time at number one, giving a moderately increasing but very steady dividend to our shareholders. And also we'll explore repurchases from time to time as an alternative means of distributing cash. Beyond that cash strategy we're not going to say a whole lot more in terms of when we might move into the third step of that use of cash strategy.

  • Greg Williams - Analyst

  • Okay, and did you guys see any pre-buy activity in the past quarter and are you seeing today?

  • Marie Ziegler - VP-Investor Relations

  • You talking specifically about IT4?

  • Greg Williams - Analyst

  • Yes, in North America.

  • Marie Ziegler - VP-Investor Relations

  • Well, it's very, very hard to call out and say that this is IT4-related or not. If you look at the Ag business, we have a very successful launch of the new 8R series products, it's been extremely well received in the market. You have strong farm cash receipts, improved net farm income, interest rates at historically low levels. And we, again, we believe that Deere provides generally a very good value proposition to the marketplace. We have updated our dealers about the general requirements of upcoming emission requirements and have assured them that our strategies of providing good value, quality, reliability, et cetera, will remain unchanged. But again, it's just very difficult to pinpoint the specific impact of IT4.

  • If you go to the Construction & Forestry division, there the division is at such low levels of activity, it's hard to argue that there is any pre-buying although again I can't preclude it because I can't definitively tell you. I can say that where they are seeing some pick-up from rental houses for example, has been in the lower, smaller stuff, below 175 horsepower so that's not subject to the start of the IT4 in 2011. So I don't have a definitive answer for you.

  • Greg Williams - Analyst

  • All right, thanks.

  • Marie Ziegler - VP-Investor Relations

  • Thank you. Next questioner?

  • Operator

  • Thank you. Our next question comes from Andy Casey and please state your company name.

  • Andy Casey - Analyst

  • Wells Fargo securities. Good morning everyone.

  • Marie Ziegler - VP-Investor Relations

  • Good morning, Andy.

  • Andy Casey - Analyst

  • A quick question on the outlook and then cash flow. On the availability that you talked about for Series 9000 Tractors, are there any initiatives being pursued to increase capacity for this fiscal year or should we assume it's pretty much steady as she goes?

  • Marie Ziegler - VP-Investor Relations

  • We have been increasing our capabilities of reaching of -- helping our capabilities of delivering products to customers over the course of the year. We've increased our schedule, as you're undoubtedly aware of, several times. We had undertaken a capacity increase starting in 2008 and are benefiting certainly from the actions taken there both on combines and large tractors. Availability of the 9000 specifically is September and for 8000, the availability, I should say effective availability in both cases, is November.

  • Andy Casey - Analyst

  • Okay, thanks, and then on cash flow, can you help me understand is this a quarterly six month question in history? What drove the receivables from unconsolidated subsidiaries benefit?

  • Marie Ziegler - VP-Investor Relations

  • Basically, we've got -- it's intercompany money, temporarily loaned to the Capital Corporation. It's as simple as that.

  • Andy Casey - Analyst

  • Okay, thank you very much.

  • Marie Ziegler - VP-Investor Relations

  • Thank you. Next questioner?

  • Operator

  • Thank you. Our next question comes from Henry Krn and please state your company name.

  • Henry Kirn - Analyst

  • Good morning guys. It's UBS.

  • Marie Ziegler - VP-Investor Relations

  • Good morning Henry.

  • Henry Kirn - Analyst

  • Wondering if you could chat about why the FX in the guidance didn't change by very much given the move in the Euro?

  • Marie Ziegler - VP-Investor Relations

  • Okay, our forecasting process, we would do our valuation of our forecast at the end of April. And we would have used the average rate for currencies that was in effect at the end of April to translate the income statement and balance sheet for 31 October 2010 and then the income for the remaining period of May through October. We have done some sensitivity analysis in terms of what and I'll talk specifically about the Euro, what a change in the Euro might mean. At the time we did the translation we were looking at about an average of EUR1.34 for the Euro. If the Euro goes between EUR1.27 and EUR1.15 you're looking at a favorable impact. We estimate all other things equal, remember they never are, but all other things equal, favorable operating profit benefit to the Ag & Turf Division of somewhere between and precisely it says $7 [million] and $22 [million], and of course it never works out exactly that way, but so you can see a little bit of the sensitivity actually does not work to harm us in this particular case.

  • Jim Field - CFO

  • So I might just add to that. In general, our trade flows, relative to the Euroland, or Euro zone versus the United States, are relatively well balanced. And to the extent that we've had the Euro be an issue relative to our financials good or bad, it generally happens when there's steep sharp movements in the Euro versus the dollar, and so the analysis that Marie has shared with you shows that, in general, we're fairly well balanced relative to the Euro. And that's why you see this, basically de minimus impact from the movement going forward. Now, Marie made a very important caveat, that is all other things being equal and of course they never are but that would be our estimate today.

  • Henry Kirn - Analyst

  • Thanks, that's very helpful, and one follow-up question. Have you seen any change in behavior from buyers in the European countries with sovereign debt issues?

  • Marie Ziegler - VP-Investor Relations

  • That's a fair question. Actually, Henry the market conditions there and the farmer buying mood is very poor and so we haven't seen any cancellations if that's what you're asking. But things are at a very low level of activity, so we haven't seen things deteriorate further. In fact, if you want to find any silver lining, they are indicating some stabilization again at a pretty low level.

  • Henry Kirn - Analyst

  • Okay, thanks a lot. Congratulations on a good quarter.

  • Jim Field - CFO

  • Thank you very much.

  • Marie Ziegler - VP-Investor Relations

  • Next questioner?

  • Operator

  • Thank you. Our next question comes from Alex Blanton and please state your company name.

  • Alexander Blanton - Analyst

  • Good morning. It's Ingalls & Snyder. Marie, your corporate inventory was up about $600 million during the first half from the end of last year and typically you run it back down in the second half to about the same level that it started. I assume you're going to do that but in relation to the earlier question about why net income --

  • Marie Ziegler - VP-Investor Relations

  • Alex, actually let me interrupt. Actually our forecast does not have us running it back down.

  • Alexander Blanton - Analyst

  • It doesn't?

  • Marie Ziegler - VP-Investor Relations

  • That's in our slide deck, we show and it is a combination of raw materials in inventory -- sorry, receivables and inventory, but both categories contribute. Last year --

  • Alexander Blanton - Analyst

  • I'm talking inventory alone.

  • Marie Ziegler - VP-Investor Relations

  • I can't give you a number as we've discussed many times separately but I will tell you both categories are up. And if you'll recall last year we were at extremely low levels of production in the fourth quarter as we were working to reduce inventories and align with --

  • Alexander Blanton - Analyst

  • But I haven't asked my question yet. My question is how much did the inventory increase, do you think, add to the first quarter net income? Because that's a factor in the second half net income being a little bit lower than people expect. Because your inventory increase inflated the first half net income a bit. How much would you say?

  • Marie Ziegler - VP-Investor Relations

  • Again, we don't have a separate number as we've discussed before for inventory separate from receivables.

  • Alexander Blanton - Analyst

  • No, but I'm asking how much -- it added to net income, overabsorption, running up the inventory added something to net income. How much would it be?

  • Marie Ziegler - VP-Investor Relations

  • Maybe I could do it this way. I'm looking for -- Again I'm going to have a combined number and this would be a benefit but it's in the first half of the year, actually, it turns out to be negative on the -- this is just looking at inventory. Because we have such low levels of production in the first quarter you're actually looking at something that would be maybe a $25 million net cost in the first --

  • Alexander Blanton - Analyst

  • Okay, we'll have to talk about it off line. Second question is this. Your guidance went up, if I add back and I assume that the charge was not in the first quarter guidance, right? In other words the guidance three months ago didn't have the charge in it?

  • Marie Ziegler - VP-Investor Relations

  • That's correct.

  • Alexander Blanton - Analyst

  • So, your guidance actually for the year is up about in net income up about 33%. And I'm wondering what was it that changed so much so dramatically and why wasn't the earlier forecast higher, maybe put it that way?

  • Marie Ziegler - VP-Investor Relations

  • We continue to see very good levels of activity in our Ag business, specifically in places like Brazil and some large equipment in the US and actually a bit of a turn in the Turf business and even in medium size tractors. So we saw some other categories starting to improve and then the construction business has seen a little bit more as our dealers are starting to see a little bit of field activity, seeing businesses starting to stabilize with a little more confidence.

  • Jim Field - CFO

  • So let me just jump in. The short answer to that, Alex, would be pretty much everything has gotten better at the macro level. A&T is up, C&F is up and the Credit Operations are up and then on top of that we're seeing a very favorable mix, we've seen favorable mix development inside of A&T -- further favorable mix development.

  • Alexander Blanton - Analyst

  • Okay, thank you.

  • Marie Ziegler - VP-Investor Relations

  • Thank you, Alex. Next questioner?

  • Operator

  • Thank you. Our next question comes from Meredith Taylor. Please state your company name.

  • Meredith Taylor - Analyst

  • Hi, good morning. It's Barclays Capital.

  • Marie Ziegler - VP-Investor Relations

  • Good morning Meredith.

  • Meredith Taylor - Analyst

  • A couple of questions on the Construction & Forestry side of the business. Could you walk through some of the assumptions around this business? I know in the last quarter you were talking about inventories flat. Sounds at this point like you're looking at some inventory build on the part of dealers and then retail sales down 5% to 10%. So can you just update those?

  • Marie Ziegler - VP-Investor Relations

  • Sure. Retail sales for the industry, we think, will now be down about 5% and we think that's frankly behind us. We think that we're approaching a bottoming if we're not already there. We've actually started to see and I want to be careful because this is from very low levels of activity. But we've actually started to see a little bit of activity out of rental and it's in smaller equipment. But again, remember, all at very low levels.

  • Meredith Taylor - Analyst

  • The second part was on the inventory side.

  • Marie Ziegler - VP-Investor Relations

  • The other part was we have more production now planned in our fourth quarter than we did when we last gave guidance and so that really drives the increase in ending inventories and receivables. Some of that is Company-owned, a little bit is in the field.

  • Meredith Taylor - Analyst

  • Okay, great and could you talk a little bit about the lead times you're seeing from your suppliers and then the lead times to dealers in the categories where you are starting to see the increase on the Construction & Forestry side?

  • Marie Ziegler - VP-Investor Relations

  • In terms of availability, actually we're doing extremely well with our suppliers and have worked pretty hard with them and they have worked hard to help meet our needs. And we actually had some various strategies to flex up and down. That's actually a part of our normal routine business planning process. The order fulfillment process is in the Construction Equipment divisions are working fine. We have plenty of ability to respond so I don't have a definitive number for you on lead times but things, again, are starting to turn and we're doing a very good job of meeting customer needs.

  • Meredith Taylor - Analyst

  • That's great. Thanks so much and congratulations.

  • Jim Field - CFO

  • Thank you.

  • Operator

  • Thank you. Our next question come from Eli Lustgarten and please state your company name.

  • Eli Lustgarten - Analyst

  • Longbow Securities. Good morning.

  • Jim Field - CFO

  • Good morning.

  • Eli Lustgarten - Analyst

  • One quick clarification, I had a phone issue. Can you repeat what the benefit was for the Euro? You said it was a slight benefit and then you cut out --

  • Marie Ziegler - VP-Investor Relations

  • Between EUR1.27 and EUR1.15, you're looking at somewhere between $7 million and $22 million, all things equal in operating profit.

  • Eli Lustgarten - Analyst

  • Yes, I realize that, thank you. Just a question and the construction equipment area. Do you have any sense how much of the improvement that you're seeing in your high production is going to its inventory restocking or rebalancing of the fleet of your dealers and so as opposed to pure end demand? I assume you're suggesting that end demand not going anywhere and almost all of the buying is replenishing the fleet. But you expect that to be finished this year in fiscal 2010?

  • Marie Ziegler - VP-Investor Relations

  • I wouldn't say it would be finished because you're at such a low level of activity and frankly, even in terms of field inventories. But you are seeing, again, from the rental companies a little bit of a turn and but most of it is fleet either -- is some replenishment on the part of our dealers.

  • Eli Lustgarten - Analyst

  • So and the same thing, do you expect -- do you have any feel for where your inventories will wind up at the end of the year? Are you still going to be, I assume, based on projections, you still expect to have very tight farm inventories at the end of the year in the farm sector?

  • Marie Ziegler - VP-Investor Relations

  • That would be true. That's in part by design and then certainly in response to a very good market conditions.

  • Eli Lustgarten - Analyst

  • Thank you.

  • Marie Ziegler - VP-Investor Relations

  • Thank you, Eli. Next question?

  • Operator

  • Thank you. Our next question comes from Seth Weber and please state your company name.

  • Seth Weber - Analyst

  • Good morning. It's RBC.

  • Marie Ziegler - VP-Investor Relations

  • Good morning.

  • Seth Weber - Analyst

  • Just on your comment about the used equipment inventories in Europe. Is that across product lines and is that more just an industry commentary or is that Deere dealers, could you just give us some color there?

  • Jim Field - CFO

  • Well, that is more or less across the line. Of course, we're over-represented by tractors and combines in Western Europe. And we do not believe that Deere is unique in this regard. And in fact, we would tell you that our inventories in general are in as good of shape as most anybody's and this back up of the used goods is really tends to be more of an industry-wide issue in Europe.

  • Seth Weber - Analyst

  • Okay, and then flipping over to Brazil, I mean you raised your forecast for the South American market. Do you expect revenue comps to be down year-over-year for the second half just given the timing of some of the programs that went in place last year? Or do you think that, that's--

  • Marie Ziegler - VP-Investor Relations

  • Actually, Seth, I'm glad you brought that up. You may not be aware and we didn't mention that overtly in the call. The Brazilian government has announced an extension or a continuation of the low rate financing under the FINAME program. It's is currently 4.5% and it ends at the end of June. There is another rate that will be effective from the first of July to the 31 of December and that is 5.5% which is up a little bit from 4.5% but still at very attractive level in the market. Regarding the Mais Alimentos program, at least as far as last week, we still had not heard anything from the government as to whether or not it would be continued. Conventional wisdom in Brazil does believe it will be continued so I wouldn't see a decline in the fourth quarter.

  • We had originally talked about that when we assumed that the FINAME rates went back to more normal levels. As we look forward into 2011, again, absent any other information you have to assume that, that special FINAME rate will end at the end of December, at least that's what for planning purposes what you would expect. You get, it will affect sales though a little bit further into our fiscal 2011 because you usually have to commit with the bank some time we expect it would be by the end of November. And then you have a few months after that to actually take delivery on the equipment so that would get us into our some time into our second quarter. That's a long winded answer.

  • Seth Weber - Analyst

  • Okay, thanks for the clarification.

  • Marie Ziegler - VP-Investor Relations

  • Thank you, Seth. Next questioner?

  • Operator

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

  • Barry Bannister - Analyst

  • Hi, it's Stifel Nicolaus.

  • Marie Ziegler - VP-Investor Relations

  • Good morning.

  • Barry Bannister - Analyst

  • Good morning. Now that the dust has settled I wanted to step back and ask a bigger picture question. In Deere, as a whole, and lately in Construction & Forestry, this obsession with working capital has caused pretty extraordinary swings in production tonnage and operating leverage and it's resulted in volatility of operating earnings with EPS down 40% in 2009 and then back up 42% in 2010. So what I'm getting from investors is they really view Deere as more of a short-term speculative vehicle and not so much a long-term investment.

  • And the incentive system inside Deere is SVA-based has a very sharp focus on capital employed, so we can expect these huge swings in production schedules on a regular basis going forward. So I guess my question is do we have a situation here of misaligned interests? And would it be better to smooth earnings a little bit over the cycles by ultimately over and under producing over time rather than panicking, cutting production, and quickly raising production we will find ourselves short competitively of inventory? Do you have any thoughts on that?

  • Marie Ziegler - VP-Investor Relations

  • I certainly do. We would tell you our SVA model has been extremely powerful in raising the overall returns we have generated as a Company. You may recall we traditionally turned our assets maybe a little more than one time, we're well over two times. We think that's helpful to our customers because they get new fresh product that is specifically designed to meet their needs as opposed to taking inventory that has been sitting out sometimes for, frankly, too long at the dealer. And it's not optioned the way the customer wants it. In terms of our ability to manage working capital, you're not mentioning the very powerful effects that it has had on our ability to generate cash flow and we think that is critical. And we think actually we get very solid feedback on this.

  • When the market turns down, Barry, eventually you're going to have to react and it's a question of timing whether you do it today or tomorrow. We do not think we have been knee-jerk at all in responding to market conditions, and again, I think that our very superior returns speak for themselves.

  • Barry Bannister - Analyst

  • Does your $4 EPS guidance in 2010 include any loss for the sale of the windmills?

  • Jim Field - CFO

  • We have not arrived at any definitive course of action relative to the wind business. And as a result, our forecast does not contemplate any definitive action one way or the other, other than it continues to be in the portfolio. What we've announced is that we've undertaken a strategic review and at the right time we will reveal what the results of that review contemplate. But right now, our forecast contemplates that wind is a continuing piece of the John Deere portfolio. I would go back to the previous question, Alex, and or Barry, sorry, and just also offer the point that 2009 was an extraordinary year in terms of the schedule reductions that were put in place and then the reactions. And, one, that I would say obviously if you're going to develop any hypothesis, I think it needs to be taken with a grain of salt in that it was so extraordinary.

  • And we are firmly, of the opinion, that long term that being very, very quick to react in terms of schedule. Making sure that we have the right product out there at the right time with the right optionality so we don't have to give it away is in fact in the long term best interest of our shareholders. And it's a very complicated subject that would be very willing to discuss with you further and I apologize for calling you Alex and I apologize to Alex.

  • Barry Bannister - Analyst

  • I feel honored. Thanks a lot.

  • Marie Ziegler - VP-Investor Relations

  • Next questioner, please?

  • Operator

  • Thank you. Our next question comes from Mark Koznarek and please state your company name.

  • Mark Koznarek - Analyst

  • Hi, it's Cleveland Research.

  • Marie Ziegler - VP-Investor Relations

  • Good morning Mark.

  • Mark Koznarek - Analyst

  • Good morning. How much did foreign exchange contribute to operating income in the quarter?

  • Marie Ziegler - VP-Investor Relations

  • It was $80 million and it's primarily Ag, I mean, virtually all Ag.

  • Mark Koznarek - Analyst

  • Okay, and then for your cash flow outlook, cash flow from operations, can you explain something to me? Maybe I'm just doing my math wrong but you're forecasting that to increase by $600 million, pretty healthy. But net income in your guidance is up a little over $400 million when you add back that charge and then your receivables and inventories are going up as well. So I'm presuming working capital will be more of a use than previously expected and your depreciation actually is going down a little bit. So what am I missing that contributes an incremental $200 million, or more to cash flow from operations?

  • Marie Ziegler - VP-Investor Relations

  • Well with a rise in payables, with the rise in activity late in the fourth quarter, you get a little bit of payables and then we've got dividends from Financial Services that we didn't have last year and I think those will be the two biggest --

  • Jim Field - CFO

  • The dividends by itself, I think is $200 million a year ago because we were re-levering the balance sheet of the Capital Corporation. We didn't take any money out of the Financial Services, so effectively their earnings were not monetized whereas this year, at least two-thirds of their earnings will be monetized in terms of cash in the equipment operations.

  • Mark Koznarek - Analyst

  • Okay, and a comment about working capital with the payables? You're saying that working capital is more neutral rather than--

  • Marie Ziegler - VP-Investor Relations

  • I don't have it broken out exactly that way. I have it by line items but as we're ramping up those schedules in the fourth quarter, you do, because of the timing end up with some payables and--

  • Jim Field - CFO

  • For example, in the payables last year, our incentive compensation accruals would have gone down significantly. I think we made a comment that, or a year ago, that 6 points of the SA&G decline was because of the reduction in the incentive compensation expense. Well that's a reduction in accrual which through the cash flow statement effectively shows up almost as a use of cash and then as that accrual is being rebuilt, that's a non-cash charge to earnings and so it's those sorts of items.

  • Mark Koznarek - Analyst

  • Okay, all right, great. That helps, thank you.

  • Marie Ziegler - VP-Investor Relations

  • Mark, I think we've got time for one more question?

  • Operator

  • Thank you. Our final question comes from Jamie Cook and please state your company name.

  • Jamie Cook - Analyst

  • Hi, good morning and congratulations. Just a quick question, two quick questions, Marie. One, I'm curious on your R&D and SG&A expense, when we think about each quarter we've raised that expense, your percentage increase a couple points relative to where we were when you first started off, yet we've underspent in the first half. So why that's going higher or how we think about the impact on Q3 relative to Q4? I'm trying to think if there's anything else going on there? Or is that cushion in the guidance? And then my last question, just on your 2011 farm cash receipts forecast, again, another stellar year, it's probably the second best year in US farmer history. Under what scenario would 2011 sales be down in the US? Just based on your cash receipt forecast or am I missing something why it's not going to be up, I guess?

  • Marie Ziegler - VP-Investor Relations

  • Let me go back and do the R&D first. The R&D spend, we have no deliberate cushioning in either R&D or SA&G. The expenses required to meet IT4 are real and that engineering will be ramping up as we move through time. Does it get all the way up 13%? I can't guarantee it but that is a very real cost and we've got plans in place for that. SA&G, there will be some launch expenses and I think there is -- as we weren't sure how the year would progress I think there might have been a few things in SA&G that might have been postponed in the second half of the year that we had some flexibility on. I know even in my own case, some training, that I didn't do in the first quarter or first half I may do in the second.

  • Jamie Cook - Analyst

  • But is it split evenly between Q3 and Q4 if I think of your total expense for the year, you know what I mean? Is it split evenly between Q3 and Q4 the remainder of what we need to spend?

  • Marie Ziegler - VP-Investor Relations

  • I don't have that level of detail, I am sorry.

  • Jamie Cook - Analyst

  • Okay and then the last question just your 2011 cash receipt forecast for the United States, I'm just trying to figure out what I'm missing under what scenario sales could be down. Is it Tier 4, anything in your mind where we're not having another up stellar year in the United States for farm equipment?

  • Marie Ziegler - VP-Investor Relations

  • At this stage of the game we don't have guidance for 2011 and it's very, very difficult to predict the factors that you're looking at seem to be very good. We would hope there would be some upside coming as you see recovery in livestock and from the Turf and Utility division as well. But we do not have a forecast, so I'm unable to give you a better answer.

  • Operator

  • All right, I thought I'd try. Congrats.

  • Marie Ziegler - VP-Investor Relations

  • Thank you all for participating in the call today and of course, as usual, we'll be available to answer questions throughout the day. Bye.

  • Operator

  • Thank you. This does conclude today's conference call. We do thank you for your participation and you may now disconnect your lines.