Good morning, and welcome to the Deere & Company's fourth 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 Huegel, Director of Investor Relations. Thank you, sir. You may begin.
Thanks, Laura. Hello. Also on the call today are Rajesh Kalathur, our Chief Financial Officer, and Susan Karlix, our Manager of Investor Communications. Today, we'll take a closer look at Deere's fourth quarter earnings, then spend some time talking about our markets and our initial outlook for fiscal 2015. 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 and NASDAQ OMX. Any other use, recording, or transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited.
Participants in the call, including the Q&A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call. This call includes forward-looking comments concerning the company's plans and projections for the future that are subject to important risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially is contained in the company's most recent Form 8-K and periodic reports filed with the Securities and Exchange Commission. This call also may include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, or GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures, is included in the release and posted on our website at www.johndeere.com/financialreports under Other Financial Information. Susan?
Thank you, Tony. With today's announcement of our fourth quarter results, John Deere completed another year of solid performance. We did so in spite of weaker conditions in the global farm sector, particularly in the sale of large farm machinery. In response to this situation, we moved aggressively. We restrained costs, we reduced assets, and we realized the benefit of having a broad-based business line-up. As a result, Deere was able to deliver strong results, including our second-best year ever in terms of net income. We also maintained our sound financial condition, generated healthy levels of cash flow, and returned some $3.5 billion to investors in dividends and share repurchases. All in all, it was another good year, one in which the company further demonstrated its commitment to disciplined operations and the resilience of its business model.
Let's take a closer look at the fourth quarter in detail, beginning on slide three. Net sales and revenues were down 5% to $8.965 billion. Net income attributable to Deere & Company was $649 million. EPS was $1.83 in the quarter. On slide four, total worldwide equipment operations net sales were down 7% to $8 billion. In the quarter-over-quarter comparison of net sales, Landscapes and Water accounted for four points of the change. Price realization in the quarter was positive by one point. Currency translation was a negative one point. Turning to a review of our individual businesses, let's start with Agriculture & Turf on slide five. Sales were down 13%, primarily due to lower shipment volumes of large ag equipment in the U.S. and Canada. Operating profit was $682 million. In addition to volume, margins in the quarter were negatively impacted by lower production in our factories.
Output hours in the large ag equipment factories were down, depending on the factory, anywhere from 35%-55%. This illustrates the aggressive manner in which we stepped on the brakes during the quarter to align production with reduced order volumes. Product mix, production costs primarily related to engine emission regulations, warranty costs, and an impairment charge for our China operations were other factors impacting margins in the quarter. Before we review the industry sales outlook, let's look at fundamentals affecting the ag business. Slide six outlines U.S. farm cash receipts, which in spite of lower grain prices, remain at historically high levels, thanks to help from record livestock receipts. As a result, our forecast calls for 2014 cash receipts to be about $413 billion, up about 1% from 2013, which would be the highest level ever recorded.
Given the record grain yields of 2014 and lower commodity prices going forward, our forecast calls for cash receipts to be down about 5% in 2015. Of note, although livestock receipts remain at high levels, crop receipts for 2015 are forecast to be down about 17% lower than 2012's crop receipt record. On slide seven, global grain stocks-to-use ratios remain at somewhat sensitive levels, even after abundant harvests. Global grain and oilseed demand remains strong while supplies appear to be adequate. Unfavorable growing conditions in any key region of the world, as well as unknown impacts from any geopolitical tensions, could lower production, reduce the stocks-to-use ratio, and result in prices quickly moving higher. Our economic outlook for the EU 28 is on slide eight. Economic growth continues in the region, albeit at a slow pace.
With feed costs easing, beef prices strong, and milk prices at good levels, margins remain supportive for livestock and dairy farmers. Grain prices have declined, and dairy margins are expected to tighten, resulting in a decrease in 2015 farm income. Farm machinery demand in the EU region is expected to be lower for the year. On slide nine, you'll see the economic fundamentals outlined for other targeted growth markets. In the CIS, declining economic growth and further tightening of credit availability continue to weigh on equipment sales. Western equipment manufacturers are being heavily impacted by geopolitical uncertainties. In China, economic growth is slower than expected. The Chinese government continues to increase its investment in ag equipment subsidies, but the growth rate has slowed. This, among other things, has led to a decrease in industry sales. Turning to India, positive sentiment surrounding the new government continues.
However, the monsoon season rainfall was below normal, which could result in lower overall agriculture output. Slide 10 illustrates the value of agricultural production, a good proxy for the health of agribusiness in Brazil. The information on this slide has changed from what we have presented in the past. Crops included in the value of Ag production are now more closely aligned to those that have the largest impact on our business, namely soybeans, sugar, corn, ethanol, cotton, rice, and wheat. We are no longer including crops like coffee and fruits. Additionally, we are now showing the value of Ag production in U.S. dollars rather than the local currency. Ag production is expected to decrease about 14% in 2015 in dollar terms due to lower global commodity prices. Keep in mind, however, with the weak real, the value is much more attractive in the local currency.
Even with the recent drop in prices, Ag fundamentals remain positive for grains, and sugar margins are expected to improve in the coming year. Our 2015 Ag and Turf industry outlooks are summarized on slide 11. Although the Ag economy remains in a relatively healthy state, lower commodity prices and farm incomes are putting pressure on demand for farm equipment, especially larger models. At the same time, conditions in the livestock sector are more positive, providing support to sales of mid and smaller-size tractors. As a result, we expect industry sales in the U.S. and Canada to be down 25%-30% for 2015. The EU 28 industry outlook is down about 10% due to lower crop prices and farm incomes, as well as potential pressure on the dairy sector.
In South America, industry sales of tractors and combines are projected to be down about 10% in 2015 as a result of the headwinds affecting agricultural producers. This follows a 13% decline in 2014, compared with the extremely strong levels of 2013. Shifting to the CIS, we expect industry sales to further deteriorate, with Western Ag equipment manufacturers feeling the most impact due to geopolitical issues and resulting restrictions on credit availability. In Asia, sales are projected to be down slightly. Turning to another product category, industry retail sales of turf and utility equipment in the U.S. and Canada are projected to be flat to up 5% in 2015. Putting this all together on slide 12, fiscal year 2015 Deere sales of worldwide Ag and Turf equipment are now forecast to be down about 20%.
The Ag and Turf division operating margin is forecast to be about 8% in 2015 due to lower shipment volumes and a less favorable product mix as large Ag machinery shipments decline. Before moving to Construction & Forestry, I want to stress, Ag and Turf sales were down 9% in 2014 and are anticipated to be down another 20% in 2015. In relation to our structure line, that would bring sales down to what we consider trough levels, with the division operating at less than 80% of normal volumes. Now let's focus on Construction & Forestry on Slide 13. Net sales were up 23% in the quarter. Operating profit was up 93%, the result of higher shipment volumes and lower SG&A expenses as the division continues to cut costs. The division's incremental margin was about 31%. Moving to Slide 14.
Looking at the economic indicators on the bottom part of the slide, the economy continues to move forward. GDP growth is improving, unemployment is falling, and construction hiring is on the increase. Housing starts are slowly ramping up, home inventories are low, and lot shortages exist. Based on these factors, Deere's Construction & Forestry sales are forecast to be up about 5% in 2015. Global forestry markets are expected to be about flat on the heels of a 10% increase in 2014. C&F's full-year operating margin is projected to be about 11%. Let's move now to our Financial Services operations. Slide 15 shows Financial Services provision for credit losses as a percent of the average owned portfolio at the end of the year, with nine basis points. This reflects the continued excellent quality of our portfolios. Our financial forecast for 2015 contemplates a loss provision of about 24 basis points.
The increased provision is a reflection of the unsustainably low loss levels of the last four years. Even with the increase being forecast, losses would remain below the 10-year average of 26 basis points and well below the 15-year average of 43 basis points. Moving to Slide 16, worldwide Financial Services net income attributable to Deere & Company was $172 million in the fourth quarter versus $157 million last year. 2014 net income attributable to Deere & Company was $624 million. The 2015 forecast is about $610 million. Slide 17 outlines receivables and inventory. For the company as a whole, year down $1.2 billion. That was equal to 22.7% of prior 12-month sales, compared to 24.8% a year ago. The decrease, which came entirely from Ag and Turf, is reflective of the aggressive way we have cut production in line with our 2015 outlook.
We expect to end 2015 with total receivables and inventory up about $400 million, with the increase coming from the C&F division. Our 2015 guidance for cost of sales as a percent of net sales, shown on Slide 18, is about 78%. When modeling 2015, keep these factors in mind. Price of about two points, as well as an unfavorable mix of product, as we discussed earlier, and Tier 4 product costs. Now let's look at a few housekeeping items. Looking at R&D expense on Slide 19, R&D was up about 2% in the fourth quarter and down about 2% for the year. Our 2015 forecast calls for R&D to be about flat with 2014 levels. Moving now to Slide 20. SA&G expense for the equipment operations was down about 14% in the fourth quarter and down 12% for the full year.
Landscapes and Water accounted for about nine points of the change in the fourth quarter and about eight points for the year. On Slide 21, our 2015 forecast contemplates SA&G expense being down about 5%. Landscapes and Water will account for about two points of the change in the year-over-year comparison. Turning to Slide 22, pension and OPEB expense was down about $20 million for the quarter and down about $145 million for the full year. Pension and OPEB expense is forecast to be up about $85 million in 2015. On Slide 23, the Equipment Operations tax rate was approximately 40% in the fourth quarter, primarily due to the impairment charge for our China operations mentioned earlier. The full year 2014 tax rate was about 34%. For 2015, the projected effective tax rate is forecast to be in the range of 34%-36%.
Slide 24 shows our equipment operations history of strong cash flow. Cash flow from the equipment operations was approximately $4.5 billion in 2014, and is forecast to be about $2.9 billion in 2015. Slide 25 outlines our use of cash priorities, which are unchanged and of no doubt familiar to many of you. Our number 1 priority is to manage the balance sheet, including liquidity, to support a rating that provides access to low cost and readily available short and long-term funding. Thus, Deere is strongly committed to its single A rating. Our second use of cash priority is funding value creating investments in our operations. A third priority is to provide for the common stock dividend, which has been raised 114% since 2010. Over time, we want to consistently deliver a series of moderately increased dividends while targeting, at mid-cycle earnings, a 25%-35% payout ratio on average.
In this regard, we are mindful of the importance of maintaining the dividend and not raising it beyond a point that can be sustained by our cash flow. Share repurchase is our preferred method of deploying excess cash once the previous requirements are met and as long as such repurchase is value enhancing. In 2014, Deere repurchased 31.5 million shares at a cost of $2.7 billion, the highest on record. Cumulatively, from 2004 to 2014, we have returned about 60% of cash from the equipment operations to shareholders through dividends and share repurchases. The 2015 outlook for the first quarter and full year is on slide 26. Net sales for the quarter are forecast to be down about 21% compared with 2014. This includes price realization of two points. In the year-over-year comparison of first quarter sales, Landscapes and Water account for about two points of the change.
When modeling the first quarter, keep in mind the Ag division will see a considerable decrease in volume, in addition to an unfavorable product and geographical mix versus the first quarter of 2014. The full year forecast calls for net sales to be down about 15%. Price realization is expected to be positive by about two points. Finally, our full year 2015 net income forecast is about $1.9 billion. In closing, there is no question John Deere faces challenging conditions in 2015. Yet, even with a further pullback in the global agricultural sector, the company expects to remain solidly profitable in the year ahead. Our earnings forecast reflects the aggressive actions we are taking to control costs and assets and make deep cuts in factory production. It shows the benefits of having a business lineup that is about more than large farm equipment.
One other thing, the trends that hold so much promise for John Deere's future, trends based on population growth, rising living standards, and increased demand for grain, remain very much intact. They are largely unaffected by the periodic ups and downs of the farm economy. As a result, we believe John Deere can earn solid returns even in a weak farm economy, deliver financial performance much improved over downturns of the past, and see substantial benefits from the world's growing need for food, shelter, and infrastructure in the years ahead. Tony?
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, in 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. Laura?
Thank you. At this time, if you would like to ask a question, you may press star one on your touch tone phone. To remove yourself from the queue, you may press star two. Once again, if you have a question, please press star one. Our first question comes from Andrew Kaplowitz. Please state your company name.
Hey, guys, it's Barclays. Nice quarter.
Thanks, Andy.
Tony, Susan talked about your FY 2015 guidance being at your definition of trough levels, but can you talk about your conviction level that the market won't go below trough given the relatively strong upturn we've had over the last several years? Is it because you see Europe and Brazil at very low levels, or do you think North American high horsepower will trough in FY 2015?
If you look, and Susan mentioned, certainly as you think about the way we view the business and the below 80%, as you're aware, that would put us below trough levels, as we tend to view the business between running generally between 80 and 120. As you think about the obvious question, how long will it last? Will things get worse? First of all, let's be fair, it is a bit premature to think about what will happen beyond 2015. In some of the analysis that's been done internally, specifically around from our chief economist, again, we continue to believe that farm cash receipts is the best indicator of sales in the U.S. and Canada. Specifically for large ag, it would be tied much more closely to crop cash receipts, which we've seen come down quite a bit recently.
Our chief economist did point out that much of that increase in the U.S. corn stocks that we've seen is related to above normal weather, and that's resulted in yields really well in excess of trend. As you look out into 2015 and 2016, so for the crop that will be planted this spring. If you assume trend yields, so just normal weather, not above normal weather, but normal weather, trend yields. Assume demand continues at the same pace as 2014, so no increase in demand, but holding demand solid. Even if you assume acreage stays the same, you would see a drawdown in U.S. corn carryovers as a result of that. The demand would outpace the production. Of course, as you're probably aware, most analysts now expect U.S. corn farmers to reduce acreage somewhat next year.
If you assume smaller acreage, trend yield, that would be very supportive of both corn prices and would likely boost cash receipts.
Okay, Tony, that's helpful.
Hey, Andy, this is Raj. Let me add to this. You've been talking about the end market demand for commodities. That has been growing strongly since 1996. If you look at corn prices are very sensitive at low stocks to use ratio levels. We are talking about, even in the 2014, 2015 period, about sub 15% stock to use ratio levels. As Tony said, at trend yields, it is hard to see how our current large ag forecast for fiscal 2015 can last several years, let alone get worse. Again, our chief economist would say, unless we can predict very good weather years continuously for multiple years.
Okay, Raj, that's helpful. The next question is probably for you, actually. I know what you're going to say, but I got to ask it anyway. Can you talk about your share buyback activity? You obviously stepped it up in the quarter quite a bit, but how should we think about it in 2015, given the lower free cash flow you're going to have? It still seems like you have relatively good flexibility on your balance sheet, to keep your A rating, given the strong free cash flow in 4Q. Can you talk about your ability to do more in 2015?
Now, first our 2015 operating cash flows are still pretty strong. Okay? We are forecasting still pretty strong. As you know, Andy, our use of cash priorities, they're well articulated. We remain committed to these priorities. Of course, for share repurchases, it is a use of excess cash. Further, we desire for repurchases to be value enhancing for our long-term shareholders. We are mindful of the current share price relative to our intrinsic value. Now, share repurchase decision will continue to be made with these factors in mind. If you look at 2004 through 2014, 60% of Equipment Operations' operating cash flow was returned to shareholders, either via dividends or share repurchases. Over an extended period of time, we expect to continue returning this level of cash to shareholders.
Thanks, Raj.
Okay. Thanks, Andy. We'll move on to the next caller.
Thank you. The next question comes from Stephen Volkmann, please state your company name.
Hi, good morning, everybody. Happy Thanksgiving. It's Jefferies.
Hey, Steve.
I'm wondering if we can just get a little more near term and granular here. Can you just talk about what you're seeing with respect to whatever order boards you might have used as you thought about your forecast for 2015? I guess I'm trying to think about how much visibility you actually have into this, and maybe you can sort of loop in the used equipment question at the same time.
Okay. We'll assume that's your related follow-up. In all seriousness, as you look at the early order programs that we base the forecast on, and again, these would relate to large ag equipment except for large tractors. Things like combines, sprayers, planters, tillage equipment. We've certainly seen a reduction, but keep in mind also that we have seen a number of changes year-over-year in these programs. If you think about combines, last year we had an early order window ahead of the typical early order program related to Tier 4 transitions. Sprayers also were impacted by transitions. Planters, we had a fast start program, again, kind of an extra early order window. There are a lot of differences year-over-year. Given that, as we look at early November, most programs are down 40% or more on the early order program.
That, again, is not making any adjustments for those year-over-year differences where we saw some more aggressive orders early on with these products. Those are the type of numbers that we're seeing. Certainly tractors, as you look at availability on large tractors, that's a bit more challenging because there we have a significant difference year-over-year in our daily build rates. Availability isn't necessarily that significantly different. The biggest difference would really be in place to help facilitate that as well. Probably most importantly, as you look at pricing year-over-year, now through the year, we saw some reduction. We're starting to lap some of that production a bit. I'm sorry, saw prices come down a bit in the year. We're starting to lap some of those lower prices.
Most of the large ag equipment, you're plus or minus a single digit in terms of year-over-year pricing. It has moderated at this point, at least for Deere. We would tell you that at least the intelligence we show would indicate that our pricing and our inventory levels are in much better shape than the competition.
Okay, good. It's a holiday, I'll pass it on.
All right. Thanks, Steve.
Thank you. The next question comes from Steven Fisher, please state your company name.
Great, thanks. It's UBS.
Good evening.
Just curious how you guys approach the guidance this year. I think a lot of investors are interested in your perspective as to whether it should be considered conservative, because I think you've been conservative historically, but at the same time, there's still some surprises this past year on ag. Just curious for any additional color you might be able to provide on your approach.
As you think about next year, obviously depending on the market that you're talking about, you have more or less visibility. Kind of going back to Stephen Volkmann's previous question, as you think about large ag in the U.S. and Canada, however, while we don't have full visibility at this point, we certainly have a much better visibility in this market for that large ag equipment than we would in any of our other markets through our early order programs, the availability on large tractors, those sorts of things. I would tell you that our forecast is very much in line with those expectations. To your point, there's always risk. We would attempt at this point in the year to come out with what our best estimate is for the market based on what we're seeing in our order books and what we're hearing from dealers and customers.
Steve, this is Raj. I would add that the way we are preparing for it is pretty aggressive in terms that we are preparing for a greater fall in ag, okay, than what may actually happen. Again, the philosophy is if at the end, the ag end markets prove to be more resilient or positive, it should be easier for us to walk up with the market. If you look at what we are doing in terms of pulling levers, as you heard in Susan's comments, we are pulling levers pretty aggressively, whether it is on the expense side, SG&A. If you look at what our forecast was in 2014 at the beginning of the year, 4% down to at the end of the year in 2014, 12% down. In 2015, they're saying we're going to be further 5% down.
In inventory receivables, even at the end of the third quarter, we said we'll be down about $300 million. We were actually down $1.2 billion. That should show we are actually pulling levers pretty hard, expenses, costs, and assets. You can go on with capital expenditures, you'll see a similar trend. Every agricultural unit is executing our plans to walk down the line. Look at the large ag units, they're implementing crop plans. Okay? We are aggressively reacting to it.
Great. That's helpful. Then just to follow up on the used inventories question, I know you mentioned, Tony, that maybe they're not coming down as quickly as you'd like. I guess to what extent do you think dealers need further incentives to help sell that used equipment? To what extent is Deere considering stepping up to provide those incentives?
As you know, Steve, we have implemented, especially as it relates to large equipment, a pool fund strategy that's been in place for a number of years now That would provide the incentives that we believe our dealers need to move this equipment. We do continue to monitor the level of pool funds available to dealers. We think they're still at supportive levels. In terms of for us, when we move into these end markets, lower-end markets like this, you wouldn't see us necessarily with higher incentive costs related to this because, again, theoretically, the pool funds are there and already available for our dealers to move this equipment based on what we've contributed with the new equipment sales that have driven the used. I would say I wouldn't anticipate higher incentive, overall incentive budgets as you move year-to-year, other than what's natural.
You'll naturally see a little bit higher % as you move into lower-end markets, but you won't see a huge increase or really much of an increase at all in used incentives necessarily.
Okay, thanks very much.
Okay, thank you. Next caller.
Thank you. The next question comes from David Raso, and please state your company name.
Evercore ISI. A question on the C&F segment. I'm just trying to think through the recent growth rates. You're implying strong incremental margins for next year, and you're also implying your inventory and receivables go up $775 million. It all sounds like a positive view on that markup, then you give a 5% top line for the segment. Can you square up that kind of inventory and receivable build, only assuming 5% for your own growth?
Yeah, sure. That's a great question and glad you mentioned it because it does look on the surface like field inventories and our inventories are going up pretty dramatically, at least relative to the sales level. What I would tell you there is there have been some changes in some of the wholesale terms on C&F, and really they're changes that better align us to the market. As a result of that, we believe that will result in a little bit higher level of receivables. In fact, most of that increase, the vast majority of that increase is actually receivables. I want to stress that's not a huge increase in the field inventory levels. It's really a difference in what gets financed with John Deere Financial versus maybe some other outside financing entities.
Okay, that's helpful. That was more receivables than inventory. Then lastly, for the end of the year on ag, can you help us with, say, North American dealer inventory? I know you look at used inventory at the dealers as a percent of their trailing 12-month sales. Can you give us some metrics that we can benchmark throughout the year? Like, where do you feel you are now, and where do you plan to exit the year when you give us this inventory receivable type number for the company at down $375 million? I'm just trying to square up how we can track or on a production basis, do you feel you'll be setting up your dealers to exit 2015 with the appropriate inventory levels?
That would always be our intention. In fact, I would point out we had a very large decrease, especially in the fourth quarter, as we pulled back on production. A lot of what maybe some had anticipated in lower receivables and inventory in 2015 actually happened in early 2014, which goes a little bit to the cash flow story in the sense of some pointing out the lower cash flow in 2015. Remember, we ended 2014 $500 million higher than what we had been forecasting. That was all driven by a greater reduction in inventory and receivables than what we had been forecasting. We've done a lot of work already, but certainly have some additional work as we move through the year. Absolutely, we would expect to have our dealers in good shape from an inventory perspective as we exit 2015.
We think we're in pretty decent shape today as it relates to that. In fact, if you look in the appendix of the slides, we do talk about some of our inventory as it relates to row crop tractors and combines. Generally, as you know, our large ag equipment, we tend to be about half of what the rest of the industry would have as a % of sales. We ended this year at 6%, the end of October, 6% of trailing 12-month sales. You don't have the October data yet for industry, but if you look at the September data, the rest of the industry would be almost six times the level of inventory we would have been at on combines at the end of October. Recognizing you've got a month difference there, so I'm assuming they haven't pulled back their inventories during the month of October.
That's a significant difference and one that we would expect to continue to maintain.
No, I appreciate the color. On the used side, I think that's clearly the issue, right? Obviously, a dealer selling new takes the used trade-in. His comfort with his used is probably as important as anything right now going into trying to think through 2015 going into 2016. Is there any metric you can give us some sense of dealer used to trailing 12-month sales was, whatever the number was at the, say, quote, "the peak" three, four, five months ago. Where is it now, and where do you expect it at through 2015?
Yeah, unfortunately, we've never disclosed that. I would tell you certainly, as you think about the bank, we've talked about measuring this in a range of a band, and we would be higher in the bands and certainly would be looking to move those inventory levels towards the bottom end of the band. Unfortunately, I just can't share much more than that from a competitive perspective. We don't share those details.
I appreciate that. Okay. Thank you very much. Happy holiday.
Thank you.
Thank you.
Thank you.
Next caller.
The next question comes from Nicole DeBlase. Please state your company name.
Yeah, thanks. It's Morgan Stanley. Good morning, guys.
Good morning.
My questions are around the FinCo. It looks like you guys are only projecting a 3% year-on-year decline in FinCo net income during 2015. I'm just curious, with ag down so much, how you're maintaining net income year-on-year. Is it possible that we could see a lag impact of this, where FinCo net income starts to fall more in 2016?
As we've talked about, certainly there is a little bit of a lag factor in terms of how lower sales would impact the portfolio of John Deere Financial. In fact, next year, we would be expecting some increase in the portfolio, even with these kind of decreases. As you think about it, the average life of the note generally is around three years, even though they're five-year notes in most cases, but you'd have an average of about three years. There is, again, that kind of tail as those high sales years continue to benefit the portfolio. Now, given that, I would also point out that if you think about the slope and we talk about our structure lines, the slope of the structure line for John Deere Financial is much flatter.
You don't tend to see, even as you move in and out of cycles, as dramatic of an impact on their returns as you go through the cycle. While you could argue perhaps if you're going to assume lower portfolio growth or reduction in the portfolio, you'd see some lower income, you wouldn't expect to see the type of magnitude that you see on the equipment side.
Okay, got it. That's helpful, Tony. My second question is Section 179. What have you guys embedded in the outlook? Are you expecting reinstatement?
Not in our outlook. Just as we said in recent conversations, we continue to assume that there, in our forecasting, we're assuming that there is no extension of the tax incentive. At the same time, we would also continue to tell you that we believe the odds still favor an acceptable resolution. Candidly, next week will be very telling in terms of whether that will happen this calendar year or whether that's something that will happen into 2015.
Okay, thank you. I'll pass it on. Happy Thanksgiving.
Thank you. You too. Next caller.
Thank you. The next question comes from Jamie Cook. Please state your company name.
Credit Suisse. I guess just two questions. One on the pricing front, I think you said about 2%. I know you don't like to disclose what your assumptions are in ag versus construction, but I was just a little struck that I'm assuming you'll assume you'll get some pricing on the ag side. Given the severity of the market, can you just talk about your comfort level, and would you be willing to maintain price even at the risk of losing market share? My second question is just on the, I think the implied decrementals on the ag business is like 35%, 40%. Can you just talk about the cadence? Should the first half be much worse? I'm just trying to think about or do we normalize to that level as we exit the year? Thanks.
Sure. As you think about pricing into next year, I would point out both ag and turf and construction and forestry are contributing to that number. They are both positive. We would tell you that certainly we feel pretty confident in the forecast that we have with the price realization. Keep in mind, as you look back over the last decade, it's actually been closer to 3%, actually a little over 3% on average. We are recognizing a little bit lower level of price realization than what we've seen in the last decade or so on average.
For example, in the fourth quarter, I think you only got 1%, right? I don't know. I don't know if that's reflective of the market got much weaker.
Yeah, keep in mind with Tier 4 transitions and so on, some of that is about timing year-over-year of when those hit in terms of the price increases. Generally, we would just now start seeing our price increases being effective 1 November. A year ago, you could have seen some products with some earlier price as we moved through the year. In fact, as you talked about the 8R and 7R tractors, we took a short-term price increase and then another bump when we went to final Tier 4 as one example. Sometimes the timing of those will impact the year-over-year quarter. I wouldn't imply anything by that 1% in the fourth quarter being reflective of lower as we move forward. Forget what your other question was now.
Decremental.
The decrementals. Yeah. Certainly, as we talked about, Susan strongly hinted at it in her opening comments, remember that in our first quarter in particular, we have a very difficult compare with the first quarter of 2014. I think we talked about it actually on the last quarter call as well. Because of Tier 4 transitions, we shipped a fair number more Combines in particular in the first quarter last year than what we typically would. That is obviously not going to repeat itself this year, and so it will be a difficult comp, and I would argue that you should expect the decrementals to reflect that in the first quarter for sure.
All righty. Thanks. I'll get back in queue. Happy Thanksgiving.
All right. Thanks. Thank you, Nadine. Next caller.
Thank you. The next question comes from Jerry Revich. Please state your company name.
Good morning. It's Goldman Sachs.
Hi, Jerry.
I'm wondering if you could talk about just dealer inventories. Looks like you're not expecting much of a shift in ag trade receivables and inventories next year. In the slide deck, you laid out the inventories on a trailing 12-month basis. If you switch those around to a forward-looking basis, based on the orders you outlined, you're at about 30% of forward sales in row crop tractors and 8% in combines. Can you just step us through why we shouldn't expect a more significant reduction in trade receivables in ag compared to the slide that you laid out?
I think, again, as I think I mentioned when I was speaking with David, keep in mind that when you're looking at the 2015, you have to also look at what we did in 2014, and in particular, in the fourth quarter of 2014. We have dramatically reduced in the fourth quarter the level of inventory, both within our Deere inventory as well as our field inventory levels. We've done a lot of work already. We talked about reducing our production to keep our manufacturing in line with what we're seeing in retail demand. As importantly, remember that we've done a lot of work in recent years as we have moved to this build-to-order strategy to again, really reduce our field inventories in both good years and not so good years.
We don't have as much work as perhaps some of our competitors, certainly what we would have had historically in terms of heavy levels of field inventory that need to get drawn down as we move into these cycles. Part of the strategy in terms of being able to continue to provide the type of strong returns that we would expect throughout an entire cycle even as we move into a downturn. I think as you look at our returns next year, that's reflective of that. We're very confident in the level of inventory and receivables that we currently have forecasted at the end of 2015. Of course, as we go through the year, we'll refine that, and we'll make changes as we look and start to get better visibility of what 2016's going to look like.
At this point, we're very confident in that forecast.
Okay. Thank you, Tony. I'm wondering if you could talk about on the financial services business, just touch on, if you could, the delinquency rates that you're seeing at this point versus a year ago. I know your loss provision accounting is up slightly. Can you just flesh that out for us a bit more? Obviously you're coming off a very good year.
I think the short answer to that is we're certainly forecasting a higher provision level. Susan mentioned it's really more reflective of the fact that we have been at unsustainably low. We try to communicate that repeatedly, that we were at unsustainably low levels. I would maybe turn that around a little bit and say it is absolutely not or should not be taken as any indication that we have weakness in that portfolio. It continues to be a very strong, very sound portfolio. We're not seeing really increases in our past due rates or anything of that nature. It's just recognizing that we aren't going to stay at these historically low levels as we move forward. There's not much more I can say on that, I guess. With that, we'll go ahead and move to the next caller. Thank you.
Thanks.
Thank you. The next question comes from Mig Dobre. Please state your company name.
Yeah, good morning, Robert W. Baird. Just maybe looking to clarify from the prior line of questioning here. Your shipments to U.S. and Canadian dealers for 2015. My understanding is that based on where inventory levels currently are, should be lagging your retail sales forecast. Am I interpreting this correctly? Can you maybe frame it?
Shipments. Well, obviously our volumes would be slightly lower, yes, because we are bringing down receivables somewhat in the year. That's the $375.
All right. Perfect. My second question, I guess is on R&D and SG&A. You're guiding for flat R&D, I'm trying to understand why we shouldn't be seeing this line item come down a little bit and SG&A down only maybe 3%, excluding Landscapes and Water, even though the revenue obviously is moving quite a bit lower. Are there some levers that you can pull there that perhaps you're not discussing at this point?
I think certainly last quarter we talked about, Raj mentioned in his comments that with R&D, we would be balancing both the desire to pull levers, as well as recognizing our need to continue to invest in our business. Effectively holding that flat is a reflection of that. You look at SA&G, while you could potentially argue that you would have apparently anticipated the level of reduction, you also have to look back and recognize what we did in 2014, and in particular, as we started to pull levers in the fourth quarter. I would just tell you, similar to receivables and inventory, continue to look at both of those together in terms of the two years combined. Instead of looking at just what we did in 2015, recognize what we did in 2014 as well.
Mick, this is Raj. On R&D, when it's flat, if you look at within it, the components, the portion that's coming off of the emissions, that will be allocated more towards either product innovations or more towards continuous improvement. The continuous improvement part should help us on the cost reduction side.
Okay. Okay. Thank you. Let's go ahead and move to the next caller.
Thank you. The next question comes from Ross Gilardi, please state your company name.
Hey, Bank of America, Merrill Lynch. Good morning, everybody.
How are you?
Yeah, good, thank you. I just had a couple questions on the Brazilian market. I mean, the combine numbers were a little steadier last month. Do you have any thoughts on that? Are you seeing any stabilization in your order books down in Brazil? Or could that have been some pre-buying in anticipation of a hike in FINAME? Then my related question would be on FINAME, what do you expect to see there?
Sure. I think you're potentially correct in terms of what's going on there. Again, we are looking for lower end markets. Really, our group there would tell you, moving more towards typical or more normal levels. We're coming off still of very high levels in 2013. The market is still strong. It's still a very attractive market for us. It is coming down a bit more off of those 2014 levels. I wouldn't ever read much into monthly numbers, if you will. Certainly, there is some speculation that farmers will be buying ahead of the announcement on FINAME, simply because there's uncertainty. Generally, what we would expect and what most are expecting is that the FINAME rates will stay close to where they are currently, so flat to up slightly, maybe 500 basis point improvement. That's really what we're assuming is in that realm.
I don't think there's anyone assuming they're going to go down. That's part of the reason why you may be seeing a little bit of pull ahead now in anticipation of what may happen. Again, still pretty strong end markets. I'm sorry, 50 basis points. I said 500 basis points. 50 basis points, thank you. Increase in the FINAME rate. Flat to slight increase is what we're anticipating for FINAME.
Thanks, Tony. I'm glad it's not 500 basis points.
Yeah, me too. Thank you. Next caller.
Thank you. The next question comes from Ann Duignan. Please state your company name.
Hi. Good morning. JPMorgan.
Hi, Ann.
Hi. Can we talk a little bit about your outlook for 2015 to be trough and 80% below normal, or at 80% of normal? The last time you said we hit normal was back in 2006, and clearly the outlook going into 2015 is not 20% below the volume levels we saw in 2006. Can you just address your comfort level with 2015 being the trough and what could go wrong? Where is the downside? You've given us all the upside.
Sure. If you think about trough levels, to your point, as we look at the market, and to be fair, keep in mind, as you pointed out 2006, we adjust what we view as normal levels every year as we grow market share, as we enter new markets, those sorts of things. It isn't a static number as we move forward. Certainly we've seen growth in our business since 2006. By the way, the A&T forecast would not be at 80%. It'd actually be below 80% in our current forecast. I think from a confidence perspective, again, it's our best view of the market. It's how we're currently interpreting that. I think if you look historically as well in prior downturns, to expect another significant step down next year would imply you'd have three years in a row with pretty strong reductions.
That would not be the norm as you look historically. In fact, there's only really one period if you look back from 1965 forward, where we saw three sequential years of lower sales. Even in that scenario, you saw one of those years I think was less than 1% down. The other two were a little bit higher step function down. Given all of that, given how we view the market, given where we have seen things from a historic basis, our view would be that the risk of 2016 sales certainly being down significantly from this level is relatively small.
What are some of the downside risks?
I would tell you the biggest downside risk would be that we would have incredibly positive weather again, and that you would see trend yields moving forward. J.B. Penn, our Chief Economist, who you know well, would say that normal weather even, you would see stock levels come down, commodity prices move up, and that would be very supportive of cash receipts. Again, while there's always risk, we think it's really very low. Unfortunately, we're going to have to move on. We'll take one more call.
Thank you. The final question comes from Adam Uhlman, please state your company name.
Good morning. It's Cleveland Research. Thanks for squeezing me in. I was wondering if we could go through the Ag and Turf revenue outlook. If you could maybe talk about how you're thinking about Deere's revenues in 2015 in comparison to what you forecast the unit volumes, regions of the geographies, where you think you might outperform and underperform. Wrapped into that, just build on my second question on what your assumption is for parts revenues next year. Thanks.
I'll take the second question first, we don't guide on parts revenues. Similar to financial services, we would point out that the slope is much flatter on parts. If you move in and out of downturns and upturns, it will fluctuate with the market, but not as dramatically. I can't say much more than that, really, on parts. Generally, I would tell you that most of our assumptions are, as you think about industry, relatively in line. The biggest one that we always talk about with the industry is Brazil. At this point, certainly we would continue to anticipate market share growth. The other thing to always remember with Brazil is that industry outlook is only looking at tractors and Combines, not the other markets.
We do have a significant amount of our sales coming from things like sugarcane harvesters and planters and sprayers and that type of equipment.
Great.
With that, unfortunately, we're over a little bit, and I apologize for that. We'll go ahead and bring our call to a close. We appreciate your participation on the call. As always, we'll be available the rest of the day to answer any additional questions you may have. Thank you.
Thank you. This does conclude today's conference. We do thank you for your participation. You may disconnect your lines at this time.