Good morning and welcome to Deere's 4th 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 Hiegal, Director of Investor Relations. Thank you.
You may begin.
Hello. Also on the call today are Raj Kalathur, our Chief Officer Marie Zeigler, Vice President and Treasurer and Susan Carlick, Manager, Investor Communications. Today, we'll take a closer look at Deere's 4th quarter earnings and full year results, then spend some time talking about our markets and the outlook for 2013. 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. 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 and 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.
They 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 ks 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. I will now turn the call over to Raj.
Good morning and afternoon everyone. First, let me say how pleased I am to be part of today's call. To give you some background about who I am, I joined John Deere in 1997 and have spent my career in different functional areas starting in finance including business development, sales and marketing and operations in North American and Asian locations. Before becoming the Deputy Financial Officer in April 2012, I was based in Singapore as Vice President of Sales and Marketing for our Ag and Turf Businesses in Asia and Africa. Before that, I was Managing Director of our company's India operations.
I'm looking forward to bringing the benefit of my business experience to my role as CFO and to working with our Investor Relations team and many of you. Before turning things over to Susan for a fuller discussion of our results, a few words about what we experienced in the Q4 and our future business prospects. In our last conference call in August, we noted that our 3rd quarter performance was impacted by manufacturing inefficiencies, which particularly affected the production of combines. At the time, our then CFO, Jim Field said we expected these issues to be largely behind us by the end of the fiscal year. And I'm pleased to say that's exactly what happened.
Our factories have done a good job of catching up with demand and are running quite well. In addition, John Deere has completed its best ever 4th quarter and best ever full year in terms of both sales and earnings. We are pleased with our record results in 2012. As we all know, the world faces some big economic challenges today ranging from the U. S.
Fiscal cliff possibilities to euro debt crisis to the slowdown in emerging market economies. Today's economic uncertainties are real and troubling and John Deere is taking serious precautions in response. However, we don't see these issues having a lasting impact on the powerful tailwinds that we believe will drive demand for agriculture and construction equipment well into the future. In fact, we couldn't agree more with our CEO, Sam Allen's comments in today's earnings announcement that we have great confidence in Deere's prospects and in our ability to deliver value to investors in the future. Susan?
Thank you, Raj. Now let's take a look at the 4th quarter in detail beginning on slide 3. Net sales and revenues were up 14% to $9,800,000,000 in the quarter. Net income attributable to Deere and Company was $688,000,000 On slide 4, total worldwide equipment operations net sales were $9,000,000,000 up 14% quarter over quarter. Included is an unfavorable impact from currency translation of about 3 points.
Price realization in the quarter was positive by 4 points. Turning to a review of our individual businesses. Let's start with Ag and Turf on slide 5. Sales were up 16% in the quarter. Operating profit was 9.30 $1,000,000 There is one item that affected operating profit I'd like to touch on.
As mentioned in the press release issued this morning and noted on this slide, the division recorded a small write down approximately $33,000,000 pretax relating to our Water business. This write down reflects the near term actions we have taken to integrate Water into the A and T division's business and distribution channel. John Deere Water continues to be a long strategic opportunity for the company. Before we review the industry sales outlook, let's look at some of the fundamentals affecting the Ag business. Slide 6 outlines U.
S. Commodity price estimates that underlie our financial forecast. Corn, soybean and wheat prices are reflective of the weather driven events that affected the growing season and are supportive of equipment sales. Prices for cotton continue to fall as stock levels globally are about 65% higher than 2 years ago. Slide 7 highlights cash receipts.
Driven by strong crop prices, strong crop prices are expected to continue and livestock receipts are forecast to increase, spurring 20 13 cash receipts even higher. As a reminder in our modeling current and prior year cash receipts are the primary driver of equipment purchases in the U. S. Market. With cash receipts at record levels, this bodes well for future farm prospects.
Our economic outlook for the EU 27 is on slide 8. The investment mood remains positive due to high commodity prices and corresponding strong income levels. However, the overall economic situation continues to weigh on farmer sentiment as wet weather accounted for a poor U. K. Harvest and inadequate rainfall hampered the fall winter crop planting in the Southeast EU.
On slide 9, you'll see the economic fundamentals outlined for a few of our other targeted growth markets. Slide 10 illustrates the value of agricultural production in Brazil. This is a good proxy for the health of agribusiness. It encompasses over 20 different crops and has a high correlation to tractor sales over time. With forecasts for an increase in acres planted, higher yields and sustained high crop prices, the 2013 value of ag production in Brazil is expected to increase about 9% over the 2012 level.
Our 2013 ag and turf industry outlooks are summarized on slide 11. Industry sales in the U. S. And Canada are expected to be about flat in relation to the strong levels of 2012. We continue to see strength in demand, especially for high horsepower tractors, but our outlook is tempered by the drought related effects on the livestock and dairy sectors.
The EU27 industry outlook is flat to down 5% from the attractive levels of 2012. Our 2013 industry outlook in the CIS countries is modestly higher on the heels of strong commodity prices. South America are expected to be up about 10% in 2013. With strong commodity prices, forecast call for an increase in planted acres resulting in higher yields. In addition, current government programs in Brazil support higher amounts of financing and lower interest rates, which will benefit the industry in our fiscal 2013.
In Asia, we expect little change in 20 13 compared with 2012. Soft economic conditions continue in both India and China As well, high interest rates and the impact on crop yields from the delayed monsoon bear caution in India. The uncertainty over subsidy policy framework under the new Chinese government is also a factor in our outlook. Turning to another product category. We expect industry retail sales of turf and utility equipment in the U.
S. And Canada to be up about 5% in 2013, reflecting some improvement in the U. S. Economy. We expect to outperform the industry with the launch of new turf and utility products, especially new utility vehicles in commercial and residential mowers.
Putting this all together on Slide 12, fiscal year 2013 operating margin for the Ag and Turf division is forecast at about 15%. Before moving to C and S, let's touch on our early order programs. The combine early order program began in August with sales being allocated by quarter this year. Orders for combines are progressing nicely with all production sold out for quarters 1 and 2. Dealers began placing orders for 3rd quarter production earlier this month.
In aggregate, the other seasonal programs for planters, sprayers, drills, air seeding and tillage are all up double digits. Of note, sprayer production is almost full even with additional capacity available this year. Our 2013 outlook is supported by this promising early order activity. Let's focus now on Construction and Forestry on Slide 13. Net sales were up 7% in the quarter.
Operating profit was $120,000,000 an increase of 38%. For the quarter, C and S incremental margin was about 31%, a noticeable improvement over the 8 incremental margin realized in the Q4 of 2011. Price realization and higher shipment volumes contributed to the results. On slide 14, looking at the economic indicators on the bottom part of the slide, keep in mind these global insight projections assume a rational resolution to the so called fiscal cliff and the expiration of the payroll tax cuts. Even as the housing sector slowly recovers and consumer confidence is up, overall economic growth continues at a slow pace.
Deere C and S business continues to benefit from sales independent rental companies and the energy and material handling sectors. As well, Deere dealers continue to see strength in the rental and used equipment markets. Fiscal 2013 net sales in Construction Forestry are forecast to be up about 8%. Global Forestry markets are expected to be flat in 2013 as weakness in Europe is being offset by improvement in the United States. C and S full year operating margin is projected to are add additional research and development costs and selling administrative and general expenses.
We expect such growth related expenses and costs with little to no revenue from the new factories to run through 2013 and well into 2014. These factories position us well for the future as Brazil is one of the world's fastest growing construction equipment markets and China is an important market long term. While Construction and Forestry's full year 2013 outlook is stronger than 2012, its Q1 will be against a very tough compare. Recall in the Q1 of 2012, the division had extremely high production volumes of high horsepower machines prior to the transition to interim Tier 4 engines. In the Q1 of 2013, shipments will shift to more purchased products like excavators and commercial worksite machines.
So not only will mix shift away from the higher horsepower machines, keep in mind that purchased products have no impact on absorption. Higher product costs associated with Interim Tier 4 will have an impact in the quarter as well as the global growth expenses discussed earlier. Nonetheless, the full year outlook is good. Let's move now to our Financial Services operations. Slide 15 shows the Financial services provision for credit losses as a percent of the total average owned portfolio at 31 October 2012 was essentially 0.
This reflects the excellent quality of our portfolios as well as some allowance reductions in the U. S. Construction and Forestry and Brazil Ag portfolios, reflecting improved market conditions. Our 2013 financial forecast contemplates the loss provision returning to a more typical level of about 26 basis points as a percentage of the average owned portfolio. Keep in mind, the 10 year average is about 34 basis points.
Moving to slide 16. Worldwide Financial Services net income attributable to Deere and Company was $122,000,000 in the 4th quarter, which is about flat with the previous year. Before moving to receivables and inventory, let's touch on 2 items in Financial Services quarterly results that may warrant further explanation. 1 is the higher reserves for crop insurance claims. In the Q4 of 2011, we accrued an underwriting gain on our crop insurance premium.
The opposite happened in the Q4 of 2012. We accrued an underwriting loss. Year 2012 for the drought, the majority of which was recorded in the Q3. The second item is the higher provision for credit losses. In the Q4 of 2011, reductions were taken on the allowance for doubtful receivables, whereas there were no similar reductions made in the Q4 of 2012.
It is important to note as we discussed on slide 15, the provision as a percent of the total average owned portfolio was essentially 0 in the Q4 of 2012, reflecting the excellent quality of our portfolios. Worldwide Financial Services net income attributable to Deere of about $500,000,000 in 2013. Slide 17 outlines receivables and inventory. For the company as a whole, receivables and inventory ended the year up about $1,300,000,000 This was in line with our forecast and provides further evidence that our 3rd quarter execution issues have been resolved. We expect to end 2013 with ag and turf receivables and inventory nearly flat with 2012 levels.
CNF will be up about $175,000,000 due to expected further recovery in the sector. Before moving on, it is important to note that in fiscal 2012, over 5,000 new employees joined the John Deere team. These additions are necessary to support our growth both domestically and internationally and will impact cost of sales, R and D and S and G in 2013. Since almost 2 thirds of the new employees came aboard in the last three quarters of 2012, there will be a noticeable increase in expense in the first half of the year, especially in the Q1. As we head into the new fiscal year, we will begin providing guidance on the cost of sales as a percent of net sales as shown on slide 18.
Cost of sales may be impacted by price realization, production or manufacturing costs, raw material costs, engine emission product costs, absorption and the effects of foreign currency exchange. Cost of sales is expected to be approximately 74% of net sales in 2013. For modeling purposes, keep in mind price realization. We are forecasting about 3 points in 20 13. Interim Tier 4 product costs that we've talked about the last 2 years.
On slide 17, we talked about 20 2017 receivables and inventory expected to be up about $200,000,000 a far lower increase than we had in 2012, which affects absorption and the impact on cost of sales from the new employees discussed earlier. Looking at R and D expense on slide 19. R and D was up about 16% in the 4th quarter and up about 17% for the full year compared to the same period last year. In August, we provided full year 2012 R and D guidance of up about 15%. Due to the extremely short time frame between full implementation of interim Tier 4 and the regulatory dates for final Tier 4, spending has been accelerated in many product areas.
Our 2013 forecast calls for R and D expense to be up about 3%. Moving now to slide 20. SA and G expense for the equipment operations was up about 9% in the 4th quarter and up about 7% for the full year. SA and G expense is forecast to be up about 7% in 2013. Percent in the 4th quarter and 35% for the full year as you can see on Slide 21.
The quarterly rate was impacted by updated accounting standards Codification 740 reserves, a lower Section 199 deduction and the goodwill impairment charge for water. For full year 2013, the effective tax rate is forecast to be in the range of 34% to 36%. On slide 22, you see our equipment operations history of strong cash flow. We are forecasting cash flow from equipment operations to be about $3,400,000,000 in 2013. Slide 23 outlines our use of cash priorities, which is unchanged and no doubt familiar to many of you.
Our number one 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 A rating. You may have noticed we had about $6,000,000,000 in enterprise cash and marketable securities on the balance sheet at 31 October. With all the uncertainty in the global economy, coupled with our normal heavy first quarter seasonal needs, we felt it prudent to pre fund our 1st quarter requirements. Long term, we do not plan to continue this level of pre funding.
Our second use of cash priority is funding value creating investments in our operations such as the 2 new construction facilities in Brazil referenced earlier. A third priority is to provide for the common stock dividend, which we have raised 64% since 2010. Over time, we want to consistently deliver a series of moderately increased dividends, while targeting a 25% to 35% payout ratio on average. In this regard, we are mindful of the importance of maintaining the dividend and thus not growing it beyond a point that can be comfortably sustained by our cash flow. Share repurchase is our method of deploying excess cash once the previous requirements are met and as long as such repurchase is value enhancing.
From 2,004 through 20 12, we have returned 60% of cash from operations to shareholders through dividends and share repurchases. On slide 24, we outline our 2013 outlook for the full year and the Q1. Our net sales forecast for the full year is up about 5% compared to 2012. This includes about 3 points of price realization. Our full year 2013 net income forecast is about $3,200,000,000 The Q1 forecast calls for net sales to be up about 10% compared with the Q1 of 2012.
Price realization in the quarter is expected to be positive by about 4 points with unfavorable currency translation of approximately 1 point. In closing, John Deere enters 2013 on a strong pace. We are looking for a continuation of this performance in the year ahead, thanks in large part to strength in the global farm sector. At the same time, the company is capitalizing on the positive long term macroeconomic trends by pursuing new markets, adding productive new models of equipment and extending its competitive position throughout the world. John Deere's plans for helping meet the world's growing need for food, shelter and infrastructure are well on track and achieving a good deal of success, all of which supports our confidence about the future and to serve customers and investors over the long term.
Tony?
Thank you, Susan. We're now ready to begin the Q and A portion of the call. The operator will instruct you on the polling procedure. But 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 queue.
Operator?
Thank you. We will now begin the question and answer Our first question or comment comes from Andy Kaplowitz. Your line is open and please state your company name.
Good morning, guys. Barclays.
Good morning, Andy.
Could you guys talk a little bit more about the U. S. Ag market, the outlook for 13? How are tractors doing so far? I know you don't have an early order program, but how are they doing maybe some lead times?
And then I think we understand the livestock market is relatively weak, but if you've got things like sprayers basically sold out and you've got combines pretty strong, is there potential upside to a flat market? And again assuming it's a strong market to begin
with. Yes. Andy, this is Tony. And I would say that, on the tractor question, our order books, you point out, we don't have an early order program, but the order book for U. S.
And Canada is roughly the same type of availability as last year. But keep in mind that is with higher capacity. So as you look at ADAR tractors, for example, availability is out to April 2013 timeframe, again similar to last year and then the 9RT track tractors would be May of 2013.
So it looks pretty good. Tony, maybe I could shift gears and ask you about, so you've decided to do new guidance in cost of sales and I'm sure you guys anticipate that we would ask you about to break that down a little bit if you could or at least help us think about material costs and emission cost in 2013. How should we think about it? And how did it end up in 4Q?
Sure. And as we move forward, in the past, as you know, we've given specific numeric guidance. We can certainly help kind of directionally. With the as we look at those costs, Susan cited really the 3 highest increases. Emissions cost would be the greatest increase.
Absorption also is impacting the year as you see a lower build in inventories and receivable and then the various overhead spend including the portion of that employee cost or employee adds that impact cost of sales. So those are the 3 main drivers in the year.
But at least material costs should be pretty benign at least in the forecast for 13
fairs. It was not significant enough to bear mentioning.
Got you. Okay. I'll get back in queue. Thank you.
Thank you.
Thank you. Our next question or comment comes from Jamie Cook. Please state your company name.
Hi. This is actually Andrew Buscaglia on behalf of Jamie Cook. Thanks for taking my question. Good morning. So if you were to add back that the $33,000,000 goodwill charge to ag, incremental still seem a little bit late at 9% or so.
Can you just talk through some of
the factors driving incrementals in the quarter? And then how they stood relative to your expectations? Sure.
Andrew, now there are 2 items this is Raj. There are 2 items that in particular you need to make note of. 1 is the goodwill charge that was about $33,000,000 for water pretax and 31,000,000 dollars in after tax. And if you include that plus the effective tax rate increases was almost a $70,000,000 impact to our net income that was one time, okay? So you got to look at both sides.
And these 2 alone on a one time basis impacted the net income by $70,000,000 So if you add that back to the net income, now it would have been higher than the guidance we provided and higher than the first call consensus estimates.
And then if you look at ag in particularly, certainly the goodwill charge would have impacted those margins. But the press release talked about increased production costs, things like interim Tier 4 costs, manufacturing overheads as well as some profit shares that hit cost of sales difference year over year. Interim Tier 4 costs alone in the quarter was about $105,000,000 so a little over $100,000,000 And then S and A, SG and A and R and D both were up pretty considerably in the quarter.
Okay. And then on those interim Tier 4 costs, can
you just talk about your expectations on
spend for Tier 4 and
13? Yes. Again, as we talked about before and coming in line really with what our expectations are, certainly not going to see a year over year increase like we saw in 2012, but it's not an insignificant number. As you look out into 2013, you have 2012 and you'll see a full year increase in 2013. So they will be up and it is the number one driver of cost increase in our cost of sales.
Okay. Thank you.
Okay. Thanks guys. Next caller?
Thank you. Our next question is from Rob Wertheimer. And please state your company name.
It's Vertical Research and good morning everybody. Good morning. Two quick ones if I can. I mean the early order season looks like it's going great. Do your customers seem to have concerns about soil moisture?
Weather is hard to predict for next year, but where we're going into this year? Or is that a concern that's sort of fading? And it's just a regular weather uncertainty?
Sure.
It is something that bears watching in the U. S. Certainly, but it's way too early to make any predictions at this stage of the game. But it is something that we're watching. Has it affected initial sales?
Certainly not from the commentary on the early order programs on ranging from combines to sprayers and even frankly what you're seeing with the tractor activity?
Yes. It seems like they're not overly concerned. I don't know if you're willing to answer this one, but can you tell us where underlying construction margins if you could do just for the U. S. Or ex the growth investments are trending?
I mean, obviously, you're investing a lot. You've gained share I think in construction. I think the business is doing well, but it's not showing up the margins. And I just don't know how big a drag that is on the growth
side. I am unable to quantify it for you or I guess maybe unwilling. But suffice it to say that you have seen the Construction Equipment division performing very well prior certainly to the recession. And we have we are delivering that kind of performance, but there's no question that we are impacted in this division by pretty for them pretty significant investments not only in growth in Brazil and we're talking about China, but also frankly in some IT4 expenses. And now I guess I should be starting to say final Tier 4 expenses.
Again, the time, the lag time between the implementation of IT4 and final Tier 4 is very compressed.
Okay. I'll stop. Thank you very much.
Thank you, Rob. Our next question is from Jerry Revich. Please state your company name.
Hi. It's Goldman Sachs. Good morning and happy Thanksgiving.
Thanks, Jerry. Happy Thanksgiving.
You've had strong retail sales for tractors in Europe over the past couple of months. Can you talk about if that's driven by your regional mix or new product lineup? And whether you expect the tailwinds for Deere versus the industry to continue as you look into the early part of 2013?
There are a number of factors at play in Europe, including the very significant product line expansions that you saw when you were in Lisbon 1.5 years ago. We've also made strides in strengthening our distribution capabilities in the market and we think that's starting to pay some nice dividends.
Okay. Thanks. And just to circle up on the interim Tier 4 discussion, Tony, what's the magnitude of increase in 2013 versus '12, if you could quantify that for us? It's nice to hear that the combine production issues have been addressed, but certainly your guidance is looking for 4% net income growth and 5% sales growth. And I'm just wondering if you could just flesh out for us the Interim Tier 4 headwinds and the overhead headcount headwinds that Susan alluded to in her remarks.
This is Marie. I'll just say it's over $200,000,000 impact on the IT for the cost.
So I think this is a question that will come up often. So let me address the cost of sales items. So if you look at the item by item, let me provide some qualitative view for each one of these. Price realization of course impacts the cost of sales as a percent of net sales. That's up 3% it's already said.
Volume is going to be up for 2013 of our two points. Manufacturing inefficiencies in 2012 that we had you should not see in 2013. Now material we said is not significant either way in terms of IT4 material. In terms of IT4 material, it's like Marie just said, it's not as high as last year. I would say it's about 60% of what we had last year.
Depreciation is going to be higher and overhead expenses as you can imagine the 5,000 additional people and that's going to impact cost of sales SG and A and also R and D. So to that extent that's going to be higher as well.
Thank you very much.
Thank you.
Thank you. Our next question is from Ann Duignan. Please state your company
name. Hi, good morning guys. JPMorgan. Good morning. Hi.
Can you talk a little bit about what I'm worrying about here is price increase is up 3%. Is that enough to more than offset the higher cost of Tier 4? Or are we looking at structurally lower margins going forward? The margin this quarter in ag and turf should have been higher given the number of combines you were intending to ship out. So I'm just trying to get a sense of what's cyclical and what if there's anything secular?
Sure. As you look at where we ended the year, pretty much in line with what we were saying from a price perspective. For the Ag and Turf division, we had we were about 90% of the interim Tier 4 costs were covered or recovered through 2012. C and F is as expected again a little lower than that about 75%. So certainly with the price realization we're looking at next year, would expect to get much further along the line on that.
What does that mean, Tony, much further? It doesn't sound like you're going to get
to 100%. If you look at the 3%, I don't know exactly at 100%. Certainly, ag and turf is already at 90%. So I think it's fair to assume you're going to get to the 100% there. And we're looking at these on a product by product basis.
So as we've talked about with the smaller ag equipment, it's harder to recover that cost. It's a higher percent of the cost of the equipment on a product that is more price sensitive. So versus large ag, which is where construction has similar challenges as well. So certainly, if you look at the 3% price realization versus the cost increase in just the year, it's more than covered.
Hey, Ann, this is Raj. Now you did I'm assuming notice that the operating margins go up in 2013 compared to 2012. Now the other thing if you look at the incremental margins, of course they are better in 20 13 compared to 2012, it's improving. And if you were to calculate the net income incrementals, that would be about 6.6% for 2012 goes up about 2 points, roughly 2 points for 2013. So the margins are actually getting better from 2012 to 2013.
Okay. That's helpful color. And then just circling back, if we look at SG and A up 7% this year up another 7% next year that's what 3 times the rate of inflation. Are you using any kind of marketing or financing programs out there to support sales?
So Anne, let me just maybe kind of set the table here and go back to net sales as a and the change in net sales versus the change in our SG and A, because I think that might help calibrate things. In 2010, I'm going to go back 3 years, our net sales were up 14%, SG and A was up 10%. In 2011, we were up 25% for net sales, SG and A only up 12%. Net sales in 12 as you know we've just reported up 14, SG and A up 7. So there's a little bit of catch up if you will from some spend required to support the infrastructure, if you will, of these higher sales in the form primarily of people.
So we think that, while we are very mindful of our expenses and I can assure you as a member of the CFO staff, we're very mindful of our expenses. We are actually are exhibiting good control relative to the types of growth that we have not only delivered, but we have envisioned for the future.
And if I can add to what Marie said Ann. Now the 2012 versus 2011, 14% to 7% that Marie mentioned. If you look at the quarter 4, okay? Quarter 4 of 2011, our SG and A was about $769,000,000 okay? It's a 9.5% increase above the quarter 4, 2012.
So that's fine. Now if you look at the guidance we had going into July, in August guidance going into the 4th quarter, we actually did better than the guidance we provided to you at that point. So I think the guidance we provided was about $880,000,000 and our quarter 4 actual to SG and A was $842,000,000
And Ann, this is Tony. The other thing I would add there is, I think your question kind of focused in on potential incentive programs in the market. And if you look at our price realization both in 2012 and again in 2013 with 4 points and then another 3 points, that would be pretty hard to do with incentive programs in the market.
So your incentive programs, if they were financing, would show up in pricing or would they show up in SG and A?
They would show up in the pricing, yes. So, okay.
Our next question or comment is from Ashish Gupta.
Good morning. Good morning.
Can you quantify the impact on operating profit from the combine issues? And I think you had had an issue in Q1, Q3 and then Q4 as well?
We talked about in the Q3, some costs from the execution issues and that was part of the spend increase that we spoke to last quarter. But, I think maybe what you're getting at is certainly from a shipping pattern perspective, we had some impact from the combine, much lower shipments than normal in the 1st part of the year, especially in the Q1 and then picking up in the back half of the year. And again, of course, that's impacted because of the IP4 transition.
That was on plan. It was the Q3 that wasn't.
And there was really no impact from any manufacturing inefficiency issues for combines in Q4, okay? So all of that was in Q3 and we said that will be behind us and it is behind us.
Great. And then I know you mentioned that your lead times for tractors are looking similar to last year, but with the added capacity. And I guess, I was just wondering, could you remind us sort of the year over year increases in capacity for the products like sprayers and tractors where you've added on?
Well, keep in mind, it's hard to we certainly have talked about within Waterloo the expanded capacity that is as you know that's a facility that's really for global production on the 7, 8, 9000 series tractors. So it's hard to distinguish how much of that capacity is specifically related to the U. S. And Canada production. So we talked about in the past for Waterloo specifically by the end of 2012, we would add 15% capacity there.
And then again, we made another announcement in March of last year for an additional 10% capacity that is coming here coming through 2013. So it will be in place in kind of mid-twenty 13 is what we had indicated that capacity would be in place. So, again, I wouldn't take that to mean that you've got a full 10% capacity increase in Waterloo tractors for the U. S. And Canada market, but we do in fact in 2012 have higher capacity for that market.
Okay?
Fair enough. Thanks a lot.
Thank you.
Thank you. Our next question or comment comes from Steve Volkmann. Your line is open and please state your company name.
Hi, good morning everybody. It's Jefferies.
Good morning.
My question is about the comment that Susan made on wanting to to prefund the Q1 and having extra cash on the balance sheet and maybe not needing to do that going forward. So I guess I'm trying to figure out what would be a more normal kind of level of cash? And I'll ask my related follow which is have you changed your view of what dividends should be given potential changes in taxation? And also you talk about sort of mid cycle earnings, which raises the question. I think in the past you've said things about where you think we are versus mid cycle in your various businesses.
So maybe you can help us with that too.
Wow. Okay. First of all, we would view with our global growth, the operating cash requirements that you would see at typically at a year end would be somewhere in the $4,000,000,000 to $5,000,000,000 range. And that really reflects the changing nature of the business. And that's basically where we are today.
So we've got about $1,000,000,000 to $1,500,000,000 extra in prefunding. Depending on how market conditions play out as we move through the end of the year and we see hopefully a very successful resolution to this fiscal cliff, we more feel necessary to have that level of prefunding. So that I think takes care of your question.
Thank you.
Regarding the dividend, the dividend really is in the purview of the Board. And so I will not be able to make a comment on the dividend. And your third question, would we are not providing, I guess, a prescriptive or a point blank number on when we are. It's fair to say that the Ag markets in the U. S.
Are very strong, not as strong in markets outside. And construction is still in, I'll say, a recovery mode, although they're getting closer to a more typical cycle. So
3 questions for you Steve.
But I asked them quickly. Thank you very much.
Thank you very much. Thank you. Our next question is from David Raso.
ISI. I'm just making sure I understand the moving parts on the margin guidance for next year. Can you clarify the IT 4 cost? Somebody mentioned up $200,000,000 then another mention was, but that's only 60% of the cost we had in 2012. Is that the right way to look at it?
It's basically the rough numbers would be was $300,000,000 or so 2012, but it's only $200,000,000 in 2013. So it's a $100,000,000 benefit year over year?
No. As you keep in mind, when we talk about incremental costs, in 2012, the total costs were about $485,000,000 higher year over year, okay? When we talk about the impact cost of sales being up again in 20 14, that's in addition to the $485,000,000 so it's additive. So if you look back further, 2011 was 155, we had another 485 last year and then we're adding on top of that yet again this year.
Okay. So to frame the positives and negatives for year year margin in ag, this will be the question or I mean the idea is you're implying incremental margins next year of 28% for ag and turf. And if you adjust for some of the goodwill in this quarter call it 25%, 26%. So it's still a pretty healthy number. But your costs are up for interim Tier 4, but the price for ag alone, you said 3% for the whole company.
Is ag and turf a little bit beyond that, I guess, you're saying a little higher 3%?
We don't guide on specific division. Certainly, both divisions are
The overhead absorption receivables and inventories went up over $1,000,000,000 for Ag and Turf in 2012. This next year, it's obviously a lot more modest barely up at all. So a negative would be the overhead absorption. And you have some cost as well with the employees. But for the mix and we can debate if the sales guidance is conservative not off the order book, but I'm just trying to take it at face value.
The mix the U. S. Comments have been relatively positive. South America, I would argue is a decent margin geography for you in ag when it comes to margins. Would you describe the mix from the order book, the geography, however you want to look at it?
Is the mix going into 13% for ag and turf? Would you view that as positive for margins?
When we talk when we think about that ourselves, we tend to look at products not geographies. And you have products in some geographies that have very attractive yields and some that don't. And so it's really more product centric. With that, Tony didn't mention it as one of the driving factors. So David, we don't have a comment on
Okay. All right. Appreciate it. Thank you.
Thank you.
Our next question comes from Seth Weber. And please state your company name.
Hi. It's Adam Nielsen on for Seth. How are you? Thanks.
Good. How are you?
Good. Thanks. Just wondering if
you could speak a bit
about the competitive environment in Brazil. It looks like you pick up some share in tractors since into the fall. So are you able to hold pricing pretty stable there in defensive margins? Or is it getting a little more competitive?
Yes. I mean, certainly, again, if you look at our price realization for the year, I think that's indicative of our ability to hold that price.
Okay. And then along similar lines On
those tractors, on large tractors, most of those are ordered well in advance of when we're actually shipping and retailing those. So that's also impacting it.
And for the sake of those who may not be as familiar with our Brazilian operations, we have made significant investments down there in factory capacity. We have had a very significant broadening of our tractor line, but frankly have many product lines. 2 years ago approximately, we launched 50 new products, many of which were in categories that we were not yet competing. We've also have a very good dealer organization who have been growing their presence and their
Our dealer channel has been strengthening and our price realization has been good, okay? So it's a positive story for us so far.
Okay. Great. And along the same lines the cost drag next year in 2013 relative to this year, can you frame that for us? I know China will be a little later, but can you frame those for the new capacity adds?
In terms of capacity no, actually the it would be implied or included in the kinds of guidance that we've already provided, We're not going to be able to comment specifically on the factory. Thank you.
Okay. Thanks. Next caller.
Thank you. Our next question is from Robert McCarthy.
It's Robert W. Baird. Can I first just get a definitional clarification? You're talking about fiscal 2013 COGS being 74% of what exactly? Is it net sales for the equipment operations or net sales and revenue for the equipment operations?
Net sales of the equipment operations.
Net sales of the equipment operation. Yes. So excluding finance and interest income and other income that are reported
as well? Yes. As typical when we're providing our guidance, it would be on the equipment operations with Financial Services on the equity basis.
Yes. Just wanted to make absolutely sure. Absolutely. And in the release, of course, there are comments about strength in or expected continued strength in large equipment in the U. S.
And Canadian market offsetting pressure on U. S. And livestock and dairy sectors. That does imply improved mix in the U.
S. And Canada, doesn't it?
Again, I think we've got a number of
Okay. So it's an immaterial consideration. Okay. So the other question I had was Mr. Allen was on television a couple of days ago, talking about the uncertain current macro environment and made comments about Deere having specifically slowed or deferred certain investments.
How do I think about your the guidance that you're issuing today for expense levels and CapEx unchanged full year CapEx. In light of those comments, does it suggest that the CapEx budget has some upside if we see a quick resolution to fiscal cliff issues for example? Can you help us here?
Yes. Robert, this is Raj. Now our forecast essentially for CapEx and other expenses indicate caution based on the economic uncertainties, okay? Now, we have asked the divisions we have approved the capital expenditures and expenses, but asked our units to delay as much of it as practical into January, okay? Now the current plans of course reflect our assessment of the probabilities of different economic outcome.
As the economic scenarios become clearer, we may economic scenario turns positive. So you should see that as just a pragmatic sensible approach to both CapEx and expenses.
Yeah. I got it. Okay. Thank you very much.
Rob. Okay. Next caller?
And are you ready for the next question?
Yes, please.
Thank you. Our next question comes from Vance Edelson. Please state your company name.
Good morning. It's Morgan Stanley. You had mentioned a few months ago that you might need to extend the balance sheet a bit in Europe to facilitate sales given the credit conditions. Any update on that? Would you say that's an upward or downward trend at this point?
I think what we were referring to there is that we're actually looking at some partnerships with some banks to help us facilitate financing in various markets. And we have or are close to having in some markets some new agreements that will help us in countries in Europe and in the former Soviet Union where we or be flak, I guess, would be better to say where we haven't had a presence. But I don't have anything to publicly announce on this call.
Okay. That's helpful. And just a quick follow-up on something you recently mentioned. I think you said you're getting closer to recovery mode on the construction side and overall you're calling for modest improvement in the U. S.
Is that a bit conservative even with the sluggish economic growth that you cite just given the possibility of bouncing off the bottom now that there actually are some green shoots. Could you elaborate a little on what leads to the forecast for modest improvement?
On Construction and Forestry, again, we're really it's a similar story to what we saw last year. We're continuing to see strength in the rental channel, energy related, those sorts of things is what's drive continuing to drive that modest improvement for that particular division.
Got it. Okay. Thank you.
Okay. Thank you. Operator, I think we have time for one more question.
Thank you. Our next question comes from Eli Lusgaarden. Please state your company name.
Longbow Securities. Good morning, everyone. Good morning.
Good morning.
Good morning.
Okay. Can I get one clarification? In the back of your release, you have pension and OPEB expenses going up $70,000,000 You didn't cite it as an expense, is it Don? Is that correct? Is it about a dime impact for higher pension expenses?
You didn't get as much in 2012?
Well, that's funding.
No, it's an expense. No, it's an expense. Sorry.
It's up about it will be about $70,000,000 That's on an enterprise basis. Of course, most of that is equipment operations.
So there is an impact that should have been that we would notice in the numbers. Can we and And that
would be Eli, that's about 2
roughly about 2 thirds cost of sales and the rest SA and G.
Yes. And you showed that there is a cost. You gave us also the Q1 is going to be up 10%. Can you give us and the rest of the year is sort of very modest, I guess, based on your forecast. Can you give some of that 10% gain, is that just normal seasonality and the easy comparison in combines?
There's some questions about the depreciation expense benefit expiring at the end of the year. So whether or not people are trying to actually get equipment, are you seeing any of Alternatively, the insurance checks seem to be coming later and probably not till January February. Did you have any of that factored in? Give us some help on how the insurance checks are playing out, the depreciating expense and how it affects the Q1 and later quarters?
Yes, certainly. I think as you said in part of that, I think it's more of a reflection of last year and the lower sales of combines. Keep in mind, in terms of the tax of the product right of combines that last year or in terms of
the tax
incentive, keep in mind, they have to take possession by that by the end of the year. And with the order books and the position that we've had them in, they would have needed to have those ordered well in advance in order to take advantage of any of that tax incentives. The other thing to keep in mind, it's 50% this year. In 2011, it was 100 percent. So it would really go down to the more traditional as you look out into 2013, it goes down to the 5 year depreciation, so 20%.
So it's not as large of a step function from 12% to 13% as it was from 11% to 12%.
And the insurance check impact, because that's probably the most significant one that people worry about because they're not going to get the checks in January February, at least according to the most appropriate.
Yes. I think our expectation for credit would be that by the end of the year about 70% of our expected claims will be paid by then.
By the end of calendar year.
By the end of the calendar year. Yes, sorry.
Yes, I was more not
so much worried about claims on you, but
I was asking more on the impact of pharma purchases and timing of it and whether it Well, that's
I mean, but that's our checks from our John Deere Insurance. I it's hard to know what other insurance companies are doing. But if you look at just our business, for our customers, 70% of the expected payments will be made by the end of the calendar year.
And is there Bob, is there any place that you have sort of excess inventories or issues, particularly in construction equipment, we now see a big widespread inventory liquidation going on because a lot of rental channels are filled and do back of are we seeing of any shutdowns or any place where inventories are out of whack in any part of the product
going?
Out in the field inventory? No. No. For construction, heck, by virtue of
the fact that we're actually projecting inventories will end next year up a bit, we're in very good shape. And again, on the Ag side, while there's always little pockets here and there, it's pretty de minimis relative to the size of the business.
And no excess combined used inventory or anything, you should be?
We're very comfortable with levels across the board.
Thanks, Eli.
Okay. Thanks, Eli. And with that, we thank you for your participation in the call. As always, we'll be available the rest of the day to answer any additional questions you
may have.
Operator? That concludes today's conference call. Thank you for your participation. You may disconnect at this time.