Deere & Company - Earnings Call - Q3 2011
August 17, 2011
Transcript
Speaker 4
Good morning and welcome to Deere & Company's third quarter earnings conference call. Your lines have been placed on listen-only until the question and answer session of today's conference. I would now like to turn the call over to Mr. Tony Hegel, Director of Investor Relations. Thank you, you may begin.
Speaker 6
Thank you and good morning. Also on the call today are Jim Field, our Chief Financial Officer, Marie Ziegler, Vice President and Treasurer, and Susan Karlich, Manager of Investor Communications. Today, we'll take a closer look at Deere & Company's third quarter earnings, then spend some time talking about our markets and how we see the fiscal year ending 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 is copyrighted without the express written consent of Deere & Company and 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 U.S. Additional information concerning these measures, including reconciliation 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 third quarter, here's Susan.
Speaker 2
Thank you, Tony. John Deere's strong performance continued in the third quarter of 2011, with earnings climbing 15%. Both earnings and sales were the highest for any third quarter in the company's history. More than that, it was our seventh straight quarter of improved earnings and the fifth straight quarter of record earnings for that particular period. Last quarter's gains were broad-based, with all divisions contributing higher results. As we've pointed out in the past, it is significant that our record performance is occurring in the face of certain key markets being in the early stages of recovery. This reflects our success managing costs and assets while enhancing our geographic footprint, enriching our product lineup, and above all, helping customers throughout the world be more profitable and productive. Now, let's look at the quarter in more detail. We're going to start with slide three.
Net sales and revenues were up 22% to $8.4 billion in the quarter. Net income attributable to Deere & Company was $712 million, an increase of 15%, and again, was our fifth consecutive quarterly income record. On slide four, total worldwide equipment operations net sales were $7.7 billion, up 24% quarter over quarter. Currency translation in the quarter was positive, high six points, while price realization on net sales was a positive three points. Production tonnage is shown on slide five. Worldwide production tonnage was up 9% in the quarter. In response to increased demand aided by the successful implementation of SAP, construction and forestry tonnage was higher than forecast. For the company, projected worldwide production tonnage is up about 13% in the fourth quarter and up 21% for the full year. Let's turn to the company outlook on slide six.
Fourth quarter sales are expected to increase by approximately 20% versus the same quarter of 2010, with positive currency translation of about four points. For the full year, projected equipment net sales will be up about 25% compared with fiscal year 2010. This includes about four points of positive currency translation and three points of positive price realization. Net income attributable to Deere & Company is now forecast to be approximately $2.7 billion in fiscal 2011. Turning to review of our individual businesses, let's start with agricultural and turf on slide seven. Sales were up 22% in the quarter. Production tonnage was up 7%. Operating profit rose to $859 million, yielding a 13% operating margin. As we have discussed in the last three conference calls, 2011 incremental margins were anticipated to decline as we move through the year. This is borne out with A&T's third quarter incremental margin of 3%.
Of the many factors that affected operating and product costs in the quarter, the primary ones were higher shipment volumes and improved price realization, both of which benefited results. On the negative side, raw material costs were about $165 million higher than a year ago. S&G costs, primarily associated with global growth initiatives, foreign exchange translation, and higher incentive compensation expenses, were higher by about $75 million. These factors put pressure on incremental margins. Before we review the sales outlook, let's look at some of the fundamentals affecting the ag business. Slide eight outlines the U.S. commodity price estimates that underlie our financial forecast. The forecast was prepared prior to last Thursday's bullish USDA supply and demand report. However, for your reference, we have included the latest USDA numbers in this slide. While the USDA's price estimates are higher than ours, its yields, as shown on slide nine, are lower.
Thursday's USDA report enhanced the already strong economic outlook for U.S. farmers. Slide 10 highlights cash receipts, the most important driver of a farmer's decision to purchase equipment. As mentioned earlier, our forecast was completed prior to the USDA report, but we ran its crop price and yield data through our model. Incorporating those numbers in our model resulted in an increase to crop receipts of about $5 billion in 2011 and about $12 billion in 2012. Of course, the same increase would apply to total gross cash receipts. 2011 U.S. farm cash receipts are at record highs, and 2012 is near record, boding well for the ag business. Deere's outlook for the EU27 is shown on slide 11. Farm income and the future prospects for farming in the EU27 are positive. Grain, beef, and milk prices remain at good levels due to global demand and beef supply shortages.
2011 margins for the arable farmer are expected to be strong. Used equipment levels are low, and farmers are increasing their purchases of agricultural equipment. Weather, though, has slightly tempered our near-term outlook. In May, we discussed abnormally dry weather. Now, abundant rainfall in parts of Eastern and Western Europe is hampering the harvest and impairing grain quality. Slide 12 highlights the new products introduced in Region Two, which includes the EU27 and CIS markets in June. Many of you joined us in Portugal and were a part of the over 6,000 participants from 57 countries who saw more than 100 new products that will be available to these growing markets in 2012. Pursuant to this introduction, about 80% of the over 140 horsepower tractor models and combines are new or updated, and we have an enhanced portfolio of farm implements.
Products and technologies are important contributors to our success, but the dealer is critical, especially when combined with so many exciting new products and technologies. The dealer of tomorrow's strategy puts Deere & Company in a strong position heading into 2012. Now, turning to a different part of the world, farm net income for Brazil and Argentina is on slide 13, led by increases in sugarcane and soybeans from 2010 levels. The two crops that drive the bulk of equipment purchases in Brazil, farm net income is now expected to be about $20 billion in 2011. The about $6 billion decrease since our last forecast is accounted for by higher input costs, lower, though still strong, international commodity prices, and the Brazilian currency strengthening against the U.S. dollar.
Nevertheless, Brazil's 2012 income is expected to improve to about $21 billion, which would be slightly more than this year's record of about $20 billion. In Argentina, farm income is forecasted at about $8 billion in 2011 and about $8.4 billion in 2012 due to high commodity prices. Our 2011 ag and turf industry outlooks are summarized on slide 14. Fundamentals in the U.S. and Canadian farm sectors remain robust. Our industry forecast of up 5% to 10% is unchanged from last quarter. Based on weather conditions cited earlier, the EU27 is now projected up 10% to 15% for the year. In the CIS, farm income is expected to increase in 2011 on the heels of significantly higher levels of production and grain prices. Also, milk and beef prices are expected to remain at high levels. Russia continues to take actions to support the ag sector.
Just to name a few, fertilizer, seed, and livestock subsidies and fixed diesel prices are in place. 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, enable us to expect notably higher industry sales in 2011. Moving to Asia, we continue to expect sales to rise sharply again this year. Industry sales in South America are now expected to be down about 5% in 2011 in relation to last year's strong levels. Underlying economic fundamentals for the region are strong, but trade policies in Argentina continue to restrict sales. Our industry forecast has been adjusted to reflect strength in the large ag sector, which partially offsets the weakness in the small tractor market in Brazil.
Deere expects to outperform the industry in the region as a result of the success of new products introduced last year, as well as the ongoing investment in our dealer network and our presence in cotton and sugarcane equipment. Turning to another product category, after rising about 15% in 2010, we expect retail sales of turf and utility equipment in the U.S. and Canada to be about flat in 2011. Our new line of utility vehicles continues to be extremely well accepted in the marketplace. Putting ourselves together on slide 15, Deere sales for worldwide ag and turf are now projected to be up about 21%. Currency translation is positive, about four points. Operating margin for the division is forecast at about 14%. Before moving on, we'd be remiss not to mention the progress of our early order program.
Response to our 2012 early order programs for air seeding, sprayers, planters, and tillage equipment has increased significantly from the healthy levels experienced in the same period last year. Slide 16 focuses on our interim Tier 4 compliant 8R tractor, a story we like to talk about. The 8335R is the first row crop tractor ever tested in Nebraska to break through the 300 PTO, or power takeoff, horsepower barrier. The tractor delivered record-breaking power while maintaining industry-leading fluid efficiency. In the 75% of pull at maximum power drawbar test, the IP4 engine in the 8335R delivered 15.45 horsepower hours per gallon. This is better fuel efficiency than the 8320R it replaced and up to 28% more efficient than competitors' official result for their Tier 3 tractors. These are outstanding results, which we believe validate our single fluid EGR engine design.
Let's focus now on construction and forestry on slide 17. Deere's net sales were up 34% in the quarter, while production tonnage was up 20%. The division's operating profit rose 67% to $110 million, helped by higher shipment and production volumes and improved price realization. These positive factors were partially offset by increased raw material costs of about $30 million and higher selling, administrative, and general expenses. The S&G increase included higher incentive compensation expenses in line with improved operating performance. C&S incremental margin was about 13%. On slide 18, from very low levels of the last few years, net sales in construction and forestry are now forecast to be up about 45% in fiscal 2011, following last year's 41% increase. C&S is benefiting from improved sales to independent rail companies, as well as strength in the energy and ag-related sectors.
Also encouraging, Deere dealers continue to see an improvement in rental utilization and used equipment markets. Global forestry markets are expected to build on last year's big gain. The industry was up about 50% last year. Our current forecast calls for a further increase in 2011 of 25% to 30%. The full year operating margin for Deere's C&S division is projected to be about 8%. Now, moving to the economic indicators on the bottom part of the slide. Fundamentally, economic growth has been slower coming out of this recession than previous ones. The havoc we've seen in the financial markets over the last few weeks has added further elements of uncertainty, while economic indicators continue to deteriorate. The numbers shown are Global Insights' August forecast. It is likely these figures will change over the next couple of months as recent events are processed and forecast numbers begin to stabilize.
Let's move now to our financial services operations. Slide 19 shows the annualized provision for credit losses at 8 basis points as a percent of the total average owned portfolio at the end of July. The 2011 full year credit loss forecast is now about 15 basis points. That's down about 8 points from our last forecast and around 30 points lower than 2010. This reflects much lower write-ups, primarily in the construction and forestry portfolio. We're also seeing fewer repossessions, and on the repossessions that are taking place, we are experiencing better pricing and improved recovery rates. Moving to slide 20, worldwide financial services net income attributable to Deere & Company was $126 million in the quarter versus $102 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 now projecting worldwide financial services net income attributable to Deere & Company of about $460 million in 2011. Now, on slide 21, let's take a look at receivables and inventory. For the company as a whole, receivables and inventories were up roughly $1.8 billion compared to a year ago and are expected to be about $775 million higher for the full year. The increases are primarily attributable to growth in emerging markets, including higher parts inventories to support rising equipment populations, as well as higher inventory to facilitate the transition to interim Tier 4, stronger European, CIS, and construction equipment markets, and currency movements. Now, let's discuss the latest on retail sales. Slide 22 presents the product category detail in the U.S. and Canada for the month of July, expressed in units. Utility tractor industry sales were down 8%. Deere was down less than the industry.
Row crop tractor industry sales were up 11%. Deere was up more than the industry. Four-wheel drive tractor industry sales were up 5%. Deere was down a single digit. Combine industry sales were down 25%. Deere was down more than the industry. Regarding combines, our shipping patterns this year are front-end loaded in preparation for the transition to interim Tier 4. This is a different pattern than we normally see. Looking at Deere dealer inventories for both row crop tractors and combines, Deere ended July with inventories at 18% of trailing 12-month sales. Turning to slide 23, in the EU27, sales of John Deere tractors and combines were up double digits in July. Deere's retail sales of selective turf and utility equipment in the U.S. and Canada were up double digits in the month. Construction and forestry sales in the U.S.
and Canada, on both a first-in-the-dirt and settlement basis, were up double digits for the month. Let's turn now to raw material and logistics on slide 24. Third quarter material costs were up about $195 million in comparison with the third quarter of 2010. Our full year forecast assumes an increase of about $700 million versus last year. About $600 million of the difference is for ag and turf and about $100 million for C&S. This is an increase from our previous guidance, reflecting higher steel, tire, and logistics costs. Although steel prices have trended down recently, Deere's steel costs lag market movements by about three to six months. With about three points of price realization forecast for the year, we will roughly cover the raw material cost increases. Looking at R&D expense on slide 25, R&D was up about 22% in the 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 meet 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 26, S&G expense for the equipment operations was up about 14% in the third quarter. Growth accounted for about five points of the increase, and currency translation was about four points. Incentive compensation, in line with our improved financial performance, accounted for about three points. Of the approximately 13% increase in S&G expense forecast for the year, incentive compensation will account for about three points, with currency translation and growth accounting for about two points each.
Moving to the income tax rate, on slide 27, the third quarter effective tax rate for the equipment operations was about 34%. In 2011, our effective tax rate is forecast to be in the range of 33% to 35%. On slide 28, you see our equipment operations' history of strong cash flow. We anticipate cash flow from equipment operations of about $2.7 billion in fiscal 2011. As slide 29 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 developments, 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 $125 million.
Finally, turning to slide three, you see a summary of the amounts returned to investors through share repurchase over the last seven years. During the third quarter, we repurchased 5.9 million shares for about $500 million. That brings the total number of shares repurchased since 2004 to about 133 million shares at a cost of about $7 billion, or almost $53 a share on average. In closing, John Deere is on the home stretch of what CEO Samuel Allen calls a year of exceptional achievement. Our strong performance is providing healthy momentum for the company's growth plans, which center on expanding our competitive position throughout the world. We firmly believe this record of aggressive investment puts the company on a sound footing to address the world's increasing need for food, shelter, and infrastructure.
We remain confident these positive trends have staying power apart from the global economic concerns at the moment and will prove rewarding to our investors and other stakeholders over the long haul. Tony.
Speaker 6
Thank you, Susan. Now we are 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 4
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. Our first question comes from Jerry Revich, and please state your company name.
Speaker 3
Good morning. It's Goldman Sachs.
Speaker 6
Hi, Jerry.
Speaker 3
Hi. Tony, can you talk about where you see industry sales in CIS and Russia this year relative to the 2008 highs? It sounds like we're seeing a very sharp recovery off a low base. I'm wondering if you could just put that in perspective for us versus 2008.
Speaker 6
Right. Certainly, we've talked about the fact that Russia is up strongly, but 2008 were very strong levels, and I would certainly say we're not back at those levels.
Speaker 3
Where are we relative to those levels roughly? Can you comment on that?
Speaker 1
It's me, Jerry. We will actually have an analysis for you as we complete the fourth quarter, but we don't have that exact detail available at this moment.
Speaker 3
Okay. On the working capital increase, can you talk about which emerging markets are you most constructive on heading into next year? Is it primarily Russia and CIS, or are you turning more constructive on Brazil as well?
Speaker 6
Keep in mind, the increase in receivables and inventory, you know, for starters, really it's in line with what the increased markets that we're seeing this year. While they're up year over year on a % of rolling 12, really are actually below last year's levels. It's really more of a reflection of current markets.
Speaker 1
If I could just add on to that, as you are well aware, we've had a significant launch number of new products in Europe. Last year, we launched a bunch of new products in Brazil. We've got a large number of products available coming out in the U.S. We really see good global opportunities for ag really, well, globally throughout the world.
Speaker 3
Thank you.
Speaker 6
Thank you.
Speaker 4
Thank you. Our next question comes from David Michael Raso, and please state your company name.
Speaker 0
ISI. My question is on margins, but I guess I first need a clarification. Did you say ag and turf margins 14% for the full year and construction 8%?
Speaker 6
Yeah, that's what the guidance would imply, yes.
Speaker 0
Because it seems like your net income guidance for the fourth quarter is roughly, excuse me, a 20% decline sequentially, but the segment profits are implied only down 5%.
Speaker 1
We don't do any of our comparisons, David, just as a reminder, sequentially because you've got an awful lot of noise and variability quarter to quarter. If you look year over year, obviously, we are looking for an improvement over our fourth quarter result. I mean, you can do the math. It's about $100 million in round numbers, $100 million.
Speaker 0
I appreciate that, but unless there's an odd translation from your segment profits to your P&L, and there's always a bit of a difference, why would your net income guidance sequentially be down 20% when your operating profit guidance is only down 5%? I mean, there's a little lower credit income assumed, fourth versus third. My question is around margins, but that's a clarification I think I would first need because, again, why such a diversion between your business segment?
Speaker 1
I'm going to go offline and you'll have to talk about your numbers. I'm not following.
Speaker 0
Let me proceed with the bigger question on the margins. The incrementals, obviously, this quarter were pretty low, especially in ag and turf. You highlighted some of the costs that were driving that. How should we be thinking about which of those costs are things that evolve away because the new product ramp goes away, maybe better raw material issue, and how much is it a mix issue related to the geographic divergence we're seeing from slower growth in North America ag versus the other regions? How should we be thinking about that kind of in summation for thinking about incremental margins for that division?
Speaker 6
You're talking about in this specific quarter or for the year?
Speaker 0
The 3% incrementals for the third quarter, and which of those costs are the costs you feel? How should we think about incrementals for that division if you just put up a 3, essentially?
Speaker 6
Right. Certainly, we've talked all year about the headwinds and the tougher compares, and we moved into and further into the year, and really, that's what you're seeing with that 3% incremental margin. As you look at comparable to last year, and keep in mind, we're at 13% absolute margin, but we're comparing to a 16% margin a year ago. That's part of the challenge, to compare year over year, as well as the headwinds we've cited, in particular, raw material and interim Tier 4 costs would be heavier and more back-end loaded in the year. We've talked about that again throughout the year, and that's really what you're seeing reflected in the numbers.
Speaker 0
Sure. That's how we got to today's 3%. Looking forward, you had raw materials as roughly two-thirds of the total cost you cited. If you add those two pieces back to raw and then the SG&A and the FX and incentive comp, the incrementals we read is 24%. Still, some of those costs don't go away.
Speaker 6
Exactly.
Speaker 0
Yeah. How should we be thinking about, for example, the SG&A growth-related expenses? How much were those? The raw material with the Tier 4 pricing upcoming versus the cost to create the Tier 4 product, how are we thinking about price versus cost moving forward? I'm just trying to frame it because obviously, the 3%, are you trying to insinuate that's how we should think about incrementals going forward? I would assume not.
Speaker 1
This is Marie. David, for the year, we're going to have another tough compare as we go into the fourth quarter. As we look out into the future in 2012, you are correct that some of the large ramp-up in R&D expenses will be behind us. We don't see R&D heading down, but we will have completed as we move into model year 2012. We'll have completed a very significant product launch. I do want to go back to the very beginning you asked about geographic mix. The issue is not geography, but this year, we do see a recovery in smaller ag equipment. If we are looking year over year, and this is true for the full year as well as in the quarter, the mix of large ag is proportionately a little less as you've seen recovery in smaller ag segments.
Mix in terms of operating margin is about one point.
Speaker 0
Okay.
Speaker 6
Marie, let me, David, this is Jim Field. Let me first come back to your first question and then add just a little more color also to your second question. Clearly, we'll take your first question offline, and I'll let the IRS staff provide you with more details. As you know, sequentials are very hard to do in this business because of the fluctuating production levels. The fourth quarter historically is a seasonally weaker quarter from a production standpoint and a quarter where we have many of our factories taking shutdowns for various purposes. Therefore, we don't tend to look so much at sequential views of the business, and it is very, very, and can be extremely misleading depending on how we line up production one year versus another year.
Clearly, we have a pattern of drawing down inventories and receivables in the fourth quarter, which generally would be, on a sequential basis, a negative drag on net income. Having said that, we'll have the crew get with you and understand your analysis, and we'll be more than happy to share ours with you. Relative to the incremental margin question, I think we've said for some period of time that it's our intention over a longer period to recover material cost stops when we have them, as well as to recover the cost stops related to the IT for implementation. In any given period, there's going to be distortions because it's not going to be totally aligned. As we shared with you last year, we were in a favorable price situation, and we actually had material costs declining.
It's hard when you look at any particular quarter, but when you want to think about incremental margins for this business over a longer period of time, I think you can think about the incremental margins that this company has historically enjoyed and have every expectation that we'll enjoy those sorts of incremental margins going forward. In fact, if you were to look at our incremental margin picture over a longer period, which would normalize some of these distortions, you'd see incremental margins, for instance, from the 2009 to the 2011 period that would be more in the 20s, mid-20s, 22% to 25%, depending on the period that you looked at for the business that we're talking about, which would be much more in line with your expectations.
The long-winded way of saying there's lots of noise and lots of moving parts here in any particular quarter, but you and I know you're not suggesting this, but actually just asking for further clarification, it would be a wrong assumption to think that these were the sorts of incremental margins that we would enjoy over a longer period of time. With that, thanks for the questions, and we look forward to getting with you on your analysis. Okay. Thanks, David.
Speaker 0
Thank you.
Speaker 6
Next question.
Speaker 4
Thank you. Our next question comes from Eli Lustgarten, and please state your company name.
Speaker 6
Capital Markets. Good morning, everyone.
Speaker 0
Hi, Eli.
Speaker 6
Hi.
Speaker 0
Margins are the things that probably will drive us most to try to figure out. You know this quarter in ag came in roughly 13.5%. It looks like you're 100 basis points below expectations across the board. With keeping margins at 14%, you're implying it looks like with tonnage also down that you're implying that the fourth quarter is somewhat better than maybe we had it we would have expected a quarter, you know, at the end of the second quarter. Can you give us one, what costs were worse in this third quarter than you expected? Can you talk a little bit about it? Is the fourth quarter somewhat better than you expected, and are the costs a little bit different, a little bit better? Can you give us some color on what's going on in costs and volume both between the third and fourth?
Speaker 1
Maybe I should just start, Eli. As you know, we do not do quarterly guidance, so I can't speak to your expectations. I can speak to our expectations where, as we discussed over the course of the year, starting in the fourth quarter, that as we moved into 2011, we would have more difficult comparisons and that we anticipated by virtue of our full-year guidance that those incremental margins would decline. Again, Tony talked about some of the reasons: raw material headwinds, the very significant launch of interim Tier 4, which is affecting R&D. It affects our factory productivity. We had talked earlier in the year about over the course of the year, $100 million in costs just related to the very significant number of new product launches. We have product launch expenses every year, but just because of the sheer volume of expenses, it's a more significant cost.
As we move through the quarter, or excuse me, through the year, Jim talked about absorption and some of the effects there.
Speaker 0
I guess what I'm trying to get at is can you talk a bit about the costs in the third quarter that were maybe somewhat higher than you expected? As you gave guidance for the fourth quarter, are some of the volume and costs somewhat better than you would have thought about a quarter ago?
Speaker 1
The only item that has changed from our previous guidance in a material way is raw material, which is about $100 million in round numbers increase from our implied previous guidance. That affected certainly the third quarter, and it will affect the fourth quarter. That's the only thing that has significantly changed.
Speaker 0
For example, your guidance for the Japanese impact is much lower now.
Speaker 1
That is.
Speaker 0
Than before, and you know that basically by itself would be worth $18.
Speaker 6
If you recall, Eli, our guidance before was for the balance of the year, and now we're heading into the fourth quarter. We didn't split that guidance, but you know that you'd be wrong to assume that it's the delta between, for instance, the top line in the full 300 and the 70.
Speaker 0
Okay. I'll talk offline. Let me just ask a quick follow-up. If you talk any more with the new introduction of interim Tier 4 equipment or more models, have you talked any more about what the pricing of those products are? You know we expect to have a new rollout coming out in this country. Can you talk a little bit about the pricing of the new interim Tier 4 products coming out?
Speaker 6
The IT, the new products have not been announced at this point. Of course, we're in the midst of a new product introduction here in the U.S. and Canada, so that should be coming soon. At this point, we don't have that information.
Speaker 0
All right. Thank you.
Speaker 6
Thank you.
Speaker 4
Thank you. Our next question comes from Jamie Lyn Cook, and please state your company name.
Speaker 5
Hi. Good morning. Credit Suisse.
Speaker 6
Hey, Jamie.
Speaker 5
Just a couple of questions. One, and I apologize if I missed this, can you quantify what the Tier 4 costs were in this third quarter and whether the $170 million for the full year still holds? I'm just trying to get a feel for the impact of, you know, their Q3 versus Q4. Also, can you provide an update on the SAP transition in C&S, how many weeks you were shut down this quarter, and how we think about it in Q4?
Speaker 6
Right. For interim Tier 4 costs, our guidance is now at $165 million.
Speaker 5
Okay.
Speaker 6
I'm sorry. It's $160. I'm sorry.
Speaker 5
It's more or less in line with prior guidance. How much was in the third quarter? About $45?
Speaker 6
About 45, yep.
Speaker 5
Million. We've got about $75 million in the fourth quarter. Okay. The next question.
Speaker 6
On SAP, that implementation actually went very well, pretty much as planned. We talked about previously, it was about a week in the second quarter that production was shut down, and then a full week, effectively two weeks in the third quarter, there was a full week of shutdown. As things ramped up, that equated to about another week of product shutdown. It went very well as planned.
Speaker 5
Sorry, one follow-up question. When I think everyone's trying to ask the question about incrementals longer term, as I think about the puts and takes for next year, R&D won't, you know, maybe on a dollar basis is the same, but it's not going to be up as a % base. We're not going to have the Tier 4, which is about $160 million. Are there any other things directionally we should be thinking about, big-ticket items in 2012, whether it's pension, you know, anything else that we can think about without you guys specifically guiding, I guess, to incremental?
Speaker 6
First of all, I would speak to the interim Tier 4 costs. I don't think it would be correct to assume that that's going to be level year over year because we have a significant number of models that will be introduced for the 2012 years. Plus, you have the sequential increase as you move into 2012, as we've introduced throughout the year. You'll have a full year of cost on this year's models versus partial year in 2011. Again, year over year, I think you should expect to see interim Tier 4 product costs increasing through 2012 and quite honestly into 2013 as we have the sequential partial year in 2012 on some of these new products that will have a full year of production in 2013.
Speaker 1
We are mindful of those costs as we think about our price and on the products. I would just note that the costs of compliance of interim Tier 4 are not that dissimilar between a big piece of equipment and a little piece of equipment relative to the cost of the equipment. In not all cases will we achieve pricing parity, if you will, in year one, but we certainly are very committed to achieving pricing parity, if you will, over time.
Speaker 5
That's a headwind in next year, but you haven't addressed the other items. Like, is pension a headwind next year? You said R&D is going to be level. I'm just trying to think about the puts and takes.
Speaker 1
If you looked at price pension today and looked at where the interest rate environments are, you may have maybe another $50 million in pensions.
Speaker 0
If it's 50 bps, it would be about $75 million to $80 million.
Speaker 1
Between pension and OPEB.
Speaker 0
Between pension and OPEB, as you know, Jamie, you set those rates based on the last day of the year and where the yields are at that point in time. If we had to look at it today, we'd be looking at 35 to 50 basis points decline, which would be somewhere between $50 million and $75 million.
Speaker 1
Great. I'll get back to you. Thank you.
Speaker 5
Thank you, Jamie.
Speaker 1
Thank you.
Speaker 4
Thank you. Our next question comes from Stephen Volkman, and please state your company name.
Speaker 0
Hi. Good morning. It's Jefferies.
Speaker 6
Morning.
Speaker 0
All right. Just a couple of clarifications, if we could. I think when you were talking about your U.S. farm cash receipt forecast for 2012, if I heard you right, you marked that the market sort of versus the recent USDA numbers and said that would add $12 billion to the forecast. Am I hearing that right?
Speaker 6
If you took the USDA estimates that came out last week and specifically their yield estimates and their price estimates, we ran that back through our model, and that would increase about $12 billion for 2012 cash receipts. Billion, I'm sorry.
Speaker 0
Right. Okay. Good. Thanks. The comment you just made on the, sorry?
Speaker 6
I was just saying that's only updating our model for those two items, the yield and price.
Speaker 0
Understood. Thank you. Second quick thing, Jim, you just made a couple of comments on pension, but I think you were speaking just to the discount rate and not to the return on plan assets. Am I correct on that?
Speaker 6
That's correct. That was just on the discount rate side of it. The return on the plan assets, you know, you get into some smoothing techniques and what your any individual return is, and then the corridor. Historically, most of our volatility has been driven more so by the exchange rate rather than the return assumption. Return assumption proved over longer periods to be very, very defendable.
Speaker 0
Great. Thanks. Just quickly, we've talked, I think, on a couple of calls about the used combine market, and you know it looks like new combine sales are sort of one of the weaker spots, and maybe that's an availability issue. I don't know. Is there anything in the used combine market in North America we should know about?
Speaker 6
It's important to know that in the quarter, used combine inventories did go down in the quarter as expected. You know, and again, keep in mind, as Susan Karlich talked about at the beginning in her opening comment, our shipping patterns in combines are different this year. It was much more heavily loaded towards the first half of the year versus the second half. That's some of what you're seeing in the retail numbers as well.
Speaker 0
You're not worried about the used combine market, I guess.
Speaker 1
We're continuing to monitor it, but used equipment prices are holding or are up slightly. Turnover continues to be extremely good. We're monitoring it.
Speaker 0
Thank you very much.
Speaker 6
Thank you.
Speaker 4
Thank you. Our next question comes from Ann Dykman, and please state your company name.
Speaker 5
Hi. Good morning. JPMorgan Chase & Co.
Speaker 6
Hi, Ann.
Speaker 5
Hi. Can you talk a little bit about this whole Nebraska test and why you emphasize horsepower and fuel efficiency per horsepower as opposed to just miles per gallon? Can you give us a little bit more detail there and talk us through apples for apples? What's the net result? You were offering equipment that was more fuel efficient than your competitors. Competitors thought that their SCR engines would be more fuel efficient than yours. Just a little bit more color on that slide. It seems like you were trying to get a message across to us there.
Speaker 6
I think it's just a continued message on the successful launch of that 8R tractor. As we talked throughout the year, we felt very comfortable and were excited about the fuel efficiency on that tractor and that we would wait until that official Nebraska test was completed. It validated our assumptions. We've had, as you pointed out, the most fuel-efficient tractors in the market in the past. This tractor is actually more fuel-efficient than its previous model and also delivering more power. Keep in mind, that's just at the test level. The other thing this tractor brings is improved telematics that enables the farmer-customer to be able to evaluate how that tractor is operating in the field and further optimize performance and profitability. That's hard to test and doesn't come through in the testing, but again, adds additional efficiency to that farmer's operation.
Speaker 5
Does this mean that this tractor is even more fuel-efficient than new competitors' products, or have theirs not been tested yet and that net you'll still have the same gap?
Speaker 6
My understanding is the competitor equipment has not gone through the official Nebraska test.
Speaker 5
Okay. Secondly, on the whole GPS issue, can you talk a little bit? We've gotten a number of questions this past quarter around the GPS interference and the whole mess that could take place out there in terms of interference with particularly agricultural equipment and also construction equipment. Can you just update us on what's going on there, a little bit of background, and what Deere & Company's position is right now?
Speaker 6
Sure. We are continuing and have been closely monitoring the developments. It is really around the Lightsquared network and actively working on making sure that by ourselves and with others, many others who are concerned about the potential interference of GPS, specifically what that could mean to our customers, who obviously we just talked about the telematics and so on in this new 8R tractor. Many of our customers use high-precision GPS systems, both in ag as well as construction and forestry. We are clearly staying on top of that and making sure that our concerns are expressed.
Speaker 5
What is the timeline? When should we expect some kind of finalization or ruling?
Speaker 6
Yeah. August 15 was the deadline for filing responses to the FCC. They have not clearly stated when they will announce any decisions.
Speaker 5
Okay. Just finally, real quick, you gave us an update on early order programs on some smaller equipment, like tillage equipment. Have you started the early order program for tractors or combines? If yes, how are those going?
Speaker 6
The combine early order program started August 1. It's very early. Last year it would have been the 1st of July, so it's not easy to compare. The delay was really related to the new product that's being introduced. It's very early in terms of feedback. At this point, we're very pleased with the response to that early order program. Unfortunately, I don't have much else to say on that. We'll obviously have a better update at the fourth quarter.
Speaker 1
I might just note, Ann, that we have just started introducing this product to our dealer. It's very, very early. Hence, the reason for the start 1 August instead of 1 July. Regarding tractors, we don't actually do early order programs on tractors. We just traditionally have an ordering book, and on the 8000s, I believe availability is December.
Speaker 6
December.
Speaker 1
We have a different pattern this year. Last year was pretty significantly impacted because of the model year transition. We actually had a little longer wait last year, but that had to do with the model transition. The order book continues, frankly, looks very good there.
Speaker 5
Okay. I guess we'll see you at Farm Progress and see how it's progressing at that point.
Speaker 6
All right. Thank you. Next caller.
Speaker 4
Thank you. Our next question comes from Andy Casey, and please state your company name.
Speaker 0
Wells Fargo Securities. Good morning, everyone.
Speaker 6
Hi, Andy.
Speaker 0
Jim, I just wanted to make absolutely sure I understand your comments about the longer-term Ag and Turf incremental margin performance. Is that basically suggesting we should expect Ag and Turf margins are not really peaking out at 14%?
Speaker 6
I wasn't necessarily addressing where or where they might peak as much as addressing the notion that we, when you look at any individual quarter, that we're going to have a lot of noise. When you look at the incrementals, while we go through this transition, as we said, we fully intend to recover the cost of the implementation of the interim Tier 4, but any particular quarter, we're going to have noise in that. That will be recovered over a longer period. We have an aspiration at mid-cycle when our businesses are at mid-cycle, and that includes all aspects of the business, to achieve a 12% return and one at the top of the cycle, a 14.5% margin. We said this year, for instance, we're benefiting by about a point vis-à-vis normal mix because large ag is a larger piece than normal relative to small ag.
Hopefully, that provides some clarification on your question, but if not, come back.
Speaker 0
Sure. I'll follow up later. On the separate question on construction and forestry, you talked about the uncertainty of the overall economy and what's going on with construction activity forecasts. This year, the U.S. industry has pretty much benefited from replacement demand. I'm wondering, in your conversations with the rental companies, do you still expect CapEx trends to increase over time, meaning calendar 2012, or are you generally expecting kind of flattening because of the uncertainty? I'm just wondering about the duration of the fleet refresh that's going on.
Speaker 1
In their conference calls, they've indicated that they intend to take their average fleet ages down. Maybe that's the best indicator there.
Speaker 0
Sure, no change in the short term?
Speaker 1
Correct.
Speaker 0
Okay, thank you very much.
Speaker 6
Thank you.
Speaker 4
Thank you. Our next question comes from Andrew Oban, and please state your company name.
Speaker 0
BOB, Merrill Lynch. Can you hear me?
Speaker 6
We can.
Speaker 0
Yes. When we look at your inventory increase in the Ag and Turf division, any way just to break it down by key markets, product lines, as to what are we getting ready for? Meaning, is it, I understand you gave a very broad description of why you're doing it, but you know, how much of it, if you could just simply break it down, how much of it is for North America and how much of it is Europe and maybe if any of it is combines?
Speaker 6
Yeah. We don't have a specific geographic breakdown, but as you look at the end of July, as we evaluate the receivables and inventory, we would say it's roughly a quarter of that increase would be related to parts inventory. Another 20% would be related to BRIC countries and the growth in those countries. Exchange was actually another 15%, and then another additional 15% related to interim Tier 4. That includes engine bunkering as we move forward.
Speaker 0
If I could ask a follow-up question on combines, given that you sort of modified your production in the quarter, how far along do you feel you are in the process of sort of fixing this excess inventory of combines that we had on the channel at the end of the spring? Thank you.
Speaker 6
We talked about the level of combines. They're certainly on an absolute level at high levels. It's come down again in the quarter, as we've expected. We're continuing to work on that. We have programs in place. We've talked about the pool funds and the availability there to help with that. At this point, we've seen positive pricing year over year on used combines as well as turns continuing to hang in there.
Speaker 1
Remember, Andrew, that our new combine sales are very much front-end loaded this year because of the transitions between interim Tier 4 and Tier 3 production and the timing of the emissions regulation. Front-end loaded, when you sell a new combine, in virtually almost all cases, you get a used combine in. That accelerated the combine inventories as we moved into the fall. We expected to see those things start to move. As Tony indicated, we are starting, still early, but we're starting to see the first indications that those things are moving.
Speaker 0
ID4 product will be available when for combine?
Speaker 1
Model year 2012.
Speaker 0
Which is what month? Sorry.
Speaker 1
I don't know exactly when they ship. It'll be sometime early in the fiscal year.
Speaker 0
Thank you very much.
Speaker 6
Thank you. I figured we have time for one more call.
Speaker 4
Thank you. Our final question comes from Henry Kern, and please state your company name.
Speaker 3
Hey, good morning, everyone. It's UBS Investment Bank.
Speaker 6
Hey, Henry.
Speaker 3
Just following up on Andy's earlier question on the economic uncertainty. Have you seen any actual impact on any of your businesses so far, either a pullback or cancellations in either ag and turf or construction?
Speaker 6
At this point, we have not. We have not.
Speaker 3
If the global economic concerns prove to be founded, what cost levers could you pull and how quickly could you change investment plans?
Speaker 1
That's very speculative. It would depend on what actions, what reactions you were seeing in the marketplace where. We actually had a good test case in 2009, and we saw the company pull in on our capital expenditures, manage our inventories down accordingly as the business was transitioning. It would be really a potentially a replay of what you saw in 2009. It's very, very speculative at this point.
Speaker 3
Sure, that makes sense. Thanks a lot.
Speaker 1
I just want to conclude by pointing out that the global ag fundamentals are still extremely strong. I can't emphasize enough that Thursday's USDA report was very positive for global agriculture. I think I'd like to end on that note.
Speaker 6
Okay. Thanks, Marie. That concludes our call. As always, we will be available throughout the day to answer any additional questions. Thank you.
Speaker 4
Thank you. This does conclude today's conference call. We thank you for your participation. You may now disconnect your lines.