Good morning, and welcome to the Deere Second 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 ahead.
Good morning. Also on today's call are Jim Field, our Chief Financial Officer as well as Susan Carlick and Justin Marabek from the Deere Investor Relations staff. Today, we'll take a closer look at Deere's 2nd quarter earnings and then spend some time talking about our markets and how we see the second half of the year shaping up. After that, we'll respond to your questions. Please note that slides are available to complement the call this morning and they 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 Thompson Reuters. Any other use, recording or transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited. Participants in today's 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. The 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 these 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 or 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. And finally, this call will include financial measures that are not in conformance with accounting principles generally accepted in the United States of America known as GAAP. Additional information concerning these measures including reconciliations to comparable GAAP measures is posted on our website at www.johndeere.com under Financial Reports, 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 the call. And now for a closer look at the Q2, here's Susan.
Thanks, Marie. John Deere's strong performance continued in the Q2 of 2010. Earnings were up 16% on a sales increase of 6%. Results would have been higher without a charge related to the recent enactment of U. S.
Healthcare legislation. The quarter's improvement was broad based. The gain was led by ag and turf, but all three divisions had higher profit. Among the highlights, our Construction and Forestry business saw its 1st year over year profit increase in 9 quarters. Solid execution of our business plans was again a big story for the quarter as was disciplined costs and asset management.
Trade receivables and inventories declined by some $900,000,000 Finally, in line with improved business conditions, our full year earnings forecast has been increased and now totaled approximately $1,600,000,000 All in all, it was a productive quarter and John Deere seems well on its way to a very good year. Let's look at the quarter in more detail starting with Slide 3. This is a supplemental slide illustrating the impact of the tax charge for U. S. Healthcare legislation taken in the quarter.
Excluding the approximately $130,000,000 charge, net income attributable to Beer and Company would have been $677,000,000 or 1.58 dollars per share. On Slide 4, we show that net income attributable to Deere and Company on a reported basis was 5 $47,000,000 As we mentioned, that was a 16% increase in profit on a 6% increase in net sales and revenues. Turning to slide 5, total worldwide equipment operations net sales were up 6% to $6,500,000,000 Deere's 2nd highest sales on record in the 2nd quarter. Currency translation on net sales was positive by 4 points and price realization was positive by 2 points. Both equipment divisions had positive price realization in the quarter.
Turning to Slide 6, worldwide production tonnage was up 7% in the quarter. Construction and forestry tonnage was up considerably in large part easy comparison with the Q2 of 2009 when tonnage was down 62% from the previous year's level. In addition, improving global economic conditions, better pulp prices and low field inventories are benefiting the forestry segment in 2010. Tonnage outside the U. S.
And Canada increased due to strength in Argentina and Brazil, China, India and Mexico. For the full year, worldwide production tonnage is now forecast to be up about 11%. Let's turn to the company outlook on Slide 7. 3rd quarter sales are expected to be up 21% to 23% compared with the Q3 of 2009. In the financial forecast, currency translation on net sales is expected to be positive by about 2 points.
For the full year, net equipment sales are forecast to be up 11% to 13% compared with fiscal year 2,009. This includes about 3 points of positive currency translation and approximately 1.5 points positive price realization. This is in line with our previous guidance of 1 to 2 points. Net income attributable to Geer and Company is now forecast to be about $1,600,000,000 for the year versus our prior guidance of about $1,300,000,000 dollars That includes the 2nd quarter tax charge of approximately $130,000,000 for U. S.
Healthcare legislation. Turning to review of our individual businesses, let's start with Ag and Turf on Slide 8. In the quarter, net sales were up 1% and so was production tonnage. Operating profit, however, improved by nearly $250,000,000 or 35 percent to $952,000,000 The increase was primarily due to improved price realization, higher production volumes, the favorable effects of foreign exchange and lower raw material costs. These factors were partially offset by higher post retirement benefit costs.
You might notice we didn't include the A and T incremental margin this quarter. It calculates at about 4 98% due to the very large swing in operating profit on the small increase in sales. A and T executed well with an operating margin in the quarter of about 17%. The decision is benefiting again this year from strong sales of large ag equipment in the United States and Canada. Compared with a normal year, a favorable mix contributed 1 point of margin in the quarter.
Before we review the sales outlook, let's look at some of the fundamentals affecting the Ag business starting on Slide 9. Commodity prices for the 'nine-ten crop have remained steady at attractive levels since our last forecast with soybean seeing an improvement. Soybean exports have remained at good level despite strong South American crop and the good weather we have been experiencing here in the U. S. Tends to favor more corn planting.
Cotton prices remain well above year ago levels driven by strong Chinese demand and a reduction in the global cotton supply. On Slide 10, we have included Deere's estimate of U. S. Acres planted for 20 ten-2011. They are the same as the USDA estimates.
Corn acreage is expected to increase 2.3 1,000,000 acres to 88,800,000 in order to meet growing demand for feed, exports and ethanol. Turning to slide 11, 2010 U. S. Farm cash receipts are now forecast to be up about 5% from 2,009 levels, a slight improvement from our last forecast. Livestock is driving the increase in 20.10 receipts.
The industry should finally expect profits this year after 2 years of losses. As you can see, 2011 farm cash receipts are expected to be up slightly from 2010 levels. Here's outlook for the EU27 is shown on Slide 12. We are beginning to see stabilization in this market, but at very low levels. We don't expect any real recovery in 2010.
Farmer sentiment in the region remains negative. Small grain, pork and beef prices are expected to remain under pressure and used equipment inventories remain at high levels due to the lack of product going to Central Europe. The industry forecast for 2010 unit tractor sales is slightly below level seen during the last recession in the early 1990s. Slide 13 highlights farm net income in Brazil and Argentina. Income from 2 main crops soybeans and sugarcane drive the bulk of equipment purchases in Brazil.
So going forward, we will provide a breakout of these 2 crops when discussing farm net income. Corn, paddy rice and cotton make up the other category. 2010 farm net income is driven by the strength in sugar due to a drastic drought driven reduction in output from India and China. Demand for sugar though is only part of the story in Brazil. Other positive factors include demand for Brazilian commodities globally as well as government sponsored low rate finance programs like tsunami and masa Alamitos.
These are all contributing to positive producer attitudes, which translate into higher spending on farm equipment. In April, the Brazilian government announced the Fonami financing program would be extended through the end of December. For loans taken through the end of June, the interest rate will remain at 4.5%. For loans taken from July through December, the interest rate will be 5.5%, still an extremely attractive rate in the Brazilian market. Argentina is recovering from the severe 2,009 drought with ag commodity production up over 40% in 2010.
With farm net income about $6,000,000,000 higher than 2,009, we are seeing increased demand for tractors, combines, sprayers and forage equipment. Clearly, the markets are improving and there is a lot of good news out of Brazil. The next two slides illustrate the long term potential we see in the country. Slide 14 shows Deere estimates for planted acres and production of soybeans in Brazil over the next 8 years. Planted acres are expected to increase about 45% and production about 60%.
The story is similar for sugarcane. On Slide 15, you can see we expect sugarcane planted acres to increase about 65% and production about 55%. To take advantage of this opportunity, Deere opened a tractor factory in Brazil in 2,007 to complement our combine factory. And in 2,008, we announced an 80 $1,000,000 expansion adding capacity to both factories. Of course, we didn't undertake this without the buy in of our dealers who are committed to representing John Deere and willing to invest in their own businesses.
Moving to Slide 16, you can see we have added almost 70 dealer locations in the last 6 years. And on Slide 17, we have expanded our product offerings to meet the needs of our customers. In fact, in 20102011, we will add 50 new or updated products to our lineup covering a broad array of categories from tractors and combines to turf equipment and precision technology. It's an exciting picture for Brazil and it's clear why Deere and its dealers are looking forward to the opportunity that lies ahead and to serving our growing customer base there. Turning to another great opportunity for John Deere, as you can see on Slide 18.
On the heels of a slight pickup in activity and loosening of liquidity in Russia, John Deere celebrated the grand opening of Astama Dyadava manufacturing a part center outside of Moscow last month. We began limited assembly of large tractors, combines, motor graders and 4 wheel drive loaders. Slide 19 highlights our 2010 industry outlook. Sales of agricultural equipment in the U. S.
And Canada are now forecasted to be up 5% to 10%. That's quite a change from our February forecast of comparable to 2,009 and our November 2,009 forecast of down about 10%. We continue to see our order book strengthen, especially for large ag equipment. Remember, the combine early order program ended in January with a significantly higher than expected response rate. Demand for large tractors has been higher than expected as well.
The new 8R series tractor has been very well received in the marketplace. We have continued to add schedule throughout the first half of the year and effective availability is November 2010. Effective availability for the 9,000 tractors is September 2010. Conditions in Western Europe remain weak with ag sales there still expected to be down 10% to 15% in the year. Although Russia is up slightly, other countries in the region remain down.
Sales in Central Europe and the CIS are expected to remain under pressure. And based on the factors we covered earlier, South America is now projected to increase about 25%. Turning to another product category, we expect retail sales of turf equipment and compact utility tractors in the U. S. And Canada to be up 5% to 10% in the year.
We remain cautiously optimistic for this market as we have witnessed a slow steady movement in the right direction. Economic indicators are improving, weather has been favorable for sales and we have had a very good start to the all important spring selling season. Putting this all together on Slide 20, beer sales for worldwide ag and turf are now projected to be up 9% to 11% in the year versus our previous forecast of up 4% to 6%. Currency translation on
net sales is projected
to be positive about T operating margin is forecast to be around 12% to 13%. Let's focus now on Construction and Forestry on Slide 21. With dealers replenishing their fleet and global forestry market strengthening from a very low base, Sears net sales were up 52% in the quarter. Production tonnage was up 82%. The division reported an operating profit of $36,000,000 due to the very large volume increases from last year's very low base and positive price realization, C and S incremental margin was about 36%.
On Slide 22, although we are forecasting the U. S. Construction industry to be down about 5% for the full year, we feel the market has reached its bottom. We are encouraged by a number of positive developments. Independent rental companies are in talks and in some cases beginning to purchase earthmoving equipment.
Also, Deere dealers are starting to see an improvement in rental utilization and used equipment turns. As mentioned earlier, global forestry markets are improving with pulp prices up significantly from last year and U. S. Lumber production increasing. On Slide 23, construction and forestry sales are now expected to be up about 30% in 2010 from the very low levels of 2,009.
Our previous forecast was up about 21%. Our forecast now has P and S operating margin slightly above breakeven for the year. Previously, the division had been forecasted to lose money. Let's move now to our credit operations. Slide 24 shows the worldwide credit operations provision for credit losses as a percent of the total average portfolio.
Year to date on an annualized basis, the provision is 52 basis points. In the first half of the year, write offs in the construction and forestry portfolios have been considerably lower than expected. We are encouraged by improvement in recovery rates and increased pricing on repossessions. However, we do continue to have high levels of repossessions and delinquent accounts. Consequently, we remain conservative in our forecast provision.
The full year provision for John Deere credit is forecast to run about 71 basis points, which is an improvement over our prior forecast of about 88 basis points. On Slide 25, past dues for the worldwide credit operations are about flat with last year. Another promising sign is the C and F revolving charge and financing lease past dues are all lower than a year ago. Annualized write offs continue to reflect the excellent performance of our Ag portfolio coupled with improvements in the other portfolios. Moving to Slide 26, worldwide credit operations net income attributable to Deere and Company was $84,000,000 in the quarter versus $68,000,000 last year.
The biggest factors were an improvement in financing spreads, a lower provision for credit losses, growth in the portfolio and higher commissions from crop insurance. These were partially offset by lower tax credits related to wind energy projects and higher SANG. Looking ahead, we are now projecting worldwide credit operations net income attributable to Deere and Company of about $300,000,000 in 2010. Now let's turn our focus back to the equipment operations and take a look at receivables and inventory on Slide 27. For the company as a whole, receivables and inventories were down roughly $900,000,000 in the second quarter versus Q2 of 2009.
We are now forecasting receivables and inventories to be up about $700,000,000 for the year. The increase of $250,000,000 from our outlook last quarter is a result of increasing production levels especially in the 4th quarter. Now let's discuss the latest on retail sales. On Slide 28, you see the product categories for U. S.
And Canada for the month of April expressed in units. For utility tractors, industry sales were down 6%, beer was down low double digits. Row crop tractor industry sales were up 6% and beer was up less than the industry. 4 wheel drive tractor industry sales were up 40%, Deere was up more than the industry. And for combines, industry was up 21%, Deer was up a single digit.
Looking at Deer dealer inventories in the bottom chart, Rowcrop Tractors, Deere ended April with inventories of 18% of trailing 12 month sales. Combine inventories were at 8% of sales. Turning to Slide 29, in Western Europe sales of John Deere tractors were down a single digit and combines were down double digits in April. Deere's retail sales of selected turf and utility equipment in the U. S.
And Canada were up double digits in the month. Construction forestry sales in the U. S. And Canada on both a first in the dirt and settlement basis were up double digits in the month. Slide 30 shows raw material and logistics costs down about $70,000,000 in the quarter.
We now forecast material cost decreases of approximately $100,000,000 for the year. This is slightly lower than our previous forecast reflecting higher commodity price projections for inputs like steel. By division, the ag and turf savings are forecast at about $125,000,000 For Construction Forestry, we are now forecasting a material cost increase of about $25,000,000 This is due to the currency impact on partner products and higher steel prices. Now let's look at a few housekeeping items. Looking at R and D expense on Slide 31, R and D was up about 4% in the quarter with currency translation accounting for about 1 point.
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 13%. We expect R and D to ramp up in the second half of the year due to interim Tier 4 durability build and feasibility testing on products that have interim Tier 4 production dates after 2011. Moving now to Slide 32, pension expense in the 2nd quarter was up about $70,000,000 The 2010 forecast calls for an increase of about $350,000,000 in pension and OPEB expense, which is down from our previous forecast of about $400,000,000 Of the $350,000,000 about $300,000,000 will hit cost of sales leading about $50,000,000 in S and G. Approximately million of the additional expense is attributable to the Ag and Turf division, while the increase for C and F is about CAD75 1,000,000 On Slide 33, SA and G expense for the equipment operations was up about 8% in the quarter.
Variable incentive compensation accounted for about 5 points and currency translation added about 3 points. For fiscal 2010, we now project SANG to be up about 9 points. Variable incentive compensation is expected to contribute about 4 points of the change as profitability improves. In fiscal 2009, when profitability was lower, variable incentive compensation was about 6 points lower than it was in 2,008. Pension in OPEB accounts for about 2 points and currency translation about 2 points.
Moving to the tax rate on Slide 34, the 2nd quarter tax rate includes the charge for U. S. Healthcare legislation of about $130,000,000 For 20.10, the full year effective tax rate is expected to be about 40%. This includes the $130,000,000 charge. Excluding the charge, the forecast effective tax rate for 20.10 is 34% to 35%.
Before touching on cash flow, currency movements both translation and transaction or trade flows increased operating profit by about $80,000,000 in the 2nd quarter predominantly in Ag and Turf. On Slide 35, you see the strong cash flow from our equipment operations even in years of tough market conditions like 2,009. This reflects in large part our success managing assets and controlling working capital level. We anticipate strong cash flow from the equipment operations in 2010, about $2,500,000,000 up from last year's $1,400,000,000 Such strong cash flow is further testament to the successful execution of the SBA model. On slide 36, capital expenditures are expected to be about $900,000,000 for the year, primarily driven by interim Tier 4.
Depreciation and amortization is projected to be about $550,000,000 Our forecast currently includes about $600,000,000 of pension and OPEB contributions in the year. In closing, John Deere has reached the halfway mark of 2010 on a strong pace. We're looking forward to delivering a solid second half of the year. Our performance no doubt reflects some improvement in overall economic conditions. It certainly reflects strong demand for large farm machinery in United States and other key markets.
By the same token, we are benefiting from the solid execution of our operating and marketing plans, allowing us to quickly capitalize on these positive moves in the marketplace. We've been quite successful extending our competitive position as well, increasing capacity and adding productive new models of equipment to serve an expanding global customer base. As a result, we believe our company is well positioned to benefit from a growing worldwide economy and to continue delivering value to our customers and investors for the long haul. Marie?
Thank you, Susan. We are now ready to begin the Q and A portion of this call. The operator is going to instruct us on the polling procedure. As usual, however, I ask that you respect the rest of the audience participants and ask 2 questions, a limit of 2 questions, No follow-up in that limit. If you have additional questions, you are of course welcome to get back into the queue.
Laura, we're ready. Thank you.
Our first question comes from Robert Wertheimer. Please state your company name.
It's Morgan Stanley. Good morning, everybody.
Good morning.
Two questions. It's tough on such a good quarter. So let me see on the ag margin, I wanted to ask first, is there anything particularly abnormal in price cost? Is this just where the lower materials flow through and you got the pricing and so that would erode or is maybe some of the old commercial consumer margins coming up?
Are you talking about in the quarter or in our guidance?
The quarter. Beg your pardon.
In the quarter, we are experiencing some improvement obviously in market conditions for the old turf. But you're absolutely right that pricing was positive. We talked about 2 points for the company and raw materials was also a positive.
Let me ask in Brazil then for the second one. Your share has been very good in the past couple of years. It was a little less good in the past 3, 4 months on high horsepower tractors is what I'm talking about. I know that's lumpy, but is there been any have there been any production issues and when are the new models all launching that should help that as well?
There have not been any production issues, but you are correct that we are in the process of a transition. I don't have the exact dates on the individual models and a couple actually come in from other markets. But we you need Rob, as you well know, you need to look at market share over a long period of time. You have normal ebbs and flows. We feel very good about the positioning of our product line, especially now that we have these new products available.
All right. Thank you.
Thank you.
Next. Thank you. Our next question comes from Jerry Rebich. Please state your company name.
Good morning. It's Goldman Sachs.
Good morning, Jerry.
Marie, can you please talk about the drivers of the production ramp in your international ag facilities? How much of that is to support the transition to Tier 4 interim versus stronger production for North America, Brazil and Russia? Thank
you. For international factories, in terms of producing for the U. S, there would be some with medium sized tractors in particular. They're coming from markets like Mexico and Manheim. So there would be some activity there.
Most of those products though, I think virtually all would not be subject to IT IV requirements until starting in 2012 because of the horsepower breaks. And if you recall, the IT IV breaks at 175 for 2011 and then below 175 in 2012. Does that answer your question, Jerry?
Absolutely. And Marie, on the R and D side, Susan alluded to the step up in investment in the back half of the year. Should we look at a similar pace of investment
going forward until the full Tier 4 interim
product rollout is
back because there is just an enormous number of launches ahead of us.
Thank you very much.
Thank you, Jerry. You. Our next question comes from David Raso. And please state your company name.
ISI. My question relates to the guidance. The first half of the year you had sales of $10,800,000,000 and the second half you're guiding to 12.6 $1,800,000,000 of sales growth sequentially I'm talking.
Yes.
And on the segment profits, the first half you did about 1,300,000,000 dollars the back half guidance roughly implies $1,200,000,000 So again, we're saying sales are going up $1,800,000 sequentially, but profits go down $100,000,000 Now I could see the R and D first half to second half does go up $100,000,000 You get a little D and A help, a little pension help, but let's call that 100, I understand the 1.3 going to 1.2. But on the revenue growth of 1.8 dollars if I think of a typical incremental margin of 25% that you would get that you're saying we're not going to get at all. Sequentially, not year over year, sequentially that's implying your price versus cost in the back half of the year is like negative 3%.
Our raw materials in the back half of the year are expected to be a negative of approximately $170,000,000 that's what's implied in the guidance in those final 6 months.
Well, that's year over year though. I'm talking sequentially. Do we think price versus cost is that negative?
Yes, because we've had favorable price or favorable raw material costs in both the 1st and the second quarters. We had two points of positive price realization in both of for the company in both the first and the second quarters in our guidance David, which is as Susan pointed out is unchanged. We're looking at for the full year about 1.5 and that implies to be a little less in the second half of the year. You have higher S and G as we move into the back half of the year
too. But again, sequential is different than the year over year. In the channel, we learned that you did raise price in April and it depends how quickly you can ship what is under the old pricing with the new pricing. Can you help me understand price versus cost, are there pricing actions that you're taking, including we heard you weren't price protecting orders from dealers for their inventory, but you are protecting of course customer invoice.
Can you
help me understand the price versus cost better than on your pricing actions? I
did not. At the time that we announced the price increases, we pretty much had a full order book close for tractors. And as you know, we were long since done with the combine early order program. So those there are very modest benefits to us in the Q4 in terms of price realization from those actions. So there'll be more evident as you move through 2011.
That's helpful. Okay. Thank you very much.
Thank you, David.
Thank you. Our next
I guess, earnings power, particularly in the Ag and Turf division. I guess I'm assuming that the turf margins are still well below the ag margins. And so it looks to me like this was actually a record quarter for ag margins going back as far as my model actually back to 85. But where do you think we are on sort of percent of normal in ag? And is there any reason we shouldn't be thinking of this business as getting close to 20% at the peak in terms of EBIT margin?
You might be surprised when I tell you where we think we are relative to normal in worldwide ag and turf. And we think we're actually below average. Where we are very strong is in the United States and Canada, specifically in large ag equipment. But in many other areas, we are very low, as we've talked about in Europe and in Russia, for example, and although recovering in the smaller products like compact utility tractors and the turf and etcetera, etcetera. And you have Brazil recovering or I should say maybe more broadly South America recovering, but still not to the very high levels or the good levels that they would have been.
So that so as we think about where we are relative to our total opportunity, we would tell you that we're again below our average sales opportunity. That said, Susan did point out that we are benefiting in the quarter and actually this would be true for the full year by about a point because of the heavy mix of large ag equipment. We also have good pricing as we talked about in the quarter and a tailwind on raw materials that will slip the second half of the year. You're right, by our calculations going back that 17% is very, very strong and compares against we as we calculate our previous peak in the second quarter would have been about 15%. So I would say there is additional upside certainly in terms of volumes to summarize, but you do need to bear in mind that we have a very favorable mix of large equipment and it's worth about 8 points.
And again, I want to emphasize that point is not year over year we've seen this favorable mix really in 2,008 to some degree and certainly 2,009 and this year. Does that help?
Okay. It does. But just to push you a
little bit, I mean, if we can get all these markets recovering globally, won't that be enough to more than offset the one point of mix that we have here and margins should be structurally higher?
Well, I would tell you that we are aspiring in this business to get ourselves to about a 14.5% margin. That would be over a full year, obviously, not in each quarter. And so we have a little bit of work to do. And but we are very focused on improving that return.
Okay.
Thank you.
Thank you. Our next question comes from Ann Duignan. Please state your company name.
Good morning. It's JPMorgan and it's Greg Williams sitting in for Ann Duignan. Hello.
You guys have $3,600,000,000 in
cash this quarter versus about $3,400,000,000 last quarter. What are your priorities for excess cash going forward? Yes, I'll take that. We have for some period of time had a very well articulated and consistent use of cash policy, which is number 1, we're firmly committed to the A rating. Number 2, we're going to continue to make the requisite investments in the business to continue the long term viability and sustainability of the business and extend our competitive advantage.
And number 3 is, we will look then once we've appropriately satisfied the first two and once we're comfortable that we are carrying enough liquidity given what's going on in the external market environment, particularly the capital markets that we will look from time to time at number 1 for giving a moderately increasing, but very steady dividend to our shareholders and also we'll explore repurchases from time to time as an alternative means of distributing cash beyond that cash strategy. We're not going to say a whole lot more in terms of when we might move into the 3rd step of that use of cash strategy.
Okay. And did you guys see any pre buy activity in
the past quarter and are you seeing any today?
You're talking specifically about IT4?
Yes, in North America.
Well, in the it's very, very hard to call out and say that this is IT4 related or not. If you look at the Ag business, we have a very successful launch of the new 8R series products. It's been extremely well received in the market. You have strong farm cash receipts, improved net farm income, got interest rates at historically low levels. And we again, we believe that year provides generally a very good value proposition to the marketplace.
We have updated our dealers about the general requirements of upcoming emission requirements and have assured them that our strategies are providing good value, quality, reliability, etcetera, will remain unchanged. But again, it's just very difficult to pinpoint the specific impact of IT4. If you go to the Construction and Forestry division, there the division is at such low levels of activity. It's hard to argue that there is any pre buying, although again I can't preclude it because I can't definitively tell you. I can tell you that where they are seeing some pickup from rental houses for example has been in the lower the smaller stuff, stuff below 175 horsepower.
So that's not subject to the start of the IC4 in 2011. So I don't have a definitive answer for you. All right. Thanks. Thank you.
Next questioner.
Thank you. Our next question comes from Andy Casey. And please state your company name.
Wells Fargo Securities. Good morning, everyone.
Good morning, Andy.
Quick question on the outlook and then cash flow. On the availability that you talked about for Series 9,000 tractors, are there any initiatives being pursued to increase capacity for this fiscal year or should we assume it's pretty much steady as she goes?
We have been increasing our capabilities of reaching of helping our capabilities of delivering products to customers over the course of the year. We've increased our schedule as you're undoubtedly aware of several times. We had undertaken a capacity increase starting in 2,008 and are benefiting certainly from the actions taken there on both combines and large tractors. Availability of the 9,000 specifically is September and for 8, the availability effect I should say effective availability in both cases effective availability is November.
Okay. Thanks. And then on cash flow, can you help me understand, this is a quarterly kind of 6 month question in history. What drove the receivables from unconsolidated subsidiaries benefit?
Basically, we've got an inter company money temporarily low Capital Corporation. It's as simple as that.
Okay. Thank you very much.
Thank you. Next questioner.
Thank you. Our next question comes from Henry Kern. And please state your company name.
Hey, good morning, guys. It's UBS.
Good morning, Henry.
Wondering if you could chat about why the FX in the guidance didn't change by very much given the move in the euro?
Okay. Our forecasting process, we would do our valuation of our forecast at the end of April and we would have used the average rate for currencies that was in effect at the end of April to translate the income statement and balance sheet for the balance sheet for 31 October 2010 and then the income for the remaining period of May through October. We have done some sensitivity analysis in terms of what and I'll talk specifically about the euro, what a change in the euro might mean. At euro might mean. At the time, we did the translation, we were looking at about an average of 1.34 for the euro.
If the euro goes between 1.27 and 1 point 15, you're looking at a favorable impact. We estimate all other things equal, remember they never are, but all other things equal, favorable operating profit benefit to the Ag and Turf division of somewhere between and precisely it says 7% and 22%. And of course, it never will work out exactly that way. But so you can see a little bit of the sensitivity actually does not work to harm
us in this particular case. So I might just add to that. In general, our trade flows relative to the Euroland or Eurozone versus the United States are relatively well balanced. And to the extent that we've had the euro being an issue relative to our financials good or bad, it generally happens when there's steep sharp movements in the euro versus the dollar. And so the analysis that Marie has shared with you shows that in general, we're fairly well balanced relative to the euro.
And that's why you see this basically de minimis impact from the movement going forward. Now, Marie made a very important caveat that is that is all other things being equal and of course they never are, but that would be our estimate today.
Thanks. That's very helpful. And one follow-up question, Have you seen any change in behavior from buyers in the European countries with sovereign debt issues?
That's a fair question. Actually, Henry, the market conditions there and the farmer buying mood is very poor. And so we haven't seen any cancellations if that's what you're asking, but things are at a very low level of activity. So we haven't seen things deteriorate further. In fact, if you want to find any silver lining, they are indicating some stabilization again at a pretty low level.
Hey, thanks a lot. Congratulations on a good quarter.
Thank you very much.
Thank you.
Next questioner. Thank you. Our next question comes from Alex Blanton. And please state your company name.
Good morning. It's Ingalls
and Snyder.
Marie, your inventory your corporate inventory was up about $600,000,000 during the first half from the end of last year. And typically, you run it back down in the second half to about the same level as it started. Assuming you're going to do that, but in relation to the earlier question about why net income
Alex, actually let me interrupt. Actually, our forecast does not have us running it back down.
It doesn't?
Okay. That's on our in our slide deck we show and it is a combination of raw materials and inventory sorry receivables and inventory, but both categories contribute. Last year
Well, I'm talking inventory alone.
Sorry, I'll do that.
I can't give you a number as we've discussed many times separately, but I will tell you both categories are up. And if you'll recall, last year, we were at extremely low levels of production in the 4th quarter as we were working to reduce inventories and align with
Well, I haven't asked my question yet. My question is how much did the inventory increase do you think add to the Q1 net income because that's a factor in the second half net income being a little bit lower than people expect because your inventory increase inflated the first half net income a bit. How much would you say?
Again, we don't have a separate number as we've discussed before for inventory separate from receivables.
No, but I'm asking how much the how much it added to net income, over absorption running up the inventory added something to Neticum, how much would it be?
Maybe I could do it this way.
Looking for here.
Again, I'm going to have a combined number. And this would be a benefit, but it's in the first half of the year actually it turns out to be negative on the this is just looking at inventory because we had such low levels of production in the Q1. You're actually looking at something that would be maybe a $25,000,000 net cost in the first quarter. Okay.
Quarter. We'll have to talk about it offline. A second question is this, your guidance went up. If I add back and I assume that the charge was not in the first quarter guidance, right? In other words, the guidance 3 months ago didn't have the charge in it?
That's correct.
Okay. So that your guidance actually for the year is up about and net income up about 33% then. And I'm wondering what was it that changed so much so dramatically and why wasn't the earlier forecast higher? Maybe put it that way.
We continue to see very good levels of activity in our ag business specifically in places like Brazil and from large equipments in the U. S. And actually a bit of a turn in the turf business and even in medium sized tractors. So we saw some other categories starting to improve. And then the construction business is a little bit more as our dealers are starting to see a little bit of field activity, seeing business is starting to stabilize a little more confidence.
So let me just jump in on. A short answer to that Alex would be pretty much everything has gotten better at the macro level. T is up, C and F is up and the credit operations are up. And then on top of that, we're seeing a very favorable mix. We've seen favorable mix development inside of A and T, further favorable mix development.
Okay. Thank you.
Thank you, Ad. Next questioner. Thank you.
Our next question comes from Meredith Taylor. And please state your company name.
Hi, good morning. It's Barclays Capital. Good morning, Meredith. A couple of questions on the construction and forestry side of the business. Could you walk through some of the assumptions around this business?
I know in the last quarter you were talking about inventory flat. It sounds at this point like you're looking at some inventory build on the part of dealers and then retail sales down 5% to 10%. So can you just update those? Sure. Retail sales for the industry, we think will now be down about 5%, and we think that's frankly behind us.
We think that we're approaching a bottoming if we're not already there. We've actually started to see and I want to be careful because this is from very low levels of activity, but we've actually start to see a little bit of activity out of rental and it's in smaller equipment. But again, all remember very low levels. Then the second part of it was on the inventory side. Yes.
Sorry. The other part was, we have more production now planned in our 4th quarter than we did when we last gave guidance. And so that really drives the increase in ending inventories and receivables. Of that's company owned, a little bit of it's in the field. Okay, great.
And then could you talk a little bit about the lead times that you're seeing from your suppliers and then the lead times to dealers in the categories where you are starting to see the increase on the construction and forestry side? In terms of availability, actually we're doing extremely well with our suppliers and have worked pretty hard with them and they have worked hard to help meet our needs. And we actually had some various strategies to flex up and down. That's actually a part of our normal routine business planning process. The order fulfillment processes in the Construction Equipment division are working fine.
We have plenty of ability to respond, so I don't have a definitive number for you on lead times. But things again, things are starting to turn and we're doing a very good job of meeting customer needs. That's great. Thanks so much and
Our next question comes from Eli Lusgarten. Please state your company name.
Longbow Securities. Good morning. Good morning. Good morning. One quick clarification, because I had a phone issue.
Can you repeat what the benefit was for the euro? You said it was a slight benefit and I cut out.
Between 127,000,000 115,000,000 you're looking at somewhere between 7,000,000 and $29,000,000
Between $2,000,000 Between $2,000,000 Between
$2,000,000 Between $2,000,000
Yes, I realize that. Thank you. A different question, in fact, the construction equipment area, do you have any sense how much of the improvement that you're seeing in your high production is going through inventory restocking or rebalancing of the fleets of your dealers as opposed to pure end demand? I assume that you're sort of suggesting that with end demand being still going anywhere, almost all the buying is replenishing the fleet. And do you expect that to be finished this year in fiscal 2020?
No, I wouldn't say it would be finished because you're at such a low level of activity and frankly even in terms of field inventory. But I you are seeing, again, from the rental companies a little bit of a turn. And but most of it is fleet either is replenish is some replenishment on the part of our dealers.
So it is an improvement. And the same thing, do you expect do you have any feel for where your inventories will wind up at the end of the year? You still going to be I assume based on production, what you're seeing demand, you're still supposed to have very tight farm inventory at the end of the year in the farm sector.
That would be true. That's in part by design and then certainly in response to very good market condition.
Okay. Thank you.
Thank you, Eli. Next question.
Thank you. Our next question comes from Seth Weber. And please state your company name.
Hey, good morning. It's RBC.
Good morning.
Good morning. Just on the your comment about the used equipment inventories in Europe, is that across product lines? And is that more just an industry commentary or is that Deere dealers? Can you just give us some color there?
Well, please go ahead. Okay.
That is more or less across the line. Of course, we're overrepresented by tractors and combines in Western Europe. And we do not believe that Deere is unique in this regard. And in fact, we've take we would tell you that our inventories in general are as in good shape as most anybody's and this backup of the used goods is really tends to be more of an industry wide issue in Europe.
Okay. And then, flipping over to Brazil, I mean, you raised your forecast for the South American market. Do you expect revenue comps to be down year over year for the second half, just given the timing of some of the programs that went in place last year? Or do you think that that's
Actually Seth, I'm glad you brought that up. You may not be aware and we didn't mention that overtly in the call. The Brazilian government has announced an extension or continuation of the low rate financing under the Phenami program. It is currently 4.5% and it ends at the end of June. There is another rate that will be effective from the 1st July to 31st December and that is 5.5 percent, which is up a little bit from 4.5 percent, but still a very attractive level in the market.
Regarding the Mesa Alamitos program, at least as far as last week, we still had not heard anything from the government as to whether or not it would be continued. Conventional wisdom in Brazil does believe it will be continued. So I wouldn't see a decline in the Q4. We had tsunami rates went back to more normal levels. As we look forward into 2011, again, absent any other information, you have to assume that that special phenomena rate will end at the end of December, at least that's what for planning purposes what you would expect.
You get it will affect sales though a little bit further into our fiscal 2011, because you usually have to commit with the bank sometime we expect it would be by the end of November. And then you have a few months after that to actually take delivery on the equipment. So that would get us into our sometime into our Q2. That's a long winded answer.
Okay. Thanks for the clarification.
Thank you, Seth. Next questioner.
Thank you. Our next question comes from Barry Bannister. And please state your company name.
Hi, it's Stifel, Nicholas.
Good morning.
Good morning. Now that the dust is settled, I wanted to step back and ask a bigger picture question. In Deere as a whole and lately in construction and forestry, this obsession with working capital has caused pretty extraordinary swings in production tonnage and operating leverage. And it's resulted in volatility of operating earnings with EPS down 40% in 'nine and then back up 42% in 'ten. So what I'm getting from investors is that they really view Deere as more of a short term speculative vehicle and not so much a long term investment.
And the incentive system inside Deere is SBA based, has a very sharp focus on capital employed. So we can expect these huge swings in production schedules on a regular basis going forward. So I guess my question is, do we have a situation here of misaligned interests? Would it be better to smooth earnings a little bit over the cycles by ultimately over and under producing over time rather than panicking, cutting production and quickly raising production when we find ourselves short competitively of inventory. Do you have any thoughts on that?
I certainly do. We would tell you that our SBA model has been extremely powerful in raising the overall returns that we have generated as a company. You may recall that we traditionally turned our assets maybe one a little more than one times, we're well over 2 times. We think that's helpful to our customers because they get new fresh product that is specifically designed to meet their needs as opposed to taking inventory that has been sitting out sometimes for frankly too long at the dealer and it's not optioned the way the customer wants it. In terms of our ability to manage working capital, you're not mentioning the very powerful effects that it has had on our ability to generate cash flow.
And we think that is critical. And we think, actually we can get very solid feedback on this. With the market turns down Barry, eventually you're going to have to react. And it's a question of timing whether you do it today or tomorrow. We do not think we have been knee jerk at all in responding to market conditions.
And again, I think that our very superior returns speak for themselves.
Does your $4 EPS guidance in 20.10 include any loss for the sale of the windmills?
We have not arrived at any sort of definitive course of action relative to the wind business and as a result our forecast does not contemplate any sort of definitive action one way or the other other than that it continues to be in the portfolio. What we've announced is that we've undertaken a strategic review and at the right time we will reveal what the results of that review contemplate. But right now, our forecast contemplates that wind is continuing piece of the John Deere portfolio. I would go back to the previous question, Alex, and I'm very sorry. And just also offer the point that 2,009 was an extraordinary year in terms of the schedule reductions that were put in place and then the reactions.
And one that I would say, obviously, if you're going to develop any sort of hypothesis, I think it needs to be taken with a grain of salt and that it was so extraordinary. And we are firmly of the opinion that long term to that being very, very quick to react in terms of schedule, making sure that we have the right product out there at the right time with the right optionality, so we don't have to give it away is in fact in the long term best interest of our shareholders. And it's a very complicated subject that we'd be very willing to discuss with you further. And I apologize for calling you Alex and I apologize to Alex.
I feel honored. Thank you a
lot. Next questioner please.
Thank you. Our next question comes from Mark Kocnerich. Please state your company name.
It's Cleveland Research.
Good morning, Mark. Good morning. How much did foreign exchange contribute
to operating income in the quarter?
It was $80,000,000 and it's primarily ag, I mean virtually all ag.
Okay. And then for your cash flow outlook, cash flow from operations, can you explain something to me? Maybe I'm just doing my math wrong, but you're forecasting that to increase by $600,000,000 pretty healthy. But net income in your guidance is up a little over $400,000,000 when you add back that charge. And then your receivables and inventories are actually going up as well.
So I'm presuming working capital would be more of a use than previously expected. And your depreciation actually is going down a little bit. So what am I missing that contributes an incremental 200 or more to cash flow from operations?
Well, with the rise in payables with the rise in activity late in Q4, you get a little bit on payables. And then we've got dividends from the financial services that we didn't have last year. And I think those are the 2 biggest
The dividends by itself, I think is $200,000,000 a year ago because we were relevering the balance sheet of the Capital Corporation. We didn't take any money out of the financial services sub. So effectively their earnings were not monetized, whereas this year at least 2 thirds of their earnings will be monetized in terms of cash in the equipment operations.
Okay. And a comment about working capital with the payables, you're saying that working capital is more neutral rather than
I don't have it. I don't have it broken out exactly the way I've guided by line items. But the as you're as we're ramping up those schedules in the Q4, you do because of the timing end up with some payables. And we also have For example,
in the payables last year, our incentive compensation accruals would have gone down significantly. I think we made a comment that or a year ago that 6 points of the SA and G decline was because of the reduction in the incentive compensation expense. Well, that's a reduction in an accrual, which through the cash flow statement effectively because it shows up almost as a use of cash. And then as that accrual is being rebuilt, that's a non cash charge to earnings. And so, it's those sorts of items.
Okay. All right. Great. That helps. Thank you.
Mark, I think we've got time for one more question.
Thank you. Our final question comes from Jamie Cook. And please state your company name.
Hi, good morning and congratulations. Just a quick 2 quick questions, Marie. One, I'm curious on your R and D and SG and A expense. When we think about each quarter, we've raised that expense. Your percentage increase a couple of points relative to where we were when we first started off.
Yet we're under we've underspent in the first So why that's going higher? How we think about the impact on Q3 relative to Q4? I'm trying to think if there's anything else going on there or is that cushion in the guidance? And then my last question, just on your 2011 farm cash receipts forecast, again another stellar year. It's probably the 2nd best year in U.
S. Farmer history. Under what scenario would 2011 sales be down in the U. S? Just based on your cash receipt forecast?
Am I missing something that it could why it's not going to be up, I guess?
Let me go back and do the R and D first. The R and D spend, I we have no deliberate cushioning in either R and D or S and G. The expenses required to meet IT for our real and that engineering will be ramping up as we move through time. Does it get all the way up to 13% up 13%, I can't guarantee it, but that is a very real cost and we've got plans in place for that. SANG, there will be some launch expenses.
And I think there is as you know, we weren't sure how the year would progress. I think there might have been a few things in SA and G that might have been postponed into the second half of the year that we had some flexibility on. I know even in my own case some training that I didn't do in the Q1, I made first half I may do in the second.
But is it split evenly between Q3 and Q4? If I
think of your total expense for the year, what do you know what I mean? Is it split evenly between Q3 and Q4 the remainder of what we need to spend?
I don't have that level of detail. I'm sorry.
Okay. And then the last question just your 20 11 cash receipt forecast for the United States. I'm just trying to figure out I'm missing under what scenario sales could be down. Is it Tier 4 anything in your mind where we're not having another up stellar year in the United States for farm equipment?
At this stage of the game, we don't have guidance for 2011 and it's very, very difficult to predict. The factors that you're looking at seem to be very good. We would hope there would be some upside coming as you see recovery in livestock and from the Turfia and Utility division as well. It's but we do not have a forecast, so I'm unable to give you a better answer.
All right.
I thought I'd try. Congrats.
Thank you all for participating in the call today. And of course, as