Deere & Company - Earnings Call - Q2 2011
May 18, 2011
Transcript
Speaker 6
Good morning and welcome to Deere & Company's second quarter earnings conference call. Your lines have been placed on listen-only until the question and answer session of today's conference. I will now turn the call over to Mr. Tony Hegel, Director of Investor Relations. Thank you, you may begin.
Speaker 7
Good morning. Also on the call today are James Field, our Chief Financial Officer, Marie Ziegler, Vice President and Treasurer, and Susan Karlich, our Manager of Investor Communication. As some of you may be aware, Justin Marovic has moved on to other responsibilities within the company, and over the next several months, Josh Gierissen will be transitioning to the IR staff to replace Justin as Manager of Investor Relations. Today, we'll take a closer look at Deere & Company's second quarter earnings, then spend some time talking about our markets and how we see the second half of 2011 shaping up. 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.
First, a reminder: this call is being broadcast live on the internet and recorded for future transmission and use by Deere & Company and Thomson Reuters. Any other use, recording, or transmission of any portion of this copyrighted broadcast without the express written consent of Deere & Company is strictly prohibited. Participants in the call, including the Q&A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call. This call includes forward-looking comments concerning the company's projections, plans, and objectives for the future that are subject to important risks and uncertainties. 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/financialreports under Other Financial Information. Now, for a closer look at the quarter, here's Susan.
Speaker 4
Thank you, Tony. Today, John Deere announced earnings for the second quarter of 2011, and what a quarter it was. Income jumped 65% on a 25% increase in sales and revenue. Sales and earnings both reached their highest point for any single quarter in the company's history. As we've been pointing out for some time, our performance reflects the skillful execution of our business plan, plus strong demand for our innovative lines of equipment. In addition, the company's ongoing actions to expand its global presence are showing good results and helping draw new customers worldwide to the John Deere brand. We're also starting to see positive movement in some key markets that are in the early stages of recovery, namely construction equipment in the United States and farm machinery in Europe and the CIS. We're looking forward to further improvement in these areas in the future.
Finally, our full-year earnings forecast has been raised and now stands at approximately $2.65 billion. All in all, it was an impressive quarter, unprecedented in many respects, and the company seems well on its way to an equally impressive year. Now let's look at the quarter in more detail, starting with slide three. Net sales and revenues were up 25% to $8.9 billion in the quarter. Net income attributable to Deere & Company was $904 million. As you just heard, both were the highest for any quarter in the company's history. Slide four is a reminder as you compare the two quarters. It details the tax charge impact in the second quarter of 2010. On slide five, total worldwide equipment operations net sales were $8.3 billion, up 27% year over year, and the first time quarterly sales have exceeded $8 billion.
Price realization in the quarter was positive by four points, while currency translation was up three points. Production tonnage is shown on slide six. In line with equipment net sales, worldwide production tonnage was also up 27% in the quarter. The table at the bottom of the slide illustrates 2011 tonnage by quarter. It emphasizes a considerably higher year-over-year change in the first half of the year, paired with our expectations for the second half. Second half incremental margins will be impacted by this same pattern. Much of the difference in tonnage results from our interim Tier 4 product transition plan. Also, C&S dealers placed orders earlier this year in anticipation of the implementation of SAP in late April and early May. Projected worldwide production tonnage is up about 11% in the quarter and up about 19% for the full year. Let's turn to the company outlook on slide seven.
Third quarter sales are expected to increase by approximately 20% versus the same quarter of 2010, with positive currency translation on net sales of about 6%. For the full year, projected equipment net sales will be up 21% to 23% compared with fiscal year 2010. This includes about 3% of positive currency translation and 3% of positive price realization. Net income attributable to Deere & Company is now forecast to be approximately $2.65 billion in fiscal 2011 versus last quarter's guidance of about $2.5 billion. Turning to a review of our individual businesses, let's start with Ag & Turf on slide eight. Both sales and production tonnage were up 24% in the quarter. Operating profit was $1.2 billion. The profit improvement was primarily due to higher shipment and production volumes and improved price realization, partially offset by increased raw material expenses and higher selling, administrative, and general expenses.
In line with our strong operating performance, incentive compensation expenses are higher, which is driving a good part of the S&A&G increase. Operating margin was strong in the quarter, about 17%, while the incremental margin was approximately 15%. Before we review the sales outlook, let's look at some of the fundamentals affecting the ag business. Slide nine outlines our U.S. commodity price estimates. Corn stock-to-use ratios are at one of the lowest levels on record due to growing global consumption, coupled with its disappointing yields in 2010. As a result, we raised our corn price estimates for the 2011-2012 crop year by $0.60 to the low end of the USDA price forecast. Wheat prices and exports are expected to remain strong as the world recovers from the 2010 supply shock.
Soybean prices are expected to remain high through the 2011-2012 crop year as stocks are low and Chinese demand is growing. In the latest USDA supply and demand report, China is projected to import 58 million metric tons of soybeans in 2011-2012. This amounts to about 22% of worldwide production. Global levels of high-quality cotton are extremely low. Asian demand and exports to other countries will allow cotton prices to remain strong. 2010 U.S. farm cash receipts are shown on slide 10. They remain at a healthy level and are little changed since our last forecast. Farm cash receipts are now forecast to reach $371.4 billion in 2011, $41 billion more than the all-time high of $330.5 billion recorded in 2008. This quarter, we are introducing our 2012 farm cash receipts forecast. At over $365 billion, we anticipate 2012 receipts will remain very close to the record-setting 2011 level.
Historically, farm cash receipts for both the current and prior years are a key driver for current year ag equipment sales. Slide 11 highlights forecast acres planted and yields for the 2011-2012 crop year. It is still too early to know the ultimate outcome, as acres and yield will be determined by weather in the short run. Deere's outlook for the EU27 is shown on slide 12. Farm income and the future expectations of farmers in the EU27 are improving. Grain, beef, and milk prices remain at good levels, while pork prices are improving. 2011 margins for the arable farmer are expected to approach those experienced in 2007-2008. Used equipment levels are low, and we are seeing a higher tendency for farmers to invest in ag machinery. Farm net income in Brazil and Argentina is on slide 13.
Led by increases in sugarcane and soybeans, the two crops that drive the bulk of equipment purchases in Brazil, farm net income is now expected to be about $26 billion in 2011. The outlook for 2012 remains positive, with farm net income expected to be about $22 billion, 44% above 2010 levels. Contributing to strength in the region are strong global demand for Brazilian commodities, as well as high sugar and cotton prices and lower production costs. Farm income in Argentina is forecast at about $7.6 billion in 2011 and about $6.4 billion in 2012 due to high commodity prices. Our 2011 Ag & Turf Industry Outlooks are on slide 14. Fundamentals in the U.S. and Canadian farm sectors remain robust, and we have raised our industry forecast, which now calls for an increase of 5% to 10%.
Based on factors cited earlier, the EU27 is now projected up about 15% for the year. In the CIS, farm income is expected to increase in 2011 on the heels of significantly higher grain prices than the 2009-2010 crop year. Also, milk and beef prices are expected to remain at high levels. Russia has taken several actions to support the ag sector. For example, subsidies are in place for such things as grain, railway transportation costs, fertilizer, seed, and livestock. There is increased support for the ag modernization program, and loans and subsidies are being directed to last year's drought regions. All these factors, coupled with an easing in financing availability, have led to an increase in our industry guidance. We now expect notably stronger gains in the CIS countries this year from the depressed level of last year.
Moving to Asia, sales are forecast to grow strongly again this year. Industry sales in South America are expected to be down 5% to 10% in 2011 in relation to last year's strong levels. Underlying economic fundamentals for the region remain positive. However, recently enacted trade policies in Argentina and weakness in the small tractor market in Brazil are contributing to the more subdued outlook. Sales of lower horsepower tractors have benefited from Brazilian government programs that targeted smaller farms over the last few years. These programs may have reached the saturation point. Tractor sales under these programs accounted for about 35% of 2009 industry sales, about 22% in 2010, and are running around 17% year to date 2011. For the last couple of quarters, we've talked about the 50 new products that have been introduced to the Brazilian market over the last year.
Deere's lineup of tractors changed dramatically in 2010 and 2011 as we broadened our lineup with features and price points to appeal to broader segments of the market. We expect the strong start seen in the first half of the year to continue as we benefit from these products. Other positives are the ongoing investment in our dealer networks and our presence in cotton and sugarcane equipment. Turning to another product category, after rising almost 15% in 2010, we expect retail sales of turf and utility equipment in the United States and Canada to be about flat in 2011. Our new line of utility vehicles continues to be extremely well accepted in the marketplace. Putting this all together on slide 15, Deere sales for worldwide Ag & Turf are now projected to be up about 20%. Currency translation is positive, about four points.
Operating margin for the division is forecast at about 14%. As we discussed last quarter, small ag equipment sales are expected to recover from their fairly low levels of the past few years. The Ag & Turf division's operating margin will receive about one point of benefit from the mix of large ag equipment sales in comparison with the normal year. Remember, last year, the mixed advantage was greater, about two points more than a typical year. Before moving on to Construction & Forestry, I'd like to point out that Deere made two additional announcements this morning. The first relates to the large square baler outlined on slide 16. Deere and the Kuhn Group have established a strategic cooperation to provide a Deere-branded baler manufactured by Kuhn for Europe and the CIS countries in 2012.
This is one of the first steps to increasing our product offering in the EU27, which is a key priority in our company strategy. The large square baler fills the portfolio gap for the livestock, commercial, and contractor customer segments and leverages the strength of our John Deere dealer network. With the acquisition of the intellectual property license from Kuhn, Deere will manufacture a large square baler adapted to customer requirements for distribution outside Europe and the CIS by 2014. On slide 17, the second announcement concerned a new operation in Harbin, China. With an initial outlay of about $80 million, we are building a factory to manufacture mid and large-sized tractors, sprayers, planters, and harvesting equipment. Groundbreaking is expected to take place in the third quarter of calendar year 2011, with production beginning in late 2012.
This is our seventh manufacturing location in China, including two joint ventures, all of which primarily serve the rapidly growing Chinese markets. Let's focus now on Construction & Forestry on slide 18. Deere's net sales were up 46% in the quarter, while production tonnage was up 51%. The division's operating profit of $105 million was helped by higher shipment and production volume and improved price realization. These were partially offset by higher selling, administrative, and general expenses and increased raw material costs. The increase in SANG expense included higher incentive compensation expenses in line with our improved operating performance. On slide 19, fundamentally, growth is slower coming out of this recession than in previous ones.
Unusually bad weather, which hurt the construction industry, lower defense spending, surging oil prices, and continuing efforts to cut government spending at the state and federal level have caused deterioration in economic indicators since our last forecast. Following last year's 41% increase, net sales in Construction & Forestry are forecast to be up about 35% in fiscal 2011. This would bring construction sales for the year to about what we would consider typical trough levels. C&S is benefiting from improved sales to independent rental companies, also encouraging Deere dealers to continue to see an improvement in rental utilization and used equipment markets. Meanwhile, global forestry markets are expected to build on last year's big gain. The industry was up 50% last year. Our current forecast calls for a further increase in 2011, up 35% to 40%, led by strong pulp and paper prices.
The full-year operating margin for Deere's C&S division is projected to be in the neighborhood of about 8%. Let's move now to our financial services operations. Slide 20 shows the worldwide financial services annualized provision for credit losses at 10 basis points as a percent of the total average owned portfolio at the end of April. The 2011 full-year forecast is now about 23 basis points. That is down about 15 basis points from our last forecast and almost 25 basis points lower than 2010. This reflects much lower write-offs, primarily in the construction and forestry portfolio. We're also seeing fewer repossessions and much stronger used equipment values. On the repossessions that are taking place, we are experiencing better pricing and improved recovery rates. Moving to slide 21, worldwide financial services net income attributable to Deere & Company was $105 million in the quarter versus $87 million last year.
The higher income was primarily due to growth in the portfolio and a lower provision for credit losses. Looking ahead, we are projecting worldwide financial services net income attributable to Deere & Company of about $435 million in 2011. Now, on slide 22, let's turn our focus back to the equipment operations and look at receivables and inventory. For the company as a whole, receivables and inventories were up roughly $1.8 billion compared with the second quarter of 2010. This mainly reflects parts and complete goods in support of global growth, particularly in the BRIC countries. On a full-year basis, receivables and inventories are expected to increase about $100 million due to improved global prospects and some interim Tier 4 Stage 3B transitions late in the year. Now let's discuss the latest on retail sales. Slide 23 presents the product category detail in the U.S.
and Canada for the month of April expressed in units. Utility tractor industry sales were down 5%. Deere was down in line with the industry. Row crop tractor industry sales were up 1%. Deere was down a low single digit. Four-wheel drive industry sales were up 4%. Deere was down a single digit. Combine industry sales were up 19%. Deere was up more than the industry. Looking at Deere dealer inventories for row crop tractors, Deere ended April with inventories of 17% of trailing 12-month sales. Combine inventories were at 10% of sales. Turning to slide 24, in the EU27, sales of John Deere tractors and combines were up double digits in April. Deere's retail sales of selected turf and utility equipment in the U.S. and Canada were down double digits in the month. Last year's early and warm spring makes April sales difficult to measure against.
This is especially true considering that turf and utility sales in April of this year were impacted by severe weather and tornadoes, especially in the southeastern U.S., which is a key sales region. Construction & Forestry sales in the U.S. and Canada on both a first and a dirt and settlement basis were up double digits for the month. Let's turn now to raw material and logistics on slide 25. Second quarter material costs were up about $175 million in comparison with the second quarter of 2010. The increase was mostly Ag & Turf. For the fiscal year, our forecast assumes a negative margin impact from raw material of about two points, with a percentage breakdown about 85% Ag & Turf and 15% Construction & Forestry. With three points of price realization forecast for the year, we will fully cover these cost increases.
Looking at R&D expense on slide 26, R&D was up about 12% in the second quarter. For fiscal 2011, R&D expense is forecast to be up about 17%. As stated in previous quarters, R&D spending is expected to remain at high levels for the next few years as we approach significant product launches with interim Tier 4 engines and soon thereafter these final Tier 4 emission standards. Also included in the R&D spend is ongoing new product development expense for our growing global customer base. Moving now to slide 27, SANG expense for the equipment operations was up 19% in the second quarter. Incentive compensation accounted for about eight points of the increase in line with our improved financial performance. Currency translation was about two points of the increase, and growth accounted for about one point. For the full year, SANG is expected to be up about 14%.
Incentive compensation will account for about three points of the change, with currency translation accounting for about two points and growth about one point. Moving to the income tax rate on slide 28, the second quarter effective tax rate for the equipment operations was about 32%. For 2011, our effective tax rate is forecast to be in the range of 33% to 35%. The renewal of the R&D tax credit through this year affected both rates. On slide 29, you see our history of strong cash flow from Deere & Company's equipment operations. We anticipate cash flow from equipment operations of about $3.1 billion in fiscal 2011. As slide 30 illustrates, for 2011, capital expenditures are expected to be about $1.1 billion, primarily driven by investments related to interim Tier 4. The increase is also related to new product development as well as our expanded presence in global growth markets.
Depreciation and amortization for 2011 is expected to be about $600 million, with pension and OPEB contributions of about $115 million. Finally, turning to slide 31, you see a summary of the amounts returned to investors through share repurchases over the last seven years. During the second quarter, we repurchased 3.2 million shares, or about $300 million. Since 2004, we have repurchased about 127 million shares at a cost of $6.5 billion. That works out to an average purchase price of $51.57. In closing, John Deere has reached the halfway mark of 2011 on a strong pace and fully expects to have a record year. What's more, our record of strong financial performance is driving aggressive levels of investment, which puts the company on a solid footing for the future. Indeed, John Deere is exceptionally well positioned to address the world's growing need for agricultural commodities, shelter, and infrastructure.
We believe these developments will have a positive impact on demand for productive farm and construction equipment for years, if not generations to come, and that they have tremendously exciting promise for the company and its investors. Thanks.
Speaker 7
Thank you, Susan. Now we're ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. As a reminder and consideration of others, please limit yourself to one question and one related follow-up. If you have additional questions, we ask that you rejoin the queue. Operator?
Speaker 6
Thank you. At this time, if you would like to ask a question, please press star one on your touch-tone phone. To withdraw your request, you may press star two. Once again, to ask a question, please press star one. Our first question comes from Jamie Cook, and please state your company name.
Speaker 3
Good morning, Credit Suisse. A couple of questions. One, you mentioned in the beginning that the C&S business, and when you think about farm Europe and CIS, are still relatively at trough levels. Can you talk about how you're viewing the U.S. and Brazil relative to peak within the farm business? Last, unless I missed it, you talked about the Japan income, you talked about the Japan hit for the year. Can you just talk about how we should see that impacting the quarters of one quarter? Was there any in this quarter and how we think about Q3, Q4?
Speaker 7
Sure. First of all, in terms of you were talking, you asked first, I believe, about Ag & Turf for South America.
Speaker 3
In the U.S.
Speaker 7
In the U.S., and in the U.S., certainly from a large ag perspective, you know, it's a very strong market. Within the smaller ag equipment, you would have some room yet to improve. I mean, it's come back this year, and you'll see that, you know, we've talked about that in our margins. Last year there were a couple of points of margin benefit on large ag. This year, you know, as small ag has also come back, we're closer to one point of margin benefit, so the negative one year over year. Certainly in South America, you know, that's an interesting market because, you know, we're seeing weakness in the smaller ag sector in Brazil. Large ag is performing pretty well, and cotton and especially sugar are at very strong levels there as well. Certainly pretty strong, but good opportunities for us in both markets.
Speaker 3
Just to be clear, you gave a cash receipt forecast for 2012. It sounds like you would expect the strength in the U.S. and tractor sales to continue into 2012, or you're not seeing any signs of weakness at all within the U.S. farm equipment market?
Speaker 7
As you know, we wouldn't give a forecast for 2012 at this point. There's a lot yet to happen between now and then in terms of crops and so on. Certainly, as you look at our forecast, and we've said for years that the farm cash receipts are a good indicator of future equipment sales. It's our number one indicator in terms of our internal modeling, both in the current year as well as one year out. Certainly, that would bode well for sales in the U.S. and similarly in Brazil and Argentina. Sales or net income for farmers in those markets are very strong.
Speaker 3
Okay. The second question, just with Japan, sorry.
Speaker 7
Yeah, with Japan, you know, certainly there would be a little bit in the second quarter, but you know, that's going to mostly impact our third and fourth quarters. Again, keep in mind that's, you know, just effectively as we look as we have our outlook, you know, sales that effectively lost sales with a related margin on those funds.
Speaker 3
Okay, thanks. I'll get back in queue.
Speaker 6
Thank you. Our next question comes from Jerry Revich, and please state your company name.
Speaker 5
Hi, good morning. It's Goldman Sachs.
Speaker 7
Good morning, Jerry.
Speaker 5
It's Tony. Can you say more about the impact of the tragedy in Japan on your business? Your excavator margins are significantly lower than the profit drag. You're estimating what other product lines are impacted, or can you just help us with the high profit drag relative to the sales drag you're thinking about there?
Speaker 7
Sure. You're right. Most of our impact is in our Hitachi related, related to product with our Hitachi relationship. Keep in mind on that product that we only recognize the marketing or distribution margin on that. We, as part of that relationship, do not have the manufacturing margins on our books. That's why you'll see a little bit maybe lighter margin impact than what you might otherwise see.
Speaker 5
The $80 million profit drag, or $70 million profit drag on only a $300 million sales drag, implies much greater operational difficulties than what that distribution arrangement implies. That's the bridge I'm trying to gap, Tony.
Speaker 7
I mean, those margins would actually be lighter than what you would normally see.
Speaker 5
Yeah, the operating profit hit I would have expected to have been lower than the $70 million to your point because the margins on those sales are lower.
Speaker 3
We're not following you. This is Marie. Jerry, we've got $300 million of sales impact. As you are aware, Hitachi did lose several months of production in one of its northern factories that would be the primary source for these large mining machines and excavators. Those factories are expected to be up and running, I believe it is yet this week. We think our supply base and Hitachi in particular can be commended for the work that they have put into recovering from this tragedy.
Speaker 5
I agree, but let me just, my question is the $70 million profit drag implies north of 20% margins on those Hitachi excavators. To Tony's comment, that is a lower margin business for you, and it's not a drag in your production facility. That's the part that I'm.
Speaker 2
Let me try to clarify, Jerry. What you're right, it applies the 23% operating margin. What we have in there is we have Hitachi branded mining machines, and then we have the mid-size and large excavators. A portion of that business has margins that are greater than 23%, and a portion of that has margins that are less than 23%. This is the blended average of those margins. Yes, you're right. Some of this is a pure distribution margin, which would be significantly less than the 23%, and some of it we enjoy a little bit more margin. I don't think you should read anything more than that's the weighted average margin of the equipment that's been disrupted.
Speaker 5
That's very helpful color. On the ag equipment business, can you help us with the bridge for the Ag & Turf EBIT performance this quarter versus last year? Perhaps touch on what was the impact of interim Tier 4 product rollout costs, considering how strong pricing was this quarter versus raw material expenses. I was looking for a higher operating leverage than that. I'm wondering if you could just step us through the pieces there. Thank you.
Speaker 3
Again, we talked about the fact that we had very good operating margins at 17% for the second quarter. The factors that did weigh some on the incremental margin were things that we had discussed in advance, like raw material costs, higher SG&A, higher R&D. In the quarter, there's a little bit of absorption impact, as we had talked about for the full year, as Ag & Turf has a very significant number of product introductions and capital expenditure ahead of it and some behind. That had some impact in the second quarter as well. It's disruptive to the factories as we're bringing some of this capital in.
Speaker 5
Reporter of Magnitude, can you?
Speaker 3
No new information.
Speaker 5
Okay. Can you quantify that last point, Marie, reporter magnitude?
Speaker 3
We have talked about for the full year, full company, about $100 million. We don't have a breakdown by quarter, but there would be some impact in this quarter.
Speaker 5
Thank you.
Speaker 3
Thank you, Jerry. Next question.
Speaker 6
Thank you. Our next question comes from Charles Albert Edward Dillard, and please state your company name.
Speaker 0
First question is, can you talk about what explains the $1.6 billion increase in inventory year to date since October? About one month's production, I figure, in the first six months.
Speaker 3
Actually, Charlie, we ended October with our inventories in round numbers somewhere between $1 billion higher. That reflected the very high levels of production we had in the fourth quarter relative to a year ago, and the fact that the production would be somewhat heavier this year versus a typical seasonal pattern than it would traditionally be. That said, we still expect to end the year with our inventories in very round numbers, essentially flat for the full company with last year. This reflects very good business conditions in many parts of the world and the prospects of better conditions in places like Europe and the CIS.
Speaker 0
Okay. My second question has to do with the CIS. You mentioned you're seeing stronger gains over there. Could you kind of benchmark that against the peak of three, four years ago, and what are you seeing now? Do you think that this might accelerate over the next couple of three years, or will you?
Speaker 7
Hey, Charlie, this is Tony. Keep in mind, while we're certainly looking at what we refer to as notable improvements year over year, we're off of very low levels. If you look at where we were in 2008, our sales in the CIS last year were less than half of those levels. It's certainly low, coming off of low levels, but we're seeing some strong improvement there.
Speaker 0
Okay, thank you.
Speaker 6
Thank you. Our next question comes from Ann Dykman, and please state your company name.
Speaker 1
Hi there, JPMorgan Chase & Co. Hi, guys. Can you talk a little bit about North America ag equipment? You know, we know that farmers will continue to trade equipment into 2012, as you pointed out, cash receipts remain strong. They need the value of their used equipment to remain strong. Can you comment on the used equipment industry in North America, both used equipment values as well as the inventories of used equipment, and maybe any difference or similarities between combines and tractors?
Speaker 7
Absolutely. When you look at used equipment values, they're actually holding very strong. They're either flat to improved year over year, including combines. Combine used equipment values are actually slightly higher year over year in the U.S. That certainly bodes well. When you look at inventory levels, tractors are at used equipment are at very good levels. Combines, of course, are at relatively high levels year over year. Some of that's driven by the timing of our sales. As you look at a typical seasonal pattern of our sales, again, driven by our interim Tier 4 transition, we've shipped quite a bit more combines, new combines in the first half of the year compared to what we normally would. With it, as you know, with a new combine comes in almost all cases, a trade-in and use. Certainly, we're at higher levels.
We also track those within a band, and they would still be, our levels would still be in a reasonable band based on new equipment sales. We feel comfortable with the levels that they're at, but you're right, they are at high levels.
Speaker 1
Would you agree that if cash receipts come in somewhere around where you're forecasting and used equipment values stay around where they're currently at, that there's no reason to think that the North American ag equipment sector will fall off a cliff next year?
Speaker 7
As we look at what our dealer response is, our dealers seem to be comfortable that they'll be able to move those combines, and they've been very aggressive at doing that both within the U.S. as well as with some export markets.
Speaker 5
Thanks. Certainly, Ann, this is Jim. That would be consistent with history. I mean, as we've said, we model the business and sales based on cash receipts as being the largest driver. If you don't have, if the used is still flowing through the channel and you have good cash receipts, history would suggest that you're going to have good retail activity.
Speaker 1
Yeah, I agree with that. Just a follow-up, a different topic. I'm just curious, you spent about $600 million buying back shares in the quarter. Can you tell us what the share count was, the diluted share count at the end of the quarter, just for modeling?
Speaker 3
We were about 420 million shares.
Speaker 1
Was that at quarter end?
Speaker 3
That's at quarter end.
Speaker 1
Okay, thank you. I'll get back in line. I appreciate it.
Speaker 6
Thank you. Our next question comes from Henry Kern, and please state your company name.
Speaker 5
It's UBS. Good morning, guys. If the North American ag demand conditions weren't, would you be able to ramp production above what's implied in guidance, or are you bumping against where you could go for production at this point?
Speaker 7
You know, as you look at our order book, I assume you're referring to in the U.S. with the large ag equipment?
Speaker 5
That's exactly right.
Speaker 7
Yeah. As you look at our order book today, on 8R tractors, our effective availability is really out into about the November timeframe. On the 9,000 series, we're out into October. Keep in mind, we have a significant number of interim Tier 4 transitions on those large ag products in the year. As we've talked about in the past, we do have some capacity limitations this year with those transitions.
Speaker 5
Could you talk about on the supply chain side, their ability to ramp and how much that might be holding you back? Where are you seeing bottlenecks and where things?
Speaker 7
We do not have any, I mean, of course, on any given day, there are issues that we would be working through, but there are no supplier issues that are currently hampering our ability to produce product, again, with the exception of, you know, Japan.
Speaker 5
Thank you very much.
Speaker 2
Let me just elaborate on that. First, I think kudos has got to go to our excellent supply management professionals around the world and our supply base. As Tony said, at any point in time, there may be a particular issue somewhere that we're dealing with. Sans Japan, we've managed through this pretty flawlessly. We have a lot of confidence in our supply management team and our suppliers around the world. Thank you.
Speaker 5
Okay, next question.
Speaker 6
Thank you. Our next question comes from David Raso, and please state your company name.
Speaker 0
Can you give us a little more quantification of how you're thinking about the incremental the next couple of quarters? I'm just trying to think through the price versus cost in the back half of the year. It looks like you're implying it's, you know, it's a positive. If anything, it's positive enough to offset those incremental costs you cited for some of the new products. The sales growth you're implying is higher than your SG&A growth for the second half. I'm just trying to think through why the incremental margins look like you're almost implying they'll be lower than your operating margins. If you can maybe just flesh out first, kind of for the bogey, how are you thinking about your incremental the next two quarters?
Speaker 3
As Susan had indicated, David, as we look in the back half of the year, especially in Ag & Turf, we do see that incremental margins we expect will be softer than what you've seen in the first and second quarters. Some of the factors for that, again, are alongside the significant number of IT4 transitions that lie ahead of us. We won't have the same pattern of year-over-year sales and tonnage kinds of gains. You don't have some of the opportunities for incremental margin opportunities that you would have. We've talked about raw material expenses. We had very, very good price realization in the quarter. We have improved our guidance for the year to 3 points, but our actual price realization was 4 points in the quarter. It will abate a little.
We certainly expect that we will cover our product raw material costs up in the second half of the year, but you won't have maybe the same kind of margin opportunity. Finally, we do have higher product costs related to IT4 componentry. We've talked about that before. That's the catalytic converters and things like that that are on these IT4 compliant engines. For the full year, full company, that's about $170 million. We'll see more of that cost in the second half than we did in the first half as we ramp up some extra models.
Speaker 7
Right. This is Tony. The other thing I would add to that is keep in mind as we bring our inventory levels down in the second half of the year, you know, we've benefited from absorption in the first half, and that will flip and move the other direction here in the second half and will be a drag on margins as well.
Speaker 0
Between the two segments, do you see one more than the other? I mean, obviously, Ag & Turf has more new product rollout, I would argue. Is that where you expect to see more sequential degradation and incremental?
Speaker 7
Keep in mind with C&S as well, you know, right now they're in the midst of an SAP transition. They've swift some shutdowns ahead of that a couple of weeks, and of course, we'll also have some pretty slow ramp-ups. Effectively, they're at about three weeks of lower production. If you look specifically, it's a third quarter for that particular division. That will certainly have an impact on margins. As Marie Ziegler cited, some of the interim Tier 4 costs, that certainly is more directed at the Ag & Turf product lines than C&S.
Speaker 0
For clarification, Jim, if you want to tackle this, we're implying incrementals below operating margins for the second half of the year.
Speaker 3
I would just say that our forecast, we've been very candid in terms of what our incremental or our absolute margin guidance is for the two divisions. I think we'll let the numbers speak for themselves.
Speaker 0
Okay. I appreciate it. Thank you very much.
Speaker 7
Thank you. Next question.
Speaker 6
The next question will come from Robert Worther. Your line is open.
Speaker 5
Hey, good morning. It's Morgan Stanley. Real quick follow-up on South America, just to confirm that the reduction of the market growth outlook does not involve any large equipment in your view. I think you said the word saturation for small equipment, not so much on just the financing, but the actual market. I wonder if you could comment on where you think large equipment is there.
Speaker 7
Yeah, if you look at South America, there's really two factors that Susan cited. Again, and you're correct, it's on the small ag side, there's a, as I referred to it, an MDA program that's really targeted at small tractors and small farms. That's been in the past a pretty high % of the overall tractor sales and has sequentially reduced year over year. We would expect a similar pattern again this year, as well as when you look at overall South America, Argentina, with some of the recent trade policies, would certainly have a dampening effect. On large ag, and especially part of what's not included in that outlook, would be cotton and sugar. There's certainly strong markets there.
Speaker 0
She didn't take the large ag part down. Okay. The second question would be on just a little one on tax rate guidance. You're sort of below where you've been for the year. Does the unchanged tax rate guidance imply a higher mix in the U.S. towards the second half of the year? You know, Tier 4 aside, that would be a positive margin shift, I would think.
Speaker 2
Yes. Yeah, this is Jim. I don't know that I would necessarily jump to that conclusion. We've got a lot of discrete items that impact particular quarters depending on the timing of certain events. There's an element of lumpiness to the tax rate in the quarterly periods that sometimes defies a little bit of logical reasoning.
Speaker 0
Okay, that's helpful. Thank you.
Speaker 2
I would not jump to the conclusion that it's an income mix necessarily.
Speaker 0
Got it.
Speaker 2
Okay. Thank you. Next question.
Speaker 6
Thank you. Our next question will come from Seth Weber. Please state your company name.
Speaker 0
Hi, it's RBC. Good morning. I guess just first a clarification, did you raise your IT4 costs from $160 to $170 then? Is that what I heard?
Speaker 7
Yes, we did. Yes, that's correct.
Speaker 0
Okay. On the Construction & Forestry business, you mentioned that with a 35% growth this year, you're basically kind of getting back to trough levels. Looking at your, I guess, slide 19, you're talking about another 3% decline next year in non-res construction. I mean, what I'm trying to understand is how much of this is just restocking and replacement, and what will we need to see growth in that business next, going forward?
Speaker 7
Right. This is Tony. First of all, just to clarify, the trough levels are for the construction side of that division only. Certainly, some of what we're seeing, obviously, there is some restocking, but also, as we've indicated previously, you tend to see some overshooting of the fundamentals, both on the high side and on the low side. We believe that's part of the story as well, that some of this is really a correction of the retail environment back up to what the underlying fundamentals would support. To your point, not at strong levels. We're at, as we've indicated, certainly still, while year-over-year percentages are high, still at basically trough levels.
Speaker 0
Okay, thanks. If I could just ask a follow-up, can you give us some color on, you know, where you're at for Europe capacity on the Ag & Turf business? I mean, it sounds like you're starting to get a little bit more comfortable with the dynamics in that market, you know, relative to North America. Do you still have excess capacity in Europe if you needed to expand that there?
Speaker 7
Yeah, certainly that market is coming back, as we've indicated. We've bumped up our outlook again there, but would not have capacity issues in Europe.
Speaker 0
Okay. Thank you.
Speaker 5
Next question.
Speaker 6
Thank you. Our next question will come from Andy Casey. Please state your company name.
Speaker 5
Good morning, everyone.
Speaker 2
Morning.
Speaker 5
I'm on cash flow outlook. I kind of get it, but can you walk us through the approximate $200 million reduction? Looks like $100 million is related to the adjusted receivable and inventory. Where's the other $100 million coming from?
Speaker 3
Actually, the bulk of it really is receivables and inventory because we changed our guidance from down $250 million to up $100 million.
Speaker 5
Oh, okay.
Speaker 3
There is probably some exchange running through there, you know, with rates.
Speaker 5
Timing on sales?
Speaker 3
There is a bunch of mismatch, but that's really the biggest factor.
Speaker 5
Okay. When you look at that receivable and inventory reduction, could you help us? What portion is going to happen in Q3? Because you have the Construction & Forestry shutdown, you've got some other stuff going on in Q4.
Speaker 3
Andy, I don't have a split between how it'll go in the third quarter and the fourth quarter. Typically, I wouldn't have a comment there.
Speaker 5
Okay. Lastly, back on the Brazilian market, there's been some competitor comment about aggressive pricing directed primarily at you guys. Some of that may be related to your segmentation of the market. What are you seeing with respect to industry pricing?
Speaker 7
From our perspective, what I can tell you is for Deere & Company in Brazil, we have had positive price realization both in the second quarter year to date and in what we anticipate for the fiscal year. Certainly, we've done very well in that market with our market share. We would cite two factors for why that's happening. We've talked a lot in recent months about the new products we have in that market. This is probably closer to, we would argue this is as expected, as well as we've invested quite a bit into our dealer network there. We have a very strong distribution network and good products with a great fit for that market. I think you're seeing the results of that.
Speaker 5
Thank you very much.
Speaker 7
Thank you. Next question.
Speaker 6
Thank you. Our next question will come from Joel Tiss. Your line is open. Please state your company name.
Speaker 2
I'm with Buckingham Research.
Speaker 5
Hey, Joel.
Speaker 2
How are you doing?
Speaker 5
Just on this Brazilian, you know, a little bit of a disconnect between the farmer profitability increasing and sales flat to down for the year. Can you just give us a sense about, and I'm not asking for a 2012 forecast, but do you think we're setting up some pent-up demand for 2012? Like, is this more of a transitional issue, or do you think there's something a little more structural beyond just the financing?
Speaker 3
The government subsidies, Joel, in that small end were extremely attractive. As that market segment had, they really weren't dependent, if you will, on farm income. There's very much a disconnect in terms of what was happening with that small tractor segment versus the farm income. The prospects for farm income, as we've said, are very good in Brazil. That supports a broad array of implements, tractors, cotton equipment, sprayers, sugar cane harvesting equipment. The prospects remain very good for the market.
Speaker 5
Okay. Just to try to cheat a little bit, I'm going to glue two questions together, but they're both easy. The percentage of construction equipment that goes into rental, and also just philosophically, why keep, you know, more than $3 billion worth of debt on the equipment operations when you have more than that in cash? Thank you.
Speaker 3
The rental is about 15% of our construction business. Over time, structurally, that probably could grow. Given what's happened with the liquidity crisis, you may see some contractors choosing to rent a little longer than they would typically. That's item one. In terms of the debt level, the reason for keeping cash is in part for liquidity. Prior to the liquidity crisis, we had talked about having about $1 billion of cash on our balance sheet for liquidity. As we continue to grow our business overseas, and quite candidly, because of the liquidity concerns, we're targeting something more in the range of $2.5 to $3.5 billion in cash. You should expect that going forward. That said, don't forget, we have been buying back shares. You're seeing us return cash that way. Additionally, we've had eight dividend increases since 2004.
We're continuing to reward our shareholders directly with a return of cash in the form of dividends, share repurchases, as well as continuing to make the necessary investments to grow our business platform. Thank you.
Speaker 5
Okay, thank you.
Speaker 6
Thank you. Our next question comes from Mark Kosnorick. Please state your company name.
Speaker 5
Hi, it's Cleveland Research. Good morning.
Speaker 2
Hi, Mark.
Speaker 5
Question on the effective capacity impact of the Tier 4 launches in large ag equipment. All things held equal, moving into 2012, those large ag Tier 4 problems will be behind us, the launch problems. What kind of effective capacity increase are we looking at next year? Everything else held equal.
Speaker 7
We would say for large ag specifically in Waterloo, our capacity year over year for 2012 would go up in the 10% to 15% range. That's not coming just from the interim Tier 4 impact. We've also talked about adding capacity there through 2012, and we'll get some benefit of that capacity increase throughout the year. Those two combined would add about 10% to 15%, 2012 over 2011.
Speaker 5
That's Waterloo and East Moline?
Speaker 7
That's Waterloo, large tractors.
Speaker 5
East Moline basically would be similar?
Speaker 7
They would have some interim Tier 4 advantage, but we're not adding additional capacity there like we are in Waterloo.
Speaker 5
It'd be less. Then sort of the flip side of that, you're now, you know, 7,000s and smaller stuff has to transition next year. Are we going to expect to see sort of a, you know, sort of a hit to effective capacity because of that transition, similar to the numbers you just stated here for large ag?
Speaker 7
You’ll have some capacity impact next year as those products transition.
Speaker 5
Yeah, overall it could wash, but at least large ag is going to have some effective increases.
Speaker 7
Exactly. Exactly.
Speaker 5
Okay, very good. Thanks.
Speaker 7
Thank you. Next question.
Speaker 6
Thank you.
Speaker 7
We have time for one more question.
Speaker 6
Our final question is from Steve Volkman. Please state your company name, sir.
Speaker 0
It's Jefferies. Good morning.
Speaker 5
Good morning.
Speaker 0
Morning. I think most of them have been answered, but I'll ask a corollary to Mark, which is on the cost side. I guess, as we look into 2012, it would seem that there are a number of things that have kind of hit us here in 2011 that should go away in 2012. I'm wondering if we should be thinking about incremental margins actually kind of going back up again as we get into 2012, or do you see enough on the cost front that it's too early to kind of commit to that?
Speaker 2
You know, Steve, we're not going to get into talking too much about 2012 margins, but there are a couple of issues that we have dealt with this year that we certainly wouldn't anticipate next year. R&D going up 17% again. I think we've said that we are going to stay at healthy levels, but we're not certainly anticipating those sorts of double-digit increases. I think it's fair to say, without commenting too much on 2012, that as you look through the analyses, there are some items here that we wouldn't expect to repeat.
Speaker 0
Okay.
Speaker 2
Thank you very much.
Speaker 0
Okay. Just a quick follow-up, if I could. You guys have talked a little bit lately about trying to better balance your shorter-term performance, which has been great on the back of SVA, with some longer-term growth opportunities. I'm just wondering if there's a sort of a strategic shift that we should be thinking about, and if there's some bigger projects out there that we should be starting to think about you guys pursuing that kind of balance you better with longer-term growth.
Speaker 2
I would start to answer that question that, as what we said in prior, is we remain fundamentally committed to SVA and the SVA model. We're going to focus on that, but at the same time, focus on our two global growth platforms, which is agricultural and construction equipment. I think the announcements that you saw this morning are good evidence of our commitment to delivering growth for the future, but at the same time, delivering some very, very solid operating results. I think that's the kind of performance you should expect from us going forward. We're going to be focused on both aspects of the business: solid performance and solid growth. With that, we should sign off. Thank you very much.
Speaker 0
Thanks, Jeff.
Speaker 7
Okay. Thank you. Thank you all for your interest. As always, we'll be available throughout the day for any follow-up questions. Thank you.
Speaker 6
Thank you. This does conclude today's conference call. We thank you for your participation. You may now disconnect your lines.