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Operator
Good morning and welcome to Deere & Company's fourth-quarter earnings conference call.
(Operator Instructions)
I would now like to turn the call over to Mr. Tony Huegel, Director of Investor Relations.
Thank you, sir.
You may begin.
- Director of IR
Thank you.
Hello.
Also on the call today are Raj Kalathur, our Chief Financial Officer, as well with as Josh Jepsen and Susan Karlix from the IR team.
Today we'll take a closer look at Deere's first quarter earnings, then spend some time talking about our markets and our current outlook for FY16.
After that, we'll respond to your questions.
Please note the slides are available to complement the call this morning.
They can be accessed on our website at www.johndeere.com.
First a reminder: This call is being broadcast live on the internet and recorded for future transmission and use by Deere & Company.
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 plans and projections for the future that are subject to important risks and uncertainties.
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.
This call also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, or GAAP.
Additional information concerning these measures, including reconciliations to comparable GAAP measures, is included in the release and posted on our website at www.johndeere.com/earnings under other financial information.
Before we move ahead with today's call, I'd like to pay a word of tribute to our Manager of Investor Relations, Susan Karlix.
As many of you know, Susan will be retiring soon after 35 years with the Company.
Susan has been a valued member of the Investor Relations team for the past 13 years.
Over this time, she has become well known to investors as a trustworthy source of information about the Company and a familiar voice on the quarterly earnings conference call.
Within Deere, and across the IR field, Susan enjoys an impeccable reputation for accuracy and professionalism.
This will be Susan's final call with us.
She'll be missed for her many contributions and remembered for the steady hand and conscientious style she brought to her work every day.
I'm sure Susan's friends in the analyst community join all of us at Deere in wishing her much health and happiness as she closes out her career and enters the next chapter of her life.
Thank you, Susan.
Now, Josh.
- IR
Thank you, Tony.
With the announcement of our first quarter results, John Deere has started out 2016 on a profitable note.
Our results, however, were lower than last year reflecting the continuing impact of the downturn in the global farm economy and weakness in construction equipment markets.
All of Deere's businesses remained solidly profitable for the quarter.
This shows our continuing progress managing costs and creating a more flexible, responsive cost structure.
We also lowered our annual guidance for both sales and earnings, with most of the change due to foreign currency and weaker markets in construction equipment.
Now let's take a closer look at our first quarter results in detail beginning on slide 3. Net sales and revenues were down 13% to $5.525 billion.
Net income attributable to Deere & Company was $254 million.
EPS was $0.80 in the quarter.
On slide 4, total worldwide equipment operations net sales were down 15% to $4.8 billion.
Price realization in the quarter was positive by 2 points.
Currency translation was negative by 4 points.
In comparison with our previous net sales guidance of down about 11%, the difference is largely attributable to lower sales volumes for agriculture and turf equipment.
Turning to a review of our individual businesses, let's start with agriculture and turf on slide 5. Net sales were down 12% in the quarter-over-quarter comparison.
The decrease was mostly due to lower shipment volumes of large ag equipment in the United States and Brazil.
Partially offsetting these declines were higher sales in Europe.
Foreign currency exchange had a negative impact on sales as well, largely driven by the euro and Brazilian real.
Operating profit was $144 million, down from $268 million last year.
The decrease in operating profit was primarily driven by lower shipment volumes, unfavorable foreign currency exchange, and a less favorable product mix.
These factors were partially offset by price realization, lower selling, administrative, and general expenses, and lower production costs.
The division's decremental margin in the quarter was about 26%.
Before we review the industry sales outlook, let's look at fundamentals affecting the ag business.
Slide 6 outlines US farm cash receipts.
Given the record crop harvests of the last three years and the resulting lower commodity prices, our estimate for 2015 cash receipts is now down about 10% from 2014's peak levels.
Our 2016 forecast contemplates total cash receipts to be about $381 billion, down slightly from 2015.
On slide 7 grain stocks to use ratios remain at somewhat sensitive levels on a global basis, even after the abundant harvests of the past three years.
Global grain and oilseed demand remains strong, while supplies are now fully adequate.
Even so, unfavorable growing conditions in any key region of the world, as well as unknown impacts from any geopolitical tensions could result in prices quickly moving higher.
Our economic outlook for the EU 28 is on slide 8. Economic growth is improving at a moderate pace.
Farm income remains below the long-term average, and weakness persists in the dairy sector.
As a result, we're expecting lower industry farm machinery demand in the EU region.
On slide 9, you'll see the economic fundamentals outlined for China and India.
Because of the economic slowdown in China, we continue to anticipate lower industry sales.
While the government support of mechanization is helping the sector, changes in government subsidies are causing uncertainty.
Turning to India, the government continues providing assistance to the ag sector with programs such as minimum support prices for commodities.
Although the region has experienced two consecutive below normal monsoon seasons, our forecast calls for a modest rebound in industry sales in 2016.
Shifting to Brazil, slide 10 illustrates the crop value of agricultural production, a good proxy for the health of agribusiness there.
Ag production is expected to decrease about 2% in 2016 in US dollar terms, due to lower global commodity prices.
The situation, however, is more positive in local currency due to the devaluation of the real.
Brazilian farmer profitability remains at good levels as crops are sold in dollars.
Although ag fundamentals remain positive, farmer confidence is low due to economic and political concerns, growing inflation, and uncertainty over government sponsored financing programs, all of which are leading to lower equipment sales.
In spite of these short-term concerns, the long-term fundamentals for our ag business in Brazil remain strong.
Our 2016 ag and turf industry outlooks are summarized on slide 11.
You will note there are no changes from the guidance provided last quarter.
Low commodity prices and stagnant farm incomes in the US and Canada are continuing to pressure demand for farm equipment, with the decline being most pronounced in the sale of high horsepower models.
Our forecast for industry sales in the US and Canada remains down 15% to 20%, with large ag equipment sales down 25% to 30%.
The EU 28 industry outlook remains flat to down 5% in 2016 due to low crop prices and farm incomes, as well as continued pressure on the dairy sector.
In South America, industry sales of tractors and combines are projected to be down 10% to 15% in 2016.
Shifting to Asia, sales are expected to be flat to down slightly due in part to weakness in China.
Turning to another product category, industry retail sales of turf and utility equipment in the US and Canada are projected to be flat to up 5% in 2016, benefiting from new products and general economic growth.
Putting this all together on slide 12, FY16 Deere sales of worldwide ag and turf equipment are now forecast to be down about 10%.
This includes about 4 points of negative currency translation.
The deterioration in our forecast is driven almost entirely by foreign currency exchange.
Ag and turf division operating margin is forecast to be about 7% in 2016, unchanged from the previous forecast.
The implied decremental margin for the year is about 23%.
Now let's focus on construction and forestry.
Net sales were down 23% in the quarter as a result of lower shipment volumes and unfavorable foreign currency exchange, partially offset by price realization.
Operating profit was $70 million in the quarter, down from $146 million last year.
The decrease was driven by lower shipment volumes, partially offset by price realization and lower selling, administrative, and general expenses.
The division's decremental margin was about 21%.
Moving to slide 14.
Looking at the economic indicators at the bottom part of the slide, GDP growth is positive, construction spending is up from 2015 levels, and housing starts are expected to exceed 1.2 million units this year.
In spite of these encouraging signs, the industry is operating at a slow pace.
Contributing factors are weak conditions in the North American energy sector, and the movement of equipment from energy producing regions to other parts of the country.
Rental utilization rates continue to decline.
Economic growth outside the United States is sluggish, and the mix of housing starts in the US is skewed to multifamily homes, reducing demand for earth moving equipment.
As a result, Deere's construction and forestry sales are now forecast to be down about 11% in 2016.
The change from our previous forecast is largely driven by lower sales in the United States and Canada and the negative foreign exchange effect of about 1 point.
The forecast for global forestry markets remains down 5% to 10% from the strong levels we've experienced in recent years, primarily as a result of lower sales in the US and Canada.
C&F's full-year operating margin is now projected to be about 7%.
The implied decremental margin for the year is about 27%.
Let's move now to our financial services operations.
Slide 15 shows the annualized provision for credit losses as a percent of the average owned portfolio.
At the end of January, it was 8 basis points, reflecting the continued excellent quality of our portfolios.
The financial forecast for 2016 contemplates a loss provision of about 19 basis points.
Even so, this will put the year's losses below the 10-year average of 26 basis points and well below the 15-year average of 39 basis points.
Moving to slide 16, worldwide financial services net income attributable to Deere & Company was $129 million in the first quarter, versus $157 million last year.
The lower results were primarily due to the unfavorable effects of foreign currency exchange translation, higher losses on residual values primarily for construction equipment operating leases, less favorable financing spreads, and a higher provision for credit losses.
These were partially offset by lower selling, administrative, and general expenses.
2016 net income attributable to Deere & Company is now forecast to be about $525 million, which is down from last year.
The outlook reflects less favorable financing spreads, an increased provision for credit losses, and the negative effects of currency exchange translation.
Remember that 2015 results benefited from a gain on the sale of the crop insurance business of about $30 million.
Before we move on to receivables and inventory, let's discuss the losses on residual values noted in the earnings release that affected the quarter's results.
A majority of the losses were due to impairment charges for construction equipment.
The losses were mainly related to short-term leases of production-class equipment.
We continue to closely monitor the leasing portfolio, adjust residual values on the existing portfolio as needed, and take appropriate actions on new contracts to ensure we are mitigating future risk.
Slide 17 outlines receivables and inventories.
For the Company as a whole, receivables and inventories ended the quarter down $205 million.
We expect to end 2016 with total receivables and inventory down about $550 million, with reductions from both divisions.
2016 guidance for cost of sales as a percent of net sales shown on slide 18 is about 79%, unchanged from last quarter.
When modeling 2016, keep these unfavorable impacts in mind: unfavorable product mix, tier 4 product costs, and overhead spend.
On the favorable side, we expect price realization of about 2 points, favorable raw material costs, lower pension and OPEB expense, and lower incentive compensation expense.
Now let's look at a few housekeeping items.
With respect to R&D expense on slide 19, R&D was down 4% in the first quarter including about 2 points of negative currency translation.
Our 2016 forecast calls for R&D to be down about 3%, with about 1 point of negative currency translation.
Moving now to slide 20.
SA&G expense for the equipment operations was down 11% in the first quarter, with currency translation, incentive compensation, and pension and OPEB accounting for about 8 points of the change.
Our 2016 forecast contemplates SA&G expense being down about 4%.
The same factors just cited for the quarter also account for about 6 points of the full-year change.
Turning to slide 21.
Pension and OPEB expense was down $44 million for the quarter, and is forecasted to be down about $200 million for the full year, unchanged from the previous forecast.
On slide 22, the equipment operations tax rate was 20% in the quarter, primarily due to discrete items.
While it's not our practice to provide specifics on discrete items, I would point out that the R&D tax credit was extended for 2015 during the quarter.
For 2016, the full-year effective tax rate is forecast to be in the range of 33% to 35%.
Slide 23 shows our equipment operations history of strong cash flow.
Cash flow from the equipment operations is now forecast to be about $2.1 billion in 2016.
The reduction from our previous guidance is largely attributable to the forecasted change in working capital and lower net income.
The Company's second-quarter financial outlook is on slide 24.
Net sales for the quarter are forecast to be down about 8%, compared with 2015.
This includes about 2 points of price realization, and unfavorable currency translation of about 3 points.
Turning to slide 25 and the full year outlook.
Our forecast now calls for net sales to be down about 10%.
Price realization is expected to be positive by about 2 points.
Currency translation is negative by about 3 points.
Finally, our full-year 2016 net income forecast is now about $1.3 billion.
In closing, although Deere expects another challenging year in 2016, our forecast represents a level of performance that is much better than we have experienced in previous downturns.
This illustrates the continuing impact of our efforts to establish a more durable business model and a wider range of revenue sources.
At the same time, Deere's financial condition remains strong, and the Company is continuing to forecast a healthy level of cash flow this year.
As a result, we're well positioned to continue looking to the future and making investments in innovative products, advanced technology, and new markets.
These actions we're confident will deliver significant value to our customers and investors in the years ahead.
I'll now turn the call over to Tony.
- Director of IR
Thanks, Josh.
Now we're ready to begin the Q&A portion of the call.
The operator will instruct you on the polling procedure, but in consideration of others and our hope to allow more of you to participate in the call, again please limit yourself to one question.
If you have additional questions, we ask that you rejoin the queue.
Carlo?
Operator
Thank you.
(Operator Instructions)
Thank you.
Our first question will be coming from the line of Jamie Cook from Credit Suisse Securities.
Your line is open.
- Analyst
Hi, good morning.
Congratulations, Susan.
We will miss you.
So in terms of my questions, I guess Tony, last quarter you talked about production in large ag and you talked about as we think about the back half of the year that production should be more in line with retail demand.
Can you talk about if there's any change there?
And then also any progress you made on the used inventory issue within large ag.
Thanks.
- Director of IR
So as you think about inventory, and some may have noticed along that line with the receivables and inventory forecast that it is -- it did change and the reduction is actually a little lower from what we had in original budget.
I would point out first of all, that's really more related to changes in small ag.
So if you look at large ag, the forecasted change in dealer receivables is really very, very similar, very much in line with what we had in original budget.
Used equipment, we continue to make progress.
Still, as we talked about previously, there's still a lot of work there especially on large tractors.
I think last time we talked about down 18% roughly from the highs that were set in 2014.
Today we would put large ag used at about 23% lower.
So again, continuing to make some good progress there.
Maybe as importantly as we bring that down, used pricing on our large ag equipment is remaining steady.
So again, continuing to make progress, but those efforts will certainly continue through 2016.
- Analyst
Thank you.
I'll get back in queue.
- Director of IR
Thank you.
All right, thanks.
Operator
Thank you.
Our next question will be coming from the line of Stephen Volkmann from Jefferies.
Your line is open.
- Analyst
Good morning everybody.
Congratulations, Susan.
My question is on the cost structure here, Tony.
I'm trying to figure out -- I know you have some flexibility.
You've shown some really good control on these decremental margins, and I know your most recent contracts have given you some increased down days and weeks and so forth.
I guess I'm trying to figure out where we are in that process, and if things get weaker do you still have additional levers you can pull?
Or are we getting to the end there?
- Director of IR
Certainly to your point, from a production perspective we do have some additional -- we went from in our UAW factories previously we had 10 weeks per year, and that has gone to 16 with the new contract this year.
So that does provide some additional flexibility and we would have additional flexibility.
We've also talked in our forecast for R&D, while down a bit is not a lever we've pulled significantly hard at this point.
And again, that's trying to take a long-term view.
So depending on if our perspective changes in terms of the length of this downturn, that would be certainly an area we would continue to be able to pull levers.
I would note from original budget, our SA&G forecast has come down further in terms of what we're forecasting.
That's an area we continue to look at and attempt to identify costs that can come out.
And as those are identified we'll add those into the forecast.
So again, I don't want to imply, however, that we have the same type of leverage that we would have had coming off of the peak.
Obviously we're already at very low levels.
So our ability to pull cost out relative to any further sales declines will be more challenging.
We've been pretty open about that.
This year fortunately with incrementals or decrementals as the case may be we've gotten some benefit from the pension and OPEB change and some other factors, lower material costs, those sorts of things.
But still, I think demonstrating that we are very focused on cost management and doing an effective job to date.
- Analyst
Some day there will be incrementals again.
- Director of IR
Absolutely.
And I'll look forward to that.
- Analyst
Thank you.
- Director of IR
All right.
Next caller.
Operator
Thank you.
Our next question will be coming from the line of Timothy Thein from Citigroup Global Markets.
Your line is open.
- Analyst
Thank you.
Tony, the question relates to your degree of confidence on that 1.5 to 2 points of positive pricing that you're expecting for this year.
I'm sure you're going to have a lot more visibility on that in the next month or two, but just maybe update us there in terms of any changes, and I'm especially interested in C&F.
Obviously a lot lower contributor to the overall pie.
But just in light of this current and revised forecast, maybe just update us on your thoughts on pricing overall?
Thank you.
- Director of IR
I think the important thing maybe to note is as you look at that 2 points of price realization, both divisions continue to contribute positively to that 2 points of price realization.
And so that has not changed.
Certainly the price environment is very challenging, especially for construction.
We have a large competitor who's been pretty open about some negative pricing for their business.
And so far our businesses have been able to hold the line and keep pricing on a positive slant.
So that is a challenge, however, but one we remain focused on as we go forward.
Next caller.
Operator
Thank you.
Our next question will be coming from Robert Wertheimer from Barclays Capital.
- Analyst
Congratulations, Susan, we will miss you.
Just a quick question on your priorities on use of cash flow.
Down cycle progresses a little bit, there's a little bit less cash flow to be had.
Would you see cutting back on share repurchases as the first thing?
Would you do anything less for the leasing?
What are you thinking on as you get to the normal, more cyclical lower levels of cash flow?
- CFO
This is Raj.
Now, I want to first say our cash flow from operations is still pretty strong, over $2 billion.
And we've talked about our cash use already several times in the past.
They remain the same.
Our highest priority is our single A rating.
We are maintaining a strong balance sheet and ample liquidity.
And maintaining access to attractive funding sources is even more important during a downturn like right now.
So next priority is organic and inorganic investments that will benefit the Company in the long term.
And we are, as Tony mentioned, continuing to invest in R&D, especially with a focus on innovation.
And we take a long-term view with respect to inorganic options, and we have discussions over multiple years sometimes with inorganic options that are aligned with our strategy.
So we recently announced two acquisitions.
One was Monosem, based in France, and the other was Precision Planting based in the US.
And we will use about $325 million of cash for just those two.
The next priority is dividends, and our goal is to keep dividends at about 25% to 35% of mid-cycle earnings.
And we'll maintain our dividends even through difficult downturns.
And finally, share repurchases are a residual use of cash and deployed only if the distance from intrinsic value is significant so it's beneficial to our longer term shareholders.
When the distance of intrinsic value makes repurchases attractive now, our higher priorities will obviously take precedence.
So the other point I'll make is you may recall that quarter one is typically a significant user of cash on the operations side.
So if you put all those together, I think that's a summary of our thought is on the cash.
- Director of IR
Thank you.
Next caller.
Operator
Thank you.
Next question will be coming from the line of Andy Casey from Wells Fargo Securities.
Sir, your line is open.
- Analyst
Thanks a lot.
Good morning, everybody, and all the best, Susan.
I'm trying to reconcile the unchanged US and Canada ag and turf outlook and the modifications you made to the commodity outlook in the appendix.
In the appendix you decreased the farm cash receipts projections for 2015 and 2016, mostly due to livestock but also in the crop area.
And then the net cash income projection for 2015 and 2016 dropped about 8% and 16% respectively.
But despite all that, you maintained US and Canada end market view.
I'm just wondering if you could help us understand why the reduced farm financial outlook really did not impact the end market view?
- Director of IR
Sure.
At this point while certainly the statistical modeling that we have in place and looking at farm cash receipts and so on still plays somewhat of a role in our forecasting.
At this point in the process the actual orders would tend to take a stronger -- make a stronger impact on the forecast.
And as we're seeing those orders come in, we're still very much in line with what we had had for our previous forecast.
So we are seeing sales down certainly for North American ag with a greater impact on the large ag business, but I would say our order books are very much in line with that outlook.
- Analyst
Okay.
Thank you.
- Director of IR
Thank you.
Next caller.
Operator
Thank you.
The next question will be coming from Ann Duignan from JPMorgan.
Your line is open.
- Analyst
Yes, hi, good morning.
- Director of IR
Hi, Ann.
- Analyst
Just a quick clarification first before my question.
Monosem and Precision Planting, are they now included in your revenue guidance?
And how much do they impact your revenue guidance?
- Director of IR
We closed on Monosem in the quarter, so they certainly would be.
And we would anticipate some in the forecast for Precision Planning as well.
- Analyst
How much are they adding to your outlook?
- Director of IR
This is going to have to be your question, Ann.
- CFO
All I will say, Ann, is both of them together will be slightly accretive for us and very small in terms of the revenue.
So it's not really -- I think let's leave it at that.
- Director of IR
I'm sorry, you'll have to get back in the queue for your next question.
Next caller.
Operator
Thank you.
The next question will be coming from Joe O'Dea from Vertical Research Partners.
Your line is open.
- Analyst
Hi, good morning.
- Director of IR
Joe.
- Analyst
On financial services, the revenue, or sorry the net income in the quarter was roughly in line with what you're guiding for the full year if you just spread it equally.
But could you talk about cadence that you're looking at, whether or not over the course of the year you anticipate some reduction in the receivables book and how we should think about any oscillations throughout the course of the year?
- Director of IR
I think as you think through the back half or through the remainder of the year, one thing I would point out is as you look at our forecast for the provision versus the year-to-date annualized number, it would anticipate some increase there in terms of cost.
Certainly at these lower levels of sales, while the average portfolio doesn't change dramatically as you move through the year, just like we saw last year, you would start to see some impact from that as well.
So certainly you'd see a little bit lower receivables as we go through the year.
So I'd say those are probably the two biggest differences from first quarter in terms of headwind for financial services as you go through the rest of the year.
- Analyst
Okay.
Thank you.
- Director of IR
Thank you.
Next caller.
Operator
Thank you.
Next question will be coming from Eli Lustgarten from Longbow Research.
Your line is open.
- Analyst
Good morning, everyone and congratulations, Susan.
- Director of IR
Hi, Eli.
- Analyst
Let me just ask a question on the decrementals and production schedules.
It's interesting, I think you said the decremental in farm was 26% and the year is 23%, and you refer to reverse case 21% in construction and 27% for the year.
Can you talk about how you changed your production schedules that are leading to farm getting better and construction getting worse?
It sounds like you cut production a lot more in the second half of the year in construction and maintained a balance in farm.
- Director of IR
Certainly as you look at the forecast -- I'll start with construction.
When you look at the forecast change for construction, most of that change is really as you look out towards the back part of the year.
So as we talked about last quarter, there was some optimism if you will towards the back half of the year that we'd start to see not an incredible amount, but some increase in sales as we went through the year.
Most of that optimism candidly has been removed from the forecast.
And so what we're forecasting today for construction is we'd say normal seasonality.
So you'll see some improved sales as you go through the year, but really nothing beyond, again, a typical seasonality.
So with ag and turf, again, you get some better clarity as you go through the year.
We talked about some higher level of impact of FX as well.
FX tends to from a decremental perspective provide a little bit of benefit and boost of decrementals.
So that would also be contributing to some of the change in our forecast on the decrementals as on ag.
Those would probably be the highlights I would point out.
- Analyst
We had our meeting with Sam Allen.
He basically made the statement that he did little cuts in construction equipment and should have done it bigger.
Was there any reason why you wouldn't take construction down faster in the markets other than --
- Director of IR
That is a good point.
I think I would argue that's what we're doing.
Again, as I point out, there is little optimism in this forecast for construction beyond the typical seasonal improvement in sales here and there as you go through the year.
So it is not anticipating an overall increase in or boost in industry demand from these current levels.
And so I think that's effectively what we've attempted to do is look at it from that perspective.
- CFO
This is Raj.
To your point, we have not only taken down the market or industry projections for CE, we've also taken down our schedules and our forecasts further, just to go -- illustrate the point you made that Sam had earlier discussed with all of you.
- Director of IR
Thank you.
Next caller.
Operator
Thank you.
The next question will be coming from Henry Kirn from Societe Generale.
Your line is open.
- Analyst
Hi, good morning, everyone.
I'll echo the congratulations to Susan.
In addition to the acquisitions that you just made, are there more potential spots where it would be cheaper to buy than build?
And under what circumstances would you be willing to meaningfully step up the M&A focus?
Thanks.
- CFO
This is Raj.
Of course we're not going to talk about any specific M&A and so on, but I'll just tell you a little bit about our approach to M&A.
It is more strategic than opportunistic, and we take a long-term perspective with M&A.
What I mean is we identify M&A candidates that align with and strengthen our strategy, really.
And we have discussions with them in some cases multiple years before they become actionable.
Downturns like the current one we are in tend to sometimes provide a window of opportunity for some of these long-term discussions to materialize into acquisitions.
Monosem and Precision Planting are examples of our approach to M&A.
I'm going to leave it at that and not talk more.
Okay?
- Director of IR
Thank you.
Next caller.
Operator
Thank you.
The next question will be coming from Brett Wong from Piper Jaffray.
Your line is open.
- Analyst
Hi, guys, thanks for taking my question.
You kept the volume guidance for South America unchanged.
Do you have more conviction around that figure now than you did back in November, or is there still a bit of uncertainty?
And maybe you could talk about the order book down there?
- Director of IR
I think any time we talk about I'd say markets really outside of the US for large ag, South America in particular, the visibility is not as far out.
So always remember that versus large ag in the US and Canada where we do have the best visibility from an order book perspective.
So there's certainly I would say continued risk in South America and potential opportunity.
I would say you have both.
So risk, Brazil continues -- while the farmers in Brazil continue to operate at very profitable levels because of the fact that they do sell their commodities in US dollars, so the FX is benefiting them.
But the overall government concerns remain.
The FINAME financing there appears to have stabilized somewhat.
So [motor frota] is back in place and the funding appears to be in place for that as well.
We've heard some positive comments from government officials regarding their commitment to that.
But again, there's always risk.
And remember their fiscal year ends in June.
And so what happens with the FINAME financing and other supports beyond June would continue to be a question as well.
Now on the flip side, you have Argentina where we would argue there's potential upside opportunity there.
If the reforms continue to progress and if those reforms are fully implemented such that we have the ability not just to import but also export and so on, we think that could be a really good opportunity for us.
You may have heard when we were out traveling with Sam, the fact that it is a very profitable market for us.
And so the opportunity to sell more product into Argentina would certainly be beneficial for us.
So there are a lot of puts and takes as you think about South America, but all in all the industry outlook -- again, remember that's on tractors and combines, remained unchanged.
So that's really not much change in our current view of what that market may look like.
Okay.
Next caller.
Operator
Thank you.
The next question will be coming from Steven Fisher from UBS Securities.
Your line is open.
- Analyst
Good morning and best wishes, Susan.
How are you thinking about the tradeoff of price versus market share in small and medium size ag equipment?
Because from what we hear, everyone sounds like everyone's trying to pressure everyone else.
As you think about it, does it make sense to incentivize sales to hold on to your market share?
Or do you just leave that to your dealers and the strength of your brand and not give in on price?
- Director of IR
I think I would say it's a similar strategy to what we've had on an overall basis from a Company perspective, and that is that balanced approach.
Pricing continues to be important to us.
We continue to in most cases trade at a premium to our competition, and certainly we would continue to be focused on price realization in small ag.
Now, where we've really increased our focus is on innovation in that area, and we brought in some very attractive product.
So in that case quite often it's not so much about discounting but making sure you have the right features on that product that customers are willing to pay for, and not having excessive amounts of features that they aren't willing to pay for, if you will.
So that tends to be our focus, is making sure we really understand that market, that we're delivering the product that that customer is looking for, and that we can do that with positive pricing.
- Analyst
Thank you.
- Director of IR
Thank you.
Next caller.
Operator
Thank you.
Next question will be coming from Nicole DeBlase from Morgan Stanley Investment Research.
Your line is open.
- Analyst
Thanks.
Congratulations to Susan.
So there's been a few questions on construction and forestry already, but something I want a little bit more clarity on is Sam had said at the breakfast in January that you were working through excess inventory levels in the channel.
And I guess I'm just curious how much progress you made there during the quarter, and if you would now characterize construction and forestry industry levels as healthy or in line with end user demand?
- Director of IR
Certainly as you look at the reported receivables and inventory you'll note that they're slightly higher year over year.
So I would say that's still an ongoing focus as we move through the year is to pull those inventory levels down.
So you look at ending inventories, it actually does year over year we would -- with our current forecast we would finish both inventory and within our factories as well as dealer inventories at or below where as a percent of sales where we were at the end of 2015.
So still will be a focus.
It is not -- we are not finished in that progression.
But definitely very focused on making sure that happens.
- Analyst
Okay.
Thank you.
- Director of IR
Next caller.
Operator
Thank you.
Next question will be coming from Larry De Maria from William Blair & Company.
Your line is open.
- Analyst
Good morning.
Best of luck to Susan.
Can you just update us on where the pooled fund stands this year?
I don't know if that's been worked down, or is there much left for dealers to use?
And perhaps is that a reason why you're still getting that nice positive pricing and the steady residual values, because the dealers are using those funds?
If you could update us on that, thank you.
- Director of IR
Pool funds for those that may not be aware, those are funds that dealers effectively earn when they sell new equipment that they then can utilize for various incentives on used.
And certainly we would say overall -- I'll tell you, really no change from last quarter.
Overall, they're in good shape.
Now, there are some -- we couldn't say that for every dealer.
We'd have some dealers where we wouldn't be comfortable with the level of pool funds they have relative to the equipment that's on their lots.
We are seeing dealers shifting the use of those more towards the retail sale portion.
As you may be aware, they can use those funds both to provide low or no interest wholesale funding while that inventory is on their lot, or they can also use it towards various incentives.
I think part of the reason why used pricing is staying high, A, that's historically how Deere equipment has responded in this type of environment, and B, some of those incentives aren't focused on simply reducing the purchase price.
So we're looking at things like lower rate financing opportunities, providing additional warranty on the equipment, those sorts of things that provide incentives to the customer without degrading the purchase price, if you will.
So again, we did see in -- want to be clear, when we came into the downturn we did see some small decreases in used pricing, but they've held very firm at those small single digit type of declines, at least to date.
We are pleased with that aspect.
- Analyst
Thank you.
- Director of IR
Next caller.
Operator
The next question will be coming from David Raso from Evercore ISI.
Your line is open.
- Analyst
Hi, good morning.
I'm just trying to figure out what you're trying to imply about incremental residual value losses in ag.
You highlight the construction higher residual values, but when we look at the comments you made about used you feel in ag is holding steady.
You're obviously making some assumptions around future issues by raising the loss provision.
Can you help us understand, with are you implying about your change from provisions and your used equipment comments on ag when it comes to -- from here going forward, what is the level of residual value risk within the ag book?
- Director of IR
First of all, you need to separate those two because provision relates to the retail note portfolio.
- Analyst
I understand.
It's a commentary on the health of the end market where used prices are versus --
- Director of IR
Yes.
But I just want to clarify that, because again, while used equipment prices have held firm, they did from that initial decline -- we did see some initial decline.
And so when you look at losses on returned leases, keeping in mind the average for new equipment, the average lease term is around three years and used is actually moved to that, used to be a little bit further out.
So most of the lease returns that are coming back today would have been written three years ago, at least on average.
So really still in the height of the market.
Recoveries aren't as high as what they would have been historically.
They're still very, very strong, but we're still seeing a little bit of a decline in the recovery rate on the ag equipment coming in.
But I wouldn't imply anything beyond that.
Certainly from a provision increase, a lot of those increases come from things like our revolving credit portfolio, which is where you tend to see some responsiveness early on, not just the ag portfolio.
So those are the things that are really driving those higher level of provisions in the forecast.
The other thing I'd be quick to point out is they're higher, but they're higher off of historical -- as you know very, very low levels and let's just say that forecast is dead on and we hit 19 basis points this year.
That's still a very attractive level for any portfolio to be maintaining in this type of an environment with the provision on credit losses.
So again, we feel very good about the strength of the farmer and their ability to continue to pay for the equipment they have financed with us.
- Analyst
I appreciate the answer, Tony, but doesn't really answer the question.
I'm trying to figure out if you feel used prices are now sequentially steady.
- Director of IR
Yes.
- Analyst
If they stay at these levels, let's just say this is it, they're this straightforward.
What level of residual value risk or losses are baked into your guidance?
Because obviously you highlight the construction side, today and I appreciate that.
But the used comment sequentially about pricing was interesting.
I'm just trying to help everybody gauge where are we.
Clearly there are as you pointed out not quite the recoveries of the past.
Can you help us a bit in framing it?
- Director of IR
I would tell you at this point what's anticipated in the forecast for ag is largely inconsequential.
Yes, there are some losses in the forecast, but we're not talking about -- especially when you put it relative to the size of that portfolio.
You look at those portfolios, construction as we talked about is more than two-thirds of the impairment charges that we took in the quarter.
And the size of the portfolio is significantly smaller.
Again, I think that's the key difference, and I wouldn't extrapolate any of what we're talking about from construction towards ag.
There are significant differences in those portfolios between ag and construction on our leasing.
So you think about things like the term of the leases.
Most of the losses we're seeing and the impairments we're talking for construction are around short-term leases.
We have less than 5% of the ag operating lease portfolio would be what we deem a short-term lease, 12 months or less, where you've got 22% of production-class equipment leases that would be in that view.
We also lease a lot more used equipment in ag, which again, in our view is -- would reduce some of that risk.
So about 42% of our ag portfolio is used equipment versus about 14% of construction.
I'm sorry, 3% of construction is used equipment.
And probably the most important difference between those two, similar to what we would talk about from a retail note perspective with the dealer reserve, on our operating leases over half of the ag operating leases in the US and Canada have some level of dealer guarantee on the residual values which provides obviously protection around any losses on residual value.
More importantly, it drives a very engaged dealer in the process when these leases come back, or when the equipment comes back off of lease.
Very, very different portfolios, and I wouldn't say we're trying to imply anything when we talk about higher provisions or the value of used equipment other than the fact that they're holding steady.
And if that continues, our risk on operating leases in ag are quite low.
Now, that's still a risk that we can maintain those used equipment prices, but at this point that is holding up well.
- Analyst
That's great detail.
Thank you very much.
- Director of IR
Next caller.
Operator
Thank you.
The next question will be coming from Mike Shlisky from Seaport Global Securities.
- Analyst
Susan, best of luck.
Wanted to ask quickly about Europe.
I think you had mentioned that ag sales were actually up in Europe in the quarter.
Either way, I've seen data where you're seeing Deere gain some share in some key markets in Europe.
Could you maybe take us through are there any countries that are doing better for you and are any doing worse, and any product categories that are doing better or worse?
And perhaps is it possible for Deere itself to beat your overall market outlook for the year at all?
Thanks.
- Director of IR
As you think about Europe, first to the second part of that question, we certainly hope so.
Any year that we enter we would hope to gain some market share.
We have a lot of new product that's entering the European market.
We've been recognized from numerous trade shows with that innovation, both Agritechnica as well as a number of shows since then that we've received a variety of awards for that innovation.
So again, especially in some of those key products we would certainly hope to gain some share.
But as you think about in the short term with Europe, I would note that in the first part of the year that we're getting some benefit from France.
They had what's been referred to as a super amortization program which does allow for some additional amortization of equipment in the early stages of the ownership, which is providing some benefit for sales there.
And we did see that increase in sales in France.
That program is scheduled to end in mid-April.
It's based on retail.
So those would be tractors that would need to be sold to customers by mid-April.
And so we are, again, seeing a bit of advantage from that.
Outside of that, I think if you think about Europe there does overall continue to be some headwind there with just like a lot of parts of the world with lower commodity prices.
Dairy is a significant market for the European farmer, and we continue to see pressure there.
I think every quarter we anticipate in the next six months for that to start to moderate, and each quarter it keeps getting pushed out.
It seems to be holding on in a stubborn way in terms of the pressure on dairy right now for those farmers.
But with that, I think that's -- I'm not sure I can add much more value beyond that.
Appreciate the question.
- Analyst
That's great, Tony.
Thank you.
- Director of IR
Thank you.
Next caller.
Operator
Thank you.
Our next question will be coming from Jerry Revich from Goldman Sachs & Company.
Your line is open.
- Analyst
Good morning and Susan, congratulations.
Tony, I'm wondering if you could just update us on your warranty performance on tier 4 products, either frequency of repair, cost of repair?
And you took up your accruals last year I think as you typically do with new products, and can you remind us from an accounting standpoint when can we expect accruals to normalize if the performance remains favorable?
How long before you make that accounting change?
Thanks.
- Director of IR
With warranty related questions, yes, keep in mind that's part of -- that would fall into our pricing.
And so to the extent you have higher returns and allowances, that does affect our pricing.
So you would see it there in terms of lower price realization, I think would be the answer.
But generally, to your point you'll occasionally have some issues in a specific quarter where you had to book some accruals on specific products with new equipment.
But generally that's been a favorable trend and helped from a pricing perspective.
- Analyst
And sorry, Tony, the performance on tier 4 final products, has that been favorable versus expectations and versus the accounting accruals so far?
- CFO
Jerry, this is Raj.
You look at every new product development program, so every wave of that typically has more issues that come up with it and then it subsides.
If you look at what we have seen in our transitions from tier 3 and into IT 4 and to tier 4, we are very comfortable with what we are seeing in terms of the products that have warranties in our name with this wave of new product development programs.
- Director of IR
And I did want to clarify my comment.
The returns and allowances are in our net sales numbers, they are not in our pricing calculation.
I misspoke when I said that.
But it does impact our net sales.
- Analyst
Thank you.
- Director of IR
Thank you.
Next caller.
Operator
Thank you.
The next question is coming from Seth Weber from RBC Capital Markets.
Your line is open.
- Analyst
Hi, good morning, guys, this is [Ellen McLaughlin] on for Seth today.
Just wondering if you could provide a little more color on your lower organic C&F outlook?
Just trying to figure out if it's end market demand deteriorating or right sizing of channel inventory.
And then what's your confidence in your ability to maintain the positive C&F pricing with the current demand environment?
- Director of IR
Basically as I mentioned earlier in the call, primarily the lower sales forecast for construction and forestry is around US and Canada.
And so we lowered our end market outlook for sales in the US and Canada.
And again, a lot of that is just as oil prices have remained very low the pressure that's putting on the overall market continues.
And so much of the optimism we had of the markets improving as we go into the back half of the year were pretty much removed out of the forecast.
So again, we continue to forecast positive price, and that's our best estimate at this point.
And probably can't say much more beyond that.
We have time for one more caller.
Operator
Thank you.
Our last question will be coming from the line of Vishal Shah from Deutsche Bank Securities.
Your line is open.
- Analyst
Hi, thanks for taking my question.
So Tony, can you maybe just talk about the margin assumption changes for each segment for 2016, and also where your large ag utilization rates are currently?
Thank you.
- Director of IR
Again, when you think about large ag utilization, we talked about last year it does vary by -- or last quarter, it does vary by product.
Certainly when you think about where we are as a percent of mid-cycle in those products, you'd be at 50% or less in some of those facilities.
And so that's where we continue to operate.
I would say mostly as you think about changes in the margin outlook, obviously FX is impacting that, and that's probably the biggest change from last quarter on the ag part.
So really very little from a volume perspective in terms of the changes from original budget.
Certainly for the year volumes would have an impact.
So with that, I think we will need to conclude the call.
We do appreciate you calling in and the questions.
And as always we will be around to take questions throughout the day.
Thank you.
Operator
Thank you.
That concludes today's conference call.
Thank you all for participating.
You may now disconnect.