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Operator
Good morning, and welcome to the Deere third 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 of IR
Good morning.
Also on the call today are Jim Field, our Chief Financial Officer as well as Susan Karlix, and Justin Marovec, from the Deere Investor Relations staff.
This morning we'll take a closer look at Deere's third quarter earnings and then spend some time talking about our markets and how we see the last quarter of our fiscal year shaping up.
After that, we'll respond to your questions.
Please note that slides are available to complement the call this morning and 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 the call, including the Q&A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call.
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 & 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 are not an offer to sell or a solicitation of offers to buy any of the Company's securities.
This call may also include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, otherwise known as GAAP.
Additional information concerning these measures, including reconciliations to comparable GAAP measures is posted on our website at www.johndeere.com/financialreports under 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 today's call.
And now for a closer look at our third quarter, here is Susan.
Susan Karlix - Manager, Investor Communications
Thank you, Marie.
John Deere's strong performance continued in the third quarter of 2010.
Income was up 47% on a sales increase of 18%.
Earnings were the highest for any third quarter in the Company's history and sales were the second highest.
The gain was led by Ag & Turf, which had another blockbuster quarter.
Construction and Forestry had its highest profit in seven quarters, and our Credit Operations had another solid performance.
The Company is being helped by somewhat improved business conditions, but tailwinds are only part of the story.
After all, construction markets are still weak by historical standards, and some Ag markets such as Europe and the CIS remain under pressure.
What our results clearly show is the disciplined execution of our business plans and our focus on serving customers with advanced products and services.
This has allowed us to fully capitalize on the current market conditions.
Now let's look at the quarter in more detail starting with slide three.
Net sales and revenues were up 16% to $6.8 billion in the quarter.
Net income attributable to Deere & Company was $617 million and as just mentioned, up 47% compared with the third quarter last year and our highest ever income for a third quarter.
Turning to slide four, total worldwide equipment operations net sales were up 18% to $6.2 billion.
Currency translation on net sales was flat versus our May forecast for currency to be up about 2 points in the third quarter.
Price realization in the quarter was positive by 2 points.
On slide five, worldwide production tonnage was up 31% in the quarter.
This slide illustrates that with one exception, tonnage in each SBU and region was up in line with the forecast provided a quarter ago.
The exception was outside the US and Canada where tonnage came in lower than anticipated due to continued weakness in Western Europe.
For the full year, worldwide production tonnage is now forecast to be up about 14%.
Let's turn to the Company outlook on slide six.
Fourth quarter sales are expected to be up approximately 32% compared with the fourth quarter of 2009.
Currency translation on net sales is expected to be negative by about 1 point.
Net income attributable to Deere & Company is forecast to be approximately $375 million in the fourth quarter.
For the full year, net equipment sales are forecast to be up about 12% compared with fiscal year 2009.
This includes about 2 points of positive currency translation and approximately 2 points of positive price realization.
Turning to a review of our individual businesses, let's start with Agriculture and Turf on slide seven.
Production tonnage was up 24% in the quarter on a 12% increase in sales.
Operating profit, however, jumped by nearly $345 million, or 72% to $824 million.
The increase was primarily due to higher shipment and production volumes and improved price realization, partially offset by higher post retirement benefit costs.
As you can see, margins were impressive.
The division had an operating margin of approximately 16% in the quarter and an incremental margin of about 61%.
Before we review the sales outlook, let's look at some of the fundamentals affecting the Ag business starting on slide eight.
On the heels of the recent commodity price increases, the outlook for most crop prices is up considerably for the 2010/2011 crop year.
Corn prices are being helped by increasing global demand and have moved in sympathy with the poor grain crop in many areas of the world.
We project that 2009/2010 stocks in the US and Canada will end 250 million bushels below a year ago and fall another 150 million bushels in the coming year.
Soybean exports have remained strong.
Growing global consumption is expected to keep soybean prices at extremely favorable levels for the 2010/2011 crop.
Global wheat stocks have tightened with lower winter wheat plantings as well as yield losses in Western Europe and to an even greater extent in the CIS.
2010/2011 cotton prices remain well above the '08/'09 levels, driven by the recovery in global demand and a reduction in the global cotton supply.
Turning to slide nine, 2010 US farm cash receipts are now forecast to be up about 6% from 2009 to about $317 billion.
That's about $4 billion higher than our last forecast and is driven by increased crop receipts.
2011 farm cash receipts are forecast to be slightly above the 2010 levels.
Deere's outlook for the EU-27 is shown on slide 10.
The recent upward movement in grain prices might seem at odds with our rather subdued 2010 industry sales outlook for Western Europe.
No doubt, some customers are locking in crop sales at attractive prices, which should provide support for 2011.
That said, industry sales of new goods have been weak this year, particularly in combines.
While European farmer sentiment is slowly improving, the dairy and livestock sector is still reeling from losses of prior years.
Drought has hurt yields for customers in many areas, and used equipment inventories remain at high levels.
Slide 11 illustrates the extreme heat and drought conditions in Russia and Eastern Europe.
These conditions have sparked wildfires, and the picture on the right depicts some of the smoke from those fires visible from our Domodedovo facility outside Moscow.
Last week the USDA estimated that 2010/2011 FSU-12 wheat production would be down about 23%.
Some industry observers believe the losses could go even higher.
Although Russia is reporting success controlling the fires, the consequence of the severe drought and its impact on global grain markets won't be fully known for some time.
Farm net income in Brazil and Argentina is on slide 12.
We continue to see good farm net income from soybeans and sugar cane, the two crops that drive the bulk of equipment purchases in Brazil.
Other positive factors include strong global demand for Brazilian commodities, a 5% to 10% decrease in input costs and strong government sponsored low-rate finance programs that run through at least the end of calendar year 2010.
These all contribute to positive producer attitudes which translate into higher spending on farm equipment.
We have increased our forecast for 2010 farm net income in Argentina.
With milk and beef prices high, we continue to see increased demand for tractors, combines, sprayers and forage equipment.
Although too early to predict, we are closely monitoring the development of a La Nina weather pattern that could result in lower production and yields in 2011.
Slide 13 highlights the latest additions to our tractor lineup in India.
In June, we introduced the 5036C and 5041C tractor models.
These tractors were designed and developed in India with features tailored to the India market.
These 35 and 41-horsepower tractors joined the recently introduced 5038D, expanding our presence in the targeted 31 to 40-horsepower market.
This horsepower segment makes up almost 50% of the tractor industry in India.
Our 2010 industry outlooks are on slide 14.
Sales of agricultural equipment in the US and Canada are forecast to be up 5% to 10%.
We continue to see strength in our order books and have early order programs in place for our seasonal equipment.
Although very early, the combine early order program is progressing well and as planned.
In absolute numbers, orders are well ahead of last year.
In the sprayer, planter and tillage equipment programs, we are seeing strong results, very similar to last year.
Demand for large tractors has been strong as well.
The 8R series tractor introduced last year has been very well received, and we have continued to add schedule throughout the year.
We are just now introducing the interim tier 4 compliant 8R to our dealers and are encouraged by the initial orders of over 1,000 units.
Well over half are retail sold with customer names on the order.
Effective availability for 8R series tractors is February 2011.
Effective availability for our four-wheel drive tractors is November 2010.
Earlier, we touched on the conditions in Western Europe.
While fundamentals are promising as we enter 2011, current market conditions are weak, and we are therefore lowering our industry forecast.
We now expect Ag sales to be down 15% to 20% in the year.
Sales in Central Europe and the CIS are expected to remain under pressure and based on the factors we covered earlier, we are increasing our industry forecast for South America to up 25% to 30%.
Turning to another product category, we expect retail sales of turf and utility equipment in the US and Canada to be up 10% to 15% in 2010 from the very low levels of a year ago.
We have seen an uptick in the commercial mowing, riding lawn equipment and golf markets.
However, with general economic conditions still uncertain, our optimism for this segment remains tempered with caution.
Putting this all together on slide 15, Deere sales for worldwide Ag & Turf are now projected to be up about 8% in the year.
Currency translation on net sales is projected to be positive, about 2 points.
For the year, the A&T division's operating margin is forecast to be around 13%.
The division continues to benefit from strong sales of large Ag equipment in the United States and Canada, with relatively weak sales in the turf and utility segment.
In May's call, we said favorable mix added 1 point of margin to Ag & Turf's second quarter results.
Now, with our new forecast for the full year, this favorable mix is expected to add about 2 points to the division's margin in relation to a typical year.
Let's focus now on Construction & Forestry on slide 16.
Deere's net sales were up 59% in the quarter, while production tonnage nearly doubled, being up 96%.
The division reported operating profit of $66 million.
On slide 17, although we are forecasting the US construction industry to be down about 2% for the full year, we believe the market has reached its bottom.
The business is experiencing a slow improvement.
We are encouraged by the activity we have seen with independent rental companies and in the highway construction segment.
Also encouraging, Deere dealers continue to see an improvement in rental utilization and used equipment turns.
Still, we remain cautious.
Uncertainty over the economic recovery persists, and we have lowered our outlook for 2011 housing starts.
Meanwhile, global forestry markets are up significantly from the very low levels of last year and our factories have responded quickly to the increased demand.
We are now forecasting Construction and Forestry sales to dealers to be up about 35% in 2010 from the very low levels of 2009.
The division's full year operating margin is forecast to be in the low single digits.
Let's move now to our Credit operations.
Slide 18 shows the Worldwide Credit Operations provision for credit losses as a percent of the total average owned portfolio.
Year-to-date on an annualized basis, the provision is 49 basis points.
Writeoffs in the Construction & Forestry portfolios continue to improve.
Recovery rates are improving steadily.
We are seeing fewer repossessions and increased pricing on the repossessions that are occurring, up 9% to 10% since last fall.
The full year provision for John Deere Credit is forecast to run around 55 basis points, an improvement over our prior forecast of about 71 basis points.
On slide 19, past dues for the Worldwide Credit Operations are lower than last year, with Construction & Forestry being the main driver of improvement.
Annualized writeoffs reflect the significant improvement in C&F losses.
Moving to slide 20, Worldwide Credit Operations net income attributable to Deere & Company was $95 million in the quarter versus $99 million last year.
The biggest factors were an improvement in financing spreads and a lower provision for credit losses.
These were partially offset by lower tax credits related to wind energy projects.
Looking ahead, we're now projecting Worldwide Credit Operations net income attributable to Deere & Company of about $325 million in 2010.
Now let's turn our focus back to equipment operations and take a look at receivables and inventories on slide 21.
For the Company as a whole, receivables and inventories were up roughly $450 million in the third quarter versus third quarter 2009.
Keep in mind, we ended fiscal 2009 with receivables and inventories at rock bottom levels.
In fact, they were $1.3 billion lower than at the end of fiscal 2008.
For fiscal year 2010, we are now forecasting receivables and inventories to be up about $950 million.
This reflects higher production volumes in the fourth quarter versus the very low volumes in the fourth quarter last year.
These higher production volumes are intended in part to facilitate the transition to interim tier 4.
They also reflect higher demand in the Construction & Forestry division and some Ag & Turf markets.
Now let's discuss the latest on retail sales.
Slide 22 presents the product category detail in the US and Canada for the month of July expressed in units.
Utility tractor industry sales were up 3%.
Deere sales were up double digits.
Row crop industry tractor sales were down 10%.
Deere was down in line with the industry.
Four-wheel drive industry sales were down 2%, Deere was down double digits.
Combine industry sales were down 7%, and Deere was down slightly less than the industry.
Looking at Deere dealer inventories in the bottom chart, for row crop tractors, Deere ended July with inventories at 18% of trailing twelve month sales.
Combine inventories were at 19% of sales.
Turning to slide 23, in Western Europe, sales of John Deere tractors were up double digits, and combines were down double digits in July.
Deere's retail sales of selected turf and utility equipment in the US and Canada were up a single digit 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 for the month.
Slide 24 shows raw material and logistics costs up about $10 million in the quarter.
We now forecast material cost decreases of approximately $150 million for the year.
By division, the Ag & Turf savings are forecast at about $175 million.
For Construction & Forestry, we continue to forecast a material cost increase of about $25 million.
This is due to the currency impact on partner products and higher steel prices.
While this forecast is an improvement over last quarter, remember that prices for many commodities have been moving up recently, and our cost increases typically lag the commodity markets by three to six months.
Now let's look at a few housekeeping items.
Looking at our R&D expense on slide 25, R&D was up about 5% in the third quarter with currency translation accounting for negative approximately 2 points.
Year-to-date, R&D expense is up about 6%.
For the full year, R&D expense is expected to be up about 10%.
We expect R&D spending to increase in the fourth quarter as we approach significant product launches with interim tier 4 engines and remain at high levels over the next three years as we approach the final tier 4 emission standards.
Moving now to slide 26, Pension and OPEB expense in the third quarter was up about $100 million.
The 2010 forecast calls for an increase of about $350 million in Pension and OPEB expense, unchanged from our previous forecast.
We have had a slight change in the split between cost of sales and SA&G.
Of the $350 million, about $275 million will hit cost of sales with about $75 million now 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 27, SA&G expense for the equipment operations was up about 17% in the quarter.
Variable incentive compensation accounted for about 8 points, and currency translation added about 3 points.
For fiscal 2010, we project SA&G to be up about 9 points, unchanged from our previous forecast.
Variable incentive compensation is expected to account for about 5 points of the change as the Company's performance has continued to improve.
Pension and OPEB accounts for about 2 points and currency translation about 1 point.
Moving to the income tax rate on slide 28, the third quarter effective tax rate for the equipment operations was about 34%.
The full year 2010 effective tax rate is expected to be about 40%.
That includes the tax expense of about $130 million related to US healthcare legislation recognized in the second quarter.
Excluding the charge, the forecast effective tax rate for 2010 would be about 34%.
Before touching on cash flow, the combined effect of translation and transaction, or trade flows, increased operating profit by about $60 million in the third quarter, primarily in Ag & Turf.
On slide 29, you see the strong cash flow from our equipment operations, even in years of tough market conditions like last year.
This reflects in large part our success managing assets and controlling working capital levels.
We anticipate cash flow from equipment operations of about $2.4 billion for the year, a $1 billion increase over 2009.
Such strong cash flow is further testament to our successful execution of the SVA model.
As you can see on slide 30, in accordance with our stated use of cash priorities, we resumed share repurchase in the quarter, buying back some 1.7 million shares.
As we generate good cash flow, share repurchases will continue to be an avenue we consider when assessing our use of cash.
Turning to slide 31, capital expenditures are expected to be about $850 million for the year, primarily driven by the interim tier 4 emissions rules.
Depreciation and amortization is projected to be about $550 million.
Our forecast currently includes about $700 million of Pension and OPEB contributions in the year.
In closing, John Deere enters the last quarter of 2010 on a strong pace.
Our performance reflects somewhat more positive economic conditions and strong demand for large farm machinery, particularly in the United States.
At the same time, John Deere remains focused on serving a growing global customer base, steadily increasing capacity, adding productive new models of equipment and successfully extending our competitive position throughout the world.
As a result, we believe the Company is exceptionally well positioned to benefit from a growing economy and to help meet the world's increasing need for food, feed, fuel, shelter and infrastructure well into the future.
Marie?
Marie Ziegler - VP of IR
Thank you, Susan.
We're now ready to begin the Q&A portion of this call.
The operator will instruct us on the polling procedure.
As a reminder, and in consideration of others, please limit yourself to two questions and as always, you are welcome to get back into the queue.
Operator?
Operator
(Operator Instructions) Our first question comes from Ann Duignan.
Please state your company name.
Ann Duignan - Analyst
Hi, good morning, JPMorgan.
Marie Ziegler - VP of IR
Good morning, Ann.
Ann Duignan - Analyst
Hi.
My first question is on the near term, your fourth quarter outlook.
Particularly on the Ag & Turf side, you noted that margins would be about 13%.
That would imply much lower margin in Q4 than I have been forecasting and much lower than Q3.
Marie, I think you guys addressed it in the call, but I just wanted to make sure, are you anticipating a significant hit on gross margins because of the build up of pre Tier 4 interim engines?
Is that what maybe I was missing in my forecast?
Marie Ziegler - VP of IR
Not directly, Ann.
In fact, instead of just addressing Ag & Turf, let me look at it for the full Company in relation to our full guidance and give you some of the numbers that are implicit in our guidance.
With increased profitability for the Company, incentive compensation is rising and in the fourth quarter over last year, it will be about a $90 million expense.
Again, very low levels of activity in the fourth quarter last year.
Materials, which has been either a neutral or tailwind for us in the first three quarters of this year will be an expense in our projection.
It is $75 million.
R&D, we have a pretty significant jump.
That's why Susan called out the fact that year-to-date we're up 6%, for the forecast up 10%.
That's about $55 million in the fourth quarter.
That is a lot of money, and that is very much impacted by IT4 for us as we're getting ready to enter into this very significant launch phase.
And remember, we have got final Tier 4 following on the heels in just like three years.
Another factor is overhead absorption, and we estimate that at about $50 million -- I shouldn't say overhead absorption, it is overhead expense.
We have a very significant spend in R&D.
Likewise, we have a very significant spend in capital expenditures ahead us in the fourth quarter, and that is disruptive to the factory efficiency as you bring new machine tooling in, as you train operators.
And so we've provisioned for that in our outlook.
And then the only other thing of note would be SA&G is a little higher as well.
Ann Duignan - Analyst
Okay.
That's very helpful.
I just wasn't sure what I was missing there.
And then longer term, I know you won't talk specifically about our outlook for 2011.
I know better than to ask directly, but could you talk a little bit about the overall global impact?
With a negative impact in Russia because of the drought, what that might due to protein sector in Europe and their input costs versus the positive impact it may have for US farmers and South America farmers.
How are you looking at putting all of these pieces together as you look into 2011 and the health of global agriculture as we step forward?
Marie Ziegler - VP of IR
There is no question that the recent run in commodity prices driven by the events in the CIS and even into eastern Europe certainly has supported the prospect for crop farmer incomes.
You are -- you correctly note that the livestock sector is a little more concerned, obviously with what's happened, especially just having come out of two years of very, very difficult financial situations.
It is not as likely, therefore, you will have much crop -- much herd expansion globally in the face of these rising feed costs.
But overall for the farm sector, it would appear to be very positive as you look into 2011.
Some of the other factors, though, Ann, that we're considering as we ourselves look into the future, obviously with the events of the last couple of weeks regarding the global economy which seems to vary day by day, people are perhaps a little less certain than they were and that does raise a note of caution, especially a lot of talk about the US economy which would affect certainly our construction equipment business and our turf and utility and frankly, even the small ag sector.
Because a lot of that is economically sensitive because it goes into homeowners and large property owners, et cetera.
The other thing that you would want to think about is rising material -- rising commodity costs affecting our materials as we go into 2011.
I mentioned in the first question that I was answering of yours that we had a tailwind or neutral in the first three quarters of the year.
That's worth about $250 million.
If raw material costs just stay where they are today, obviously that's something that would not be repeated.
The other thing I would just note is that we are going to be in the midst of this IT4 transition.
We are very encouraged by the early results on it, but none the -- we have got some good orders, as Susan mentioned, on the 8000s, but it is very early, so you're really looking at a very small base.
So, we'll see how that plays out as we look ahead.
Jim, do you want to add anything?
Jim Field - CFO
No.
I think that pretty much covers it.
Ann Duignan - Analyst
How about pension?
That's the one thing you didn't touch on for going into 2011.
Marie Ziegler - VP of IR
As pension looks today and of course, all things are never equal, we probably -- because interest rates are looking a little lower than they were at 31 October of 2009, you probably have a little bit headwind there as well, maybe $75 million.
But obviously, we're a long way from 31 October when we'll actually be setting the rates.
Ann Duignan - Analyst
I appreciate that.
Okay, thank you very much.
I will get back in line.
Appreciate it.
Operator
Thank you.
Our next question comes from Stephen Volkmann, and please state your company name.
Stephen Volkmann - Analyst
Good morning, it is Jefferies.
Marie Ziegler - VP of IR
Good morning.
Stephen Volkmann - Analyst
I am wondering, Marie, you gave some forecast for cash receipts in the US and net income in Latin America.
Can you frame for us how you think European farmers are going to be looking in 2011?
Marie Ziegler - VP of IR
It is early, but people are pretty encouraged by the improvement in commodity prices.
You're hearing some stories of customers having locked in some good crop prices and selling their crops for good amounts of money, so we're encouraged.
We still have used equipment to deal with, which is unknown exactly how that will impact the market as you move into 2011.
We're starting to see a little bit of that equipment move again.
That's very encouraging, but there is a lot yet to be done, Steve.
Stephen Volkmann - Analyst
Sounds like you're saying farm income probably up in 2011 in Europe?
I don't want to put words in your mouth, but.
Marie Ziegler - VP of IR
I'm -- that will play off against what happens ultimately with livestock prices and what happens to their feed costs, and livestock is -- about half the farmers in Europe have livestock, so it is significant to our customers.
Stephen Volkmann - Analyst
Okay, great --
Marie Ziegler - VP of IR
Go ahead.
Stephen Volkmann - Analyst
Sorry.
And just a follow-up on the construction business.
Obviously, we have seen a nice recovery there in top line and in margins.
How much of that is sort of dealer restocking?
And do you think that -- how much longer -- where are we in that game and how much longer can that go?
Marie Ziegler - VP of IR
There is actually not very much dealer restocking taking place.
Mostly what's happening, last year when the dealer sold maybe three units, he or she would replace one.
Now it is more one for one replacement, so very little channel fill.
Jim?
Jim Field - CFO
Yes, I think construction, if we look at history, it has a very long runway in front of it because we are still at very depressed levels relative to mid cycle volumes.
So, I think we have a situation where we're running roughly 60% of mid-cycle volumes, so we think there is plenty of runway there.
Stephen Volkmann - Analyst
Great.
That's helpful.
Thank you.
Marie Ziegler - VP of IR
Thank you, Stephen.
Next.
Operator
Thank you.
Our next question is from Jerry Revich, and please state your company name.
Jerry Revich - Analyst
Good morning, it is Goldman Sachs
Marie Ziegler - VP of IR
Good morning, Jerry.
Jerry Revich - Analyst
Marie, can you say more about the drivers of your increased inventory and receivables guidance for Ag & Turf?
What proportion of the increase is related to interim Tier 4 and which regions are driving the rest of the increase?
Thank you.
Marie Ziegler - VP of IR
Well first of all, we're seeing strength in our construction and forestry business, so that is certainly a part of it.
The other factors, just as we're getting closer to the first of January, we're starting to land on some of our plans, so we know a little bit more precisely how some of the transitions are going to occur.
And also, very candidly, demand looking pretty good.
The early order -- again, it is very early.
You're looking at small numbers, so I want to be very careful we put this in the appropriate context.
But the demand for the products, early order programs seem to be going fairly well.
Again, early, so that's encouraging.
If you look at our tonnage increases for the full year and the fact that our third quarter tonnage basically came in as projected, that tells you that all of that increase is really happening in the fourth quarter.
So, it will take time for that production to actually translate into a retail sale, because you've got to work it through the factory and through the receivable.
So, we actually feel pretty good.
Actually, Jim took a look at our receivables and inventories by historic standards, and they look really quite good.
Do you want to talk there?
Jim Field - CFO
Yes, it is a big increase when you look at it, or perhaps could be viewed as a big increase when you look at it on a year-over-year basis.
But if you look back on historical context, really, this is receivables returning to levels that we last saw in '08 and inventory actually that ends at levels that are below the '08 level.
So, I think that hopefully provides some useful context when looking at that increase.
Jerry Revich - Analyst
Absolutely.
Thanks for that.
And Jim, good to see you buying back stock for the first time in awhile this quarter.
Can you update us on your framework for stock buyback?
Are you going to be looking at it as a portion of your excess free cash flow, or update us on your broader framework.
That would be great.
Thank you.
Jim Field - CFO
Yes, well, I appreciate that.
Unfortunately, I think -- can't say a whole lot beyond the notion that we have had a very consistently articulated use of cash policy, and share repurchases is one of the things that we will look at from time to time based on our cash position, and we did so in the third quarter.
Can't provide much more than that at this time.
Thank you.
Jerry Revich - Analyst
Thank you.
Marie Ziegler - VP of IR
Thanks, Jerry.
Next question.
Operator
Thank you.
Our next question comes from David Raso, and please state your company name.
David Raso - Analyst
ISI.
Good morning.
Marie Ziegler - VP of IR
Good morning, David.
David Raso - Analyst
My question relates to that last comment about the production in the fourth quarter and it will take some time to translate into retail sales.
Just trying to think about the margins in the ag division.
Two questions related to that then are at what time in the order book can I no longer get pre-interim Tier 4 tractor out of Waterloo?
Are we already into the market knowing when we officially are out of production slots for pre-interim Tier 4?
Marie Ziegler - VP of IR
Well, remember, we have a rolling product launch, so all that has been announced so far would be the 8Rs.
And if you would walk into your John Deere dealer today to order an 8R tractor, you will be ordering an interim Tier 4 tractor.
David Raso - Analyst
But my question though is broader Waterloo product line.
Marie Ziegler - VP of IR
We have not made any further statements other than the 8R.
David Raso - Analyst
Should it be terribly different than the 8R?
Marie Ziegler - VP of IR
We haven't launched -- so, it is going to be a little while you could assume, because we haven't said anything about the other -- some of the other products out of Waterloo.
David Raso - Analyst
I am just trying to think through the profitability of Ag & Turf in the fourth quarter and what's that implying about 2011.
Because even if I do add back some of those year-over-year impacts from short term incentive comp up, materials, overhead absorption and so forth but also take the sales guidance for the year, it just seems like the implied incremental margins in the fourth quarter are interesting low.
So, I am just trying to think about the puts and takes.
I guess broader picture then for the whole company, the construction margins for the fourth quarter, again, look around mid single digits to get you to kind of lower single digit for the year.
How are you thinking about the profitability of that division?
You took down the 2011 housing starts, though you're still implying some pretty healthy growth in housing starts 2011 versus 2010.
Bigger picture, how are you thinking about the construction division profitability off this recent kind of mid single digit level?
Marie Ziegler - VP of IR
In the fourth quarter specifically?
David Raso - Analyst
Well, you already can do the fourth quarter or you're implying 5% to 6%.
Marie Ziegler - VP of IR
So we don't have any -- David, I am sorry, I don't have any comments on 2011, if that's where you're going.
David Raso - Analyst
Well, broader picture, how should I be thinking about the 5% to 6% we have been seeing third quarter, fourth quarter?
How are you viewing that in the context of profitability of the division broadly?
Marie Ziegler - VP of IR
Well, considering that they're at under 60% of what typical volume would be, we think they are working very hard and have demonstrated very good expense control and efficiency.
As they move up into what I will call the sweet spot, which would be in the 80% range and above, that their opportunities will grow for profitability.
Jim Field - CFO
I think David, too, when you look at that, and you had some large percentage increases in sales, but if you look at the absolute dollar numbers and the incremental margin that that would be expected to throw off, and then you overlay what's going on with pension and OPEB, I think you get a long way to understanding the performance that that division has demonstrated.
And I think the other thing we would say, long-term, the construction division has demonstrated over a long-term what they can do, and we would every expectation that over time they would return to where they'd been at other points in the cycle.
David Raso - Analyst
In a nutshell, the run you had from 2004 to 2007 in that division with solid double digit margins, I am trying to think it through how quickly do you feel, if we can get the revenue growth in 2011, is this structurally a double digit margin business in pretty short order?
Or is it how you're thinking about mix for 2011 and a lot of other things, is that a little too aggressive a ramp and how you're seeing the recent run rate?
Marie Ziegler - VP of IR
First of all, I can't comment on 2011.
But I would very adamantly, very vehemently state that we see no reason at all why this business does not return to margins that it delivered in that period of time.
And if you'll recall, their peak margin in that business was 14%, and they actually are aspiring to a 14.5% margin.
Like the ag business, in the near term, IT4 will affect them as well.
They also have a staggered product launch that will be rolling out over the next couple of years, and so you will have from some impacts from that.
But this business is on very solid footing.
David Raso - Analyst
Thank you very much.
I appreciate it.
Marie Ziegler - VP of IR
Thank you.
Next question.
Operator
Our next question comes from Henry Kirn, and please state your company name.
Henry Kirn - Analyst
Hello, good morning, guys.
It is UBS.
Marie Ziegler - VP of IR
Good morning.
Henry Kirn - Analyst
Could you chat a little bit about the impact of the prebuy that your dealers may be reporting to you, at least on the equipment where you will have Tier 4 out early next year?
Marie Ziegler - VP of IR
As you look at what's happening, the very good level of cash receipts that we have in the marketplace,and it's accentuated further, frankly, by the recent run in commodity prices, you have got improved farm net income as expenses like fertilizer and various things have come in, you've got historically low interest rates, very good value proposition in the market.
We feel that the underlying economic fundamentals are in good support of the level of activity that we have seen.
As we are moving into -- closer to our launch dates, there is no question that there is some pull ahead.
But we believe the factors that I just mentioned are -- really are the primary decision drivers.
The other thing that you can -- again, it is very small numbers, but it could provide some comfort, if you will, is the fact that the early order positions are looking good on some of our products.
And the specialty perhaps more profoundly that the IT4 8R has a good order bank, again, very early in the year and very early in the launch, but it is actually been very encouraging.
Henry Kirn - Analyst
That's helpful.
And on the construction equipment side, philosophically, would you be willing to build some inventories at some point in front of expected rebound in demand from the rental guys and other contractors?
Marie Ziegler - VP of IR
Our philosophy is to produce to retail demand.
In construction, actually it is a slightly different set of circumstances.
As you're aware, in construction in some areas, you are required to use the latest technology, so you need to be -- if IT4 engines are available, you need to be using that.
Additionally, the bulk of the construction product line really is below 175, so that's not -- horsepower, so that's not going to be affected until 2012.
And the other thing is, very frankly, we're at extremely low levels of activity, and you don't see contractors, a lot of contractors with the financial confidence to go out and buy equipment that they may or may not use.
The only indications where you may have a little bit of prebuy ahead is in motor graders and some governmental segments.
So, that's pretty small.
Henry Kirn - Analyst
Thanks a lot.
Marie Ziegler - VP of IR
Thank you.
Operator
Thank you.
Our next question comes from Meredith Taylor, and please state your company name.
Meredith Taylor - Analyst
Hi, good morning.
It is Barclays Capital.
Marie Ziegler - VP of IR
Good morning, Meredith.
Meredith Taylor - Analyst
I am just going to go back to the Ag & Turf margin topic.
I appreciate the fact that you've laid out a lot of the headwinds that you're looking at fourth quarter versus third quarter.
Something that I am hoping you can talk a little bit more about, though, is the role that mix and productivity played in the third quarter for this business and what your expectations are as we look ahead to the fourth quarter?
I know you did note some overhead headwinds associated with interim Tier 4, but if you could just talk about those two items, in particular third quarter versus fourth quarter that would be helpful.
Marie Ziegler - VP of IR
Absolutely.
In the third quarter, we did not make a comment specifically year-over-year on mix.
Susan's comments about the two points overall for the year really relates to a typical year, so we're not looking at something that -- because remember, we had a very good mix of large ag in 2009 as well.
So, wouldn't really be a year-over-year factor.
If you looked at the third quarter and said just generally, how does that compare to a "typical year" then yes, it would be about two points.
If you look at absorption, last year in the third quarter, we dropped receivables and inventories, I think it's like $1.7 billion, and this year it was, I don't know, $300 million or $400 million.
So, there is a favorable absorption impact in our third quarter results, and that is for the Ag & Turf division.
It's about $90 million in their operating margin.
Meredith Taylor - Analyst
Okay.
And then as we roll forward to fourth quarter, how should we think about mix there?
And then continued benefits from lean operational initiatives, et cetera?
Marie Ziegler - VP of IR
I don't have a comment per se on mix.
I know some of the smaller stuff is coming up in the quarter, but I don't know what the actual impact is.
Jim Field - CFO
And actually, in the -- in terms of the efficiency of the operations, as Marie said, we have a lot of transition going on.
And we do have some manufacturing inefficiencies built into the forecast for the fourth quarter, reflecting the very significant amount of change that's going to be occurring over this period of time and some pretty significant capital outlays.
Meredith Taylor - Analyst
Okay.
And just a quick follow-up on LATAM.
As I've looked at the ANFAVEA data over the last couple of months on the combine side of the market, I've noticed some volatility in terms of your wholesale numbers.
Could you talk a little bit about what might be driving this?
Marie Ziegler - VP of IR
Yes.
On the combine side, we converted to SAP on the first of May, and so we knew that we would not have shipments into the marketplace as we were making that transition.
And so what you're really seeing is a -- we're in a transitional period of we -- we're behind those -- transition issues are behind us, but you're seeing the result of having just now restarting the shipping.
So it was planned.
Meredith Taylor - Analyst
Okay, great.
Thanks so much.
Marie Ziegler - VP of IR
Thank you.
Next question.
Operator
Thank you.
Our next question is from Eli Lustgarten, and please state your company name.
Eli Lustgarten - Analyst
Longbow Securities.
Good morning, everyone.
Marie Ziegler - VP of IR
Good morning.
Eli Lustgarten - Analyst
We're all having trouble with the fourth quarter, and maybe we put in context that we haven't gotten the first three quarters anywhere close anyway.
So, that what's probably what having everybody -- you listed $270 million worth of impact, but a large part of those things that you gave us, material R&D and that were known to be bigger in the fourth quarter.
Anyway, we have known that.
So, can -- are any of it much bigger than we had expected?
Because you still can't get the margins almost cutting in half unless you put in either a huge impact from the transition products in the launch and what have you putting into the guidance at this point.
That's the trouble we're all having at this point.
Is something else going on?
Did you put more in the quarter in these costs than we expected?
Because we knew they were all going up in the fourth quarter.
R&D was going to be higher in the fourth quarter, we knew that from your guidance before, as were material costs.
So it can't be -- something has to be driving the margin almost in half, which is what you're forecasting from the third quarter, and the only thing I can think of, you had more Ag & Turf.
And the only other thing I can think of is you've got a lot of inefficiency from the new product launches in the (inaudible).
Marie Ziegler - VP of IR
That's what we're trying to pick up with that $50 million overhead, if you will.
The incentive comp probably is higher than maybe what you were expecting, because of course, we have upped our guidance for income in total, so that might also be at work here.
There is also a little bit of inventory build that, of course, that doesn't convert immediately into sales, and so you don't get the margin -- the marketing margin on that.
There may be a little bit of that as you guys are thinking about your modeling, but, Jim, do you have anything to add?
Jim Field - CFO
No.
I think the incentive comp has certainly increased over what we had initially had laid out in the fourth quarter as the income forecast has improved, most of that has gotten caught up.
Marie Ziegler - VP of IR
The other thing that I haven't mentioned is taxes, and taxes in the quarter are about $50 million.
It is very hard to calculate the tax rates between the fourth quarter of last year and the fourth quarter of this year, so that I'd just tell you point-blank, that's approximately the net impact.
It is higher taxes of about $50 million, if that helps.
Eli Lustgarten - Analyst
Yes.
And can we ask, one other question on looking at 2011 production capability and pricing, you have -- prices have been announced and the new product have been relatively strong, so looking into next year, pricing going up for what you have announced and the interpretation that we're going to see more.
How much more production capability will you have for a lot of these models?
Because for the most part, we're told that you sold out for this year in most of the big product line.
How much more incremental production capacity will you have next year, and is the prebuy that we're talking about actually going to be a rolling prebuy in this market?
Because interim Tier 4 gets phased in over a couple of years, and the prices clearly are going up materially as the product goes on.
Marie Ziegler - VP of IR
It is true that we have a rolling launch.
Again, we're not sure how much prebuy there is occurring, because the economic factors seem to support the level of activity that we are experiencing, and you have got good orders following into 2011.
But are you correct that it will be a series of rolling launches, both on the ag and construction side, if that helps.
Waterloo had not put in all of the capacity that had been approved in 2008.
They put in -- I don't know if you recall, but it was about a 40% increase, and they had about 25 points of the 40 in, and I expect that the remaining 15 will be available.
I don't know if by the end of this year, but sometime in the not too distant future, so that will provide some additional assistance.
Harvester had a 30% capacity increase that was in place really by -- really, would have been fully available to us this year.
And so that's there and ready to be used as required, and then there have been capacity at other facilities as well.
Eli Lustgarten - Analyst
So we're talking about at Waterloo, probably another 10% or 15% incremental production available next year that we didn't have this year?
Marie Ziegler - VP of IR
On that -- well, 40 points.
Maybe 10.
Eli Lustgarten - Analyst
Okay.
Alright, thank you.
Operator
Thank you.
Our next question comes from Seth Weber, and please state your company name.
Seth Weber - Analyst
Hello, good morning, it is RBC.
Marie Ziegler - VP of IR
Good morning.
Seth Weber - Analyst
Sorry if I missed this, but could you, on the production tonnage adjustment, so your third quarter outside North America was below forecast, but then you raised your forecast for the full year.
Can you talk about where that's coming from?
Marie Ziegler - VP of IR
Europe would have been the primary driver for the decline in the third quarter, reflecting a little softer conditions.
The market in Brazil is very strong and -- in South America, I guess I should say, and so you would have some opportunity there.
Seth Weber - Analyst
Okay.
So you're thinking the fourth quarter Latin America would have been stronger than you would have thought last quarter?
Marie Ziegler - VP of IR
Yes, and I have been -- I am not sure how Europe plays out in this.
You're not talking huge numbers.
Seth Weber - Analyst
I'm sorry?
Marie Ziegler - VP of IR
We're not talking huge numbers here.
Seth Weber - Analyst
Okay.
Jim Field - CFO
I think the change is 23% to 24%, so it is really in the margin in terms of the full year.
So, the other piece, of course, that's been very strong, and we mentioned it a little bit, is the global forestry markets and so there would be some production being added there as well.
Seth Weber - Analyst
Okay, that's helpful.
Thank you.
And then I think Susan mentioned that your visibility into Brazil or Latin America financing right now is kind of through December, but -- the program is through December.
Could you handicap or help us -- are you hearing anything about that getting extended, or could you tell us what your current thinking might be as far as next year?
Marie Ziegler - VP of IR
I -- we believe that we will not know what the outcome of that will be until after the elections.
In our planning, we're assuming that interest rates could rise from the current 5.5% but that they would be unlikely to go all the way up to a market rate, which -- the rate before these current low rate programs that is come into place was 9.5%.
And so perhaps you got closer to 9.5%, but maybe not all the way there.
So we -- I don't have an exact number to give you, but I can tell you that in our own financial planning, as we're looking into 2011, we're going to assume that those -- the 5.5% does end at the end of December and that the rate goes up a bit.
Now, the impact, though, for us will be delayed, actually for the industry, because the customer can make a contract by the end of the year having entered into a contract at the 5.5%.
And we can deliver, I think it's -- I am not sure if it is 60 or 90 days still.
So, for us, really effectively, our first and second quarters, or at least a good chunk of the second quarter would be still effectively benefiting from that 5.5%.
Seth Weber - Analyst
Okay.
That's helpful.
Thanks for the clarification.
Marie Ziegler - VP of IR
Thank you.
Next.
Operator
Thank you.
Our next question --
Marie Ziegler - VP of IR
I am sorry, I think this is going to be our last question.
Operator
Thank you.
Our final question will come from Joel Tiss, and please state your company name.
Joel Tiss - Analyst
Hi, from Buckingham Research.
Marie Ziegler - VP of IR
Good morning.
Joel Tiss - Analyst
I just wondered if you could, in terms of the fourth quarter incremental margins, other people have asked about that.
But can you talk a little bit about the flow of production versus the inventory drawdown, and just so we can get a sense of what else may be going on there?
Marie Ziegler - VP of IR
I am not sure I know how to answer that question, Joel.
Joel Tiss - Analyst
Is there less overhead absorption baked into your numbers because you're going to under produce retail to clean out the old 2009, 2010 inventories?
Marie Ziegler - VP of IR
No.
Really, the additional overhead that we are talking about really is just additional expense from rearranging production lines, the disruption that you have when you may have additional overtime, because you have to bring people in to reset lines because you're adding a new piece of tooling or making some factory rearrangements, so it is really more related to that.
Jim, can you help?
Jim Field - CFO
I would agree.
If you look at the absolute levels of absorption, they will be higher than a year ago.
Where we're losing it is more on the spend side of the overhead equation.
Joel Tiss - Analyst
Is that higher level of expenses going to flatten out as we go into 2010?
I mean 2011, I'm sorry.
Marie Ziegler - VP of IR
Again, I don't have -- we don't have a forecast for 2011.
We will have a staggered series of launches, and I don't know how all of that will play out.
When we have our -- we ourselves do not have our budget process done for 2011, so we'll see how that ultimately plays out.
Maybe I could end with the note that although there are a lot of things going on in the fourth quarter in terms of our guidance, I still want to point out that $375 million, which is our guidance, is -- would imply our second highest fourth quarter ever.
And that's despite the start of these launches and some additional expenses and the fact that you have weak markets in Europe and the former CIS.
And Construction & Forestry, although recovering, is still, as we mentioned, still below 60% of typical.
So, we are very, very proud of the results that we are delivering and we hope to deliver.
And with that, thank you all for participating in today's call, and we will be available the rest of the day to answer your questions.
Thank you.
Operator
Thank you.
This does conclude today's conference call.
We do thank you for your participation, and you may now disconnect your lines.