Good morning. Welcome to John Deere & Company's third quarter earnings conference call. Your lines have been placed on a listen-only until the question and answer session of today's conference. I'd now like to turn over the call to Mr. Josh Jepsen, Director of Investor Relations. Thank you. You may begin.
Hello. Also on the call today are Raj Kalathur, our Chief Financial Officer, John May, President of Agricultural Solutions and Chief Information Officer, Ryan Campbell, Vice President and Corporate Controller, and Brent Norwood, Manager, Investor Communications. Today, we'll take a closer look at Deere's third quarter earnings, then spend some time talking about our markets and our current outlooks for fiscal 2018. After that, we'll respond to your questions. Please note, slides are available to complement this call. They can be accessed on our website at www.johndeere.com/earnings. First, a reminder. This call is being broadcast live on the internet and recorded for future transmission and use by Deere & Company. Any other use, recording, or transmission of any portion of this copyrighted broadcast without the express written consent of Deere is strictly prohibited.
Participants in the call, including the Q&A session, agree that their likeness and remarks in all media may be stored and used as part of the earnings call. This call includes forward-looking comments concerning the company's plans and projections for the future that are subject to important risks and uncertainties. Additional information concerning factors that could cause actual results to differ materially is contained in the company's most recent Form 8-K and periodic reports filed with the Securities and Exchange Commission. This call may also include financial measures that are not in conformance with the accounting principles generally accepted in the United States of America, or GAAP. Additional information concerning these measures, including reconciliations to comparable GAAP measures, is included in the release and posted on our website at www.johndeere.com/earnings under quarterly earnings and events. Brent?
John Deere had another solid quarter, with contributions from both our equipment operations and financial services group. The higher reported earnings were a result of favorable market conditions and a positive response to our innovative and advanced product lineup. In agricultural markets, replacement demand continues to drive sales activity for large equipment, while construction equipment sales benefited from increased investment in oil and gas, housing, and global transportation. Now, let's take a closer look at our third quarter results, beginning on slide three. Net sales and revenue were up 32% to $10.3 billion. Net income attributable to Deere & Company was $910 million or $2.78 per diluted share. The results for the quarter included a favorable net adjustment to provisional income taxes of $62 million. Excluding this item, adjusted net income was $849 million. On slide four, total worldwide equipment operations net sales were up 36% to $9.286 billion.
Currency translation was negative by one point. Price realization in the quarter was positive by one point. The impact of Wirtgen was 17 points. Turning to a review of our individual businesses, starting with agriculture and turf on Slide five. Net sales were up 18% in the quarter-over-quarter comparison, primarily driven by higher shipment volumes, price realization, and lower warranty expenses. Operating profit was $806 million, up 16% from the same quarter last year, or 35% when excluding the impact from the sale of SiteOne. Operating margins for the quarter were 12.8%. Before we review the industry sales outlook, let's look at the fundamentals affecting the ag business. On Slide six, corn stocks-to-use ratio is expected to decline in response to increasing global demand and drought conditions experienced during the first crop in Argentina, which lowered the country's corn production by roughly 25%.
Conversely, soybean stocks-to-use ratio is forecast to build in response to higher-than-expected yields in the U.S. Wheat stocks-to-use ratio is projected to decline in 2018 in response to intensifying drought conditions in Europe, Australia, and the Black Sea region. As a result, U.S. farmers are seeing increasing export demand for the year. Slide seven outlines U.S. farm cash receipts. 2018 farm cash receipts are estimated to be about $375 billion, roughly flat with 2017. Crop cash receipts are projected to be on par with last year, as favorable commodity prices in corn and wheat are partially offset by softness in the soybean market. Receipts from livestock are also flat due to strong domestic and export demand balanced by growing supply and lower prices. Our ag economic outlook for the EU 28 is on Slide eight.
While crops began the season in fair condition, more recent results across the EU have varied due to regional droughts. Nonetheless, the overall crop value of production is still expected to increase in 2018. Overall, arable farm profitability remains slightly below long-term averages, though severe regional droughts are negatively impacting Central and Northeast Europe, while the Southern and Western regions report more positive conditions. Furthermore, favorable wheat prices are also contributing better margins in key markets. Profitability for the dairy segment remains above long-term averages, though production and input costs will likely be impacted by recent drought conditions. Shifting to Brazil on Slide nine. The chart on the left displays the crop value of agricultural production, a good proxy for the health of agribusiness in Brazil.
The value of ag production is expected to be about the same as last year, with strong prices and increased export demand benefiting industry sales in the second half of the year after a slow start earlier this year. On the right side of the slide, you will see eligible rates for ag-related government-sponsored finance programs. In June, details for the 2018-2019 Moderfrota program were announced and received positively in the market. Interest rates for large farmers were decreased 100 basis points, while popular features, such as a seven-year repayment term and 14-month grace period were kept in place. Higher demand during the quarter's regional farm equipment shows reflected strong enthusiasm for the program. Overall conditions in Brazil support solid farmer confidence as premium pricing for soybeans, lower financing costs, and favorable exchange rates help offset recent increases in freight prices.
These factors, along with our strong trend of operating results and market share gains, position us very well for continued growth in the region. At this point, I'd like to welcome to the call John May, President of Deere's Agricultural Solutions and Chief Information Officer. He will provide comments on the outlook for Ag & Turf, an update on Deere's precision ag strategy, and a review of recent M&A transactions in Crop Care. John?
Thank you, Brent. Our 2018 Ag & Turf industry outlooks are summarized on slide 10. Industry sales in the U.S. and Canada are forecast to be up approximately 10% for the year. For 2018, results have been largely driven by replacement demand as customers cite the need to update their aged fleets and show a strong preference for greater productivity enabled through the latest technology. Even as trade issues have weighed on farmer sentiment more recently, we've still seen replacement demand reflected in the phase one results of our 2019 planter and sprayer early order programs, which both ended slightly higher than last year's phase one results.
While it's still too early to draw firm conclusions regarding overall 2019 ag demand, it is noteworthy to highlight the early order programs' higher take rates of advanced precision features, which clearly demonstrates the economic benefits of our solutions and supports the growth of our precision ag strategy. With sentiment likely to remain fluid over the coming months, farmers continue to show a strong willingness to invest in technology that improves both productivity and economic outcomes. Moving on to the EU 28. Industry outlook is forecast to be between 5%-10% in 2018, up from previous guidance of approximately 5%. In South America, industry sales of tractors and combines are projected to be flat to up 5% for the year.
This is primarily driven by solid industry fundamentals in Brazil, which is offset by weakness in Argentina as a result of drought conditions experienced in the first half of the year. Shifting to Asia. Industry sales are expected to be relatively unchanged from 2017, though India continues to deliver strong results in the region. Lastly, industry retail sales of turf and utility equipment in the U.S. and Canada are projected to be flat to up 5% in 2018. Putting this all together on slide 11. Fiscal year 2018 Deere sales of worldwide Ag & Turf equipment are now forecast to be up approximately 15%. The Ag & Turf division's operating margin is forecast to be about 12.5% for the year, up roughly two points from 2017 after excluding the gains on the sale of SiteOne last year. Moving on to slide 12.
I'd like to elaborate on Deere's precision ag journey and provide insights into our current strategy. In collaboration with our product platforms, the Intelligent Solutions Group is advancing Deere's precision ag strategy and leading the industry in machine optimization, job execution, and mobile management for the farmer. Over the last two decades, we've aggressively invested to ensure our equipment is easier, smarter, and more precise than any other solution available, and we are committed to extending our industry-leading position in the future. Today's portfolio of ISG's tools include precision hardware, telematics, digital solution, and advanced customer support. Recent precision hardware introductions demonstrated significant economic value to farming operations, and in some cases, already achieving take rates in excess of 50%. For example, the recently released Combine Advisor feature utilizes sensors and algorithms to automatically optimize multiple combine settings, resulting in better grain quality while minimizing losses.
Additionally, the introduction of our ExactApply spraying technology provides individual nozzle control to increase yields and reduce input costs by 2%-5%. With regards to telematics, there are currently over 130,000 ag machines in the field today. Our automatic guidance system, AutoTrac, delivers sub-inch accuracy and is available in 100 countries, as shown on slide 13. It is worth noting that 2018 is a record year in the adoption of this technology. In recent years, digital products have become increasingly critical to farming operations, and the John Deere Operations Center seamlessly manages production data and enables better decision-making on the farm. Additionally, the system, the most collaborative in the industry, allows over 85 partnering companies to connect, enabling farmers to collaborate with their trusted advisors.
On a rolling 12 basis in the U.S. and Canada alone, Deere has nearly 100 million engaged acres that are actively uploading data into our digital tools. Worldwide, we are seeing significant progress in engaged acres at an accelerated rate of adoption. Related to machine optimization, we are now using technology to enhance our customer support capabilities, and our Expert Alerts feature is an excellent example of recent innovation impacting farmers. These alerts provide predictive maintenance notifications to both the customer and the dealer, allowing farmers to avoid costly downtimes and enabling dealers to provide better service. Given the state of our current precision portfolio, we are increasingly optimistic about the future impact of precision technologies as the inclusion of machine learning, computer vision, and robotics holds potential to unlock billions of dollars in agricultural value.
To further advance Deere on the machine automation journey, last year, we acquired Blue River Technology. Blue River is the leading integrated ag machine learning company in the industry. The acquisition provides Deere a competency in artificial intelligence, which we view as core capability that will increasingly drive the basis for competition in ag equipment. This capability will enable our machines to, one, sense conditions in the field, two, make decisions, three, execute the appropriate action, and four, learn and adjust. These steps could eventually shift decision-making today from the field level down to the individual plant level. Blue River's first product, See & Spray, is still a few years away from commercialization, but we currently are testing this product in thousands of acres this season. The product identifies and then selectively sprays weeds instead of spraying the entire field.
This vastly decreases the amount of herbicide used in operation, which improves economics for the farmer while reducing chemical usage in our food chain. Last month, I had the pleasure of attending a customer day in Texas, where over 60 customers viewed the product demonstrations firsthand. The feedback was highly encouraging and let us know we are on the right path. Ultimately, we see See & Spray as just the tip of the iceberg for the inclusion of artificial intelligence in ag equipment. The ability to automate many farming jobs from planting to harvesting will be enabled through the use of this technology. Turning to slide 14, let's discuss a few other recently completed acquisitions that have enhanced our crop care product portfolio and supported the development of a global crop care solution to further enable our precision ag strategy.
Over the last three years, Deere has very effectively utilized M&A to help execute our crop care strategy, completing four acquisitions, including Monosem, Hagie, Mazzotti, and King Agro, and the recently announced PLA acquisition. Each of the above-mentioned transactions provided Deere with either a leading market position or an industry-leading capability. To highlight a few, Monosem provided Deere the market leading position in Europe for planters and will enable Deere to create the most capable tractor-planter combination in the region. Similarly, the acquisitions of Hagie and PLA provided Deere leading market positions in their respective product forms and geographies. Importantly, these transactions supplied Deere with the right products to combine with our foundational precision technologies and other Deere-manufactured components. Perhaps most importantly, the transactions have served as a key enabler to enhance and advance precision technologies globally and a critical complement to our R&D investments.
With rapidly increasing adoption rates for technology, Deere is keeping pace, both organic and inorganically, to further extend our lead in precision ag. I will turn the call back over to Brent Norwood. Brent?
Now, let's focus on construction and forestry on slide 15. Net sales for the quarter of $2.99 billion were up 100% compared with last year, driven by strong demand for construction and forestry equipment, as well as by the acquisition of Wirtgen, which contributed 77% of the positive improvement. Third quarter operating profit was $281 million, benefiting from higher shipment volumes, the Wirtgen acquisition, and lower warranty expense, partially offset by higher production costs and higher sales incentive expenses. C&F operating margins were 9.4% for the quarter, but 10.5% excluding Wirtgen. Moving to slide 16. The economic environment for the construction, forestry, and road-building industries looks strong and continue to support increased demand for new and used equipment. For the year, U.S. GDP is forecast to grow at about 3%, which is above the 20-year average.
Correspondingly, U.S. housing demand remains solid, with housing starts expected to be about 1.3 million units for 2018, as inventories of new and existing homes available for sale remain at 36-year lows. Residential construction continues to serve as an important indicator for earth-moving equipment sales, and current housing demand levels suggest continued growth in the segment. Additionally, construction investment in the U.S. is forecast to grow 3.8% for the year, led largely by increased activity in oil and gas. With oil prices now forecast to average about $67 a barrel for the year, backlogs for many oil field contractors are extending through 2019, which is supportive for further equipment demand. Lastly, global transportation investment this year is forecast to grow about 6%, driving increased demand for road construction equipment such as milling machines, rollers, and asphalt pavers, which are all important product lines for Wirtgen.
These positive economic indicators are reflected in a strong order book, which is now extending well into 2019. Moving to the C&F outlook on slide 17. Deere's Construction and Forestry sales are now forecast to be up about 81% in 2018 as a result of stronger demand for equipment, as well as the acquisition of Wirtgen. The net sales forecast includes about $3.15 billion attributable to Wirtgen, which was adjusted downward due entirely to FX. The forecast for global forestry markets is up about 10% as a result of improvement in sales in the U.S. and Canada and strong demand for cut-to-length products in Europe and Russia. C&F's full-year operating margin is projected to be about 8.5%, which includes the negative impact of purchase accounting and acquisition costs from Wirtgen. Excluding Wirtgen, C&F projects operating margins to be about 10.5%.
Wirtgen continues to perform as expected, with strong backlogs and operating margins now forecast to achieve the high end of our 3%-4% guidance. Let's move now to our financial services operations. Slide 18 shows the provision for credit losses as a percentage of the average owned portfolio. Financial forecast for 2018, shown on the slide, contemplates a loss provision of about 15 basis points, six basis points lower than our previous forecast. This would put loss provisions for the year below the 10-year average of 25 basis points and the 15-year average of 27 points. Moving to slide 19. Worldwide financial services net income attributable to Deere & Company was $151 million in the third quarter. The results for the quarter included about $4 million in net tax reform related charges arising from the remeasurement of deferred tax assets and deemed earnings repatriation.
Excluding tax reform related items, adjusted net income in the third quarter was $148 million, up about 13% compared to the same quarter last year. For the full year in 2018, net income is forecast to be about $815 million. Excluding the impact for the previously mentioned tax reform related items, adjusted net income is forecast to be $583 million. Beyond 2018, effective tax rates for John Deere Financial are forecast to be between 24% and 26%. Slide 20 outlines receivables and inventories. For the company as a whole, receivables and inventories ended the quarter up $3.8 billion. In the C&F division, the majority of the increase is attributable to Wirtgen, while for Ag, the increase is due to higher sales.
By the end of fiscal year 2018, receivables and inventories are expected to increase about $2.5 billion from 2017 levels, driven largely by the inclusion of Wirtgen, as well as the higher sales across the company. Slide 21 shows the cost of sales as a percentage of net sales. Cost of sales for the third quarter was 77%. Our 2018 cost of sales guidance is about 76% of net sales, unchanged from previous guidance. When modeling 2018, keep these unfavorable impacts in mind. Higher production costs, such as freight and material costs, and higher incentive compensation costs. On the favorable side, we expect price realization of about one point and a more positive product mix. Let's look at some additional details. With respect to R&D expense on Slide 22, R&D was up about 23% in the third quarter.
Approximately 12% of the increase relates to the acquisitions of Wirtgen and Blue River Technology. Our 2018 forecast calls for R&D to be up about 21%, with acquisition-related activity accounting for nine points of the increase and currency translation for one point. The balance of the R&D increase largely relates to strategic investments in large Ag and Precision Ag that helps drive growth for these key areas. Slide 23. SA&G expense for the equipment operations was up 19% in the third quarter, with acquisition-related activities and incentive compensation accounting for most of the change. Our full year 2018 forecast for SA&G expense is up about 16%. Excluding acquisition-related expenses, SA&G is forecast to be flat for the year. Slide 24.
The equipment operations tax rate was 24% in the third quarter, which included a favorable adjustment of approximately $62 million arising from tax reform-related net deferred tax asset remeasurement and deemed earnings repatriation. Fourth quarter, the effective tax rate is expected to be in the range of 25%-27%, which implies a full year effective tax rate of approximately 55%. For 2019, Deere's full year effective tax rate is projected to be between 25% and 27%. Slide 25 shows our equipment operations history of strong cash flow. Cash flow from the equipment operations is now forecast to be about $3.5 billion in 2018, compared to previous guidance of $3.8 billion. The decrease in forecast largely relates to an anticipated increase in working capital. The company's financial outlook is on Slide 26. Fourth quarter equipment sales are forecast to be up about 21% compared with the same quarter last year.
Our full-year outlook now calls for net sales to be up about 30%, which includes about one point of price realization and 12 points for the acquisition of Wirtgen. Our full year 2018 GAAP net income forecast is now about $2.36 billion. The full-year net income forecast includes charges of $741 million, resulting from tax reform related net deferred tax asset remeasurement and deemed earnings repatriation. Excluding the impact of these items, adjusted net income is forecast to be about $3.1 billion. I will now turn the call over to Raj Kalathur for closing comments. Raj?
Before we respond to your questions, let me share a few thoughts on the third quarter and our expectations for the rest of the year. First, it's important to note the continued demand for ag equipment, even as the industry faces uncertainty around trade. While farmer sentiment remains dynamic in this environment, it is critical to remember that we are still in a replacement market, and farmers have shown continued willingness to invest in technologies that enhance operational efficiencies and produce tangible economic results. This has been evident in the initial results from our early order programs, which produced high take rates for our advanced precision features. While it's still too early to form a complete outlook for 2019, we believe the continued ag equipment demand affirms both our significant investment in precision ag and our overall current strategy.
Second, the solid levels of demand we are experiencing across our two equipment divisions have produced excellent cash flow generation year to date. As a result, we contributed $1 billion towards our pension during the third quarter in order to take advantage of last year's higher corporate tax rate. Additionally, we announced a 15% increase to our quarterly dividend to $0.69 per share on May 30th in order to build towards our desired dividend payout ratio that targets 25%-35% of mid-cycle earnings. Lastly, during the quarter, we repurchased $400 million worth of shares. These actions reflect confidence in our ability to deliver results even in fluctuating market conditions. Lastly, as global agricultural markets navigate uncertainty, the underlying fundamentals and tailwinds to our business model remain unchanged. Global demand for grains continues to grow consistently, even as trade flow patterns readjust to accommodate various policy changes.
Overall, we are encouraged by the outlook for the rest of 2018 and the early interest for our latest technology to come in model year '19. We will continue to work on delivering strong results for the remainder of this year and beyond.
Thanks, Raj. Now we're ready to begin the Q&A portion of the call. The operator will instruct you on the polling procedure. In consideration of others and our hope to allow more of you to participate, please limit yourself to one question. If you have additional questions, we ask that you rejoin the queue. As a reminder, John May will be with us and available for questions. Angela?
Thank you. We will now begin our question and answer session. If you'd like to ask a question, please press *1. Our first question comes from Jerry Revich with Goldman Sachs. Your line is open.
Yes. Hi, good morning, everyone.
Morning.
Morning.
John, I'm wondering if you could talk about for the major equipment categories, what are the take rates that you folks saw for advanced technology, precision technology over the course of this past year? Based on the results that you alluded to in your prepared remarks, what do you expect the take rates to look like as we enter 2019?
First of all, I think a way to think about the take rates, Jerry, is there's three areas where you're going to see this technology within our equipment. Number 1, it's included in our base cost of our machine, and those would be things such as touch screen displays that have a significant amount of software that optimize the vehicle's performance based on sensor data and feedback that the machine's getting.
We also see take rates and monetization on premium options. In your report, you listed a couple of those. One would be Combine Advisor or ActiveYield. These are premium options that our customers make the choice to add to their equipment. The third area where we see take rates across agricultural precision ag is in subscriptions required to fine-tune the machines, if you will. An example of that would be higher fidelity guidance systems. For example, moving to an RTK-based systems. Overall, across all areas of technology, we've seen strong adoption. Maybe let me give you a couple of facts I think you'll find interesting. If you look at AutoTrac alone and you compare AutoTrac in 2013, which was a peak year for the production of agricultural equipment to 2018, in 2018, we sold more AutoTrac systems than we did in 2013.
If you look over the last three years and you look at each individual region, all four regions across the globe, every year we see an increase in the overall take rate and adoption of the technologies. That makes us really excited that number 1, the customers are seeing the benefit in greater productivity, improving the cost structure of their business, ultimately making them more profitable, and that the technology is going to continue to have significant value to their business going forward. We're excited for what we're seeing in take rates. I can tell you in the last few years, it's been more significant than we've seen in the past.
Sorry, Yeah, please.
Maybe just an example. This is Ryan. ExactEmerge is our most productive, most advanced row units. The take rates from a 2018 to 2019 perspective in EOP are up 50%. Just to give you kind of an order of magnitude of what we're seeing based on the technology and the high productivity that we're delivering in a lot of our crop care machines.
Okay.
Perfect. Thanks.
Next question.
Our next question comes from Andy Casey with Wells Fargo Securities. Your line is open.
Good morning, thanks. I wanted to get an update on cost headwinds. I'm trying to assess if these are more or less temporary. If I take the full-year guidance back into the implied Q4 gross margin, it kind of looks like you're expecting somewhere around 26%, if I'm doing the math right. That'd be a bigger year-to-year improvement than you've really seen in each of the first three quarters in the sequential step-up. I'm just wondering, what are you seeing that could be driving that? Is that better productivity, or are you seeing kind of the cost curves flatten out?
Andy, I think if you're thinking about ag and turf, for example, on the material side, we do see that impact in 4Q. 4Q from a year-over-year perspective would actually be kind of the higher impact as we think about those costs coming in. We've talked about the way our contracts are lagging. You do see that impact in 4Q. I think importantly, when you think about the full year, our ag and turf margins have stayed the same in light of the fact that we've seen higher material as well as an FX headwind in the quarter.
Okay. With the pricing actions that you're doing and the ongoing productivity, would you expect the gap between price cost to narrow as you go into fiscal 2019 or maybe neutral or positive?
Yeah. As you think about our commentary from last quarter, we remain the same. The price actions we're taking for model year 2019, we expect to offset that material inflation that we've seen in 2018 and 2019. That remains unchanged and we feel confident in that. Thank you.
Okay, thanks.
Next question.
Our next question comes from Jamie Cook with Credit Suisse. Your line is open.
Hi, good morning. I'm sorry, just a little more color on the order book. In construction, it seems like you have a very good visibility relative to what's normal. If you could give color there as well as any more color that you could give on the ag side in terms of visibility versus where we sat last year. If you could start there. Raj, just another question. Obviously, the cash flow is strong. You're buying back stock last quarter and this quarter. The stock has come down significantly as we think to 2019. Given your balance sheet, should we think repurchase is another lever for you guys to grow earnings? Thank you. Which one do you want us to answer? All of them.
Jamie, I'll start on the order book. On the construction side, as Brent noted, we continue to see that order book extend. We're well into 2019. That's really driven by what we're seeing from customer demand. Contractors with backlogs that are extending. I'd say good visibility there, more than we would traditionally have as we think about.
What quarter again?
2019. I think for the most part, we'd be working through Q1 of 2019. As you think about the Ag side, the early order program, John mentioned some where we've seen that first phase. Even when you think about the timing of that first phase of the EOP, that began in June. It ended in mid-July. We tend to see more activity at the end of those phases. Even in the uncertainty that we saw, that first phase ended up slightly higher. I think we feel good about the continued replacement demand - that we're seeing drive that technology adoption come through the business. I think as you think about tractor order book, tractors year-over-year, we're slightly ahead of where we were a year ago at this time on a higher production schedule. That would be positive as well.
Jamie, on the cash use, our priorities have not changed. We are generating strong cash flows and expect to generate strong cash flows throughout the cycle as we have demonstrated in the past. Again, mid-single-digit rating is the most important investments for growth. As John explained, see, they're actually delivering very good results. We'll continue to have that as our second priority. Dividends, we've always said 25%-35% of mid-cycle earnings. What I will add there is we have more room for growth and opportunity for growing our dividends. When we see it appropriate, that might be an opportunity there. On share repurchases, as you know, we always think about the long-term-minded investors and adding value to them when we repurchase shares. We have also said we think our intrinsic values are much higher.
Given the current share prices, you should expect us to be buying back some shares.
Great. Thank you.
Thanks.
I'll get back in queue.
Next question.
Our next question comes from Adam Uhlman with Cleveland Research. Your line is open.
Hi, good morning, everyone. I was wondering if we could expand on what's happening over in Europe. You raised your full-year sales outlook. There's a lot of cross-currents with dairy pricing and wheat pricing, I guess. What's your view on how calendar, the second half of 2018 plays out? Is there any inventory positioning that you're doing with emission standard changes? If you could maybe just talk through that as well. Thanks.
Adam, when you're thinking about Europe, I think what we've seen there is this year, we've seen dairy margins and livestock margins have held in above the long-term averages, which have been supportive. I think on the arable side, we've also seen improvements in margins. This year, you're starting to see some impacts from the drought. I'd say it's very regional, though. Where we've seen places that have not been impacted by the drought tend to be places that are stronger, important markets for Deere. I think that's been impactful for us as we think about our fiscal year. I think that is a difference when you think about fiscal versus calendar year with some of the things that have occurred with registrations in our fiscal year, but not the calendar year.
We've also seen strong wheat prices that have benefited European farmers as well, that are helping to offset some of the downside that you've seen in, say, places that are affected by the drought. As far as inventory goes, I think overall, when we think about managing our inventories, particularly field inventories on a global basis, I think we feel good about where we're at. In North America, large ag inventories we continue to manage well producing in line with retail demand. I think no major shift or difference there. Small ag, as we've talked about, we've strategically built a little bit of inventory to ensure that we've got inventory in the field because of the buying patterns of those customers.
I'd say really, the rest of world, I don't think there's any significant change in terms of our view of inventory as we think about each individual either product line or market.
All right. Thanks. We'll go to the next question.
Our next question comes from Steven Fisher with UBS. Your line is open.
Thanks. Good morning. Just focusing on the costs a little bit more. Just other than the cost of goods sold impact, wondering if we should be thinking about other costs as net headwinds or tailwinds next year. R&D, you mentioned 21%, I think 9% organically. Is that going to abate? What about other SA&G costs and incentive comp?
Yeah, I think when you think about R&D. R&D is one that we tend to look at as more of a strategic investment in the business, in somewhere where we take a lot of pride in the ability to continue to invest strategically in R&D even throughout the downturn and today in technology. As John mentioned, we're seeing the benefit of that in the adoption of technology. I think that's an area that we continue to invest in and probably not significant changes. S, A, and G, some of the things with deal costs, some of those sorts of things will roll off as you think about Wirtgen. I think S, A, and G, when you take out the acquisition side, we're flat on organic basis on sales that are up high teens.
I think that's an area where we have leveraged and as we've taken cost out, we've been able to adjust there.
Incentive comp, should we be thinking that that is a reset as a tailwind for next year at this point?
Yeah. This year, I'd say this year we're up slightly. It's about $75 million higher year-over-year. As our goals have shifted and changed, it really depends on where we come in. I wouldn't expect a significant amount of difference there.
Okay, thank you.
Next question.
Our next question comes from Rob Wertheimer with Melius Research. Your line is open.
Hey, you touched on it briefly, a question on receivables inventories, which were up, I think in both divisions, not a ton, but for the second quarter in a row. Is there anything, I don't know, operationally different than you thought at Wirtgen? Maybe just generally, what's caused that bump up?
Thanks, Rob. Yeah, I think the Wirtgen is, when you look at the total change, is a big piece of that. I think that's just their business. They own their retail in a large part of the world, working through kind of the forecast there. I think that's the large portion of that. I think if you look at our forecast, this quarter compared to last quarter, up slightly on ag, up slightly on C&F. C&F side really in line with what we're seeing on higher sales. As I mentioned earlier, the order book extending into 2019. I think the other piece would be, as you think about on the ag side is small ag is where we're seeing some of that increase on inventory. That's a business that is really driven more on overall GDP growth. We're continuing to see strong demand there.
I'd say that's the major driver there.
Perfect. The dealer inventory on the 100 plus was up a little bit. Is that kind of the 105, like the 6 series, or is that anything else going on?
I'd say that's really kind of across those different categories. As we've talked about 100 plus is a really wide category from large utility tractors through 8000s. I think we will, as we've shifted a little bit of our seasonality this year, as we talked about some of the ramp-up issues and supply constraints, we've got more production second half of the year on large ag. We do expect that we're maybe a little bit atypical from normal seasonality and that we'll produce and sell through that in the latter half of the year.
Great. Thank you.
Thanks. We'll move on to the next question.
Our next question comes from Michael Shlisky with Seaport Global. Your line is open.
Good morning. I wanted to maybe ask some more questions on Wirtgen here. Can you give us a sense as to what the organic growth outlook is there? Has it changed from earlier in the year? If you could also share, I know it's early, but has Wirtgen gotten any share gains in the U.S. so far since you started owning it a few quarters ago?
Mike, when we look at Wirtgen, the business is performing as we expected, if not better, as we talked about. We've seen actually margins have stepped up over the last couple of quarters. The revenue guide was really just impacted by FX. When we look at the order backlog there continues to be really strong. As we look forward there continued growth. I think we've noted in our slides, we think that global kind of road building transportation sector is up about 6% year-over-year and end up higher, low double digits, excuse me, in some of the key emerging markets. I think that's continuing to perform as we would've hoped.
As far as the share gains are concerned, have you gotten anything so far this year, you think?
Yeah, we don't have a lot of additional detail or comment there. I think performing as we would continue to hope and expect.
Thanks, Josh.
Thanks, Mike. We'll go to the next question.
Our next question comes from Seth Weber with RBC Capital Markets. Your line is open.
Hey, good morning, guys. Wanted to go back to a couple of prior questions. I think Andy and Steve just asking about costs and thinking about the margins. It looks like your implied incremental margin on ag and turf is kind of a mid 30% range for this fourth quarter. Josh, you said that this is kind of the high point for the cost headwind. I mean, are you comfortable with us thinking about incrementals next year in ag and turf should be better than that sort of mid 30% range? Thanks.
Seth, when we think about the fourth quarter, I think as we talked about, there's FX headwind and you've got some of the material and freight headwind in the quarter. That is particularly impactful in the quarter. I think as you think about going forward, obviously we don't have a forecast for 2019 yet, we will have the price that comes in that impacts the cost inflation that we've seen. As we've discussed, we expect that offsets the inflation in material that we've seen in 2018 and 2019. That will be impactful and beneficial to our margins. If you looked at our margins today, full year, just below 25, around, say, 23%. If you excluded the material and freight impact, you'd be at that about 35%.
This is Ryan. Fourth quarter, just to clarify, correcting for foreign exchange, we're right in that mid-20s range, which is consistent with what we've had for the full year.
Okay. It's not that kind of low to mid-30s. It's because FX is kind of skewing that number. Is that what you're saying, Ryan?
Yeah, some of the things that Josh talked about with respect to material obviously are hitting us. We've got the R&D step up that we talked about. The implied number is in the teens. If you adjust for FX, you get to the mid-20s, which is consistent with what we've been saying.
As Josh said, the pricing actions that we've announced and are in the marketplace should give us comfort, give everybody comfort that we feel good about going into next year's from an incremental margin perspective.
Okay. We'll follow up offline. Thanks, guys. Appreciate it.
Thanks. Next question.
Our next question comes from Ann Duignan with J.P. Morgan. Your line is open.
Hi. Good morning.
Morning.
I wanted to ask a question about your lower warranty costs in the quarter, and I would like you to square that with your discussion of your telematics and technology that's predictive maintenance and able to help farmers reduce their warranty costs. How do you square both of those with the fact that we're now in a replacement cycle where farmers are feeling the need to replace their equipment because they're afraid of having a high warranty cost, their equipment is coming out of warranty? Could you just square all those pieces together for us with the lower warranty, lower expense, lower accruals versus farmers replacing because their fear of a higher warranty cost? Thank you.
I think there's been a lot of focus on warranty and making sure we're continuing to get products to customers and they're having a good experience with us and we're reducing the cost of warranty. As you noted, rightly, reducing downtime, which is particularly concerning. As it relates to our offerings, I'll let John talk a little bit more about it, but certainly what we're doing on a predictive maintenance perspective does help in reducing warranty because you're taking care of issues before they pop up. I'll let John maybe expand a little bit on that.
Thanks for the question, Ann. If you take a look at the fact that we have 130,000 large ag, large production machines that are in the field today that we are connected to, and they are streaming data to us as they're in the field. We have the ability, based on the data we receive, and a set of advanced algorithms, to predict failures before they happen, communicate the potential of a failure to the customer and to the dealer. Within minutes, the dealer can be on the phone with the customer with a solution that's part of that Expert Alerts. Just to put it in perspective for you, if you look last year, we just launched the technology. We had machines streaming in over 11,000 alerts that they were predicting before a machine had actually failed.
That has a big impact on quality and a big impact on uptime for our customers.
Would that lengthen the life cycle of the equipment and lengthen the replacement cycle?
Yeah. Ann, we'll take that offline. Thank you. Next question.
Our next question comes from Joe O'Dea with Vertical Research Partners. Your line is open.
Hi, good morning. Just wanted to ask on the construction pricing side of things. It sounds like on ag and turf, the price increases we really won't see take effect until next year, which I think makes sense given a full order book for this year anyway. On construction, I think you were implementing some price increases middle of the year in response to some of the cost inflation. When do we start to see that flow through the P&L, just given the size of the order book and strength that you have on that side as well?
Thanks, Joe. That's a good question. I think on the construction side, we have continued to see a pretty competitive market. As you pointed out and we talked about last quarter, we were planning some price realization actions in the second half of the year. We actually put those into effect as a discount reduction. That took effect the 1st of July. We did see the benefit of that in July. Our expectation is we continue to see that benefit in the fourth quarter. As we start to think about model year 2019, we'll continue to look at, be market-based, what's going on, but also cognizant of the fact that you've got material prices and other things moving up.
Got it. Thank you.
Thanks. Next question.
Our next question comes from Stephen Volkmann with Jefferies. Your line is open.
Great. Thanks, guys. Good morning. I just had kind of a big picture question. I guess we can all sort of try to figure out the tariffs and all that other stuff. Given that we are sort of starting a replacement cycle here, would you expect absent things like tariffs and major changes in farm income, et cetera, do you think ag sales would be up more next year or sort of a similar amount or maybe less? I'm just trying to get a sense of what you think the replacement demand is.
Yeah, that's fair. I think what we're seeing is the replacement demand is continuing. I think over some of these months, we've seen some of the sentiment obviously be weighed upon with some of the trade concerns. Continuing to see that demand for equipment. Really, I think what's important is it's not just the new buyer looking for updated tech, the latest technology in productivity, but it's working down through that trade ladder. Whether it's the second, third, or fourth buyer, they're upgrading technology as well. I think that's really important in terms of what we're seeing. I think when you step back and look at the fundamentals, really from where we were a quarter ago, they haven't necessarily changed in terms of cash receipts are relatively flat to where we were. Demand for grains globally continues to grow and drive where we're at.
Hey, Stephen, this is Raj. Let me add a few more comments to what Josh said. The situation right now is dynamic for the farmers, and this can change. As we see it right now, the farm economic conditions for 2019, you think about the crop fundamentals have actually strengthened for several crops like corn, wheat, cotton, which outweigh the soy situation. As a result, we forecast total cash receipts, a leading indicator for our large ag sales, for 2019 to be higher than for 2018. That would say, absent all these other noises, that the demand will be up. Given the anticipated commodity prices and input costs, we would anticipate the net returns per acre for major crop farmers, large ag customers, to be higher in 2019 than 2018.
For an illustrative Midwestern farm, say half corn, half beans, half land rented, we see the economics as indicating net returns per acre to be stronger, perhaps some even up to 20% above this year. This would be the highest net returns per acre that farmers will have seen over the past five years or so. And on the cost side, you were to say remember some of this cost is too high if conditions were more at equilibrium. If something changes, there is an opportunity for the cost to come back down, and that can be beneficial. It may go up if new things show up. Overall, the point being made is that the farm economics picture for next year may actually be stronger than realized because of improving commodity market fundamentals worldwide with little change in farm costs.
Uncertainty surrounding the trade and market availability conditions may have distracted from the North American farm economics today. Thank you.
Okay, great. Can I get just a quick follow-up, Raj? Let's call it a 5 to 10-
We'll take it offline.
Yeah, we'll follow up offline, Steve. Thank you. Next question.
Our next question comes from Ross Gilardi with Bank of America. Your line is open.
Good morning, guys. I just wanted to ask a bit, how would these high take rates for some of these advanced features influence both revenue growth and drop-through margins? Could it actually add a couple of hundred basis points of growth in the next year? I would think the drop-through on some of these advanced features is a lot higher than it would be for the equipment itself. If you comment on that, and then just any thoughts on this $12 billion farmer subsidy, how it would work, and any sense of how much of that would potentially even go towards equipment?
Thanks, Ross. I think maybe starting with the latter on the $12 billion of farm aid. I think it's been viewed positively as a short-term solution but doesn't really address the bigger issue, which is getting a long-term resolution to some of the trade concerns. I think there is still a fair bit of uncertainty in terms of how that program will work. The three different components, you've got the market facilitation. That's the big piece expected to try to cover some of the impact of trade, particularly on soybeans which is, I think, assumed to be the vast majority of those dollars, and then the food purchase as well as trade promotion. I think there's still a lot of questions. My understanding is I think later into August, early September, there'll be much more clarity around how those programs come together and how those payments will transact.
I'd say right now, I don't know that those are necessarily being factored in due to the calculus for farmers today. As you think about your question on kind of the technology take rates and what does that mean to margins, I think, as we talked about, we're very encouraged by what we're seeing in terms of take rate growth. As we talked about 50% higher on ExactEmerge, ExactApply 10% higher. Some of those Combine Advisor ActiveYield were nearly double our expectations this past year. That adoption combined with the growth in engaged acres and some of these other pieces, I think are promising. As we think about margins, we've not dialed in exactly what this means from a margin perspective or carved that out. We do feel like it will contribute, is and will contribute to margin growth in the future.
Today, obviously, there's a lot of investment going along with a lot of these features, but we think there's economic value to be unlocked with our customers, and that we'll be able to share in that.
This is John May. The only thing I'd add is I think if you look at from a customer's perspective and you look at the fact that when they acquire these technologies, the payback from their perspective is less than a year. There's been some recent reports out there that would show that in some cases, the payback is within months, which generates strong productivity, strong profitability for our customers, which has a big benefit to our company.
A way to think about it is these are offerings that are margin improving for us and significantly margin improving for our customers.
Thanks very much.
We're at the top of the hour, we appreciate everyone's participation, and we will be available and do callbacks. We'll talk to everyone soon. Thank you very much. Have a good weekend.
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