Good morning, and welcome to the Deere's Third Quarter Earnings Conference Call. Your lines have been placed on listen only until the question and answer session of today's conference. I would now like to turn the call over to Ms. Marie Ziegler, Vice President, Investor Relations. Please go
Good morning. Also on the call today are Jim Fields, our Chief Financial Officer as well as Susan Carlick and Justin Marovec from the Deere Investor Relations staff. This morning, we'll take a closer look at Deere's 3rd quarter earnings and then spend some time talking about our markets and how we see the last quarter of our fiscal year shaping up. After that, we'll respond to your questions. Please note that slides are available to complement the call this morning and can be accessed on our website at www.johndeere.com.
First, as usual, a reminder, this call is being broadcast live on the Internet and recorded for future transmission and use by Deere and Thomson Reuters. Any other use, recording or transmission of any of any portion of this copyrighted broadcast without the express written consent of care 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 projections, plans and objectives for the future that are subject to important risks and uncertainties. Actual results might differ materially from those projected in forward looking statements.
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. The company, except as required by law, undertakes no obligation to update revise its forward looking information. The call and accompanying materials are not an offer to sell or a solicitation of offers to buy any of the company's securities. This call may also include financial measures that are not in conformance with accounting principles generally accepted in the United States of America, otherwise known as GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures is posted on our website at www.johne deere.com/financialreports under other financial information.
Call participants should consider the other information on risks and uncertainties and non GAAP measures in addition to the information presented on today's call. And now for a closer look at our Q3, Deere Susan.
Thank you, Marie. John Deere's strong performance continued in the Q3 of 2010. Income was up 47% on a sales increase of 18%. Earnings were the highest for any third quarter in the company's history and sales were the 2nd highest. The gain was led by Ag and Turf which had another blockbuster quarter.
Construction and Forestry had its highest profit in 7 quarters and our credit operations had another solid performance. The company is being helped by somewhat improved business conditions, but tailwinds are only part of the story. After all, construction markets are still weak by historical standards and some Ag markets such as Europe and the CIS remain under pressure. What our results clearly show is the disciplined execution of our business plans and our focus on serving customers with advanced products and services. This has allowed us to fully capitalize on the current market conditions.
Now let's look at the quarter in more detail starting with Slide 3. Net sales and revenues were up 16% to $6,800,000,000 in the quarter. Net income attributable to Deere and Company was $617,000,000 and as just mentioned up 47% compared with the Q3 last year and our highest ever income for
a
31% in the quarter. This slide illustrates that with one exception, tonnage in each SBU and region was up in with the forecast provided a quarter ago. The exception was outside the U. S. And Canada, where tonnage came in lower than anticipated due to turn to the company outlook on slide 6.
4th quarter sales are expected to be up approximately 32% compared with the Q4 of 2,000 and 9. Currency translation on net sales is expected to be negative by about 1 point. Income attributable to Deere and Company is forecast to be approximately $375,000,000 in the 4th quarter. For the full year, net equipment sales are forecast to be up about 12% compared with fiscal year
2,009. This includes about 2
points of positive currency translation and approximately 2 points of positive price realization. Turning to a review of our individual businesses, let's start with Agriculture and Chirp on Slide 7. Production tonnage was up 20 4% in the quarter on a 12% increase in sales. Operating profit however jumped by nearly 345 $1,000,000 or 72 percent to $824,000,000 The increase was primarily due to higher shipment and production volumes and improved price realization partially offset by higher post retirement benefit costs. As you can see, margins were impressive.
The division had an operating margin of approximately 16% in the quarter and an an affecting the Ag business starting on Slide 8. On the heels of the recent commodity price increases, the outlook for most crop prices is up considerably for the 20 ten-twenty eleven crop year. Corn prices are being helped by project that 2,009, 2010 stocks in the U. S. And Canada will end 250,000,000 bushels below a year ago and fall another 150,000,000 bushels in the coming year.
Soybean exports have remained strong. Growing global consumption is expected to keep soybean prices at extremely favorable levels for the 'ten 'eleven crop. Global wheat stocks have tightened with lower winter wheat plantings as well as yield losses in Western Europe and to an even greater extent in the CIS. 2010-eleven cotton crisis remain well above the 'eight, 'nine levels, driven by the recovery in global demand and a reduction in the global cotton supply. Turning to Slide 9, 2010 U.
S. Farm cash receipts are now forecast to be up about 6% from 2 1,009 to about $317,000,000,000 That's about $4,000,000,000 higher than our last forecast and is driven by increased crop receipts. 2011 farm cash receipts are forecast to be slightly above the 20 10 levels. Sears outlook for the EU 27 is shown on Slide 10. The recent upward movement in grain prices might seem at odds with our rather subdued 2010 industry sales outlook for Western Europe.
No doubt, some customers are locking in crop sales at attractive prices, which should provide support for 2011. That said, industry sales of new livestock sector is still reeling from losses of prior years. Drought has hurt yields for customers in many areas and used equipment inventories conditions have sparked wildfires and the picture on the right depicts conditions have sparked wildfires and the picture on the right depicts some of the smoke from those fires visible from our Dama Dedevia facility outside outside Moscow. Last week, the USDA estimated the 20 ten-eleven FSU-twelve wheat production would be down about 23%. Some industry observers believe the losses could go even higher.
Although Russia is reporting success controlling the fires, the consequence of the severe drought and its impact on global grain markets won't be fully known for some time. Farm net income in Brazil and Argentina is on Slide 12. We continue to see good farm income from soybeans and sugarcane, the 2 crops that drive the bulk of equipment purchases in Brazil. Other positive factors include strong global demand for Brazilian commodities, a 5% to 10% decrease in input costs and strong government sponsored low rate finance programs that run through at least the end of calendar year 2010. Forecast for 20 10 farm net income in Argentina.
With milk and beef prices high, we continue to see increased demand for tractors, sprayers and forage equipment. Although too early to predict, we are closely monitoring the development of a La Nina weather pattern that could result in lower production and yields in 20 11. Highlights the latest additions to our tractor lineup in India. In June, we introduced the 5,036C and 5041C tractor model. These tractors were designed and developed in India with features tailored to the India market.
35 and 41 horsepower tractors joined the recently introduced 5,038 D D expanding our presence in the targeted 31 to 40 horsepower market. This horsepower segment makes up almost 50 percent of the tractor industry in India. Our 2010 industry outlooks are on Slide 14. Sales of agricultural books and have early order programs in place for our seasonal equipment. Although very early, the combine early order program is progressing well and as planned, in absolute numbers, orders are well ahead of last year.
In the sprayer, planter and tillage equipment programs, we are seeing strong results very similar to last year. Demand for large tractors has been strong as well. The 8R series tractor introduced last year has been very well received and we've continued to add schedule throughout the year. We are just now introducing the interim Tier 4 compliant AR to our dealers and are encouraged by the initial orders of over 1 1,000 units, well over half are retail sold with customer names on the order. Effective availability for 8R Series tractors is February 2011.
Effective availability for our 4 wheel drive tractors is November 2010. Earlier, we touched on are therefore lowering our industry forecast. We now expect ag sales to be down 15% to 20% in the year. Sales in Central Europe and the CIS are expected to remain under pressure. And based on the factors we covered earlier, we are increasing our industry forecast for South America to up 25% to 30%.
Turning to another product category, we expect retail sales of turf and utility equipment in the U. S. And Canada to be up 10% to 15% in 2010 from the very low levels of a year ago. We have seen an uptick in the commercial mowing, riding lawn equipment and golf markets. However, with general economic conditions still uncertain, our optimism for this segment remains tempered with caution.
Year.
Beer sales for worldwide ag and turf are now projected to be up about 8%
in the year. Currency translation on net sales is projected to be positive about 2 points. For the year, the AMT division's operating margin is forecast to be around 13%. The division continues to benefit from strong sales of large ag equipment in the United States and Canada with relatively weak sales in the Turf and Utility segment. In May's call, we said favorable mix added 1 point of margin to Ag and Turf's 2nd quarter results.
Now with our new forecast, for the full year, this favorable mix is expected to add about 2 points to the division's margin in relation to a typical year. Let's focus now on Construction and Forestry on Slide 16. Deere's net sales were up 59 percent in the quarter, while production tonnage nearly doubled being up 96%. The division reported operating profit of 66 $1,000,000 On Slide 17, although we are forecasting the U. S.
Construction industry to be down about 2 percent for the full year, we believe the market has reached its bottom. The business is experiencing a slow improvement. We are encouraged by the activity we have seen with independent rental companies and in the highway construction segment. Also encouraging, over the economic recovery persists and we have lowered our outlook for 20 11 housing starts. Meanwhile, global forestry markets are up significantly from the forestry markets are up significantly from the very low levels of last year and our factories have responded quickly to the increased demand.
We are now forecasting forestry sales to dealers to be up about 35% in 2010 from the very low levels of 2,009. The division's full year operating margin is forecast to be in the low single digits. Let's move now to our credit operations. Slide 18 shows the worldwide credit operations provision for credit losses as a percent of the total average owned portfolio. Year to date on an annualized basis, the provision is 49 basis points.
Up 9% to 10% since last fall. The full year provision for John Deere credit is forecast to run around 50 5 basis points, an improvement over our prior forecast of about 70 1 basis points. On Slide 19, past dues for the worldwide credit operations are lower than last year with construction and forestry being the main driver of improvement. Annualized write offs reflect a significant improvement in C and F losses. Moving to Slide 20, worldwide credit operations net income attributable to Deere were an improvement in financing spreads and a lower provision for credit losses.
These were partially offset by lower tax credits related to wind energy projects. Looking ahead, we are now projecting worldwide credit operations net income attributable to Deere and Company of about $325,000,000 in 20.10. Now let's turn our focus back to the equipment operations and take a look receivables and inventories on Slide 21. For the company as a whole, receivables and inventories were up roughly 4 $50,000,000 in the Q3 versus Q3 2,009. Keep in mind, we ended fiscal 2,009 with receivables and inventories at rock bottom level.
In fact, they were 1 $300,000,000 lower than at the end of fiscal 2,008. For fiscal year 2010, we are now forecasting receivables and inventories to be up about $950,000,000 This reflects higher production volumes in the 4th quarter versus the very low volumes in the Q4 last year. These higher production volumes are intended in part to facilitate the transition to interim Tier 4. They also reflect higher demand in the Construction and Forestry division and some ag and turf markets. Now let's discuss the latest on retail sales.
Slide 22 presents the product category detail in the U. S. And Canada for
the
Deer industry sales were down 2%, gear was down double digits. Combine industry sales were down 7% and slightly less than the industry. Looking at Deere dealer inventories in the bottom chart, for row crop tractors, Deere ended July with inventories at 18% of trailing 12 month sales. Combine inventories were at 19% of sales. Turning to Slide 23, in Western Europe, sales of John Deere tractors were up double digits and combines were down double digits in July.
Deere's retail sales of selected turf and utility equipment in the U. S. And Canada were up single digit in the month. Construction and forestry sales in the U. S.
And Canada on both the first in the dirt and settlement basis were up double digits for the month. Slide 24 shows raw material and logistics costs up about $10,000,000 in the quarter. We now forecast material cost decreases of approximately $150,000,000 for the year. By division, the Ag and Turf savings are forecasted about $175,000,000 For Construction and Forestry, the have been moving up recently and our cost increases typically lag the commodity market by 3 to 6 months. Now let's look at a few housekeeping items.
Looking at R and D expense on Slide 25, R and D was up about 5% in the 3rd quarter with currency translation accounting for negative approximately 2 points. Year to date, R and D expense is up about 6%. For the full year, R and D expense is expected to be up about 10%. We expect R and D spending to increase in the 4th quarter as we approach significant product launches with interim Tier 4 engines and remain at high levels over the next 3 years as we approach the final Tier 4 emission standards. Moving now to Slide 26, pension and OPEB expense in the 3rd quarter was up about $100,000,000 The 2010 forecast calls for an increase of about $350,000,000 in pension and OPEB expense, unchanged from our previous forecast.
We have had a slight change in the split between cost of sales and SANG. Of the $350,000,000 about $275,000,000 will hit cost of sales, but about $75,000,000 now in S A and G. Approximately $275,000,000 of the additional expense is attributable to the Ag and Turf division, while the increase for C and F is about $75,000,000 On Slide 27, and G expense for the equipment operations was up about 17% in the quarter. Variable incentive compensation accounted for about 8 points and currency translation added about 3 points. For fiscal 2010, we project SANG to be up about 9 points, unchanged from our previous forecast.
Variable incentive compensation is expected to account for about 5 points of the change as the company's performance has contributed to improve. Pension and currency translation about 1 point. Moving to the income tax rate on Slide 28. The 3rd quarter effective tax for the equipment operations was about 34%. The full year 2010 effective tax rate is expected to be 20 Q2.
Excluding the charge, the forecast effective tax rate for 20.10 would be about 34%. Before touching on cash flow, the combined effect of translation and transaction or trade flows increased operating profit by about $60,000,000 in the 3rd quarter, primarily in ag and turf. On Slide 29, you see the strong cash flow from our equipment operations even in years of tough market conditions like last year. Reflects in large part our success managing assets and controlling working capital levels. We anticipate cash flow from equipment operations of about $2,400,000,000 for the year, a $1,000,000,000 increase over 2,009.
Such strong cash flow is is further testament to our successful execution of the SBA model. As you can see on Slide 30, in accordance with our stated use of cash priorities, As Turning to slide 31, capital expenditures are expected to be about $850,000,000 for the year, primarily driven by the interim Tier 4 emissions rule. Depreciation and amortization is projected to be about $550,000,000 Our forecast currently includes about
$700,000,000
of 2010 on a strong pace. Our performance reflects somewhat more positive economic conditions and strong demand for large farm machinery, particularly in the United States. At the same time, John Deere remains focused on serving a growing global customer base, steadily increasing capacity, adding productive new models of equipment and successfully extending our competitive position throughout the world. As a result, we believe the company is exceptionally well positioned to benefit from a growing economy and help meet the world's increasing need for food, feed, fuel, shelter and infrastructure well into the future. Marie?
Thank you, Susan. We are now ready to begin the Q and A portion of this call. The operator will instruct us on the polling procedure. As a reminder and in consideration of others, limit yourself to 2 questions. And as always, you are welcome to get back into the queue.
Operator?
Thank Our first question comes from Ann Duignan. And please state your company
name. Hi, good morning, JPMorgan. Good morning, Ann. Hi. My first question is on the near term, your 4th quarter outlook.
Particularly on the Ag and Turf side, you noted that margins would be about 13%. That would imply a much lower margin in Q4 than I have been forecasting and much lower than Q3. Marie, I think you guys addressed it in the call, but I just want to make sure. Is are you anticipating a significant hit on gross margins because of the buildup of pre Tier 4 interim engines? Is that what maybe I was missing in my forecast?
Not directly Anne. In fact, instead of just addressing ag and turf, let me look at it for the full company in relation to our full guidance and just give you some of the numbers that are implicit in our guidance. With the increased profitability for the company incentive compensation is rising and in the Q4 over last year
it will be about a
$90,000,000 expense, again, very low levels of activity in the Q4 last year. Material, which has been either a neutral or a tailwind for us in the 1st 3 quarters of this year will be an expense in our projection, it's $75,000,000 R D, we have a pretty significant jump. That's why Susan called out the fact that year to date we're up 6%. For the forecast, we're up 10%. That's about $55,000,000 in the 4th quarter.
That is a lot of money and that is very much impacted by IT 4 as we're getting ready to enter into this very significant launch phase. And remember, we've got final Tier 4 falling on the heels in just like 3 years. Another factor is overhead absorption and we estimate that at about $50,000,000 I shouldn't say overhead absorption, it's overhead expense. We have a very significant spend in and D. Likewise, we have a very significant spend in capital expenditures ahead of us in the Q4 and that is disruptive to the factory efficiency as you bring new machine tooling in, as you train operators.
And so we've provisioned for that in our outlook. And then we the only other thing of note would be SA and G is a little higher as well.
Okay. That's very helpful. I just wasn't sure what I was missing there. And then longer term, I know you won't talk specifically about your outlook for 2011. I know better than to ask directly.
But could you talk a little bit about the overall global impact of, let's say, a negative impact in Russia because of the drought, what that might do to the protein sector in Europe and their input costs versus the positive impact it may have for U. S. Farmers and South America farmers. How are you looking at putting all of these pieces together as you look into 2011 and the health of global agriculture as we step forward?
There's no question that the recent run-in commodity prices driven by the events in the CIS and even into Eastern Europe certainly has supported the prospect for crop farmer income.
You are you correctly note that
me note that livestock sector is a little more concerned obviously with what's happened especially just having come out of 2 years of very, very difficult financial situations. It is not as likely therefore you will have much crop, much herd expansion globally in the face of these rising feed costs. But overall for the farm sector, it would appear to be very positive as you look into 2011. Some of the other factors though, Anne, that we are considering as we ourselves look into the future. Obviously, with the events of the last couple of weeks regarding the global economy, which seems to vary day by day, people are perhaps a little less certain than they were and that does raise a note of caution, especially a lot of talk about the U.
S. Economy, which would affect certainly our Construction Equipment business and our turf and utility and frankly even the small ag sector because a lot of that is economically sensitive because it goes into homeowners and large property owners, etcetera. The other thing that you'd want to think about is rising material rising commodity costs affecting our materials as we go into 2011. I mentioned in the first question that I was answering of yours that we had had a tailwind or neutral in the 1st 3 quarters of the year. That's worth about $250,000,000 If raw material costs just stay where they are today, obviously, that's something that would not be repeated.
And the other thing, I would just note is that we are going to be in the midst of this IT port transition. We are very encouraged by the early results on it, but nonetheless we've got some good orders as Susan mentioned on the 8 1000s, but it's very early. So you're really looking at a very small base. And so we'll see how that plays out as we look ahead. Jim, do you want to add anything?
No, I think that pretty much covered you.
How about pension? That's the one thing you didn't touch on for
going into the 11?
As pension looks today and of course all things are never equal, we probably because interest rates are looking little lower than they were at 31 October of 2009, you probably have a little bit of a headwind there as well, maybe CAD 75,000,000 But obviously, we're a long way from 31 October when we'll actually be setting the rates.
Yes. I appreciate that. Okay. Thanks very much. I'll get back in line.
Appreciate it.
Thank you. Our next question comes from Steven Volkmann. Please state your company name.
Hi, good morning. It's Jefferies.
Good morning.
I'm wondering, Marie, you gave some forecast for cash receipts in the U. S. And net income in Latin America. Can you just frame for us how you think European farmers are going to be looking at
improvement in commodity prices. You're hearing some stories of customers having locked in some good crop prices and selling their crops for good amounts of money. So we're encouraged. We still have used equipment to deal with, which is unknown exactly how that will impact the market as you move into 2011. We're starting to see a little bit of that equipment move.
Again, that's very encouraging, but there's a lot yet to be done, Steve.
It sounds like you're saying farm income probably up in 2011 in Europe. I don't want to put words in your mouth, but
I'm that'll play off against what happens ultimately with livestock prices and what happens to their feed costs. And livestock is about half the farmers in Europe have livestock. So it's significant to our customers.
Okay, great. Go ahead.
Sorry. And just a follow-up on the construction business. Obviously, we've seen a nice recovery there in top line and in margins. How much of that is sort of dealer restocking? And do you think that how much longer where are we in that game?
How much longer can that go?
There is actually not very much dealer restocking taking place. Mostly what's happening last year when the dealer sold maybe 3 units, he or she would replace 1. Now it's more 1 for 1 replacement. So very little channel fill. Jim?
Yes. I think construction, if we look at sort of history, it has a very long runway in front of it, because we are still at very depressed levels relative to mid cycle volumes. So, I think we have a situation where we're running roughly 60% of mid cycle volume. So we think there's plenty of runway there.
Great. That's
Our next question comes from Jerry Revich. Please state your company name.
Good morning. It's Goldman Sachs.
Good morning, Jerry.
Marie, can you say more about the drivers of your increased inventory and receivables guidance for ag and turf? What proportion of the increase is related to interim Tier 4 and which regions are driving the rest of the increase? Thank you.
You. Well, first of all, we're seeing strength in our construction and forestry business. So that is certainly a part of it. The other factor is just as we're getting closer to the 1st January, we're starting to land on some of our plans. So we know a little bit more precisely how some of the transitions are going to occur.
And also very candidly demand looking pretty good. I mean, again, it's very early you're looking at small numbers. So I want to be very careful we put this in the appropriate context. But the demand for the products, early order program seem to be going fairly well, again early. So that's encouraged us.
If you look at our tonnage increases for the full year and the fact that our 3rd quarter tonnage basically came in as projected that tells you it's all of that increase is really happening in the Q4. So it will take time for that production to actually translate into a retail because you've got to work it through the factory and into through the receivable. So we actually feel pretty good. Actually, Jim took a look at our receivables and inventories by historic standards and they look really quite good. Do you want to talk about that?
No, yes, I mean, it's a big increase when you look at it or perhaps could be viewed as a big increase when you look at it on a year over year basis. But if you look back on historical context, really this is receivables returning to levels that we last saw in 'eight and inventory actually that ends at levels are below the 'eight level. So I think that's hopefully provides some useful context when looking at that increase.
And Jim, good to see you buying back stock for the first time in a while this quarter. Can you update us on your framework for stock buyback? Are you going to be looking at it as a portion of your excess free cash flow or just update us on your broader framework? That would be great. Thank you.
Yes. Well, I appreciate that. Unfortunately, I think we can't say a whole lot beyond the notion that we've had a very consistently articulated use of cash policy and share repurchases is one of the things that we will look at from time to time based on our cash position and we did so in the Q3. I can't provide much more than that at this time. Thank you.
Thank you. Next question.
Thank you. Our next comes from David Rosso. And please state your company name.
ISI. Good morning. Thank you. My question relates to that last comment about the production in the Q4 and it will take some time to translate into retail sales. And just trying to think about the margins in the Ag division.
Two questions related to that then are, at what time in the order book can I no longer get pre interim Tier 4 tractor at a Waterloo? Are we ready into the market knowing when we officially are out of production slots for pre interim Tier 4?
Well, remember, we have a rolling product launch. So all that's announced so far would be the 8Rs. And if you would walk into your John Deere dealer today to order an 8R tractor, you will be ordering an interim Tier 4 tractor.
But my question though is the broader Waterloo product line?
We have not made any further statements other than the 8R.
Should it be terribly different than the 8R?
We haven't launched some of I mean, we so it's going to be a little while you could assume because we haven't said anything about the other some of the other Waterloo.
Okay. I'm just trying to think through the profitability of ag and turf in the 4th quarter and what's that implying about 2011? Because even if I do add back some of those year over year impacts from short term incentive comp up materials, overhead absorption and so forth, but also take the sales guidance for the year, it just seems like the implied I guess broader picture then for the whole company, the construction margins for the Q4, again, look around mid single digits get you to the kind of lower single digit for the year. How are you thinking about the profitability of that division? You took down the 11 housing starts, so you're still implying some pretty healthy growth in housing starts 'eleven versus 'ten.
Bigger picture, how are you thinking about
4th quarter specifically?
Well, you already can do the 4th quarter or you're implying So
we don't have any comments.
David, I'm sorry, I don't have any comments on 2011, if that's where you're going.
Well, broader, how should I be thinking about the 5% to 6% we've been seeing 3rd quarter, 4th quarter? How are you viewing that in the context of the profitability of the division broadly?
Well, considering that they're at under 60% of what typical volume would be, we think they are working very hard and have demonstrated very good expense control and efficiency. As they move up into what I will call the
opportunities will grow for profitability.
Okay. And then, opportunities will grow for profitability.
I think David too, when you look at that and you have some large percentage increases in sales, but if you look at the absolute dollar numbers and the incremental margin to understanding the performance that that division has demonstrated. And I think the other thing we would say, long term, the construction division has demonstrated over a long term what they can do and we would have every expectation that over time they would return to where they've been at other points in the cycle.
In a nutshell, that run you had from 2004 to 2007 in that division with solid double digit margins, I'm just trying to think through how quickly do you feel if we can get the revenue growth in 2011, is this structurally a double digit margin business in pretty short order or is it how you're thinking about mix for 2011 and then a lot of other things that is that a little too aggressive a ramp and how you're seeing the recent run rate?
First of all, I can't comment on 2011, but I would very adamantly, very vehemently state that we see no reason at all why this business does not return to margins that it Ag business in the near term, IT4 will affect them. Ag business in the near term, IT4 will affect them as well. They also have a staggered product launch that will be rolling out over the next couple of years. And so you'll have some impacts from that, but there this business is on very solid footing.
All right. Thank you very much. I
Our next question comes from Henry Kern.
It's UBS.
Good morning.
Could you chat a
little bit about the impact of the pre buy that your dealers may be reporting to you, at least on the equipment where you do where you will have Tier 4 out early next year?
As you look at what's happening, there's the very good level of cash receipts that we have in the marketplace and it's accentuated further, but frankly by the recent run-in commodity prices. You've got improved farm net income as expenses like fertilizer and various things have come in. We've got historically low interest rates, very good value proposition in the market. We feel that the underlying economic fundamentals are in good support of the level of activity that we've seen. As we are moving into closer to our launch date, there's no question that there is some pull ahead, but we believe the factors that I just mentioned do are really the primary decision drivers.
The other thing that you can again, it's very small numbers, but it could provide some comfort, if you will, is the fact that the early order positions are looking good on some of our products and the especially perhaps more profoundly that the IT-four-eight has a good order bank, again, very early in the year and very early in the launch, but it's actually been very encouraging.
And on the construction equipment side, philosophically, would you be willing to build some inventories at some point in front of expected rebounded demand from the rental guys and other contractors?
Our philosophy is to produce to retail demand. In construction, actually, it's slightly different set of circumstances. As you're aware, in construction, in some areas, you are required to use the latest technology. So you need to be if IT4 engines are available you need to be using that. Additionally, the bulk of the construction product line really is below 175, so that's not horsepower.
So that's not going to be affected until 2012. And the other thing is very frankly, we're at extra levels of activity and you don't see contractors, a lot of contractors with the financial confidence to go out and buy equipment that they may or may not use. The only indications where you may have a little bit of pre buy ahead is in motor graders and some governmental segments. So that's pretty small.
Thanks a lot.
Thank you.
Thank you. Our next question
comes from Meredith Taylor. And please state your company name.
Hi, good morning. It's Capital.
Good morning, Meredith.
I'm just going to go back to the ag and turf margin topic. I appreciate the fact you've laid out a lot of the headwinds that you're looking at Q4 versus Q3. Something that I'm hoping you can talk a little bit more about though is the role that mix productivity played in the Q3 for this business and what your expectations are as we look ahead to the Q4? I know you did note some overhead headwinds associated with interim Tier 4, but if you could just talk about those two items in particular, Q3 versus Q4, that would be helpful.
Absolutely. In the Q3, we did not make a comment specifically year over year on mix. Relates to a typical year. So we're not looking at something that because remember we had a very good mix of large ag in 2,009 as well. So wouldn't really be a year over year as a factor.
If you looked at the Q3 and said just generally how does that compare to a typical year then yes it would be about 2 points. If you look at absorption, last year in the Q3 we dropped receivables and inventories. I think it's like $1,700,000,000 and this year it was, I don't know, dollars 3,000,000 or $400,000,000 So there is a favorable absorption impact in our Q3 results and that is for the Ag and Turf division, it's $90,000,000 in their operating margin.
Okay. And then as we roll forward to 4th quarter, how should we think about mix there and then continued benefits from lean operational initiatives, etcetera?
I don't have a comment per se on mix. I know some of the smaller stuff is coming up in the quarter, but I don't know what the actual impact is. And actually in
terms of the efficiency of the operations, as we said, we have a lot of transition going on and we do have some manufacturing inefficiencies built into the forecast for the Q4, reflecting the very significant amount of change that's going to be occurring over this period of time and some pretty significant capital.
Okay. And just a quick follow-up on LatAm. As I've looked at the ENPOVATE data over the last couple of months on the combine side of the market, I've noticed some volatility in terms of your wholesale numbers. Could you talk a little bit about what might be driving this?
Yes. On the combine side, we converted to SAP on the 1st May. And so we knew that we would not have shipments into the marketplace as we were making that transition. And so what you're really seeing is a we're in a transitional period of we I mean, we're behind those transition issues are behind us, but you're seeing the results of having just now restarting the shipping. So it was planned.
Okay, great. Thanks so much. Thank
you. Next question.
Thank you. Our next question comes from Eli
Longbow Securities. Good morning, everyone.
Good morning.
It's funny, we're all having trouble with the 4th quarter. Maybe put in the context that we haven't gotten the 1st 3 quarters anywhere close anyway. So I know it's true, but that's what having everybody you listed a $270,000,000 worth of impact, but a large part of those things that you us material R and D that were known to be bigger in the Q4. Anyway, we've known that. So can you give us some of it much bigger than we had expected?
Could you still can't get the margins almost cutting in half unless you put in either a huge impact from the transition products and the launches, what have you, who is putting into the guidance at this point. That's the trouble we're all having at this point. So something else going on, did you put more in the quarter in these costs than we expected? So we knew they were all going up in the Q4. R and D was going to be higher in the Q4.
We knew that from your guidance before as were material costs. So it can't be that something has to be driving the margin almost in half, which is what you're forecasting from the Q3. And the only thing I can think of, yes, you have
more I can turn from you. The only other thing I can
think of is that you've got a lot of inefficiency in from the new product launches in new models and all those foot clean.
That's kind of what we're trying to pick up with that $50,000,000 overhead, if you will. The incentive comp probably is higher than maybe what you were expecting because
of course we've upped our
doesn't convert immediately into sales and so you don't get the margin the marketing margin on that. There may a little bit of that as you guys are thinking about your modeling. Jim, do you have anything to add?
No. No. I think the incentive comp is certainly increased over what we had initially had laid out in the Q4 as the income forecast has approved, most of that's gotten caught up.
The other thing that I haven't mentioned is taxes and taxes in the quarter that might that are about the 50 dollars 1,000,000 It's very hard to calculate the tax rates between the Q4 of last year and the Q4 of this year. So I'll just tell you point blank that's approximately the net impact. It's higher tax is about €50,000,000
if that helps. Yes. And can we ask one other question on looking at 2011 production capability and pricing, Prices have been announced, the new product has been relatively strong. So we're looking into next year, pricing going up for what you have announced and the cessation that we're going to see more. How much more production capability will you have for a lot of these models, because for the most part, we're told that you sold out for this year and mostly the big product line.
How much more incremental production capacity we have next year? And is this pre buy that we're talking about actually can be a rolling pre buy in this market because interim Tier 4 gets phased in over a couple of years and the price is clearly going up materially as products goes
on?
It is true that we have a rolling launch. Again, we're not sure how much pre buy there is occurring because the economic factors seem to support the level of activity that we are experiencing. And you've got good orders following into 2011. But you are correct that it will be a series of rolling launches both on the ag and construction side. If that helps, had not put in all of the capacity that had been approved in 2,008.
They put in I don't know if you recall, but it was about a 40% increase and they had about 25 points of the 40 in and I expect that the remaining 15 will be available. I don't know if by the end of this year, but sometime in the not too distant future. So that will provide some additional assistance. Harvester had a 30% capacity increase that was in place really by really would have been fully available to us this year. And so that's there and ready to be used as required.
And then there have been capacity adds in other facilities as well.
So we're talking about at Waterloo probably another 10% to 15% incremental production available next year that we didn't have this year?
On that, well, 40 points, yes, maybe 10.
All right. Thank you.
Thank you. Our
the production tonnage adjustment, so your Q3 outside North America was below forecast, but then you raised your forecast for the full year. Can you just talk about where that's coming from?
Europe would have been in Brazil is very strong and in South America, I guess, I should say, and so you would have some opportunity there.
Okay. So you're thinking the Q4 Latin America would have been stronger than you would have thought last quarter?
Yes. And I'm not sure how Europe plays out in this. You're not talking huge numbers.
I'm sorry?
We're not talking huge numbers here.
Okay.
I mean, I think the change is 23% to 24%. So it's really in the margin and in terms of the full year. So, and the other piece of course that's been very strong and we mentioned it a little bit is the global forestry markets and so there would be some production being added there as well.
Okay, that's helpful. Thank you. And then just I think Susan mentioned that your visibility into your visibility into Brazil or Latin America financing right now is kind of through December, but the program is through December. Could you handicap or help us? Are you hearing anything about that getting extended or just tell us what your current thinking might be as far as next year?
We believe that we will not know what the outcome of that will be until after the elections. In our planning, we're assuming that interest rates could rise from the current 5.5%, but that they would be unlikely to go all the way up to a market rate, which the and the rate before these
current low rate programs
that come into place was 9.5%. And so perhaps you've got closer to 9.5%, but maybe not all the way there. So we I don't have an exact number to give you, but I can tell you that in our own financial planning as we're looking into 2011, we're going to assume that those the 5.5% does end at the end of December and that the rate goes up a bit. Now the impact though for us will be delayed actually for the industry because the customer can make a contract by the end of the year having entered into a contract at the 5.5 percent and we can deliver, I think it's I'm not sure if it's 60 or 90 days still. So for us, really effectively, our first and second quarters or at least a good chunk of the second quarter would be still effectively benefiting from that 5.5%.
Okay. That's helpful. Thanks for the clarification.
Thank you, Seth. Next. Thank you. Our next question comes from the line of Matt.
I'm sorry, I think this is going to be our last question.
Thank you. Our final question will come from Joel Tiss. Please state your company name.
Hi, from Buckingham Research. Just
wondered if
you could, in terms
of the Q4 incremental margins, other people have asked about that, but can you just talk a little bit about the flow of production versus the inventory drawdown and just so we can get a sense of what else is what else may be going on there?
I'm not sure I know how to answer that question, Joel.
So is there less overhead absorption baked into your numbers because you're going to under produce retail to clean out the old 2000 and 9, 2010 inventories?
No. Really the additional overhead that we are talking about really is just additional expense from rearranging production lines, the disruption that you have when you may have additional overtime because you have to bring people in to reset lines because you're adding a new piece of tooling or making some factory rearrangements. So it's really more related to that. Jim, can you help?
No, I would agree. I mean, if you look at the absolute levels of absorption, they'll be higher than it's been a year ago. But where we're losing it at is more on the spend side of the overhead equation.
And is that higher level of expenses going to flatten out as we go into 2010 I mean 2011, I'm
sorry. Again, I don't have we don't have a forecast for 2011. We will have a staggered series of launches and I don't know how all of that will play out. We'll when we have our we don't we ourselves do not have our budget process done for 2011. So we'll see how that ultimately plays out.
Maybe I could just end with a note that although there are lot of things going on in the Q4 in terms of our guidance, I still want to point out that 375 dollars, which is our guidance, is would imply our 2nd highest 4th quarter ever. And that's despite these the start of these launches and some additional expenses and the fact that you have weak markets in Europe and the former CIS and construction and forestry, although recovering as we mentioned, still below 60% of typical. So we are very, very proud of the results that we are delivering and we hope to deliver. And with that, thank you all for participating in today's call, and we will be available the rest of the day to answer your questions.