強鹿 (DE) 2017 Q2 法說會逐字稿

Good morning, and welcome to Deere & Company Second 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.

You may begin.

Thank you.

Also on the call today are Raj Kalathur, our Chief Financial Officer; and Josh Jepsen, Manager, Investor Communications.

Today, we'll take a closer look at Deere's second quarter earnings, then spend some time talking about our markets and our current outlook for fiscal 2017.

After that, we'll respond to your questions.

Please note that slides are available to complement the call this morning.

They can be accessed on our website at www.johndeere.com/earnings.

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.

Josh?

Today, John Deere reported second quarter financial results, and the story was a good one, with market conditions showing signs of further stabilization.

On an overall basis, we're seeing modestly higher demand for our products, with the agricultural sector in South America staging a strong recovery.

At the same time, our performance reflects the actions we've taken to expand our customer base and operate more efficiently.

We're benefiting from the sound execution of our operating plans, the strength of our broad product portfolio and the steps we've taken to bring down structural costs.

As a result of all these factors, we've raised our forecast and are now calling for significantly higher earnings for the full year.

Now let's take a closer look at our second quarter results, beginning on Slide 3. Net sales and revenues were up 5% to $8.287 billion.

Net income attributable to Deere & Company was $802 million.

EPS was $2.49 in the quarter.

On Slide 4, total worldwide equipment operations net sales were up 2% to $7.26 billion.

Price realization in the quarter was positive by 2 points.

Currency translation did not have a material impact in the quarter.

Turning to a review of our individual businesses, let's start with Agriculture & Turf on Slide 5. Net sales were up 1% in the quarter-over-quarter comparison, primarily due to price realization.

Operating profit was $1.003 billion, up from $614 million last year, a result of more favorable sales mix, price realization and the favorable effects of currency exchange.

The quarter also benefited from a gain on the sale of a partial interest in SiteOne Landscape Supply Inc., which contributed about 3 points of operating margin.

For more details regarding the transaction, please see the notes in today's earnings release.

Operating margins were 17.3% for the quarter.

Excluding the SiteOne impact, operating margins were about 3.5 points higher than last year's second quarter.

Before we review the industry sales outlook, let's look at fundamentals affecting the ag business.

Slide 6 outlines U.S. farm cash receipts.

Following the forecasted about 5% reduction in 2016 cash receipts, we expect 2017 total cash receipts plus government payments to be about $367 billion.

This is roughly flat with 2016 as declines in meat animals and food grain cash receipts mostly offset gains in dairy and cotton cash receipts.

On Slide 7, record soybean and corn production from South America is expected in 2016-'17.

Global grain and oilseeds stocks-to-use ratios are forecast to remain at elevated but generally unchanged levels in 2016-'17 as abundant crops are mostly offset by strong demand around the world.

Chinese grain stocks continued to increase in 2016, with supply, domestic production plus imports outpacing demand.

Chinese stocks of grains now represent almost half of the world's stocks.

Remember, these Chinese stocks are unlikely to be exported.

That means the world market remains sensitive to major production setbacks, geopolitical disruptions or trade disputes.

Our economic outlook for the EU 28 is on Slide 8. Economic growth in the region is improving though geopolitical risks remain elevated.

Arable farm income remains below the long-term average due to high global grain stocks and last year's poor harvest.

However, conditions appear to be bottoming out in 2017.

The dairy market is recovering, with prices at normal levels and forecast for margins moving above the 5-year average.

Meanwhile, sentiment for dairy farmers is improving and remains positive for beef and pork producers.

Note that nearly half of EU farm incomes are derived from dairy and livestock.

Shifting to Brazil on Slide 9. The chart on the left displays the crop value of agricultural production, a good proxy for the health of agri business in Brazil.

Ag production is expected to increase about 9% in 2017 in U.S. dollar terms due to record acreage expansion and yield expectations.

In local currency, the value of production is forecast to be up about 1%.

Brazilian farmers, since they sell their crops in US dollars, remain solidly profitable.

On the right side of the slide, you will see eligible rates for ag-related government-sponsored financed programs.

Rates from Moderfrota remained at 8.5% for small and mid-sized farmers and 10.5% for large farmers.

Importantly, the overall budget for Moderfrota has been raised again by about BRL 1 billion to BRL 8.55 billion in total.

This demonstrates the government's ongoing commitment to agriculture and continues to improve farmer confidence.

Despite the current political uncertainty, news on the 2017-2018 harvest plan is still anticipated in the coming weeks for the budget year that begins in July.

Our 2017 Ag & Turf industry outlooks are summarized on Slide 10.

Industry sales in the U.S. and Canada are now forecast to be down about 5%, with a slight improvement in both large and small models of equipment.

As noted previously, it does appear the large ag market is stabilizing.

Signs supporting the stabilization include: a considerably lower rate of industry sales decline in 2017 versus the past 2 years and the used equipment environment that is more supportive of sales.

The EU industry outlook is now flat to down 5% in 2017.

While there's improved sentiment in the region due to higher dairy and livestock margins, low crop prices and farm incomes as well as geopolitical risks continued to weigh on the market.

In South America, industry sales of tractors and combines are projected to be up about 20% in 2017.

Positive industry sentiment in Brazil and Argentina continues to drive this improvement.

Shifting to Asia.

Sales are expected to be flat to up slightly, with growth in India being the main driver.

Turning to another product category.

Industry retail sales of turf and utility equipment in the U.S. and Canada are projected to be roughly flat in 2017.

Putting this all together on Slide 11.

Fiscal year 2017 Deere sales of worldwide Ag & Turf equipment are now forecast to be up about 8% versus 2016, driven largely by growth in our overseas markets.

Our Ag and Turf division operating margin is forecast to be about 11.5% in 2017.

The implied incremental margin for the year is about 43% or around 35% without the impact of SiteOne and the voluntary employee separation program.

In comparison with last quarter's forecast, the change is driven by sales improvements in all of our main geographies, including large ag in North America, and results in about 45% incremental margins, net of the SiteOne impact.

Now let's focus on Construction & Forestry on Slide 12.

Net sales were up 7% in the quarter as a result of higher shipment volumes and price realization, partially offset by higher warranty costs.

Operating profit was $108 million for the quarter, up from $74 million last year.

The increase was driven by higher shipment volumes and price realization.

These factors were partially offset by higher warranty costs and a less favorable sales mix.

Operating margins were 7.4% in the quarter, about 2 points higher than last year's second quarter.

The division's incremental margin was about 35%.

Moving to Slide 13.

The economic fundamentals affecting the Construction & Forestry industries in North America are cause for optimism.

GDP growth is positive, job growth continues, construction spending is up from 2016 levels and housing starts are expected to exceed 1.25 million units this year.

Construction investment was up in the first quarter of 2017 by almost 10%, led by a rebounding oil and gas and residential activity.

Commercial and institutional construction activity continued to increase moderately.

Machinery rental utilization rates have improved after 2 years of deterioration, and used inventory has come down in the past quarter.

All in all, our outlook reflects a strong order book as well as what we've seen in the way of retail sales growth over the last 3 months.

Moving to the C&F outlook on Slide 14.

Deere's Construction & Forestry sales are now forecast to be up about 13% in 2017, with no material currency impact.

The forecast for global forestry markets is down about 5%, a result of lower sales in the U.S. and Canada.

C&F's full year operating margin is now projected to be about 6%, with an implied incremental margin of about 24%.

Let's move now to our Financial Services operations.

Slide 15 shows the provision for credit losses as a percent of the average owned portfolio.

At the end of April, the annualized provision for credit losses was 18 basis points, reflecting the continued excellent quality of our portfolios.

The financial forecast for 2017, shown on the slide, contemplates a loss provision of about 28 basis points, slightly lower than the previous forecast.

This will put losses just above the 10-year average of 26 basis points and below the 15-year average of 34 points.

Moving to Slide 16.

Worldwide Financial Services net income attributable to Deere & Company was $103.5 million in the second quarter versus $102.6 million last year.

The improvement was primarily due to lower operating lease losses and impairments, largely offset by less favorable financing spreads and higher SA&G.

Financial Services 2017 net income attributable to Deere & Company is now forecast to be about $475 million, down slightly from our previous forecast due to higher SA&G, mainly for incentive compensation.

Slide 17 outlines receivables and inventories.

For the company as a whole, receivables and inventories ended the quarter down $363 million due to reductions in the Ag & Turf division.

We expect to end 2017 with total receivables and inventories up about $400 million, with increases in both the Ag & Turf and C&F division.

The increases are consistent with higher sales in both divisions.

Slide 18 shows cost of sales as a percent of net sales.

Cost of sales for the second quarter was 75%.

Our 2017 cost of sales guidance is about 77% of net sales, an improvement of about 1 point from last quarter.

When modeling 2017, keep in mind the unfavorable impacts of emissions costs, voluntary separation expenses, incentive compensation and raw material prices.

On the favorable side, we expect price realization of about 1 point savings related to the voluntary employee separation program and a favorable sales mix.

Now let's look at some additional details with respect to R&D expense on Slide 19.

R&D was down 6% in the second quarter.

Our 2017 forecast calls for R&D to be down about 1%.

Moving to Slide 20.

SA&G expense for the equipment operations was up 8% in the second quarter, with the main drivers being incentive compensation and commissions paid to dealers.

Our 2017 forecast calls for SA&G expense to be up by about 7%.

Roughly 2/3 of the full year change is expected to come from incentive compensation, voluntary separation expenses and commissions paid to dealers.

Turning to Slide 21.

The equipment operations tax rate was 31% in the quarter.

For 2017, the full year effective tax rate forecast is now in the range of 32% to 34%.

Slide 22 shows our equipment operations history of strong cash flow.

Cash flow from the equipment operations is now forecast to be about $3.1 billion in 2017.

The company's financial outlook is on Slide 23.

Net sales for the third quarter are forecast to be up about 18% compared with 2016.

Our full year outlook now calls for net sales to be up about 9%, which includes about 1 point of price realization.

Finally, our full year 2017 net income forecast is now about $2 billion.

In closing, with this recent performance, John Deere has demonstrated a continued ability to produce impressive results through all phases of the business cycle.

This kind of resilience illustrates our success in finding ways to operate more efficiency and develop a wider range of revenue sources.

It shows something else, too: the impact of the consistent investments we've made in advanced technology, new products and additional markets.

Actions such as these are leading to strong performance in 2017.

What's more, they support our conviction that John Deere is well positioned to deliver significant value to our customers and investors over the long term.

Thank you, Josh.

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

The operator will instruct you on the calling procedure.

(Operator Instructions) Operator?

(Operator Instructions) And we do have our first question.

It's from Jerry Revich of Goldman Sachs.

Tony, the margin performance this quarter came despite warranty costs that were a headwind here.

I'm wondering if you could talk about what's been driving the higher-quality costs for you folks over the past 2 years compared to history, and over what time frame would you expect warranties to return to the low 2% range that's more typical for you folks in the past?

Yes, that was something certainly that was cited in the press release, both for equipment operations and construction, specifically.

And I just -- I think I'd remind people to start with, with Tier 4 emissions requirements, we had a significant number of new product introductions coming very, very rapidly, and that -- more rapidly than you would tend to see.

So the cycle of new products tended to ramp up, and you're starting to see a little bit of the effects of that.

And to that point, we're not talking about significant challenges with a product or a couple products.

It's here and there, smaller warranty costs that just accumulate a bit.

The other thing I'd remind everyone is we do have slightly higher warranty costs related to the change we made in our parts warranty experience.

So we've extended the warranty period for parts, and that does come at a little bit higher cost.

Some of that also, specific to construction, when you think about the warranty costs this quarter, is some of the year-over-year compare.

And specifically, again, for that division, there were some favorable adjustments last year, slightly favorable, and so the compare was a little more challenging for them.

So those are really some of the key reasons.

And sorry, Tony, over what time frame would you expect performance to return to more typical levels?

Yes, you'll continue to see that get better.

Now keep in mind, you're going to see that occasionally, especially in some of the earlier quarters of a year, there's always risk because the numbers are relatively small.

But certainly, that is a key focus that we have as a company to continue to improve the warranty experience for -- primarily for our customers, the quality experience.

So I would expect over the next fairly short period of time, you'll see those things changing pretty rapidly.

Our next question is from Steven Fisher of UBS Securities.

Just a bigger picture question on the ag cycle.

We're now again forecasting growth in your ag business and starting to raise some of the regional forecasts.

How are you thinking about the shape of the ag recovery from here, assuming that the crop forecast that you have play out as expected and things develop in South America as you're thinking?

Yes.

I think the latter part of your question is important to keep in mind.

I mean, at this point, it's still very, very early, especially as you really think about Northern Hemisphere crops and so on.

That will make, obviously, a pretty large impact in terms of what -- how we see the future.

But if you assume current fundamentals, current assumptions where you have normal weather, candidly, if you look at our forecast, you're not seeing significant changes in the outlook underlying fundamentals for our farmer customer.

Not a lot of change in crop prices.

But I think what you are seeing today is the impact of the stabilization.

And so while you aren't necessarily -- it's hard to argue today for significant recovery and commodity prices and so on, we're also largely not anticipating significant reductions.

And so as farmers adjust to that, we are starting to see some of them stepping in a bit more into the market and beginning some replacement of their equipment.

Again, I would say, it's more about stabilization and the change that, that drives in the mindset of the farmer customer.

Now there are exceptions to that.

Obviously, you go to Brazil and today, anyway, we're seeing some very strong recovery.

That's a farmer customer who had stayed relatively profitable through this downturn.

And as a result, they are in a strong financial position.

As we have seen in prior months, some of the uncertainty and political environment stabilizing in Brazil, we certainly saw some very, very strong recovery there.

Obviously, in the last week, there has been -- the last few days, some uncertainty injected back into that market.

We'll see where that goes in terms of both the uncertainty that's currently there.

Does that stay?

Or do things stabilize again a bit?

And then what impact that may or may not have on our customers' buying decisions.

But largely, outside of Brazil and South America, I would argue you're really just seeing stabilization and some uptick in demand as a result of that.

All right.

Our next question is from Jamie Cook from Crédit Suisse Securities.

Tony, I guess, the margin performance in the ag business even ex SiteOne was pretty impressive.

And I understand you're guiding ex SiteOne to sort of mid-40s incremental margins, but it does imply the incrementals in the back half of the year sort of fall off.

So I'm just wondering, given how early we are in the cycle, why the implied incremental margins deteriorate in the back half of the year?

Is it we're being conservative?

Is it -- or can you talk to the headwinds that are implied in that margin target?

Sure.

Yes, and I think if you think about margins, and specifically for ag, there's a number of different ways you can kind of slice it and look at it.

Now if you look at absolute margins in the back half of the year, and again, there are a lot of moving pieces in our numbers, because unlike some others, we don't strip out a bunch of stuff in our reporting.

We do pure GAAP reporting.

But specifically, if you look at just some of those onetime charges and eliminate them, things like SiteOne, things like the voluntary separation charges, the margin beat we've had in the first half of the year on ag has been about 2 points.

If you look at the guide for the back half of the year, it's consistent.

We're about a 2-point improved margin ex those onetime items, in -- again, in the back half of the year.

So again, I think that's pretty consistent.

Remember, if you think about, too, on the overall forecast, and here, I'm going to be very clear, I'm not talking about the incremental change from first quarter.

But if you look at the full year forecast as it is, you still -- you're starting to see some benefit from some of the large ag products.

But overall, you're still seeing not as attractive of a mix in those margins and in that forecast, and that's part of why you're seeing the margins where they are.

While still very strong in the back half of the year, you're just not seeing quite as strong as maybe what some would've anticipated or what we would anticipate if it was driven by large ag.

And so that's really some of the key differences.

Our next question is from David Raso from Evercore ISI.

On the conversation around the retail outlook kind of post this year, I was just curious how you're thinking about replacement demand.

If you look at the appendix, you have projections for '17 and '18 when it comes to corn prices and acres and so forth.

That seemed pretty consistent with the USDA.

And it really doesn't apply any cash receipt growth next year, but you mentioned the idea of replacements and stabilization.

At this outlook, would you expect retail in the U.S. to be up next year with these crop fundamentals?

David, I mean, I think if you note where our working capital receivables and inventory forecasts are for the end of the year, I think it's appropriate to assume that next year is going to be up.

Okay.

So that's -- I was trying to read that into the idea of you being able to raise your view of inventory and receivables in the channel as well as in ag, not just construction.

So we can take that as a sign of confidence that you feel better about the retail environment in '18 from what we've learned in the last few months in stabilization and replacement spend and all that.

Is that a fair assessment?

It's certainly the sustainability of what we're seeing beginning to occur today.

We don't want to get into the 2018 forecast, David.

But I think the statement that we have in terms of a shift in our thinking in terms of working capital at the end of the year should give you a good idea.

Yes, I know.

I think the earnings power you're putting up with very little retail help and the ability to grow next year, again without much crop help, just emboldens investors to feel, look, if I can catch any lightning in a bottle on grain prices, that's all upside and along the way, you're still growing earnings to the upside surprise.

So -- and again, we do feel retail can grow with this backdrop of the commodity environment.

So make sure I (inaudible)

Yes.

And David, I think that's a good point.

Now if you look at broader, longer-term global demand for commodities, still going up.

And if you look at the USDA for the '17-'18 production forecast, it's lower, which means the stocks-to-use is what we're saying is likely to come down.

And the equilibrium -- all we'll say is the equilibrium is getting tighter.

Now we haven't put in our projections any disruption to the production for commodities.

But if any of those should come up, there's even further upside, you're right.

Our next question is from Michael Shlisky from Seaport Global Securities.

I want to follow up on David's question there and maybe point to a different slide in your appendix.

Towards the back of the slides, you outlined U.S. farming debt levels at the highest levels that we've seen in the last 15 years here in 2017.

So Raj, just trying to get a feel for the kind of upside you might be seeing next year.

You guys sensed that farmers are going have to start paying down some of their debt first before buying anything major going forward, whether it's this year or next.

And is that kind of what we're kind of waiting for?

Is it -- that farmers -- if farmer incomes turn upward, would paying down debt be the first thing to do and then turn towards buying any kind of machinery?

Yes, I mean, it's always the question, right?

And I think the thing to point out is, it's easy to point that the debt levels have risen.

But again, I think we would point, too, from a historic perspective, farmers are still ending in much better shape than what they would've been previously.

And certainly, if you continue at these kind of levels, you'll continue to see those creep up a bit as we have.

But we don't view that as a significant risk certainly at this point.

And I think what you're seeing today in the buying behavior of customers maybe answers that question for you.

We're starting to see them step back in and place those orders and see those retails moving up a bit, even in this environment.

And again, I think I want to separate that from a significant recovery type of conversation versus if the effects of seeing stabilization for our farmer customers and their willingness now to step in, at least modestly, step back in and begin to think about some replacement.

So all right.

Our next question is from Ann Duignan of JPMorgan Securities.

Just on the fundamentals again.

If we look at what's happened in Brazil in the last week or so or even in the last few days, we saw significant farmer selling of crops, both beans and corn, down there, and that weighed on bean prices and corn prices has reached yesterday.

Can you just talk about what's happening in Brazil, farmers now selling products?

What impact that could have on U.S. exports as we move into the next marketing year?

And how that could weigh on the outlook for cash receipts for U.S. farmers going forward?

I think, obviously, what transpired over the last couple of days is still very fresh, and impacts are, I'll say, uncertain at this point, how long does it last, those sort of things.

Largely, I think that when you think about the selling from Brazilian farmers, I mean, outside of the last couple of days, it was pretty clear that they had been holding onto those crops, looking for better pricing.

I think most forecasts were anticipating that they would, at some point, need to sell them and that they would be exported.

So I'm not sure if we'll have a significant impact necessarily on the broader export assumptions, either for Brazil or for the U.S. But certainly, the timing of those got pulled up pretty considerably.

Now the good news of that is, with the FX and the reason that farmers are releasing that with the FX changes, it's bringing a lot of cash into those farmer pockets again, and they're seeing some benefit in the short term from the FX change.

So that would be at least one positive that you could potentially point to for our Brazilian customers and again, at least in the short term.

But it's early.

And the overall impact, we'll have to weigh and keep our eye on as things move forward.

And to add to Tony's point, if you look at the soybean prices, the current prices, you're right, they're down, okay, because of the additional soybean coming into the market from Brazil.

But if you look at the futures, number futures, they haven't changed much.

So that should help with what Tony just said.

And then if you look at the longer term, since you brought up Brazil, longer-term ag export is very critical to Brazil and for their foreign exchange.

And historically, you've seen governments, regardless of the party, support the ag sector very well.

And we will -- while there is uncertainty, we cannot say what's likely to happen.

And if you look at the past and if you look at what is good for Brazil, okay, we should -- we see them continuing to support the ag sector.

Our next question is from Neil Frohnapple from Longbow Research.

Within the construction business, could you provide more granularity on the positive price realization in the quarter?

So as the competitive pressures ease, particularly in light of the higher sales outlook for the year, and just thoughts on whether you think you have turned the corner on this and what the outlook is from here?

Yes, that's a good question.

And I would tell you, the positive price realization in the quarter was really more about last year versus this year.

And as you may recall, second quarter last year, we had a pretty substantial accrual change as we increased incentives going into the market and had to then, again, change the accrual we had for a product that had previously been sold, shipped to dealers but not retail sold.

And so the compare, I would say, was a pretty easy compare, and that was driving that positive price year-over-year.

I would not say we've turned the corner.

I would not say things have gotten less competitive in that market.

In fact, if you look at our fiscal year guidance, really very little change, and we would continue to see kind of flattish to slightly negative price realization for construction for the year.

So again, that was more about a quarter impact, really no change in the annual guide there.

Our next question is from Nicole DeBlase from Deutsche Bank Securities.

So my question is just on the cadence of the rest of the year.

So based on the outlook for the third quarter, the up 18% for equipment ops, the math I'm getting is that 4Q looks kind of flattish year-on-year.

And first, is that completely wrong?

And then second is, what's driving the significant deceleration?

Is it just tougher comps in Brazil?

Or is there something else that we should be thinking about?

Yes, and you're looking at for the company versus...

Yes, for the total equipment ops for Deere.

Yes.

For total equipment ops, yes.

If you look at fourth quarter, we would have it up a little bit.

But keep in mind, fourth quarter is a pretty light quarter.

And remember, versus last year, too, actually pretty easy compare, especially as it relates to ag.

And I guess, I should say for both ag and construction, pretty significant underproduction in the fourth quarter.

You'll see underproduction as you typically would as we move into the end of the year, but again, it would be up slightly in the fourth quarter.

Okay.

But I guess, since last year, the comp was easy, like could there be some conservatism baked into there?

That's what I'm getting at.

It just seems kind of...

Well, again, all of -- yes.

I mean, all of those -- I mean, you're seeing our ending inventories are -- receivables and inventory is, as you can see in our guidance, is up.

And so there's certainly some benefit there.

But again, the percentage change in the fourth quarter, because we're coming off -- the dollars may not be as impactful as the percentage in terms of the changes is what I would say there.

And the percentage for Q4 is closer to 16%.

If you just take the 9% for the full year, that's what it would work out there.

Okay?

Our next question is from Robert Wertheimer from Barclays Capital.

My question, you guys sometimes comment on this not terribly specifically, but it's basically production versus retail.

So your industry guidance is obviously industry equipment guidance.

And it's kind of an Ag & Turf kind of flattish, and your revenues are up substantially.

And so in between those 2 numbers can be parts, can be market share, can be reversal of path on a production, can be overproduction and it was (inaudible) next year.

So I'm just a little curious, are you able to say where you're producing this year versus retail in whether it's over or under and whether you have share gain factored in?

Sure.

I mean, yes, there's some share gain factored in.

Again, it depends.

You have to be -- I'd be a little careful to speaking very broadly versus specific product.

If you think about large ag, for example, certainly, versus last year where we were underproducing retail, this year, we would be at or pretty much at retail.

So year-over-year, you're getting a sales lift because we're not underproducing.

I would say, really, construction, if you look just broadly at the construction equipment last year, significant underproduction.

And this year, we're actually overproducing a bit to retail.

So dealers are building inventories some in the channel.

So you get kind of a double benefit there.

But I'd say, the greater benefit is, similar to the large ag, the fact that we're not underproducing this year.

Now as you look at some of the other product, it's going to be a mix here and there based on where we ended last year, how we view current year and looking out into next year.

But small ag, for example, in the U.S., you'd see a bit of underproduction.

But obviously, overall, you're seeing some overproduction as our receivables and inventory numbers are going up slightly.

But again, I wouldn't read too much into that.

Our next question is from Ross Gilardi of Bank of America Securities.

Tony, you just touched on a little bit of that, but -- a little of my question.

But could you give a little more color on Construction & Forestry?

I mean, Cat put up negative 4% retail sales growth in North America construction yesterday for April.

And you're putting up -- and you're guiding to 13% revenue growth in Construction & Forestry for '17.

So what's happening?

I mean, are you seeing a genuine acceleration in demand?

Or is this just -- a lot of this is just Deere dealer pipeline sale just because your dealer inventories were just so depleted going into this year?

Yes, I mean, certainly, I'd say it's a combination of things that -- as I mentioned with answering Rob's question, certainly, last year, as you recall, we ended our dealer inventories on a percent of sales basis at the lowest level we've had in over a decade.

And so -- and even this year on our forecast on a percentage basis, we're, I think, the second lowest in over a decade.

So we're not building a lot of inventory.

But certainly, we're not underproducing like we were.

So that has given us a pretty significant lift.

We talked about in the first quarter, our order books are really quite strong, and they continue to be strong through the second quarter.

More importantly, over the last several months, we've seen retail sales actually up year-over-year as well.

So that's certainly been encouraging.

And that's a big part of the reason why our forecast has now increased is we're starting to see those dealer orders pulling through into the retail channel.

So from our perspective, industry retails, we're still flat to down slightly for U.S. construction equipment.

But as you look at things like the smaller, what we call, commercial work site or compact equipment, that continued to be very strong.

And we have new product there too that's helping to benefit the business.

So there are a number of pieces.

A big portion of that, though, is about our shipping to retail year-over-year versus underproducing last year.

Our next question is from Andrew Casey from Wells Fargo Securities.

I guess, I want to return to the underproduction, overproduction comment versus retail.

But if you look at the first 6 months, you saw a mid-single-digit decline in U.S. equipment sales.

Most of that seemed to be related to Ag & Turf.

And then if I combine last quarter's report with this quarter's, the first half receivables of inventory down about $670 million in Ag & Turf.

Is most of that $670 million inventory reduction?

Or did you see kind of down receivables for the first 6 months?

Yes.

I think it's -- I want to say it's -- yes, most of the reduction actually has been in trade receivables year-to-date.

Okay.

And then can you update us, kind of follow-on on that, can you update us on the U.S./Canada high-horsepower farm equipment order availability?

Sure.

Yes.

And then -- yes.

So if you look at -- obviously, combines are pretty straightforward.

There's really no change from last year.

I mean, our early order program accounts for over 90% of that in any given year.

So that's pretty full.

As you look at -- I'll talk to the Waterloo tractor numbers.

Last quarter, I think we talked about it being relatively consistent, with some puts and takes here and there.

That order book actually has strengthened pretty significantly over the quarter.

And I would say, broadly speaking, our availability across the board on Waterloo product, that includes 7000, 8000 and 9000 Series tractors, would be ahead or further out this year versus last year, and some of them fairly significantly.

So again, over the course of the quarter, we've seen some real strength in the order book for those large tractors.

Our next question is from Joel Tiss from BMO Capital Markets.

I just wondered if you could give us a sense, maybe the old baseball analogy on how far are you through the cost reduction efforts.

Yes.

Joel, we are making good progress with respect to the cost reduction -- structural cost reduction goal of $500-plus million that we talked about.

Now you'll recall that when we talked about it, we said, if the investing conditions stay the same as in 2016 levels, we will aim to get over $500-plus million in structural cost reduction by the end of 2018, okay, so -- and be fully realized, end 2019.

And a couple of things I will point out.

While we are making very good progress towards the structural portion, the controllable part of cost reduction, there are some headwinds, one essentially being the material inflation.

And then there is a second one that might confuse, when you look at the total picture, which is lever pulling.

So as the volumes come up, we had pulled a lot of levers over the last 3 years, and as the volumes come up, we'll be releasing some of those.

But if you look at the underlying structural cost reduction, we are making very good progress.

And we are committed to hit the $500-plus million that we talked about.

Our next question is from Sebastian Kuenne from Berenberg Bank.

I have a question regarding Ag & Turf.

You had a roughly flat Q1 -- sorry, Q2.

You expect a very strong growth for the rest of the year.

In what markets do you think you would outperform most compared to the competitors, given that you're certainly cautious on the U.S. and Europe?

So what are the key margins, by how much you think you can outperform the sector?

Yes, we try to be a little cautious around getting too specifically -- too specific on market share just from competitive reasons, obviously.

I mean, I think we talked a little bit on an earlier question about the fact that we do have anticipated market share gains in several of our key markets.

We've had a (inaudible) a long history of market share gains in Brazil on both tractors and combines.

And as we've continued to localize product there, I think that's expected to continue.

It's not uncommon, as you begin to see a bit of recovery and so on in markets even like North America with large ag.

That tends to be some of our best opportunity to see some market share -- positive market share shifts.

And certainly, our investment in things like precision ag will benefit that and will help boost some of that.

We've done a lot of work on product and our dealer network in Europe as well and would hope to see at least some modest improvement as we move forward there.

So I would say, it's fairly broad where we would expect some market share shifts.

But some markets may be a little more significant than others.

And unfortunately, I can't get much more detailed.

But I appreciate the question.

Our next question is from Seth Weber from RBC Capital Markets.

In the prepared remarks, I think I heard something about used equipment becoming more supportive of the environment in North America.

Can you give us any additional color there, whether that's a reference to inventory levels or are you seeing pricing getting better?

Any additional help there would be great.

Yes.

And you're right.

You heard that correctly.

And I think it's a combination of things.

I mean, certainly, used equipment levels do continue to come down, and so that's been beneficial.

In fact, we've kind of given a number versus the peak of summer 2014.

Last quarter, we said it was down about 34%.

It continued to come down in the second quarter of this year, down about 36% from the peak.

So that's certainly been supportive.

And if you talk with many of our dealers, that the volume, I'll say, overhang of use has become much less challenging for them.

Pricing, I would still say, very stable.

It continues to stabilize in certain products.

And I want to be very clear.

Specifically, certain products, you might see some strengthening in pricing but broadly is supported.

But the benefit to our dealer is the confidence that they have in the value, not just the volume, but the value they have placed on that used inventory is much stronger today.

And that just gives them a much better position to be able to consider on both new and used sales and be able to work with customers that way.

So you feel like that they're more open to taking in new business because they have better visibility to the used market.

Is that what you're saying, basically?

Right.

And more -- and I would say -- and we started to say this even as early as third quarter last year, the confidence that they have, in some cases, it's about their ability to take the equipment, but it's also significantly more confidence in the value they place on it and their ability to get the appropriate level of margin when they turn that used piece of equipment.

So that's why the comment was written the way it was.

It's not just about the ability to sell new, but it's also about their ability to sell used at profitable levels has become much more supported.

All right.

Our next question is from Stanley Elliott from Stifel, Nicolaus & Company.

You actually kind of just answered the question, but is there a way to parse out how much of the increase on the construction side was from some of the new products deal at CONEXPO?

You did talk about some of the smaller -- the mini class, but also there's a fair amount going on, on the production side class there as well.

And then lastly, could you mention anything about the parts commitment having any impact on the sales outlook?

Yes.

I would say, I mean, again, the large portion of the sales increase for Construction & Forestry is, again, I would emphasize, is really about the difference in our production to retail year-over-year.

Certainly, those new products are having some benefit.

I mentioned the commercial worksite products.

You're certainly seeing some benefit kind of more broadly with products as well, to your point, some of the production class equipment.

I don't have a specific number that would identify how much specifically is coming from new products versus the change in retail.

But certainly, there's benefit there.

From a parts perspective, and I'm not sure I would necessarily attribute it immediately to the change in the warranty, that'll take a bit of time to really see the full impact.

But certainly, as you think about our sale year-over-year, parts is certainly stronger year-over-year as well, so that's helping to benefit that business.

Our next question is from Jerry Revich from Goldman Sachs.

Tony, can you talk about how you view normalized margins in Ag & Turf?

Obviously, really strong performance here towards the bottom of the cycle.

And so if you apply your normal operating leverage, that would get you to 15%, 17%-type margins at normalized volumes.

And I'm wondering, at which point do you folks start to think about, is that too high from a competitive standpoint?

How do you think about what's normalized in this cycle for you?

Yes.

I'll start and if Raj wants to throw any more in.

But certainly, we've been pretty open in talking about it even as we introduced the $500 million reduction in structural costs.

At that time, we talked about our mid-cycle margins as we would calculate them for the enterprise would be around 13%.

And we've also been pretty open, to your point, about how much is too much is wanting to make sure you kind of strike that balance between growth and margins.

Certainly, our strategy calls for a 12% margin at mid-cycle.

We are committed to maintaining 12% or higher mid-cycle margins.

But as we continue to improve the current structure of the business, in some cases, we believe what will drive larger shareholder value and the greater shareholder value isn't necessarily to see those structural improvements just drop into higher and higher margins, but be able to leverage some of that towards some growth opportunities.

And so that's what we'll try to balance is opportunities to grow at, at least that 12% mid-cycle margin with higher margins dropping to the bottom line.

So that's a little bit of how we think about it.

All right?

Our last question is from Brett Wong from Piper Jaffray & Co.

Just wondering, looking at Brazil, talking about your expectations for Moderfrota rates coming up here in June.

Were you surprised that you didn't see rates change during the Ribeirão Preto show?

And do you think that impacted sales at all during that show?

And are there any -- are the changed expectations or change rate expectations factored into your guidance for the region in the year?

That's a great, great question.

I'm not sure we're necessarily surprised.

I think as we spoke with our group there actually ahead of the show, they were not anticipating it being announced at the show this year.

Now I think it's worth noting some additional funding was announced at the show to kind of close out the -- and provide enough funding to cover through the current fiscal year through the end of June.

We would continue to anticipate the announcement, potentially in the next couple of weeks, even with, as Josh mentioned in his opening comments, even with some of the uncertainty today that's in that market.

And there's a variety of questions candidly around what could happen going forward versus you have, obviously, could rates be lower and some would argue that the rates could come down a little bit, given the fact that the broader market rates in Brazil have decreased?

Others are actually advocating for rates to stay relatively the same but provide a higher level of funding, so you can fund more business.

So we'll see where they land.

I think the important part of the conversation though is at least based on information or conversations we've had with government officials there, and I would say history and even very recent history, they continue to be very supportive of agriculture, specifically around the finale in the Moderfrota program.

And so some that are doing a bit of saber rattling about what could happen to that program, I think that would be a significant divergence from what they've shown in recent times.

So there's always risk.

I'm not saying there's no risk here.

But certainly, we remain confident that the government will do everything they can to help support agriculture, including supporting the FINAME program.

So okay, with that, I think we'll go ahead and conclude the call.

We appreciate everyone's participation.

And as always, we'll be around for the rest of the day for any follow-up questions.

Thank you.

Operator?

That concludes today's conference.

Thank you for your participation.

You may now disconnect.